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Amazon.com Inc. (NASDAQ:AMZN)

Q1 2006 Earnings Conference Call

April 25, 2006, 5:00 p.m. EST

Executives

Jeff Bezos - Founder and CEO

Tom Szkutak - CFO

Kim Nelson - Director, Investor Relations

Analysts

Mark Mahaney - Citigroup

Anthony Noto - Goldman Sachs

Safa Rashtchy - Piper Jaffray

Doug Anmuth - Lehman Brothers

Imran Khan - JP Morgan

Jeetil Patel - Deutsche Bank

Justin Post - Merrill Lynch

Robert Peck - Bear Stearns

Mark Rowen - Prudential

Shawn Milne - Friedman Billings Ramsey

Presentation

Operator

Good day, everyone and welcome to the Amazon.com first quarter 2006 financial results teleconference. (Operator Instructions). For opening remarks, I will be turning the call over to the Director of Investor Relations, Ms. Kim Nelson. Please go ahead, Ms. Nelson.

Kim Nelson

Hello and welcome to our Q1 '06 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 and responses to your questions reflect management's views as of today, April 25, 2006 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 2005 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 2005. Now I will turn the call over to Tom.

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Tom Szkutak

Thanks, Kim. This was another successful quarter for Amazon.com. I will start with comments on our financial results. Trailing 12-month free cash flow grew 20% to $501 million. Free cash flow is operating cash flow minus capital expenditures. Trailing 12-month free cash flow includes a one-time payment of $40 million in connection with the patent lawsuit settlement in Q305 and excludes $13 million of tax benefits from stock-based compensation that are classified as positive financing cash flows under FAS 123R. Adjusting for these two items, TTM free cash flow grew 32% to $554 million.

As a reminder, the financial measure we're working to maximize over the long-term is free cash flow per share. 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 21 million or 4.9% of shares outstanding, down from 24 million or 5.7% of shares outstanding. We strive to efficiently manage share count.

Return on invested capital was 32%. ROIC is TTM free cash flow divided by average total assets minus average current liabilities.

Revenue grew 20% to $2.28 billion or 25%, excluding the $94 million unfavorable impact in year-over-year changes in foreign exchange rates. Worldwide unit growth was 24%.

Third-party units representing marketplace and merchant's units sold on Amazon sites were 29% of total units, up from 27%. Active customer accounts, representing customers who have ordered in the past year, surpassed 57 million, up 19%.

Electronics and other general merchandise, or EGM, increased 33% to $639 million or 38% excluding foreign exchange rates. EGM represents 28% of worldwide sales, up from 25%. Gross profit grew 19% to $547 million in Q1, and gross margin decreased 9 basis points to 24%, primarily due to greater shipping loss driven by free shipping in Amazon Prime and our lower product prices. These decreases were partially offset by increased third-party sales.

Now I will discuss operating expenses, excluding stock-based compensation expense under FAS 123R which we early adopted in Q105. Fulfillment, marketing, technical content and G&A combined was $427 million or 18.8% of sales, up 141 basis points. Fulfillment was $190 million or 8.3% of sales, down 24 basis points.

In 2006 we expect to increase our fulfillment space less than in 2005 to extend our capacity to satisfy peak demand. For example, we are opening a new fulfillment center in Leipzig, Germany which we expect will be operational by Q3 this year.

Marketing was $54 million or 2.4% of sales, up 11 basis points. Technology and content increased 69% year-over-year to $138 million, and we expect this percentage to decrease substantially in the back half of this year. Q106 represents 6.1% of sales, up 177 basis points. G&A was $45 million or 0.2% of sales, down 24 basis points. As a reminder in Q105, we recorded an $8 million charge related to litigation matters.

Now I will talk about our segment results. Consistent with prior periods, we don't allocate stock-based compensation or other operating expense to our segments. In the North American segment, revenue grew 21% to $1.25 billion. Media revenue grew 17% to $815 million, and EGM revenue grew 33% to $374 million, representing 30% of North America revenues, up from 27%. Apparel, jewelry and sporting goods revenue all more than doubled year-over-year.

Gross profit grew 22% to $341 million, and gross margin increased 18 basis points to 27.3%, largely due to third-party sales, as well as an $11 million increase in other revenue primarily driven by Amazon Enterprise Solutions; partially offset by Amazon Prime, our price reductions across product categories, product mix shift and free shipping.

North America segment operating income decreased $4 million to $62 million, a 5% operating margin. In the International segment, revenue grew 18% to $1.03 billion. Revenue growth accelerated to 29%, adjusting for the $96 million year-over-year unfavorable impact from foreign exchange rates during the quarter.

Media revenue grew 13% to $763 million or 24%, excluding FX, the highest growth rate since Q4 of 2004. EGM revenue grew 33% to $265 million, or 45% excluding FX, representing 26% of international revenues, up from 23%. Gross profit grew 15% to $206 million or 26% excluding FX, while gross margin decreased 53 basis points to 20% primarily from free shipping, product price reductions and a mix shift.

International segment operating income decreased $4 million to $58 million, a 5.6% operating margin. Excluding FX, international operating income increased 6%. The combination of operating income in North America and International segment is our consolidated segment operating income, or CSOI. Our segment information and our press release reconciles CSOI to GAAP operating income.

CSOI declined 7% to $120 million or flat year-over-year, excluding the $8 million unfavorable year-over-year impact from foreign exchange rates. Unlike CSOI, our GAAP operating income includes stock-based compensation expense and other operating expense. GAAP operating income decreased 2% to $106 million. Excluding the $8 million impact from year-over-year changes in foreign exchange rates, operating income increased 6% to $114 million.

Our provision for income taxes was $45 million in Q1, or a 47% rate for the quarter, reflecting our current estimate of our annual effective tax rate. Our effective tax rate remains higher than the 35% statutory rate, primarily due to taxable income associated with the transfer of certain operating assets in connection with establishing our EU headquarters in Luxembourg.

We expect these asset transfers to result in tax expense for the financial reporting year above the 35% statutory rate throughout 2006 and beneficially impacting our effective tax rate over time. Since we have deferred tax assets related to our NOLs, these asset transfers will not have a significant impact on our cash taxes paid in 2006, which we expect to be approximately $25 million compared with $12 million in 2005. We are endeavoring to optimize our global taxes on a cash paid basis, not for tax expense on a financial reporting basis.

GAAP net income was $51 million or $0.12 per diluted share compared with $78 million and $0.18 per diluted share. Q105 includes a $26 million or $0.06 per diluted share gain for the accumulative effect of a change in accounting principles related to the adoption of FAS 123R.

Turning to the balance sheet, cash from marketable securities increased $184 million to $1.3 billion. In Q106 we redeemed EUR 250 million or $300 million in principal amount of our 6 7/8. This redemption mitigates potential dilution of over 2.9 million shares and reduces our annual cash interest expense by approximately $21 million.

Inventory increased 33% to $538 million, and turns decreased 7% to 14.4 as we expanded the breadth of our product category selections and our fulfillment centers and took advantage of buying opportunities from vendors. 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 net fixed assets, which includes net capitalized software development costs, increased 47% from a year ago to $361 million. Our capital expenditures were $46 million for Q1. $26 million of CapEx was software development costs.

Our growth continues to be fueled by our relentless focus on the primary input to customer experience: convenience, selection and price. Some recent examples of our progress include Amazon Prime. We're pleased to see strong quarter to quarter sequential growth for new Amazon Prime subscriptions. We continue to see increased purchases by Amazon Prime customers across more categories, with especially heavy use in electronics, kitchen and health and personal care. For $79 a year, Amazon Prime members get all-you-can-eat, free two-day shipment.

We introduced 'click to call', a new feature for our US, UK, German and French websites which allows customers to be connected quickly with a customer service representative who will often already have the customer's account information in front of them, saving the customer time and increasing satisfaction.

Amazon's Japanese website introduced several new payment methods which allow customers to pay for their Amazon.co.jp purchases with online banking at approximately 70,000 convenience stores and ATMs throughout Japan.

Amazon's German and UK websites launched wedding registries enabling couples to choose gifts from millions of products for their household, including kitchen and home appliances, cookware, cutlery, electronics and more.

Amazon Web Services launched Amazon S3, a simple storage service for software developers. S3 provides an application programming interface for highly scalable, reliable, low latency data storage at very low cost. Developers continue to adopt Web Services. Over 160,000 have registered to date, upgraded to 60% year-over-year.

Amazon's German website, Amazon.de, introduced the Advantage program. This enables increased selection and 24-hour availability for customers by allowing vendors to store their products on consignment in Amazon's fulfillment center.

We acquired ShopBop.com, a retailer of fashion forward apparel, shoes and accessories for women, featuring products from more than 75 leading designers including Marc Jacobs, Juicy Couture and True Religion. Third-party sellers remained a key part of our selection expansion in worldwide active seller accounts, merchants with an order from a customer during the preceding 12 months exceeded 1.08 million, up 15% year-over-year.

Amazon Enterprise Solutions announced two new partners -- Benefit Cosmetics, a subsidiary of luxury group LVMH, and Timex.

Some pricing highlights include the average customer discounts across books, music and video products purchased on www.Amazon.com increased more than 150 basis points year-over-year. Customers have enjoyed our '4 for 3' offer in books on Amazon.com. Order four books under $10 and pay for only three. Over the past 12 months, customers have saved approximately $0.5 billion on shipping throughout our worldwide free shipping offers and Amazon Prime.

I will 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 to date to be appropriately conservative assumptions. However, there is a high level of uncertainty surrounding fluctuations 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 movement in the euro between reporting dates. We also have zero exposure related to our interest expense and on this euro-denominated debt. We incur a foreign currency gain or loss corresponding with the inter-company balances denominated in foreign currencies which are settled amongst subsidiaries.

Depending on the amount and timing, an unfavorable resolution of outstanding legal matters could materially affect our business, results of operations, the income position or cash flows in a particular period.

Our effective tax rate in 2006 is subject to significant variations based on changes in our corporate structure and business operations, the amount of expenses incurred that are permanently non-deductible for U.S. tax purposes such as stock-based compensation paid to foreign employees, the tax characterization of income earned and changes in current tax laws and estimates, including the variability in predicting our taxable income and the taxable jurisdictions to which it relates.

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

We are appealing a recent court decision that terminates our ToysRUs.com contract, and we are seeking a stay of the termination pending a decision on our appeal. While we believe we will prevail and that ToysRUs.com's claims lack merit, the timing and possible outcomes of this litigation are uncertain, and possible effects of termination are not reflected in the following guidance. If we do not prevail, operating profit could be negatively impacted by as much as $50 million for the year, including as much as $25 million for the second quarter.

For Q2 we expect net sales of between $2.03 billion and $2.18 billion or growth of between 16% to 24%. This guidance anticipates greater than $50 million or over 280 basis points of negative impact from foreign exchange due to the dollar's continued strength.

GAAP operating income to be between $32 million and $67 million or between a 69% decline and a 36% decline. This includes stock-based compensation and amortization of intangible assets of approximately $38 million.

We anticipate consolidated segment operating income, which includes a negative impact from foreign exchange and excludes stock-based compensation and other operating expense, to be between $70 million and $105 million or between 47% decline and 20% decline.

For calendar year 2006, we expect net sales of between $9.95 billion and $10.5 billion or growth of between 17% and 24%. This guidance anticipates approximately $150 million or over 175 basis points of negative impact from foreign exchange.

GAAP operating income to be between $390 million and $520 million or between a 10% decline and 20% growth. This includes approximately $125 million for stock-based compensation and amortization of intangible assets.

We anticipate consolidated segment operating income, which includes a negative impact for foreign exchange and excludes stock-based compensation and other operating expense to be between $515 million and $645 million or a 9% decline and 14% growth.

Operating leverage to improve in the second half of the year compared with the first half of the year. We expect our 2006 free cash flow growth rate to trend similar to our operating profit growth rate year-over-year. This excludes the impact of FAS 123R which should be less than $100 million of excess tax benefits from stock-based compensation being classified as positive financing cash flows instead of operating cash flows, up from $7 million in 2005.

We expect capital expenditures, including capitalized software development costs, to be approximately $225 million.

We will continue to strive for year-over-year annual growth and free cash flow and free cash flow per share while investing in our long-term opportunities. We are confident that if we continue to improve customer experience and execute efficiently, our value proposition, as well as our free cash flow, will further expand. Thanks and with that, let's move to questions.

Kim Nelson

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

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Mark Mahaney, Citigroup.

