Thank you for standing by. Good day, everyone, and welcome to the Amazon.com second quarter 2012 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 Vice President of Investor Relations, Mr. Sean Boyle. Please go ahead.
Hello, welcome to our Q2 2012 financial results conference call. Joining us today is Tom Szkutak, our CFO. We will be available for questions after our prepared remarks. The following discussion and responses to your questions reflect management's views as of today, July 26, 2012, only, and will include forward-looking statements. Actual results may differ materially. Additional information about factors that could potentially impact our financial results is included in today's press release and our filings with the SEC, including our most recent annual report on Form 10-K. As you listen to today's 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. During this call, we will discuss certain non-GAAP financial measures.
In our press release, slides accompanying this webcast, 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. Unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2011. I'll turn the call over to Tom.
Thanks, Sean. I'll begin with comments on our second quarter financial results. Trailing 12-month operating cash flow was $3.22 billion, compared with $3.21 billion. Trailing 12-month free cash flow decreased 40% to $1.1 billion. Return on Invested Capital was 11%, down from 21%. ROIC is trailing 12-month free cash flow divided by average total assets minus current liabilities, excluding the current portion of long-term debt over five quarter end. The combination of common stock and stock-based awards outstanding was 468 million shares compared with 468 million shares. Worldwide revenue grew 29% to $12.83 billion, or 32% excluding the $272 million unfavorable impact from year-over-year changes in foreign exchange rates. We're grateful to our customers who continue to take advantage of our low prices, vast selection, and shipping offers. Media revenue increased to $4.12 billion, up 13%, or 15% excluding foreign exchange.
EGM revenue increased to $8.16 billion, up 38%, or 42% excluding foreign exchange. Worldwide EGM increased to 64% of worldwide sales, up from 59%. Worldwide paid unit growth was 43%. Active customer accounts exceeded 180 million. Worldwide active seller accounts were more than two million. Seller units were 40% of paid units, compared to 36% of paid units in Q2 of 2011. Now I'll discuss operating expenses excluding stock-based compensation. Cost of sales was $9.49 billion, or 73.9% of revenue, compared with 75.9%. Fulfillment, marketing, technology and content, and G&A combined was $2.99 billion, or 23.3% of sales, up approximately 307 basis points year-over-year. Fulfillment was $1.3 billion, or 10.1% of revenue, compared with 9.2%. Tech and content was $970 million, or 7.6% of revenue, compared with 6.3%. Marketing was $521 million, or 4.1% of revenue, compared with 3.3%.
Now I'll talk about our segment results, consistent with prior periods, we do not allocate to segments our stock-based compensation or other operating expense line item. In the North America segment, revenue grew 36% to $7.33 billion. Media revenue grew 18% to $1.87 billion. EGM revenue grew 41% to $4.94 billion, representing 67% of North America revenues, up from 65%. North America segment operating income increased 61% to $344 million, a 4.7% operating margin. In the International segment, revenue grew 22% to $5.51 billion. Adjusting for the $269 million year-over-year unfavorable foreign exchange impact, revenue growth was 28%. Media revenue grew 8% to $2.25 billion, or 12% excluding foreign exchange. EGM revenue grew 34% to $3.22 billion, or 42% excluding foreign exchange. EGM now represents 59% of international revenues, up from 53%. International segment operating income decreased 91% to $16 million, or 0.3% operating margin.
Excluding the unfavorable impact from foreign exchange, International segment operating income decreased 74%. Consolidated segment operating income decreased 7% to $360 million, or 2.8% of revenue, down approximately 109 basis points year-over-year. Excluding the unfavorable impact from foreign exchange, CSOI decreased 4%. Unlike CSOI, our GAAP operating income includes stock-based compensation expense and other operating expense. GAAP operating income decreased 47% to $107 million, or 0.8% of net sales. Our income tax expense was $109 million, a 75% effective tax rate for the quarter, and includes a one-time expense of $51 million related to the integration of the Kiva Systems acquisition. Accordingly, our Q2 2012 effective tax rate is higher than both our current estimated 2012 annual effective rate and our 2011 effective tax rate. GAAP net income was $7 million, or $0.01 per diluted share, compared with $191 million and $0.41 per diluted share.
Q2 2012 net income includes $65 million of estimated loss related to the acquisition and integration of Kiva Systems. Turning to the balance sheet. Cash marketable securities decreased $1.39 billion year-over-year to $4.97 billion. Inventory increased 36% to $4.38 billion, and inventory turns were 10.1, down from 11.3 turns a year ago, as we expanded selection, improved in-stock levels, and introduced new product categories. Accounts payable increased 24% to $7.07 billion, and accounts payable days decreased to 68 from 69 in the prior year. Our Q2 2012 capital expenditures were $657 million. The increase in capital expenditures reflects additional investments in support of continued business growth, consisting of investments in technology infrastructure, including Amazon Web Services, and additional capacity to support our fulfillment operations. I'll conclude my portion of today's call with guidance.
Incorporated into our guidance are the order trends that we've seen to date and what we believe today to be appropriately conservative assumptions. Our results are inherently unpredictable and may be materially affected by many factors, including a high level of uncertainty surrounding exchange rate fluctuations, as well as the global economy and consumer spending. It's not possible to accurately predict demand, therefore, our actual results could differ materially from our guidance. As we describe in more detail in our public filings, issues such as settling intercompany balances in foreign currencies amongst our subsidiaries, unfavorable resolution of legal matters, and changes to our effective tax rates can all have a material effect on guidance. Our guidance further assumes that we don't conclude any additional business acquisitions, investments, or settlements, record any further revisions to stock-based compensation estimates, and that foreign exchange rates remain approximately where they've been recently.
For the Q3 2012, we expect net sales of between $12.9 billion and $14.3 billion or growth between 19% and 31%. This guidance anticipates approximately 425 basis points of unfavorable impact from foreign exchange rates. GAAP operating income or loss to be between $350 million loss and $50 million loss, down from $79 million income in the comparable prior year period. This includes approximately $275 million for stock-based compensation and amortization of intangible assets. We anticipate consolidated segment operating income or loss, which excludes stock-based compensation and other operating expense, to be between a $75 million loss and $225 million in income, or between 129% decline and 14% decline. We expect capital expenditures, including capitalized software development, to be approximately $0.8 billion-$0.9 billion.
These anticipated investments are driven primarily by our expectations of continued business growth, consisting of investments in technology infrastructure, including Amazon Web Services, and additional capacity to support our fulfillment operations. We remain head-down focused on driving better customer experience through price, selection, and convenience. We believe putting customers first is the only reliable way to create lasting value for shareholders. Thanks. With that, Sean, let's move to questions.
Great. Thanks, Tom. Let's move on to the Q&A portion of the call. Operator, will you please remind our listeners how to initiate a question?
At this time, we will now open the call up for questions. In the interest of time, we ask that you limit yourself to one question. If you would like to ask a question, please press star 1 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 press star then one on your touchtone telephone at this time. Please hold while we poll for questions. Thank you. We will take our first question from Spencer Wang with Credit Suisse.
Thanks. Good afternoon. Just one question on Kiva in a couple of parts, Tom. Now that you've closed the acquisition, can you talk about how you'll deploy the Kiva technology? Is that for new fulfillment centers only, or can you use that in your legacy fulfillment centers, and perhaps what type of operational efficiencies that could gain? Last part would be, is there any impact on our 3Q guidance from the Kiva acquisition specifically? Thanks.
In terms of Kiva itself, we're very excited to have Kiva as part of the Amazon team. We're looking forward to getting great productivity over time through the use. Again, it's very early, and you'll just have to stay tuned in terms of the plan. In terms of the impact, you mentioned Q3. Let me just provide a little bit of data on both Q2 actuals and Q3. In terms of GAAP operating income, in Q2, it was -$25 million. For Q3, it's approximately -$35 million. On net income for Q2, it was a loss of approximately $65 million. Those are the numbers for Q2 and Q3. Again, we're very happy to have them part of the team, and we look forward to working with them going forward.
We will go next to Heather Bellini with Goldman Sachs.
Hi, guys. Great quarter. Question on the gross margin continues to climb up. I was wondering if you could give any commentary there around how agency versus wholesale in e-books is contributing to that.
Yeah. The bigger issue is not that, it's related to overall 3P. There's a number of different factors certainly driving the improvement in the implied gross margins that you're referring to. As it relates to 3P, it's on the broader 3P. If you take a look at, from a units perspective, third party was 40% of our total units in Q2. That's up from 36%. It's approximately 400 basis points increase as percentage of total units, which is certainly one of the factors that you're seeing there.
We will go next to Herman Leung with Susquehanna.
Hey, great. Thanks for the question. This is Deepak sitting in for Herman. The question I had was on the hardware business. How important do you think is the hardware strategy to you for the digital content now, given that Kindle Fire has been out there for a while? Could you discuss about the strategy on the business and how it's driving the digital content?
Sure. We're very excited about both the hardware and the content side of the business. We think if you take a look at our devices, certainly it's very integrated, which is great for customers. We think it's an incredible experience. We've been very excited about the progress we've made so far from both the device and content standpoint, and we're super excited about the roadmap that we have. Again, very happy with what the team's doing there.
We will go next to Brian Nowak with Nomura Equity Research.
Thank you, and thanks for taking the question. This is Aram Rubinson sitting in for Brian Nowak. I noticed that shipping costs were lower as a percent of sales for the first time in nearly three years. The driver, it looks like, is shipping cost per unit, which fell about 10%. Can you talk about how much of that might be attributable to the proximity of distribution centers to metro areas, lower fuel, more favorable carrier pricing, et cetera, and whether or not you see anything on the horizon that would change that course?
Yeah. There's a number of different factors, but certainly one of them is we're getting closer to customers, and that's just with our wide multi-node fulfillment network. That's certainly having an impact on that. Again, we have a lot of opportunities to improve that over time. Again, the team's making good progress, and you're seeing that reflected in the results so far.
We'll go next to Justin Post with Bank of America Merrill Lynch.
Hi. Thanks for taking my question. This is Paul Bieber for Justin. Just going back to the gross margin question, I was wondering if you could give us some color on the relative impact of a few different things, category maturity, advertising, 3P, and maybe digital content on gross margins. Which ones are impacting gross margins more than others? Just a quick question on the taxes. What will the impact of sales tax collection in Texas and California be on gross margins?
In terms of your question on gross margins, we're not breaking that up, but certainly 3P is having an impact, mix of business is having an impact. We continue to try to work with our partners to get even better prices on the goods that we provide for customers, which is certainly impacting it. Mix of business, things like AWS is certainly impacting that as well given the growth rates there. Again, those are things that are impacting. In terms of sales taxes, any impact that we certainly would expect to see would be included in the guidance that we're giving for Q3. One thing to keep in mind as it relates to that is right now approximately 50% of our business around the world, we either collect sales tax or value-added tax. We have very good businesses in most jurisdictions.
Keep that in mind as you think about any upcoming changes.
We'll go next to Doug Anmuth with JP Morgan.
Hi. Thanks. This is kaizad Gotla in for Doug. Just a couple of questions. Can you discuss the international media deceleration? Looks like it decelerated from 22%-12% on an ex-FX basis. Can you just give us an update on the fulfillment center plans for the rest of the year? Thanks.
Sure. I'll take international and total first, the same is true for media. Really, I'll even start with the total business. Total business grew 32%, this is on a local currency basis. One thing to keep in mind is for both the total business international growth and international media, we had very strong growth last year, Q2. In fact, our total growth rate last year was 51% for the total business. On a local currency basis, that was 44% growth. That's the highest growth quarter we've had in over 10 years. When you look at that, when you're comparing ourselves in Q2 this year, we had very good growth given that compare to last year. That's some of what you're seeing also in international media, as you mentioned. International media was up 8%. On a local currency basis, it was up 12%.
Certainly it's a challenging compare. Also, there were some timing things as we launched with the unfortunate events in Japan last year. We certainly did have some releases that we know were scheduled for late in the quarter that obviously didn't happen, that moved into Q2 just from a supply standpoint. Those are certainly impacting that region and some other things. Again, think of it in terms of the comparison point to last year is probably the best thing to do.
We'll go next to Mark Mahaney with Citi.
Hi, this is Rohit Kulkarni filling in for Mark. Couple questions. Can you talk about or disclose anything about mobile, how that's affecting your business? eBay talked about mobile affecting their growth rates quite materially, perhaps even by a few percentage points and accounting for almost 10% of their revenues, maybe. Second is, can you talk about the broad philosophy of management about short-term profitability versus long-term growth? As in, probably this is the first time in a while that you have bracketed negative pro forma operating income in your guidance. How should we view your short-term investment or the short-term profitability outlook? Thank you.
Sure. First, in terms of mobile, clearly smartphones and tablets are significant tailwinds for our business. Although we're not breaking out the numbers, it's a big tailwind on our business, and it's going great. We're seeing a very nice impact from that. Again, it's a tailwind that we expect that will continue. In terms of short-term versus long-term, we're all about trying to make sure we do the right long-term things for both customers and shareowners. More specifically around Q3. Q3 is similar to Q2 and other previous quarters in that we're investing certainly for the long term. On the flip side, keep in mind, as you look at Q3 specifically, we're getting ready for our most seasonal quarter. We expect, given the growth that we've had, we're seeing very strong growth, so we're investing heavily to get ready for that.
