Amazon: Views on Consumer Sentiment and AI Investment Pace

The following is the summary of Amazon's second quarter financial report conference call in 2024. For financial report analysis, please refer to " AI Accelerates Investment, Users Become More Frugal, Is Amazon Going to "Quit" Again? 》

I. Review of Core Financial Information:

II. Detailed Content of the Financial Report Conference Call

2.1. Key Points from Executive Statements:

1. Business Progress

① AWS Business

a. AWS revenue growth accelerated from 17.2% in the first quarter to 18.8% in the second quarter year-on-year; Driving factors: 1) Customer company cost optimization completed, focusing on new efforts; 2) Advancing infrastructure modernization, migrating to the cloud; 3) Actively applying AI, leading to increased demand

b. AI business continues to grow, with AWS AI revenue reaching billions of dollars. AWS offers a variety of choices in the generative AI field, including self-developed chips Trainium and Inferentia, Amazon SageMaker platform, and Amazon Bedrock service

c. Amazon Q generative AI assistant has gained strong adoption, excelling in code suggestions, testing, and automation. Q's code conversion feature helped Amazon migrate over 30,000 Java JDK applications in a few months, saving $260 million and 4,500 years of developer time

② Advertising Business

a. Advertising revenue increased by $20 billion in the past 12 months, with annual revenue exceeding $50 billion

b. The video advertising business is in its early stages but shows significant growth potential, especially in the direct integration of brand advertising with sales and subscription registrations

c. Making a strong debut in the advertising market and receiving positive feedback, brands continuously optimize ad performance through Amazon's measurement and advertising technology, with fewer ads than linear TV and other streaming TV providers

③ Retail Business

a. Customers tend to prefer low-priced goods, driving a trend where unit sales growth exceeds revenue growth; So far this year, over 5 billion items have been delivered through Prime on the same day or next day

b. Seller fee adjustments have influenced behavior changes, with a significant year-on-year increase in units driven by lowering fees for clothing items

c. ASP has decreased as customers choose lower-priced items whenever possible

④ Cost Optimization and Operational Efficiency

a. Amazon continues to focus on reducing service costs through the expansion of automation and robotics technology

b. Regionalization of inventory networks, inventory optimization, and improvements in the delivery network will further enhance efficiency. These improvements will bring customers better choices, lower prices, and faster delivery speeds c. By reducing costs, Amazon can support more low ASP products for economical delivery, enhancing market competitiveness.

⑤ AI and Technology Investment

a. AI plays a critical role in various areas, including shopping assistants, virtual try-ons, seller tools, and internal operational optimization.

b. Generative AI-driven innovations have been widely applied to customer experience and internal processes. The Project Private Investigator combines generative AI and computer vision to detect defects before products reach customers, and is expected to continue driving business transformation in the future.

⑥ Prime Video and Content Creation

a. Prime Video has hundreds of millions of monthly viewers globally. Amazon's MGM Studios recently received 62 Emmy Award nominations.

b. The recently launched series "Radiation" has become the second most popular original series in Prime Video history, while "The Idea of You" attracted nearly 50 million global viewers in the first two weeks of its release.

c. The fourth season of "The Boys" ranked first in 165 countries/regions within the first two weeks of its premiere.

⑦ Kuiper Low Earth Orbit Satellite Project

a. The satellite manufacturing for the Kuiper project is accelerating, with mass production satellites expected to begin delivery later this year.

b. A distribution agreement has been reached with Vrio to provide Kuiper project satellite broadband services to residential customers in seven countries in South America. This is expected to become a significant business growth driver.

2. Financial Performance

① Capital Expenditure

a. Capital expenditures in the first half of the year were $30.5 billion, with an expected increase in capital investment in the second half, primarily to support AWS infrastructure needs.

② Third Quarter Outlook

a. Prime Day was the largest ever; operating profit margin is expected to be impacted by Prime Day promotions and related marketing expenses.

b. Digital content costs will increase in the third quarter due to the return of NFL Thursday Night Football games.

2.2 Analyst Q&A

Q: There has been a theme in recent earnings reports that there may be overinvestment in the AI field rather than underinvestment. How do you view the relationship between AWS and AI investments, especially in terms of long-term capitalization pace and rhythm compared to AWS investment?

A: AWS faces significant logistical challenges in operations, including managing capacity across approximately 35 regions and 110 availability zones globally. Each region and availability zone involves precise capacity allocation for thousands of SKUs and over 200 AWS services. Underallocation of capacity can lead to service interruptions, affecting the company's ability to scale applications, while overallocation can impact cost-effectiveness and operational profit. Over the years, we have learned how to manage capacity reasonably in these areas by building complex algorithms and models to ensure a balance between demand and return on investment In the field of AI, we face similar challenges. Although AI is a new field and demand may fluctuate significantly, we have already built sufficient capabilities and skills to respond to changes in customer demand signals. Typically, when customers require a large capacity, we receive significant signals in advance. Despite investing heavily in AI and infrastructure, due to strong demand, we hope to further increase capacity. This will become an important pillar for our future business development.

Q: What are your thoughts on the pace of investment in custom chips? From a broader perspective, how do you view the return on investment of custom silicon in the medium to long term?

A: The development of custom chips is very interesting, and our strategy is based on our 18 years of operating AWS. Initially, we had a deep collaboration with Intel in the general CPU field, but customer feedback indicated that even with a significant increase in volume, total spending would not decrease even if the unit cost decreased. This led to the development of the custom chip Graviton, which is now in its fourth generation. Graviton provides customers with 30% to 40% cost savings and better value for money compared to other leading x86 processors.

Five years ago, we saw similar demand in the accelerator field (especially GPUs). With major suppliers scarce in the market, customers wanted higher value for money. So we developed Trainium (training chip) and Inferentia (inference chip), both of which are now in their second generation, offering a very competitive value proposition. With the current tight GPU supply, there is strong demand for our custom chips, and we are ramping up production of these chips as quickly as possible. I believe that custom silicon will have the same promising return prospects as Graviton and become a differentiating advantage for AWS compared to other competitors.

Q: Regarding the retail gross margin in the second quarter, based on our estimates, the retail gross margin was slightly lower than expected. Were there any additional pressures affecting the gross margin, such as discounts or the Kuiper project? How should we interpret some of the driving factors of the second quarter retail gross margin?

A: The operating profit margin of the North American segment decreased by 20 basis points from the first quarter to the second quarter, partly due to the annual increase in stock compensation expenses, which increased by about $1.8 billion in the second quarter, affecting all three segments. Nevertheless, the store portion of the North American segment saw an improvement in profit margin in the first quarter, mainly due to significant improvements in service costs, increased delivery speed, expanded selection, and enhanced security.

In the second quarter, spending in some investment areas increased, which is a normal occurrence. The first quarter is usually the lightest quarter for investments, while in the second quarter, investments in areas like Prime Video and devices increased. It is worth noting that spending on the Kuiper project increased in the second quarter compared to the first quarter as we began manufacturing satellites that will be launched in the third and fourth quarters

Q: Regarding the improvement of North American profit margins, you have mentioned in the past that you hope to restore the profit margin to pre-pandemic levels. Can you reiterate the internal execution philosophy? Is there a timetable for achieving this goal? How do you balance profit improvement with new investments like Kuiper and reinvesting profits?

A: We believe there is an opportunity to expand the profit margins of the retail business, but this requires long-term work rather than achieving it in one quarter. The post-pandemic rebound has brought cost challenges, forcing us to reevaluate everything in the network, including our long-standing philosophies. This has revealed many opportunities to reduce service costs.

The first example is the regionalization of the US network, which not only significantly reduces service costs but also improves the speed of delivering goods to customers. While regionalization has had a greater impact than expected, we are still optimizing and there are more ways to further reduce service costs. Another example is the regionalization of our inbound network, which will bring goods closer to end users, reducing delivery times. In addition, we are studying measures to consolidate more units into one package, which also helps reduce costs, is more environmentally friendly, and is preferred by customers.

From a strategic and philosophical perspective, reducing service costs will allow us to offer more product choices, especially products with low average selling prices (ASPs). These are products that we typically do not stock due to the current high service costs. But with the reduction in service costs, we can expand our selection, attracting more customers to make purchases. We do not believe that reducing service costs and making new investments are mutually exclusive. We have the ability to do both at the same time. The retail team will continue to focus on expanding choices, maintaining low prices, shortening delivery times, and reducing service costs, while the Kuiper team is dedicated to providing broadband services to hundreds of millions of households globally without broadband access. These two efforts are parallel, and we believe we can achieve both goals simultaneously.

Q: The three factors of accelerated growth and recovery rate of AWS in the second quarter sound sustainable. Is there any reason to believe that this growth will not continue to accelerate in the second half of this year?

