Amazon.com Inc. (AMZN) Q4 2017 Earnings Conference Call Transcript

Amazon.com, Inc. (NASDAQ: AMZN) Q4 2017 Earnings Conference CallFeb. 1, 2018, 5:30 p.m. ET

Prepared Remarks:

Operator

Thank you for standing by. Good day, everyone, and welcome to the Amazon.com Q4 2017 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 Q4 2017 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 2016.

Our comments and responses to your questions reflect management's views as of today, February 1, 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.

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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 majors 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.

I'd also like to update you on the impact of the recent U.S. tax reform legislation. In our Fourth Quarter results, we recorded a provisional tax benefit for the impact of the new tax legislation of approximately $789 million, which is primarily driven by the remeasurement of federal net deferred tax liabilities resulting from the permanent reduction in the U.S. statutory corporate tax rate to 21% from 35%. As we complete our analysis of this new legislation, we may make adjustments to the provisional amounts. Those adjustments may materially impact our provision for income taxes in the period in which the adjustments are made.

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, 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. Thank you.

Our first question comes from the line of Mark Mahaney with RBC Capital Markets. Please proceed with your question.

Mark Mahaney -- RBC Capital Markets -- Analyst

Thanks. I'd like to focus on the North American retail operating margin. That 4.5% was the highest I think we've seen in a couple of years, maybe the highest since you've actually broken that segment out. So could you just go through the drivers behind that? I know you called out Alexa as being better than expected. Was that one of the factors? Was it the full quarter of the Whole Foods impact? Was it advertising revenue? Just what drove that result and how sustainable is it? Thank you.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Sure, Mark. Let me address your question by answering the entire company. I'll note where the North America elements are strongest. So for the quarter, we came in at the highest end of our revenue range, $60.5 billion, 36% FX-neutral growth, and 25% FX-neutral growth excluding the Whole Foods acquisition. So the fact that we came in at the high end of the range, volume was high, especially in North America, and a lot of times in Q4, and in other quarters actually, we see better efficiencies when the warehouses are busy. So it was a very clean operational quarter, I would say. The Ops team did a great job handling record volumes in Q4 and also incorporating all the new capacity we had opened in 2017. If you'll remember, we have added over 30% to our fulfillment square footage in 2017 coming off a similar increase in 2016. So amid all these opening of new buildings, many of them late in the year, the Ops team did a fantastic job.

Advertising was also a key contributor as we're continuing to make the offerings more valuable, both to customers and advertisers alike. And that was particularly strong in North America. Although not in the North America segment, I would also point out AWS had a strong quarter, accelerating growth versus Q3 and also expanding operating margins by 100 basis points.

So particularly in North America, I would say it was the strong top-line volume combined with increased advertising revenues and also very clean operational performance. Obviously there's a lot of things that can happen in Q4, from weather to demand patterns changing. We've seen additional costs creep in, in the name of customer experience, in prior years and this was, in hindsight, probably one of the cleaner Q4s recently.

Operator

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

Douglas Anmuth -- JP Morgan Securities -- Analyst

Thanks for taking the question. Brian, I was hoping you could talk about how you're thinking about your primary investment areas in 2018 and perhaps if you could put it into context of '17. Are there things that are notably different this year relative to last year? And also how you think about the margin trajectory relative to what we saw last year? Thank you.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Sure. I will be giving you guidance quarter by quarter, but I can talk to the general trends in the large investment areas. Let me start with AWS infrastructure and the growth in technical and sales teams. That will continue. We're in a $20 billion run rate in top-line revenues for AWS, up from $18 billion last quarter. So we're very happy with both the progression in new services and features that we've been able to bring to customers and also their response. We'll continue geographic expansion and continuing, again, to build on our tech teams and our sales teams. So that expense is going to continue and likely increase.

Prime benefits will continue to increase as well. Prime Video, Prime Now, Amazon Fresh, all of our major Prime benefits we continue to expand globally. Devices, as Jeff said in the press release, we are very happy with the results of Alexa. It's a very positive surprise for us, both on a -- adding a little bit more to that, we had record device sales. We had very high levels of customer engagement, including increased levels of voice shopping. Growth in functionality. Growth in our partners we work with. Skills layer, we've increased rapidly. We're over 30,000 skills for Alexa.

