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Amazon.com, Inc. (NASDAQ:AMZN)

Q4 2009 Earnings Call

January 28, 2010 5:00 pm ET

Executives

Rob Eldridge - Investor Relations

Thomas J. Szkutak - Chief Financial Officer

Analysts

Mark Mahaney – Citi

James Mitchell – Goldman Sachs

Imran Khan – J.P. Morgan

Jeetil Patel – Deutsche Bank

Justin Post – Bank of America-Merrill Lynch

Douglas Anmuth – Barclays Capital

Scott Devitt - Morgan Stanley

Sandeep Aggarwal – Collins Stewart

Benjamin Schachter – Broadpoint AmTech

Youssef Squali – Jefferies & Co.

Colin Sebastien – Lazard Capital Markets

Operator

Good day and welcome to the Amazon.com Q4 financial results conference. (Operator Instructions) For today’s opening remarks and introductions, I would like to turn the call over to Mr. Rob Eldridge. Please go ahead, sir.

Rob Eldridge

Hello and welcome to our Q4 2009 financial results conference call. Joining us today is Tom Szkutak, our CFO. He and I will be available for questions after our prepared remarks.

The following discussion or responses to your questions reflect management's views as of today, January 28, 2010 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 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 will 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 2008. Now I will turn the call over to Tom.

Thomas J. Szkutak

Thanks Rob. I will begin with comments on our fourth quarter financial results. Trailing 12-month free cash flow grew 114% to $2.92 billion. Return on invested capital was 66% up from 41%. ROIC is trailing 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 461 million shares compared with 446 million. Worldwide revenue grew 42% to $9.52 billion or 37% excluding the $354 million favorable impact from year-over-year changes in foreign exchange rates.

We are grateful to our customers who continue to take advantage of our low prices, best selection and free shipping offers including Amazon Prime.

Media revenue increased to $4.68 billion, up 29% or 23% excluding FX rates.

EGM revenue increased to $4.61 billion up 60% or 54% excluding FX rates. Worldwide EGM increased to 48% of worldwide sales, up from 43%.

Worldwide unit growth was 37%. Active customer accounts exceeded 105 million, up 19%. Worldwide active seller accounts were more than 1.9 million, up 24%. Seller units were 28% of total units.

Worldwide gross profit was $1.98 billion, up 47%.

Now I will discuss operating expenses excluding stock-based compensation. Fulfillment, marketing, technology and content and G&A combined was $1.3 billion or 14.5% of sales, down 25 basis points year-over-year. Fulfillment was $733 million or 7.7% of revenue compared with 7.9%.

Tech and content was $297 million or 3.1% of revenue compared with 3.5%.

Marketing was $269 million or 2.8% of revenue, up from 2.5% in the prior year.

Now I will talk about our segment results and consistent with prior periods, we do not allocate to segments or stock based compensation or other operating expense line items.

In the North America segment, revenue grew 36% to $4.96 billion. Zappos, which is included in our results beginning November 1, 2009 contributed approximately $200 million to our fourth quarter revenue.

Media revenue grew 20% to $2.1 billion. EGM revenue grew 54% to $2.66 billion, representing 54% of North America revenues, up from 48%. North America gross profit grew 50% to $1.17 billion and gross margin increased 211 basis points to 23.6%, driven by increases in other revenue, improvements in inventory management including vendor pricing and increases in 3P product sales, partially offset by lower prices for our customers and changes in product mix.

North America segment operating income increased 113% to $278 million, or 5.6% operating margin.

In the international segment, revenue grew 49% to $4.56 billion. Revenue growth was 37%, adjusting for the $344 million year-over-year favorable impact on foreign exchange rates during the quarter.

Media revenue grew 37% to $2.58 billion or 26% excluding FX. And EGM revenue grew 68% to $1.95 billion or 56% excluding FX. EGM now represents 43% of international revenues, up from 38%.

International gross profit grew 42% to $806 million, or grew 31% excluding FX, while gross margin decreased 79 basis points to 17.7%, driven by lower prices for our customers and changes in product mix, partially offset by improvements in inventory management including vendor pricing and increases in 3P product sales.

International segment operating income increased 39% to $319 million, a 7% operating margin. Excluding the favorable impact from foreign exchange rates, international segment operating income increased 25%.

