Q3 2007 Earnings Call Transcript

 |  About:, Inc. (AMZN)
by: SA Transcripts


Good day, everyone and welcome to the third quarter2007 financial results teleconference. (Operator Instructions) For opening remarks, I will be turning thecall over to the Director of Investor Relations, Ms. Kim Nelson. Please goahead.

Kim Nelson

Hello and welcome to our Q3 2007 financial resultsconference call. Joining us today is Tom Szkutak, our CFO. Jeff Bezos, ourfounder and CEO, and Tom will both be available for Q&A.

The following discussion and responses to your questionsreflect management's views as of today October 23, 2007 only, and will include forward-looking statements. Actualresults may differ materially. Additional information about factors that couldpotentially impact our financial results is included in today's press releaseand our filings with the SEC, including our 2006 annual report on Form 10-K.

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

During this call, we will discuss certain non-GAAP financialmeasures. In our press release, slides accompanying this webcast and ourfilings with the SEC -- each of which is posted on our IR website -- you willfind additional disclosures regarding these non-GAAP measures, includingreconciliations of these measures with comparable GAAP measures.

Finally, unless otherwise stated, all comparisons on thiscall will be against our results for the comparable period of 2006.

Now I will turn the call over to Tom.

Tom Szkutak

Thanks, Kim. I'll begin with comments on our financialresults. Trailing 12-month free cash flow increased 118% to $800 million, whilethe combination of common stock and stock-based awards outstanding wasunchanged from a year ago at $435 million. Worldwide revenue grew 41% to $3.26billion, or 38% excluding the $75 million favorable impact from foreignexchange. Q3 2007 revenue benefited by approximately 290 basis points ofyear-over-year growth from Harry Potter VII sales, plus attachments.

Media revenue increased to $2.09 billion, up 36%, or 32%excluding FX. EGM revenue increased to $1.08 billion, up 54% or 51% excludingFX. EGM accounted for 33% of worldwide sales in Q3 2007, up from 30% for thesame period last year. Our worldwide unit growth was 32%, and active customeraccounts exceeded 72 million, up 17% year over year.

Worldwide gross profit was $762 million, up 39%. Grossmargin decreased 45 basis points to 23.4%, primarily due to lowering prices andchange in product mix partially offset by increases in our third-partybusiness. Worldwide active seller accounts were over 1.2 million, and third partyunits were 32% of total units versus 30% in the prior year.

Amazon Prime memberships more than doubled year over year.

Now I will discuss operating expenses excluding stock-basedcompensation. Fulfillment, marketing, tech and content and G&A combined was$585 million, or 18% of sales, an improvement of 273 basis points year overyear. Fulfillment was $285 million or 8.7% of net sales, down 31 basis pointsyear over year. During the quarter, we opened new fulfillment centers in Phoenix, Arizona and Saran, France.

Technology and content was $181 million, or 5.6% of netsales, an improvement of 122 basis points year over year, as we continue togrow into our new level of spending. Marketing was $72 million or 2.2% of netsales, an improvement of 51 basis points year over year. In recent years, ourmarketing spend has been between 2.2% to 2.7% of net sales.

Now I'll talk about our segment results, and consistent withprior periods, we do not allocate the segments or stock-based compensation orother operating expense line items.

In the North America segment, revenuegrew 42% to $1.79 billion. This is the highest growth rate in seven years.Media revenue grew 38% to $1.08 billion. EGM revenue grew 54% to $631 million,representing 35% of North American revenues, up from 33%. We saw anotherquarter of strong sales in electronics, toys and baby, and soft goods whichincludes jewelry, apparel, shoes and sporting goods. North American gross profitgrew 34% to $460 million, and gross margin decreased 159 basis points to 25.7%,primarily due to lower prices and changes in product mix. North Americansegment operating income increased 263% to $79 million, a 4.4% operatingmargin.

In the international segment, revenue was $1.47 billion, up40% or 33% adjusted for the $72 million favorable foreign exchange impact. Mediarevenue grew 33% to $1.01 billion or 27% excluding FX. EGM revenue grew 54% to$448 million or 45% excluding foreign exchange. International gross profit grew47% to $302 million, or 39% excluding FX, while gross margin increased 88 basispoints to 20.5%, reflecting the increase in third party mix, partially offsetby lower prices and changes in product mix. International segment operatingincome increased 94% to $98 million or 6.6% operating margin. Excluding the $5million favorable impact from FX, international operating income increased 81%.

CSOI grew 145% to $177 million or 5.4% of net sales, up 228basis points year over year. Unlike CSOI, our GAAP operating income includesstock-based compensation expense and other operating expense. GAAP operatingincome grew 207% to $123 million or 3.8% of net sales.

Our provision for income taxes was $44 million in Q3 or a35% rate for the quarter, which includes an $8 million year-to-date adjustmentto reflect our current estimate of our annual effective tax rate of 29%, whichincorporates our strong North America growth.

As a reminder, there is potential for significant volatilityof our effective tax rate due to several factors, including variability inaccurately predicting the amount and mix of taxable income by jurisdiction. In2007, we anticipate cash paid for income taxes will be approximately $25million, compared to $15 million in 2006, as we continue to benefit from NOLsinside the United States.NOL utilization is impacted by many factors, including our excess stock-basedcompensation deductions.

GAAP net income was $80 million or $0.19 per diluted share,compared with $19 million and $0.05 per diluted share.

Turning to the balance sheet, cash and marketable securitieswere $1.91 billion, an increase of $690 million year over year. Inventoryincreased 32% to $970 million, and inventory turns decreased from 13.2 a year ago to 12.4 as we expandedselection, improved in-stock levels across product categories and geographiesand introduced new product categories.

Our investment in net fixed assets, which includes netcapitalized software development costs, increased $42 million from a year agoto $491 million. Our return on invested capital was 42%. ROIC is TTM-free cashflow divided by average total assets minus average current liabilities.

I will conclude my portion of today's call with guidance.Incorporated into our guidance are the order trends that we have seen to-dateand what we believe today to be appropriately conservative assumptions.However, there is a high level of uncertainty surrounding exchange ratefluctuations, as well as the global economy and consumer spending. It's notpossible to accurately predict demand and therefore, our actual results coulddiffer materially from our guidance.

As we described in more detail in our public filings, issuessuch as marking our euro-denominated debt to market quarterly, intra-companybalances in foreign currencies that settle amongst our subsidiaries,unfavorable resolution of legal matters and changes to our effective tax ratecan all have a material effect on guidance.

Our guidance assumes that we don't record any additional intangibleassets or any further revisions to stock-based compensation or ourrestructuring-related estimates, and that FX rates remain approximately wherethey have been recently.

For Q4 we expect net sales of between $5.1 billion and $5.45billion, or growth of between 28% and 37%. This guidance anticipates greaterthan 300 basis points of positive impact from foreign exchange.

GAAP operating income to be between $221 million and $291million, or grow between 12% and 48%. This includes $54 million primarily forstock-based compensation and amortization of intangible assets.

We anticipate consolidated segment operating income, whichexcludes stock-based compensation and other operating expenses, to be between$275 million and $345 million, or grow between 20% and 51%.

For calendar year 2007 we expect net sales of between$14.263 billion and $14.613 billion, or growth of between 33% and 36%. Thisguidance anticipates greater than 300 basis points of positive impact from foreignexchange rates.

GAAP operating income to be between $605 million and $675million, or growth of between 56% and 74%. This includes $191 million primarilyfor stock-based compensation and amortization of intangible assets.

We anticipate consolidated segment operating income, whichexcludes stock-based compensation and other operating expense, to be between$796 million and $866 million, or grow between 59% and 73%.

We anticipate our 2007 free cash flow growth rate to trendsimilar to our operating profit growth rate year over year, with somevariability from changes to working capital. We expect capital expenditures,including capitalized software development costs, to be approximately $250million.

We will continue to strive for year-over-year annual growthof free cash flow and free cash flow per share, while investing in ourlong-term opportunities. We are confident that if we continue to improvecustomer experience and execute efficiently, our value proposition, as well asour free cash flow, will expand.

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

Kim Nelson

Great. Thanks, Tom. Let's move on to the Q&A portion ofthe call with Jeff and Tom. Operator, will you please remind our listeners howto initiate a question?



(Operator Instructions) Your first question comes fromJeetil Patel - Deutsche Bank.

Jeetil Patel - Deutsche Bank

Looking at the -- call it almost 11 million -- new activecustomers you've had in the past year, can you discuss their purchase frequencyor if they are buying from you just as voraciously as the previous set ofactive customers? What's driving the accelerated growth across the board?

Second, can you talk about the broader impact of lowerconsumer spending you're seeing in your business? Are you seeing any effect, ordo you think that perhaps the online side is a little bit more immune to it,given that it seems to be more about pricing as a big driver of why folks buyonline, in addition to convenience and other factors?

Tom Szkutak

Jeetil, I'll take the second half of the question first. Interms of the impact of consumer spending, I think what you're seeing for us,and we're certainly not a bellwether for the economy, but what you're seeing iscustomers reacting and responding to just a very good customer experience:continued focus on lower prices, increased selection and certainly, speed ofdelivery with Prime being a factor. We think that plays well, as reflected inour guidance for Q4 as we enter into the holiday season. The customer is reallygoing to get a great customer experience again in Q4, as they did in Q3.

The first part of your question, we haven't broken out anyparticular details on active customers beyond what we mentioned earlier in thecomments. So I really can't help you much with that one.

Jeetil Patel - Deutsche Bank

Do you think it's more driven by selection that you'reseeing the accelerated growth, or do you think it's actually more just thecustomer/consumer reaction? Thanks.

Tom Szkutak

Again, as Imentioned, it's a combination of increased selection. We've increased selectionin the categories we're in, going much deeper. We've added new categories overtime, as you've seen. We continue to get even sharper on pricing, and those arethings that we have a constant focus on. We also want to make sure thatinventory is there, so that we can get it to customers very fast, which you cansee reflected in our turns. So all of those things we spend a lot of time on,and that certainly impacts the customer experience. That is reflected in thegrowth rates that you've seen in Q3.


Your next question comes from Anthony Noto - Goldman Sachs.

Anthony Noto - Goldman Sachs

Tom, after an extended period of investment, you have nowgone to a period of obviously being able to grow into your expenses and drivevery high incremental margins. I was wondering as you look into 2008, would youcharacterize that as another year of growing into your expenses and drivingcontinued margin expansion? Or is it a year in which you may have more balancedinvestment versus improved profitability?

I have a follow-up question for Jeff on the consumer as itrelates to online behavior. Thanks.

Tom Szkutak

Unfortunately, we're not giving guidance on 2008 today.Consistent with what we've done over the last couple of years, we'll be givingguidance on our next call after our Q4 earnings. But as it relates totechnology and content spending, roughly 15 or 18 months ago, we certainlytalked about the fact that we had spent the previous two to two-and-a-halfyears increasing our investment in a number of key areas. We said in the secondhalf of last year that would start to slow down. You saw that most prominentlyin Q4 of last year, and that continued in the first three quarters of thisyear, as we have grown into this level of investment. I think certainly thatyou've seen that to date.

I think one of the things you should keep in mind which is alittle different than where we were back in 2004 when we started this increasein investment, is our base is bigger. We can afford to invest with this higherbase that we have, more so than we did in 2004. So again, we will be sharingguidance for 2008 on our next call, but hopefully that helps.

Jeff Bezos

I'll just add to that by saying that the bigger base mightallow us to make investments over time, with less of a step function changethan you've seen in the past.

Anthony Noto - Goldman Sachs

I was also wonderingif you could comment, if you think about Amazon's value proposition for theconsumer today versus maybe three years ago, that value proposition has alwaysoffered increased selection, better prices and greater convenience.

What do you think has changed at Amazon vis-à-vis the “on land”experience that has resulted in a meaningful widening of that gap?

Jeff Bezos

I think it is really just the continuation of those thingsthat you mentioned. Year in and year out, we have been adding categories andadding very significant selection and depth inside categories. It sometimessurprises people to learn that we continue to do that, even in the categorieswe have been involved in the longest, such as books. But we do continue todeepen our categories there.

We've gotten better at managing inventory, so we're moreoften in-stock, which allows us to deliver products to customers much faster.We've also just incrementally over time gotten more efficient, better at defectreduction so we can do things accurately for customers at low cost. That hasallowed us to continuously lower prices.

I think it's the combination of those things: gettingproducts to customers quickly, having the broad selection and the deepselection, and having very attractive price points in combination with freeshipping. That package of things, we have been very, very consistent on for along time. I don't think there any changes there. I just think that every year,we get a little bit better.


Your next question comes from David Joseph - Morgan Stanley.

David Joseph - Morgan Stanley

I have one questionrelated to gross margin. It looks like it came down by about 44 basis pointsyear over year, and we did notice that your shipping loss was up nearly about40%, but it looks like your third party sellers were actually accelerated. I'm wondering if there was a one-time impactthere from Harry Potter. Maybe you can also talk a little bit about thecontribution from third party sales.

As an additional comment on that, our question would befulfillment and G&A. G&A actually declined on an absolute basis; fulfillmentdeclined on a percentage basis of revenue. Fulfillment might be scale, but canyou tell us a little bit about if we'remissing anything on fulfillment, but also what might have lead to decline inG&A? Thank you.

Tom Szkutak

In terms of gross margins, yes, Harry Potter is having aneffect. It was slightly less than a contribution profit breakeven event for us.You should assume that's a lower gross margin than our average, so it isbringing it down.

In terms of our overall expense, as you look at our directsegment operating expenses, there are certainly a number of different impacts butkeep in mind, as I was mentioning a few questions ago, in the first threequarters of last year our direct segment operating expenses in total whichincludes tech and content, fulfillment, G&A and marketing, were growing ata rate that was faster than revenue, and Q3 is no exception to that. So we'regetting leverage on each of those line items.

David Joseph - Morgan Stanley

With the impact to gross margin on Harry Potter, should weexpect that to normalize over the next couple of quarters?

Tom Szkutak

Again, we're not giving guidance on those individual lineitems, but certainly what we expect is reflected in our Q4 guidance, but it didhave an impact on our Q3 results.


Your next question comes from Victor Anthony - Bear Stearns.

Victor Anthony - Bear Stearns

I wonder if you could give us an update on yourinternational expansion plans beyond the six international locations that youhave right now? I am curious as to what geographies look attractive. And, anysort of timeframe?

The second question is really on the internationalelectronics and other general merchandise category. It looks like there was asignificant acceleration in revenues on that line, and I was curious as to whatis driving that particular acceleration.

The final question is really on your guidance for 4Q. Itlooks the pro forma operating margin at the midpoint is really calling for amodest improvement on a year-over-year basis, compared to the sizable jump inthis particular third quarter that you just reported. I'm wondering if there'sanything of note in that particular quarter in the guidance? Thanks.

Tom Szkutak

As it relates to theinternational expansion, we certainly will add new geographies over time, butwe certainly think there's a lot of improvement in terms of additionalselection that we can add in the geographies that we're in. We really like thegeographies that we're in.

In terms of categories today, we're most penetrated in the U.S.right now, and each of the individual geographies outside of the U.S.don't have the same depth that we do in our website. So that'sclearly a focus for us as we add new categories, selection within thoseexisting categories as well as new categories.

You mentioned the EGM growth in international beingaccelerated this quarter. What's driving that is some of the things that we'vebeen talking about which is really just fundamentals. We have been addingselection. We continue to try to improve the customer experience, making surethat our prices are sharp in all of the geographies and categories that we'rein and continue to work on reducing those overall customer-facing defects. Sothose are the things that are really helping our international EGM growth.

In terms of guidance, the implied guidance for CSOItranslates into a range of 5.4% on the low side to 6.3% on the high side foroperating margins, with the midpoint being at 5.9%, which is up from 5.7% lastyear. Two things to keep in mind. One is, as you look at last year's results,through the first three quarters the growth rate for those individual quarters,excluding foreign exchange, were anywhere from 23% to 25%. In Q4, it jumped to30% and we've had sizable growth since then. So again, we're overlapping that30% growth rate.

The second piece is, as I was mentioning about our directsegment operating expenses growing at a faster rate for the first threequarters of last year, it was growing at a faster rate than revenue. In Q4, ourdirect segment operating expenses were actually growing at a slower rate thanrevenue and we are overlapping that as well. So those two factors, must certainlybe taken into account as we look at our guidance for Q4.


Your next question comes from Mark Mahaney - Citi.

Mark Mahaney - Citi

I wanted to ask aboutthe progress or status of some of the digital media offerings. It looks likeUnbox is coming up through a couple of iterations, nice healthy improvement inthe product and in the user interface. You've had the music service out. Canyou quantify at all or give any qualitative comments about what kind oftraction you're seeing for those segments?

Maybe just to stress out the negative, are you seeing anysigns that is cannibalizing existing sales of CDs or of DVDs? Thanks a lot.

Jeff Bezos

I would just say that we're very happy with the earlyresults that we're seeing. We're getting terrific feedback from customers.Everybody loves the DRM free format, so selling MP3s is very successful for us.We have a lot of initiatives that we continue to work on. One of the thingswith our MP3 store is the way we look at it, the onus is on us to continue toconvince music labels that this is a good way to sell their music. So wecontinue to work on that, but we're very happy with the way that it's going.

Our approach on this is you get out there and you getstarted, and you try to figure out what customers want and try to figure outhow to give it to them, and then just repeat that consistently over a number ofyears. So you can count on us to keep working on those things. We're thrilledwith the early results from customers.

Mark Mahaney - Citi

No evidence that it'shad any impact on the physical CD or DVDs sales?

Jeff Bezos

We haven't seen anyevidence of that. I think it's way too early to know whether you would see anyof that.


Your next question comes from Brian Pitz - Bank of America.

Brian Pitz - Bank of America

First, any commentaryon the performance or traction of some of your newer, higher-margin categoriessuch as handbags, shoes or even auto parts? Then maybe some thoughts on newareas for expansion?

A follow-on to the digital media question, you're offeringthis digital locker to store digital books and video downloads. Is it possiblefor you to add essentially similar features for music downloads as well, downthe road? Thanks.

Jeff Bezos

Well, with respect toyour last question first, that's exactly the kind of thing that we try tosolicit feedback on from customers and see if it would be helpful and if it is,then work together with our industry partners to try and figure out how to makethat happen.

As far as some of the new categories go, we like the resultswe see. When we launch a new category, we always go through a period where wehave to have significant inventory upfront relative to the early sales, sothat's one of the factors that contributes in our corporate-wide inventoryturns. But those are very good investments and what we see is over time, we getvery good at managing these new categories.

What we're initially trying to do when we launch a newcategory is make sure that the customer experience is good, even from thebeginning. So we forward-invest in the customer experience in a new category tomake sure that it's going to be acceptable to customers. We try to get betterat it, and then we hone the economics in those new categories over time.


Your next question comes from Scott Devitt - StifelNicolaus.

Scott Devitt - Stifel Nicolaus

The question relates to Merchants@ internationally. Ibelieve the marketplace has been open in the international market for a fewyears now, so I'm trying to get a better understanding of how significantMerchants@ can be internationally, over time.

I was wondering if you could just talk about the mixdomestically between Amazon Marketplace for third party units and Merchants@,just to better understand the dynamics? Thank you.

Tom Szkutak

If you take a look at our international third party business,as I mentioned in the opening remarks, our total worldwide third party units asa percentage of total units is 32%. We haven't broken out the details betweenNorth America and international, but certainly the North America is morepenetrated than international is. But we see nice progress in international interms of improving as a percentage of third party units. So we are very pleasedwith how that part of the business is going, and that's certainly one of thedrivers that you see reflected in our gross margins on international.

In terms of how big it can be, it's a difficult question toanswer. What we do is two things. We're very focused on trying to improve ouroverall customer experience, which includes third parties. We're focused onimproving the retail side of our business, meaning product that we selldirectly, and so we are continuously trying to add selection, add newcategories, improve in-stocks, as Jeff mentioned, to drive the retail business.

Then we're also focused on how do we improve the sellerexperience, so it makes it easier for sellers to sell?

So ultimately where that will end up in terms of balancewill be up to the customer to decide on what that ultimate mix will be. But ourgoal is certainly to improve the experience, keep on improving the experiencefor both sellers and customers. We think with that, the customers can decidewhere that ends up.

Jeff Bezos

One category to highlight, perhaps -- especially as we gointo the holiday season here -- is the toy category. This is going to be, byfar, our best customer experience in the toy category in the company's history.And it is not only Amazon retail toys, but there is also now a very strongnetwork of third party toy sellers in the toy category. The combination ofthose is providing an outstanding customer experience. That will be part of ourrecord holiday, and we're really excited about it.

Scott Devitt - Stifel Nicolaus

Thank you very much. Are you able to give any informationdomestically related to Amazon Marketplace versus Merchants@ which maybe couldgive better color as to the international dynamics?

Tom Szkutak

I apologize. We really can't help you with that.


Your next question comes from Justin Post - Merrill Lynch.

Justin Post - Merrill Lynch

I have a couple ofinterrelated questions to gross margin. I've got your third party units upnorth of 40%. It really looks like you are taking share there. Can you quantifyat all the impact on gross margins? Do you expect that to really help nextyear?

Then if you look at the U.S.,if you back out the Harry Potter revenues, everybody is going to have their ownassumptions, but it looks like gross margins were still down in the U.S.,ex-that. Is that just because of the new categories, or was that more pricing-related?Could you really get into what drove that, and is that part of your 4Qguidance?

Tom Szkutak

In terms of the North America piece, certainly Harry Potter is having a negative impacton gross margins. Also, mix of business is impacting gross margins as well. Interms of the other part of your question, the first part, can you just repeatthat again?

Justin Post - Merrill Lynch

We have your third party units outstripping your regularunit growth; we have it at over 40%. What kind of impact is that having ongross margins, and do you think that could be a positive driver as we look outto next year?

Tom Szkutak

Well in terms of impact, certainly our third party businessin general helps our gross margins, and certainly other factors to think aboutwhen you look at our gross margins are we continue to lower prices forcustomers, we continue to try to make sure we get great prices from suppliersand also mix of business. Those are the key factors that are impacting grossmargins. In terms of 2008 again, we will be giving our guidance for 2008 afterthe Q4 call.

Justin Post - Merrill Lynch

Last question. As you look out to the holidays, any specificproducts that you're excited about or want to mention that we should be lookingfor on Amazon?

Jeff Bezos

There are probably a bunch, but the one that I wouldhighlight is Amazon Prime. I mean, especially during the holiday season, wehave been very successful signing up Amazon Prime members, but there are stilla lot of people out there that would benefit from being Amazon Prime members.The people who are members love it; that's certainly, for the holiday season, avery good product.


Your next question comes from Imran Khan – JP Morgan.

Imran Khan - JP Morgan

I understand that your gross profit margin in internationalis 20.5%. Obviously, third party is significantly lower in the internationalmarket. I am trying to get a better sense of how quickly you can narrow the gapbetween U.S.and international gross profit margins?

Jeff, you talked about putting customers first to drive thegrowth and increase shareholder value. As your third party business becomes abigger and bigger part of your business and your third party sellers numbergrows, how do you ensure customer satisfaction? Thank you.

Jeff Bezos

I'll take that second one first. It's a very good question,and it's something we spend a tremendous amount of time thinking about andfocusing on. We've done a lot over time to maintain that customer experience.It starts with making sure that we have a good method of evaluating third-partysellers and making sure that they are sincere and want to do a great job forcustomers. We have a big team of people that do that.

The other thing is we have started something calledFulfillment by Amazon, which is getting a lot of early traction, growingrapidly. It allows third-party sellers to effectively let us do the fulfillmentfor them so they can, using Fulfillment by Amazon, send products directly toour fulfillment centers and then we do the packing and shipping directly tocustomers.

That has a lot of systemwide efficiencies in it for thethird party seller and for us, because for one thing, if a customer orders twoitems they may order an item from us and they might order an item from thethird party seller. If the third party seller is using Fulfillment by Amazon,then we can marry those two items together in a single box, which saves asignificant amount of money in transportation costs. We're able to pass some ofthat savings on to the third party sellers who use Fulfillment by Amazon.

At the same time, from a customer experience point of view,if we are the ones fulfilling that third party unit, the customers get all ofthe benefits that they are accustomed to when they buy an Amazon retail unit.So for example, they get gift wrap, they get Free Super Saver Shipping. If theyare Amazon Prime members, they get two-day shipping for free on that third partyunit. So it basically levels the playing field for third party sellers andallows them to give the consumer all of the same benefits that Amazon retail isproviding. That's an example of the kind of program that we tried to put inplace. We're seeing very good reception from our seller community in taking usup on that offer.

Tom Szkutak

In terms of the firstpart of your question, it's difficult to predict the answer to your question asit relates to gross margins. I can tell you how we think about it, though. Someof the inputs are as we enter new categories we're trying to make sure that wehave a great customer experience.

We start with adding selection. We continue to work on theinput to customer experience, making it convenient for customers, making surethat the pricing is right. Over time, what happens is you'll get scale in thatparticular category. When you do that, good things happen. You have more thirdparties that are attracted to those detail pages to sell their products on. Wealso get better savings from vendors as we buy more from vendors.

So as you think about those countries that we are in today,as we improve the scale of those by again, adding new selection, adding newcategories, those are the things that will help us with our core part of ourretail business as well as third parties and getting better savings fromvendors.

So the combination are certainly the things that will helpus improve over time in international.

Imran Khan - JP Morgan

Jeff, in terms of Amazon Prime, you have had that for awhile. Could you talk a little bit about the learnings you have had from AmazonPrime? How does that help you to improve your fulfillment and inventorymanagement efficiency? Do you think as we continue to have Amazon Prime andmore customer takes, you can actually have better selections and better stockavailability and can enhance your fulfillment? Thank you.

Jeff Bezos

Well, one of theopportunities over time is, what Amazon Prime does as it continues to grow isit increases our express shipping volume. We have more volume now being shippedtwo-day rather than standard because for $79 a year, Amazon Prime members getunlimited free two-day shipping with no hurdle. So you can right now our FreeSuper Saver Shipping offer is available to everyone, but it's a slower class ofservice and it has a $25 minimum order threshold in order to qualify for SuperSaver Shipping. So Amazon Prime members have no threshold, and they get two-dayshipping for free. It's a very big change in the customer experience for anAmazon Prime member, and one that we know they love.

Our opportunity over time on the cost structure side is alarge one when we have sufficient scale to take advantage of it, because theopportunity is to modify the fulfillment center network so that it's optimizedfor faster delivery. You can imagine that a network optimized for two-daydelivery would look a bit different from a network optimized for standarddelivery. Those kinds of opportunities are available to us in the future as wecontinue to scale.


Your next question comes from Doug Anmuth - Lehman Brothers.

Doug Anmuth - Lehman Brothers

I wanted to follow up on Prime. What have the early returnsof Prime been in Japan?Second, can you give us some color on the large amount of hiring that you didduring 3Q? I think you added 1,400 people to your headcount. Was that mostlybased in fulfillment centers, or was there another part of the business?

Jeff Bezos

The answer to the second part of your question is yes, themajority of that was fulfillment center related as we get ready for the holidayseason. Those are largely variable personnel as we grow our business in Q4.

In terms of the Prime question as it relates to Japan it'svery, very early. From what we see so far we're very pleased. Customers lovethe offering that we have. They are very excited about it, so it's still very,very early but we're getting very good feedback from customers.


Your next question comes from Jeffrey Lindsay - SanfordBernstein.

Jeffrey Lindsay - Sanford Bernstein

We had a couple of things we wanted to ask about. Weunderstand from the press that there's some dispute about the patentexclusivity of 1-Click. Could you give us some guidance on how significant theloss of 1-Click patent exclusivity could be for Amazon?

Second, could you also give us some guidance on what thepotential impact could be from loss of the Borders book business in 2008? Finally,could you just give us an indication of how well you're doing in freshgroceries? Thank you.

Jeff Bezos

In terms of 1-Click,we have a longstanding practice of not talking about such matters outside ofour public filings. You should refer to our public filings.

In terms of the other parts of your question, the grocerypiece, we have a category, dry goods/grocery that we're very pleased with theperformance to-date. It's a great way for customers to buy a number ofdifferent dry goods, an assortment of dry goods items, generally in bulk. So weare very excited about what we see there so far. But again, it's still veryearly.

Jeffrey Lindsay - Sanford Bernstein

We were wondering about the Borders book business? Could youcomment on that?

Jeff Bezos

I don't really have any comments on any specific contracts.


Your next question comes from Shawn Milne - Oppenheimer.

Shawn Milne - Oppenheimer

Tom, I just have a couple of housekeeping questions. Interms of your revenue growth guidance in the fourth quarter, are you assumingany material follow-on impact from Harry Potter?

I just wanted to follow up on the fulfillment question. Itdid dip below as a percent of sales a little bit from what we were looking for.Are you seeing any impact already from what Jeff was talking about in terms ofscale with the fulfillment network? Or is it just the Harry Potter impact onfulfillment costs in the third quarter? Thanks.

Jeff Bezos

In terms of the impact of Q4 as it relates to Harry PotterVII, there certainly will be sales that will happen related to Harry PotterVII, but it won't be as sizable as what you're seeing in Q3, or at least we'renot anticipating that. In quarters where we've had sales such as that, that hasbeen the biggest impact. In terms of fulfillment, what you're seeing is justleveraging our overall fulfillment center infrastructure. I don't have anyother comments beyond that.


Your final question comes from Colin Sebastian - LazardCapital Markets.

Colin Sebastian - Lazard Capital Markets

Thanks for taking my questions, two quick ones, one is a follow-upon Prime. Obviously, you're seeing a positive impact there on unit sales andsubscriptions doubled year over year. I'm wondering if you have begun marketingthat more aggressively off of the website? If so, what traction you might beseeing there?

Jeff Bezos

Not in any significant way. Most of our marketing is to our existingcustomers on the website.

Colin Sebastian - Lazard Capital Markets

On FPS, the Flexible Payment Service, I'm curious what kindof traction you are seeing for that service early on? What kinds of retailersare you seeing adopt the service? Thank you.

Jeff Bezos

For anybody else on the call who may not know this, FPSstands for Flexible Payment Service. It is one of our infrastructure web services,with the Elastic Compute Cloud, the Simple Storage Service, and the Simple QueueService. These services are all developer-facing services, so they are a set ofAPIs that software developers can use to build web scale applications.

Obviously if you're building web scale applications, in manycases you have to be able to charge people for things. The Flexible PaymentService is the first payment service specifically designed from the ground upfor developers, and it has a lot of features that make it very flexible andeasy to use for developers to incorporate payments into their own applications.

So that set of services that we're offering to developers isgrowing very, very rapidly and has gotten an unusual amount of traction. We arevery, very gratified to see this early uptake in the development community.It's happening at the very small scale with small software developers;one-person and two-person shops. It's also happening at the middle scale withventure capital-funded startups; and then at the large scale, with enterprisecustomers all the way from the small up to the big. So it's a very exciting andnew product offering.

These infrastructure services are things that we needed tobuild for ourselves in order to run the web scale application called Amazon.While we were in the process of building these things, we decided to build themin an external way so we could charge for them and turn them into a new profitcenter.

We're very excited about this.

Kim Nelson

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

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