QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
For
the quarterly period ended June 30, 2006
o
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
Commission
File Number: 000-26529
AUDIBLE,
INC.
(Exact
name of registrant as specified in its charter)
DELAWARE
(State
or other jurisdiction of
incorporation
or organization)
22-3407945
(I.R.S.
employer
identification
number)
65
WILLOWBROOK BLVD. WAYNE, NEW JERSEY
(Address
of principal executive offices)
07470
(Zip
Code)
(973)
837-2700
(Registrant's
telephone number, including area code)
None
(Former
name, former address and former fiscal year, if changed since last
report)
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days.
Yes
x No
o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of “accelerated and
large accelerated filer” in Rule 12b-2 of the Exchange Act.
oLarge
Accelerated Filer x
Accelerated Filer o
Non-accelerated filer
Indicate
by check mark whether the registrant is a shell company (as define in Rule
12b-2
of the Exchange Act).
Yes
o Nox
As
of
August 4, 2006, 24,390,193 shares of the registrant's common stock were
outstanding.
Accounts
receivable, net of provision for refunds and chargebacks of $31
at June
30, 2006 and December 31, 2005
1,930
2,337
Accounts
receivable, related parties
607
594
Royalty
advances
431
471
Prepaid
expenses and other current assets
1,696
899
Inventory
801
498
Total
current assets
66,501
72,392
Property
and equipment, net
10,001
8,159
Other
assets
935
114
Total
assets
$
77,437
$
80,665
LIABILITIES
AND STOCKHOLDERS' EQUITY
Current
liabilities:
Accounts
payable
$
2,698
$
4,750
Accrued
expenses
3,633
4,802
Accrued
royalties
5,111
5,104
Accrued
compensation
1,297
868
Deferred
revenue
9,639
6,459
Total
current liabilities
22,378
21,983
Deferred
revenue, noncurrent
271
99
Royalty
obligations, noncurrent
172
188
Commitments
and contingencies
Stockholders'
equity:
Common
stock, par value $.01. Authorized 40,000,000 shares at June 30,
2006 and
December 31, 2005; 24,390,193 and 24,326,503 shares issued and
outstanding
at June 30, 2006 and December 31, 2005, respectively
244
243
Additional
paid-in capital
190,324
192,547
Deferred
compensation
--
(3,696
)
Accumulated
other comprehensive (loss) income
(16
)
15
Accumulated
deficit
(135,936
)
(130,714
)
Total
stockholders' equity
54,616
58,395
Total
liabilities and stockholders' equity
$
77,437
$
80,665
See
accompanying notes to condensed consolidated financial statements.
(1)
Description of Business and Business Conditions
The
Business
Audible,
Inc. (together with its subsidiary, the “Company”), incorporated on November 3,
1995, was formed to create the Audible service, the Internet's leading
provider
of digital spoken entertainment information and educational programming
for
playback on personal computers and mobile devices. The Company commenced
commercial operations in October 1997.
For
the
three and six month periods ended June 30, 2006, the Company reported a
net loss
of $2,182 and $5,222, respectively, and has an accumulated deficit of $135,936
as of June 30, 2006. The Company's cash and cash equivalents balance as
of June
30, 2006 is $10,707. In addition, the Company has short-term investments
of
$49,834.
The
Company may, in the future, need to raise additional funds to finance its
continued growth. No assurance can be given that such additional financing,
if
needed, will be available on terms favorable to the Company or to its
stockholders, if at all.
(2)
Summary of Significant Accounting Policies
Basis
of Presentation
Commencing
in the first quarter of 2005, the Company began its international operations
in
the United Kingdom, as Audible Limited (“Audible UK”). Audible UK is a
wholly-owned subsidiary of Audible, Inc. and therefore its results of operations
are consolidated as of the end of each reporting period. All inter-company
transactions and balances have been eliminated.
The
accompanying condensed consolidated financial statements as of June 30,
2006 and
for the three and six month periods ended June 30, 2006 and 2005, are unaudited
and, in the opinion of management, include all adjustments (consisting
of normal
recurring adjustments and accruals) necessary to present fairly the results
for
the periods presented in accordance with U.S. generally accepted accounting
principles. Operating results for the three and six month periods ended
June 30,
2006 are not necessarily indicative of the results that may be expected
for the
year ending December 31, 2006. These condensed consolidated financial statements
should be read in conjunction with the audited consolidated financial statements
and notes thereto for the year ended December 31, 2005, from the Company's
Annual Report on Form 10-K.
Cash
and Cash Equivalents
The
Company considers short-term, highly liquid investments with original maturities
of three months or less at the time of purchase to be cash equivalents.
Cash
equivalents consist primarily of money market funds and notes due from
governmental agencies. Cash consists of funds held in the Company's checking
account.
Restricted
Cash
During
the third quarter of 2005, the Company deposited a $25 retainer in an
interest-bearing account, which is included in Other Assets on the accompanying
condensed consolidated Balance Sheets.
-6-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Investments
purchased with a maturity of more than three months, and less than twelve
months, are classified as short-term investments. The Company's short-term
investments, as of June 30, 2006 and December 31, 2005, of $49,834 and
$55,616,
respectively, consisted of governmental agency notes and mortgage-backed
securities that are to be held to maturity because the Company has the
positive
intent and ability to hold these securities to maturity. Held to maturity
securities are stated at amortized cost, adjusted for amortization of premiums
and accretion of discounts to maturity. Dividend and interest income are
recognized when earned. Premiums and discounts are amortized or accreted
over
the life of the related held-to-maturity security as an adjustment to yield
using the effective interest method. A decline in the market value of
held-to-maturity security below that is deemed to be other-than-temporary
results in a reduction in carrying amount to fair value. The impairment
is
charged to operations and a new cost basis for the security is established.
To
determine whether an impairment is other-than-temporary, the Company considers
whether it has the ability and intends to hold the investment until a market
price recovery and considers whether evidence indicating the cost of the
investment is recoverable outweighs evidence to the contrary. Evidence
considered in this assessment includes the reasons for the impairment,
the
severity and duration of the impairment, changes in the value subsequent
to
period end, and forecasted performance of the investee.
The
amortized cost, gross unrealized holding losses and the fair value of
held-to-maturity debt securities at June 30, 2006 was $49,834, $36 and
$49,798,
respectively.
All
of
the debt securities classified as held-to-maturity mature before June
30, 2007.
Provision
for Refunds and Chargebacks
The
provision for refunds and chargebacks is recorded as a reduction of revenue
and
is estimated based on a percentage of revenue, taking into account historical
experience. A portion of the provision is recorded as a reduction of accounts
receivable based on an estimate of refunds that will be made related to
sales
that were unpaid at period-end. The remaining portion of the provision
is
reflected as an accrued liability at period-end. Actual refunds and chargebacks
could differ from the Company’s estimate.
The
amount of the provision that was recorded as a reduction of accounts receivable
as of June 30, 2006 and December 31, 2005 was $31. The amount of the provision
reflected in the accrued liability was $99 and $287 at June 30, 2006 and
December 31, 2005, respectively.
Inventory
Inventory
is stated at the lower of cost or market using the first-in, first-out
method.
Inventory consists of digital audio players manufactured by third
parties.
Audio
Production Costs
The
Company capitalizes audio production costs incurred in connection with
the
creation of the master copy of an audio title, which includes talent, editorial
and other costs. These costs are included as a non-current asset on the
condensed consolidated Balance Sheets presented. These costs are stated
at the
lower of cost, less accumulated amortization, or fair value. These production
costs are amortized beginning in the month the title is released, on a
straight-line basis over a two year period, and are recognized as cost
of
content revenue in the condensed consolidated Statement of Operations.
The
remaining unamortized balance is periodically reviewed, and adjusted if
necessary, to reflect the net realizable value.
-7-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Property
and equipment, which includes computer server and Web site equipment, office
furniture and equipment, leasehold improvements, internally developed software,
studio equipment, and software licenses, are stated at cost. Property and
equipment under capital leases are stated at the present value of minimum
lease
payments. Depreciation is calculated using the straight-line method over
the
estimated useful lives of the respective assets, which is three years for
computer server, Web site equipment, and software licenses, and two years
for
internally developed software, and studio equipment. Property and equipment
held
under capital leases are amortized on a straight-line basis over the estimated
useful life of the asset. In June 2006, the Company reassessed the estimated
useful lives of office furniture and equipment and leasehold improvements.
Prior
to June 2006, office furniture and equipment was depreciated using the
straight
line method over a two year period and leasehold improvements were amortized
on
a straight-line basis over the lease term or the estimated useful life
of the
asset, whichever was shorter. In June 2006, the Company changed the estimated
useful life of these assets to seven months. The change in estimate does
not
have a significant impact on the Company’s financial statements, nor is it
expected to have a significant impact on future periods. The amortization
is
included within depreciation expense in the condensed consolidated Statements
of
Cash Flows.
Work
in
process primarily consists of expenditures for the development of various
computer software projects incurred subsequent to the completion of the
preliminary project stage, as well as a software license not yet put into
use.
In accordance with SOP 98-1,
Accounting for Costs of Computer Software Developed or Obtained for Internal
Use,
the
Company has capitalized external direct costs of material and services
developed
or obtained for these projects and certain payroll and payroll related
expenses
for employees directly associated with these projects. Amortization for
each
software project begins when the computer software is ready for its intended
use.
Impairment
of Long-Lived Assets
The
Company reviews its long-lived assets for impairment when events or
circumstances indicate that the carrying amount of an asset may not be
recoverable. If the sum of the expected cash flows, undiscounted and without
interest, is less than the carrying amount of the related asset, an impairment
loss is recognized as the amount by which the carrying amount of the asset
exceeds its fair value, generally based on discounted cash flow.
Royalty
Advances and Royalty Obligations
Royalty
advances represent payments made and payments to be made to various content
providers pursuant to minimum guarantees under their royalty agreements,
net of
royalties expensed. The corresponding royalty obligations represent payments
to
be made to the content providers for audio content delivered pursuant to
minimum
guarantees under their royalty agreements. These agreements give the Company
the
right to sell digital audio content over the Internet. The royalty obligations
recorded in the accompanying condensed consolidated Balance Sheets are
classified between current (included in accrued expenses) and non-current
based
on the payment terms specified in the agreements. The Company periodically
adjusts the balance of these advances to reflect their estimated net realizable
value based on the difference, if any, between the carrying amount of the
asset
and the discounted future revenue stream. Royalty expense is included in
cost of
content and services revenue in the accompanying condensed consolidated
Statements of Operations.
Fair
Value of Financial Instruments
Financial
instruments that potentially subject the Company to significant concentrations
of credit risk consist of cash and cash equivalents, short-term investments,
accounts receivable, accounts receivable from related parties, accounts
payable
and accrued expenses. At June 30, 2006 and December 31, 2005, the fair
values of
these financial instruments approximated their carrying values due to the
short-term nature of these instruments.
-8-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In
accordance with the provision of Statement of Financial Accounting Standard
(“SFAS”) No. 52,
Foreign Currency Translation,Audible
UK, whose functional currency is the British Pound, translates its balance
sheet
into U.S. dollars at the prevailing rate at the balance sheet date and
translates its revenues, costs and expenses at the average rates prevailing
during each reporting period. Net gains or losses resulting from the translation
of Audible UK's financial statements are accumulated and charged directly
to
accumulated other comprehensive (loss) income, a component of stockholders'
equity.
Since
the
inception of Audible UK operations, Audible Inc. has made periodic cash
fundings
to Audible UK to assist with the cash flow needs of the start up subsidiary.
Audible Inc. expects these periodic fundings to continue into the foreseeable
future. In addition to cash fundings, Audible, Inc. has paid certain expenses
on
behalf of the subsidiary, such as a security deposit on office space and
payroll
of U.S. employees working on the UK business. All of these fundings were
made
with the intention of treating them as a long-term investment. In accordance
with the provisions of SFAS No. 52, the foreign currency gain/loss at each
reporting period resulting from the inter-company account is recorded to
accumulated other comprehensive (loss) income.
Reclassifications
Certain
prior period amounts have been reclassified to conform to current period
presentation.
Revenue
Recognition
Content
and Services
Consumer
content revenue consists primarily of content sales made from the Company's
Web
sites and content sold through its agreement with the Apple iTunes Music
Store.
At the Company's Web site, customers purchase content either through an
AudibleListener membership plan or on an a la carte basis. When purchased
on an
a la carte basis, the Company recognizes revenue from the sale of individual
content titles in the period when the content is purchased and delivered.
The
Company generally recognizes revenue from the sale of a la carte content
subscriptions pro rata over the term of the subscription period.
The
“legacy” AudibleListener monthly membership plans generally provide customers
two audio credits for a fixed monthly fee. Customers may use these audio
credits
to download audio of their choice from the Web site. “Legacy” AudibleListener
audio credits provided under a monthly membership plan have a life of 30
days,
after which they expire. The Company recognizes revenue from the sale of
legacy
AudibleListener memberships ratably over the AudibleListener's monthly
membership period, which is 30 days. This results in approximately 50%
of the
AudibleListener membership fees received during each calendar month being
deferred at month end and recognized as content revenue in the following
month.
In
December 2005, the Company introduced new AudibleListener membership plans,
designed to provide customers more flexibility in using their audio credits.
Depending upon the AudibleListener membership plan, customers receive and
can
“bank” or delay using a maximum number of audio credits, depending on the
membership plan. The banking feature will result in audio credits being
used
(delivered) over different periods for different customers. This may result
in
slower revenue growth than the Company experienced in prior periods because
the
customer has a longer period of time to use their audio credits. In addition,
some of the new AudibleListener plans include new membership benefits,
ranging
from a complimentary daily newspaper to everyday discounts of 30% on a
la carte
purchases. The daily newspaper and 30% discount benefits are “serial” elements
that are delivered continuously over the membership period, whereas the
content
selections underlying the audio credits are discrete elements that are
delivered
at different times based on individual customer behavior. As a result of
the
characteristics of the new AudibleListener memberships, they are considered
revenue arrangements with multiple deliverables; however under EITF
00-21,
Revenue Arrangements with Multiple Deliverables,
because
the deliverables are not eligible for separation, they are accounted for
as a
single unit of accounting. As a result, revenue is recognized for these
new
AudibleListener membership plans using the lesser of straight-line or
proportional performance (based on content delivery) over the maximum membership
period.
Upon
launch of the new AudibleListener plans in December 2005, the legacy
AudibleListener plans were no longer available to new customers. Customers
who
have legacy memberships have the option of either converting to one of
the new
AudibleListener membership plans or continuing their legacy membership.
Revenue
is recognized from the sale of UltimateListener, the prepaid discounted
content
package, in which the customer receives twelve audio credits, and gift
programs,
when the content is downloaded, over the membership period or subscription
period, as applicable.
-9-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Point
of Sale Rebates and Discount Certificate Rebates
Part
of
the Company's marketing strategy to obtain new AudibleListeners includes
retail
promotions in which the Company pays retailers to offer discounts to consumers
on their purchase of AudibleReady devices if they become AudibleListeners
for
twelve months. The Company also has retail promotions in which it purchases
electronic discount certificates or gift cards from retailers and gives
them
away to the Company's customers when they sign up to be AudibleListeners
for
twelve months. Point of sale rebates, which are discounts given by a third
party
retailer to a customer on the purchase of a digital audio player at the
point of
sale of the Audible membership, are recorded as a reduction of revenue
in the
period the discount is given in accordance with Emerging Issues Task Force,
or
EITF, Issue No. 01-9,
Accounting for Consideration Given by a Vendor to a Customer (Including
a
Reseller of the Vendor's Products),
or EITF
01-9. The cost of discount certificate rebates and gift cards that are
given to
a customer by Audible at the time the customer purchases the Audible membership
are recorded as a cost of content and services revenue in accordance with
EITF
01-9.
Services
Revenue
Corporate
services revenue consists of library sales and audio production services.
Where
applicable, the Company recognizes corporate service revenue as services
are
performed after persuasive evidence of an agreement exists, the price is
fixed,
and collectibility is reasonably assured. Collectibility is based on past
transaction history and credit-worthiness of the customer.
Hardware
Revenue
Hardware
revenue consists of sales of AudibleReady digital audio players. Most of
the
Company's AudibleReady digital audio devices are sold at a discount or
given
away when a customer signs up for a three or six-month or one-year commitment
to
an AudibleListener membership. For multiple-element arrangements in which
a
customer signs up for a membership and receives an audio player for free,
revenue is first allocated to the two elements (device and membership)
using the
relative fair value method under EITF Issue No. 00-21. However, the delivered
item (hardware) is limited to the non-contingent consideration, which,
for a
free device, consists of only shipping and handling fees. The free hardware
device reflects the subsidy incurred to acquire a customer with a commitment
to
AudibleListener. For players sold separately, hardware revenue is recognized
upon shipment of the device, pursuant to a customer order and credit card
authorization and includes amounts received for shipping and
handling.
-10-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Related
party revenue consists of revenue earned under agreements with Audible
Germany
(see Note 7) and France Loisirs (see Note 8). Revenue under the Audible
Germany
agreement includes $30 earned per month over the initial 30-month term
of the
agreement, which began on August 30, 2004. The Company recognizes $30 per
month
only after Audible Germany has agreed that the services delivered for the
prior
60-day period were satisfactory and collection of the amount is reasonably
assured. Revenue under the France Loisirs agreement includes a $1,000 technology
licensing fee that is being recognized on a straight-line basis over the
initial
24-month term of the agreement, which began on September 15, 2004. Of the
$1,000, France Loisirs has paid $875 as of June 30, 2006; in addition,
$21 has
been recorded as a related party accounts receivable as of June 30, 2006.
Revenue earned under each of these agreements also includes consulting
services
performed by certain of the Company's employees and reimbursement of certain
incremental costs incurred by the Company that are billed to Audible Germany
and
France Loisirs in accordance with EITF Issue 01-14,
Income Statement Characterization of Reimbursement Received for ‘Out-of-Pocket’
Expenses Incurred.
Other
Revenue
Other
revenue for the three and six month periods ended June 30, 2006 primarily
included revenue from fees earned under a product development and distribution
agreement, which is being amortized on a straight-line basis over a 58
month
period. Other revenue for the three and six month periods ended June 30,
2005
primarily consisted of revenue from commissions earned by the Company for
referring customers to a retail partner to purchase a digital audio device,
which is recognized in the period when the purchase is completed.
Customer
Concessions
The
Company defers revenue for expected replacement audio credits based on
a
historical experience of the credits issued. The Company defers revenue
for
other audio credits and coupons when they are delivered to the customers
based
on estimated values. Actual customer credit and coupon issuance and usage
patterns could differ from the Company's estimates. The concessions are
recorded
as a reduction of revenue and an increase to deferred revenue.
Shipping
and Handling Costs
Shipping
and handling costs, which consist of costs and fees associated with warehousing,
fulfillment, and shipment of digital audio devices to customers, are recorded
as
a component of marketing expense in the condensed consolidated Statements
of
Operations. These costs totaled $40 and $75, for the three month periods
ended
June 30, 2006 and 2005, respectively, and $120 and $162 for the six month
periods ended June 30, 2006 and 2005, respectively.
Cost
of Content and Services Revenue
Cost
of
content and services revenue includes royalties incurred on sales of content
as
specified by the terms of the content agreements, periodic net realizable
value
adjustments to royalty advances, discount certificate rebates, production
costs
incurred in connection with creation of certain audio products, and other
non-recoupable content costs. Royalty expense for sales of content is incurred
based on either a percentage of revenue or a fixed price per title as per
the
royalty agreement. In certain cases, the royalty cost per title may differ
depending upon whether the title is sold as part of the AudibleListener
membership or sold as an a la carte sale.
-11-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The
Company expenses the costs of advertising and promoting its products and
services as incurred. These costs are included in marketing expense in
the
accompanying condensed consolidated Statements of Operations and totaled
$1,272
and $809 for the three month periods ended June 30, 2006 and 2005, respectively,
and $3,103 and $1,401 for the six month periods ended June 30, 2006 and
2005,
respectively.
Legal
Fees
The
Company expenses legal fees, including those expenses expected to be incurred
in
connection with loss contingencies, as incurred.
Use
of Estimates
The
preparation of financial statements in conformity with U.S. generally accepted
accounting principles requires management to make estimates and assumptions
that
affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of the financial statements, and reported
amounts of revenues and expenses during the period. Significant items subject
to
estimates include the recoverability of the carrying amount of property
and
equipment (including internally developed software), the provision for
refunds
and chargebacks, customer concessions, recoverability of royalty advances,
valuation of deferred tax assets, certain accruals and fair value of share-based
compensation. Actual results could differ from those estimates.
Income
Taxes
The
Company accounts for income taxes using the asset and liability method
of SFAS
No. 109,
Accounting for Income Taxes.
Under
the asset and liability method, deferred tax assets and deferred tax liabilities
are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax basis and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect
on
deferred tax assets and liabilities of a change in tax rates is recognized
in
results of operations in the period in which the tax change occurs. Deferred
tax
assets are reduced, if necessary, by a valuation allowance for any tax
benefits,
which are more likely than not, not going to be realized.
Equity
Instruments Issued for Goods and Services
The
Company issues warrants to purchase shares of common stock to non-employees
as
part of their compensation for providing goods and services. The Company
accounts for these warrants in accordance with the EITF Issue No.
96-18,
Accounting for Equity Instruments that are Issued to Other than Employees
for
Acquiring, or in Conjunction with Selling, Goods or Services.
The
exercise price of the warrants is determined by the closing price of Audible's
common stock on the day of the agreement. Fair value of the warrant issued
is
estimated using the Black-Scholes model with the best available assumptions
concerning risk-free interest rate, expected term of the warrant, dividend
yield
and expected volatility. The fair value of the warrant is expensed on a
straight-line basis over the term of the agreement and is recorded within
the
operating expense line item that best represents the nature of the goods
and
services provided. Depending on the terms of the warrant, the Company applies
variable plan or fixed plan accounting in accordance with EITF No.
96-18.
-12-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Basic
net
(loss) income per share is computed by dividing net (loss) income by the
weighted average number of common shares outstanding for the period. Diluted
net
(loss) income per share reflects the potential dilution that could occur
if
securities or other contracts to issue common stock were exercised or converted
into common stock and resulted in the issuance of common stock. Potential
common
shares consist primarily of incremental shares issuable upon the assumed
exercise of stock options, warrants and restricted stock units using the
treasury stock method.
For
the
three and six month periods ended June 30, 2006 diluted net loss per share
is
equal to basic net loss per share, since all potential common stock was
anti-dilutive. For the three and six month periods ended June 30, 2005,
diluted
net income per share is computed by dividing net income by the diluted
weighted
average common shares outstanding.
The
reconciliation of weighted average basic common shares outstanding to weighted
average diluted common shares outstanding is as follows:
Three
months ended
June
30,
Six
months ended
June
30,
2006
2005
2006
2005
Basic
weighted average common shares outstanding
24,501,629
24,169,396
24,491,745
24,089,237
Effect
of dilutive potential common shares:
Stock
options
--
1,600,944
--
1,698,009
Warrants
--
210,549
--
260,945
Restricted
stock
--
6,111
--
3,913
Diluted
weighted average common shares outstanding
24,501,629
25,987,000
24,491,745
26,052,104
For
the
three and six month periods ended June 30, 2006, all potential common shares
have been excluded from the diluted calculation because the Company was
in a net
loss position, and their inclusion would have been anti-dilutive. For the
three
and six month periods ended June 30, 2005, warrants and stock options with
exercise prices greater than the average market price of the common stock
in the
period were excluded from the diluted calculation as their inclusion would
have
been anti-dilutive.
The
following table summarizes the potential common shares excluded from the
diluted
calculation:
Three
months ended
June
30,
Six
months ended
June
30,
2006
2005
2006
2005
Stock
options
2,412,730
553,092
2,412,730
455,518
Warrants
716,723
627,110
716,723
528,822
Restricted
Stock
882,157
--
882,157
--
-13-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The
Company's 1999 Stock Incentive Plan (the “Plan”) permits the granting of stock
options, stock appreciation rights, restricted or unrestricted stock awards,
performance rights and other stock-based awards to employees. For options
granted to new Audible employees as part of their compensation package,
the
exercise price is determined by the closing price of Audible's common stock
on
the day immediately preceding each employee's start date. For the majority
of
additional option grants made to existing employees, the exercise price
is
determined based on the closing price of the day immediately preceding
the grant
date. The majority of the options granted vest over a fifty-month period
and
expire ten years from the date of the grant. All stock-based compensation
is
granted through share-based employee compensation plans maintained by Audible.
The
number of authorized common shares available for issuance under the Plan
is
5,700,000 shares. As of June 30, 2006 and December 31, 2005, options to
purchase
2,412,730 and 2,629,809, respectively, shares of common stock were outstanding.
As of June 30, 2006 and December 31, 2005, 882,157 and 261,557, respectively,
of
restricted share awards had been granted, net of forfeitures.
Effective
January 1, 2006, the Company adopted SFAS No. 123 (revised), “Share-Based
Payment”
(“SFAS
123R") utilizing the modified prospective approach. Prior to the adoption
of
SFAS 123R, stock option grants were accounted for in accordance with the
intrinsic value method prescribed in Accounting Principles Board Opinion
No. 25,
"Accounting
for Stock Issued to Employees"
("APB
25") and accordingly, no compensation expense was recognized for these
awards
except for awards that had intrinsic value on the grant date. Restricted
stock
was also accounted for under APB 25 and compensation expense was recognized
for
restricted stock awards based on intrinsic value (which was equal to fair
value).
Under
the
modified prospective approach, SFAS 123R applies to all new awards and
to
previously issued awards that were unvested on January 1, 2006, and awards
that
are modified, repurchased or cancelled after January 1, 2006. Compensation
expense recognized for the first and second quarters of 2006 includes
compensation cost for all share-based payments granted prior to, but not
yet
vested as of January 1, 2006, based on the grant-date fair value estimated
in
accordance with the original provisions of SFAS 123, and compensation expense
for all share-based payments granted subsequent to January 1, 2006, based
on the
grant-date fair value estimated in accordance with the provisions of SFAS
123R.
Prior periods were not restated to reflect the impact of adopting the new
standard. Total compensation expense for share-based payment arrangements
recognized for the three month periods ended June 30, 2006 and 2005 was
$1,563
and $135, respectively, and $2,657 and $172 for the six month periods ended
June
30, 2006 and 2005, respectively. At June 30, 2006, Audible had $13,423
of
unrecognized compensation expense related to share-based payments which
is
expected to be recognized over a weighted-average period of 2.50 years.
No
compensation cost was capitalized in any asset for the three or six month
periods ended June 30, 2006.
The
unearned share-based compensation related to stock options and restricted
stock
awards is being amortized to compensation expense over the requisite service
period. The Plan does not make a separate reference to provisions regarding
participant retirement and the vesting terms in stock options and restricted
stock awards relating to participants eligible for retirement; therefore,
in
accordance with the provisions of SFAS 123R, compensation expense, for
stock
options and restricted stock awards to participants that are retirement
eligible
on the grant date, is amortized to compensation expense over the requisite
service period, rather than immediately at the grant date.
The
Company receives a tax deduction for certain stock option exercises, generally
for the intrinsic value of the award on the exercise date and a tax deduction
for increases in the value of restricted stock upon vesting. Prior to the
adoption of SFAS 123R, all tax benefits resulting from the exercise of
stock
options and restricted stock were reported as operating cash flows in the
condensed consolidated Statements of Cash Flows. SFAS 123R requires the
cash
flows resulting from tax benefits in excess of the compensation costs recognized
for these options (excess tax benefits) to be classified as financing cash
flows. Further, under SFAS 123R, excess tax benefits are recognized as
a credit
to additional paid-in capital only in the period in which the deduction
reduces
income taxes payable. Since the Company currently has significant net operating
loss ("NOL") carryforwards that are fully reserved through the valuation
allowance, any excess tax benefits related to the exercise of stock options
will
not be recorded until after the Company utilizes its NOL carryforwards to
reduce current income taxes payable. For the six month periods ended June
30, 2006 and 2005, there was none and $147, respectively, excess tax benefit
recognized resulting from share-based compensation. The Company’s net cash
proceeds from the exercise of stock options was $354 and $590 for the six
month
periods ended June 30, 2006 and 2005, respectively.
-14-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
All
stock
incentives (options and restricted stock) issued to employees and non-employee
directors are awarded according to the applicable plan terms. The source
of
shares for exercised stock options and delivery of vested restricted stock
are
newly issued shares.
As
a
result of adopting SFAS 123R on January 1, 2006, the Company’s loss from
operations, loss before income taxes, and net loss for the three and six
month
periods ended June 30, 2006 is $640 and $1,313 higher than if it had continued
to account for share-based compensation under APB Opinion No. 25. Basic
and
diluted net loss per common share for the three and six month periods ended
June
30, 2006 was $0.03 and $0.05 higher than if the Company had continued
to account for share-based compensation under APB opinion No. 25.
On
November 10, 2005, the FASB issued FASB Staff Position 123(R)-3 (“FSP 123R-3”),
“Transition
Election Related to Accounting For the Tax Effects of Share-Based Payment
Awards”,
that
provides an elective alternative transition method of calculating the pool
of
excess tax benefits available to absorb tax deficiencies recognized subsequent
to the adoption of SFAS 123R (the “APIC Pool”) to the method otherwise required
by paragraph 81 of SFAS 123R. The Company may take up to one year from
the
effective date of this FSP to evaluate its available alternatives and make
its
one-time election. The Company is currently evaluating the alternative
methods,
however neither alternative would have an impact on the Company’s results of
operations or financial condition for the three or six month periods ended
June
30, 2006, due to the fact that the Company currently has net operating
loss
carryforwards and has not realized any tax benefits under SFAS 123R. Until
and
unless the Company elects the transition method described in this FSP,
the
Company will follow the transition method described in paragraph 81 of
SFAS
123R.
The
following table illustrates the effect on the Company’s net income and net
income per common share had the Company accounted for share-based compensation
in accordance with SFAS 123 for the three and six month periods ended June
30,
2005:
Three
months ended
Six
months ended
June
30, 2005
June
30, 2005
Net
income, as reported
$
823
$
1,713
Add:
Total share-based employee compensation expense included in reported
net
income
135
172
Deduct:
Total share-based employee compensation expense determined under
the fair
value method for all awards
(741
)
(1,273
)
Pro
forma net income
$
217
$
612
Basic
net income per common share:
As
reported
$
0.03
$
0.07
Pro
Forma
$
0.01
$
0.03
Diluted
net income per common share:
As
reported
$
0.03
$
0.07
Pro
forma
$
0.01
$
0.02
The
Company has on occasion issued options to employees to purchase shares
of common
stock at a price less than the fair value of the stock at the time of issuance.
Prior to the adoption of SFAS 123R, the difference between the fair value
on
grant date and the exercise price of options issued, as well as the value
of
restricted stock on the grant date, was accounted under APB 25 and was
recorded
as deferred compensation, a component of stockholders' equity, and was
amortized
as compensation expense on a straight-line basis over the vesting term
of the
option or restricted stock, as applicable. In connection with the adoption
of
SFAS 123R, the unamortized deferred compensation balance of $3,696 at December
31, 2005 relating to previous grants of options that had intrinsic value
at the
time of issuance and restricted stock was eliminated against additional
paid-in
capital on January 1, 2006.
-15-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The
Company uses the Black-Scholes option pricing model to estimate the fair
value
of stock options with the following weighted-average assumptions for the
indicated periods:
Three
months ended
Six
months ended
June
30,
June
30,
2006
2005
2006
2005
Dividend
yield
--
--
--
--
Expected
volatility
76.6
%
116.3
%
76.6
%
118.8
%
Risk-free
interest rate
4.50
%
3.70
%
4.50
%
3.70
%
Expected
life of option (years)
4.63
5.00
4.63
5.00
The
assumptions above are based on multiple factors, including historical exercise
patterns of employees in relatively homogeneous groups with respect to
exercise
and post-vesting employment termination behaviors, expected future exercising
patterns for these same homogeneous groups and both the implied and historical
volatility of the Company’s stock price. The expected life of the option
represents the period of time that the option granted is expected to be
outstanding. Expected volatility is calculated based on the historical
and
implied volatility of the Company’s stock price. The risk free interest rate is
based on the U.S. Treasury yield curve commensurate with the expected term
in
effect at the time of grant. For the three months ended June 30, 2006,
the
Company did not grant any stock option awards, and therefore there was
no
re-measurement done for the assumptions used.
The
following table represents stock option activity for the six month period
ended
June 30, 2006:
Stock
Options
Number
of Shares
Weighted-Average
Exercise Price Per Share
Aggregate
Intrinsic Value
Weighted-Average
Remaining Contractual Life
Balance,
December 31, 2005
2,629,809
$
8.13
6.98
Years
Granted
13,100
$
10.85
Exercised
(133,524
)
$
2.66
Forfeited
(80,367
)
$
12.87
Expired
(16,288
)
$
13.23
Balance,
June 30, 2006
2,412,730
$
8.26
$
9,897
6.35
Years
Options
exercisable at June 30, 2006
1,774,733
$
8.19
$
7,720
5.79
Years
Vested
and expected to vest at June 30, 2006
2,359,969
$
8.24
$
9,747
6.31
Years
The
following table summarizes stock option activity for the six month periods
ended
June 30:
Stock
Options
2006
2005
Weighted-average
grant date fair value of options granted
$
6.86
$
13.63
Total
fair value of options that vested during the period
$
1,335
$
954
Total
intrinsic value of options exercised during the period
$
1,000
$
2,986
-16-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
During
the three month periods ended June 30, 2006 and 2005, the Company granted
awards
to receive 649,000 and 118,500 restricted stock units, respectively, to
employees under the Plan. During the six month periods ended June 30, 2006
and
2005, the Company granted awards to receive 661,400 and 146,500 units of
restricted stock, respectively, to employees under the Plan. The restricted
shares either cliff-vest or vest periodically between three months to
forty-eight months after the grant date. During the three month periods
ended
June 30, 2006 and 2005, 37,300 and no units of restricted stock were forfeited
due to employee termination. During the six month periods ended June 30,
2006
and 2005, 40,800 and no units of restricted stock were forfeited due to
employee
termination. The fair value of restricted stock on the grant date is determined
by the closing price of Audible's stock on the day immediately preceding
the
grant date. Actual shares under these awards are not issued until vesting
is
complete. Under the terms of the restricted stock awards, unless different
provisions are noted on the restricted stock award, the Company is required
to
issue to the recipient the number of whole shares of common stock that
equals
the number of vested whole restricted stock shares following the date on
which
the restricted stock share becomes vested.
The
following table summarizes nonvested restricted stock activity for the
six month
period ended June 30, 2006:
Weighted-Average
Grant-Date
Nonvested
Restricted Stock
Units
Fair
Value
Nonvested
at December 31, 2005
258,083
$
16.23
Granted
661,400
$
10.45
Vested
(3,333
)
$
12.82
Forfeited
(40,800
)
$
11.46
Nonvested
at June 30, 2006
875,350
$
12.09
The
following table summarizes restricted stock activity for the six month
periods
ended June 30:
Restricted
Stock
2006
2005
Weighted-average
grant date fair value of shares granted
$
10.45
$
16.87
Total
fair value of shares that vested during the period
$
43
$
30
Total
stock available for future stock option and restricted stock grants is
approximately 977,000.
-17-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Property
and equipment at June 30, 2006 and December 31, 2005 consists of the
following:
June
30,
2006
December
31, 2005
Computer
server and Web site equipment
8,897
6,599
Software
licenses
4,235
745
Internally
developed software
2,538
1,357
Office
furniture and equipment
1,633
1,558
Leasehold
improvements
1,006
975
Studio
equipment
$
660
$
652
Work
in process
427
3,283
Total
property and equipment
19,396
15,169
Less:
accumulated depreciation and amortization
(9,395
)
(7,010
)
Total
property and equipment, net
$
10,001
$
8,159
Depreciation
and amortization expense on property and equipment totaled $1,263 and $238
during the three month periods ended June 30, 2006 and 2005, respectively,
and
$2,385 and $377, during the six month periods ended June 30, 2006 and 2005,
respectively.
The
gross
amount of property and equipment and related accumulated amortization recorded
under capital leases were as follows:
June
30,
2006
December
31, 2005
Computer
server and Web site equipment
$
743
$
743
Less:
accumulated amortization
(561
)
(437
)
Total
computer server and Web site equipment, net
$
182
$
306
(4)Accrued
Expenses
The
components of the accrued expenses balance are as follows:
June
30,
2006
December
31, 2005
Professional
fees
$
725
$
1,084
Revenue
sharing and bounty payments
708
774
Retail
rebates and discounts
658
578
Refunds
and chargebacks
99
287
Marketing
129
468
Accrued
expense - related parties
399
333
Royalty
obligations
275
293
Other
accrued expenses
640
985
Total
accrued expenses
$
3,633
$
4,802
-18-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
As
of
June 30, 2006 and December 31, 2005, the Company had issued 24,390,193
and
24,326,503 respectively, shares of common stock. As of June 30, 2006 and
December 31, 2005, the Company had 4,011,610 and 3,774,755, respectively,
shares
of common stock reserved for common stock warrants, options and restricted
stock.
Warrants
The
Company issues common stock warrants to third parties in exchange for services.
The fair values of warrants issued in exchange for services are determined
by
the Black-Scholes model, in accordance with EITF Issue No. 96-18 and are
recognized as an expense under fixed plan or variable accounting depending
on
the terms of the agreements over the periods in which services are being
performed. The assumptions used in the Black-Scholes pricing model to calculate
fair values, including risk-free interest rate and volatility, are determined
using available information on the measurement date. Expected dividend
yield of
zero is used for all calculations. There were no warrants issued in the
2006 or
2005 periods. All warrants previously issued were fully vested as of December
31, 2004. Accordingly, there was no expense related to warrants recognized
during the six month periods ended June 30, 2006 or 2005.
Common
Stock Repurchase Program and Treasury Stock
In
February 2006, the Company's Board of Directors authorized a new common
stock
repurchase program, pursuant to which the Company may from time to time
repurchase (through open market repurchases at prevailing market prices),
up to
an aggregate of $25,000 of the Company's outstanding common stock. During
the
six month period ended June 30, 2006, 236,500 shares were repurchased at
an
average price of $9.67. The Company subsequently legally retired the treasury
stock. At the February 8, 2005 Board of Directors meeting, the Board voted
that
all 229,741 shares of common stock held as treasury shares by the Company
at
that time were to be retired, and the Company subsequently legally retired
the
treasury stock. As of June 30, 2006 and December 31, 2005, the Company
held no
shares of common stock as treasury stock.
Comprehensive
(Loss) Income
The
following table sets forth comprehensive (loss) income for the periods
indicated:
Three
months ended June 30,
Six
months ended
June
30,
2006
2005
2006
2005
Net
(loss) income
$
(2,182
)
$
823
$
(5,222
)
$
1,713
Other
comprehensive (loss) income:
Foreign
currency translation adjustment
(26
)
17
(31
)
18
Comprehensive
(loss) income
$
(2,208
)
$
840
$
(5,253
)
$
1,731
(6)
Audible UK
In
February 2005, the Company launched Audible UK, a spoken audio Web site
service
mirroring the audible.com service, but focused on the UK marketplace. Audible,
Inc. purchased one share of Audible UK stock on February 7, 2005, which
at that
date became a wholly-owned subsidiary of Audible Inc. Audible UK began
commercial operations in June 2005.
-20-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
On
August
30, 2004, the Company, Verlagsgruppe Random House GmbH (“Random House”) and
Holtzbrinck Networxs AG (“Holtzbrinck”) entered into a joint venture agreement
(the “Joint Venture”) to form Audible GmbH (“Audible Germany”). Random House is
an affiliate of Bertelsmann AG. Bertelsmann AG and its affiliates own
approximately 5.6% of Audible's common stock, inclusive of certain common
stock
warrants held by the entities.
Audible
Germany has the exclusive rights to operate a German language Audible Web
site.
Under the Joint Venture, Random House and Holtzbrinck each contributed
approximately $17 in exchange for each receiving a 24.5% interest in Audible
Germany. The Company was required to contribute $34 in exchange for a 51%
interest in Audible Germany. After the initial formation, Random House
and
Holtzbrinck were to provide additional financing of approximately $1,490
each in
certain installments, subject to Audible Germany meeting certain milestones.
The
full amount has been funded by Random House and Holtzbrinck. In the event
of
liquidation of Audible Germany, this additional financing by Random House
and
Holtzbrinck accrues interest at 8% per annum and is senior to Audible's
capital
investment. The Company may, but is not obligated to, contribute additional
capital to the entity. Also under the License, Audible Germany will pay
the
Company royalties ranging from 0.5% to 3% of revenue up to an annual royalty
cap
of the U.S. dollar equivalent of €1.5 million, subject to Audible Germany
achieving certain operating margins. No royalties have been received by
the
Company under the License. Any profits distributed by Audible Germany are
to be
distributed in accordance with the ownership interests. In July 2006, a
new
investor contributed €280,000 for a 5% interest in Audible Germany. This
contribution then reduced the Company’s interest to 48% and Random House and
Holzbrinck ownership percentage to 23.5% each.
The
Company previously determined that Audible Germany is not a variable interest
entity as defined in FASB Interpretation No. 46R,
Consolidation of Variable Interest Entities, an interpretation of ARB No.
51
(“FIN
46R”) because, as a development stage enterprise, Audible Germany has sufficient
equity to permit it to finance the activities in which it is currently
engaged
in without additional subordinated financial support. In addition, the
other
criteria within FIN 46R that would characterize Audible Germany as a variable
interest entity were not met. Rather, Audible Germany is considered to
be a
voting interest entity. Another analysis under FIN 46R is expected to be
performed during the third quarter of 2006 when Audible Germany is expected
to
receive additional funding.
Under
EITF 96-16,
Investor's Accounting for an Investee When the Investor has a Majority
of the
Voting Interest but the Minority Shareholder or Shareholders Have Certain
Approval or Veto Rights,
the
Company has determined that the minority shareholders, together, have
significant participatory rights, allowing them to participate in significant
decisions of Audible Germany and to block significant decisions proposed
by
Audible. As a result of the significant participatory rights held by the
minority shareholders, the Company does not have unilateral control over
Audible
Germany. Therefore, Audible does not consolidate the results of Audible
Germany
but rather accounts for its investment in Audible Germany under the equity
method of accounting. Under the equity method of accounting, the Company
records
51% of the profits, if any, and 51% of the equity losses but only until
such
time that the Company records losses equal to the initial investment of
the
Company plus any profits previously recorded. The initial investment was
reduced
to zero during 2004. Audible has no further obligation to fund the operations
of
Audible Germany. The Company will continue to monitor its portion of unreported
equity losses in the event that Audible Germany subsequently generates
income.
The Company would resume applying the equity method after its share of
profits
equals the unreported equity method losses.
In
connection with the Joint Venture, on August 30, 2004, the Company entered
into
a license and services agreement with Audible Germany (the “License”). Under the
License, Audible Germany has launched a German language spoken word audio
service. The terms provide for the Company to provide intellectual property
and
substantially all of the technological infrastructure for the operation
of the
service. In return, Audible Germany is required to pay Audible $30 each
month
for a period of 30 months, beginning in September 2004. Every 60 days during
this agreement, the parties meet to review and accept the services. The
monthly
payments are subject to refund if Audible Germany does not accept the services,
subject to reasonable cure. Under the License, Audible recognizes $30 of
revenue
per month once Audible Germany has agreed that the services delivered for
the
prior 60-day period were satisfactory and collection of the amount is reasonably
assured.
During
the three and six month periods ended June 30, 2006 the Company recognized
$90
and $180, respectively, in related party revenue under the License
agreement as the related services were delivered and accepted on or before
June
30, 2006. During the three and six month periods ended June 30, 2005,
the
Company recognized $90 and $210, respectively, under this License agreement.
As
of June 30, 2006 the $180 related to revenues recognized for the six
months
ended June 30, 2006 have not been collected. These accounts receivable
were
capitalized as part of the Company’s equity investment in Audible Germany.
During the three months ended June 30, 2006, the Company recorded its
share of
the equity loss up to the amount of its investment of $180, included
in general
and administrative expenses on the accompanying condensed consolidated
Statements of Operations. As of June 30, 2006, an agreement pertaining
to future
funding for Audible Germany has not been reached, with the intention
that it
will be finalized in the third quarter of 2006.
In
addition, the Company also recognized none and $108, and $31 and $50 in
billings
for certain consulting services and related incremental reimbursable costs
incurred in connection with the License in accordance with EITF 01-14 during
the
three and six month periods ended June 30, 2006 and 2005, respectively.
These
amounts are included in related party revenue on the condensed consolidated
Statements of Operations. The Company accrues for amounts to be paid to
Audible
Germany related to revenues earned by Audible Inc at the Apple Germany
iTunes
music store. These amounts are included in accrued expenses in the condensed
consolidated Balance Sheets as of June 30, 2006 and December 31,
2005.
-21-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
On
September 15, 2004, the Company, France Loisirs S.A.S. (“France Loisirs”) and
Audio Direct S.A.S., a wholly owned subsidiary of France Loisirs (“Audio
Direct”), entered into a 24-month Master Alliance Agreement (the “Agreement”).
France Loisirs is a wholly owned subsidiary of Bertelsmann AG. Bertelsmann
AG
and its affiliates own 5.6% of Audible's common stock, inclusive of certain
common stock warrants held by the entities.
Under
the
Agreement, in the first quarter of 2005, France Loisirs launched a French
language spoken word audio service through Audio Direct. The terms provide
for
Audible to provide intellectual property and substantially all of the
technological infrastructure for the operation of the service. In return,
France
Loisirs is required to pay Audible $1,000, payable as follows: $250 in
September
2004, $250 in October 2004, $250 in January 2005 and $21 for each of the
following 12 months. As of June 30, 2006, the Company had received the
three
installments of $250 each and six monthly payments of the $21. Commencing
the
first fiscal year after the business achieves positive net income, the
Company
will receive a royalty of 5% of the business's net paid revenue. Net paid
revenue refers to net revenues for digital spoken word content after the
deduction of taxes but excluding certain hardware revenue. The 5% royalty
will
apply until the business net paid revenue exceeds €20,000,000. Once net paid
revenue exceeds €20,000,000, the Company will receive a flat fee of €1,000,000.
If net paid revenue exceeds €33,300,000, the Company will receive a royalty
payment of €1,000,000, plus 3% of net paid revenue in excess of €33,300,000. An
additional royalty is payable equal to one-half of the distributable pre-tax
profits of the business.
FIN
46R
addresses the consolidation by business enterprises of variable interest
entities (VIEs) and requires that if an enterprise is the primary beneficiary
of
a variable interest entity, the assets, liabilities, and results of the
activities of the variable interest entity should be consolidated in the
financial statements of the enterprise.
Audio
Direct is considered a VIE because its equity is not sufficient to permit
the
entity to finance its activities without additional subordinated financial
support. Audible and France Loisirs form a related party group, as defined
in
FIN 46R, as a result of the Bertelsmann affiliation and the number of seats
that
Bertelsmann holds on the Audible Board of Directors. Under FIN 46R, the
entity
within the related party group that is most closely associated with the
variable
interest entity is the primary beneficiary.
Based
upon analysis, the Company determined that France Loisirs is more closely
associated with Audio Direct, primarily because France Loisirs is required
to
fund the operations of Audio Direct, including the $1,000 payment due to
Audible. France Loisirs is therefore considered to be the primary beneficiary
of
Audio Direct. As a result, the Company does not consolidate the results
of Audio
Direct but rather accounts for its variable interest in Audio Direct under
the
cost method of accounting.
Because
the Company has not made and is not required to provide any funding to
France
Loisirs or Audio Direct, it has no exposure to loss under the
Agreement.
The
$1,000 in fees are non-refundable and not subject to any acceptance provisions.
Since fair values do not exist for the different services (elements) that
Audible is providing, the services are considered a single unit of accounting
under EITF 00-21 and accordingly, the $1,000 in fees is recognized as related
party revenue on a straight-line basis over the 24-month term at the rate
of $42
per month, provided collectibility is reasonably assured.
During
the three and six month periods ended June 30, 2006 and 2005, the Company
recognized $125 and $250 in related party revenue in connection with the
Agreement, representing the straight-line recognition of $1,000 in revenue
being
recognized over the 24-month term of the Agreement. As of June 30, 2006
and
December 31, 2005, none and $187, respectively, was recorded as deferred
revenue
related to the Agreement. In addition, for the three and six month periods
ended
June 30, 2006 and 2005 the Company recognized $42 and $92, and $13 and
$23,
respectively, in billings for certain consulting services and related
incremental reimbursable costs incurred in connection with the Agreement
in
accordance with EITF 01-14. These amounts are included in related party
revenue on the condensed consolidated Statements of Operations. The Company
accrues for amounts to be paid to France Loisirs related to revenues earned
by
Audible Inc at the Apple France iTunes music store. These amounts are included
in accrued expenses in the condensed consolidated Balance Sheets as of
June 30,
2006 and December 31, 2005.
-22-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(9)
Product Development, Licensing, Marketing and Distribution
Agreement
On
May
16, 2005, the Company entered into a five-year agreement with a new
content provider to develop, license, market and distribute audio
content. The Company will be paid an exclusivity fee, a product development
fee and production fees for audio content produced under the
agreement. In addition, the Company will make royalty and revenue
sharing payments to the publisher based on sales of the products produced.
As of June 30, 2006, the Company billed the publisher $732, of which the
full
amount has been received as of June 30, 2006, in connection with this
agreement. The fees associated with this agreement are being amortized
over a 58
month period beginning in the month the Company commenced production of
audio
through the expiration of the agreement. During the three month periods
ended
June 30, 2006 and 2005, $64 and none, respectively, was recorded as other
revenue in connection with this agreement. During the six month periods
ended
June 30, 2006 and 2005, $129 and none, respectively, was recorded as other
revenue in connection with this agreement. As of June 30, 2006 and December
31,
2005, the Company recorded $255 and $233, and $252 and $99
as deferred revenue current and non-current, respectively, on the
accompanying condensed consolidated Balance Sheets, relating to this agreement,
representing cash received in advance of being recognized as
revenue.
(10)
Commitments and Contingencies
Lease
Obligations
The
Company has an operating lease on its office space in Wayne, New Jersey
that
expires in December 2008. The lease contains a renewal option for a period
of
three years. In February 2005, Audible UK signed a one year lease for office
space, which includes office amenities. This lease was subsequently amended
in
the second quarter of 2005 for additional space and was renewed in May
2006 for
an additional two years. Total future minimum lease obligations as of June
30,
2006 under these lease arrangements are $1,787.
Rent
expense of $233 and $148 was recorded under operating leases for the three
month
periods ended June 30, 2006 and 2005, respectively, and $360 and $248 for
the
six month periods ended June 30, 2006 and 2005, respectively.
There
are
no future minimum lease payments due under capital leases as of June 30,
2006,
which were paid in full during the first quarter of 2005.
-23-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Royalty
obligations represent payments to be made to various content providers
pursuant
to minimum guarantees under their royalty agreements, net of royalties
paid. The
royalty obligations recorded in the accompanying condensed consolidated
Balance
Sheets are classified between current and non-current based on the payment
terms
specified in the agreements, and relate to audio content that has been
delivered
to Audible. Royalty obligations pursuant to minimum guarantees for audio
content
to be delivered in the future are reflected as a commitment in the table
below.
Service
Agreements
The
Company has entered into operational and marketing agreements and purchase
orders with various vendors to provide certain contracted services. The
majority
of the amounts committed are for hosting services related to the Company's
Web site.
Committed
Purchases
Committed
purchases represent agreements the Company has made for future purchases
of
goods and service. The balance primarily consists of consulting services
for
technology and development projects and marketing services.
Summary
of Cash Commitments and Obligations
The
following table shows future cash payments due under the Company's commitments
and obligations as of June 30, 2006:
Year
Operating
Leases
Royalty
Obligations
(1)
Service
Agreements
Committed
Purchases
Total
2006
$
438
$
511
$
1,284
$
496
$
2,729
2007
742
265
1,286
--
2,293
2008
607
1
868
--
1,476
2009
--
--
15
--
15
2010
--
--
--
--
--
2011
and thereafter
--
--
--
--
--
Total
$
1,787
$
777
$
3,453
$
496
$
6,513
(1)
Of
the $777 in total royalty obligations, $275 is recorded in accrued expenses
and
$172 is recorded as royalty obligations, non-current, in the accompanying
condensed consolidated Balance Sheet as of June 30, 2006. The remaining
obligation of $330 relates to content that has not yet been delivered as
of June
30, 2006.
Contingencies
Various
legal actions, claims, assessments and other contingencies arising in
the normal
course of business, including certain matters described below, are pending
against the Company. These matters are subject to many uncertainties,
and it is
possible that some of these matters could be ultimately decided, resolved
or
settled adversely. The Company has recorded accruals for losses related
to those
matters which it considers to be probable and that can be reasonably
estimated.
Although the ultimate amount of liability at June 30, 2006 that may result
from
those matters for which accruals have been recorded may differ, the Company
believes that any amounts exceeding the recorded accruals would not be
material
to the consolidated financial position or results of
operations.
-24-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In
June
2001, the Company and certain of its officers were named as defendants
in a
securities class action filed in United States District Court for the Southern
District of New York related to its initial public offering in July 1999.
The
lawsuits also named certain of the underwriters of the IPO as well as certain
of
the Company's officers and directors and former directors as defendants.
Approximately 300 other issuers and their underwriters have had similar
suits
filed against them, all of which are included in a single coordinated proceeding
in the Southern District of New York (the “IPO Litigations”). An amendment
complaint was filed on April 19, 2002. The complaints allege that the prospectus
and the registration statement for the IPO failed to disclose that the
underwriters allegedly solicited and received “excessive” commissions from
investors and that some investors in the IPO allegedly agreed with the
underwriters to buy additional shares in the aftermarket in order to inflate
the
price of the Company's stock. The Company and certain of its officers,
directors, and former directors were named in the suits pursuant to Section
11
of the Securities Act of 1933, Section 10(b) of the Exchange Act of 1934,
and
other related provisions. The complaints seek unspecified damages, attorneys'
and expert fees, and other unspecified litigation costs.
On
July
1, 2002, the underwriter defendants in the consolidated actions moved to
dismiss
all of the IPO Litigations, including the action involving the Company.
On July
15, 2002 the Company along with other non-underwriter defendants in the
coordinated cases also moved to dismiss the IPO Litigations. On February
19,
2003, the court ruled on the motions. The court granted the Company's motion
to
dismiss the claims against the Company under Rule 10b-5, due to the
insufficiency of the allegations against the Company. The motions to dismiss
the
claims under Section 11 of the Securities Act were denied as to virtually
all of
the defendants in the consolidated cases, including the Company. The Company's
individual officers, directors and former director defendants in the IPO
Litigation signed a tolling agreement and were dismissed from the action
without
prejudice on October 9, 2002.
In
June
2003, a proposed settlement of this litigation was reached among the plaintiffs,
the issuer defendants in the consolidated actions, the issuer officers
and
directors named as defendants, and the issuers' insurance companies. The
settlement would provide, among other things, a release for the Company
and for
the individual defendants for the conduct alleged to be wrongful in the
amended
complaint. The Company would agree to undertake other responsibilities
under the
partial settlement, including agreeing to assign away, not assert, or release
certain potential claims the Company that may have against the underwriters.
Any
direct financial impact of the proposed settlement is expected to be borne
by
the Company's insurance carriers.
In
June
2004, the proposed settlement was submitted to the court for preliminary
approval. The court requested that any objections to preliminary approval
of the
settlement be submitted by July 14, 2004, and the underwriter defendants
formally objected to the settlement. The plaintiff and issuer defendants
separately filed replies to the underwriter defendants' objections to the
settlement on August 4, 2004. The court granted preliminary approval on
February
15, 2005, subject to certain modifications.
On
August
31, 2005, the court issued a preliminary order further approving the
modifications to the settlement and certifying the settlement cases. The
court
also appointed the Notice Administrator for the settlement and ordered
that
notice of the settlement be distributed to all settlement class members
beginning on November 15, 2005 and completed by January 15, 2006. The settlement
fairness hearing was held on April 24, 2006, and the court reserved decision.
If
the court determines that the settlement is fair to the class members,
the
settlement will be approved. There can be no assurance that this proposed
settlement would be approved and implemented in its current form, or at
all.
Due
to
the inherent uncertainties of litigation and because the settlement approval
process is not complete, the Company cannot accurately predict the ultimate
outcome of the matter.
Starting
on or about February 22, 2005, several class actions were filed against
Audible
and two of the Company's executives in the United States District Court
for the
District of New Jersey. The plaintiffs purport to represent a class
consisting of all persons (other than Audible's officers and directors
and their
affiliates) who purchased the Company's securities between November 2,
2004 and
February 15, 2005 (the "Class Period"). The plaintiffs allege that the
defendants violated Section 10(b) of the Securities Exchange Act of 1934
and
Rule 10b-5 there under by failing to make complete and accurate disclosures
concerning the Company's future plans and prospects. The individual
defendants are also alleged to be liable under Section 20(a) of the Exchange
Act. All of the defendants are alleged to have sold stock at inflated
prices during the Class Period. In December 2005, the United States District
Court for the District Court of New Jersey consolidated the class action,
appointed a group of lead plaintiffs and appointed lead plaintiff’s counsel. By
prior agreement, the plaintiff’s consolidated amended complaint was filed on
February 14, 2006.
-25-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
On
April
20, 2006, the Company provided the plaintiffs’ counsel in the consolidated
securities class actions with a memorandum in support of a motion to dismiss
the
consolidated amended class action complaint. On June 26, 2006, the plaintiffs’
counsel provided the Company with a memorandum in opposition to the motion.
On
or about August 11, 2006, the Company intends to provide the
plaintiffs’ counsel with a reply brief in further support of the motion to
dismiss. At the suggestion of the Court, the Company has agreed with the
plaintiffs’ counsel not to file the motion to dismiss and the supporting papers
until the briefing has been completed.
In
April
2005, a derivative action was filed in the state court of New Jersey against
Audible, the two executives named as individual defendants in the class
actions
described above, six of the Company's outside directors, and three of the
Company's stockholders. The derivative action makes the same factual
allegations as the class actions described above and adds allegations that
the
six outside directors named as defendants and/or the stockholders who nominated
them sold stock at inflated prices at or about the time of the secondary
offering of securities that the Company made in November 2004. The plaintiff
in
this derivative action purports to seek a recovery of the damages allegedly
sustained by Audible rather than by investors who allegedly purchased securities
at inflated prices.
In
May
2005, the Company learned of a second derivative action which was filed
during
April 2005 in the United States District Court for the District of New
Jersey
against Audible, the two executives named as individual defendants in the
class
actions described above, and all seven of the Company's outside directors.
The
derivative action makes the same allegations as the class actions described
above and adds allegations that all of the individual defendants are responsible
for an alleged failure of internal controls that resulted in the 45-day
delay in
the filing of the Company's Form 10-K for 2004. The plaintiff in this derivative
action purports to seek a recovery of the damages allegedly sustained by
Audible
rather than by investors who allegedly purchased securities at inflated
prices.
The
plaintiffs in the derivative actions voluntarily agreed to stay those actions
pending the outcome of the Company’s motion to dismiss the class actions
described above.
The
Company believes that all of the claims described above are without merit
and
intends to defend the actions vigorously. Due to the inherent uncertainties
of
litigation and because these actions are at a preliminary stage, the Company
cannot accurately predict the ultimate outcome of these matters.
In
May
2005, Digeo, Inc. commenced an action against Audible for patent infringement
in
Federal District Court in the State of Washington. The Company has filed
an
answer asserting the patent is invalid and unenforceable and that its
services
do not fall within the scope of the claims of the Digeo patent. In June
2006,
the Company filed a motion to dismiss, asserting, among other things,
that Digeo
does not have standing to sue. The Company believes the case is without
merit
and will not have a material adverse impact on its financial position
or results
of operations.
-26-
AUDIBLE,
INC. AND SUBSIDIARY
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(11)
Supplemental Disclosure of Cash Flow Information
Cash
Paid for Interest and Taxes
The
Company paid interest of $0 and $1 during the six month periods ended June
30,
2006 and 2005, respectively.
No
income
taxes were paid in the six month periods ended June 30, 2006 and
2005.
(12) Customer
Concentration
For
the
six month periods ended June 30, 2006 and 2005, Apple Computer accounted
for
22.0% and 13.2% of total revenue, respectively.
As
of
June 30, 2006 and December 31, 2005, Apple Computer accounted for 72.6%
and
62.1%, respectively, of the Company's accounts receivable.
(13)
Financial Information by Geographic Area
Revenues
and long-lived assets for the Company's United States and United Kingdom
operations are as follows:
Revenues
United
States
United
Kingdom
Consolidated
Three
months ended June 30, 2006
$
18,447
$
694
$
19,141
Three
months ended June 30, 2005
$
15,288
$
10
$
15,298
Six
months ended June 30, 2006
$
37,596,
$
1,260
$
38,856
Six
months ended June 30, 2005
$
28,193
$
9
$
28,202
June
30, 2006
Long-lived
assets
$
10,887
$
49
$
10,936
June
30, 2005
Long-lived
assets
$
2,254
$
35
$
2,289
(14)
Subsequent Events
In
July
2006, the Company entered into a global master agreement with Apple Computer,
Inc. Pursuant to the agreement, the Company will continue to be the exclusive
source of audiobooks and other book-related spoken-word material to Apple’s
iTunes music stores worldwide and will continue to provide the iTunes music
store with comedy, lectures, speeches, periodicals, educational programs,
Audible originals, spiritual programming, paid podcasts, and other spoken-word
programs. All Audible content will continue to receive branding within
the audio
stream and in the iTunes music store. Under the terms of the agreement,
Apple
and the Company intend to pursue co-marketing and promotion programs. The
term
of the agreement expires on September 30, 2010.
ITEM
2.
Management's Discussion and Analysis of Financial Condition and Results
of
Operations
(dollars
in thousands except per share data)
The
following discussion and analysis of our financial condition and results
of
operations should be read in conjunction with our audited consolidated
financial
statements and notes thereto appearing in our 2005 Annual Report on Form
10-K.
This discussion and analysis contains forward-looking statements that involve
risks and uncertainties. Our actual results may differ materially from
those
anticipated in these forward-looking statements as a result of a number
of
factors.
This
Quarterly Report on Form 10-Q contains forward-looking statements and
information relating to our Company. We generally identify forward-looking
statements using words like “believe,” “intend,” “will,” “expect,” “may,”
“should,” “plan,” “project,” “contemplate,” “anticipate,” “seek” or similar
terminology. These statements are based on our beliefs as well as assumptions
we
made using information currently available to us. Because these statements
reflect our current views concerning future events, these statements involve
risks, uncertainties and assumptions. Actual results may differ significantly
from the results discussed in these forward-looking
statements.
Overview
Our
Business
Our
goal
is to be the preeminent supplier of spoken-word digital audio on the Internet.
At our Web sites, our customers can select, purchase, and download spoken
audio
of their choice of over 106,000 hours and over 32,000 different programs
amongst
a wide range of categories. Our AudibleListener membership plans provide
our
customers a wide variety of monthly and annual membership options, depending
upon their listening preferences. Customers can access our content at our
Web
sites, www.audible.com (United States) and www.audible.co.uk (United Kingdom),
or at our related parties Web sites, www.audible.de (Germany) and www.audible.fr
(France), or at Amazon.com and at the Apple iTunes music store.
Key
Business Metrics
For
the
six month period ended June 30, 2006, we generated total revenue of $38,856
and
a net loss of $5,222. During this period, total number of new AudibleListener
members added was approximately 144,000, compared to approximately 106,000
total
acquired in the first six months of 2005. This increase in new AudibleListeners
acquired resulted in total AudibleListeners of approximately 309,000 as
of June
30, 2006, compared to approximately 245,000 as of December 31, 2005 and
approximately 205,000 at June 30, 2005.
Churn,
a
measure of AudibleListener member cancellation rate, decreased for the
first
half of 2006 over 2005, due primarily to the increase in new AudibleListeners
that have joined one of our annual membership programs, and a sharp decline
in
members acquired through free trial programs. Monthly churn is defined
as member
cancellations in the period divided by the sum of members at the beginning
of
the period plus gross member adds, divided by three months. Members that
are financially delinquent are counted as churn.
The
average monthly churn in AudibleListener Members for the three month
period
ended June 30, 2006 was 3.4% compared to 4.6% in the first quarter of
2006 and
4.7% in the second quarter of 2005.
For
2006,
our major goals include increasing the number of new AudibleListeners
we
acquire, continuing to increase the breadth and depth of content that
we offer
to our customers, further reducing our churn rate and increasing customer
satisfaction.
We
expect
that our net revenues during 2006 will grow over 2005 levels, primarily
from
continuing to increase the number of AudibleListeners we acquire, improving
the
merchandising of our content to our customers, reducing the monthly churn
rate
and increasing customer satisfaction.
Members
of our senior leadership team regularly review key operating metrics such
as new
AudibleListeners acquired, customer purchase patterns, customer satisfaction,
churn rate, Web site performance and effectiveness of our marketing programs.
We
believe that an understanding of these key metrics as well as financial
measures
and how they change over time is important to us as well as to other parties
analyzing our business results and future market opportunities.
The
discussion of our condensed consolidated financial results contained herein
is
intended to assist investors, analysts and other parties reading this report
to
better understand the key operating and financial measures as well as the
changes in our consolidated results of operations, and the primary factors
that
accounted for these changes.