Consolidated segment operating income grew 66% to $597 million or 6.3% of revenue, up 91 basis points year over year. Excluding the $31 million favorable impact from FX rates, CSOI grew 58%.

Unlike CSOI, our GAAP operating income includes stock-based compensation expense and other operating expense. GAAP operating income grew 75% to $476 million, or 5% of net sales.

Our income tax expense was $85 million in Q4, or an 18% rate for the quarter. GAAP net income was $384 million, or $0.85 per diluted share compared with $225 million and $0.52 per diluted share.

Now I will discuss full year results. Revenue grew 28% to $24.51 billion or 29% excluding the $182 million unfavorable impact of year-over-year changes in foreign exchange rates.

North America revenue grew 25% to $12.83 billion, and International grew 31% to $11.68 billion, or 33% growth excluding year over year changes in FX.

Consolidated segment operating income or CSOI grew 44% to $1.57 billion or 48% excluding $40 million of unfavorable impact from FX rates, and operating margin increased 71 basis points to 6.4%.

GAAP operating income grew 34% to $1.13 billion or 4.6% of net sales.

Turning to the balance sheet, cash and marketable securities increased $2.64 billion year over year to $6.37 billion. Our cash and marketable securities primarily consist of cash, government and government agency securities, AAA rated money market funds and other investment grade securities. Such amounts are recorded at fair value.

In January 2010 our board of directors authorized a program to repurchase up to $1 billion of our common stock, replacing our previous share repurchase program.

Inventory increased 55% to $2.17 billion and inventory turns were 12.2, unchanged from a year ago, even as we expanded selection, improved in-stock levels, and introduced new product categories.

Accounts payable increased 56% to $5.61 billion and accounts payable days increased to 68 from 62 in the prior year.

Our 2009 capital expenditures were $373 million.

While we are not providing CapEx guidance on today’s call, we want to remind you that we are beginning the transition to our new Seattle offices this year. We will incur incremental CapEx of approximately $100 million in 2010 in support of this multi-year project.

I will 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 to date to be appropriately conservative assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including the high level of uncertainty surrounding exchange rate fluctuations, as well as the global economy and consumer spending.

It is not possible to accurately predict demand and therefore our actual results could differ materially from our guidance.

As we describe in more detail in our public filings, issues such as: settling intra-company 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 have been recently.

We are prospectively adopting accounting standard update #2009-13, Revenue Recognition, Multiple Delivery Revenue Arrangements as of January 1, 2010. Sales of our Kindle e-Reader are considered arrangements with multiple elements which include the device, wireless connectivity and software upgrades. The revenue related to the device, which is a substantial portion of the total sales price, and related costs, will be recognized at the time of delivery.

Revenue for the wireless connectivity and the software upgrades will continue to be amortized over the life of the device, which remains estimated at two years. The impact of the adoption of the standard is included in the first quarter 2010 guidance.

For Q1, we expect net sales of between $6.45 billion and $7 billion, or growth of between 32% and 43%. This guidance anticipates approximately 500 basis points of positive impact from foreign exchange.

GAAP operating income to be between $275 million and $365 million or growth between 13% and 50%. This includes approximately $100 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 $385 million and $475 million or growth of between 20% and 48%.

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, Rob, let's move to questions.

Rob Eldridge

Great. Thanks, Tom. Let's move on to the Q&A portion of the call. Operator, will you remind our listeners how to initiate a question?

Question-and-Answer

Operator

(Operator Instructions) Your first question comes from Mark Mahaney – Citi.

Mark Mahaney – Citi

Quick question. That tax rate of 18%, should we extrapolate from that going forward? Secondly, any broad comment on your ability to sell, increasingly sell, consumer staples, particularly momentum behind that Subscribe and Save program?

And then finally, could you help us quantify at all the Kindle impact? The difference in accounting, maybe by providing an adjustment for what Kindle revenue or something would have been like last year? Some way for us to parse out how much of an increase, or how much of the guidance could you speak to, to a change in the revenue recognition? Thanks a lot.

Thomas J. Szkutak

In terms of tax rate it was 18% for the quarter, 22% for the year. That includes certainly the reason why the change in Q4 is related to the jurisdictions that we operate in. Again, we are not providing guidance beyond 2009 for taxes.

In terms of consumer staples, it is certainly a category that we like. It is growing very nicely. Subscribers can save from an adoption standpoint, and it is working, so those are things we are going to continue to focus on, as well as other things to try to grow that particular category.

As it relates to the Kindle change, we have provided some information in the 10-K. Essentially the way you should think about guidance is certainly the change is effective 01/01/10 so it is included on our Q1 guidance, so for the units that we sell, a substantial portion of the price times those units will be reflected in our revenue. In addition to that, we have approximately $500 million of deferred revenue from shipments from last year that we amortized between 2010 and 2011. So a portion of that $500 million will also be in Q1.

Operator

Your next question comes from James Mitchell – Goldman Sachs.

James Mitchell – Goldman Sachs

Just to follow up on the previous question, you mentioned that a portion of the $500 million deferred revenue will be booked in Q1. Could you run through that, because I assume that it would be a retroactive restatement from previous quarters.

Also, when you look at the Zappos benefit to 1Q10 revenue, is it [inaudible] 4Q09 $200 million, given on the one hand you have a full three months in the quarter? But on the other hand, it is the seasonally slower quarter? Thank you.

Thomas J. Szkutak

In terms of the change, we are adopting it prospectively so as of 01/01 we are not restating. So again, that is reflected in our Q1 guidance.

In terms of Zappos, how to think about it, I think probably the best way to do it would be – again, we are not giving guidance on Zappos specifically, it is reflected in the guidance that we gave for Q1 – we have released certainly previous quarters so you can go back to Q1 of last year and make your own assumptions in terms of growth rate for year over year and certainly there would be a range there, but you can see that is probably the best way to think about it and look at what you would put in for Q1.

Operator

Your next question comes from Imran Khan – J.P. Morgan.

Imran Khan – J.P. Morgan

Thank you for taking my questions. One is housekeeping and one more of a big picture question. Housekeeping North American gross margins improved 200 basis points on a year over year basis? I am trying to understand what are some of the moving parts that are helping drive these gross margins higher, and how should we think about the swing factors in the North American gross margins.

Secondly, as we look at the media business become more digital and we see more and more new devices coming to the marketplace, could you help us understand how AMZN’s competitive position change in the marketplace? i.e. physical versus web, you have some competitive advantage but if a lot more devices are sold that you can download books electronically, how does your competitive position change?

Thomas J. Szkutak

In terms of your first question, North American gross margins are up a little over 200 basis points as you mentioned. A number of drivers, certainly we had a nice increase in other revenue which includes the web services business and those other agreements that go into that line item. Inventory management, we are getting better at inventory management which also flows into our operating results as well. We are getting better prices from suppliers and partners. We had good third party sales. Those are the key contributors.

Partially offsetting that were certainly lower prices during the quarter, so those are the drivers for gross margin.

In terms of how we are thinking about the digital and physical within media, we think we are positioned very nicely from a digital perspective. We have obviously some longer-standing relationships with many, many different partners around the world in those particular categories. We think we are focused on the customer and I think Kindle is certainly a good example of that. We think we’ve built a very-nice purpose-built device – excuse me, that is purpose-built for reading and we believe that readers deserve to have a dedicated device with great selection and great prices.

So those are the things we’ve worked on in the 27 months since launch and those are the things we will continue to focus on starting with the customer.

Operator

Your next question comes from Jeetil Patel – Deutsche Bank.

Jeetil Patel – Deutsche Bank

First of all, you’ve been in Prime in the international markets for a little over two years now, and if we go back domestically you saw a nice little acceleration in unit growth when you hit the two-year mark. Is it safe to assume that you are seeing a similar trend internationally given the growth internationally plus the unit growth acceleration?

Second question, you have got a lot of different services you’ve worked on over the years between Kindle, digital music, digital video, cloud computing and web services. Is there any sort of perspective or view that you have that maybe there is an opportunity to consolidate or integrate all of these services together in a unified platform that can be licensed or OEM’d to other companies to utilize while you manage the background behind it?

Thomas J. Szkutak

In terms of your first question, Prime, we are very pleased with the performance of Prime in each of the geographies and it is certainly contributing to our international growth as well as it continues to help our North American growth. So other factors that are also helping international are certainly we’ve added a number of categories; along with those categories comes a lot of selection. We’ve continue to improve our in-stock levels. Prime, as you’ve mentioned is helping and just making sure we have great prices. So getting product to customers fast is important and Prime is one of the ways that helps us do that.

In terms of your second question, I am not sure there is a lot I can help you with there. In each of those services our primary focus is that we have a great customer experience, and that is the one thing that is common in all of those and we are going to continue to focus as we have in our physical business on how do we make sure that we have an integrated experience, and those are the things that are common.

Jeetil Patel – Deutsche Bank

Do you think all those individual services can be offered as a bundled solution?

Thomas J. Szkutak

I would hate to speculate on something like that. We are focused on what is right for customers and many of those have distinct customer sets that are different from each other and we are focused on how to make that experience great.

Operator

Your next question comes from Justin Post – Bank of America-Merrill Lynch.

Justin Post – Bank of America-Merrill Lynch

Two questions. First, when you look at the deferred revenues on the cash flow statement I think you recognized 444, you had that much as deferred revenues this year in the fourth quarter versus 162. My first question is, is there anything materially different besides Kindle in those two numbers?

Second thing, you say you have millions of Kindle users. Is it safe to assume that you have over 2 million now, at least?

Finally, when you think about the category roll out road map, could you give us any thoughts on where you are in that? Are you 80% of all the categories you can roll out? Or are there still a lot more opportunity? How would you frame that opportunity at this point in your life cycle? Thank you.

Thomas J. Szkutak

In terms of deferred revenue, there are a number of things that go into deferred revenue. Certainly Kindle has been one of those. Kindle has [inaudible] for some time as we roll that off. The other is certainly Prime, as well as a few others, but those are certainly two of the bigger items.

In terms of category roll out, hard to say in percentage terms but we have a lot of room to add additional selections. If you look at it on a worldwide basis, think about it this way: we have many new geographies that we can enter, some of which, many that we support today from an export standpoint but we could certainly roll out more geographies, so we can add category selection there.

We can add many new categories in all of our geographies, and then also we are adding a selection in categories that we’ve been in for 10 or more years, each year we continue to grow the selection of those categories. So it is one of the inputs to growth. It is one that we are very focused on and we continue to be focused on for many years to come, because there is just a lot of selection to add.

And then I think there was a third part, I apologize…

Justin Post – Bank of America-Merrill Lynch

For Kindle users, is it at least 2 million? Can you give us any thoughts on that?

Thomas J. Szkutak

Again, other than the quote I can’t really add much to that.

Operator

Your next question comes from Douglas Anmuth – Barclays Capital.

Douglas Anmuth – Barclays Capital

Thanks for taking questions. Can you talk about your thoughts on potentially opening up to the epub reader standards for the Kindle, and also provide some color on why you’ve separated the Kindle device team from the Kindle media team internally? Thanks.

Rob Eldridge

Hi Doug, it’s Rob here. How are you doing? In terms of epub, our platform here is designed to have a seamless experience across the whole set of devices with whisper sync, and we think that’s the right customer experience for us to continue to deliver in the future.

And your second question?

Douglas Anmuth – Barclays Capital

Separating out the Kindle device team from the Kindle media team internally.

Thomas J. Szkutak

Again, we are not commenting on how we are organized, we have a great team across many geographies to figure out the best way to serve customers and beyond that we can’t comment.

Operator

Your next question comes from Scott Devitt - Morgan Stanley.

Scott Devitt - Morgan Stanley

Thanks for taking the question. First was related to the emergence of new hardware in the digital book business and also the emergence of potentially higher price points and how you think that your relationship with publishers could potentially evolve over time in terms of impacting the $9.99 price point?

Secondly, and again just qualitatively because I know you won’t answer this directly, but 3P mix U.S. versus International, can you give us some gauge in terms of the differences and distinctions in those areas? Thank you.

Thomas J. Szkutak

In terms of 3P, we are again pleased with both segments. We continue to grow nicely in our seller business and we continue to look for ways to improve that experience not only for our customers but for sellers, which is certainly another customer set that we have. One example of that is fulfill by Amazon which has certainly been helpful in terms of growing our selection from sellers and the number of sellers as well.

In terms of discussions about any of the other relationships with vendors, and this would be any category, not just the one that you mentioned, certainly any of those discussions that we would have would be between us and those particular partners. But the main focus of those discussions would always be for us, how do we make sure we can offer customers the selection they want at great low prices? So those are the things that we are always continually focused on in each of our categories and each of our geographies.

Operator

Your next question comes from Sandeep Aggarwal – Collins Stewart.

Sandeep Aggarwal – Collins Stewart

Thanks for taking my question. Tom, can you talk about the international penetration of Kindle? I know you don’t talk about the units, but maybe in terms of number of countries where the Kindle is not available? But internationally, perhaps the ratio of U.S. versus non-U.S. units sold, or maybe the growth trajectory of Kindles sold in U.S. versus International?

Thomas J. Szkutak

Sure, obviously we are not providing a lot of data. It is available in 130 countries today. We think it is a great opportunity for customers as well as for us long term, and we are continually trying to figure out ways in those geographies even better than it is today. I can’t add any more detail to that.

Operator

Your next question comes from Benjamin Schachter – Broadpoint AmTech.

Benjamin Schachter – Broadpoint AmTech

I just want to go back to the U.S. gross margin question. As I recall last year you talked a lot about the macro situation leading to better pricing from vendors, this year it sounds like you also got better pricing from your vendors. So any qualitative remarks on what is driving your ability to get the better vendor pricing? Is it purely volume or are there other things there?

And then just quickly, any comments on the Amazon branded products? Any update there? Thanks.

Thomas J. Szkutak

Sure. No, it is certainly the biggest factor would be volume, but it is in a few different pieces. One is you can take a look at our overall growth, which in the case of North America was up 36%, that was certainly helped by Zappos as part of that. If you take out Zappos from the number that I gave you it would be 31% growth which is still a nice acceleration from where we’ve been recently.

So that is one, just overall volume. The other is when you look at North America, some of the categories that we’re in that we’ve just started a few years ago becoming more and more meaningful, so as those become more and more meaningful good things happen. We are able to get better prices from suppliers but also they become more attractive for third-party sellers to sell on our detail pages, so it is a combination of those items that allowed us to grow gross margins in Q4, while lowering prices for customers, so it was a combination of those factors.

Operator

Your next question comes from Youssef Squali – Jefferies & Co.

Youssef Squali – Jefferies & Co.

In the press release it said something to the effect that you sell six Kindle books for every ten physical books. Can you give us that number a year ago just so we can have something to compare it to?

Second, I would like to ask the inverse of that question with regard to Apple and the operating system. Will Apple continue to support the Kindle app with their iPad?

Thomas J. Szkutak

To your second question, yes. The answer to your first question is I can’t give you that, but again, so far this year six of ten was digital versus physical where we have both editions.

Operator

Your last question comes from Colin Sebastien – Lazard Capital Markets.

Colin Sebastien – Lazard Capital Markets

First about your pricing strategy, if there has been any change there with regard to being a price follower or a price leader?

Secondly, looking at the Q1 outlook if you can talk about some of the variables that might lead to year over year contraction in the CSOI margin, was that Zappos-related perhaps, or deferred revenues from Kindle or something else?

Thomas J. Szkutak

In terms of pricing, no, nothing has changed. We are all about making sure we have great prices across all of our categories across all of our geographies so nothing has changed there. In terms of Q1 we have given a range that we think is appropriate and as you can see from the lower end of the range, as you described, for the upper range you see operating margins improving year over year and again, we are very positive about what we saw in Q4 as well as what we saw as we progressed throughout 2009 yet there is still a degree of uncertainty out there and so we think that is representative of the guidance that we’ve given and we think it is appropriate.

In terms of your other questions, in terms of individual breakouts of businesses, we are not providing that as part of our guidance.

Operator

Thank you. That concludes the question and answer session. Mr. Eldridge, I’ll turn the conference back over to you.

Rob Eldridge

Great. Thank you for joining us on the call today and for your questions. A replay will be available on the investor relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter.

Operator

This concludes today’s conference. Thank you for your participation.

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