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Here’s the entire text of the prepared remarks from Amazon’s (ticker: AMZN) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.

TRANSCRIPT SPONSOR
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Executives

Executives:

Tim Stone, Vice President of Investor Relations
Tom Szkutak, Senior Vice President and CFO
Jeff Bezos, President, CEO and Chairman

Analysts:

Doug Anmuth, Lehman Brothers, Analyst
Jeetil Patel, Deutsche Bank, Analyst
Brian Pitz, Morgan Stanley, Analyst
Anthony Noto, Goldman Sachs, Analyst
Justin Post, Merrill Lynch, Analyst
Imran Khan, JPMorgan, Analyst
Safa Rashtchy, Piper Jaffray, Analyst
Bob Peck, Bear Stearns, Analyst
Scott Devitt, Legg Mason, Analyst
Mark Rowen, Prudential, Analyst
Mark Mahaney, Citigroup, Analyst
Heath Terry, Credit Suisse First Boston, Analyst

[Operator]: Good day, everyone, and welcome to the Amazon.com Third Quarter 2005 Financial Results Conference Call. Today’s call is being recorded.

At this time, I would like to turn the call over to the Vice President of Investor Relations, Mr. Tim Stone. Please go ahead, sir.

[Tim Stone, Vice President of Investor Relations]

Hello, and welcome to our Q3 '05 financial results conference call. Joining us today is Tom Szkutak, our CFO. Jeff Bezos, our Founder and CEO, and Tom will both be available for Q&A.

The following discussion or responses to your questions reflect management's views as of today, October 25, 2005 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 2004 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, I 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 IR website, you'll find additional disclosures regarding these non-GAAP measures, including reconciliation to these measures of comparable GAAP measures.

Finally, unless otherwise stated, all comparisons in this call will be against the results for the comparable period of 2004.

Now, I'll turn the call over to Tom.

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[Tom Szkutak, Senior Vice President and CFO]

Thanks, Tim. This was another successful quarter for Amazon.com. I'll start with comments on our financial results. The financial measure we're working to maximize over the long term is free cash flow per share. Trailing 12 months free cash flow grew 13% to $475 million. As announced in August 2005, we settled a patent lawsuit on terms including a previously unanticipated payment of $40 million in Q3 2005.

Q3 2005 trailing 12 months free cash flow would have grown 22% to $515 million excluding this payment. Free cash flow is operating cash flow minus capital expenditures. Free cash excludes stock-based compensation and includes cash taxes paid, which is well below our booked tax provision due to our NOLs.

The combination of common stock and stock-based awards outstanding was 438 million shares, compared with 434 million, up 1%. Stock-based awards outstanding were 24 million or 5.8% of shares outstanding, down from 27 million or 6.5% of shares outstanding. We strive to efficiently manage share count to create more cash flow per share and long-term value for owners.

Return on invested capital was 34%. We now have $248 million of deferred tax assets, up from $12 million a year ago. For comparison, excluding tax assets and this $40 million legal settlement, ROIC would have been 44% flat with Q3 of 2004.

Revenue grew 27% to $1.86 billion or 28% excluding the $7 million unfavorable impact from year-over-year changes in foreign exchange rates. This was the first time in over three years that we have been negatively impacted by foreign exchange rates. We will continue to talk about our results with and without the impact of FX, as we have done since Q2 of 2002.

Q3 2005 worldwide revenue benefited by approximately 260 basis points of year-over-year growth from Harry Potter 6 tales plus pre-order attachments. Excluding Harry Potter 6 plus attachments and changes in foreign exchange rates, revenue growth accelerated to 25% in Q3, up from 24% on a comparable basis in Q2 of 2005.

Worldwide unit growth was 28%. Third-party units, representing Marketplace and Merchandise units sold by Amazon sites, were 30% of total units, up from 28%. Third-party units as a percentage of total units were 17% just three years ago.

Active customer accounts, representing customers who ordered in the past year, surpassed 52 million, up 19%. Media increased 20% to $1.3 billion. Electronics and other General Merchandise or EGM, increased 43% to $491 million, representing 26% of worldwide sales, up from 24%. And for the first time on a trailing 12 month basis, our sales were over $8 billion, 45% of which came from our International segment, and worldwide EGM sales surpassed $2.1 billion.

Gross profit grew 30% to $463 million in Q3, and gross margin increased 62 basis points to 24.9%, primarily due to increased third-party sales and a $29 million increase in other revenue, partially offset by a greater shipping loss, driven by free shipping in Amazon Prime, our lower product prices including customer savings on Harry Potter 6 and the continued mix shift to International and EGM. Although gross margins increased this quarter, I would like to take the opportunity to reiterate that we're focused on profit dollars, not percentage margins.

Now, I will discuss operating expenses excluding stock-based compensation expense under FAS 123(R), which we early adopted in Q1 this year.

Fulfillment, marketing, technology and content and G&A combined were $342 million or 18.4% of sales, up 59 basis points. Fulfillment was $166 million or 8.9% of sales, down 32 basis points. We have expanded our fulfillment capacity in 2005 through efficiency gains, as well as increases in leased warehouse space. We plan to continue expanding our worldwide fulfillment capacity in order to accommodate greater selection and meet anticipated shipment volumes from ourselves as well as third parties for whom we provide the fulfillment. We expect absolute amount spent in fulfillment and fulfillment-related cost of sales to increase over time. In Q3, we opened fulfillment centers in Pennsylvania, Texas and Scotland and our new fulfillment centers in Kentucky and Japan will open to serve customers in Q4.

Marketing was $42 million or 2.3% of sales, roughly flat as a percentage of sales year-over-year. Technology and content was $108 million or 5.8% of sales, up 136 basis points. We intend to continue hiring computer scientists and software engineers to invest in further innovation of customers, and we expect annual technology and content costs devoted to our sole platforms: Search, Web Services, Digital and other initiatives to increase in absolute dollars throughout 2005.

G&A was $26 million or 1.4% of sales, down 36 basis points. In Q3 2005, we recorded a $12 million credit for actual and expected reimbursement by an insurer of certain legal costs previously incurred by us. Excluding this credit, G&A would have been $38 million or 2.1% of sales, up 28 basis points.

Now, I will talk about our segment results. Consistent with prior periods, we don't allocate stock-based compensation or other operating expenses to our segments. In the North American segment, revenue grew 28% to $1.04 billion, the fastest rate of growth in over four years. Media revenue grew 21% to $684 million, including sales of Harry Potter 6 in Q3. In EGM, revenue grew 33% to $304 million, representing 29% of North America revenues, up from 28%.

Gross profit grew 31% to $292 million, and gross margin increased 71 basis points to 28.1%, largely due to a $29 million increase in high-margin other revenues and an increase in third-party sales, partially offset by Amazon Prime, our price reductions across product categories, product mix shift and free shipping.

North America segment operating income increased $9 million to $66 million, and operating margin declined 64 basis points to 6.4%. A significant majority of our technology and content costs are incurred in the US, with most of them allocated to our North America segment.

In the International segment, revenue grew 26% to $817 million. Revenue growth was 28%, adjusting for the $9 million year-over-year unfavorable impact from foreign exchange rates during the quarter.

Media revenue grew 19% to $629 million. In EGM, revenue grew 62% to $187 million, representing 23% of International revenues, up from 18%. Gross profit grew 29% to $171 million, while gross margin increased 47 basis points to 20.9%, primarily from an increase in third-party sales, partially offset by increased free shipping, product price reductions and product mix shift.

International segment operating income increased $17 million or 46% to $55 million, and operating margin increased 88 basis points to 6.7%. The combination of operating income in our North America and International segments is our consolidated segment operating income or CSOI. Our segment information financial statement in our press release reconciles CSOI to GAAP operating income. CSOI grew 28% to $121 million. Excluding the $12 million insurance reimbursement, consolidated segment operating income would have been $109 million or 5.9% operating margin.

Unlike CSOI, our GAAP operating income includes stock-based compensation expense and other operating expense. GAAP operating income decreased 32% to $55 million. Excluding the negative impact of the $40 million legal settlement, operating income would have increased 17% to $95 million or 5.1% operating margin.

Our provision for income taxes increased $18 million to $21 million in Q3, or a 42% rate for the quarter, which includes the year-to-date adjustment benefit of $4 million to reflect our current estimate of our annual effective tax rate of 50%. Our effective tax rate remains higher than the 35% statutory rate, primarily due to taxable income associated with the Q1 '05 transfer of certain operating assets from US to international locations. We expect these asset transfers to result in tax expense for financial reporting above the 35% statutory rate throughout 2005 and beneficially impact our effective tax rate over time.

On a cash basis, since we have NOLs, these asset transfers will not have a significant effect on cash taxes paid in 2005. We expect cash taxes paid to be approximately $25 million in 2005, compared with $4 million in 2004. Cash taxes paid were $11 million Year-to-date.

GAAP net income was $30 million or $0.07 per diluted share, compared with $54 million and $0.13 per diluted share. The $24 million decline in GAAP net income is primarily due to the $18 million increase in income taxes and $20 million after-tax impact of the litigation settlement. Excluding the legal settlement, net income would have been $50 million or $0.12 per diluted share.

Turning to the balance sheet, cash and marketable securities increased $234 million to $1.4 billion. Since Q3 '04, we repurchased $265 million of our convertible debt.

Inventory increased 28% to $456 million, and turns decreased 11% to 14.8, as we expanded the breadth of our product category selection in our fulfillment centers and took advantage of buying opportunities from vendors. Inventory turns have been approximately 15 each quarter this year. We will continue to increase our mix of direct buying in existing and new product categories, enabling us to offer even lower prices to customers.

Our investment in fixed assets, which includes net capitalized software development costs, increased 42% from a year ago to $322 million. Our capital expenditures were $76 million for Q3 and $149 million year to date. $57 million of year-to-date CapEx was software development costs.

Our growth continues to be fueled by our relentless focus on the primary inputs of customer experience: convenience, selection and price. Some recent examples of our progress include Amazon Prime. We continue to be pleased with the initial Amazon Prime results and have seen increased purchases by Amazon Prime customers across more categories, especially heavy purchases in electronics, tools, kitchen and health and personal care.

For $79 a year, Amazon Prime members get all-you-can-eat free express shipping. Customers continue to join Amazon Prime, and we anticipate even higher enrollment rates as we get closer to the holidays.

Amazon's Search Inside the Book program continues to expand rapidly. At this point, one out of every two books Amazon sells in the US are fully searchable. Working directly with publishers, Amazon has made it possible to search the complete interior text of hundreds of thousands of books. In addition to searching, customers can look at full interior pages that match their search criteria. Based on the success of the program in the US, we have now launched Search Inside the Book in the UK, Germany, France and Canada.

A9.com, a subsidiary of Amazon.com, launched A9.com Maps, a new service that shows users an interactive map and over 35 million corresponding street level images in a single interface in 24 cities.

Developers continue to adopt our Web Services tools. Over 135,000 have registered to date, upgraded in 60% year-over-year. One example of the flexibility and utility of Web Services is that customers can now exchange coins and bills at Coinstar centers with no transaction fee for a gift certificate instantly redeemable at Amazon.com. Coinstar implemented this using Amazon Web Services APIs. Third-party sellers remain a key part of our selection expansion. And worldwide active seller accounts, merchants with an order from a customer during the preceding 12 months, for the first time exceeded 1 million, up 29% year-over-year.

Some pricing highlights include the average customer discount across books, music and video products purchased on Amazon.com increased approximately 375 basis points year-over-year. The average customer discount for electronics purchased on Amazon.com increased over 100 basis points year-over-year. Customers so far this year have saved over $300 million on shipping through our worldwide free shipping offers in Amazon Prime. And starting today, customers shopping Amazon.co.uk now qualify for free shipping on orders over 15 pounds, down from the prior threshold of 19 pounds.

I'll conclude my portion of today's call with guidance. Incorporated into our guidance are the order trends that we have seen to date and what we believe today to be appropriately conservative assumptions. However, there is a high level of uncertainty surrounding fluctuation in the euro, pound, yen, Canadian dollar and yuan exchange rates, as well as the global economy and consumer spending and the impact on both of world events. While we are cautiously optimistic, it is not possible to accurately predict demand, and therefore our actual results could differ materially from our guidance.

Let me also remind everyone that we mark our euro-denominated debt to market at the end of each quarter, which results in a gain or loss for any movements in the euro between reporting dates. We also have exposure to the euro related to our interest expense on this euro-denominated debt. We incur a foreign currency gain or loss corresponding with intercompany balances denominated in foreign currencies, which are to be repaid among subsidiaries. Depending on the amount and timing, an unfavorable resolution of outstanding legal matters could materially affect our business, results of operations, financial position or cash flows in a particular period.

Our effective tax rate in 2005 and beyond are subject to a significant variation based on changes in our corporate structure, timing differences, current tax laws and estimates such as estimate revisions resulting from changes in foreign exchange rates and our stock price.

Our guidance assumes that we don't record any additional intangible assets or any further revisions to stock-based compensation or our restructuring-related estimates, and that foreign exchange rates remain approximately where they have been recently.

For Q4, we expect net sales of between $2.86 billion and $3.16 billion, or growth of between 13 and 24%. This guidance anticipates an over $100 million negative impact from foreign exchange due to the dollar's continued strengthening. GAAP operating income to be between 135 and 210 million, or be between a 17% decline and 29% growth. This includes stock-based compensation and amortization of intangible assets of approximately $30 million, up from $20 million based on our prior stock-based compensation accounting method. We anticipate consolidated segment operating income, which excludes stock-based compensation and other operating expense, to be between $165 million and $240 million, or between a 7% decline and 35% growth.

For calendar year 2005, we expect net sales of between $8.373 billion and $8.673 billion, or growth of between 21 and 25%. GAAP operating income to be between $403 million and $378 million, or between a 9% decline and 8% growth. This includes $144 million for stock-based compensation, amortization of intangible assets and the $40 million legal settlement.

In 2004, stock-based compensation and amortization of intangible assets was $59 million under our prior stock-based compensation accounting method. We anticipate consolidated segment operating income, which excludes stock-based compensation and other operating expense, to be between $547 million and $622 million, or growth of between 12% and 27%. We expect 2005 free cash flow to grow year-over-year, and we expect capital expenditures including capitalized software development costs of approximately $200 million.

As a reminder, we will be giving 2006 expectations when we report our Q4 results. Our financial focus is on long-term growth and free cash flow per share. We are confident that if we continue to improve the customer experience, including increase in selection and lowering prices, and execute efficiently our value propositions as well as our free cash flow will further expand.

Thanks. And with that, Tim, let's move to questions.

[Tim Stone, Vice President, Investor Relations]

Thanks, Tom. Let's move onto the Q&A portion of the call with Jeff and Tom. Operator, will you please remind our listeners how to ask a question?

Related:

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Rydex Investments continues to drive change in the financial industry by introducing investment products and services that challenge conventional thinking, empower investors and provide essential new options for uncertain market conditions. Rydex manages $14 billion in assets via more than 60 mutual funds and exchange traded products.

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