Amazon.com, Inc. (AMZN) Q4 2012 Earnings Report, Transcript and Summary

Good day, everyone and welcome to today’s program. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the Q&A session. (Operator Instructions) It is now my pleasure to turn the program over to Cindy McCann.

Good afternoon and thank you for joining us. On today's call are John Mackey and Walter Robb, Co-Chief Executive Officers, A.C. Gallo, President, Glenda Flanagan, Executive Vice President and Chief Financial Officer, Jim Sud, Executive Vice President of Growth and Development and David Lannon and Ken Meyer, Executive Vice Presidents of Operations. As a reminder, all forward-looking statements on this call are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions discussed today. This may be due to a variety of factors, including the risks outlined in our company's most recently filed Form 10-Q and 10-K. Please note, our press release and scripted remarks are available on our website. We assume you have read our press release, so we will use this time to focus on highlights from the quarter and year as well as out future outlook. Please note fiscal year 2012 was 53-weeks, with the extra week falling in Q4, making it a 13-week quarter. I will now turn the call over to John Mackey.

Thank you, Cindy. Good afternoon, everyone. I would like to begin by expressing sympathy for the many people including our team members, customers, suppliers and investors impacted by Hurricane Sandy. On behalf of our leadership team, I would also like to thank our team members for their exceptional efforts in the wake of the storm. We are proud to have been among the last to close and the first to re-open up doors in so many communities impacted by this powerful and destructive storm. Turning now to our financial results. Our Q4 performance reflected another quarter of strong sales momentum and earnings growth. On a 12-week to 12-week basis, we produced 33% earnings per share growth on 14% sales growth. We delivered significant year-over-year improvement and record Q4 results including a 76 basis point increase in gross margin to 35.3%, a 40 basis point decrease in direct store expenses to 25.5% of sales, a 117 basis point improvement in store contribution to 9.8% of sales, a 105 basis point increase in operating margin to 6%, marking our third consecutive quarter of over 100 basis points of improvement, 79 basis point improvement of EBITDA margin to 8.7% and 157 basis point improvement in return on invested capital to 12.7%. Our comparable store sales increased 8.5%, and our identical store sales increased 8.3%. Given the continued moderation and inflation and sluggish economic data points, we were very pleased to produce an acceleration in our two and three year stacked idents. Our three year stacked ident increased 25.4% reflecting three years of 8% plus increases. In line with the trends we have seen all year, transaction count increased seven percent, with broad-based sales momentum across regions, departments, and store age classes. Year over year, our customers continued to shift their purchases toward organic…

(Operator Instructions) We will take our first question from the site of Edward Kelly of Credit Suisse. Your line is open.

I was hoping that you could maybe give us some, I know it's difficult, but there has been a lot of moving parts over the last quarter with July 4 shift and then current quarter with Sandy. If you could give us some sense as to how you really think the underlying trend in the comp is progressing and, I guess, why is it so hard to, maybe, us an impact on your year-to-date number? So if you could give us some color on that that would be great.

It is messy because we had the Living Social deal last year and now we have Hurricane Sandy this year. If it were a few more weeks down the road, then we could see what the post-storm normal looks like and that would help us to quantify the impact of Sandy for the two-weeks and now continuing that it is there. So, we do think that the guidance for the year is still a good guidance and we are comfortable with that and we feel like that that’s the best information we can give you along with just the facts of what the comps are so far this week. We are helping you to see that we are not through the impact yet.

Yes. Plus, New York is getting hit again today. So it is hard to quantify. I know you want that information. We would like to have it too but we don’t have it. I will just say that if you look at our track record, historically, our comps, 7%, 8%, 8.5%, that’s been our trend line not just this year or last year but pretty much for 30 years. So I would think our guidance is good and for now, we will stick with that.

Okay and just one follow-up question for you. Your older stores have been comping very well. Surprisingly strong, I guess, given that the stores are obviously busy, parking lots are full, that incremental traffic probably meets more friction there. How do you think about capacity at your older class of stores and your ability to sustain the current level of comp and what do you do to enable that to happen?