We've got 4,000 plus smart home devices from 1,200 unique brands. So the relationships we're having with external companies is actually helping to accelerate the adoption of Alexa with customers. So really a strong usage of Alexa with our devices. Obviously Echo, Echo Show and the Echo family, all directly tied to Alexa, but also Fire TV and tablets. We're seeing more and more engagement. Alexa usage on Fire TV is up 9x year-over-year. Music listening time on Alexa was 3x higher this holiday season. So that's what we mean when we said far exceeding our expectations. Those are the things I would point to. And that is an area, again, where we'll continue to invest heavily and, as you say, double-down on that.

Fulfillment, again, fulfillment capacity especially fueled strong top-line growth and growth in Amazon fulfilled units, which again is growing much quicker than our unit growth rate. We expect that and hope that to continue as well into 2018. Video content, we spoke about on the last call, we do like the results we're seeing with engagement on customers. Their buying habits, their engagement with the Video content, their use of it on devices, and we will continue to increase our budget in that area.

But I'll incorporate that into the guidance each quarter as we move through the year.

Operator

Thank you. Our next question comes from the line of Ross Sandler with Barclays. Please proceed with your question.

Ross Sandler -- Barclays -- Analyst

Hey, guys. Just two questions. AWS reaccelerated again this quarter. Can you just give us some color on what were the key drivers there with it lapping some of the price activity from a year ago? Was it higher utilization, moving up the stack? Any color there would be helpful. And then a question on shipping costs. So it looks like it grew about 31% up on shipping costs in the quarter and that's been kind of moving in tandem with the Amazon fulfilled unit growth. Is that the right way to think about it? It looks like it might be getting a little bit of leverage in the model right now. What's driving that, the shipping cost leverage? Thank you.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Sure. Let me start with that last one. Yes, shipping costs are going to be very tied to AFN unit growth and also the impact of greater Prime adoption and faster shipping methods. So, yeah, we consider that a very strong quarter, down sequentially and the growth that we've seen recently. That will fluctuate quarter to quarter. Again, it was a very strong operational quarter in Q4. And we've expanded the number of items that ship free. There are now over 100 million items in the U.S. So shipping costs is always going to be a strong part of our offering and it's going to be increasing due to our business model. And we, at the same time, look to minimize the costs by getting more and more efficient in that area.

AWS, yes, if you remember last year, we did have price increases in December of last year toward the end. So it had a partial impact on the quarter. But generally just strong usage growth. Usage growth continues to be strong, growing at a higher rate than our revenue growth rate. And customers continue to add workloads and expand. And as I said, we're adding new services and features all the time, over 1,400 in 2017 alone. So it's a number of factors, I would say. It's not as simple as a price decrease last year. But very happy with the performance of the AWS business, now over a $20 billion run rate.

Operator

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

Mark May -- Citigroup Global Markets -- Analyst

Thank you. Brian, if you look back historically, your Q1 operating income guidance has typically been $300 million to $400 million lower than your Q4. Obviously it's significantly greater than that this quarter. Maybe if you could shed a little light on why that is so and what are some of the key drivers there? And AWS and cloud pricing appears to have been more subtle in recent quarters. Maybe if you could talk a little bit about the pricing environment and why that has been the case, at least compared to turns from back in '14, '15, and previously. Thanks.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Sure. Let me start with guidance. So, yes, the operating income guidance is $300 million to $1 billion. Operating income last year was $1 billion. Q1 is generally when we see the volume drop off from Q4 obviously, but a lot of the costs remain from the year-over-year buildup in costs, particularly in the fulfillment network. So it's generally a headwind every Q1. Given the 30% plus growth in square footage last year that we've built, that's a major headwind from Q4 to Q1. But we also continue to invest, particularly in Alexa and our device area. As I mentioned in a number of comments earlier, we're very happy with the results, the customer adoption, the device sales that we're seeing, and general customer acceptance there. So we will continue to invest there. Those are probably the two largest factors in Q1, I would say.

Dave Fildes -- Director of Investor Relations

Yeah. This is Dave. Just on the second piece, on the pricing and the pricing environment. I mean, nothing really to call out there. I guess, just a reminder on our pricing philosophy for AWS. Periodic price reductions are a normal part of our business. We reduced prices more than 60 times with AWS since launching. So really our kind of goal and philosophy here is to drive efficiencies in our Ops and pass those savings on to customers. And some of that's through, again, the more than 60 price reductions but also finding, through new service and feature launches, better options for customers to present more efficient features for them to be able to run their businesses.

Operator

Thank you. Our next question comes from the line of Dan Salmon with BMO Capital Markets. Please proceed with your question.

Daniel Salmon -- BMO Capital Markets -- Analyst

Hey, guys, good afternoon. Thanks for taking the question. First, Brian, any comments on the impact of ASC 606 accounting changes on your first quarter guidance here. And then just second, on the advertising business, in particular the ads that we see in the search results on the site, the headline search ads, sponsored product ads, do you aim for a certain, particular ad load across the entire platform? Do you look at sort of tailoring it based on users' activity? Maybe a combination of both? I would just be interested in your thoughts on that.

Dave Fildes -- Director of Investor Relations

Yeah, this is Dave. I'll take the first part of that question just around the new revenue recognition standard. We did adopt the new standard on January 1 of this year, 2018, and you'll see that reflected in our financials for the first quarter coming up. It touches on a number of different parts of our business, in terms of how we recognize revenue. In terms of in the aggregate and the impact to our expectations to the revenue guidance for the first quarter, it's not material. There's a number of different areas, at least, that we've called out in our filings with the 10-Q and the Pass and the 10-K that'll be on file shortly that talk about the different areas that are impacted. But again, not material in the aggregate.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

And on advertising, I would say our strategy is to make the customer experience additive by the ad process. We want customers to be able to see new brands and have easier time discovering products that they're looking for. For brands, we think the value proposition is that we can find ways for them, especially emerging brands, to reach new customers. So we're working with advertisers of all types and sizes to help them reach our customer base and the goal of driving brand awareness, discovery, and better purchase decisions by the customer.

Operator

Thank you. Our next question comes from the line of Justin Post with Bank of America Merrill Lynch. Please proceed with your question.

Justin Post -- Bank of America Merrill Lynch -- Analyst

Great. I think I have two questions. First, Whole Foods, you've got over a quarter under your belt. How is it going versus your expectations and what can Amazon really bring now that you've been there for a while? How are you thinking about that? And then secondly, international decelerated a little bit this quarter. I'm just wondering if there was any country to call out or anything going on there. And we know that you spent about $3 billion international investment, I guess, last year. Where do you think the high water mark is on that? So just maybe a little bit more color on your international business. Thank you.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Sure. Let me start with the Whole Foods question. We continue to be very excited about the opportunities we have to innovate with the Whole Foods and Amazon teams together. In our physical stores, if you look at our supplemental disclosure, the physical stores revenue was $4.5 billion in Q4, which is primarily comprised of Whole Foods and was slightly better than what was built into our guidance that I gave you last call. So far our focus has been on continuing to lower prices even beyond the initial ones that discussed at the close of the deal in late August. We've launched Whole Foods products on our Amazon website and the technical work continues to make the Prime, the Whole Foods Customer Rewards Program and we expect to have more on that later in the year. We've also added lockers and much more to come. So we're very happy with the initial results out of the team at Whole Foods down in Austin.

Also I will mention that we did see a small operating income loss for the quarter from Whole Foods. At the time of the acquisition, we had stepped up the fair market value of certain assets on the balance sheet. This is going to increase the amortization. It's a non-cash charge but it'll increase amortization over the useful life and a lot of that is front-loaded. So we'll see higher amortization in the first few years and then it reverses later. So excluding these non-cash expense items, Whole Foods had a positive operating income in Q4. But you'll see in the 10-K that the operating income including the charges was slightly negative in Q4.

International growth, your comment about slowing down. I think there's a slowdown versus Q3, if that was your point. 28% growth in Q3, FX-neutral, was helped quite a bit by Prime Day and kind of the strengthening of Prime Day in a number of locales. Although we've had Prime Day in most of those countries, it's really starting to gain more and more traction there. So that is probably more of a help to Q3 than a discussion of any weakness in Q4. So we continue to be pursuing the same strategy as we have in North America, adding Prime benefits, adding devices, adding Video content, adding Amazon Fresh, Prime Now, giving a lot of value to the Prime customers in international countries as well.

And also in that number is India and India continues to be a good story for us. We feel that it's had a lot of growth in the past year. In fact, more Prime members joined India's Prime program in the first year than we've seen in any other country in the history of our world. So the selection is also increasing, Prime eligible selection is up over 25 million items, launching Video there, and also continuing to add other Prime benefits such as Prime Music will be coming soon, Amazon Family is there, as I said, Prime Video, and we had our first Prime Day in India. So that's a little bit on international growth.

Operator

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

Brian Nowak -- Morgan Stanley -- Analyst

Thanks for taking my questions. I have two. The first one, in the press release, you talk about the strength of the Prime member growth in 2017. Can you talk a little bit about what you're seeing in growth in Prime subscribers in the United States at this point? And are you still seeing similar tick-ups in consumer spending as they come into Prime as you have in the past? And the second one, Brian, to go back to an earlier question on areas of investment this year, you didn't talk a whole lot about kind of new categories to expand into beyond the old retail business. I'm curious to hear about investment needed to go into logistics, healthcare, and kind of new areas you haven't really cracked into as hard yet.

Dave Fildes -- Director of Investor Relations

Yeah, this is Dave. Thanks for the question, Brian. Just on the first piece, in terms of just Prime membership and Prime behavior, we continue to see that we're seeing signups for memberships at a strong clip. When we look at the year-over-year growth in paid Prime members on a global basis, it's been consistent. And Q4, year-over-year, or similar growth rates year-over-year to what we've seen in earlier quarters of this year. So that's of course a mix of strength in the U.S. and also strength in some of the newer markets that we've launched or introduced the Prime program in.

We continue to see that, as Prime members sign up and engage into the program, their purchasing patterns change and they do spend more as they move into the program. And of course our focus continues to be on adding some of the features around Prime that Brian's been talking about, but also importantly making sure we're adding more selection to the offering through our own efforts, first-party, but also programs like Fulfillment by Amazon, which continues to be a fast grower for us.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Yeah, and no new businesses or expansion of categories as you discussed, I would not talk to anything that's not been publicly announced, but on some of the ones you mentioned, they are under way and continuing. I would say logistics, we will continue to build our logistics capability. And that will be all the way too. And delivery, we've been able to increase service levels in many cases by delivering it ourselves. And although we have a strong partner network here, we will always be able to leverage our strength and our knowledge about where shipments are going, both within our network and to final customers, that will create opportunities for us there as we better the customer experience as well.

We continue -- I would say on the category side, the biggest effort will continue to be on groceries and consumables with the Whole Foods acquisition. And again, we continue to look at our whole offering of Amazon Fresh, Prime Now, Whole Foods, how can they work together to create better and better offerings for our customer base. And to a lesser extent versus grocery, I would say we continue to build our business, B-to-B business. And I'm very happy with the initial performance there with a number of the companies and universities that we've been working with and their initial results.

Operator

Thank you. Our next question comes from the line of Scott Mushkin with Wolfe Research. Please proceed with your question.

Scott Mushkin -- Wolfe Research -- Analyst

Hey, guys, thanks for taking my questions. So I wanted to go back to, and I think you said one of the big focuses on the year is going to be on the consumables, Now, Fresh, Whole Foods. There's been a lot of press on the Whole Foods front, the out-of-stock issue, and then clearly the Now, as we've been testing it, and Fresh has the same issue. So I was wondering if you guys could talk about what the company plans to do. I mean, there is obviously the reputational risk that can come from that. To kind of correct some of these issues and kind of what the view of the company is on the out-of-stock issues, not just at Whole Foods but just generally across the consumables business in Fresh and Now. Thanks.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Yeah, I'm not -- let me just back it to a more general statement. I'd say Whole Foods has not lessened their commitment to providing the best selection of high-quality products and having them in stock for customers. We've made no changes post-acquisition that would have impacted anything related to in-stock, except perhaps the fact that the price decreases have brought up demand and there's an amount of rebalancing related to that. So I think the out-of-stock issues that are maybe getting press are tied more to the increased demand that we're seeing and also selective, weather-related restocking issues.

But stepping beyond any short-term issues, the commitment remains to have healthy, high-quality selection in stock for products. That's what the Whole Foods team is committed to. That's what the Amazon team with them is committed to. And also across any delivery channel that we have: Amazon Fresh, Prime Now, or Whole Foods. So where there's issues, they'll be corrected. Where there's areas where we can improve our selection and delivery for customers, we'll do so. But it'll be something we're working -- the immediacy, the perishability are all challenges that everyone has in this area. But we're confident that we will have a good service and continue to delight customers.

Operator

Thank you. Our next question comes from the line of Youssef Squali with SunTrust Robinson Humphrey. Please proceed with your question.

Youssef Squali -- SunTrust Robinson Humphrey -- Analyst

Thank you. We've seen that the number of private label products on the site has increased pretty dramatically over the last 12 to 18 months. Could you speak to your private label strategy in general? How big is that segment today? How big can it become? And just broadly speaking, how are the margins in that segment versus comparable third-party products? Thank you.

Dave Fildes -- Director of Investor Relations

Yeah, thanks for the question. This is Dave. I think broadly, when we look at our strategy, it's focused on, No. 1, providing a broad selection for customers across a number of categories so that they can find and buy exactly what they're looking for. When you look at private brands, it's very much meant to supplement that great selection. And we look for ways to be able to find private label items that have a high caliber of quality but also can bring that selection and that convenience for customers and really supplement what vendors and sellers are already providing the customers in many cases. We've not broken out kind of how significant or how large that is. I think for a lot of these initiatives, when you look across categories that we offer, many of them are still earlier stage and have been around even from kind of infancy for a shorter period of time. A year or a couple of years in some cases.

Amazon Fashion is one area where you're seeing us offer a number of private apparel brands. Some of the more popular lines with customers have been things like Good Threads, Amazon's Essentials, which is men's and women's basics. Consumables, of course, is another big area where we have the benefit of working with some of the Whole Foods private label but also doing some of our other Amazon brands, things like Happy Belly and Wickedly Prime and others. So I think we'll continue to iterate on those and try to find different areas. And certainly there's other verticals that I didn't mention there that we're interested in continuing to kind of learn from customers what they want and what they're looking for there. And so we'll keep adding selection.

Operator

Thank you. Our next question comes from the line of Ken Sena with Wells Fargo. Please proceed with your question.

Ken Sena -- Wells Fargo Securities -- Analyst

Great. Thank you. Maybe if you could just remind us of the thinking behind keeping AWS retail under one corporate structure and does it make sense, given the scale of where AWS is right now? And then -- I'm sorry, I've got a little bit of an echo. I don't know why. And we're hearing from marketers just how important Amazon is to their media strategy. So I don't know if you could just maybe talk about that a little bit more broadly, in terms of the approach and your philosophy to that business. Thank you.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Sure. Yeah, we see a lot of value in all of our businesses and AWS is a key component, as is the physical consumer business. What I'll point out is the management team is a common management team. The consumer business, if you will, is if not the biggest, one of the largest customers of AWS. So we see a lot of commonality there where we -- depending on the position in the company. On the consumer side, the use of AWS has driven great infrastructure efficiencies, just like other companies see when they use AWS, turning fixed costs into variable costs and pooling resources and not having a lot of trapped capacity throughout the company and taking advantage of all the new services and features. So as an internal customer, the consumer business is very happy with AWS. And I think AWS is also very benefited by the fact that they have a large internal beta customer that tries out and uses a lot of their products and services. So it's a good combination for a lot of reasons and we see no reason to change the structure that we have.

Dave Fildes -- Director of Investor Relations

Yeah. And sorry, Ken, your second question was?

Ken Sena -- Wells Fargo Securities -- Analyst

Yeah, the second question was just on the advertising side and just we're just hearing so much more how important Amazon is to broader media budgets. And so just hoping to get maybe a little bit more color just on your approach to the business right now, some of the drivers behind the recent success. And just maybe more as you look out over the next few years, kind of how important do you see this business becoming, kind of in the grand scheme of things?

Dave Fildes -- Director of Investor Relations

Yeah. I mean, I think right now we're really just focused on finding ways to work with those companies, whether it's vendors or sellers that are coming to us, and offer them a great experience on the website and an ability to be able to reach customers. So I think there's more to come on that side. As we said, we're definitely seeing some strong growth in our advertising revenue as part of the other revenue line item. And I think we're going to keep building more and new tools based on what we're learning from our customers there to better serve in the future.

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Yeah, I think we're also part of key lean-in from brands and agencies into the e-commerce marketing space. So whether it's our site alongside search or social marketing, it's really helping them engage customers in a highly efficient manner.

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 IR 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:

Dave Fildes -- Director of Investor Relations

Brian Olsavsky -- Senior Vice President and Chief Financial Officer

Mark Mahaney -- RBC Capital Markets -- Analyst

Douglas Anmuth -- JP Morgan Securities -- Analyst

Ross Sandler -- Barclays -- Analyst

Mark May -- Citigroup Global Markets -- Analyst

Daniel Salmon -- BMO Capital Markets -- Analyst

Justin Post -- Bank of America Merrill Lynch -- Analyst

Brian Nowak -- Morgan Stanley -- Analyst

Scott Mushkin -- Wolfe Research -- Analyst

Youssef Squali -- SunTrust Robinson Humphrey -- Analyst

Ken Sena -- Wells Fargo Securities -- Analyst

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Questions and Answers:

Call participants: