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Amazon.com, Inc. (NASDAQ:AMZN)
Q1 2018 Earnings Conference Call
April 26, 2018, 5:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, everyone, and welcome to the Amazon.com Q1 2018 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'll be turning the call over to the Director of Investor Relations, Dave Fildes. Please go ahead.

Dave Fildes -- Director of Investor Relations

Hello, and welcome to our Q1 2018 financial results conference call. Joining us today to answer your questions is Brian Olsavsky, our CFO. 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 from the comparable period of 2017.

Our comments and responses to your questions reflect management's views as of today, April 26, 2018 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 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.

Questions and Answers:

Operator

At this time, we will now open up the call for questions. We ask each caller to please limit yourselves to one question. If you would like to ask a question, please press *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 * then 1 on your touchtone telephone at this time. Please hold while we poll for questions.

Our first question comes from the line of Eric Sheridan with UBS. Please proceed with your question.

Eric Sheridan -- UBS Securities -- Analyst

Thanks so much for taking the question. I wanted to ask if you had any update on the state of the advertising business? Sort of the state of conversations with advertisers, what product uptake you're seeing out in the marketplace and sort of how that's looking now as we move out of '17 and into 2018, broadly for the platform? Thanks so much.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Yes, sure, Eric. I would say advertising continues to be a bright spot, both from a product standpoint and also financially. It continued to be a strong contributor to profitability in Q1. It's now a multi-billion-dollar program. You can see in our Supplemental Revenue Disclosure it's in "Other Revenue," and it's the majority of the other revenue in that line item.

Our philosophy there, again, is we're continuing to focus on finding valuable ways to make our advertising opportunities better for customers, showing them new products that they may not have seen otherwise, and also for emerging established brands, helping them to reach customers. I think the advertisers generally are all shapes and sizes. Their common theme is they all want to reach our customers generally to drive brand awareness, discovery, and eventually purchase.

Before I go on to the second question, I want to make a comment about the Prime program. The Prime program continues to drive great strength in our top line, as you've seen over the last few years, actually. We continue to increase the value of Prime, including speed, selection, and digital entertainment options. We've been expanding free, same-day shipping and one-day options. In our two-day shipping, it's not available on over 100 million items, up from 20 million as recently as 2014. We continue to add digital benefits like Prime Video. The value of Prime to customers has never been greater.

The cost is also high. As we pointed out, especially with shipping options and digital benefits, we continue to see a rise in cost. Effective May 11th, we're going to increase the price of our U.S. annual plan from $99.00 to $119.00 for new members. The new price will apply to renewals starting on June 16th. Prime provides a unique combination of benefits. We continue to invest in making this Prime program even more valuable for our members. As a remember, we haven't increased the U.S. annual price of prime since our single increase, which was in March of 2014.

Dave Fildes -- Director of Investor Relations

And Eric, sorry to just go back to your initial question too, just to hop back on that, I just wanted to remind folks that, and we mentioned this last quarter on the call, but on January 1st we adopted an accounting standard update that amended our revenue recognition policies. The net impact to revenue in the first quarter was not material, but I do want to highlight a few areas.

As part of the adoption beginning in Q1, certain advertising services were classified as revenue, rather than a reduction of cost of sales. The impact of this change was an increase of $560 million to other revenue in Q1, which the other revenue is of course part of our supplemental sales disclosure. You'll see that other revenue in total increased 132% XFX year-over-year to about $2 billion in the first quarter. Again, $560 million is included in there. The majority of that would be included in the North America segment.

As you look at the other supplemental line items, just a few items of note. The line item online stores revenue increased about 13% XFX. Beginning in the first quarter, sales of apps and app content and certain digital media content are not presented on a net-revenue basis and included in third-party dollar services revenue, rather than that online stores revenue. So, in the first quarter, online stores revenue would have been higher but for this new standard.

The line item subscription services revenue, that increased about 56% XFX year-over-year. Prime memberships are included in that line. Again, beginning in the first quarter, we now recognize annual Prime membership revenue straight line over the 12-month period. Prior to 2018, we recognized this revenue over the 12-month period with more revenue allocated to the fourth quarter each year. In Q1 of this year, subscription services would have been lower but for this new standard.

Operator

Thank you. Our next question comes from Brian Nowak with Morgan Stanley. Please proceed with your question.

Brian Nowak -- Morgan Stanley & Co. LLC -- Analyst

Thanks for taking my questions. The first one, on Prime, let me ask you this: as you think about your U.S. Prime penetration, there's some data that shows you've done a very good job at capturing a lot of the middle-to-higher-income households and now you're raising price. Talk about the tension point you need to solve to sort of reach some of the lower-income households and even households that are not yet Prime. What are the main reasons why people in the U.S. are not signing on for Prime at this point?

The second one, on early learnings from the integration of Prime Now and Whole Foods recognizing it's only in a few cities. What can you share with what you're seeing about purchase behavior early learnings, and what are the main signposts you're watching as you determine how quickly to roll that out to move cities in the U.S. and hopefully New York soon?

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Sure, on your first question about Prime penetration. Without getting into any statistics on penetration by country, I would say we do have other options. If you'll notice, the monthly option obviously provides more flexibility for people who want to try out Prime before committing to the annual plan. There's discounted student plans. There's also discounts for other groups. We do feel it's still the best deal in retail. We work to make it better and better each day.

The second thing you mention is a good example. The ability is 10 cities to get Prime Now deliveries of Whole Foods groceries is an added benefit for people in those markets using Prime Now. As far as the Whole Foods, specifically on the question of what we'll look at as far as expanding that grocery delivery, we're going to use the 10 cities as a test and see how customers respond, just like we always do, and make sure that our deliveries are great for those people. Then we'll announce expansion plans once we digest the feedback we get from customers.

Operator

Thank you. Our next question comes from the line of Heath Terry with Goldman Sachs. Please proceed with your question.

Heath Terry -- Goldman Sachs -- Analyst

Great, thank you. I was just wondering if you could give us a sense, the accelerating growth that we saw in the U.S. business in Q1, how much of that or how would you sort of segment that in terms of specific categories? Are there any specific categories that you would call out in terms of driving that? Then as we look at the like acceleration in the AWS business, any sense that you can give us in terms of what volumes or customers -- you specifically call out sort of customer additions in some of your comments -- what customer additions have looked like in terms of driving that business particularly against sort of the comp against last year's price cuts?

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

First, you mentioned North America revenue growth. You can calculate that with and without the impact of Whole Foods, I'm sure. The general driver continues to be Prime and Prime Flywheel. We see strong customer demand, not only for the benefits that we associate with Prime. We're seeing better engagement with Prime benefits, especially digital benefits. That is always good news for eventual sales of other things. We're also selling more subscriptions -- Music Unlimited, Kindle Unlimited -- there's a number of services. There's different revenue streams that we see.

Not much more I can add by product line to North America. If I talk about AWS revenue, again, we are accelerating. We have accelerated for the last two quarters. The FX neutral growth was 48% in Q1, up from 44% on the same basis in Q4, and 42% in Q3. And now nearly a $22 billion run rate. What we're seeing is continued strong usage, both by existing customers and signing new customers. We see an increased pace of Enterprise migrations as customers are having success with AWS and increasingly trying new services. We are seeing people move more and more of their workloads to AWS and at a faster pace. Customers are moving databases to AWS as Aurora continues to grow at a very rapid clip.

Stepping back, I would say what is driving the growth? We believe, again, it's the value that we create for AWS customers. We have the functionality and pace of innovation that others don't. We have partner in ecosystem that others don't. We have proven operational capability and security expertise that's highly valued to AWS customer base.

Operator

Thank you. Our next question comes from the line of Mark May with Citi. Please proceed with your question.

Mark May -- Citi -- Analyst

Thank you. Some of the data that we've seen suggests that this year the rate of growth in the build-out of fulfillment centers and other parts of the retail logistics network, as well as data centers, but more on the former, that rate of growth is slowing this year relative to last year and even the year before. I know you guys through periods of kind of heavy investment then you grow into that capacity. But I just wonder if you comment a little bit about where we are in that ebb and flow, that cycle right now.

And in terms of the accounting change that Dave referenced earlier with regard to revenue going from cost of revenue to the other line, can you comment if that particular type of advertising, that trade dollars type of marketing, is that growing at a meaningfully different rate than the ad revenue that's already booked as revenue? Thanks.