Good question. This is David Lannon. Our old stores, we are in the constant process of renovating, updating and with all our account in our stores. So you look at small stores, as examples where we assume they are going to cap out but they don’t. The basket size continues to increase as the stores mature. Our teams continue to renovate and keep them exciting. So I think if you go into any of our 10-year old stores versus another conventional 10-year old stores, you can see that our stores are in a state of improvement.

I think that’s the secret. We continue to upgrade and improve our stores. So they don’t stand still and if you keep making them fresh and you continue to put new innovations in them, successful ideas and one of the things, hopefully, it is very good at is collaboration. So when we do successful renovations in one store or one region, it tends to spread around the company pretty rapidly.

A good example. We have an older store in Northern California in Campbell in San Jose and they just put in a nail salon, organic nail salon. First one ever. Kind of an expansion of a category that holds foods into and its essentially sold out everyday since we did it. So those are the kind of things that stores are innovating with.

This is Walter here. But I think you are asking about capacity. We just don’t really see that very often where there is a store because our real estate team is so active right now and because we are so early on in our potential for the United States of 1,000 stares that they just become the next step is to go find an additional store in that market. You have seen us do that, time and time again, quarter after quarter where we go find and expand our market presence. If we started to approach that situation, the store is very successful, we are able to go out there and find an additional store in that particular market.

Or relocate it to a bigger.

We are constrained by that if anything.

I mean the truth is that we have some stores that, smaller older stores that you would think they are reached their capacity. Just couldn’t get any more volume out of them but they still manage to do it. The sales per square foot are phenomenal from those stores. Theoretically, there has got to be some limit. Only, we have really never seen that. So it's only theoretical, not in reality.

We will move next to the site of Ken Goldman of JPMorgan.

Hi, this is actually Priscilla Tsai, in for Ken today. So you mentioned that the survey you conducted indicated that you improved your pricing position and that you are at the narrowest margin yet to competitors and I don’t think you have talked about a specific price gap to competitors before but maybe you can help us quantify or understand a bit more of what you have done with the prices? Then, I might have missed this, but did you give out a traffic and ticket breakdown?

Yes, this is Walter. We did give out the traffic and ticket. It's 7% transaction growth in the quarter which is fairly strong and in addition to that, a little bit of color for you is that our work with Nielsen on our new last routine survey we do quarter-to-quarter says that we made a 22% gain in new customers. That’s our highest gain in new customers in the last three years. So that’s pretty exciting. That’s an 80/20 sort of split and that is continuing. To your question about the price survey, again, we have talked about this each quarter but we do check well over 600 items which is the core branded item community across all sorts of competitors and we are now looking at that, in terms of market specific and what we mean by meaningful movement is that we moved north of 100 basis points this last quarter relative positioning on those items. So it's our biggest gain and our closest gap in terms of that pricing across the entire. We are looking at over 80 competitors across the United States. We are looking at them on a 30 day basis and we have been tracking this now for the last two and half, three years. This was our biggest jump in that parity over that period of time. So that’s the only number. We are not going to give you the actual numbers but that’s the relative gain. I think if you are out there and if you look at some of the other reports that come through over the last three months, I think that improved positioning really reflective and I think we are really making tremendous steps forward on our price competitiveness. We really are, at the same time, working on our quality and our differentiation.

We will move next now to the side of Ed Aaron of RBC Capital Markets.

We have heard some indications recently of some supply tightness in the industry and I was just wondering if you have encountered any challenges thus in terms of your supply chain of late?

Hi, Ed, this is A.C. Not in the packaged goods. We have been fine with that. We have been with organic milk, things like that. The one thing that’s been a little tighter this year is apples in general, organic apples and other apples. There have been a lot of freezes last spring during pollination time in the Midwest and in the Northeast, so that a lot of the local apples are not available this year, and that’s put extra pressure on Washington State. There has also been extra demand for organic. So we have found that, for apples, in general, are tighter this year. Costs are up. Retail is up a little bit. It is probably the area that we are seeing the biggest issue. In general, for the most part, meat, milk, grocery items have been bought.

I think one thing we are doing is just doing a double check on the forecasting for inventories heading into the holidays. We learn that from a couple a years ago and getting out ahead of that is to make sure that’s not going to be a concern as we anticipate a nice holiday sale this year. Make sure we are in the right stock position for that.

