Amazon.com, Inc.

Thank you for standing by. Good day, everyone, and welcome to the Amazon.com First Quarter 2019 Financial Results Teleconference. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question and answer session. Today's call is being recorded. For opening remarks, I will be turning the call over to the Director of Investor Relations, Shelly K. Pfeiffer. Thank you. Please go ahead.

Hello, and welcome to our Q1 2019 Financial Results Conference call. Joining us today to answer your questions is Brian Olsoski, our CFO, and Dave Fildes, Director of Investor Relations. As you listen to today's conference call, we encourage you to have our press release in front of you, which includes our financial results, as well as metrics and commentary on the quarter. Please note, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2018. Our comments and responses to your questions reflect management's views as of today, April 25th, 2019 only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10K and subsequent filings. During this call, we may 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. Our guidance incorporates the order trends that we've seen to date, and what we believe today to be appropriate assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the internet, online commerce, and cloud services, and the various factors detailed in our filings with the SEC. Our guidance also assumes, among other things, that we don't conclude any additional business acquisitions, investments, restructurings, or legal settlements. It's not possible to accurately predict demand for our goods and services, and therefore our actual results could differ materially from our guidance. With that, we will move to Q&A. Operator, please remind our listeners how to initiate a question.

At this time, we will now open the call up for questions. We ask each caller please limit yourself to one question. If you would like to ask a question, please push star one on your keypad. We ask that when you pose your question, you pick up your handset to provide optimum sound quality. Once again, to initiate a question, please push star then one on your touchtone telephone at this time. Please hold while we pull for questions. Thank you. Our first question comes from the line of Mark Mahaney from RBC Capital Markets. You are now live.

Okay, hey, I'm gonna ask two questions because the first one's really simple. Unit growth of 10%, is this a meaningless metric? Just talk through that number. I think it's the lowest unit growth I think we've ever seen, but just talk through a little bit about that. And then international sales growth, the sell rate is 16%. I know last, XFX, I know last quarter, you talked about some challenges in the India market. Just give us some color, please, around that growth rate. How do we think about the sustainability of that? Was that negatively impacted by developments in India? Thanks a lot.

Sure, Mark, thanks for your questions. I started on unit growth. So unit growth is 10%. Again, as I mentioned last quarter, this measurement excludes a lot of of our fastest growing businesses, things like AWS, advertising, subscription services, which cannibalize the unit calculation, things like Kindle Unlimited and Amazon Music Unlimited. And also it doesn't include Whole Foods Market. So while it is meaningful, it needs to be understood and caveated. So your second question was on international growth. Yeah, talking more about specifically India. So India, for those of you on the call last quarter, we were just heading into an uncertain period with the PN2 ruling. We did make some changes to our structure to stay in compliance with our regulations. There was a few days of downtime for some of our selection. But for the full quarter, the impact was minimal. And we're in compliance and we're very happy with the progress of the business in India. So as far as the growth is concerned in international, we had some noise in Q3 and Q4, if you'll remember with the timing of the Diwali holiday. But we feel pretty good about the Q1 growth there, even despite some downtime in India.

Thank you. Our next question comes from the line of Doug Atmos from JP Morgan. You are now live.

Thanks for taking the questions. I'll also ask too if I can. Just first Brian, can you just talk about the outperformance and operating income in one queue? Pretty significant beat there. It looks like cost of sales and fulfillment, but hoping you can provide some more color. And then why would the margin be materially lower in two queue as you're guiding? And then just second, on the outlook for revenue in the second quarter, on an FX neutral basis, the higher end implies a nice acceleration. So curious what gives you the confidence in that. Thank you.