In terms of capacity, for example, we've announced 18 new fulfillment centers so far this year. We've actually opened eight of those already this year out of the 18. We're looking at potentially opening even more than that. I'm sorry, six open so far this year out of 18. Those are certainly something that are impacting our cost so far, and you'll be seeing that heavier in Q3 as we get ready for the most seasonal quarter.
We'll go next to Mark Miller with William Blair.
Hi. I was hoping you could share some perspective on your URL expansion strategy. I'd like to know, I get some sense for the growth you're seeing there and how material it is in your overall numbers. Should we expect to see further expansion in those sites?
Yeah. It's not a lot I can help you with there. We're certainly looking as you'd expect us to do, ways to continue to grow. Certainly that would be part of our strategy.
We'll go next to Scott Tilghman with Caris & Company.
Thanks. Good afternoon. Tom, I was just curious. We've had a few quarters here where operating income has far surpassed the upper end of your guidance range, and we had a quarter here where you definitely seemed to weaken as the months went by. Just wondering what you think is causing that divergence between sort of expectations at the beginning of the quarter and how things are playing out. Just as a quick follow-up to one of the other questions, looking at the fulfillment center network, just wondering if you are satisfied with the fee increases that were put in place in February, that business is now matching the margin for the rest of the business. Thanks.
I'm sorry, could you elaborate on the months going by? I wasn't following your question.
Oh, just on operating income. We've had a few quarters here where the numbers have come in far better than guidance. We actually had.
Okay
We had a situation where Europe actually got worse as the quarter went on. I was wondering what is driving that outperformance.
Got it. Certainly, as you look at, I'll talk to Q2 since the most recent quarter. We had a lot of strength across many different areas. One of the ones I mentioned that certainly helped our operating profit as well as our gross margin was our third-party business, continued to be very strong. Certainly that was a factor. Again, there was a number of factors. One thing, too, you do see some timing differences to some extent between Q2 and Q3 in terms of our prep for Q4. You see that not only in our operating results, but you see it in our CapEx. In the last 90 days ago, we said that we would spend approximately $800 million-$900 million of CapEx for Q2. We spent a little less than $700 million. You see that number for Q3 being $800 million-$900 million as well.
Again, those are things that you're seeing just a little bit of a shift between Q2 and Q3 there.
We'll go next to Ron Josey with ThinkEquity.
Great. Thanks for taking my question. Wanted to ask you a quick question on 3P. Given it's around 40% of sales this year, items sold, what point do you believe the customer experience on Amazon is at risk given the rise of third-party sales? Any insight in terms of adoption on FBA by third parties would be very helpful. One quick follow-up just on your comments, Tom, on CapEx. I think you said came in lower in 2Q. Guidance is for another $800 million-$900 million. Is that guidance sort of consistent maybe going out, going forward, or is this sort of a one-time build around technology? Thank you.
Yeah, in terms of the third-party units, certainly FBA is having an impact on that. That's one of the drivers certainly too, that's helping us have that % of total units go up. We've looked at and been working very hard over a number of years on improving the experience for both customers and for sellers, and FBA is an example of that. What ends up happening is FBA sellers, once they're part of the program, those units that are FBA in our fulfillment network are eligible for all of our programs, including free Super Saver Shipping, Prime. Again, certainly that's a great program for customers, it's a great program for sellers, and it's a great program for investors. I don't think of it as a bad thing at all. I think of it as a good thing.
We have a lot of retail units that we send directly to customers. We're offering a great experience on third-party units, which includes FBA and a number of other programs that we have. Again, we'll continue to try to make that even better for customers and sellers over time. It's working very well. Again, the benefit of having third parties on our platform is we get to add great new selection. We also have competing offers directly on our detail pages. When customers come, they get to choose in terms of who they want to purchase from. It's a competitive environment on our platform. We think that's great for customers and for us.
We'll go next to Soyoung Lee with SunTrust.
Hi. Thanks for taking my question. I was just curious about LivingSocial. It seems to be a bigger loss than usual. Can you give us some color on what happened, perhaps? Secondly, can you talk about the kind of traction you're getting with LoveFilm given all the exclusive content you're getting there? Thanks.
LoveFilm business is doing very well. It's growing nicely. As you mentioned, we continue to add content there. We plan on adding more content there over time. Very excited to have that business as part of Amazon, and the team's doing great. In terms of LivingSocial, there's not a lot I can add to it, other than what we've disclosed.
We'll go next to Ken Sena with Evercore Partners.
Thanks. This is Andrew McNellis in for Ken. Somewhat related to other questions that have been asked, could you provide any update to your same-day shipping efforts and how that relates to sales tax and fulfillment center investment?