We also have developed a pretty good commodity buying team over the last few years here. So as we saw conditions tightening up with certain brands because of the Midwest drought, especially in areas that we pre-booked for pretty much of supply for this year for all of our bake houses and kitchens and things. So we are in good shape. We are protected on all those costs at reasonable prices. So we are not really seeing any shortages there that some other people maybe seeing.

We will move next to the site of Mark Miller of William Blair.

A long term question here on the competitive environment. Over time we are probably going to see a big expansion in the number of neighborhood markets from Wal-Mart. I was hoping you could share your perspective on how sales and margins change when the neighborhood market enters the trade area and how many markets has this happened for you? Just if you could comment on price sensitivity for your consumer overlapping items that you might need to address and then, I guess pick up of customers from conventionals that are impacted?

So, Mark, are you specifically talking about the neighborhood markets, the Wal-Mart's effort?

Yes, and implicit in my question is, are we going to see a lot more of these over time?

Yes. We have experienced that some, over the last year and a half, couple of years. There is not a significant overlap, in terms of mix or in terms of impact, on us. So, different than other competitors, it's a little less of an overlap. Is your question kind of how do we see that unfolding over the next couple of years?

Yes, I was wondering if you had specific market instances that you have looked at? You have obviously grown well with the expansion of Wal-Mart in food over time but I was wondering of your view whether it's a plus or a minus for you?

I guess, we are sitting around the table, we are sitting neutral. Wal-Mart waxes and wanes in terms of our product mix depending on how they are seeing it on any particular day and it's not as much of an overlap with some other competitors. So certainly it will affect the market and the movement of the market based on their entering but our experience thus far has not been particularly meaningful. We do have some individual markets, but I am not prepared to share that specific right now.

It's sometimes hard for people to understand but Whole Foods has this very differentiated customer base. The 20/80 rule, 20% of our customers are about 75% to 80% of our sales and they tend to be very loyal to Whole Foods. They are really what drives our business model and they are not interested in shopping in the own neighborhood for the most part. They really want to shop with us. Wal-Mart comes into a market like that, they are just taking a little bit from lots of other conventional players, but they are not really impacting us. We tend to get our share no matter who comes into our market place and that's one of our competitive advantages.

Don't hear that as we don't take it seriously. We certainly do, but in the lineup of competitors, I wouldn't put them as meaningful as some of the others.

We will move next to Kate Wendt of Wells Fargo.

I was just wondering if you could add a little color in terms of what you are seeing from your price investments in terms of basket size and frequency of shopping trends and then if you have any plans to get the message out to consumers in a broader way? Certainly it's a big step to lower prices and then the next step is letting people to know about it. So if you have any plans to increase advertising spend to reinforce your new value proposition?

Hey, Ken, you want to talk on that one?

Well, I think the thing with our market prices that are EDLP, that Walter talked about before, we merchandise them just like we merchandise specials. So we have aggressive promotions. We have one day sales, three day sales, one week sales, one month sales. We are also super active in social media. So there are daily pings on both our Twitter and Facebook across all stores on all of these items. So there's definitely a consensus building with our customers that Whole Foods has good value and good prices and of course always great quality. So we are seeing our merchants, the folks that are running the stores they know how to merchandise these products and at these great prices we can't be beat.

We have a question from Karen Short of BMO Capital.

Just curious, has there been any further discussion of some form of loyalty program for customers? I know your stance on promotions through a loyalty card but given what some of the more innovative retailers are doing, have you further evaluated whether not there's a way to introduce some type of program to reward your most loyal customers even if it isn’t cash or price reduction related?

The answer to that, Karen, is we are not going to do the kind of loyalty program that most conventional supermarkets do. We don't think that really rewards our shoppers so much as it punishes those who don't have cards. However, we are looking at this internally and we may do something that ties it together when we launch our version of Wellness Club in the next year or year and half. So, it's something we are paying attention to and we will probably try to do some kind of integrated strategy with it. Don't think we are going to announce about it today and I don't think you'll see anything for more than 12 months, but it is something we are talking about. You will probably see some movement in that direction sometime within the next couple of years.

You have a question from Charles Grom of Deutsche Bank.