Sure, Doug. Yeah, let's start with Q1. So if you remember last quarter, I made the point that 2018 saw lower growth in some of our key cost areas. Things like fulfillment capacity, which had been growing over 30% a year in 2016 and 17, dropped to 15% last year. Headcount growth was 48% in 2016. 38% if you exclude Whole Foods and Souq acquisitions in 2017, that dropped to 14% last year. And then financial leases for infrastructure, which are a good proxy for our capital investment in infrastructure, after growing 69% in 2017, grew 10%. So all of those trailing 12-month metrics actually stayed the same or slightly declined in Q1. So we had continued efficiency. We didn't put a lot of new fulfillment center capacity or infrastructure into place, at least compared to Q1 of last year. And hiring was moderate. We actually are down to 12% on a trailing 12-month basis. So I would say that is a continuation of last year, but my point from the last call still holds in that we do expect those growth rates to be higher for all of 2019. So most of that will happen in the next three quarters, and we have that built into the Q2 guidance. We also hit the high end of the revenue range, which is always good from an efficiency standpoint and the drop through on the higher end of the revenue. So now turning into Q2, I would like to tell you a bit about why that's lower. So we're currently working on evolving our prime free two-day shipping program to be a free one-day shipping program. We're able to do this because we've spent 20 plus years expanding our fulfillment and logistics network, but this is still a big investment and a lot of work to do ahead of us. For Q2 guidance, we've included approximately $800 million of incremental spend related to this investment. And just to clarify, to give a little more information, we have been offering, obviously, faster than two-day shipping for Prime members for years, one day, same day, even down to one to two hour delivered from Prime Now. So we're gonna continue to offer same day and Prime Now selection on an accelerated basis, but this is all about the core free two-day offer morphing into or evolving into a free one-day offer. We've already started down this path. We've, in the past month, significantly expanded our one-day eligible selection and also expanded the number of zip codes eligible for one-day shipping. So we're taking a significant step. It wasn't showing up in Q1. It was minimal in Q1's results. It's a significant step and it'll take us time to achieve. And we wanna ensure that we have a good delivery experience for our customers as we evolve this offer. And lastly, I would say in Q2, as a reminder, each year, Q2 is a time when we grant RSUs to employees and we traditionally see a step up in stock-based compensation expense in Q2. We're seeing the same thing this year. And that's also tied in with your question about revenue acceleration. We do believe that, although there's not explicit lift built in for the faster shipping, we have seen good order trends to month to date and we expect, we built a Q2 range around what we've seen.

Our next question is from Justin Post from Merrill Lynch. You are now live.

Great, thank you. As users consume more services and maybe get less boxes, although I guess it could be a pickup in Q2, what does that mean for a customer's stickiness? How are you thinking about getting more advertising and getting more subscription services? And maybe you could just give us a little insight into what you're seeing with Prime churn, especially in the more mature US market. Thank you.

Yeah, sure. Justin, I would say, as I said, I believe on the last call, we had more people sign up for Prime in 2018 than any other year before. So we are very happy with not only the absolute membership levels of the Prime program, but also the engagement. Our engagement in Prime benefits, shipping, hours watched on video, hours listened to on music, all of them are trending in the right direction and continue to get more and more sticky. So, well, I can't share or wouldn't share with you today the Prime, any specific Prime statistics about churn, it does remain a very compelling program. I think the announcement I just made about morphing to a one-day free shipping offer will make it even more the best deal in retail, as we say.

Our next question comes from Eric Sheridan from UBS. You are now live. Thanks

for taking the question. The advertising business saw what looks like a little bit of a step down again in Q1 versus Q4. Q4 was a fairly big step down when you strip out the accounting benefit or the last one is the accounting benefit. Can you talk a little bit about the supply and demand dynamics in the advertising business? How much of that growth you might be controlling to making decisions about ad load versus the demand to advertise among sellers on the platform? And any color you could give us on what you might be seeing in the advertising business, domestically versus internationally would be helpful. Thanks so much.