Dave Fildes -- Director of Investor Relations

Yeah, Mark. Hey, this is Dave. On that second question, we've not commented on the growth rate or given the prior year period. Not much we can say there. As I said, the $560 million, if you were to back that out and look at the pre-existing other revenue that was included in that line item, we'd be growing about 72%, but again, that's not in relation to the cogs portion.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

The question on capacity, excuse me, I'll address it as CapEx and capital leases. We're still seeing strong investment there. If I look at the quarterly trends, you're right that this quarter was up 33% in isolation versus last year. I looked back to last year's first quarter and we grew 82% year-over-year. So, it was a particularly heavy quarter, particularly for investment in warehouses. So, if I step back on the trailing 12 months, CapEx, which is predominantly tied to our fulfillment center network, is up 47%. That is above the Amazon fulfilled unit growth rate, but we've combined the strength of the FBA program and the space requirements as we, against bigger and bigger products. That's a representative number for that period.

On the capital leases, which is a good proxy for the spend to support the AWS business, that's up 49% year-over-year on the trailing 12 months. So again, usage rates continues to exceed the revenue growth rates. Usage rates are strong, but we also have a number of projects under way that seek to increase our efficiency of our data centers. A couple things in play there that hopefully keep that number closer to the revenue growth rate.

Operator

Thank you. Our next question comes from the line of Doug Anmuth with JP Morgan. Please proceed with your question.

Douglas Anmuth -- J.P. Morgan Securities -- Analyst

Thanks for taking the question. Brian, you had significant operating income upside in 1Q and I think a better outlook for the second quarter than many expected. Can you just talk about the biggest factors that drove the Delta relative to your 1Q guide and is there any reason to think that you couldn't see similar leverage in the back half of the year? Thanks.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Yes, we can in well above our range that had given of $300 million to $1 billion. I would attribute it primarily to a few things. First, the topline growth continued to be strong. Coming out of Q4, we had great consumer business strength. We also had strong AWS revenue strength, where I already mentioned that we accelerate into the quarter, which is a different trend than we've seen recently. So, customer adoption in AWS remains strong.

When we hit the higher end of our range or just above our range with FX included, we generally see really good drop through in the incremental sales, given the fixed costs we have in fulfillment centers and data centers and, quite frankly, people. We saw great efficiencies at the higher level revenue and we were able to handle it. So that was generally very good financially.

At the time of guidance, we were concerned a bit about the relatively high inventory we had at year-end in space utilizations we were still very full in our fulfillment centers, but we were able to correct that due to the high sales without having additional handling and transportation costs that you would normally see to reconfigure inventory locations. That also helped and probably was a differential versus the guidance estimate. Then lastly, I would say advertising continues to be a strong contributor to profitability and had strong results this quarter.

As far as what that portends for future quarters, for now I want to focus on Q2 and it's incorporated into our Q2 guidance, so we expect a lot of the strength areas to continue: consumer demand, AWS, and advertising. We will definitely see higher investments as we move through the year. For example, video content spend will increase year-over-year and we'll continue to hire, in particular, software engineers. We'll have some costs in Q2 ahead of what's anticipated to be a Prime Day in early Q3. Then, as you know, Q3 is generally a lower quarter due to all the work to get ready for holiday and the hiring of people and building teams.

I won't go beyond Q2 at this point, but again, we're very happy with customer reception we had in Q1 and then the income that drove.

Operator

Thank you. Our next question comes from Mark Mahaney with RBC Capital Markets. Please proceed with your question.

Mark Mahaney -- RBC Capital Markets -- Analyst

Okay, great, thanks. Two questions. That $239 million in other income, what was that? And then could you just wax a little bit, eloquently hopefully, on advertising revenue. How do you balance what should be a monstrous amount of ad revenue opportunities, especially high-margin ad revenue opportunities against an ideal or optimal consumer experience? These sponsored units I see in every search I do on Amazon seems great from an advertising perspective, but I sometimes wonder if it doesn't dilute the consumer experience. So just talk about how you balance that.

Then finally, as part of advertising, you've got also a heck of a lot of inventory around all of that video, that Prime Video that you have that you don't allow that, you don't directly charge for. How do you think about that as an advertising revenue opportunity? Thank you.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Sure, let me wax eloquently. Try to, anyway. Start with the $239 million. That is essentially attributable to warrants that we have in companies that we partnered with. We have transportation companies that we've partnered with and other technology companies. As the stock market increased in Q1, a lot of those companies also went up. So that's where we book the gain on -- warrants that we have on investments. There was a good bit of FX gain due to the shift in currency and the weakening of the dollar. That showed up on a lot of lines on the P&L, but that one was positive.