Just a follow-up on Ed's question and I hate to think so near term but I am just wondering if you guys could quantify maybe for us how your IDs were trending before we started to see the Sandy impact up here in the Northeast? Then just as a follow-up, historically, post other storms that you guys have seen throughout the country, hurricanes or what, do you typically see a large bounce back and so, is the net effect of the storm typically a net positive and net neutral? If you could help us out there, that would be great.

We are really not willing to give any more numbers than we have given already. The pre-storm there were just three weeks and it's hard to tell exactly when the pre-stocking started. So, we are probably not willing to do that and in answer to the second question, I will let the operators join in but, it depends on the severity of the storm. Often times, it has been neutral because the pre-stocking has offset the impact during the storm itself, but in this case because we actually had such a severe impact and stores were closed for so long and it took so long for so many customers to get power restored and therefore they weren't able to shop for groceries during that time. It is a bigger impact than it would have been most typical storms we have seen over the last few years.

Honestly, it's just not something Whole Foods market cares much about, because we are managing out business for the long-term and we know what our underlying comp trends are and our ident trends are. Hurricanes came, hurricanes go. It might have a temporary short-term effect, but it doesn't change the fundamentals that are driving our business. That’s really what we are focused on.

This is David. I will just give a little color. At Whole Foods market, we really take pride from our experience in New Orleans and Florida. We were first to market back open than many of our competitors. In several occasions in Jersey, Christina Minardi and the New York team, we have stores open in New Jersey, and we were the only game in town, because others stores haven't opened. So our team always band together. We have a very good process and if you really looked into it across the market in New York, New Jersey, Connecticut, often times we were first to market before any of our competitors.

We will move next to Mark Wiltamuth of Morgan Stanley.

I wanted to ask about your cash balance. You added $745 million this year. You are up to $1.5 billion in cash and marketable securities. The dividend increase barely dents that number and you are going to see another free cash inflow this year. What's the long term look on what kind of cash balance you really need and from an EVA focus isn't this cash really a drag for you right now?

It’s a great problem to have.

It’s a great problem to have. You pointed out to Johnnie's. We just made an acquisition of leases hold. I mean we have already talked about what we are going to do about our cash but it's worth repeating. One, we are accelerating our growth. We are opening more stores that we have ever opened before. We signed 45 stores in the last 12 months and we are growing faster. So that's our primary focus, is to accelerate our growth and to transfer some of that cash into stores that will increase value for our stakeholders. Number two, we just increased our dividend 43% and that's a pretty good annual dividend increase. Third, we are going to continue to be opportunistic in our stock buybacks. Fourth, we are going to continue to pile up cash. Part of that is, you are right, it's not the best thing for EVA, but one of our valuable lessons from the great recession that occurred when we were caught with a lack of liquidity at a very bad time, maybe we are preparing for the last war, but seems to me that I am not sure the American economy is out of its problems. So I am not sure what's going to happen here. We have got lots of money being pumped into the economy by the Fed. We got this so-called fiscal cliff about to hit. We have got tax rates going up. I think Whole Foods wants to keep a lot of powder dry. We are just not sure what's going to happen. So we like the position we are in. We are accelerating our growth and we are increasing our dividend and we are buying back stock and we are piling up cash. Many years ago people asked us, when are you going to have some free cash flow? When are you going to have some free cash flow? Now we are hearing, you got too much free cash flow. What are you going to do with all that extra money? So that's what we are going to do with it and we will see how this economy plays out and we may change our strategy but, for now, the strategy is just what I told you.

I just want to pile onto that, John. Just to highlight again the use of the cash to accelerate our growth at a time when many of the folks are flat. We opened seven stores in Q4, 11 more in Q1. When you look at the production of the real estate team, we are deploying more and more capital to open the stores and, we continue to move aggressively on that depending on how opportunities open up. So you may see us increase the spend there as we continue to go forward so successfully with real estate.

Our final question comes from Scott Mushkin of Jefferies and Company. Mr. Mushkin, your line is open. It appears that we have no further questions.

Okay. Thanks for listening in everybody. Please visit Whole Foods Market for everything you need to enjoy great meals over the holidays, and join us in February for our first quarter earnings call. A transcript of the scripted portion of this call along with a recording of the call is available on our website. We will talk to everybody next quarter. Have a great holiday. Bye.

Thank you.

This concludes our conference call for today. You may now disconnect your lines and everyone have a great day.