Q4 2011 Earnings Call Transcript
Transcript Call Date 01/31/2012

Operator: Thank you for standing by. Good day everyone and welcome to the Fourth Quarter 2011 Financial Results Teleconference. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. Today's call is being recorded.

For opening remarks, I would like to turn the call over to Vice President of Investor Relations, (Sean Boyle). Please go ahead, sir.

Sean Boyle - VP, IR: Hello and welcome to our Q4, 2011 financial results conference call. Joining us today is Tom Szkutak, our CFO, and John Felton, our Director of Investor Relations. We will be available for questions after our prepared remarks.

The following discussion and responses to your questions reflect management's views as of today, January 31st, 2012 only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent Annual Report on Form 10-K.

As you listen to today's conference call, we encourage you to have our press release in front of you which includes our financial results as well as metrics and commentary on the quarter.

During this call, we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you'll find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures.

Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2010.

Now I will turn the call over to Tom.

Thomas J. Szkutak - SVP and CFO: Thanks, John. I'll begin with comments on our fourth quarter financial results. Trailing 12 months operating cash flow increased 12% to $3.9 billion. Trailing 12 month free cash flow decreased 17% to $2.09 billion. Return on invested capital was 22% down from 34%. Return on invested capital is TTM free cash flow divided by average total assets minus current liabilities, excluding the current portion of long-term debt over five quarter end.

The combination of common stock and stock-based awards outstanding was 468 million shares compared with 465 million shares. During the quarter, we repurchased 1.5 million shares of our common stock for $277 million. Worldwide revenue grew 35% to $17.43 billion or 34%, excluding the $101 million favorable impact from year-over-year changes in foreign exchange rates. We're grateful to our customers who continue to take advantage for our low prices, fast selection and shipping offers.

Media revenue increased to $6.01 billion, up 15% or 14% excluding foreign exchange. EGM revenue increased to $10.91 billion, up 48% or 47% excluding foreign exchange. Worldwide EGM increased to 63% of worldwide sales, up from 57%.

Worldwide paid unit growth was 46%. Active customer accounts exceeded 164 million. Worldwide active sellers' accounts were more than 2 million. Seller units were 36% of paid units compared to 32% of paid units in Q4 2010.

Now, I'll discuss our operating expenses excluding stock-based compensation. Cost of sales was $13.83 billion, or 79.3% of revenue compared with $79.7%.

Fulfillment, marketing, technology and content and G&A combined was $3.14 billion or 18% of sales, up approximately 250 basis points year-over-year. Fulfillment was $1.62 billion or 9.3% of revenue compared with 8.2%. Tech and content was $782 million or 4.5% of revenue compared with 3.5%. Marketing was $581 million or 3.3% of revenue compared with 2.8%.

Now, I'll talk about our segment results and consistent with prior periods, we do not allocate the segments, our stock-based compensation or other operating expense line item. In the North America segment revenue grew 37% to $9.9 billion. Media revenue grew 8% to $2.56 billion. EGM revenue grew 51% to $6.88 billion representing 69% of North America revenues, up from 63%.

North America segment operating income decreased 4% to $285 million a 2 point. In the International segment, revenue grew 31% to $7.53 billion. Adjusting for the $102 million year-over-year of favorable foreign exchange impact revenue growth was 29%. Media revenue grew 20% to $3.45 billion or 18% excluding foreign exchange rates, and EGM revenue grew 42% to $4.03 billion or 41% excluding foreign exchange. EGM now represents 54% of international revenues, up from 49%.

International segment operating income decreased 46% to $177 million, a 2.4% operating margin. Excluding the favorable impact from foreign exchange rate, International segment operating income decreased 46%. CSOI decreased 26% to $462 million or 2.7% of revenue down approximately 216 basis points year-over-year. Excluding the favorable impact from foreign exchange, CSOI decreased 27%. Unlike CSOI, our GAAP operating income includes stock-based compensation expense and other operating expense. GAAP operating income decreased 45% to $260 million or 1.5% of net sales.

Our income tax expense was $86 million in Q4, resulting in a 32% rate for the quarter and a 31% rate for the full year 2011. GAAP net income was $177 million or $0.38 per diluted share compared with $416 million and $0.91 per diluted share.

Now, I will discuss the full year results. Revenue grew 41% to $48.08 billion. North America revenue grew 43% to $26.71 billion and international grew 38% to $21.37 billion, 31% growth excluding year-over-year changes in foreign exchange rates.

Consolidated segment operating income or CSOI decreased 19% to $1.57 billion or 21% excluding the favorable year-over-year impact from foreign exchange and operating margin decreased 239 basis points to 3.3%. GAAP operating income decreased 39% to $862 million or 1.8% of net sales.

Turning to the balance sheet, cash from marketable securities increased $814 million year-over-year to $9.58 billion. Inventory increased 56% to $4.99 billion and the inventory turns were 10.3, down from 11.4 turns a year ago as we expanded selection, improved in-stock levels and introduced new product categories.

Accounts payable increased 38% to $11.14 billion and accounts payable days increased to 74 from 72 in the prior year. Our Q4, 2011 capital expenditures were $550 million. The increase in capital expenditures reflect additional investment in support of continued business growth, including investments in technology, infrastructure, including investments on Web Services and additional capacity to support our Fulfillment operations.

I'll conclude my portion of today's call with guidance. Incorporated into our guidance are the order trends that we've seen to-date and what we believe today to be appropriately conservative assumptions.

Our results are inherently unpredictable and maybe materially affected by many factors, including a high level of uncertainties surrounding exchange rate fluctuations as well as the global economy and consumer spending.

It's not possible to accurately predict demand, and therefore, our actual results could differ materially from our guidance. As we have described in more detail in our public filings, issues such as settling intercompany balances and foreign currencies amongst our subsidiaries, unfavorable resolution of legal matters and changes to our effective tax rates can all have a material effect on guidance.

Our guidance further assumes that we don't conclude any additional business acquisitions or investments, record any further revisions to stock-based compensation estimates and that foreign exchange rates remain approximately where they've been recently.

For Q1, 2012, we expect net sales of between $12 billion and $13.4 billion, a growth of between 22% and 36%. This guidance anticipates approximately 50 basis points of unfavorable impact from foreign exchange.

GAAP operating income or loss to be between a loss of $200 million and $100 million of income or between 162% decline and 69% decline. This includes approximately $200 million for stock-based compensation and amortization of intangible assets.

We anticipate consolidated segment operating income which excludes stock-based compensation and other operating expense to be between zero and $300 million or between a 100% decline and 36% decline.

We remain heads-down focused on driving a better customer experience through price, selection and convenience. We believe putting customers first is the only reliable way to create lasting value for shareholders.

Thanks. With that, Sean, let's move to questions.

Sean Boyle - VP, IR: Great. Thanks, Tom. Let's move on to the Q&A portion of the. Operator, will you please remind our listeners how to initiate a question?

Transcript Call Date 01/31/2012

Operator: Jeetil Patel, Deutsche Bank Securities

Jeetil Patel - Deutsche Bank: Couple of questions, first of all on the Kindle Fire. I guess, Tom, can you maybe talk about Kindle Fire hardware units, did you see an increase in terms of unit sales on a month-on-month basis in terms of linearity? Second as it relates to Fulfillment, can you talk about what you are thinking in terms of getting closer to the end consumer and trying to drop delivery times to same-day delivery as you look forward in terms of planning and thinking of what's the optimal experience from a consumer standpoint?

Thomas J. Szkutak - SVP and CFO: In terms of data related to Kindle Fire and actually Kindle itself, the only thing I can help you with is on the holiday season which we put in the release, our unit sale nearly tripled. It was up 177% and that includes both our Kindle e-reader and Kindle Fire, so we're very pleased with the great growth we had and obviously we've been growing quite fast over the last several years from a unit perspective amounting Kindle (Stores) on a – it's on a very good base. In terms of Fulfillment and delivery time, we're continually trying to improve all of our processes from a customer standpoint and that includes our Fulfillment and delivery speed and so you've seen over the last several years, we've gotten closer and closer to customers from a delivery speed standpoint and when we do that, it helps our retail offering, but it helps also our third-parties who are participating in fulfilled by Amazon and one of the things that you're seeing in our Q4 numbers is we saw a very good unit growth and you're seeing that we expanded our third-party as a percentage of total units and one of the ways we did that is certainly fulfilled by Amazon because again from a customer standpoint, those units are available for express two day shipping or a one day if you're prime member and you pay the small fee as well as our free shipping offers.

Operator: Scott Devitt, Morgan Stanley

Scott Devitt - Morgan Stanley: The first one Tom, North American segment sales decelerated and adjustment for Kindle Fire by pretty good bid. You mentioned third-party mix which I think has a negative impact on that, and I was wondering if you could just talk through the other dynamics, is Prime is becoming more mature in the U.S. and/or the agency book business, the mix shift that you're having given the strength in the Kindle product that's actually having a negative impact on revenue growth.

Thomas J. Szkutak - SVP and CFO: Sure. In terms of our overall -- I'll talk to the total. The total worldwide as well as to the North America piece, but what I was mentioning was our growth rate for global revenue was 34% excluding exchange. That compares to 39% in Q3 and 37% last year. If you compare unit growth, that's a paid unit growth, was 46%, and again this is globally in Q4. That compares to 37% in Q4 last year, so we saw acceleration in unit growth. On top of that what we saw was third-party units grew 65% year-over-year and our third party units as a percentage of total units were 36%, up from 32%, so really what you're seeing is, you are seeing great adoption, you know, certainly great revenue from a third-party perspective but you are seeing very good adoption of FBA that has grown considerably over the last few years and that's certainly impacting that number, but obviously we only broke a portion of the revenue based on the commissions we receive for that business and our top line growth, so that's what you're seeing in total and you are seeing that also happen in North America as well as international. The other comments to -- a few other things to call out in terms of North America, if you take a look at our EGM revenue, certainly there was some impact from -- in certain subcategories related to the Thailand floods, it certainly impacted some supply. Again, the good news is, you know, we certainly had some good third-party offerings in many of those subcategories as well. Same as -- another similar effect is in North America Media we saw very, very strong growth in digital media from books to video, music, you know, all those grew very well. We did see videogames, which includes both consoles and games. Keep in mind that Q4 is very seasonal for videogames. We actually saw revenue decline year-over-year in videogames. We had very strong third party offerings, so our third-party growth was up, our unit growth in videogames was up, but our revenue was down and that's what you're seeing impacting the North America media number, particularly versus Q4 last year. So, again, those are some of the dynamics, but again, what you are seeing is, some of this, certainly, the strong performance on third-party sellers is also impacting the top line because we just recorded a portion of that sale, the commission, but you're seeing it positively impact operating income which is why you see it came in a little bit above the guidance that we gave.

Scott Devitt - Morgan Stanley: As it relates to CapEx, the run rate -- if you go back to '05 you were about 2%, a little over 2% of revenue and it's been ramping. I know some of the last two years included the building, but we exit 2012 I think at 3.7% of revenue on a trailing basis. So, I was wondering if you can just talk to the way that we should think about CapEx, percentage of revenue or otherwise over the next few years?

Thomas J. Szkutak - SVP and CFO: Sure. We look at it certainly on an incremental -- from an incremental growth standpoint and we look at it versus incremental unit growth as well as what we think the NPVs for the specific investments are, but if you break down the individual pieces, again, as we have talked about in the last several calls, we've just seen such dramatic growth in both – first of all from a retail perspective, on retail offerings, growing very fast, our third-party was fulfilled by Amazon very fast. AWS has been growing very fast, and so the capacity that we've needed support both our operation's capability as well as the infrastructure capability for our Web Services in our retail business has been very high. That said we feel that we're efficiently deploying that capital. We added as we talked about last call, we had plan to add 17 FCS which is what we did in 2011 bringing our total to 69 and again that represents the high growth that we're experiencing, so we feel very good about the investments they we're making and with 46% paid unit growth in Q4, we're still experiencing very high growth.

Operator: Mark Mahaney, Citi

Mark Mahaney - Citi: Tom, just a little more color on that North American Media growth that you talked about, The unit trends and the revenue trends videogames, anything you would want to call out in terms of the other media segments, books, music and video, and then real briefly the share buyback I think that's the first time in at least two years you've done that, any particular reason why you bought back stock in the quarter?

Thomas J. Szkutak - SVP and CFO: Sure. In terms of the North American media, again across all of our digital media very strong growth, another call that I didn't mentioned is the physical books unit growth was double-digit in Q4 year-over-year which we were very pleased, but if you think about the shift to digital content, just really rapid growth on the Kindle side. We are pleased to see that and then I mentioned the videogames was again down from a revenue perspective, third-party (GMS) was up strongly, unit growth in total for videogames was up. Again, there is some difficult compares as you can match with some of their console piece of that, and again when I talk videogames, that's both console and videogames and keep in mind that video games in particular is very seasonal high and usually we see in Q4 and we did see this Q4 as well as other Q4s, the videogames sales for the quarter has multiples of what we see in other quarters, again because of the seasonality, so that's helpful and then in terms of the stock purchase, we've had a -- there is not a lot to comment there. We have said in the past that we'll opportunistically buy when we think it's the right value and that's what we did.

Operator: Spencer Wang, Credit Suisse.

James Friedland - Cowen and Co.: Tom, two quick questions, one is I think the new disclosure on service sales maybe I missed the footnote in the press release, could you just clarify what's included there. Is that 3P, FBA, Prime, AWS and shipping or did I maybe missed something and then secondly can you share with us maybe your plans for how many Fulfillment Centers you plan on opening in 2012? Thanks.

Thomas J. Szkutak - SVP and CFO: Sure. In terms of the disclosure, you know, I would want to guide you right to the release to see exactly what is included in there, but certainly in terms of some of the big pieces, it is our third-party, it is also AWS and a number of other service offerings, so those are again documented well there and I would like to point you to that. It's also, you can see that it is growing very well and it reflects some of the comments I made earlier about the fast growing AWS business, the fast growing third-party business, service revenue was up approximately 74% year-over-year in Q4. Then in terms of Fulfillment, you know, we added 17 new FCs in 2011, that's globally. We do plan, based on the strong growth to add more in 2012. As you can imagine, you know, coming out of Q4, we are finalizing our plans for what we're going to do there and you will have to stay tuned and we will keep you updated as we go throughout the year.

Operator: Youssef Squali, Jefferies & Company.

Youssef Squali - Jefferies & Company: So, going back to the media question; Tom, can you maybe just help us quantify the videogames revenue impact maybe just on the level of deceleration. We would have thought that maybe you would – the launch of Kindle Fire et cetera we would have seen maybe a higher attach rate and therefore maybe a higher media revenue growth? Second, just on the streaming service, any plans to separate -- to offer separate pricing for the video streaming products and that's it? Thanks.

Thomas J. Szkutak - SVP and CFO: Yeah, just to be clear I'm separating our digital when I talk about our growth rates, I'm talking about our digital content businesses across the board grew very strongly during Q4. The videogames, physical as well as consoles business again grows, is a – you know, is just seasonally very high, it's not if you take a look at it, it's not dissimilar to what you see in – what you'd see what our electronics portion of our EGM business. It's a very seasonal business, very heavy weighted in Q4 and so that's no different than -- that's not different this year than in other years. What is different is growth was down from a revenue perspective year-over-year, it was up from a unit perspective and again the reason why it was up is because we had strong third-party sales in Q4. Keep in mind though, certainly, console is a part of that and again we include consoles in videogames, as part of our videogames line within North America Media and you've probably seen other press related to that as you look at other releases and updates, but there hasn't been a lot of new offerings there recently.

Youssef Squali - Jefferies & Company: On the video stream?

Thomas J. Szkutak - SVP and CFO: I'm sorry, what was your question on that, could you repeat it again?

Youssef Squali - Jefferies & Company: Just on the video streaming side, trying to figure out whether there are any short-term plans to offer a -- to strip that out basically from Kindle and from the Prime and operate as a standalone offering?

Thomas J. Szkutak - SVP and CFO: For digital video, we have a couple of different offerings one is a paid or rental offering as part of Amazon video. We also have a services part of Prime. We like both of them, we made some – we put some comments in the release about the growth rates associated with those. On the Prime Instant Video, we actually like what we see there also, so it's still early, but we like what we see. We're investing in digital content. We're seeing great adoption. We're looking at very carefully to understand a lot of different metrics around that business as you'd expect and it's still early again, we really like what we see so far and we're going to continue to monitor closely but we will be continuing to add content there.

Operator: Heather Bellini, Goldman Sachs

Heather Bellini - Goldman Sachs: I was wondering if you could comment a little bit about any cannibalization, you think you saw in traditional Kindle readers as a result of the Fire launch and then subsequently, how are you feeling about the Prime conversion of the Fire unites versus your expectations?

Thomas J. Szkutak - SVP and CFO: In terms of both devices meaning the readers and Fire did very well and we're very pleased with the growth we're seeing there and that's part of the -- both are included in the growth rate that we had in our release which is again during the holiday season, it was up 177% year-over-year and again we've been growing certainly, our Kindle reader business are very fast over the past several years since introduction and so it's on top of good base and so we're pleased with the growth rate and customers like both the reader and the Fire. Early to tell on Prime conversion, but again early stats that we're seeing, we like a lot, and so we'll continue to see how that looks going forward, but we like what we're seeing.

Operator: Justin Post, Bank of America Merrill Lynch.

Justin Post - Bank of America Merrill Lynch: Your headcount growth in the quarter was 67% which is quite a bit higher than units or revenue growth, can you talk about what all those people are focused on maybe a couple of bigger areas and is there a day coming when you could envision that kind of slowing to below either unit or revenue growth, what's maybe the timeframe on that?

Thomas J. Szkutak - SVP and CFO: Sure. First thing is we're investing in lot of different areas across the businesses we have talked about. That being said, when you look at that increase that you're referring to the majority of those increases, they are in the operations and customer service area and so again it's in support of the growth and certainly you're seeing it also at our operating cost and again we're fortune to have a lot of opportunities, we're fortunate to have the growth that we're experiencing and that's what you're seeing that growth, but certainly you'll see that as you have over time, you'll see that growth rate will go in cycles, but we certainly are feeding the growth that we're seeing and the opportunities that we have.

Operator: Jordan Rohan, Stifel Nicolaus.

Jordan Rohan - Stifel Nicolaus: I am trying to better understand the guided range for 1Q, and specifically I am looking at two things, first the impact of currency and really more macro weakness in Western Europe. Are you seeing anything there, is there anything that makes you think that things could be getting materially worse in any of your territories and specific language around which of the countries you may be saying could be quite helpful? Second I'm wondering if you're seeing or have seen over the course of the last quarter, a shift of consumer buying habits towards the hardware device sales and away from media and perhaps that could explain the deceleration in media that we appear to be seeing in North America.

Thomas J. Szkutak - SVP and CFO: In terms of international growth or in terms of -- first of all your question on guidance and the impact of exchange, we have a modest assumption around exchange as – again, we're using the recent exchange rates, but the range for growth was 22% to 36%, and it was unfavorably impacting us by about 50 basis points for foreign exchange In terms of growth and you mentioned Western Europe, if you take a look at international in Q4, it was up 29% on a local currency basis. You know, it did held up pretty well given obviously the challenges that are going on, you know, specifically in Europe from an economic standpoint. We are not – we don't view ourselves as a bellwether for the economy but certainly we are seeing that it is softer, you know, hard to quantify how much higher that international growth would have been, but it was certainly, you know, we're all seeing the same thing in terms of the reports in Europe and is certainly soft so it is impacting our overall growth rate, but hard to tell how much. Then on the North America Media growth it's actually, again, very, very strong on the digital content side; physical books were up double-digit from a unit perspective which we thought was impressive given the shift to Kindle and again videogames and videogame consoles were certainly the biggest call out there from a negative standpoint and that growth was down year-over-year on a revenue basis but up from a unit perspective.

Operator: Gene Munster, Piper Jaffray.

Gene Munster - Piper Jaffray: If we just take a step back and look at this from a high level, over the last couple of years you have been making significant investments in the business and it has been paying off with just some impressive growth numbers off of what have been larger and larger numbers. I think the big surprise for investors tonight is just what appears to be a diminishing return on that investment, and I don't know if you can use this as a forum to address that concern? Thanks.

Thomas J. Szkutak - SVP and CFO: Yeah, I'm not sure how to answer that or exactly what you mean. What I would say is we have been investing very heavily as you mentioned, and as a result of that, Q4 unit growth was 46% year-over-year. That's paid unit growth and we see a lot of opportunity in front of us and yes there is some pockets of softness with or challenges with some of the economic impact particularly in Europe. We did see some supply issues with Thailand flood, certainly some sub categories within some of our hardlines business as a result. We think those things will work themselves out over time, but we're incredibly optimistic about the opportunity that we have and that's why we have invested the way we have and we are continuing to invest in the business, so I am very pleased to see it and very pleased to have the opportunities that we have in front of us.

Gene Munster - Piper Jaffray: Your outlook in terms of investment philosophy hasn't changed versus last quarter going forward.

Thomas J. Szkutak - SVP and CFO: No. We're continuing to look as we always do. We learn every week and every month and every quarter about more and more, about customer adoption and we're looking at just a lot of positive things across the business in terms of adoption of our digital offerings, very specifically Kindle growth from a device standpoint and the contents that following that and we're seeing some very strong growth along many categories if you look at EGM, we are seeing a very good growth in categories like softlines, particularly clothing, we're seeing very good growth in consumables, we're seeing very good growth outside of some of these supply constrain, within consumer electronics, we're seeing good growth, so there is a lot of positive things within EGM. Within our business, we're seeing just tremendous growth in Amazon Web Services. So, I'm very pleased with how the team is doing there and they are just doing a great job and so there is a lot of interesting opportunities that we continue to invest in. So, we're very pleased and we're very pleased with the performance in Q4 and what it means going forward for us.

Operator: Doug Anmuth, JPMorgan.

Doug Anmuth - JPMorgan: Just a couple of things. So, you're obviously building a lot into Prime with video and also the Kindle Lending Library. Can you just give us a sense of how the profitability of a Prime customer changes over time and then also if you could comment more specifically on the early returns on sort of the media rate, media purchases as it relates to Kindle Fire owner specifically?

Thomas J. Szkutak - SVP and CFO: Sure. In each of our video, excuse me, each of our digital content that we're offering whether it be as part of Prime whether it be lending library or whether it be video, we just have early results and so from a return perspective, we're going to see -- what we can't see so far is what's happening with adoption of Prime members, what's happening with free trial conversion, what's happening with Prime memberships that we can attribute directly to those services and again it's very, very early, but so far we see we like which is why we're continuing down the path specifically of adding more content to Prime and making Prime better, and so that's something that we, you know, over time we've learned both with our physical offerings and now early on our digital offering that it's something that we think is a very good for customers and very good for shareowners, and so that's something that we're focused a lot on because we're investing a lot there, you know, we're taking a very close look at and making sure that we understand it very well, and from what we see so far, it supports continued strong investment there and so that's what we're doing. But, again, we'll continue to monitor that very closely and over time well be sharing more about how we're doing there.

Operator: That concludes today's question-and-answer session. Mr. (Boyle), at this time, I will turn the conference back to you for any additional or closing remarks.

Sean Boyle - VP, IR: Thank you for joining us on the call today and for your questions. A replay will be available on our Investor Relations website at least through the end of the quarter. We appreciate your interest in Look forward to talking with you again next quarter.

Operator: Ladies and gentlemen, that does conclude today's conference call. Thank you for your participation.