Mark Mahaney - Citigroup

Thank you very much. Two questions, please. First, on the Toys "R" Us, is it your expectation that you will get some sort of decision in the June quarter? Is why you think -- is that why you're sizing that at $25 million? Or is it very uncertain at what point in the balance of the year you'll reach a decision?

Secondly, could you talk about any trends in your technology and content spending? Are you spending in areas that are different than you have been spending over the last, say, two quarters and just in that second content area?

Tom Szkutak

Sure. I will take the second part of your question first. In terms of technology and content, no -- we're spending in the same areas that we have been talking about consistently, and we are making investments in customer experience, digital, web services, search, improving the seller platform and other productivity initiatives. So that is the same.

In terms of Toys "R" Us, certainly this ongoing litigation, to try and predict when that is going to resolve; I think it is uncertain and difficult to say.

Operator

Our next question comes from Anthony Noto, Goldman Sachs.

Anthony Noto - Goldman Sachs

Thank you very much. Tom, I wonder if you can elaborate a little bit, your second quarter guidance for consolidated operating income implies at the midpoint about a 4% operating margin, which is obviously down year-over-year and also relative to the first quarter. So it seems like there will be a more significant ramp in the second quarter in spending. Then it requires a pretty meaningful expansion in the back half of the year to about 6.3%.

I was just trying to understand what products are you investing in in the first half of this year that we will see, from a consumer facing standpoint, that could potentially drive that acceleration of revenue in the back half of the year and that margin expansion? It is really hard to have the visibility without knowing those products. Thank you.

Tom Szkutak

Sure. Just to maybe talk a little bit about Q2 in the second half. In terms of Q2, what you're seeing is Q2 historically is our lowest seasonal quarter from a revenue standpoint. We certainly have lowered prices considerably, which is certainly impacting the bottom line guidance for Q2.

We also have, as I mentioned in the opening remarks, higher fixed costs in the first half, and that growth rate will be going down in the second half. So in other words the growth rate in the second half of '06 will be lower versus the second half of 2005.

So in terms of the growth in terms of individual products and any new launches, we have not in the past announced any new categories before the launch. But certainly with the growth that you're seeing in Q1, we saw accelerated growth from 22% in Q4 to 24.8%. So we saw some nice accelerated growth and we like what we see. We're going to continue to focus on those inputs that helped drive Q1, throughout the year. So that is why you're seeing the better leverage in the second half as well as the updated guidance that we gave for the total year as well.

Operator

Our next question comes from Safa Rashtchy, Piper Jaffray.

Safa Rashtchy - Piper Jaffray

My question again relates to Toys "R" Us. Given that you lost the current or last ruling, could you give us some idea as to why you are confident that you would win? Why would it make sense not to include revenues or profits from Toys "R" Us and kind of wait to see how the ruling would be?

Tom Szkutak

Sure. Again, beyond the filings that we have made to date, we have a practice of not talking about ongoing litigation. I wanted to provide some data in the opening remarks to give some context of how we are thinking about it. I think certainly that is appropriate. But beyond that, I don't have a lot to say on Toys "R" Us.

Operator

Our next question comes from Doug Anmuth, Lehman Brothers.

Doug Anmuth - Lehman Brothers

I just have two quick questions. One actually does relate to Toys "R" Us. But I'm just trying to figure out why in 2Q you get so much of the impact there, of the $25 million potentially? So that is question number one.

The second one is your hiring, I noticed that it was only about an incremental 400 people in terms of head count in 1Q, which is a pretty dramatic slowdown -- at least on an absolute basis -- from what we saw throughout each quarter in 2005. Is that a pretty fair way to think about your head count growth going forward?

Tom Szkutak

Yes. In terms of Toys "R" Us, there is certainly a range of possible outcomes. So the Q2 impact and the total year, we are trying to give what we think is an appropriately conservative look at the situation there as we know it today. So that is how we are thinking about TRU.

In terms of the hiring, we are still continuing to hire. As you mentioned, you did see a sequential growth of 400 from year end to the end of Q1, which is lighter than we have seen in the past. As we had mentioned in the previous call, we made a deliberate decision in 2005 to increase head count specifically in technology areas. We hired a lot of software development engineers and computer scientists. You will see that over the next few years, we want to grow into that investment base. So that is really what you're seeing. So that I think answers your question.

Operator

Our next question comes from Imran Khan, JP Morgan.

Imran Khan - JP Morgan

Thank you. Good afternoon, Tom and Jeff. Actually two questions, one going back to Anthony's question. If I look at the back half of your guidance, it seems like you're expecting 66% or so -- if I take a mid-point operating profit -- coming in the second half of this year. That is not reflective of the 50% to 55% we saw in the last two years.

You talked a little bit about fixed costs will be basically first half. I was trying to get a sense, if you can talk about the quarter from those fixed costs? In terms of the technology spending, it grew 68% year-over-year. How should we think about going to Q2, Q3, Q4? How do you see the technological spending flowing, that will help them?

Tom Szkutak

Sure. The technology and content, the 69% excluding stock-based comp growth, you should see a substantial growth reduction in the second half of the year versus the second half of 2005. Then the fixed cost piece, could you just repeat that part of the question?

Imran Khan - JP Morgan

So I was wondering if you could give us some sense, what are some of those fixed costs that you have in first half but you don't have in second half?

Tom Szkutak

Sure. Part of it is just the build-up that you saw in the latter half of last year. So if you look at the operating expense over the course of last year, we have had a sizable build-up through the course of last year with Q4 being certainly the highest. You will be starting to see the lapping of that increase in the second half of the year.

Imran Khan - JP Morgan

Okay. If I may ask one follow-up question in terms of Amazon Prime. You said that you have had pretty good success with Amazon Prime. I was wondering if you could give us some color like how many customers are using Amazon Prime right now and what kind of ASP improvement you saw because of Amazon Prime? Some maybe ballpark color, I would appreciate that.

Jeff Bezos

We're not providing any numbers on Amazon Prime. What I can tell you is that we have seen very exciting growth sequentially Q4 to Q1, even though we came off a very strong Q4 for Amazon Prime. New subscriptions are up even sequentially off of our seasonally heavy quarter. So we continue to and we are able to track a bunch of numbers with Amazon Prime in terms of what it does to wallet share and increased spending, those kinds of metrics, renewal rates, et cetera. We're a very happy with what we're seeing, but we're not discussing those figures publicly.

On your earlier question, I just wanted to add to Tom's answer just to make sure that you understood. It is not so much that the fixed costs are being reduced in the back half of the year. In fact, those technology and content, for example, will probably go up in absolute dollars. It is just that as the Company continues to grow, the year-over-year growth in those numbers is less, and then as the top line grows, also we start to grow into that cost structure over the next few years.

Operator

Our next question comes from Jeetil Patel, Deutsche Bank.

Jeetil Patel - Deutsche Bank

Great. Two questions. First of all, on Amazon Prime I guess you're seeing frequency growth overall in the business of about 5% to 6% year on year. Can you talk about the impact that Amazon Prime has? Are you seeing even faster frequency growth in that audience, or do you think it's actually attracting a different customer that may not have looked at Amazon previously in terms of the active account base?

Second question: broadly, as you take a step back and look at the marketplace, it seems like subscriptions, rentals and also new product purchases and sales, they all represent just different ways of accessing content and information and products out there. How do you see your customer adapting to those different types of businesses or concepts out there? Do you think they are open to different solutions, different ways of accessing content, or do you think that it becomes still more of a retail business?

Tom Szkutak

I think our customers are very receptive to new kinds of offerings from us. Over time we have stretched the corners of how customers perceive us, and we have done that very successfully, transitioning from an online bookseller to being able to sell hardlines and now many more categories.

At the same time, we have had success with two very, very different kinds of business models from a consumer point of view. One being the retail business model and the second one being the third-party business model, which as you know now is a significant percentage of our units where third-party sellers sell through the Amazon.com website.

So not only have we kind of stretched the corners of how customers perceive us in terms of product category, but also in terms of business model. I think what we're seeing with Amazon Prime in our rental offerings is yet another business model that customers are giving us permission to pursue with them.

So not only are we happy with the new subscription growth that we have seen in Amazon Prime, but if you look at our DVD rental business in the UK and Germany, those businesses are going very well, too. Having started free trial offers there, we're even seeing acceleration in those businesses as well, and that is off of a base that we were already happy with.

Jeetil Patel - Deutsche Bank

Jeff, do you think that some of these business models can still exist inside the same category at the same time so DVD rental, DVD club service versus DVD purchases all in one?

Jeff Bezos

Yes. In fact, we have announced that we're going to be doing a program called Upgrade that will allow people to buy physical books and then for a small incremental charge get online access to those books as well. So we do think that there are offerings which can co-exist.

I would point to our third-party sales business where people can buy the new version of the book or the used version of the book or the reconditioned tool or the new tool or the new camera from somebody else. Instead of buying a new camera from us, go right from the Amazon website. That is another example of where you have two quite dissimilar business models interacting very nicely even on the same detail page.

Jeetil Patel - Deutsche Bank

Do you employ a lot of the data between different products, different business models today or not really in terms of the used pricing versus new pricing, etc.?

Jeff Bezos

I'm sorry. Could you say that again?

Jeetil Patel - Deutsche Bank

So are you leveraging a lot of the data and knowledge base from what you learn in used, what consumers are willing to pay for a particular product to, let's say, in the content area, what they are willing to pay for by chapter or by different formats for a used model versus a pure buy model?

Jeff Bezos

Not necessarily that particular example, but we do have things. For example, we can see which subcategories of books performed best inside things like Search Inside! the Book. So when we offer Search Inside! the Book, which allows people to do full text searches and view certain portions of books, we can see which subcategories of books do services like that perform better in. Then we can think about how can we extend those offerings in those kinds of subcategories. So we do have a lot of very helpful data that we can view and use it as aid in making business decisions.

Operator

Our next question comes from Justin Post, Merrill Lynch.

Justin Post - Merrill Lynch

I think on the call you mentioned you would be able to cut pricing by about 150 basis points year-over-year to the consumer. I'm wondering if you are able to get better deals from your vendors? Are you able to pass that through, and that's what you're able to maintain the margins?

The second thing, the shipping expense was up pretty consistent with the revenue growth. Do you expect any pressure from gas prices or Amazon Prime going forward? Then could you just remind me of the FAS 123 benefit that you got in the first quarter?

Tom Szkutak

Sure. In terms of impact on COGS in your pricing question, yes, it is an ongoing effort everyday to try to get better prices from our suppliers, and certainly our goal is to help pass that on in terms of lower prices to customers. So that is an everyday activity that we do globally.

In terms of shipping expense, in terms of the inflation that you mentioned, certainly that is something that we have been dealing with for several years with oil prices and energy prices where they are. We have seen a dramatic increase over the last several years. So it is just something that we have been managing over the past several years. I'm not sure what more to say about that. Then the last part of your question, I'm sorry?

Justin Post - Merrill Lynch

Yes, the FAS 123 benefit that you got in the first quarter, I think you gave that number.

Tom Szkutak

Yes, it is $13 million over the past 12 months and it is $7 million in Q1.

Justin Post - Merrill Lynch

Okay. We will get back to that later. Thank you.

Operator

Our next question comes from Robert Peck, Bear Stearns.

Tom Szkutak

I'm sorry, you were talking about expense or the impact on free cash flow? I'm not sure -- you're talking about the stock-based compensation expense or the impact on free cash flow?

Operator

I'm sorry, Mr. Post. Could you please requeue?

Tom Szkutak

Well, if he is not back on. The expense piece was $11 million. Stock-based compensation was $11 million in Q1, which was down from $19 million from last year. Then the impact of 123R on free cash flow was $7 million in Q1 or $13 million over the trailing 12 months, if that is helpful. That covered both bases.

Robert Peck - Bear Stearns

Tom, this is Bob Peck. Am I live?

Tom Szkutak

Yes.

Robert Peck - Bear Stearns

Okay. Great. I got two questions for you. The first is sort of a two-parter, though. Are you able to break out your tech spending as far as investment versus maintenance, and investment meaning your newer initiatives, not necessarily along the course, just A9, S3, et cetera.?

And part two of that is considering a lot of the initiatives you're taking are very similar to things that Google is doing, does it ever make sense for you to consider any sort of partnership with Google? Then I have got a follow-up.

Tom Szkutak

Okay. In terms of our technology and content spend, we look at it a number of different ways. We look at it certainly from a maintenance mode, an investment mode. But we look at it on an individual program basis as well. So again, we're looking at all the individual programs that we do. We review that regularly, so it is part of our planning process. In terms of partnerships and any other discussion, you know we have a long-standing practice of not talking about any particular company.

Robert Peck - Bear Stearns

Okay. Because you can see the synergies there if you did. The second question would be on Amazon Prime, really quickly. The Amazon Prime subs right now, are they profitable? With the release of eBay Express, what is your opinion of the impact of eBay Express on Amazon longer-term? Thank you.

Tom Szkutak

We do not as a matter of practice talk about other companies and definitely stick to that. I would say more generally there are going to be and there have been thousands of competitors, and there should be in this space. These are very big markets, and there can be lots of winners. What was the other part of your question?

Robert Peck - Bear Stearns

Are the Prime subs profitable?

Tom Szkutak

They are profitable on their own basis, so that each one is profitable. They are less profitable than if they did that same amount of shopping without getting free shipping. So the two-day free shipping makes them much less profitable than they would be otherwise. So do you understand what I'm saying?

Robert Peck - Bear Stearns

I do.

Operator

Our next question comes from Mark Rowen, Prudential.

Mark Rowen - Prudential

A couple of quick questions. One on the Toys "R" Us, you're saying that it is going to be $100 million impact for the year if it works out unfavorably to you. I noticed in the lawsuit that they were really fighting about the $50 million payment. So in that $100 million, are you assuming that you don't replace them with another third-party seller or your own sales? Is that like a worst-case scenario?

Tom Szkutak

I don't know where the numbers you are describing are coming from, the $100 million. What we had mentioned was that it could be up to $50 million for the year in operating profit.

Mark Rowen - Prudential

Okay. So $50 million for the year. So is that the excess payment that they made that you could not replace by putting another third-party seller in there, or do you think you could make some of that up if you did put another third-party seller in there with a higher commission or whatever?

Jeff Bezos

Yes, Mark, as you can probably appreciate, this is a matter of ongoing litigation, and I don't think it is appropriate to talk further about it. I think we have given adequate commentary in the opening remarks about it. At this stage, I would like to keep it to that.

Mark Rowen - Prudential

Okay. My second question, it relates to your North American media business. A lot of the other sellers of those products, particularly in music and movies, have been struggling over the last year, music probably longer than that. Are those categories still good for you? Are you still gaining share in a shrinking market, or are the effects of the market shrinking impacting those categories? Is it really books that is driving that category?

Tom Szkutak

When you look at the growth rates for North American media, we are still seeing very solid double-digit growth. It is up 15% year over year, 16% on a TTM basis. So we think it is a very good business for us. There has certainly been a lot of innovation and improvements in customer experience over the past few years within that space, which we think is paying off for us.

Mark Rowen - Prudential

So it is paying off in all of those categories, not just books?

Tom Szkutak

Yes, we have not broken out any of the individual categories within media, but we are certainly pleased with the individual categories that make that up.

Operator

Our next question comes from Shawn Milne, Friedman Billings Ramsey.

Shawn Milne - Friedman Billings Ramsey

A quick question, Tom, on the flow of your business in the first quarter. If you look at some data from the third party, it looks like online spending was strong in January. It was a bit weaker in February and then rebounded in March. Can you talk about the flow of your business if you saw any of those trends?

The March data actually would suggest an acceleration in online spending heading into April. Any thoughts on that? Thanks.

Tom Szkutak

Again, we are certainly running a business in a number of different countries. So I don't think it's appropriate to talk about individual months. But certainly when you look at our overall growth for the quarter, you're seeing an acceleration. You saw 22% growth in Q4 on a local currency basis, just under 25% in Q1. So again, you saw an acceleration there. But talking much more beyond that in terms of individual months, we're not going to do today.

Shawn Milne - Friedman Billings Ramsey

You talked about buying directly more in inventory. Are you buying toy inventory currently?

Tom Szkutak

No, I'm not going to comment more on the toy business.

Kim Nelson

Thank you for your questions. A replay will be available at our 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.

Tom Szkutak

Thank you.

Jeff Bezos

Thank you.

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Source: Amazon.com Inc. Q1 2006 Earnings Conference Call Transcript (AMZN)
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