Sure, yeah, we're seeing, as you can see in the operating margin, we're seeing good advertising growth both in North America and also internationally. Oh, I can't get into some of the questions about ad loads and inventory. I would say really what we're focused on right now is driving relevancy and ensuring that we service the most useful ads possible. I think that's gonna be the best experience for customers and also for advertisers. So most of our focus has been on, again, adding more functionality, adding more products and adding reporting for businesses and advertisers so they can understand the incremental customers you're seeing on Amazon through advertising with Amazon. So it's more right now about tools and making better recommendations, making it easier to use our Amazon demand side platform, things like that, operational improvements. And I guess we're very focused on serving brands as well. That's another theme that we have. Brand stores that we have are easy to create, customized, and we've had great pick up on that from brands where they can show shoppers who they are and tell their story. So it builds a better engagement for the brand and the customer and builds better customer loyalty both to that brand and also to Amazon. Then on the brand side itself, we have new reporting where we're, again, looking to measure the new to the brand shoppers and what Lyft they're seeing. So I would say right now it's more about efficiency and also performance of the advertising themselves. The other revenue growth that you see does include some non-advertising things as well. So other revenue grew 36% and it is principally advertising. Advertising grew a bit higher than that.

Our next question is from Steven Zhu from Credit Suisse. You're now live.

Thank you. And Terry, you can share in regards to the prime users awareness of the availability of stuff from Whole Foods. Is the order flow coming in from a wide number of users or is the activity coming in from a small but very dedicated number of customers? Thanks.

Yeah, thanks, Steven. And I would say that it's widespread and more prime members have adopted the Whole Foods benefit than almost any other benefit we've offered them. And they're saving, as a result, hundreds of millions of dollars. We've continued to expand the coverage for delivery. We have delivery from 75 U.S. metros through the Prime Now app and we also have pickup in over 30 metros also through the Prime Now app. So we're very, the other point I'll make is, just like last quarter, I'll remind you that the physical stores revenue is principally Whole Foods revenue but it excludes the online ordering component where people order on the Prime Now app and it's delivered to them. That shows up in our online stores classification. So last quarter I told you that our growth in store sales, including both shopping and also online deliveries, was closer to 6% in Q4 and it's a similar number in Q1. So again, we're very happy with both the prime adoption of the recognition of the prime benefits by Whole Foods and also the purchases. And you may have also noticed that we lowered prices for the third major round of price cuts since we joined forces with Whole Foods in the summer of 2017.

Thank you. Our next question is from Dan Salmon from BMO Capital Markets. You are now live.

Great, good afternoon everyone. Maybe Brian, just to return to the advertising business for a moment, it does sound like, as Eric noted, that there was a bit of more of a slowdown again, and then I guess I'll ask it this way. Do you believe that some of the improved relevance, some of the improved focus on brands as well as some of the new products can lead that business to reaccelerate at some point again or is it facing law of large numbers? And then just to follow up, just to return to the 800 million investment to improve one day shipping, it sounds like that investment is underway already and that in noting that it'll help contribute to the high end of the guidance this quarter, it sounds like the timing of that is fairly quick. I would imagine it's just simply expanding availability and that that 800 million is largely related to shipping costs, but I just wanna make sure understanding that quickly that this investment has rolled out relatively quickly and starts to take effect relatively

quickly. Yeah, I'm glad you asked that. I would say that while our 20 year head start in investments in logistics and fulfillment capacity and partner networks that we've built are helping us, we also do have a network that is tuned to two day delivery right now, principally for two day delivery. So we do need to build out more one day capacity along with our transportation partners, but we're moving quickly and we've got a good head start. There is a certain tranche that we can dial up quickly and we've started to do that and you'll see that very quickly in Q2. And then stay tuned because we'll be building most of this capacity through the year in 2019. And then your question about advertising, I wouldn't comment on acceleration or deceleration of growth. I would just say we're early on in this venture. There's a lot of, it's having a lot of pickup by both vendors, sellers and also authors. So again, we feel like if we work on the inputs in this business and continue to grow traffic to the site, we will have a good outcome in the advertising space.

Our next question is from Anthony DiClemente from Evercore. You are now live.

Thanks very much. A couple of questions. In the shareholder letter, Jeff wrote, third party sellers are kicking our first party butt. And we read through that, but as we kind of look at the trending and the pacing of the 3P business, you can see a little bit of a deceleration in the 3P seller services line and then 3P units slow down. Might suggest that the third party GMV expansion may not be happening quite as fast. So maybe just talk a little bit of that. Is this just a law of large numbers as time goes by? What is Amazon doing to sort of sustain that growth rate in the third party marketplace business? And then second question is maybe just quickly on media spend. Just update us on how you're thinking about the trajectory of video content spend. Any strategic changes there in terms of library versus originals versus films or TV content?

Thanks. Yeah, let's step back on the third party question. So again, let me reiterate our approach. So main goal here is to allow customers to have the broadest selection, the best available price, and also the most convenient options on how they receive the item. If we're delivering on those three elements, we're indifferent as to whether it's sold by us or a third party. We actively recruit sellers to sell on our platform. It's because it adds selection, if it's in the FBA program, it adds prime eligible selection. We spend billions of dollars a year, as Jeff said, on infrastructure tools and services, not only to allow sellers to sell but to help themselves more successfully. So we have a vested interest in the success of our sellers. Any growth acceleration or deceleration that you see can be very much tied to the total sales of the customer, that we have the customers in any country. So you'll still see the percentage of third party units increased and has been steadily over the last few years. So again, the sellers are as important to us as anything for servicing the customer's need for price selection and convenience. The elements that I just talked about of further investment in one day shipping is directly going to be a cost that we bear and it's also going to be a direct benefit to sellers as well who have prime eligible selection in our warehouses.

Yeah, and Anthony, just a little quick, this is Dave, on your question around media and probably more particularly the video strategy and what we're investing in. I mean, we are continuing to invest meaningfully in digital video. It's an area we're very excited about. Lots of very popular critically acclaimed shows have obviously come out, things like Homecoming, Jack Ryan, more recently Hannah, Guava Island, some great titles. So I think look for us to continue to invest there. On the accounting side, we did adopt an accounting standard in January that amended our accounting for how we account for produced original video content and under that new guidance, we capitalized production costs for original video content. Previously, we only capitalized a portion of those costs. So the net impact for the first quarter to operating income wasn't material. It was, for Q1, the impact of the change was a decrease of about $130 million to cost of sales due to the capitalization change. As we go through 2019 though, we would expect the impact to increase in the latter part or second half of the year in line with our production schedule as it grows throughout the year.

Our next question is from John Blackledge from Cowan and Company. You are now live.

Great, thanks. Just coming back to the Prime one-day delivery. Will it be available to most of the US by the holidays or by the end of the year? I think you had about 100 million items available for two-day delivery, Prime delivery. As the one-day program starts, how many SKUs will be available and would you expect to get the entire 100 million SKUs for one day at some point? And then second question, just on grocery, just curious, the appetite for further expansion outside of all the enhancements you're doing with Whole Foods. Thank you.

Sure, so yes, on the one-day free shipping versus the two-day free shipping, our goal is to evolve the two-day free shipping program into a one-day free shipping program and we're making strides on that. I got into a little bit about the capacity we have to add and the changes we have to make to our supply chain in order to deliver on that. We expect to make steady progress quickly and through the year. We'll have more for you at the end of Q2, obviously. There's a lot of error bars around this program, especially from the cost side. We feel like we're doing something very important for the customer and we are, again, trying to take advantage of the fulfillment capacity and transportation capacity, especially with third-party partners that we have. And we'll just have to see what changes have to be made to get more and more selection into that one-day category.

And then, this is Dave again, just on the grocery side of it, as you mentioned, Brian talked a bit about the Whole Foods market growth, over 500 stores, 75 metros with delivery capabilities. So continuing to grow that out. We are also continuing to invest in our other grocery initiatives. Amazon Fresh, Prime Now, which offers grocery as one of the components of the selection there for the two-hour or even one-hour delivery capabilities. And so, I think we'll keep investing in those areas and other initiatives as well, where we can get food through Pantry, Go. There's a number of initiatives there. So, excited about what we'll be able to continue to bring to customers on that space.

Our next question is from Ben Schachter from Macquarie Group. You are now live.

So, more on the one-day shipping. Should we expect that to rely mostly on USPS, UPS, other shipping services, or are you really gonna try to build out more your Amazon-owned and operated shipping? And on the numbers, 800 million for the quarter, how should we think about that ramping into the back half of the year? Thanks.

Yeah, sure, Ben. I would say we're gonna be using all of the available levers that we have right now, both AMZL and also all third-party carriers. And we'll just see how it develops going forward, but we're gonna need definitely the continued support of our external transportation partners. So, outside of the ramp, I would say that the 800 million is what I have for you today. We will see where we stand at the end of the quarter, and I'll give you insight as to what we just saw and what our outlook is for future quarters at that time. I would like to, as I don't wanna run out of time here, so I'm gonna ask a question for myself about AWS because I wanna get some information to you. Most of the questions I can tell around one day are topical and important. I do wanna highlight the AWS performance in Q1. We're now over a $30 billion annualized run rate, 42% FX-neutral growth, and two billion more of revenue in this Q1 versus last Q1. The operating margin has also expanded in that time period by 320 basis points as a result of a lot of the good work on infrastructure and efficiencies that I talked about earlier in the call, because this is, again, the backdrop of a very large expansion of our tech teams and our sales teams that support this business. We're continuing to engage with many large customers globally, particularly happy about the Volkswagen Alliance that we've joined up with them to power their Volkswagen industrial cloud that's gonna integrate more than 30,000 facilities and 1,500 suppliers and partners in Volkswagen's global supply chain over time. We have deals going with Ford on powering the cars of the future, Lyft, GoGo. A lot of really good customer wins in the quarter. And I think just more broadly, we're seeing continued momentum in enterprise migrations to AWS, and people are moving their workloads to AWS at a faster pace. Usage growth continues to be higher than revenue growth rates.

Our next question is from Mark May from Citi. You're now live.

Mark. Thank you. And actually a follow on to AWS. The growth, clearly impressive, but we did see, I think, sequentially, and I apologize, I'm not in front of the model, but I think the growth was somewhere three or 4% sequentially. There was a little bit of a slowdown in the quarter. Just wondered if there's anything that you'd call out there, pricing or any other factors that you could call out that may have contributed to that. And apologize, but another one day shipping question here. In terms of the 800 million, just curious where that gets you to in terms of coverage of zip codes and SKUs. I assume right now this is a project that's in the US. Where that gets you from a coverage standpoint, and is this something that you expect to be a near to medium term priority in some of your other developed markets like the UK, Germany, et cetera, thanks.

Yes, I'm glad you asked that. So Mark, it is, let me start with that second question. The program will be global. Most of the spend that we are seeing in Q2 is starting in North America, but this is intended to be a global improvement in speed tied to our prime program. So you will see more going forward. I can't give you exact percentages of selection and all that, mainly because we are still, again, working through that. And while we have ratcheted up a significant, turned the dial significantly in April. And so we'll see the cost impact almost immediately in the quarter. We're really gonna have to see how it goes this quarter, both on our pace of selection, addition, and expansion of one day, and let you know probably at the end of the quarter. I would say in the short run, it's also expanding and increasing our speed on all of our orders, quite frankly. On AWS revenue, let me just remind you the quarterly growth last year on an FX neutral basis. So Q1 was 48%, then 49%, then 46%, and 46%. So in the first half of the year, we have a tougher comp, if you will, versus some strong growth in the first half of last year. This is always going to be a lumpy business. It's not only dependent on us, it's also dependent on the companies that are adopting AWS. So there's differences in sales cycles, there's differences in adoption of the cloud, there's differences in migration patterns that will make any quarter to quarter movements lumpy, as I said. So we're happy with the growth, 42% on an FX neutral basis, and again, a $30 billion, greater than the $30 billion annualized run rate.

Our next question is from Heath Terry from Goldman Sachs. You are now live.

Great, thanks. I guess somewhat along those lines, or at least along the lines of growth, we saw CapEx spending and investment in capital leases decelerate to the lowest rate that it's been in several years, maybe even the lowest rate ever. And you guys have said in the past that generally CapEx sort of tracks your, that you're investing at the level of growth that you expect. I'm sure that's not representative of what you expect growth to look like. So just trying to understand sort of where the disconnect is there, and to the extent that the level of investment in physical infrastructure says anything about your expectations for future growth, what the right way to read that is.

Sure, thanks for that question, Heath. No, I would say, A, we're not expecting diminished returns in any of our businesses or growth rates, nor are we restraining the business or constraining the businesses in any way with our capital. I would point you back again to the investments that we made in 2016 and 2017. So we did front load a lot of the investment both in fulfillment centers and also infrastructure. But more than that, it's more than kind of bleeding through excess capacity. We have some really, really impressive gains in efficiencies in both the warehouses and also the data centers. We talk efficiency and every percentage utilization in our data centers is worth tens and more millions of dollars. So again, that's a big part of our model is not only investing but also working on efficiencies, adding new products and features for customers. And as we lower costs, we pass those along to customers either through new rates or new deals that we have. So I would say that, I would look back on the performance in 2018 and say that that was great work with a lot of efficiency as we also banked a lot of capacity that had been built previously. Moving forward, that's why I say it will be increasing as we move through the year. And that would be a constant battle between again, growth, geographic expansion in AWS, and also efficiencies to limit how much we actually need. I think we're also getting much better at adding capacity faster. So there's less need to build it six to 12 months in advance, I would say. Although we did just launch our Hong Kong region today as well, and I wanna point that out. The business in China is going really well and we continue to see strong growth there. And launching the Hong Kong region gets us to a footprint of 19 cities in China. So it continues to be a really good story for us.

Thank you. Our final question will come from Brian Nowak from Morgan Stanley. You are now live.

Thanks for taking my question. I'll go to a new topic, one day shipping. So Amazon, the first principle is customer obsession. And Brian, you talked about record prime subgrowth last year. I guess the question is, what are the signals or the key strategic rationale behind investing in one day? Are there certain types of users, demographics of users, categories of products, countries you think this will help you attract and retain? Seems like prime is growing pretty well. Just talk us through what you see as the big opportunity to invest in one day. And then the second one, just maybe talk to us a little bit about the early learnings on the healthcare industry side of potentially trying to move larger into healthcare.

Great. Yeah, Brian, I would say it's as simple as price selection and convenience, which is the mantra that we talk about quite often. By going to one day, it increases the convenience and it increases the available selection into the consideration set. Although we have many items that are available in one to two hours and also same day, the vast majority of our selection is available to you in two days. If we get that to one day, we literally cut it in half. That's tough math for you. I'm sorry to do that. But we think that that will open up a lot of potential purchases that will open up convenience to those customers. So we've been experimenting with a lot of different formats, as you know. Two day, one day, same day, two hour, stores. There's all types of points of being there for the customer when they need us at different points in their consideration set. So we really think it's gonna be groundbreaking for prime customers and we're very excited to add this capability. Part of this is we have the capability because we've been at this for over 20 years and continue to invest in our fulfillment capacity, our logistics capacity and also fine tune it. But I thank you for your question.

Yeah, Brian and this is Dave, just briefly on healthcare. That term could touch upon any number of different parts of our businesses. Of course, we've talked in the past about how Amazon Business serves many other companies, including the healthcare industry and providing them some great selection and fast delivery is part of the business program there. So that continues to do well and is a focus of Amazon Business amongst other verticals there that they serve. PillPack, we're probably around six months or so in since that acquisition closed. Continuing to support them in their mission and learn from them, certainly. So no real update on that. But excited about the potential there, to be sure. Thanks for joining us today on the call and for your questions. A replay will be available on our investor relations website at least through the end of the quarter. We appreciate your interest in Amazon and look forward to talking with you again next quarter.