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August 06, 1998

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Subject: Re: Comments from a new investor
Author: GRudolph

[Note: Originally, attribution was given to user name "teamrep". That was incorrect, and we apologize for the confusion.]

Repost of Some things to consider:

I. The Bullish Arguments

� Various bullish arguments that have been trotted out to justify the stock price:

1. AMZN will get ad revenue by letting others advertise on their site.

� Maybe. But is AMZN's customer list has an advantage it's that it targets book (and music and video) customers. Who would want to advertise here? Other book, cd and video merchants. Unlikely AMZN will do that.

� Maybe. But at the quarterly conference call, J. Bezos stated that AMZN will still be spending on advertising for itself at portal sites 3 years out. Sounds like a continued expenditure not revenue.

� If the purpose of successful internet advertising to get someone to leave the advertising site for the advertiser's site, then the more successful AMZN is at that - the less likely they'll have concluded a sale.

� Some consumers might be offended by seeing advertising on the site and it would let Barnes & Noble and Borders advertise their web sites as "commercial free."

� David Gardner's (of The Motley Fool) argument regarding Amazon selling high-margin advertising of other firms on AMZN's site (he started saying this last October in a Fool Portfolio Report) seems foolish in light of the company having made no indication at all at the 7/21/98 conference call that it expected future advertising revenues.

� A B.T. Alex Brown analyst, who asked about how Amazon will deal with portals, (given the large associate and ad expenses it incurs for banners at YHOO, other portals, and the new Intuit agreement), and how it will become more of a portal site itself. To which Bezos, in part replied: "We don't feel that after three years that we will be done with portals." In other words, will continue to rely on them to do advertising.

2. AMZN has Competitive Advantages

a. Head Start.

� Yet, CFO Joy Covey warned that Barnes & Noble and Borders have just recently opened up their more easily navigated sites and have begun aggressive advertising campaigns that are expected to impact competition with and making per customer acquisition costs increase further (they already increased this past quarter) both in absolute dollars and as a percentage of sales terms (no doubt pushed higher next quarter by the .01 for a book promotion started 10 days ago).

b. AMZN is like AOL.

� Just bombard the public and secure accounts. Unfortunately, AMZN does not collect monthly subscription fees as does AOL and shoppers can price shop for any one purchase with AMZN and switch among AMZN, BKS,,, etc. These are not accounts. This not a subscription service. If went there once. but never returned, you're still an account. The "accounts" can never decrease because they do not post "active customers."

c. Proprietary Filtering Technology

� Whereas the company had relied primarily on internally developed software systems, it has recently installed "collaborative filtering software" from Net Perceptions. This software enables detailed analysis of user preferences and site surfing habits. The point here is that the more advanced internet e-commerce features are being developed by specialized software firms, such as Net Perceptions, FireFly which in turn service all etailers.

d. AMZN is not a book company. It will broaden its product offerings.

� The press has reported numerous analysts and portfolio managers in the past two weeks who have attempted to justify AMZN's share price by claiming that AMZN would expand into toys, cigars, perfume, software, and some have even claimed that it would evolve into the Walmart of the web. A wonderful idea, but apparently not in the Bezos' plans.

� David Gardner of The Motley Fool publicly posted, hours before AMZN's earnings release, that if it wanted to, AMZN could be the top lobster seller on the web and claimed that: " Amazon isn't just a bookseller, no. They sell a lot of books, yep. But they also sell music now, and if they're not already #1 in market share in that business (I think they are), they will be shortly." Once again, Bezos made no claim even approaching such market share. For Gardner's full comments and retort, see:

� In commenting that he sees the music business as being more diverse and competitive than book e tailing, Bezos said, "It is unlikely that the music business will ever be as profitable as the book business . We expect lower margins and more aggressive competition than we are seeing in the book business."

� In response to a question from an analyst at Goldman Sach's, Bezos said that Amazon would be more likely to bring out new products within the areas of books, music and videos and continue expansion in Europe and other international markets. His rationale, among other factors, was that he feared stretching, what he called Executive Bandwith or the ability to effectively manage new ventures effectively.

� Expansion into software sales. If tries to sell software, they will also become a competitor of some of the very same companies that they are trying to establish niche market advantages with for book sales. Many of these companies are already associates to whom Amazon pays roughly 10% commissions. So now Amazon will turn them from allies into competitors? Bezos says he doesn't think so and no analysts opposed that view.

e. AMZN will expand overseas.

� executives see acceptance of on-line commerce occurring more slowly in Europe as they are perceived to be 2-3 years behind the US in general acceptance of e-commerce. This timetable gives Borders, Barnes & Noble and most importantly Bertelesman, time to compete in this early stage market.

f. E tailers Have no brick & mortar costs?

� In which case, why are inventories increasing faster than revenues/sales? Tony Blake, one of the analysts on the call, questioned why inventory levels had moved up over 50% from last quarter but margins had not improved. He said that the expectation in his model was for the margins to improve as the company increased inventory levels, thus reducing the reliance on paying out for the distribution costs. Joy Covey responded that Amazon expects to see "not much benefit" from handling the inventory themselves.

� Revenue and inventory growth are for the six month period: Revenues +75.8% and Inventory +89.9%. For the three month period: Revenues +32.7% and Inv. 45.9%.

� Increased CapEx for facilities.

� Covey said that the company needs to make major investments for increased facilities in Europe and in North America. Some of these expansions will include at least 2 new warehouses for distribution and redundant server facilities to insure against access and natural disaster or other service interuption problems. Dell computer, Compaq, Excite and many, other major vendors have already invested millions in providing these facilities.

� Hiding brick & mortar costs or

� But for "Marketing Expenses," we'd be profitable. Management, analysts and The Motley Fool have repeated the canard that if one removed advertising expenses, the company would be profitable immediately, it is simply trying to amass market share currently. Unfortunately, this is not true. While AMZN again reported it boosted it's advertising spending significantly, from $19.5 million (22.3% of sales) in the first quarter to $26.5 million (22.8% of sales) in the June period, this neglects to point out, as AMZN's last 10Q explicitly does, that Marketing DOES NOT equate to Advertising, since "Marketing Expenses" includes the costs of packing books, executing orders, and customer service..

� Despite the comments of Ryan Jacob, manager of The Internet Fund, that Amazon has had the ability to "turn off" marketing expense and be profitable, this is simply untrue as reducing "marketing expenses" to nothing would reduce the number of book orders processed and books shipped to zero. Of course, it was Joy Covey who, in the last quarterly conference call, created the new line item, EBITDMA (excluding marketing costs).

g. Our shoppers are not price sensitive. Loyal to amzn shopping experience.

� Recent studies by Coopers & Lybrand and Georgia Tech Graduate dept. indicate that competition on the internet is expected to grow dramatically as the ease with which price comparisons are made is facilitated greatly compared to traditional shopping methods.

II. The Numbers

1. Jeff Bezos quotes:

� "It is still early-on in the development of internet commerce . . . we do not expect growth rates to continue at historical rates.

� "It is extremely unlikely that the company will be able to maintain the same level of market share . . . as the business grows further . ."

� "It is extremely unlikely that Amazon can maintain the current growth rate . . ."

� "It is impossible to predict the impact of new competition several quarters in the future .

. . we urge caution in interpreting current levels of growth . . ." Joy Covey speaks:

� Gross margins are expected "to decline in the remainder of 1998."

2. Zero sequential growth is projected for the first time in the company's history.

� This coming quarter will be the first one that AMZN will see the full impact of B&N and Borders competition (with Borders launching an ad campaign this fall) and the company therefore expects sales to be flat to marginal sequential growth over this just reported quarter, according to Joy Covey.

� To go from over 33% sequential growth from 1st qtr to this past one ($87 mil to $116 mil) to near zero growth is quite dramatic and both Bezos and Covey repeatedly warned that is was "extremely unlikely" that Amazon would maintain past growth rates. AMZN's revenue grew sequentially 33%, margins were flat, yet the stock price tripled since the last report

� Amazon's costs are growing faster than their sales or margins.

3. Customer Acquisition Costs.

� In response to analysts questions, Joey Covey, CFO, said that customer acquisition costs were higher than the company had expected.

4. On "Beating" Estimates

� Estimates for Amzn's loss were ~.20 just 2-3 months ago. The company guided estimates up to .44 so that they could "beat estimates." That does not change the fact that the company DOUBLED its loss estimate.

5. Spectacular Sales Growth & Customer Loyalty

� Repeat sales are now at 63%, up significantly from past quarters. While impressive customer loyalty rates, (though no better than CD Now or NTKI), this too signals that sales growth rates will decline sharply in the future. As well, given a 33% quarter-to quarter growth rate in sales, if 63% are repeat customers, then approximately the entire difference between Q1 and Q2 is comprised of new sales totaling $30 million.

� Year to Year Comparison 97 to 98
1Q 2Q
Revenue 446% 329%
Accounts 446% 410%
Rev/Share 355% 281%
Stock Price 300% a 1000% b

a. The rate of growth in revenues and accounts is 1.5 times the stock price appreciation during first quarter.

b. The rate of growth in revenue is .3 times the stock price appreciation.

� Sequential Comparison (1Q to 2Q)
97 98
Revenue 68.9% 33%
Accounts 79% 34%
Rev/Share 54% 29.5%
Stock Price na 300%

This last table is significant; the sequential quarter rate of growth has dropped in half, but the stock has tripled. Losses have increased, share creep has continued. Dilution is troubling. Losses would have been over .46 if they hadn't added 1.4 million more shares.

6. Other Accounting Games - Quality of Earnings

� If you deduct the goodwill ($52mil), tangible net worth is negative $13 million. And that's assuming that the $5.4mil they added to "Deferred charges" and the $9.2mil added to "Prepaid expenses and other" have some tangible value and should not have been expensed. Does their new loan agreement have a minimum tangible net worth covenant?

� Ignoring non-operating write-offs even though they keep coming along every year regular as clockwork. But have you ever seen reported "pro forma" EPS that excludes goodwill amortization.

� Prepaid expenses, deferred charges & Goodwill are all up. Perhaps massaging profit and loss numbers on the income statement

� AMZN wants to provide, "for informational purposes" pro forma earnings (losses) w/o new company expense; but purposely chooses not to inform what pro forma revenues would have been w/o new companies.

� Cash Burn. Cash on hand, less accounts payable, less long term debt has gone from plus 15.8 mill to minus 39.8 million since December 31, 1997. this is a net cash burn of 55 million.

� Page Views. Seek reports that daily page views fell to 20.3 million in June from 22.1 million in March

III. Questions We'd love to hear AMZN answer.

1. What were the revenues from music sales?
2. What were the revenues from associate sites?
3. Why doesn't AMZN take ads on their site?
4. What's happening with those 3 acquisitions?
5. Exactly how much stock in addition to the $55 million cash was exchanged for the companies?
6. Why are inventories increasing faster than revenues?

[Edited For Length]

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