A: Predicting future growth rates is difficult, especially for the AWS business, which now has an annual revenue of $105 billion. However, we have already completed most of the cost optimization work, laying the foundation for further growth. Before the pandemic, many companies were already working to modernize their infrastructure, moving from on-premises to the cloud to save costs, accelerate innovation, and increase developer productivity. The pandemic and economic challenges forced companies into survival mode, but as the situation improves, many companies are rediscovering the advantages of the cloud. With richer features, stronger operational performance and security, and a deeper partner ecosystem, AWS continues to be the preferred choice for companies migrating to the cloud. Generative AI is still in its very early stages, and although we have generated billions of dollars in revenue from AI, the demand growth is significant. I believe these three factors are likely to continue to drive AWS development and maintain growth in the coming years In addition, about 90% of global IT spending is still local. If this situation changes, AWS as an industry leader has great growth potential. The generative AI and overall AI market will be very large, and unlike traditional IT infrastructure, most of the growth of generative AI will be established in the cloud from the beginning, providing new opportunities for the continued growth of AWS business.

Q: What is the current situation of the pharmacy business? Has it reached a stage where it can surpass early adoption and wider promotion?

A: The pharmacy business continues to grow and resonate more with customers. Expanding from retail to pharmacy services is a natural progression, but its rapid growth is mainly attributed to the team's improvements in customer experience over the past 18 months. Customers particularly appreciate the convenience and speed of Amazon Pharmacy, especially compared to traditional physical pharmacies, where the experience is often more complex with products locked behind counters requiring assistance from store staff to access.

This difference, coupled with significant improvements in our pharmacy experience, is driving positive customer responses and purchasing behavior. We are also continuing to expand this business, such as extending RxPass packages and plans to Medicare members, allowing customers and Prime members to get up to 60 common medications for only $5 per month. Additionally, we have launched same-day delivery of medications in multiple cities, currently available in 8 cities including Los Angeles and New York, with plans to expand to 12 or more cities by the end of the year. Overall, we are very optimistic about the outlook for this business and expect to continue to see significant growth.

Q: Can you share the quarterly backlog figures for AWS?

A: By the end of the second quarter, AWS's backlog was $156.6 billion, representing a year-over-year growth of approximately 19%.

Q: When AI is still in its early stages, do you see more companies moving to the public cloud to prepare their data state, even if they are not yet ready to adopt AI? What have you observed in these sales processes?

A: In the AI and analytics field, it is difficult to effectively run AI if data is not well organized. Therefore, when working with customers and system integrators, we first inquire about the data storage location, the status of data lakes, and how to access this data. Organizing and placing data in the right location typically requires some work. Many companies that have already moved to the cloud are able to better utilize AI, which is one of the reasons we see growth. However, about 90% of global IT spending is still local and has not yet moved to the cloud, and the ability to use AI more effectively will be a key driver for these companies to migrate to the cloud.

Q: AWS's operating income margin once again showed strong performance, in the mid-30% range. What are the main drivers? How should we view AWS's profit margin for the second half of the year?

A: AWS's profit margin in the second quarter was in the mid-30% range, higher than the mid-20% range from last year, mainly benefiting from cost reductions and efficiency improvements in our business. Additionally, we made adjustments to the estimated useful life of servers, contributing to a year-over-year growth of approximately 200 basis points in profit margin Despite this, AWS's operating profit margin may fluctuate and vary between quarters. We will continue to focus on attracting customers through new products and improving operational efficiency to further enhance the cost structure.

Q: How do you view the profit margin of the international segment?

A: The profit of the international segment this quarter is approximately USD 300 million, with a year-on-year increase in profit margin of about 390 basis points. Mature markets (such as the UK, Germany, and Japan) have shown continued progress, especially in improving operational efficiency and expanding customer experience. In emerging markets, we have launched in approximately 10 countries over the past few years, focusing on expanding Prime member benefits while establishing scalable solutions. Overall, whether in established or emerging markets, we have achieved good year-on-year growth in profit margin and will continue to focus on further improvement.

Q: How was the sales performance of computers, electronics, and televisions in the second quarter? Are macroeconomic trends as expected? How does this affect the outlook for the third quarter? Additionally, can the incremental investment in the Kuiper project be quantified?

A: In terms of macroeconomic trends, consumer behavior is similar to what we have observed over the past year. Consumers are very cautious in their spending, preferring lower-priced goods and seeking discounts, a trend that continued in the second quarter and is expected to persist into the third quarter.

In the second quarter, we actually saw a slight acceleration in unit growth in North America, with unit growth picking up after adjusting for leap year factors. Despite a slight decline in revenue quarter-on-quarter, mainly due to the impact of ASP and growth in daily essentials business, overall sales performance was good, but still somewhat soft compared to normal economic conditions. Low-priced goods account for a larger proportion in our current product mix, which is advantageous for us as we can quickly deliver these goods, especially in daily essentials.

Regarding the incremental investment in the Kuiper project, we are currently not quantifying this investment.

End of Document

Risk Disclosure and Disclaimer of this Article: Dolphin Research Disclaimer and General Disclosure