In
July
2006, we entered into a global master agreement with Apple Computer,
Inc.
Pursuant to the agreement, we will continue to be the exclusive source
of
audiobooks and other book-related spoken-word material to Apple’s iTunes music
stores worldwide and will continue to provide the iTunes music store
with
comedy, lectures, speeches, periodicals, educational programs, Audible
originals, spiritual programming, paid podcasts, and other spoken-word
programs.
All Audible content will continue to receive branding within the audio
stream
and in the iTunes music store. All Apple iPods and iTunes applications
will
continue to be AudibleReady® and will work with the Audible service. Under the
terms of the agreement, we and Apple intend to pursue co-marketing and
promotion
programs. The agreement contains provisions pursuant to which Apple and
Audible
will share revenues generated by the arrangement. The term of the agreement
expires on September 30, 2010.
Critical
Accounting Policies
The
Securities and Exchange Commission defines “critical accounting policies” as
those accounting policies that require application of management's most
difficult, subjective and complex judgments, often as a result of the need
to
make estimates about the effect of matters that are inherently uncertain
and may
change in subsequent periods. Based on this definition, we have identified
the
critical accounting policies and judgments addressed below. We have other
significant accounting policies, which involve the use of estimates, judgments,
and assumptions that are significant to understanding our results. For
additional information, see Note 2,
Summary of Significant Accounting Policies,
of our
condensed consolidated financial statements. Although we believe that our
estimates, judgments and assumptions are reasonable, they are based upon
information presently available. Actual results may differ significantly
from
these estimates under different assumptions, judgments or
conditions.
Our
critical accounting policies are as follows:
Revenue
Recognition
We
derive
our revenue from four main categories:
·
Content
and services revenue, which includes consumer content and corporate
services;
·
Hardware
revenue;
·
Related
party revenue; and
·
Other
revenue.
Content
and Services.
Consumer
content revenue consists primarily of content sales made from our Web sites
and
content sold through our agreement with the Apple iTunes Music Store. At
our Web
site, customers purchase content either through an AudibleListener membership
plan or on an a la carte basis. When purchased on an a la carte basis,
we
recognize revenue from the sale of individual content titles in the period
when
the content is purchased and delivered. We generally recognize revenue
from the
sale of a la carte content subscriptions pro rata over the term of the
subscription period.
Our
“legacy” AudibleListener monthly membership plans generally provide customers
two audio credits for a fixed monthly fee. Customers may use these audio
credits
to select content of their choice from our Web site. “Legacy” AudibleListener
audio credits provided under a monthly membership program have a life of
30
days, after which they expire. We recognize revenue from the sale of legacy
AudibleListener memberships ratably over the AudibleListener's monthly
membership period. This results in approximately 50% of the AudibleListener
membership fees received during each calendar month being deferred at month
end
and recognized as content revenue in the following month.
In
December 2005, we introduced new AudibleListener membership plans, designed
to
provide our customers more flexibility in using their audio credits. Depending
upon the AudibleListener membership plan, customers can receive and “bank” or
delay using up to a maximum number of audio credits, depending on the membership
plan. The banking feature results in audio credits being used (delivered)
over
different periods for different customers. In addition, some of the new
AudibleListener plans include new membership benefits, ranging from a
complimentary daily newspaper to everyday discounts of 30% on a la carte
purchases. The daily newspaper and 30% discount benefits are “serial” elements
that are delivered continuously over the membership period, whereas the
content
selections underlying the audio credits are discrete elements that are
delivered
at different times based on individual customer behavior. As a result of
the
characteristics of the new AudibleListener memberships, they are considered
revenue arrangements with multiple deliverables, however under Emerging
Issues
Task Force, or EITF No. 00-21,
Revenue Arrangements with Multiple Deliverables,
because
the deliverables are not eligible for separation, they are accounted for
as a
single unit of accounting. As a result, we recognize revenue for these
new
AudibleListener plans using the lesser of straight-line or proportional
performance (based on content delivery) over the maximum membership period.
This
may result in a decrease in revenue or slower revenue growth than we experienced
in prior periods because the customer has a longer period of time to use
their
audio credits. For example, a customer may pre-pay an annual membership
for
twelve audio credits and not use any credits for six months. Due to the
revenue
recognition model described above, this revenue will be deferred until
the
customer uses the audio credits.
Upon
launch of the new AudibleListener plans in December 2005, the legacy
AudibleListener programs were no longer available to new customers. Customers
who have legacy memberships have the option of either converting to one
of the
new AudibleListener membership plans or continuing their legacy
membership.
In
the
normal course of business, customers may contact us or contact their credit
card
company to request an adjustment for a purchase the customer paid us for
in the
past. Customers may contact us to request a refund for various reasons.
We
record a provision for expected refunds and chargebacks relating to revenue
that
was recognized in a previous period. The calculation of the provision for
estimated refunds and chargebacks is based on historical refund rates and
sales
patterns. The provision is recorded as a reduction of revenue. A portion
of the
resulting reserve is classified as a reduction of accounts receivable based
on
an estimate of refunds and chargebacks that will be made related to sales
that
were collected by the credit card processor but not remitted to us at
period-end. The remaining portion of the reserve is reflected as an accrued
liability at period-end. Actual results could differ from our
estimates.
Customer
Concessions
In
the
normal course of business, customers may contact us to request a concession
for
a purchase the customer paid us for in the past, which they are unsatisfied
with. Depending on the specific customer facts and circumstances, we will
provide the customer a replacement or complimentary credit or a coupon.
With our
legacy AudibleListener plans, customers on occasion request that we replace
an
audio credit that expired before the customer had an opportunity to use
it.
Other customers may request an audio credit or coupon because they have
had a
specific problem with content downloading or audio quality. We defer revenue
for
expected replacement audio credits based on historical experience of the
credits
issued. We defer revenue for other audio credits and coupons when they
are
delivered to the customers based on estimated values. The concessions are
recorded as a reduction of revenue and an increase to deferred revenue.
Actual
customer credit and coupon issuance and usage patterns could differ from
our
estimates.
Royalty
Expense
Royalty
expense is the largest component of cost of content and services revenue,
and
includes amortization of guaranteed royalty obligations to various content
providers, royalties incurred on sales of content, and net realizable value
adjustments to royalty advances. Many of our early content provider agreements
contained a requirement to pay guaranteed amounts to the provider. Anticipating
that sales from these agreements would not be sufficient to recoup the
amount of
the guarantees, we adopted a policy of amortizing royalty guarantees
straight-line over the term of the royalty agreement, or expensing the
royalty
guarantees as incurred, whichever was sooner. In addition, each quarter
we
review and compare any remaining unamortized guarantee balance with current
and
projected sales by provider to determine if any additional net realizable
value
adjustments are required. Royalty expense for sales of content is incurred
based upon either a percentage of revenue or a fixed price per title in
accordance with the terms of the applicable royalty agreement. The royalty
cost
per title may differ depending upon whether the title is sold as part of
an
AudibleListener membership or sold as an a la carte sale. Actual sales
could
differ from our estimates of projected sales.
Internal-Use
Software
In
accordance with Statement of Position 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for
Internal
Use,
all
costs incurred for the development of internal use software that relate
to the
planning and post implementation phases of the development are expensed.
Direct
costs incurred in the development phase are capitalized and recognized
over the
software's estimated useful life, generally two years, commencing at the
time the software is ready for its intended use. Research and development
costs
and other computer software maintenance costs related to software development
are expensed as incurred. We review the capitalized software costs for
impairment when events or circumstances indicate that the carrying amount
of an
asset may not be recoverable. If the sum of the expected cash flows,
undiscounted and without interest, is less than the carrying amount of
the
related asset, an impairment loss is recognized as the amount by which
the
carrying amount of the asset exceeds its fair value. There has been no
impairment loss recognized as of June 30, 2006. Actual cash flows could
differ
from our expectations.
Warrants
Issued To Non Employees In Exchange For Goods and
Services
We
occasionally issue warrants to purchase shares of common stock to non-employees
as part of their compensation for providing goods and services. We account
for
these warrants in accordance with EITF Issue No. 96-18,
Accounting for Equity Instruments that are Issued to Other than Employees
for
Acquiring, or in Conjunction with Selling, Goods or Services,
or EITF
96-18. The exercise price of the warrants is determined by the closing
price of
our common stock on the day of the agreement. The fair value of the warrant
issued is estimated using the Black-Scholes model. Application of management's
judgment is required in determining the assumptions concerning risk free
interest rate, expected term of the warrant, dividend yield and expected
volatility to be used in the Black-Scholes model. The fair value of the
warrant
is expensed on a straight-line basis over the term of the agreement and
is
recorded within the operating expense line item that best represents the
nature
of the goods and services provided. Depending on the terms of the warrant,
we
apply variable plan or fixed plan accounting in accordance with EITF
96-18.
Employee
Stock-Based Compensation Arrangements
In
accordance with SFAS 123(R), we measure compensation cost for stock awards
at
fair value and recognize compensation over the requisite service period
for
awards expected to vest. Estimating the portion of stock awards that will
ultimately vest requires judgment, and to the extent actual results or
updated
estimates differ from our current estimates, such amounts are recorded
in the
period estimates are revised. We consider many factors when estimating
expected
forfeitures, including types of awards, employee class, and historical
experience. We also consider many factors when estimating expected volatility
and expected life of the option. Actual results, and future changes in
estimates, may differ substantially from our current estimates.
The
following table sets forth certain financial data for the periods indicated
as a
percentage of total revenue for the three and six month periods ended June
30,
2006 and 2005:
