Q1 2013 Earnings Call Transcript
Transcript Call Date 04/25/2013

Operator: Good day everyone and thank you for standing by. Welcome to the First Quarter 2013 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 will be turning the call over to the Vice President of Investor Relations, Mr. Sean Boyle. Mr. Boyle, please go ahead.

Sean Boyle - IR: Hello and welcome to our Q1 2013 financial results conference call. Joining us today is Tom Szkutak, our CFO. 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, April 25, 2013 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 2012.

Now, I will turn the call over to Tom.

Thomas J. Szkutak - SVP and CFO: Thanks Sean. I'll begin with comments on our first quarter financial results. Trailing 12 months operating cash flow increased 39% to $4.25 billion. Trailing 12 month free cash flow decreased to 85% to $177 million. Trailing 12 months capital expenditures were $4.07 billion. This amount includes $1.4 billion in purchases of our previously leased corporate office space as well as property for development of additional corporate office space located at Seattle, Washington which we purchased in fourth quarter 2012. The increase in capital expenditures reflects additional investments in support of continued business growth consisting of investments in technology, infrastructure, including the Amazon Web Services and additional capacity to support our fulfillment operations.

Return on invested capital was 1%, down from 12%. ROIC is TTM free cash flow divided by average total assets minus current liabilities, excluding the current portion of long-term debt over five quarter ends.

The combination of common stock and stock-based awards outstanding was 471 million shares, compared with 461 million one year ago. Worldwide revenue grew 22% to $16.07 billion, or 24% excluding the $302 million unfavorable impact from year-over-year changes in foreign exchange rates. We're grateful to our customers who continue to take advantage of our low prices, vast selection and shipping offers.

Media revenue increased to $5.06 billion, up 7% or 10% excluding foreign exchange. EGM revenue increased to $10.21 billion, up 28% or 30% excluding foreign exchange. Worldwide EGM increased to 64% of worldwide sales, up from 60%. Worldwide paid unit growth was 30%. Active customer accounts exceeded $209 million. Worldwide active seller accounts were more than 2 million. Seller units represented 40% of paid units.

Now, I'll discuss operating expenses excluding stock-based compensation. Cost of sales was $11.8 billion or 73.4% of revenue compared with 76.1%. Fulfillment, marketing, technology and content and G&A combined was $3.83 billion or 23.8% of sales, up approximately 289 basis points year-over-year. Fulfillment was $1.74 billion or 10.8% of revenue compared with 9.5%. Tech and content was $1.26 billion or 7.9% of revenue compared with 6.5%. Marketing was $616 million or 3.8% of revenue compared with 3.6%.

Now, I'll talk about our segment results and consistent with prior periods, we do not allocate the segments or stock-based compensation or other operating expense line item. In the North America segment, revenue grew 26% to $9.39 billion.

Media revenue grew 14% to $2.51 billion. EGM revenue grew 28% to $6.13 billion, representing 65% of North America revenues, up from 64%. North America segment operating income increased to 31% to $457 million, a 4.9% operating margin.

In the International segment revenue grew 16% to $6.68 billion adjusting for the $301 million year-over-year unfavorable foreign exchange impact revenue growth was 21%.

Media revenue grew 1% to $2.54 billion or 7% excluding foreign exchange and EGM revenue grew 28% to $4.09 billion or 32% excluding foreign exchange. EGM now represents 61% of International revenues, up from 56%.

International segment operating loss was $16 million a 0.2% negative operating margin compared with income of $49 million.

CSOI increased 11% to $441 million, or 2.7% of revenue down approximately 27 basis point year-over-year.

Unlike CSOI our GAAP operating income includes stock-based compensation expense and other operating expense. GAAP operating income decreased 6% to $181 million, or 1.1% of net sales.

Our income tax benefit was $18 million and includes $46 million of discrete tax benefits, primarily resulting from the retroactive reinstatement of the federal research and development credit that was enacted in January 2013.

GAAP net income was $82 main, or $0.18 per diluted share, compared with $130 million and $0.28 per diluted share.

Turning to the balance sheet cash and marketable securities increased $2.18 billion year-over-year to $7.89 billion. Inventory increased 27% to $5.4 billion and inventory turns were 9.5 down from 10.4 turns a year ago as we expanded selection, improved in stock levels and introduced new product categories.

Accounts payable increased 29% to $8.92 billion and accounts payable days increased to 68 from 62 in the prior year.

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 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, investments or settlements, record any further revisions to stock-based compensation estimates and that foreign exchange rates remain approximately where they've been recently.

For Q2, 2013, we expect net sales of between $14.5 billion and $16.2 billion, a growth of between 13% and 26%. This guidance anticipates approximately 275 basis points of unfavorable impact from foreign exchange rates. GAAP operating income or loss to be between $340 million loss and $10 million income compared to $107 million income in the prior year period. This includes approximately $340 million for stock-based compensation and amortization of intangible assets.

We anticipate consolidated segment operating income, which excludes stock-based compensation and other operating expenses to be between zero and $350 million compared to $360 million in the prior year period. 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, and with that Sean, let’s move to question.

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

Transcript Call Date 04/25/2013

Operator: Brian Pitz, Jefferies & Co.

Brian Pitz - Jefferies & Co.: In February, you changed your FPA fulfillment fees, any comments on how this affected third party sales and what was the overall merchant response? And then just quickly, any update on your latest plans for new fulfillment centers in 2013?

Thomas J. Szkutak - SVP and CFO: In terms of – I'll take the second part of the question first. In terms of new fulfillment centers, we've announced three in the U.S. right now and then a few outside of U.S. consistent with prior years. It's early. We really like the growth that we're experiencing. We'll be adding more of these through the course of the year, but stay tuned and we'll update you as we go. In terms of FPA, there is not a lot I can talk to there. We're very pleased with the FPA business. We think it's great for sellers and great for customers, and we're pleased to offer that service.

Operator: Scott Devitt, Morgan Stanley.

Scott Devitt - Morgan Stanley: Tom the International segment sales growth of 21% continues to show modest deceleration and I think with the exception of 4Q it's been trailing U.S. growth and understand that AWS is mostly booked in the U.S. so that’s a piece of the delta. But you've talked in the past quarters about the investments in International driving margin to at least breakeven levels in International I was wondering if you could just talk through the deceleration and the revenue growth in those markets and whether that’s comp related Europe, macro or otherwise. Then secondly in the shipping cost on a net basis is again leveraging I think that’s a second consecutive quarter. I just wonder if you could refresh us in terms of when the accounting change occurred in terms of the shipping revenue calculation for FBA to just understand if that’s an organic number now. Thank you.

Thomas J. Szkutak - SVP and CFO: The second half of the question. There is -- it is organic so there's no, it's consistent year-over-year. So this is the first quarter it'll be consistent year-over-year. In terms of your question on International, we're seeing still very solid growth of 21% on a local currency basis. As you've read certainly there is some softness from a macro standpoint that others are seeing hard to know whether that’s impacting us and how much we are not a bellwether for the economy. But we are very pleased with the growth that we are seeing again 21% on a local currency basis. Unit growth was actually growing substantially faster than that. So again that's what we are seeing. In terms of investing you are absolutely right we're investing in a number of geographies, including certainly in China. We've been investing for several years. We'll continue to invest there. We think it's a great long-term opportunity, but we are in investment mode and certainly some of the more recent additions that we've had with Italy and Spain are certainly in investment mode as well.

Operator: Mark Mahaney, RBC Capital Markets.

Mark Mahaney - RBC Capital Markets: Just a broad question on demand that's kind of mid-teens at the low-end of revenue growth that you've been guiding to for a quarter or two now that would seem well below the average that you've seen in the past. Are there any other factors you would want to call out or specifically not call out? Do you think that things like the imposition of state sales taxes are having a near-term drag on growth rates? Last quarter, and you talked about consumer electronics at the high-end, is there any particular categories there you would want to call out as maybe driving that low that could produce a low-end of the range outside of negative FX? Thanks Tom.

Thomas J. Szkutak - SVP and CFO: Sure. We give, as we've been consistently doing, we're giving a wide range. We think that's appropriate given all the factors. That's not something new that we are doing, that's something that we have been doing for some time. You are right; the growth rate guidance for Q2 is 13% to 26%, certainly, foreign exchange having an impact that includes approximately 275 basis points of foreign exchange, so it's approximately 16% to 29% on a local currency basis. So, again, it's a wide range and there's probably not a lot to add there, but it takes into account all the things that we think we need to take into account as we give guidance. In terms of the absolute dollar range, it's very similar to what we would have in terms of the dollar range, we would have given for Q1, I think, its maybe $100 million difference in terms of the absolute value of that range that we gave. So, again a wide range, we think that that's appropriate.

Operator: Ben Schachter, Macquarie Securities.

Ben Schachter - Macquarie Securities: Are there any factors that are impacting the unit growth, particularly in the shift from physical to digital, for instance, rented video versus a purchasing of video, or is there any other factor that you'd highlight that are impacting the unit growth?

Thomas J. Szkutak - SVP and CFO: The one factor I would call out, first of all in terms of overall unit growth, our overall unit growth is 30% year-over-year, again a very solid growth. It compares to approximately 49% in Q1 of last year, so it's certainly overlapping a pretty strong growth last Q1. In terms of the physical and digital, certainly one thing that we're seeing is, certainly digital is growing at a much faster rate and we do see that, a little bit is in our third-part units as a percentage of total units. You will see that, that's approximately 40% this quarter that compares to last year up about, approximately 100 basis points. What you are seeing is because the digital units are growing at a faster rate and they are mostly first-party, you are seeing that number impacted where that percentage, as a percentage of our total is not growing as fast as it has last few quarter. And again, that's largely driven by the digital units growth that you're seeing. So again its if you were to back out for example and just look at our physical units our physical units as a percentage of total units this year versus last year is up over 300 basis points. Again that’s 3P growth as a percentage of total units.

Operator: Ross Sandler, Deutsche Bank.

Ross Sandler - Deutsche Bank: Question on the – follow-up question on the shipping, so just to your shipping cost not your net shipping margin, but just shipping cost relative to gross profit declined about 300 basis points, similarly to what you've seen over the past four quarters. So as you start to comp some of these efficiency gains that you are seeing in shipping. Do you think that line will continue to show leverage or is it going to start to level out from here? Thanks.

Thomas J. Szkutak - SVP and CFO: I'm certainly not giving guidance on any specific line item, but certainly over a long period of time we think there's opportunity to be more productive there and there is certainly efficiency gains to be had there and that's certainly that team will continuously work on.

Operator: Colin Sebastian, Robert W Baird & Company.

Colin Sebastian - Robert W Baird & Company: Just a question on web services, wonder if you can comment on enterprise-level adoption and whether there are any meaningful barriers to that happening over time, we noticed you've been pretty aggressive in hiring enterprise-level sales people.

Thomas J. Szkutak - SVP and CFO: I don't think that there is. I think the team has done a fantastic job in terms of developing services that are great for many different customer types, including enterprises, and the team is heads down focused on making sure we have a great operational services or great from an operational standpoint and securities standpoint and they are doing a terrific job and so, it's a very great opportunity for enterprises to adopt our Web Services and the team is certainly focused on that along with other customers. So again it's a great opportunity for those customers and for us.

Operator: Douglas Anmuth, JPMorgan.

Douglas Anmuth - JPMorgan: You've clearly been more aggressive in terms of video content recently and you are sort of leading with it more in the release tonight in terms of the business content. I was hoping you could just add some more color here on the value that you think that TV and movie content adds to consumers overall purchase patterns? Thanks.

Thomas J. Szkutak - SVP and CFO: Sure. It's certainly one of our digital offerings, and we have a number of – few different services. We have certainly content that we're using as part of our Prime offer that we have a lot of free content for customers. We think that's a great service to customers along with our express shipping offers as well as other content that we have free, for example, our Kindle Owners' Lending Library for books. So again, we think it's a great, Prime's a great value for customs and it's part of that value proposition. We also have a very good transaction business for video as well that's growing very, very fast and certainly customers like it and we're seeing that reflected in the results that you see today.

Operator: Justin Post, Merrill Lynch.

Justin Post - Merrill Lynch: Wondering if you could help us little bit about the Kindle ecosystem. On prior calls, a few years ago, you singled it out as a fast growth area and you are very happy with the performance. We haven't heard as much about it lately. Kind of the impact of sort of how units are doing against your expectations and then the impact it's having on prime subs and also your gross and operating margins?