Sure. In terms of delivery speed to customers, we're certainly trying to get geographically, always trying to get closer to customers. That's something that's not new. It's something that we've been doing for some time. In terms of same-day, we don't really see a way to do same-day delivery on a broad scale economically. Again, we'll continue to work on behalf of customers to try to figure out a way to serve them even better by getting product faster. In terms of same-day, we don't see a way to do that on a broad scale economically.
We'll go next to Anthony DiClemente with Barclays.
Hi. This is Perry Gold on for Anthony. Could you please touch on the online sales tax issue and how it could affect your build-out strategy for fulfillment centers? Thank you.
As I mentioned earlier, we do collect in several states within the U.S. We do collect in a number of geographies that have an equivalent value-added tax. Approximately half of our business, we actually collect sales tax or value-added tax. We do very good business in those geographies. Those geographies are reflected for the most part. If you go back the last several years, most of them have been included. We've certainly added some new geographies or new jurisdictions that we collect during that time period. You see that we've seen very strong growth even while collecting. We're very supportive of collecting. We think the best way to do that is through a federal solution, we keep working with Congress and others to try to get that passed.
We'll go next to Kerry Rice with Needham & Company.
Thanks a lot. Kind of hitting on the sales tax issue again. Amazon signed a lot of bilateral agreements with several states on the collection of sales tax, I know there's a federal effort also going on. Can you talk about if a federal sales tax is passed, how does that impact your bilateral agreements with the states? Does that supersede it, or does that have to continue to go on with those particular states and build those fulfillment centers and things in those states that you've agreed to?
Yeah, there's not a lot I can add to that. Sorry, I can't be that helpful with your question. I apologize. Again, you're right, we do support federal legislation. We're working very hard at that. One thing to keep in mind, too, we price our products irrespective of what sales tax is. That's a customer obligation. So we're pricing products very well. So that's not something that we just started doing. That's something we've been doing for a long time. That's why we have a good business in those geographies and jurisdictions where we do collect. Because customers are coming to us because they want to have value, which we offer irrespective of tax. There's been a number of different third parties that have certainly reported on that. They come because they want great convenience. They want, obviously, great service.
Those are the things we're focused on, and those are the things that we believe customers will still want over the long term. That's why we focus on those areas.
We'll go next to Matt Nemer with Wells Fargo Securities.
Hey, Tom. The international segment operating income has been under a lot of pressure. Is that primarily related to existing markets, growth in new markets? Would that be on the merchandise margin side of the P&L, or is it more of an operating cost issue?
Keep in mind with international, it's a mix of geographies, and there's some that we're investing in. We mentioned certainly in other calls, China's an area that is growing very fast, but we're certainly in investment mode there. In recent years, we've launched Italy and Spain. We're certainly investing in those geographies and like what we see there. Those are certainly impacting. We're also adding a lot of fulfillment capacity. Those are the things that are certainly impacting those numbers.
We will take our last question from Atul Bagga with Lazard Capital.
Hey, guys. Thanks for taking my question. I have two questions, one on guidance and the other one on Prime member. Can you give some color on guidance, what you're baking for growth in international versus domestic? Guidance implies there is some compression in margin. Is it again, mostly the function of the sales mix, or is something else going on there? Second on Prime members, can you remind us the profitability of Prime member versus non-Prime member, and longer term, where do you think the penetration of Prime members within your overall base?
In terms of revenue, we don't break out the segments in terms of the split. If you take a look at our guidance, it's to grow between 19% and 31%. If you look at the impact of exchanges, a little over 400 basis points. Rounded, it's just under 36% on the high end and 23% on the low end. That's the range of guidance. We're certainly pleased with what we saw in Q2, and we're certainly giving, as we have in past quarters, the appropriate wide range for Q3. In terms of the bottom line, in terms of operating income and CSOI guidance that we've given, as I mentioned earlier, certainly a number of different factors like the last several quarters as we've been talking about, we're certainly investing a lot in the business.
One thing to keep in mind is for the guidance in the upcoming quarter to Q3, we are certainly getting ready given the growth rates we've had for our most seasonal quarter. That's certainly impacting the bottom line in terms of our guidance. As I mentioned earlier, we're opening a lot of fulfillment centers. We're adding a lot of capacity for both our web service business as well as infrastructure support our retail business. Again, we're investing across the business, which is like other periods. Again, we're getting ready for Q4.
And that will-
Thank you for Sorry.
That will conclude our question and answer session. I'll turn it back over to our speakers for any additional or closing remarks.
Thank you for joining us on the call today 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.com and look forward to talking with you again next quarter.
That does conclude today's conference. We thank you for your participation.