| AUDIBLE INC Item 1A RISK FACTORS Prior to making a decision about investing in our common stock, you should carefully consider the specific factors discussed below or appearing or incorporated by reference in this annual report |
| We have a limited operating history with which you can evaluate our business and our future prospects |
| Our limited operating history and limited number of customers makes predicting our future operating results difficult |
| From the time we were incorporated in November 1995 until September 1997, we generated no revenue while we developed our secure delivery system and a prototype audio playback device, created our Web site, www |
| com, and established relationships with providers of audio content |
| We began earning limited revenue in October 1997, and have continued to focus our resources on refining and enhancing our Web site, playback and management software, expanding our content selections, and developing relationships with manufacturers of digital audio players |
| We have a limited history of selling content and content subscription services to users of portable electronic devices manufactured by other parties |
| We expect to spend resources on growing our customer base, expanding internationally, building AudibleEducation and AudibleAir, improving customer service and investing in other areas where we believe our business can be strengthened |
| -8- _________________________________________________________________ [29]Table of Contents We have limited revenue, we have a history of losses, we may not be profitable in the future, and we may need additional financing, which may not be available to us |
| This limited revenue makes it difficult to predict our future quarterly results and our revenue and operating results can vary significantly quarter to quarter |
| Our revenue is dependent upon continuing to obtain new customers, increase customer purchase rates, decrease customer cancellation rates and the availability and sales of AudibleReady players by third-party manufacturers |
| We had content and services revenue of approximately dlra18cmam594cmam000, dlra33cmam210cmam000 and dlra61cmam310cmam000 in 2003, 2004, and 2005, respectively |
| We had operating expenses of approximately dlra23cmam160cmam000, dlra33cmam238cmam000 and dlra66cmam706cmam000 in 2003, 2004, and 2005, respectively |
| Because many of our expenses, such as employee compensation and rent, are relatively fixed in the short term, we may be unable to significantly adjust our spending to compensate for unexpected revenue shortfalls |
| As of December 31, 2005, we have an accumulated deficit of approximately dlra130cmam714cmam000 |
| We have identified material weaknesses in internal control over financial reporting which may adversely affect our operations |
| Section 404 of the Sarbanes-Oxley Act of 2002 requires us to report on management’s assessment of the effectiveness of our internal control over financial reporting |
| Additionally, our independent registered public accounting firm is also required to issue a report on management’s assessment of, and the effective operation of, our internal control over financial reporting |
| During our 2005 compliance efforts, we identified material weaknesses involving insufficient accounting personnel resources, inadequate information and communication, inadequate risk assessment, ineffective contract management,` and ineffective control over retail promotions |
| See Item 9A of our Annual Report for 2005 for additional details regarding these material weaknesses |
| As a result, our independent registered public accounting firm has issued an adverse opinion on the effectiveness of internal control over financial reporting |
| Although we are in the process of implementing new controls to remediate these material weaknesses, we cannot assure you that any of the measures we implement will effectively mitigate or remediate such material weaknesses |
| Ongoing compliance with Section 404 and remediation of any additional deficiencies, significant deficiencies or other material weaknesses that we or our independent registered public accounting firm may identify, will require us to incur significant costs and expend significant time and management resources |
| We cannot assure you that any of the measures we implement to remedy potential future deficiencies will effectively mitigate or remediate such deficiencies |
| In addition, we cannot assure you that we will be able to complete the work necessary for our management to issue its annual management report for 2006 or in future years |
| We also can give no assurance that our independent registered public accounting firm will agree with our management’s assessment in future years |
| If too many AudibleListener members refrain from using their audio credits on a timely basis, there will be a delay in recognizing the revenue until the credits are either used or expire |
| Our new AudibleListener plans include the ability for AudibleListener members to roll over a certain number of audio credits and download audio later in their membership period |
| To the extent AudibleListener members roll over audio credits, the cash received from the sale of those audio credits will be reflected as deferred revenue |
| If a significant number of AudibleListeners delay in using their audio credits, the recognition of revenue related to those audio credits will be delayed and can adversely affect our recognized revenue |
| If our efforts to attract new AudibleListeners are not successful, our revenues will be affected adversely |
| We must continue to attract new AudibleListeners |
| In December 2005, we launched a redesigned Web site and new AudibleListener membership plans aimed at making the Audible service more flexible and convenient for our customers |
| The result we believe will be improved customer satisfaction and retention |
| If consumers do not perceive our new AudibleListener plans to be of value, we may not be able to attract additional AudibleListeners, and as a result, our revenues will be affected adversely |
| The funds we spend on marketing and promotional activities to acquire new members reflect assumptions about how many members we can acquire and how long they will remain members |
| If our actual experience falls short of our assumptions, our revenue and profit will be materially affected |
| If we experience excessive rates of churn, our revenues and business will be harmed |
| We must minimize the rate of loss of existing AudibleListeners while adding new AudibleListeners |
| AudibleListeners cancel their memberships for many reasons, including reasons related to changes in the available time they have for listening to spoken audio, a perception that they are not using their membership entirely, customer service issues that are not satisfactorily resolved, or competitive service offerings |
| We must continually add new AudibleListener members both to replace members who cancel and to grow our business beyond our current AudibleListener membership base |
| If too many AudibleListener members cancel their memberships, or if we are unable to attract new members in numbers sufficient to grow our business, our operating results will be adversely affected |
| Further, if excessive numbers of AudibleListener members cancel their memberships, we may be required to incur significantly higher marketing expenditures than we currently anticipate to replace these members |
| The market for our service is uncertain and consumers may not be willing to use the Internet to purchase spoken audio content, which could harm our business |
| There can be no assurance that our current business strategy will enable us to sustain profitable operations |
| Downloading of audio content from the Internet is a relatively new method of distribution and its growth and market acceptance is highly uncertain |
| Our success will depend in large part on more widespread consumer willingness to purchase and download spoken audio content over the Internet |
| Purchasing this content over the Internet involves changing purchasing habits, and if consumers are not willing to purchase and download this content over the Internet, our revenue will be limited, and our business will be materially adversely affected |
| We believe that acceptance of this method of distribution may be subject to network capacity constraints, hardware limitations, company computer security policies, the ability to change user habits, and the quality of the audio content delivered |
| While we believe we have had some measure of success in gaining market acceptance of this method of distribution, particularly through our sales of content at the Apple iTunes Music Store, there can be no assurance that this will continue |
| Under our Apple arrangement, Apple may convert the spoken-word provision elements of the agreement related to the Apple iTunes Music Store from an exclusive arrangement to a nonexclusive arrangement for both us and Apple upon 120 days notice |
| -9- _________________________________________________________________ [30]Table of Contents We may not be able to license or produce sufficiently compelling audio content to attract and retain customers and grow our revenue |
| If we are unable to obtain licenses from the creators and publishers of content to have that content available on our Web site on terms acceptable to us, or if a significant number of content providers terminate their agreements with us, we would have less content available for our customers, which would limit our revenue growth and materially adversely affect our financial performance |
| Our future success depends upon our ability to accumulate and deliver premium spoken audio content over the Internet |
| Although we currently collaborate with the publishers of periodicals and other branded print materials to convert their written material into original spoken audio content, the majority of our content originates from producers of audiobooks, radio broadcasts, and other forms of spoken audio content |
| Although many of our agreements with content providers are for terms of one to five years, our content providers may choose not to renew their agreements with us or may terminate their agreements early if we do not fulfill our contractual obligations |
| We cannot be certain that our content providers will enter into new agreements with us on the same or similar terms as those currently in effect, or that additional content providers will enter into agreements on terms acceptable to us |
| Manufacturers of electronic devices may not manufacture, make available, or sell a sufficient number of products suitable for our service, which would limit our revenue growth |
| If manufacturers of electronic devices do not manufacture, make available, or sell a sufficient number of players promoted as AudibleReady, or if these players do not achieve sufficient market acceptance, we will not be able to grow revenue, and our business will be materially adversely affected |
| Manufacturers of electronic devices have experienced delays in their delivery schedule of their digital players due to parts shortages and other factors |
| Although the content we sell can be played on personal computers, we believe that a key to our future success is the ability to playback this content on handheld electronic devices that have digital audio capabilities |
| We depend in large measure on manufacturers, such as Apple Computer, Inc, Creative Labs, Palm, Inc, Hewlett-Packard, Rio Audio, and Samsung to develop and sell their own products and promote them as AudibleReady |
| We must establish, maintain, and strengthen our brand names, trademarks, and service marks in order to acquire customers and generate revenue, or our business will be harmed |
| If we fail to promote and maintain our brand names, our business, operating results, and financial condition could be materially adversely affected |
| We believe that building awareness of the “Audible” and “Audible |
| com” brand names is critical to achieving widespread acceptance of our service by customers, content providers, device manufacturers, and marketing and distribution companies with which we have business relationships |
| To promote our brands, we will need to increase our marketing expenditures and continue to register, maintain, and enforce our registrations and other rights in these marks in the markets where we do business and plan to expand |
| Increasing availability of digital audio technologies may increase competition and reduce our revenue, market share, and profitability |
| If we do not continue to enhance our service and adapt to new technology, we will not be able to compete with new and existing distributors of spoken audio content |
| As a result, we may lose market share and our business would be materially adversely affected |
| The market for the Audible service is rapidly evolving and intensely competitive |
| We expect competition to intensify as advances in and standardization of digital audio distribution, download, security, management, and playback technologies reduce the cost of starting a digital audio delivery system or a service that gathers audio content |
| To remain competitive, we must continue to license or develop technology internally that will enhance the features of the Audible service, our software that manages the downloading and playback of audio content, our ability to compress audio files for downloading and storage, and our security and playback technologies |
| Increased competition is likely to result in price reductions, reduced revenues, higher customer cancellation rates, higher content licensing costs, higher marketing costs and loss of market share, any of which could materially adversely affect our financial performance |
| Our industry is highly competitive and we cannot assure you that we will be able to compete effectively, which would harm our business |
| We face competition in all aspects of our business and we cannot assure you that we will be able to compete effectively |
| We compete for consumers of audio content with other Internet-based audio distributors and distributors of audio on cassette tape or compact disc |
| We compete with others for relationships with manufacturers of electronic devices with audio playback capabilities |
| The business of providing content over the Internet is experiencing rapid growth and is characterized by rapid technological changes, changes in consumer habits and preferences, and the emergence of new and established companies |
| We compete with (1) traditional and online retail stores, catalogs, clubs, and libraries that sell, rent, or loan audiobooks on cassette tape or compact disc, such as Audio Book Club, Borders, and Barnes & Noble, (2) Web sites that offer podcasts and streaming access to spoken audio content, (3) other companies offering services similar to ours, such as soundsgood |
| com, Simply Audiobooks, Net Library and Overdrive Inc |
| Inc, and Microsoft Network, with the potential to offer spoken audio content |
| Many of these companies have financial, technological, promotional, and other resources that are much greater than those available to us and could use or adapt their current technology, or could purchase technology, to provide a service directly competitive with the Audible service |
| Capacity constraints and failures, delays, or overloads could interrupt our service and reduce the attractiveness of our service to existing or potential customers |
| Any capacity constraints or sustained failure or delay in using our Web site could reduce the attractiveness of the Audible service to consumers, which would materially adversely affect our financial performance |
| Our success depends on our ability to electronically, efficiently and with few interruptions or delays distribute spoken audio content through our Web site to a large number of customers |
| Accordingly, the performance, reliability and availability of our Web site, our transaction processing systems and our network infrastructure are critical to our operating results |
| We have experienced periodic systems interruptions including planned system maintenance, hardware and software failures triggered by high traffic levels and network failure in the Internet and our Internet service providers |
| We believe the complexities of our software and hardware and the potential instability of the Internet due to rapid user growth mean that periodic interruptions to our service are likely to continue |
| A significant increase in visitors to our Web site or simultaneous download requests could strain the capacity of our Web site, software, hardware and telecommunications systems, which could lead to slower response times or system failures |
| These interruptions may make it difficult to download audio content from our Web site in a timely manner |
| We could be liable for substantial damages if there is unauthorized duplication of the content we sell, which would adversely affect our business |
| We believe that we are able to license premium audio content in part because our service has been designed to reduce the risk of unauthorized duplication and playback of audio files |
| If these security measures fail, our content may be vulnerable to unauthorized duplication playback |
| If others duplicate the content we provide without authorization, content providers may terminate their agreements with us and hold us liable for substantial damages |
| Although we maintain general liability insurance, including insurance for errors or omissions, we cannot assure you that the amount of coverage will be adequate to compensate us for these losses |
| Security breaches might also discourage other content providers from entering into agreements with us |
| We may be required to expend substantial money and other resources to protect against the threat of security breaches or to alleviate problems caused by these breaches |
| We do not have a comprehensive disaster recovery plan and we have limited back-up systems, and a disaster could severely damage our operations and could result in loss of customers |
| If our computer systems are damaged or interrupted by a disaster for an extended period of time, our business, results of operations, and financial condition would be materially adversely affected |
| We do not have a comprehensive disaster recovery plan in effect and do not have fully redundant systems for the Audible service at an alternate site |
| Our operations depend upon our ability to maintain and protect our computer systems-all of which are located in our headquarters and at a third party offsite hosting facility |
| Although we maintain insurance against general business interruptions, we cannot assure you that the amount of coverage will be adequate to compensate us for our losses |
| -10- _________________________________________________________________ [31]Table of Contents Problems associated with the Internet could discourage use of Internet-based services like ours and adversely affect our business |
| If the Internet fails to develop or develops more slowly than we expect as a commercial medium, our business may also grow more slowly than we anticipate, if at all |
| Our success will depend in large part on increasing use of the Internet |
| There are critical issues concerning the commercial use of the Internet which we expect to affect the development of the market for the Audible service, including: • Secure transmission of customer credit card numbers and other confidential information • Reliability and availability of Internet service providers • Cost of access to the Internet • Availability of sufficient network capacity • Ability to download audio content through computer security measures employed by businesses The loss of key employees could jeopardize our growth prospects |
| The loss of the services of any of our executive officers or other key employees could materially adversely affect our business |
| Our future success depends on the continued service and performance of our senior management and other key personnel, particularly Donald R Katz, our Chairman and CEO We do not have employment agreements with any of our executive officers or other key employees |
| Our common stock has been relatively thinly traded and we cannot predict the extent to which a trading market will develop, which may adversely affect our share price |
| Our common stock currently trades on the NASDAQ National Market |
| Our common stock is thinly traded compared to larger more widely known companies in our industry |
| In addition, there is a significant short interest in our common stock |
| Thinly traded or common stock with a significant short interest can be more volatile than common stock trading in an active public market |
| We cannot predict the extent to which an active public market for the common stock will develop or be sustained in the future |
| Our inability to hire new employees may hurt our growth prospects |
| The failure to hire new personnel could damage our ability to grow and expand our business |
| Our future success depends on our ability to attract, hire, and retain highly skilled financial, technical, managerial, editorial, marketing, and customer service personnel, and competition for these individuals is intense |
| We may not be able to protect our intellectual property, which could jeopardize our competitive position |
| If we fail to protect our intellectual property, we may be exposed to expensive litigation or risk jeopardizing our competitive position |
| The steps we have taken may be inadequate to protect our technology and other intellectual property |
| Our competitors may learn or discover our trade secrets or may independently develop technologies that are substantially equivalent or superior to ours |
| We rely on a combination of patents, licenses, confidentiality agreements, and other contracts to establish and protect our technology and other intellectual property rights |
| We also rely on unpatented trade secrets and know-how to maintain our competitive position |
| We may have to litigate to enforce our intellectual property rights, to protect our trade secrets, or to determine the validity and scope of the proprietary rights of others |
| This litigation could result in substantial costs and the diversion of our management and technical resources, which would harm our business |
| Other companies may claim that we infringe their copyrights or patents, which could subject us to substantial damages |
| If the Audible service violates the proprietary rights of others, we may be required to redesign our software, and reencode the Audible content, or seek to obtain licenses from others to continue offering the Audible service without substantial redesign and such efforts may not be successful |
| We are a defendant in a lawsuit filed by Digeo, Inc |
| in which Digeo has asserted that we infringe one of its patents |
| While we are vigorously defending the suit, there can be no assurance that we will be successful in doing so |
| We do not conduct comprehensive patent searches to determine whether our technology infringes patents held by others |
| Furthermore, technology development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent applications pending, many of which are confidential when filed with regard to similar technologies |
| Any claim of infringement could cause us to incur substantial costs defending against the claim, even if the claim is invalid, and could distract our management from our business |
| A judgment could also include an injunction or other court order that could prevent us from offering the Audible service |
| We could be sued for content that we distribute over the Internet, which could subject us to substantial damages |
| A lawsuit based on the content we distribute could be expensive and damaging to our business |
| Our service involves delivering spoken audio content to our customers |
| As a distributor and publisher of content over the Internet, we may be liable for copyright, trademark infringement, unlawful duplication, negligence, defamation, indecency, and other claims based on the nature and content of the materials that we publish or distribute to customers |
| Although we generally require that our content providers indemnify us for liability based on their content (and we carry general liability and errors and omission insurance), the indemnity and the insurance may not cover claims of these types or may not be adequate to protect us from the full amount of the liability |
| If we are found liable in excess of the amount of indemnity or of our insurance coverage, we could be liable for substantial damages and our reputation and business may suffer |
| Future government regulations may increase our cost of doing business on the Internet, which could adversely affect our cost structure |
| Laws and regulations applicable to the Internet, covering issues such as user privacy, pricing, and copyrights are becoming more prevalent |
| The adoption or modification of laws or regulations relating to the Internet could force us to modify the Audible service in ways that could adversely affect our business |
| We may become subject to sales and other taxes for direct sales over the Internet, which could affect our revenue growth |
| Increased tax burden could make our service too expensive to be competitive |
| We do not currently collect sales or other similar taxes for download of content into states other than in New Jersey |
| Nevertheless, one or more local, state, or foreign jurisdictions may require that companies located in other states collect sales taxes when engaging in online commerce in those states |
| If we open facilities in other states, our sales into such states may be taxable |
| If one or more states or any foreign country successfully asserts that we should collect sales or other taxes on the sale of our content, the increased cost to our customers could discourage them from purchasing our services, which would materially adversely affect our business |
| A variety of risks could adversely affect our international activities |
| The operation of our international activities will require significant management attention as well as financial resources |
| If international content publishers fail to provide us with sufficient content, we may not be able to attract customers with the broad selection of local content required to be successful |
| In addition, the concept of digital spoken audio is not as well developed in Germany, France, and the UK as it is in the United States |
| This may make it more difficult to acquire new customers in Germany, France, and the UK These factors may have a material adverse affect on our financial performance |
| -11- _________________________________________________________________ [32]Table of Contents Our charter and bylaws could discourage an acquisition of our company that would benefit our stockholders |
| The following provisions could have the effect of delaying, deterring, or preventing a change in the control of our company, could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of our company, or may otherwise discourage a potential acquirer from attempting to obtain control of us, which in turn could materially adversely affect the market price of our common stock: • Our Board of Directors, without stockholder approval, may issue preferred stock on terms that they determine |
| This preferred stock could be issued quickly with terms that delay or prevent the change in control of our company or make removal of management more difficult |
| • Our Board of Directors is “staggered” so that only a portion of its members are elected each year |
| • Only our Board of Directors, our Chairman of the Board, our President or stockholders holding a majority of our stock can call special stockholder meetings |
| • Special procedures must be followed in order for stockholders to present proposals at stockholder meetings |