Amazon.com (AMZN - Free Report) reported a 1 cent loss in the second quarter, which missed the Zacks Consensus Estimate by 5 cents. Amazon has missed estimates in three of the preceding four quarters, with the four-quarter negative surprise averaging at 46.3%. Shares declined 2.29% following the news.
It’s worth noting that the company continues to see attractive growth rates, which is not that easy given its size and market position. This has only been possible because of its extensive investments, which it now appears will continue for an indefinite period of time. There are many oportunities that the etailing giant should be able to tap, so its investments make perfect sense.
Amazon reported revenue of $15.70 billion, down 2.3% sequentially and up 22.4% from the year-ago quarter. This was in line with the guidance for the quarter of $14.5-16.2 billion (down 4.5% sequentially, or up 19.6% year over year at the mid-point), although missing our expectations by a sliver. Year-over-year revenue growth was 25% excluding unfavorable currency impact.
Both product and service sales grew double-digits from the yer-ago quarter, with services growing from 16% of total revenue a year ago to 19% in the last quarter. The strength in servies is likly be driven by AWS.
Over 60% of sales were generated in North America, representing sequential and year-over-year increases of 1.1% and 29.6%, respectively. The balance came from the International segment, which dropped 7.0% sequentially while increasing 12.7% year over year (20% excluding unfavorable currency impact).
Active customer accounts increased by 6 million to more than 215 million. Active seller accounts stayed above 2 million. Paid (third-party) units were 40% of total units in the second quarter, compared to 30% in the Mar quarterand 40% in teh year-ago quarter). The relatively steady contribution is on account of growing media sales that are not third-party in nature.
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 down 13.5% sequentially and up 16.0% from last year to 14% of total revenue. The sequential decline is seasonal. The increase from the year-ago quarter continues to be driven by the consumption of digital content across categories. Members of the recently-acquired Goodreads have gone from 10 million to 20 million over the past year. 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 - Free Report) Xbox 360, Sony’s (SNE - Free Report) Playstation 3, Apple’s (AAPL - Free Report) Mac or other PCs, as well as on TV. In the last quarter, Amazon 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 (41% revenue share) was up 5.7% sequentially and 31.2% 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.
Amazon’s International media business (14% of total revenue) was down 12.6% sequentially and 0.9% year over year. This business is showing negative trends, despite Amazon’s continued efforts, particularly in emerging markets like China and India. EGM, which was around 25% of total revenue, was down 3.6% sequentially and stayed 22.1% above the year-ago level. This seems to indicate a greater preference for purchasing electronics rather than content in international locations. Once the electronics business gains momentum and Amazon has enough fulfillment centers set up, we expect further investment in content. Amazon now 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 12.5% sequentially and 63.9% from the year-ago quarter. The International contribution was consistent with the previous quarter and up 23.1% from the year-ago quarter. AWS continues to launch new services and enhance the security of its services. In the last quarter, it also announced significant price cuts. The segment could touch a billion dollars in revenue by next quarter.
The gross margin expanded 206 bps sequentially and 255 bps year over year to 26.6%. 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 5.3% sequentially and 34.3% 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 make them stick with it.
Amazon’s operating expenses of $4.42 billion were up 8.0% sequentially and 36.3% 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, technology and content, fulfillment, marketing, and general and administrative expenses as a percentage of sales grew 167 bps, 113 bps, 11 bps and 1 bp, respectively from a year ago. All expenses also increased on a sequential basis.
As a result, the operating margin of 0.5% was dropped 62 bps and 33 bps, respectively from the previous and year-ago quarters. The operating income of $79 million was down from an income of $181 million in the previous quarter and a profit of $107 million in the year-ago quarter.
The North America segment operating margin was down 56 bps sequentially and 39 bps from the year-ago quarter. The International segment operating margin was up 24 bps sequentially and down 29 bps from the year-ago quarter.
EBITDA was $1.13 billion, up 2.1% sequentially and 39.4% from last year. The cash margin of 7.2% compares favorably with the 6.9% cash margin in the previous quarter and 6.3% cash margin in the year-ago quarter.
Amazon generated third quarter net loss of $6 million, or a 0.0% margin, compared to income of $99 million, or 0.6% in the previous quarter and $7 million, or 0.1% net income margin 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 $0.01 a share compared to income of $0.21 in the previous quarter and $0.02 cents per share in the year-ago quarter.
Balance Sheet and Cash Flow
Amazon ended with a cash and investments balance of $7.46 billion, down $432 million during the quarter. The company generated $880 million of cash from operations, spending $855 million on fixed assets (including internal-use software and website development costs), $140 million on acquisitions net of cash acquired and $290 million to pay down debt and long term obligations.
Amazon saw inventories increase 0.5% sequentially, with turns went up from 8.7X to 8.3X. Receivables increased in the quarter, with DSOs up from 14 to 16.
Management provided guidance for the third quarter of 2013. Accordingly, revenue is expected to come in at around $15.45-17.15 billion (down 3.8% sequentially, or up 18.1% year over year at the mid-point), below seasonality and missing our expectations of around $17.0 billion. Operating loss (including $340 million for stock based compensation and amortization of intangible assets) is expected to come in at approximately $440 to $65 million.
Amazon’s revenue guidance looks conservative. We think this is because of greater uncertainties related to its international business and Amazon’s pricing strategy. The operating loss guidance indicates continued significant investment in the business. Therefore our thesis remains essentially unchanged.
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. The increase in users, units and partners overall indicates that it is outgrowing the 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.
Amazon has the huge task of maintaining its U.S. market share and expanding globally. We expect share losses, but think that the market will expand fast enough for Amazon to maintain a solid growth rate. However, this is dependent on its own capacity to serve customers.As a result, both fulfillment and technology & content investments will likely continue to grow. We do not consider this negative, since differentiation among online retailers is very difficult and better range, experience and support are the things that can drive traffic.
While the increase in operating expenses is a negative impact on the bottom line, we believe this is necessary. We expect the operating leverage to translate into accelerated growth in the future. However, the uncertainty regarding the timeline remains.
Therefore we expect downward revisions in estimates following the results, which could take the Zacks Rank #2 (Buy) on Amazon shares to Zacks Rak #3 (Hold).