On advertising. Let's step back a bit. It's now a multi-billion-dollar program and growing very quickly. Our main goal here is to help customers discover new brands and products. When we show sponsored products, we're trying to show people things that they maybe wouldn't have seen otherwise in their normal search results. We're looking for a good balance here, as we said. We want customers to get the benefit of the new brand and product discovery. Then we want to let sellers, for both emerging and established brands, reach those customers. Those advertisers are all shapes and sizes with a main goal of, again, trying to reach our customers, whether to drive brand awareness, discovery, or hopefully purchase.

We take the responsibility for that very seriously and are always balancing the helpfulness of the advertising and try not to make it disruptive. But you're right, there are always pressures and in that we will come down on the side of the customer. On your question on video advertising, yes, there may be opportunities over time to have more advertising in our video, but we chose to not do that right now.

Dave Fildes -- Director of Investor Relations

The only thing I'd too on that, just related to Prime Video, is you may have seen the announcement earlier today about the renewed agreement for the streaming partnership with Thursday Night Football. So, we'll have 11 games in 2018 and 2019. We'll be able to deliver that to over 100 million Prime members globally. Which is a great continuation of the partnership we've had with the NFL. We've done some times like the Prime original series All or Nothing. The third season is coming up soon, focused on the Dallas Cowboys. That was one of our first forays in the live format where we had live ads. Not only learning the technology, but learning that business. I think we've been pleased with what we've seen so far, obviously, and look forward to the next few seasons with the NFL.

Operator

Thank you. Our next question comes from Stephen Ju with Credit Suisse. Please proceed with your question.

Stephen Ju -- Credit Suisse -- Analyst

Thank you. Brian, I had a question on your international shopping rollout. I think this was recently announced. Where do you think you measure up versus some of the more local players where you might not have a direct presence in the country and where do you think your value proposition lies? Presumably, this is informed by users coming in from those regions where you don't really have an official site where people come in to buy stuff from you anyway. Which regions or countries are accounting for most of the demand that you are seeing? Thank you.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Stephen? Are you still on? Can you elaborate more on the countries you're talking about specifically?

Stephen Ju -- Credit Suisse -- Analyst

I'm just wondering, you already have a direct presence in some of the countries like China, Japan, etc. and the international shopping will presumably expand that selection to most of the globe. I'm just wondering if you're seeing incremental demand and where you might be seeing demand coming in from countries where you might not have a direct presence?

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Oh, on the global store. Okay, yes. Sorry, I thought you meant some of our expansion countries. I don't have a lot to share on that today. I think you hit on the main point -- selection and opportunities for sellers who are with us in different countries to reach buyers outside of their home countries. It's a great benefit for sellers and it only works if it's a benefit for customers on the other side.

Operator

Thank you. Our next question comes from Justin Post with Merrill Lynch. Please proceed with your question.

Justin Post -- Merrill Lynch -- Analyst

Thank you. I'd like to maybe dive into a couple of the local, recent overhangs. First, on shipping partners, just wondering how dependent are you on any shipping partner and can you talk about any initiatives you've had to build out your own shipping network? I know in some countries it might be over 50% of the stuff you're delivering. Can you talk a little bit about dependency there? Then secondly, on taxes, can you remind us what happened when Amazon started collecting taxes on your own items in various states and just an overview of your view on collecting taxes from third parties in other states, if that were to pass? Thank you.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Let me start with transportation. We have a great group of carriers that we use globally. You know who they are. But we're also growing our teams and capabilities to ensure that we can keep up with increased volume on our own, particularly around the holiday season. That's driven a lot of our expansion of Amazon Logistics. It's driven the creation of sort centers. It's driven the purchase of airplanes to move product between points within our delivery network. We will continue to operate with this combination of external partners and internal capability. We like what we see so far with our Amazons Logistics capability. It's well over 50% in some countries, particularly the U.K. It helps with, again, Prime Now and Amazon Fresh and a lot of initiatives you'll see.

Again, we mentioned that Prime Now is tied in with Whole Foods, now in 10 cities. We think it's a core competency that we have and we need to have and we'll continue to invest in that.

