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Amazon.com (AMZN - Analyst Report) reported a 12 cent loss in the third quarter, in line with the Zacks Consensus Estimate. Amazon has missed estimates in three of the preceding four quarters, with the four-quarter negative surprise averaging at 71.3%. Shares appreciated 8.3% following the news.
Amazon reported revenue of $17.09 billion, up 8.8% sequentially and 23.8% from the year-ago quarter. This was at the high end of the guidance for the quarter of $15.45-17.15 billion (down 3.8% sequentially, or up 18.1% year over year at the mid-point), beating our expectations by 1.9%. Year-over-year revenue growth was 26% excluding unfavorable currency impact.
Both product and service sales grew double-digits from the year-ago quarter, with the percentage contribution of the two categories remaining same at 81% and 19%, respectively.
Over 60% of sales was generated in North America, representing sequential and year-over-year increases of 8.5% and 30.7%, respectively. The balance came from the International segment, which grew 9.4% sequentially and 14.7% year over year (20% excluding unfavorable currency impact).
Active customer accounts increased by 9 million to more than 224 million. Active seller accounts stayed above 2 million. Paid (third-party) units were 40% of total units in the third quarter, similar to the previous quarter).
Key strategies for driving revenue growth remain a vast selection, competitive pricing, free shipping, user experience on Amazon properties and the Amazon Prime program. Fulfillment centers are also important, since they are essential for providing the level of customer service that Amazon customers have come to expect of the company. Over the past year, Amazon has been investing heavily in fulfillment and technology & content.
Amazon’s North America media business was up 20.1% sequentially and 17.8% from last year to 15% of total revenue. The solid growth continues to be driven by the consumption of digital content across categories. Last quarter, it introduced Kindle Matchbook, which enables buyers of printed books to acquire digital versions for a small fee or free.
While selling and lending books on the Kindle platform continues, Amazon is also developing its direct publishing business. In addition to Kindle ebooks, Amazon is going great guns with its video content. Prime Instant Video has the broadest reach across Kindles, Microsoft’s (MSFT - Analyst Report) Xbox platform, Sony’s (SNE - Snapshot Report) Playstation, Apple’s (AAPL - Analyst Report) Mac or other PCs, as well as on TV.
In the last quarter, Amazon started developing a host of pilot programs for kids, which will be aired exclusively on Prime Instant Video and LOVEFiLM in the UK. Amazon already has expanded agreements with Viacom, NBCUniversal, Cable & New Media Distribution and PBS Distribution, which helped expand movie and TV episode titles to 41,000. Amazon’s reach and value proposition are making it a key player in the video distribution business.
The Electronics and General Merchandise (EGM) business in North America (39% revenue share) was up 3.9% sequentially and 33.0% from last year. EGM is a more seasonal business with holiday-driven spending having a significant impact. This seasonality has increased manifold since Amazon launched the Kindle platform.
Therefore, year-over-year comparisons are more meaningful. We see very strong double-digit growth in each quarter since December 2009, which is indicative of the expansion in the market and Amazon’s growing position within it. This holiday season should benefit from the new Kindle Fire HDX, the new Kindle Fire HD and the leading e-reader Paperwhite.
Amazon’s International media business (14% of total revenue) was up 9.0% sequentially and 1.6% year over year. Better selection and improved distribution are helping sales, which grew sequentially after two quarters of double-digit decline. EGM, which was around 25% of total revenue, was up 9.6% sequentially and 23.4% above the year-ago level.
There was initially a greater preference for purchasing electronics rather than content in international locations. However, Amazon focused on fulfillment centers to begin with, but is supplementing this with media stores all over the world. In the last quarter, the company launched the Mexico Kindle store with over 2 million titles and added 9 million books to its store in India. Amazon also has Kindle stores in Brazil, Canada, China and Japan, where thousands of local language books are being sold. New product categories, better selection within categories, competitive prices and free shipping remain drivers.
The Other segment, while still small (around 6% of total revenue, mostly in North America) includes Amazon Web Services (AWS). The North America business was up 13.7% sequentially and 57.9% from the year-ago quarter. The International contribution was up 6.2% from the previous quarter and 27.5% from the year-ago quarter. AWS continues to launch new services and enhance the security of its services. The segment touched a billion dollars in revenue in the last quarter.
The gross margin shrank 97 bps sequentially while expanding 239 bps year over year to 27.7%. Sequential variations in gross margins are usually largely mix-related, although pricing is growing into an important factor given the increase in product categories all over the world. Amazon’s strategy of heavily discounting products and services when it is building a position in any market also has an effect. The fact that new product launches come hand in hand with extra launch costs, is also a negative for the gross margin. Third party sites are doing well, which has a positive impact.
Gross profit dollars increased 5.1% sequentially and 35.5% from last year, due to volume changes. The consistently rising gross profit dollars from year-ago periods indicates steadily rising business volumes. It also indicates that Amazon brings a value proposition for customers that encourage them to stick with it.
Amazon’s operating expenses of $4.75 billion were up 7.6% sequentially and 35.2% from the year-ago quarter. Amazon’s heavy investing activities (headcount, fulfillment centers, content, etc) over the past few quarters have been driving up its costs. Specifically, fulfillment and technology & content costs increased as a percentage of sales by 20 bps and 5 bps, respectively. Marketing, G&A and other declined 24 bps, 19 bps and 14 bps, respectively.
As a result, the operating margin of -0.1% shrank 65 bps sequentially, although it was still 6 bps over the year-ago margin. The operating loss of $25 million was down from an income of $79 million in the previous quarter and a loss of $28 million in the year-ago quarter.
The North America segment operating margin was down 144 bps sequentially and 83 bps from the year-ago quarter. The International segment operating margin was down 41 bps sequentially and up 58 bps from the year-ago quarter.
EBITDA was $1.09 billion, down 3.8% sequentially and up 46.7% from last year. The cash margin of 6.4% dropped from 7.2% in the previous quarter while increasing from 5.4% in the year-ago quarter.
Amazon generated third quarter net loss of $41 million, or -0.2% of sales, compared to loss of $6 million, or 0.0% in the previous quarter and loss of $274 million, or -2.0% in the same quarter last year. There were no one-time items in the last quarter. Therefore, the GAAP loss was the same as the pro forma loss of $0.09 a share compared to $0.01 in the previous quarter and $0.60 in the year-ago quarter.
Balance Sheet and Cash Flow
Amazon ended with a cash and investments balance of $7.69 billion, up $226 million during the quarter. The company generated $1.39 billion of cash from operations, spending $1.04 billion on fixed assets (including internal-use software and website development costs) and $255 million to pay down debt and long term obligations.
Amazon saw inventories increase 12.0% sequentially, with turns down slightly from 8.3X to 8.2X. Receivables increased in the quarter, with DSOs flattish at around 16.
Management provided guidance for the fourth quarter of 2013. Accordingly, revenue is expected to come in at around $23.5-26.5 billion (up 46.3% sequentially, or up 17.5% year over year at the mid-point), somewhat below seasonal. Operating loss (including $350 million for stock based compensation and amortization of intangible assets) is expected to come in at approximately -$500 to $500 million.
Amazon guidance for the next quarter is encouraging. The company has a very aggressive pricing strategy and makes huge investments in the business, which is impacting its profits. While we expect investments to continue, we are also seeing signs that they are beginning to have a positive impact on revenues. Amazon is particuarly focused on growing its international business and we expect to see much stronger growth here.
We continue to believe in Amazon’s prospects, especially its platform approach (Kindle, Prime and AWS). We think that Amazon is performing true to form, continuing to grow revenue and generate very strong cash flow quarter upon quarter (discounting seasonal variations).
As such Amazon remains one of the leading players in the fast-growing ecommerce market. We think that this has been possible because of the broad selection, free shipping and user experience that Amazon has consistently provided. This has enabled the company to gain from the shift in offline to online consumption.
The Kindle platform will remain a major growth platform for Amazon. Despite more popular tablets from Apple, we think Amazon devices come with their own value proposition, so there will be many takers. The new devices should do particularly well this holiday season despite growing competition.
Therefore we expect downward revisions in estimates following the results, which could take the Zacks Rank #2 (Buy) on Amazon shares to Zacks Rank #3 (Hold).