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FORWARD-LOOKING STATEMENTS

PART I

Item 1.  Business.

Overview

We are the leading Internet audio information and entertainment service. We specialize in the spoken word, selling membership-based spoken audio content, such as audio versions of books, newspapers, magazines, original productions and public radio subscriptions. Consumers shop, purchase and download audio content from www.audible.com® directly to personal computers for listening in a variety of ways. Most of our customers download audio to their PCs and Macs and then transfer the audio to MP3 players, personal digital assistants (PDAs), or "smart" wireless telephones for mobile listening. Others "burn" the content to audio CDs for playback on CD players. Others simply listen at their computers or though a digital home entertainment network. Audible.com® is also the Apple iTunes Music Store's pre-eminent provider of spoken word products for downloading or streaming via the Web, and Amazon.com's pre-eminent provider of spoken word content for digital distribution.

We offer customers the opportunity to join AudibleListener®, a monthly membership service. For a fixed monthly fee, AudibleListener customers may download their choice of programs from our Web site. Customers can select from more than 40,000 hours of audio content, much of which is available in digital audio format only at www.audible.com. The selection of audio at www.audible.com ranges from more than 6,000 best-selling and classic audiobooks, to audio editions of national periodicals such as The Wall Street Journal, Forbes, and Scientific American. Language instruction, personal development, stand-up comedy, children's audio, and historic speeches & readings, along with fiction, business, mystery, and romance are among the 106 categories of listening available to our customers. 

At audible.com we sell our own digital audio player under the brand name of Otis®, which is manufactured to our specifications in Korea. Several manufacturers, including Apple Computer, Creative Labs, palmOne, Gateway, Hewlett-Packard, Kenwood, PhatNoise, Rio Audio, Sony Electronics, and Toshiba support and promote the enjoyment of our audio on all or some of their MP3 players or PDAs. Manufacturers support us by including our software on their devices and inserting marketing brochures in the device box. Our manufacturing partners also provide point-of-purchase sales support,  after-market promotions, and Web-based and email customer outreach. 

We currently have over 311,000 customers in 120 countries. Since launching the service in late 1997, we have leveraged our first-to-market advantages and internally-developed technology to dominate the market for English-language downloadable audiobooks and spoken word audio.

The market for the Audible® service results from the increasing usage of the Internet, the growth of hand-held electronic devices that have digital audio capabilities, and the increasing number of hours commuters spend in traffic when they cannot read or look at a computer screen. In contrast to traditional radio broadcasts or satellite radio, the Audible service offers customers access to content of their choice and the ability to listen to what they want, when and where they want — whether commuting, exercising, relaxing or sitting at their personal computers. Unlike traditional and online bookstores, which are subject to physical inventory constraints, costs, and shipping delays, we provide a selection that is readily available in digital format that can be quickly delivered over the Internet directly to our customers.

We provide new sources of revenue for publishers of books, newspapers, magazines, journals, newsletters, professional publications and business information and producers of radio broadcasts. In addition, our service provides companies that distribute or promote our service with a wide selection of digital audio content to offer to their customers.

Industry Background 

Demand for new sources of entertainment, information and educational media continues to grow as the quantity and variety of content and its sources proliferate. Veronis Suhler Stevenson estimates that total communications spending in the U.S. was $610 billion in 2002. During 2002, Americans on average spent more than 3,500 hours reading, watching or listening to media content. We believe that many consumers seek a better way to manage and personalize consumption of this content.

According to Harris Interactive, since 1973 the median number of hours that people say they work has jumped from 41 hours a week to 49. Over the same period, Harris reports that people's leisure time has dropped from 26 to 19 hours per week. Listening is a way for individuals to consume content at times when they are unable to read, such as when they are driving. The Veronis Suhler Stevenson Communications industry Forecast for 2003 estimates that on average Americans spent more than 20 hours a week listening to the radio, compared to 17.7 hours in 1998. In comparison, Veronis Suhler Stevenson estimates that book reading declined among Americans from an average of 2.3 hours in 1998 to 2.1 hours per week in 2003. According to the 2000 United States Census, 97 million people drive to and from work alone, an increase of 15% from 1989. The average  travel time to work increased to 25.5 minutes each way, an increase of 7% from 1990. In addition, more than 42 million individual drivers have a commute of at least 30 minutes or more each way. As individuals look to use their commuting time more efficiently and manage an increasing amount of available content, audiobooks have emerged as a personalized "pay-to-listen" alternative to radio, because radio does not allow listeners to control when they listen to a particular program. A study by the Audio Publishers Association indicated that 23 million American households listened to audiobooks in 2001. An eBrain® survey conducted in July 2002 for the Consumer Electronics Association found 20% of their sample currently listen to audiobooks and 24% expect to increase their consumption in coming months.

According to the Audio Publishers Association, the U.S. market for audiobooks on cassette and CD sold in retail stores grew to $800 million in 2001. This increasing usage of audiobooks exists despite limited types of content, high prices and the limitations of cassette tapes and CDs. For instance, the audiobook market based on retail sales does not include the many audiobooks and other spoken word products sold to consumers directly or in vertical markets such as personal improvement, training, and educational markets, nor does it address the emerging market in personalized "time-shifted" radio programming or timely print content such as newspapers, newsletters, magazines, and journals.

The Internet has emerged as a powerful global communications and entertainment medium, giving millions of people the ability to access large amounts of valuable, pay-for-access media.  Jupiter Research reported that as of the end of 2003, 21.5 million households, or about one-fifth of U.S. households, were connected to the Internet via broadband. Based on historic growth rates and current trends around broadband availability, interest, and pricing, Jupiter Research forecasts that by 2008, 46 million households, representing half of online households and 40% of all U.S. households will connect via high-speed, always-on technologies. Through the Internet, people can buy various forms of information and entertainment, from books to music and video for usage both at and away from the computer.

According to International Data Corporation (IDC), mobile access to the Internet, instant messaging, music, and more are spurring a nearly fivefold run-up in worldwide sales of smart handheld devices by 2004, creating a market for those products valued at approximately $26 billion. To enable the widest possible distribution of the Audible service, our strategy is to work with digital device manufacturers to enable their devices to be AudibleReadyTM.

A key driving force in Audible's growth is the emerging market for handheld devices that play digital, or compressed, audio. The AudibleReady initiative was designed to exploit this market by entering into multiple technology and co-marketing relationships with companies that manufacture digital audio-enabled devices. The AudibleReady brand exists as a spoken word digital download and playback standard that insures satisfactory interoperability between the Audible service and digital audio-enabled devices. The AudibleReady program for digital audio device manufacturers also creates a business structure by which the manufacturer markets the Audible service to its user base in return for a percentage of revenues generated by that user base or coordinated retail sales rebates and promotional programs.

Currently Audible is focused on two primary device categories and one emerging device category for the AudibleReady initiative. The primary categories are commonly referred to as "MP3 players" and "personal digital assistants" or PDAs. The emerging device category is commonly known as "smartphones" because they combine the function of PDAs such as on-board memory, and the ability to play digital audio with cellular phone services.

Within the MP3 player market, there are players that are referred to as 'hard drive players'-- such as the Apple iPod-- that have hard drive-based memory capacities of more than 256MB, and 'flash-based players' such as select Creative Labs and Rio Audio devices that store audio files on rewritable flash memory chips of 256MB or less.

Growth in the hard drive-based MP3 player market has been led by the Apple iPod, which has carried the AudibleReady imprimatur since July of 2002 and now extends to all iPods in the market. Apple claims sales of more than 2 million iPods since the product line was launched in early 2002 and research group NDP estimated in December 2003 that iPod sales made up about 50% of the entire combined hard drive- and flash-based MP3 player market.

 Benefits to Business Affiliates.

We help content creators, device manufacturers, online e-commerce companies, consumer electronics retailers and other companies that distribute our products or promote our service to their customers to create incremental sources of revenue by aggregating premium audio content and providing a widely-accepted system for digital spoken audio distribution.

Content creators.  We provide a new source of revenue for publishers of newspapers, magazines, journals, newsletters, professional publications and business information and producers of radio broadcasts by creating a new market for content that is too timely for distribution on cassette tape or compact disc and generally too specialized for widely-broadcast radio programs. Additionally, our electronic delivery service offers publishers of audiobooks a new distribution channel for their existing audiobook content. In a strategic alliance with Random House, Inc., Random House Audible has been established as a publishing imprint within Random House, Inc.'s Random House Audio Publishing Group Division.

Older publications, including archived or out-of-print content, when converted to digital audio form, can also provide additional revenue while incurring relatively low costs for storing and delivering electronic inventory. Our solution has the benefit of reducing the risk of audio files being copied without authorization by employing a system designed to limit playback of audio files to specifically identified personal computers and digital audio players.

CD burning software providers. Leading CD burning software providers have agreed to support and promote the capability for our customers to burn the content they purchase to CD for playback in portable CD players or in CD players installed in automobiles. These CD burning software providers usually receive a percentage of revenue Audible receives from customers who burn their content to CD.

Device manufacturers.  Major manufacturers of audio-enabled digital players, such as Apple Corp. Creative Labs, Hewlett-Packard, Kenwood, palmOne, PhatNoise, Rio Audio Sony Electronics and Toshiba have agreed to support and promote the secure playback of our content on their devices. The PhatNoise Car Audio System, among the first high-capacity media jukeboxes designed specifically for automobiles, is capable of playing content purchased from us. Our service provides these manufacturers with an attractive application that takes advantage of the audio capability of their digital audio devices, which may in turn increase their sales. In most cases, these manufacturers receive a percentage of the revenue generated over a specified period of time by each new customer referred by them. Such costs are recorded in sales and marketing expense.

We also sell our own hand-held digital audio player called the Otis. The Otis is manufactured to our specifications and sold to customers on our website. Marketing the Otis gives us the added flexibility of pricing, inventory control and special sales opportunities.

Companies which distribute our products or promote our service. We have entered into marketing agreements with Apple Corp., Roxio, palmOne, Toshiba, Cox Communications, Cablevision Systems' Optimum Online broadband service, Time Warner Cable's Roadrunner broadband service, Amazon.com, Microsoft, The New York Times Company, Dow Jones (The Wall Street Journal) and others to promote our content to their customers, either directly or indirectly. In return, we have access to additional distribution outlets. We have also established relationships with electronics retailers such as Crutchfield, J&R ComputerWorld, Micro Center, MobilePlanet.com, and Tweeter to promote our AudibleListener membership plan at the point of purchase, offering consumers a rebate against the cost of an AudibleReady device. We have agreed with these companies to compensate them from sales of our content to their customers.

Our Strategy

Our objective is to enhance our position as the leading provider of subscription based, Internet-delivered, premium spoken audio content. Key elements of our strategy to achieve this goal include:

Increase brand awareness.

We seek to make "Audible" a recognizable brand. We continue to use the AudibleReady brand to signify that a player is enabled to play back Audible content. We are continuing to enhance brand awareness of the Audible service and increase visitors to our Web site by expanding our marketing efforts through online initiatives as well as co-marketing agreements. Online initiatives include a wide range of promotion vehicles that we use to communicate with existing customers as well as prospective customers. We also have a well-developed "customer-get-customer" program. Our co-marketing agreements and business relationships with cable television operators, CD burning software providers, retail partners, Apple iTunes Music Store, Amazon.com and AudibleReady player manufacturers are key elements of our plans to make potential customers aware of, and to encourage them to use our service. We continue to seek to enter into agreements with content providers a s well as owners of Internet portals and e-commerce sites to promote the Audible service to Internet users.

 Expand content collection.

We plan to acquire more digital distribution rights to audio versions of books, newspapers, radio broadcasts, magazines, journals, newsletters, conferences, seminars, performances, lectures, and speeches. With selected content providers, we plan to create additional timely digital audio editions of newspapers, periodicals and other content not otherwise available to consumers in audio format. We intend to continue to differentiate our service by expanding our collection of exclusive, original and topic-specific content, building a collection unconstrained by traditional physical inventory concerns. 

  Enable additional electronic devices, wireless phones and systems to be  AudibleReady.

We intend to continue to work with the manufacturers of hand-held electronic devices to support and promote the playback of Audible content on their players. We also seek to make future generations of AudibleReady audio players that use the MP3 audio format, a digital compression format that is currently used primarily for music playback. We are seeking to expand the AudibleReady program to include other mobile players, such as wireless phones, other hand-held computing devices as they become audio-enabled, automobile-based media jukeboxes, personal computers and in-home digital entertainment systems. We continue to offer a packaged software library to partners who wish to add Audible support to their desktop end-user audio management application. 

  Continue to improve the customer experience.

We intend to make the Audible service increasingly easy for customers to use and personalize. We intend to take advantage of the flexibility of our online distribution system to offer a variety of selections, pricing, membership, and subscription models designed to maximize customer satisfaction and to generate recurring revenue. We continue to enhance audible.com to make it easier for customers to find specific selections and to actively suggest selections that might be of interest to them based on their prior purchasing patterns. We also are enhancing our AudibleManager® software to make it simpler for customers to manage their personal audio content selections and automate downloads and transfers of content to mobile players. We provide customer service via telephone, online chat and email.

The Audible Service

Audible's integrated spoken audio delivery service includes five components: (1) our Web site, audible.com; (2) our collection of digital audio content; (3) our software for securing, downloading, managing, transferring, burning and playing audio selections; (4) a variety of AudibleReady players which include our technology and features that manage the listening experience; and (5) other services.

Audible.com.

Our Web site, audible.com, offers a large and diverse selection of premium digital spoken audio content in a secure format for download. At audible.com, visitors can browse, search for, sample, purchase, subscribe to, schedule, stream and download digital audio content. Customers can also contribute reviews and rate the content at www.audible.com, which other customers may use as part of their purchasing decision. One hour of spoken audio in our most popular format, Format 3, requires about eight megabytes of storage, and downloads to a listeners computer in approximately ten seconds using a high speed Internet connection, and less than thirty seconds to transfer the content from the computer to an AudibleReady player. Customers are offered up to five different fidelity options, allowing them to trade off between fidelity and speed of download from the Internet. According to The Wall Street Journal, more than 15 million American households have broadband connections. Veronis Suhler projects that by 2005, 68.4 million U.S. households will be online and that by 2006, 41% of online households will subscribe to a broadband Internet connection.

Digital audio content.

We currently offer more than 6,000 digital audiobooks and more than 14,000 other audio selections comprising over 40,000 hours of digital spoken audio content, segmented in four major categories:

• Audiobooks. We offer a wide selection of audiobooks. We offer both abridged (typically three to 10 hours long) and unabridged (typically five to 20 hours long) versions of books, read by the authors or by professional narrators.

• Timely audio editions of print publications. Our service enables the timely distribution of audio editions of newspapers, magazines and newsletters previously available only in print. We offer a 40-minute daily audio edition of The New York Times and selected audio content from The Wall Street Journal. We also offer audio editions of Forbes, Scientific American, Science News, Harvard Management Update, Harvard Health Letter, and others.

• Radio broadcasts. We offer popular and special-interest public radio programs shortly after they are originally broadcast so our customers have the flexibility to listen to these programs when and where they want. We offer audio versions of broadcasts such as Fresh Air, Marketplace, This American Life, The News from Lake Wobegon, Car Talk, and Science Friday.

• Lectures, speeches, performances and other audio. We offer a broad selection of lectures, speeches, dramatic and comedic performances, educational and self-improvement materials, religious and spiritual content, and other forms of spoken audio, many of which are difficult to find from any other source. We also offer specialty content created exclusively for audible.com, for example, programs featuring actor Robin Williams.

We currently have licensed Internet distribution rights to audio content from more than 135 publishers, producers of radio content and other content creators. Our license agreements are typically for terms of one to three years, and many provide us with exclusive Internet distribution rights. Under most licensing arrangements, we pay the content creator a portion of the revenue we receive. In some of our arrangements, we also pay a guaranteed advance against the content creator's revenue share.

Competition

The market for the sale and delivery of spoken audio is highly competitive and rapidly changing. Principal competitive factors in the spoken audio market include:

       • selection

       • price

       • speed of delivery

       • protection of intellectual property

       • timeliness

       • convenience

       • sound quality

Although we believe that we currently address these factors favorably with our  technology and audio service elements, we cannot be sure that we can maintain our competitive position against current or new competitors, especially those new competitors with longer operating histories, greater name recognition and substantially greater financial, technical, marketing, management, service, support and other resources.

 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, (2) Web sites that offer streaming access to spoken audio content using tools such as the RealPlayer or Windows Media Player and (3) other companies vying for consumers' time, such as satellite radio, as well as digital music streaming and download services.

Audiobooks on cassette tape or compact disc have been available from a variety of sources for a number of years. Traditional bookstores, such as Borders and Barnes & Noble, and online bookstores, such as barnesandnoble.com offer a variety of audiobooks. The Audio Book Club offers discounted audiobooks by mail order. MediaBay.com offers a small number of digital downloads of spoken audio. Rental services, such as Books on Tape, offer low pricing for time-limited usage of physical audiobooks on tape or CD, and libraries loan a limited selection of audiobooks. One or more of these competitors might develop a competing electronic service for delivering audio content.

 Even though The New York Times stated in December 2003 that "the closest thing to a well-stocked, easy to navigate chain bookstore is Audible.com" for downloadable audio content, companies and portal companies including America Online, Yahoo! or MSN may in the future compete directly with us by selling premium spoken audio content for digital download. Competition from Web sites that provide streaming audio content is intense and is expected to increase significantly in the future. Online music services such as the Apple iTunes Music Store, Roxio's Napster 2.0, and Real Networks' Rhapsody offer a wide selection of streaming and downloadable music content. Other companies have announced their intention to launch music services in 2004.

Our content providers and other media companies may choose to provide digital audio content directly to consumers. In addition, a small number of companies control primary or secondary access to a significant percentage of Internet users and therefore have a competitive advantage in marketing to those users. These providers could use or adapt their current technology, or could purchase technology, to provide a service that directly competes with the Audible service.

Many of these companies have significantly greater brand recognition and financial, technical, marketing and other resources than we do. We also expect competition to intensify and the number of competitors to increase significantly in the future as technology advances, providing alternative methods to deliver digital audio content through the Internet, satellite, wireless data, digital radio or other means.

Intellectual Property and Proprietary Rights

We regard our patents, copyrights, service marks, trademarks, trade dress, trade secrets and similar intellectual property as critical to our success. To protect our proprietary rights, we rely on a combination of patent, trademark and copyright law, trade secret protection and confidentiality and license agreements with our employees, customers, business affiliates and others. Notwithstanding these precautions, others may be able to use our intellectual property or trade secrets without our authorization. If we are unable to adequately protect our intellectual property, it could materially affect our financial performance. In addition, potential competitors may be able to develop technologies or services similar to ours without infringing our patents.

We hold nine patents and have filed several continuations cases containing multiple claims covering and further expanding various aspects of the Audible system. We do not know if the other pending patents will ever be issued and, if issued, if they will survive legal challenges. Legal challenges to our patents, whether successful or not, may be very expensive to defend.

Audible's patent portfolio concerns systems that author and deliver content for secure delivery to portable devices. Audible has maintained open continuation cases based on the original disclosure and continues to craft claims that match industry practice as it evolves. In addition to content security, Audible has pioneered the updating of a portable digital device's contents based on user preferences and content types (e.g. recurrent subscription content). Audible has a separate family of patents that applies to relevant methods and systems, including claims for portable devices with the characteristics needed to support these usage models, notably maintenance of the state of the user's consumption of media stored on a device. Audible's patents are not limited to audio content but instead apply to a broad range of media types, and the device types include not only tethered but untethered (e.g. wireless) devices as well.

We have applied for registration in the United States of several of our trademarks and service marks, including but not limited to "Audible Entertainment", "Audible Entertainment Network", "Audible Hear, There, and Everywhere", and "Who You Gonna Listen To". We do not know if all of these marks will be registered or that we will effectively protect the use of these names. "Audible", "audible.com", "AudibleManager", "AudibleReady",  "AudibleMobilePlayer", "AudibleListener", "Internet Theatre", "Click.Hear", and "AudiblePlayer" have been registered. In addition, we have begun to take affirmative steps to protect our trademarks outside of the United States as effective trademark, service mark, and copyright protection is not necessarily available in every country in which our services are available online.

We also license some of our intellectual property to others, including our AudibleReady technology and various trademarks and copyrighted material. While we attempt to ensure that the quality of our brand is maintained, others might take actions that materially harm the value of either these proprietary rights or our reputation.

We license technology from others, including elements of our compression-decompression technology that we incorporate into the Audible system. If these technologies become unavailable to us, we would need to license other technology, which would require us to redesign our system and recode our content. Although we are generally indemnified against claims that technology licensed by us infringes the intellectual property rights of others, such indemnification is not always available for all types of intellectual property and proprietary rights and in some cases the scope of such indemnification is limited. Even if we receive broad indemnification, third party indemnitors may not have the financial resources to fully indemnify us in the event of infringement, resulting in substantial exposure to us. We cannot assure you that infringement or invalidity claims arising from the incorporation of this technology, resulting from these claims, will not be asserted or prosecuted against us. These claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources in addition to potential redevelopment costs and delays, all of which could materially adversely effect our business, operating results, and financial condition.

General

We were incorporated in 1995 in the State of Delaware and commenced commercial operations in 1997. Our principal offices are located at 65 Willowbrook Boulevard, Wayne, NJ 07470. Our telephone number is (973) 837-2700.

Employees

As of December 31, 2003, we had a total of 80 full-time employees; 42 in operations, which includes 33 in customer service, 21 in technology and development, 13 in marketing, and four in general and administrative.

Item 2.    Properties.

Our principal administrative, marketing, technology and development, and operations facility is located at 65 Willowbrook Boulevard, Wayne, New Jersey, 07470, where we lease approximately 22,000 square feet. Our lease expires on December 31, 2008.

Item 3.    Legal Proceedings.

In September 2001, we and certain of our officers, directors, and former directors, were named as defendants in several putative class actions filed in the United States District Court for the Southern District of New York.  The investment banking firms that were involved in our 1999 initial public offering (the "IPO") have also been named as defendants.  The essence of the plaintiffs' claims is that the underwriter defendants allegedly allocated the opportunity to participate in the IPO by requiring their customers to pay "kickbacks" in excess of the normal commissions and to make subsequent purchases in the after market at prices in excess of the IPO price.  Allegedly, the amounts of the "kickbacks" were sometimes calculated as a percentage of the customer's paper profits over some specified period of time after the IPO.  It is alleged that these practices were not disclosed in the registration statement and prospectus for the IPO and th at, as a result, the defendants violated various provisions of the federal securities laws. Certain of the complaints purport to set forth claims on behalf of persons who acquired our common stock from July 16, 1999 to September 11, 2001. One other complaint purports to represent a class of persons who acquired our common stock between July 16, 1999 and December 6, 2000. The complaints do not specify the amount of the compensatory damages the plaintiffs are seeking, but the market loss at issue was in excess of $50 million. 

The cases have been consolidated and have been assigned to the same judge who is handling virtually identical cases filed against hundreds of other companies that completed initial public offerings between 1998 and 2000.  We along with the individual defendants, have been given an indefinite extension of time to respond to the complaints while the plaintiffs focus on pursuing their claims against the underwriters. We believe that the claims against us have no merit and, more specifically, we and the individual defendants were not aware of the alleged practices, if they occurred. We along with the individual defendants have notified the underwriters who were involved in our IPO that we expect those underwriters to indemnify us pursuant to the terms of the underwriting agreement between us and the underwriters.

On July 1, 2002, the underwriter defendants in the consolidated actions moved to dismiss all of the IPO Litigations, including the action involving us. On July 15, 2002, we along with other non-underwriter defendants in the coordinated cases, also moved to dismiss the litigation. Those motions were fully briefed on September 13 and September 27, 2002, respectively. Those motions have not yet been decided. Due to the inherent uncertainties of litigation and because the litigation is at a preliminary stage, we cannot accurately predict the ultimate outcome of the motions. In addition, the individual defendants in the IPO Litigation signed a tolling agreement and were dismissed from the action without prejudice on October 9, 2002.

Item 4.    Submission of Matters to a Vote of Security Holders.

None.

PART II

Item 5.    Market for the Company's common Stock Equity and Related Stockholder Matters.

Our common stock was traded on the Nasdaq National Market under the symbol "ABDL" from our public offering on July 16, 1999 through August 6, 2002, at which time we moved to the Nasdaq Small Cap Market. On February 18, 2003, our stock began trading on the Over-the-Counter Market (OTCBB) under the symbol "ADBL.OB". Prior to July 16, 1999, there was no established public trading market for any of our securities.

On October 29, 2002, we received a Nasdaq Listing Qualifications letter advising  us that our stock had closed below the $1.00 per share requirement for the last 180 consecutive trading days.  On November 27, 2002, we received notification from Nasdaq that we did not comply with the shareholders' equity/market value of listed securities/net income requirement, as set forth in Nasdaq Marketplace Rule 4310(c)(2)(B).  On December 19, 2002, we attended an oral hearing before the Nasdaq Listing Qualifications Panel.  On January 13, 2003 the Nasdaq Listing Qualifications Panel granted us an exception through February 18, 2003. The exception required us to demonstrate a minimum bid price per share and a minimum amount of shareholders' equity in order to maintain our stock listing on the Nasdaq SmallCap Market.  We concluded that it would not be in the best interest of our shareholders to take the steps required to meet the se minimums.  As a result, we notified Nasdaq that we would not meet these minimums, and on February 18,2003, our stock began trading on the OTCBB.

The following table sets forth, for the periods indicated, the range of high and low closing sales prices for our common stock as reported on the Nasdaq National Market, Nasdaq Small Cap Market or Over-the-Counter BB.

			High			Low
2002
First Quarter		$	1.46		$	0.75
Second Quarter			0.85			0.32
Third Quarter			0.52			0.30
Fourth Quarter			0.55			0.27
2003
First Quarter		$	0.35		$	0.20
Second Quarter			0.75			0.26
Third Quarter			1.46			0.52
Fourth Quarter			4.22			1.16
2004
First Quarter (through March 15, 2004)		$	4.14		$	3.00

On March 15, 2004, the last reported sale price of our common stock was $3.06 per share. As of March 15, 2004, we had approximately 193 stockholders of record of our common stock, although there are a significantly larger number of beneficial owners of our common stock.

We have never paid or declared any cash dividends on our common stock. Our present policy is to retain any earnings to finance the growth and development of the business and, therefore, we do not anticipate declaring or paying cash dividends on our common stock in the foreseeable future.

Recent Sales of Unregistered Securities

From January 2003 through December 2003, we sold and issued the following unregistered securities:

Warrants:

In January 2003, in connection with a services agreement, we issued a warrant to purchase 6,000 shares of common stock at a price of  $0.30 per share, which expires January 2, 2008.

In February 2003, in connection with a services agreement, we issued a warrant to purchase 6,000 shares of common stock at a price of  $0.33 per share, which expires February 3, 2008.

In March 2003, in connection with a services agreement, we issued a warrant to purchase 6,000 shares of common stock at a price of  $0.20 per share, which expires March 3, 2008.

In March 2003, in connection with a services agreement, we issued a warrant to purchase 1,000 shares of common stock at a price of  $0.26 per share, which expires March 25, 2008.

Preferred Stock:

In August 2003, Apax Partners and its affiliates ("Apax") purchased 740,741 shares, Bertelsmann Multimedia, Inc. purchased 185,185 shares and Random House Ventures LLC purchased 185,185 shares of Series C Preferred Stock at a per share price of $5.40.

The above securities were offered and sold by us in reliance upon exemptions from registration pursuant to Section 4(2) of the Securities Act of 1933 as transactions not involving any public offering.

The selected financial data set forth below should be read in conjunction  with the financial statements and related notes thereto and "Management's  Discussion and Analysis of Financial Condition and Results of Operations" and  other financial information appearing elsewhere in this Form 10-K. The selected financial data set forth below as of December 31, 2002 and 2003 and for the years ended December 31, 2001, 2002 and 2003, are derived from, and are qualified by reference to, our audited financial statements included elsewhere in this Form 10-K. The selected financial data set forth below as of December 31, 1999, 2000 and 2001, and for the years ended December 31, 1999 and 2000 are derived from our audited financial statements not included in this Form 10-K.

Certain operating expenses within the following selected financial data for 1999-2002 have been reclassified to conform to the current year presentation. These reclassifications have no effect on net loss.   See Note 2 to the financial statements for a schedule of the reclassifications made to the 2001 and 2002 operating expenses. The same type of reclassifications have been made to the 1999 and 2000 financial data shown below.

Selected Financial Data

		Year Ended December 31,
			1999			2000			2001			2002			2003
Statement of operations data:		(in thousands, except per share data)
Revenue, net:
Consumer content		$	364		$	1,443		$	5,143		$	10,940		$	18,490
Services			114			576			884			348			104
Bulk content			---			500			1,435			---			---
Total content and services			478			2,519			7,462			11,288			18,594
Hardware			314			1,273			1,293			932			666
Other			951			757			316			150			65
Total revenue, net			1,743			4,549			9,071			12,370			19,325
Operating expenses:
Cost of content and services revenue			797			3,638			4,844			4,904			5,319
Cost of hardware revenue			308			2,572			2,858			2,718			2,085
Operations			2,331			4,901			4,529			3,743			3,843
Technology and development			4,031			7,162			6,354			4,998			4,785
Marketing			6,386			16,087			14,210			11,108			4,495
General and administrative			2,468			4,382			3,837			2,485			2,633
Total operating expenses			16,321			38,742			36,632			29,956			23,160
Loss from operations			(14,578	)		(34,193	)		(27,561	)		(17,586	)		(3,835	)
Other income, net			1,102			1,602			565			85			25
Loss before state income tax benefit			(13,476	)		(32,591	)		(26,996	)		(17,501	)		(3,810	)
State income tax benefit			--			316			327			314			250
Net loss			(13,476	)		(32,275	)		(26,669	)		(17,187	)		(3,560	)
Dividends on redeemable preferred stock			--			--			(1,049	)		(1,366	)		(5,657	)
Preferred stock discount			--			--			--			--			(1,444	)
Total dividends			--			--			(1,049	)		(1,366	)		(7,101	)
Net loss applicable to common shareholders		$	(13,476	)	$	(32,275	)	$	(27,718	)	$	(18,553	)	$	(10,661	)
Basic and diluted net loss per common share		$	(0.85	)	$	(1.21	)	$	(1.03	)	$	(0.61	)	$	(0.34	)
Weighted average common shares outstanding			15,890			26,644			26,918			30,508			31,520

		As of December 31,
			1999			2000			2001			2002			2003
Balance sheet data:
Cash and cash equivalents		$	12,030		$	14,149		$	7,628		$	2,822		$	9,075
Short-term investments			24,404			1,957			--			--			--
Total assets			39,926			20,732			10,999			4,608			10,781
Noncurrent liabilities			538			713			220			135			59
Redeemable preferred stock			--			--			10,319			12,290			--
Total stockholders' equity (deficit)			4,578			14,593			(5,549	)		(13,326	)		6,105

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and related notes thereto, and other financial information included elsewhere in this Annual Report on Form 10-K.

This Annual Report on Form 10-K 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.

Accounting Reclassifications

To enhance the clarity of our operating expenses and to better reflect how we run our business, we have modified the presentation and classification of operating expenses on our Statements of Operations. These reclassifications have no effect on net loss (see note 2 to the Financial Statements for a detailed schedule of these reclassifications and relevant explanations)

Our new presentation and classifications are as follows:

Operations:  Operations expense includes payroll and related expenses for content acquisition, editorial, audio conversion and customer service, as well as credit card fees.  Customer service and credit card fees are two significant items that were previously classified in Sales and Marketing.

Technology and Development:  This category includes payroll and related expenses for information technology, systems and telecommunications infrastructure including our website, as well as technology licensing fees.  In this line, we now include certain items that were previously classified in Production expenses and Development expenses.

Marketing:  Marketing expense consists of payroll and related expenses for personnel in marketing and business development, as well as advertising expenditures and other promotional activities.  Also included are revenue sharing and bounty payments which we pay to our marketing partners.  Because we now classify customer service costs and credit card fees in operations, marketing now represents a more transparent classification of costs related to customer acquisition.

General and Administrative:  General and administrative includes payroll and related expenses for executive, finance and administrative personnel.  Also included are legal fees, audit fees, public company expenses and other general corporate expenses.  Importantly, office rent, telephone expense and medical benefits expense, which were previously fully charged to general and administrative are now allocated to each of the four operating expense lines, (excluding cost of revenue lines) based primarily upon headcount.

 Business Overview

Audible is the Internet's largest, most diverse provider of premium spoken audio services for content download and playback on personal computers, CD or AudibleReady computer based mobile listening devices.  Our customers purchase and download their choice of content, and generally listen during their daily commute or while exercising, when "their eyes are busy but their minds are free."  We believe that the Audible service allows our customers to make better use of their time, allowing them to listen to books, newspapers, magazines and time shifted radio programs that due to their busy lives, they would not have the time to read.  Our online store is located at www.audible.com and our single location of operations is Wayne, New Jersey.  

Audible has more than 40,000 hours of audio programs and 135 content partners that include leading audiobook publishers, broadcasters, entertainers, magazine and newspaper publishers and business information providers.  Most of our customers join the AudibleListener program, where for a monthly fee of either $14.95 or $19.95, they may download and listen to the content of their choice.  AudibleListeners provide us with their credit card information and are billed monthly in advance for the AudibleListener service.  Customers may also purchase individual audio titles from us on an a la carte basis.

Our customer base has grown to approximately 311,000.  We believe our growth has been driven primarily by our strong collection of content, by the growing trends of downloading and listening to audio on-the-go, and by the growing market for digital audio devices that securely play content from Audible.com.  We promote the Audible service through co-marketing partnerships with device manufactures, online promotions, promotions with retailers and our customer-get-customer referral program.  In addition, customers at Amazon.com and the Apple iTunes music store can purchase and download Audible content of their choice.

The key drivers of our business include new customer growth, the cost of acquiring a customer, the customer cancellation rate and controlling our costs. Our new customer growth is a function of developing compelling advertising and promotion programs to encourage people to try the Audible service for the first time, as well as the creation of marketing partnerships that similarly encourage consumers to try our service.  We manage customer acquisition costs by entering primarily into co-marketing deals where we pay for results, rather than advertising impressions.  We believe that the customer cancellation rate is minimized by providing the customer with a wide range of high value content, a compelling value proposition and solid customer service.

Looking ahead, we will continue to focus on new customer growth, expanding our content selection, improving the Audible service, broadening the range of AudibleReady listening devices, broadening our range of marketing and sales partnerships, providing solid customer service and controlling our costs.

Revenue from the sale of consumer content has increased in each of the last four quarters. We expect this trend to continue as we expand our customer base. As of December 31, 2003, more than 311,000 customers in over 120 countries had purchased content from our Web site.

Although we have experienced revenue growth in our content sales in recent periods, there can be no assurance that such growth rates are sustainable, and therefore such growth rates should not be considered indicative of future operating results. There can also be no assurance that we will be able to continue to increase our revenue or attain profitability or, if increases in revenue and profitability are achieved, that they can be sustained. We believe that period-to-period comparisons of our historical operating results are not meaningful and should not be relied upon as an indication of future performance.

Our revenue is derived from three main categories: (1) content and services revenue, which includes consumer content and corporate services; (2) hardware revenue; and (3) other revenue.

Consumer content revenue consists of content sales made from our website and content sold through our agreement with the Apple iTunes Music Store. Revenue  from  the sale of individual content titles is recognized in the period when  the  content  is  purchased. Revenue  from  the sale of content subscriptions is recognized pro rata over the term  of  the  subscription  period.   Revenue from the sale of monthly AudibleListener memberships is recognized 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 and recognized as content revenue in the following month. At the end of each reporting period, approximately 50% of the AudibleListener membership fees received during the last calendar month in the period is deferred as Deferred Revenue. Revenue  from  the  sale  of  UltimateListener,  our  prepaid discounted content package, and gift programs are recognized the earlier of when the content is downloaded or expiration. 

Part of our marketing strategy to acquire new AudibleListeners includes retail promotions in which we pay retailers to offer discounts to consumers on their purchase of digital audio players made by others if they become AudibleListener members.  These discounts are recorded as a reduction in revenue in the period the discount is given in accordance with Emerging Issues Task Force ("EITF") Issue No. 01-9, "Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products)".  As a result of this GAAP accounting treatment, these discounts, which we consider marketing, are not included in Marketing expense, but instead, are recorded as a reduction in revenue.  Customer refunds, although not material, are also recorded as a reduction in revenue in the period the refund is paid.

Corporate  service  revenue  consists of library sales and audio production services.  Where applicable, corporate service revenue is recognized as services are  performed  after  the agreement has been finalized, the price is fixed, and collectibility  is  assured. Collectibility is based on past transaction history and  credit-worthiness of the customer. Under multiple element corporate service arrangements, the fair value of different elements cannot usually be determined since we do not sell the items separately, therefore revenue is recognized on a straight-line basis over the term  of  the  agreement.

Hardware revenue consists of sales of AudibleReady digital audio players sold primarily at a discount or given away when a customer signs up for a one year commitment to our AudibleListener Membership. For multiple-element arrangements in which a customer signs up for a one year membership and receives an audio player for free, revenue is recognized using the relative fair value method under Emerging Issues Task Force (EITF) Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables", whereby each separate unit of accounting is recognized as revenue at its relative fair value, whereby the delivered item (hardware) is limited to the non-contingent consideration.  Since all the consideration paid by the customer is contingent upon delivery of the content, no amount is recorded as hardware revenue under these multiple-element arrangements. The free hardware device reflects the subsidy that we incur to acquire a customer with a one year 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. Cost of hardware revenue, regardless of whether the player is bundled with a membership or sold separately, is recognized upon shipment.

Other revenue in the current year consists of revenue from a license granted for certain technology rights to a device manufacturer which is being recognized on a straight-line basis over the term of the agreement. Other revenue in 2002 included revenue recognized from our profit participation from hard copy sales of products in connection with our agreement with Random House.

We are party to several joint marketing agreements with device and media storage manufacturers such as Apple, Palm, and Hewlett-Packard. Under these agreements, device manufacturers may receive a portion of the content revenue generated over a specified period of time from each new Audible customer referred by them through the purchase of a hand-held electronic device. For example, a purchaser of Hewlett-Packard's hand-held electronic device will be able to use the device and our AudibleManager software to access audible.com and download content. Hewlett-Packard will receive a percentage of the revenue related to content downloaded by this purchaser. These revenue sharing arrangements typically last one or two years from the date the device user becomes an Audible customer.

We have entered into co-marketing agreements whereby where our marketing partners will receive payments from us.  The payments to these marketing partners are generally based upon driving potential customers to the Audible website who then become customers. 

Significant Agreements

In January 2000, we entered into two agreements with Amazon.com. We were the exclusive provider of digital spoken audio to Amazon.com, as defined in the Co-Branding, Marketing and Distribution Agreement, as amended. During the three-year term of this agreement, in consideration for certain services, Amazon was entitled to $22,500,000 plus a specified percentage of revenue earned over a threshold amount in addition to common stock warrants. Under the Securities Purchase Agreement dated January 30, 2000, Amazon.com purchased 1,340,033 shares of our common stock for $20,000,000. The first $20,000,000 in payments due to Amazon.com under the amended Co-Branding, Marketing and Distribution Agreement, were offset against the $20,000,000 in consideration due to us for the purchase of common stock and no cash was exchanged. Of the remaining $2,500,000 due in cash to Amazon.com under the agreement, $1,000,000 was paid and the remaining $1,500,000 was released under an agreement reached with Amazon.com in August 2003. This $1,500,000 release of an obligation was recorded as a capital contribution as an addition to paid-in capital in the third quarter of 2003. Beginning August 6, 2003, we pay Amazon a percentage of revenue we earn from customers acquired as a result of Amazon.com directing them to www.audible.com. 

In  May  2000,  we  entered  into  a 50-month Co-Publishing, Marketing, and Distribution  Agreement  with  Random  House  to  form  a  strategic alliance to establish  Random  House  Audible, a publishing imprint,  as  defined  in the agreement, to produce spoken word content specifically suited for digital distribution.  All titles published by the imprint are distributed exclusively  on  the  Internet  by  us.  As part of this alliance, Random House, through its Random House Ventures, LLC subsidiary, purchased 169,780 shares of our common stock  for  $1,000,000.  Over  the term of the agreement we were required to contribute $4,000,000 towards funding the acquisition and creation of digital audio titles through Random House Audible.  On  March  26, 2002, the agreement was amended to waive t he  cash payment due to Random House in 2002 of $1,250,000, thereby reducing the total payments due under the agreement from $4,000,000 to $2,750,000.  In exchange for this waiver, on April 1, 2002,  we  issued  1,250,000 shares of Series B Preferred Stock ("Series B") to Random House. Through December 31, 2002, $1,250,000 of the remaining $2,750,000  obligation  had been paid, with the remaining amount of $1,500,000 due in 2003 and 2004. On February 10, 2003, the agreement was further amended so that we were no longer required to pay the $1,500,000 imprint fees that were due in 2003 and 2004.  In exchange for this amendment, Random House no longer has title output requirements to contribute to the imprint and we no longer participate in the profit from hard copy sales of products produced under the agreement. At December 31, 2002, $134,997  of  this $1,500,000 obligation had been  expensed  and was included in Accrued Expenses in the accompanying D ecember 31, 2002 Balance Sheet. This accrual was reversed during 2003 as a result of the February 2003 amendment.  On February 6, 2004 at the request of Random House, the Series B Preferred Stock was converted into 1,250,000  shares of common stock in accordance with the original terms of conversion.

In February 2001, Microsoft purchased 2,666,666 shares of our Series A Preferred Stock ("Series A") for $10,000,000 at a per share price of $3.75. Each share of Series A stock was originally convertible into four shares of common stock (equivalent to a price of $.9375 per share, which was greater than the common stock price at the  date  of  grant, therefore, there was no beneficial conversion feature associated with these preferred  shares), subject to adjustment under certain conditions.  As a result of the investment in us by Special Situations in February  2002, the conversion rate was adjusted as per the Stock Purchase Agreement to 4.0323 shares of common Stock. The Series A stock was convertible at the option  of the holder at any time prior to the fifth anniversary of the original issue date. Dividends were payable semi-annually at an annual rate of 12% in either additional preferred shares or in cash at our option. O n the fifth anniversary of the original issue date, we were required to redeem all remaining outstanding  shares  at  a  per share price of $3.75 plus all accrued and unpaid dividends.

In  February  2002,  Special Situations Funds purchased 4,069,768 shares of Common stock for $3,500,000 at a per share price of $0.86.  Proceeds received by us  net of direct costs were $3,159,000. In connection with this transaction, we issued  warrants to purchase an additional 1,220,930 shares of common stock. The warrants  were  exercisable  at  a  price  of  $1.15  anytime prior to the fifth anniversary of the issue date. As a result of the issuance of the Series C Preferred Stock ("Series C") at a conversion price of $0.54, the exercise price of the Special Situation Funds  warrants  was  adjusted  down  to  $1.01  per  share in accordance with the original anti-dilution provisions.  We  could have demanded the warrantholder exercise its rights in the event that closing bid price of a share of  our  common  stock  e xceeds  $2.30  for twenty consecutive trading sessions.  We exercised our right to call the warrants and on December 2, 2003 1,220,930 common shares were issued upon exercise of the warrants.  Proceeds of $1,233,139 were received by the Company upon the exercise of the warrants.

In August 2003, Apax purchased 740,741 shares, Bertelsmann Multimedia,  Inc. purchased  185,185  shares  and  Random  House  Ventures, LLC purchased 185,185 shares of our Series C stock at a per share price of $5.40.  We received  proceeds net of direct costs, of $5,839,772.  Each share of Series C stock was convertible at a conversion price  of $0.54 into 10 shares of common  stock.  At the time of issuance, the conversion price of the Series C stock was $0.13 per lower than the fair market value of our common stock and accordingly, a preferred stock discount of $1,444,444 was recognized as a dividend at the time of issuance. The  Series C stock was entitled to receive dividends that accrue and compound semi-annually at the rate of 6% per annum for four years following the date of initial issuance.  In the event of the conversion of the Series C  stock, all accrued but unpaid pre ferred dividends were required to be  converted into shares of common Stock.  In liquidation, the  Series C stock ranked pari passu with the our Series A stock and Series B stock. The Series C stock automatically converted to common stock on December 23, 2003.  The automatic conversion was triggered in accordance with the original terms based on the average price and average trading volume of our common stock over a 60 day period.  Upon conversion, 264,835 shares of common stock were issued to satisfy accrued dividends.  The common stock issued was valued at $3.29 per share, the closing price of the common stock on the conversion date. 

In August 2003, Apax  purchased from Microsoft all 3,473,967 outstanding  shares of Audible's Series A stock and agreed to certain amendments to that security.  As amended, the  Series A stock was no longer mandatorily redeemable,  was convertible at any  time by the holders into shares of common Stock, and dividends would have accrued and compounded semi-annually for a period of four years at the rate of 12%  per annum.  In the event of the conversion of the Series A stock, all accrued but unpaid preferred dividends was to be converted into shares of common stock. 

On February 6, 2004, Apax converted all of its Series A stock and accrued dividends into common Stock.  The Series A conversion was the result of a negotiated agreement where we issued 3,500,000 common shares and 1,000,000 warrants to purchase common stock to Apax.  Of the shares issued, 1,169,590 were issued in payment of cumulative accrued dividends at the date of conversion, and 2,330,410 shares and 1,000,000 warrants were issued as an inducement to Apax to convert its Series A shares.  The warrants are exercisable at $7.00 a share and expire on February 5, 2011.  The  fair  value  of  the 2,330,410 shares of common stock and the 1,000,000 warrants of approximately $9,873,000 will be expensed in the first quarter of 2004. In addition, the dividend charge for the 2004 period during which the Series A stock was outstanding will be approximately $614,000.

As of February 6, 2004, all of the Series A, Series B and Series C Preferred Stock has been converted to common stock and  there are no longer any special preferences or privileges in our capital structure.

Results of Operations

The following table sets forth certain financial data, as reclassified, as a percentage of total revenue during 2001, 2002 and 2003. 

		Year Ended December 31,
			2001			2002			2003
Revenue, net:
Consumer content			56	%		88	%		96	%
Services			10			3			1
Bulk content			16			-			-
Total content and services			82			91			97
Hardware			14			8			3
Other			4			1			-
Total revenue, net			100	%		100	%		100	%
Operating expenses:
Cost of content and services revenue			53			40			27
Cost of hardware revenue			32			22			11
Operations			50			30			20
Technology and development			70			40			25
Marketing.			157			90			23
General and administrative			42			20			14
Total operating expenses			404			242			120
Loss from operations			(304	)		(142	)		(20	)
Other income, net.			6			1			1
Loss before state income tax benefit			(298	)		(141	)		(19	)
State income tax benefit			4			2			1
Net loss			(294)	%		(139)	%		(18)	%
Accrued dividends on preferred stock			(12	)		(11	)		(29	)
Preferred stock discount			-			-			(8	)
Net loss applicable to common shareholders			(306)	%		(150)	%		(55)	%

Content and Services Revenue:

The following is our content and services revenue for the last three years.

Content and services revenue consists of AudibleListener membership revenue, revenue from single title sales, library revenue, bulk content revenue and corporate services revenue.

Content and services revenue has grown primarily due to the growth in our customer base and to a lesser extent price increases.  Our customer base includes all customers that have purchased Audible content at www.audible.com.  Our customer base has grown from 123,000 at the end of 2001 to 206,000 at the end of 2002 to 311,000 at the end of 2003.  We believe the increase in our customer base was driven by continuing consumer adoption of digital downloading, increased consumer awareness of the Audible service, customer satisfaction and improved marketing. In addition, in October 2003, we began to generate content revenue via sales at the Apple iTunes Music Store.  Our customer count does not include those customers that purchased our content at the Apple iTunes Music Store.

Hardware Revenue:

The following is our hardware revenue for the last three years:

Hardware revenue consists of revenue derived primarily from the shipping and handling charge to customers on devices that Audible provides for free to AudibleListeners that commit to a twelve month AudibleListener membership.  Also included are separate sales of digital audio players to consumers and libraries.

Hardware revenue has declined because we have shifted from a strategy of selling discounted devices to giving them away for free to customers who commit to a 12 month AudibleListener membership. Under ETIF No. 00-21, with these multiple-element arrangements, no revenue is recognized for the delivery of hardware because all consideration paid by the customer is contingent upon delivery of the content. 

Other Revenue:

The following is our other revenue for the last three years:

Other revenue consists of revenue derived primarily from technology licensing fees.

The decline from 2001 to 2002 was due to the end of an agreement with Microsoft relating to its distribution of our software platform.  Although we are no longer earning revenue from this agreement, AudibleReady software continues to be included in the Microsoft PocketPC operating system.  The decline from 2002 to 2003 was due to the wind-down of an agreement with Random House whereby we shared in the profits from Random House Audible titles that were sold in cassette format.  We do not expect other revenue to be a significant source of revenue in the future.

Cost of Content and Services Revenue:

The following is our cost of content and services revenue for the last three years:

Cost of content revenue consists primarily of royalties paid to publishers, as well as the amortization of publisher royalty advances and equity securities issued in connection with Random House Audible.

Cost of content and services revenue as a percentage of content and services revenue has declined during these periods. This decline is due to lower charges related to our May 2000 Random House Audible agreement and a reduction in charges related to net realizable value of advances and guarantees, partially offset by higher royalties as a function of the growth in content and services revenue.  We have transitioned from a period where we often paid royalty advances or made guarantees to content providers which were not fully recoverable to a period where most of our content agreements with publishers do not require upfront advances or guarantees. 

Cost of Hardware Revenue:

The following is our cost of hardware revenue for the last three years: 

Cost of hardware revenue in 2002 and 2003 consists of the cost of Otis digital audio players that are given away or sold to customers. In 2001, the cost of hardware revenue consisted of the cost of other digital audio players that were sold to customers.

The reduction of cost of hardware revenue was due primarily to the decline in the per unit cost of the digital audio players over the three-year period.  The cost of hardware revenue as a percentage of hardware revenue has increased as a result of reduced hardware revenue over the three-year period related to our multiple-element arrangements where the devices are given away for free with a one-year AudibleListener membership commitment.

Operations:

The following is our operations expense for the last three years: 

Operations expense consists of payroll and related expenses for content acquisition, editorial, audio conversion and customer service, as well as credit card fees.

The reduction in these costs as a percentage of content and services revenue from 2001 to 2002 was due primarily to an across the board reduction in personnel that occurred in July 2001, partially offset by an increase in credit card processing fees, which are based upon the revenue that we bill to customers.  From 2002 to 2003, the absolute level of costs have increased due to increasing personnel in customer service and higher credit card fees.  These increases are related to customer growth and revenue growth, respectively.

Technology and Development:

The following is our technology and development expense for the last three years:

Technology and development expense consists of payroll and related expenses for information technology, systems and telecommunications infrastructure, as well as technology licensing fees.

The decline in these expenses from 2001 to 2002 was due primarily to a reduction in personnel that occurred in July 2001.  From 2002 to 2003, higher website expenses due to increased bandwidth charges were offset by a decline in depreciation expense as a result of certain equipment becoming fully depreciated. As our customer base grows and the number of titles downloaded increases, we need to continually expand the bandwidth in order for our customers to be able to download their content.

Marketing:

The following is our marketing expense for the last three years:

Marketing expense consists of payroll and related expenses for personnel in marketing and business development, as well as advertising expenditures and other promotional activities. Also included are revenue sharing and bounty payments which we make to our marketing partners.

Marketing expenses in 2002 were lower than 2001 due to a reduction in personnel, lower spending on web advertising, the absence of web advertising barter transactions, lower amortization of warrant charges (due to a decline in our stock price) in connection with a services agreement and lower expenses recognized in connection with our Co-Branding, Marketing and Distribution agreement with Amazon.com.

Marketing expenses in 2003 were lower than 2002 due to lower web advertising, a $5.9 million reduction in amortization related to the expiration of our amended agreement with Amazon.com and lower amortization of warrant charges in connection with the expiration of a services agreement.   

General and Administrative:

The following is our general and administrative expense for the last three years:

General and administrative expenses consist primarily of payroll and related expenses for executive, finance and administrative personnel. Also included are legal fees, audit fees, public company expenses and other general corporate expenses.

The reduction in expense from 2001 to 2002 was due to a reduction in personnel that occurred in July 2001.  The increase in expense from 2002 to 2003 was due to higher compensation expense and the forgiveness of debt in the 2002 period in connection with promissory notes issued for shares of common stock to stockholders who are current employees, partially offset by lower stock exchange listing fees and investor relation expenses, and lower depreciation charges on leasehold improvements due to certain leasehold improvements becoming fully depreciated.  

Critical Accounting Policies

Our critical accounting policies are as follows:

Revenue Recognition:   Our revenue is derived from three main categories:

(1)           content and services revenue, which includes consumer content, corporate services and bulk content sales; (2) hardware revenue; and (3) other revenue.

Content and Services:

Consumer  content  revenue consists of content sales made from our website and content sold through our agreement with the Apple iTunes Music Store. Revenue  from  the sale of individual content titles is recognized in the period when  the  content  is  purchased. Revenue  from  the sale of content subscriptions is recognized pro rata over the term  of  the  subscription  period.   Revenue from the sale of monthly AudibleListener memberships is recognized 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 and recognized as content revenue in the following month. At the end of each reporting period, approximately 50% of the AudibleListener membership fees received during the last calendar month in the period is deferred as Deferred Revenue. R evenue  from  the  sale  of  UltimateListener,  our  prepaid discounted content package  and  gift  programs  are  recognized the earlier of when the content is downloaded or expiration.

Part of our marketing strategy to acquire new AudibleListeners includes retail promotions in which we pay retailers to offer discounts to consumers on their purchase of digital audio players made by others if they become AudibleListener members.  These discounts are recorded as a reduction in revenue in the period the discount is given in accordance with EITF No. 01-9.  As a result of this GAAP accounting treatment, these discounts, which we consider marketing, are not included in Marketing expense, but instead, recorded as a reduction in revenue.  Customer refunds, although not material, are also recorded as a reduction in revenue in the period the refund is paid.

Corporate  service  revenue  consists of library sales and audio production services.  Where applicable, corporate service revenue is recognized as services are  performed  after  the agreement has been finalized, the price is fixed, and collectibility is assured. Collectibility is based on past transaction history and credit-worthiness of the customer. Under multiple element corporate service arrangements, the fair value of different elements cannot usually be determined since we do not sell the items separately, therefore revenue is recognized on a straight-line basis over the term of the  agreement.

Bulk content revenue in 2001 consisted of sales of negotiated numbers of downloadable rights of selected content material to entities for their distribution. Bulk content sales potentially allow for additional exposure of our products through distribution channels not normally available to us. Bulk content revenue is recognized after the agreement has been finalized, the price is fixed, collectibility is assured and the content is delivered via either CD-ROM or electronic transfer and accepted without further obligation on our part. Collectibility is based on past transaction history and credit worthiness of the customer.

In 2001 the majority of our bulk content revenue was the result of barter transactions in which we exchanged bulk content for advertising. Revenue from barter transactions is recognized based on the fair value of the consideration surrendered or received, whichever is more readily determinable. Advertising received under barter arrangements is recognized in the period the advertising is broadcasted. There were no bulk content revenue transactions or barter transactions in 2002 or 2003.

 On November 26, 2003, as a result of the price of our common stock exceeding $2.30 for twenty consecutive trading sessions, we called these warrants. Special Situations Fund exercised all 1,220,930 outstanding warrants and on December 2, 2003 paid us $1,233,139 for the issuance of 1,220,930 shares of common stock.

In  August 2003, Apax purchased 740,741 shares, Bertelsmann Multimedia,  Inc.  purchased  185,185 shares and Random House Ventures, LLC purchased  185,185 shares of our Series C stock at a per share price of $5.40.  Proceeds  received  by  us, net of direct costs, were  $5,859,772.  Each share of Series C stock is convertible into 10 shares of common Stock. The Series C stock is entitled to receive dividends that accrue and compound semi-annually at the  rate  of 6% per annum for four years from the date of issuance. In the event  of  the  conversion  of  the  Series C stock, all accrued but unpaid preferred  dividends  will  be  converted  into  shares of common Stock. In liquidation, the Series C stock ranks pari passu with our Series A stock and Series B stock. At the time of issuance, the conversion price  of the Series C stoc k was $0.13 per share lower than the fair market value of the Company's  common  stock.  Since  the  Series  C  stock is convertible at any time at option of the holder, the entire $1,444,444 in preferred stock discount was  recognized  as  a  dividend at the time of issuance, and is reflected  in  the  2003 net  loss  applicable  to  common stockholders, with the  credit  to  additional  paid-in  capital.

The Series C stock automatically converted to common stock on December 23, 2003.  The automatic conversion was triggered in accordance with the original terms based on the average price and average trading volume of our common stock over a 60 day period.  At conversion date, all accrued dividends were due to be  paid in common stock.  Upon conversion, 264,835 shares of common stock were issued to satisfy accrued dividends.  The common stock issued was valued at $3.29 per share, the closing price of the common stock on the conversion date. 

At December 31, 2003, our principal source of liquidity was approximately $9,075,000 in cash and cash equivalents. 

Cash Requirements

At December 31, 2003, our principal cash commitments consisted of operating lease commitments and contractual commitments with content providers.

The following table shows future cash payments due under our commitments and obligations as of December 31, 2003