Dave Fildes -- Director of Investor Relations

Justin, this is Dave. Just on the sales tax piece, today on the first-party sales we collect on our own product in all 45 states that have a state-imposed sales tax. On the 3P piece, we do collect on behalf of our sellers in two states: Washington State as of the first of this year, and then Pennsylvania turned on here on April 1st. In terms of your question of impact from the first-party pieces coming online, many of those states come on over a period of time to get to that 45 total, going back over many years. Nothing really more to add on that.

I think I would say we do continue to believe that the sales tax issue needs to be resolved at the federal level. We're actively working with the states, with retailers, and Congress to get federal legislation passed. We're not opposed to collecting sales tax within a Constitutionally permissible system that is both system and applied evenhandedly.

Operator

Thank you. Our next question comes from Greg Mellick with MoffettNathanson. Please proceed with your question.

Greg Mellick -- MoffettNathanson -- Analyst

Thanks. On a follow-up on Prime a little bit, the fee increase. Why now? You've been adding value for a long time. Obviously, shipping costs are going up. Why is now the right time to have that fee hike, especially since membership looks like the growth number is starting to slow? Tied into that, there's a lot of Alexa mentioning in the release. Could you give us some uptake on the importance of Alexa and basically voice commerce, the metrics you get in terms of usage there and the Flywheel? Thanks.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

We always evaluate the price of Prime in all the countries we're in. We're looking for creative ways to reach the customer, as I mentioned earlier. The creation of monthly plans, student plans, etc. It's really nothing more that looking at the state of the program, the high benefits it's delivering. I mentioned that four years ago, when we last increased the price of Prime, you could get 20 million products within two days. Today, you can get over 100 million products within two days and many, many, many products within one day, same day, or two hours.

There's all kinds of new features that we've continually added to the Prime program. It's much than it was in 2014. This is a reflection of that. It's a better reflection of the cost value of the program.

Operator

Thank you. Our next question comes from John Blackledge with Cowen and Company. Please proceed with your question.

John Blackledge -- Cowen and Company -- Analyst

Great, thank you. The U.S. international revenue mix, X-Whole Foods and X-AWS looks about 64%/36%. Given investments in the international markets, would you envision international closing the gaps in the coming years? What would be the key drivers of the mix shift getting closer to 50/50? Thank you.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

I don't want to project relative proportions of the different segments, but what I can say is the international continues to see the same level of investment as we're seeing in North America or have seen in North America. When we add Prime benefits, we're probably adding them at an earlier stage of life in the Prime program internationally than we did in the U.S. They have different dynamics. We think at the end of the day customers behave the same globally in that they value low prices, selection, and great customer experience.

So, we'll continue to make these investments in Prime. We'll continue to expand section of continued FBA programs so that it increases selection even more and builds great partnerships with sellers. We'll continue to accelerate shipping. We'll continue to lower prices. [Audio cuts out] including Alexa, which we think has great stickiness in the home, and I think creates a lot of value in the home and also allows you to access over time Amazon products better.

We'll continue to invest in India, where we're seeing great progress with both sellers and also customers. We like the momentum we've seen there. The Prime program started in the first year in India grew faster than any Prime program we had seen in other countries. We're adding local content in India, video content, excuse me. We're also adding other Prime benefits. We are rolling out devices there and we're seeing Indian developers developing skills for Alexa and Alexa is up, you saw the press release, to [audio cuts out], yes, but it is important to us that they all are delighting customers and growing to the best of their ability.

Dave Fildes -- Director of Investor Relations

Thanks 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.

Duration: 33 minutes

Call participants:

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Dave Fildes -- Director of Investor Relations

Eric Sheridan -- UBS Securities -- Analyst

Brian Nowak -- Morgan Stanley & Co. LLC -- Analyst

Heath Terry -- Goldman Sachs -- Analyst

Mark May -- Citi -- Analyst

Douglas Anmuth -- J.P. Morgan Securities -- Analyst

Mark Mahaney -- RBC Capital Markets -- Analyst

Stephen Ju -- Credit Suisse -- Analyst

Justin Post -- Merrill Lynch -- Analyst

Greg Mellick -- MoffettNathanson -- Analyst

John Blackledge -- Cowen and Company -- Analyst

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