Thomas J. Szkutak - SVP and CFO: We're very pleased with Kindle in digital business and we're super excited in terms of the ecosystem. You are certainly seeing that in the results that you see today. For example, if you look at our media growth, we're certainly that ecosystem is more penetrated there than it is in International and you see that reflected in those associated growth rates. Another way you see it is, if you take a look at our top-10 best-selling items worldwide in Q1, the top-10 are all either digital or Kindle related. Paperwhite is our best-selling product worldwide, but again all ten spots in Q1 were either Kindle or digital items. And I believe that that's the first time that we've seen that. We've been looking at that from a quarter result standpoint for some period of time and we've had you know various levels of the top-10, but I think this maybe the first quarter, we've had all top-10 being either Kindle-related or digital related. So, again we're very pleased with what we're doing there and you know, we're going to continue to innovate on behalf of customers.

Justin Post - Merrill Lynch: Any impact on your gross or operating margins. You want to call out?

Thomas J. Szkutak - SVP and CFO: One thing I would say is we certainly are investing. It's certainly an area of investment and you're seeing that reflected we're making a number of investments across the business and certainly we're investing in Kindle and our digital offerings we're investing in some of the things I mentioned earlier, like China. Some of the emerging geographies so those are certainly some of the larger key investments we're making.

Operator: Matt Nemer, Wells Fargo Securities.

Matt Nemer - Wells Fargo Securities: We are hearing reports that there is refrigeration equipment going into some of your fulfillment centers outside of Seattle area. Just wondering if you can update us on plans to expand AmazonFresh?

Thomas J. Szkutak - SVP and CFO: I have nothing to announce, very pleased with that we've seen in the Seattle area. But again it's been test and we continue to monitor that test carefully. It's certainly something that we see that customers love the experience. The challenge has always been to make sure we can get the economics right and that's something we'll continue to focus on.

Operator: Stephen Ju, Credit Suisse.

Stephen Ju - Credit Suisse: Tom anything you can say in terms of how much Amazon is to video as well as potentially your own in-house produced content currently helps and will sure in the future help reduce churn in Amazon Prime.

Thomas J. Szkutak - SVP and CFO: It's something -- we haven't released any of the numbers it's something that we're tracking very closely it is something that we believe over time will reduce churn and is certainly helping today. What we are seeing is great traction. We see a lot of usage of the service, customers love it and we think it's a very interesting part of Prime offering and that's why we have been expanding and why you see some of the more recent announcement, including some of the stuff included in the earnings release today around original content. So again, it's something that we find very interesting and we're excited about it.

Operator: Ken Sena, Evercore Partners.

Ken Sena - Evercore Partners: I was just hoping you could maybe provide a little more color on the unit growth deceleration. Looking back over the last four quarters it seems like about 500 basis points or so each quarter of deceleration. You had about 200 basis points here, which is an improvement, but anything you could say just to any signs of maturity in some of the businesses maybe where that deceleration is specifically coming from? Thank you.

Thomas J. Szkutak - SVP and CFO: No, there's not a lot I can add. I mean I think the 30% is still a very strong growth rate. Again, it's growing at a faster rate than revenue, revenue at 22%, revenue at a local currency growth of 24%, very strong. Third-party growth continues to be very strong. Retail growth is strong. So again, there's not a lot I can provide you there, but again keep in mind that we are overlapping 49% growth last year Q1, which is certainly a little bit of a difficult compare, but again pleased with the 30% growth rate.

Operator: John Blackledge, Cowen and Co.

John Blackledge - Cowen and Co.: Just a question on the Amazon Advertising Platform, given the immense amount of purchase day do you have on Amazon customers, how is that being used as a competitive advantage and maybe you just provide an overall view on the direction of the Amazon Ad Platform over time?

Thomas J. Szkutak - SVP and CFO: In terms of the platform itself, we think it's a very sizable, very good long-term opportunity for us, and it's something that we've been working on for some time and we think it's very interesting. One thing you will notice, you know on our site, we're being obviously very – making sure the customer experience is great. What we're really trying to do is we're trying to help customers you know find and discover what they want to buy online. So, we're very – again, it's very customer centric, but it's also from a business standpoint a very good long-term opportunity. We have a great team that's working on the opportunity and we're excited about the long-term potential of it.

Operator: Anthony Diclemente, Barclays.

Anthony Diclemente - Barclays: I'm just wondering what you're seeing in terms of the attach rate of your transactional video-on-demand business versus usage of Prime Instant Video, I'm wondering just if your consumers tend to choose between the two, one they are making a selection or does one sort of drive the other, does a Prime subscriber have a higher transaction VOD attach rate than a non-prime. So, it will be helpful to hear what you're seeing there in terms of usage.

Thomas J. Szkutak - SVP and CFO: Yes. I think the only thing I could help you with is, we see I'll take Prime customers for example. We certainly see adoption of service in terms of free content. But those same customers are purchasing content as well and so there is a good attachment to it, which we like. And what we see Prime members doing not just within video content. But we see them doing a lot of cross shopping. So it's not surprising, we see them do maybe a customer comes and has been traditionally purchasing pre-Prime in a few categories we find that they do a lot more cross shopping, same thing with digital content. As they use the service, they may start with free content and then they will also continue to view and stream free content, but also purchase paid content. So it’s a nice effect that we are seeing which is why we like Prime so much.

Operator: Youssef Squali, Cantor Fitzgerald.

Youssef Squali - Cantor Fitzgerald: Two quick questions please, going back to the International, question. What’s causing International media to decelerate I think last year Q1 I think it was up 22% FX adjusted this quarter was up 7% is it all macro or are there any maybe other factors that you couldn’t talk about. Maybe specific to skews or something. And the other is more of a clarification, I know last quarter you gave the unit growth in aggregate versus the unit growth of 3P I was wondering if you could give that to us as well?

Thomas J. Szkutak - SVP and CFO: In terms of the International media growth this quarter was 1% on a dollar basis 7% on a local currency basis. In terms of the overall growth rate, certainly what you are seeing is digital content as part of that is growing very fast, but it's not as large or as penetrated. Our ecosystem isn't as developed I would say as it is in the U.S., and so, when you compare the two geographies for a second, that's one of the more meaningful differences that you see between the two. As you see that both are growing digital content very fast, it's just the ecosystems is more built out in North America. But again, certainly see very positive signs not given the growth we are experiencing in International, it's just on a lower base. So, that's again to be helpful there. In terms of the unit growth, we said that our overall unit growth was 30% for the quarter. Our 3P unit growth, I don't have the overall growth rate, but it's growing at a faster rate than the total.

Operator: Jordan Rohan, Stifel Nicolaus.

Jordan Rohan - Stifel Nicolaus: I was hoping you could comment on the market entry and expansion strategy for Amazon in Brazil. There seemed to be tremendous amount of press last year about it and it seems to have died to some degree. I know the Company may already be there with Amazon Web Services and some Kindle offerings, but when do you think that might get a little bit broader? Secondly, there's been some stories recently about an Internet streaming device or box or set-top box, something of those sorts. Can you comment on any new hardware form factors including apps as of some sort of a cell phone or handset that might be coming down the pipe, anything to look forward to in the Kindle family or related? Thanks.

Thomas J. Szkutak - SVP and CFO: In terms of geographic expansion, you know there is not a lot I can say specifically about Brazil. We think we're in the right geographies right now. We've expanded into a number of geographies over the past few years. That is certainly something always we look at, and you should expect us to expand into additional geographies over time. In terms of any question related to our product roadmap, you know we don't – we have a long-standing practice of not talking about what we might or might not do there, but we're certainly excited about the product roadmap that we have for the future, and you know, again we have a long-standing practice of not giving details until closer at launch.

Operator: Jason Helfstein, Oppenheimer & Co.

Jason Helfstein - Oppenheimer & Co.: Can you give us a little more color around customer growth, I mean, that number has been slowing not dramatically, but that is a slowing trend. Are you focused more on higher value customers to drive the business and any color around the quarter would be helpful?

Thomas J. Szkutak - SVP and CFO: We're actually pleased with the growth from a customer standpoint. We've seen very good growth and we continue to – we have many, many teams across Amazon that are just heads down focused on trying to improve the customer experience and inventing on behalf of customers. So, we couldn't be more pleased with what they doing, and you see that reflected in our overall growth rate this quarter with revenue up 24% on a local currency basis and units growing at 30% on top of strong growth quarter last year Q1.

Sean Boyle - 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 and look forward to talking with you again next quarter.