Amazon.com (AMZN) reported a 23 cent profit in the first quarter, just ahead of the Zacks Consensus Estimate of 22 cents. Amazon hasn’t had a very good track record of late, missing estimates as often as it beats them. And the company seems bent on spending huge amounts of money for staggeringly low returns.
Still, Amazon has proved its ability to become a major player in any market it targets, which is the reason shareholders remain positive. So the shares gained 3.9% during the day in anticipation of its results and edged up slightly after-hours.
Revenue
Amazon reported revenue of $19.74 billion, down 22.8% sequentially and up 22.8% from the year-ago quarter. This was within the guidance range of $18.2-19.9 billion (down 25.5% sequentially, or up 18.5% year over year at the mid-point) and 1.3% ahead of our expectations. Year-over-year revenue growth was 23% excluding favorable currency impact.
Both product and service sales grew double-digits from the year-ago quarter, with the percentage contribution of the two categories at 80% and 20%, respectively.
Around 60% of sales was generated in North America, representing sequential and year-over-year growth of -22.7% and 26.3%, respectively. The balance came from the International segment, which grew -23.1% sequentially and 18.0% year over year (18% excluding favorable currency impact).
Active customer accounts increased by 7 million to more than 244 million. Active seller accounts stayed above 2 million. Paid (third-party) units were 40% of total units in the quarter, up 1 percentage point from 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.
Segment Details
Amazon’s North America media business was down 19.6% sequentially and up 12.4% from last year to 14% of total revenue. The solid growth continues to be driven by the consumption of digital content across categories. 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. Additionally, Prime Instant Video has the broadest reach across Kindles, Microsoft’s (MSFT) Xbox platform, Sony’s (SNE) Playstation, Apple’s (AAPL) Mac or other PCs, as well as on TV.
The Electronics and General Merchandise (EGM) business in North America (40% revenue share) was down 26.5% sequentially and up 27.8% 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 (13% of total revenue) was down 28.9% sequentially and up 3.8% year over year. EGM, which was around 26% of total revenue, was down 19.9% sequentially and up 27.0% from the year-ago quarter. There remains a preference for electronics instead of content in international locations, which is why Amazon has been increasing its fulfillment centers.
Amazon has also launched Kindle stores in mane international markets including Brazil, Canada, China, Japan and Mexico, 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 (just over 6% of total revenue, mostly in North America) includes Amazon Web Services (AWS). The North America business was up 2.9% sequentially and 60.5% from the year-ago quarter. The International contribution was down 17.2% from the previous quarter and up 10.4% from the year-ago quarter. AWS continues to launch new services and enhance the security of its services. In the last quarter, Amazon again reduced prices in order to retain its leadership position. The segment did more than $1.2 billion in revenue in the last quarter.
Gross Margin
The gross margin expanded 230 bps sequentially and 224 bps year over year to 28.8%. 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. Third party sites are doing well, which has a positive impact.
Gross profit dollars were down 16.1% sequentially due to the seasonal decline in revenue. There was however a 33.2% increase from last year, due to volume increases. In fact, 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.
Operating Metrics
Amazon’s operating expenses of $5.54 billion were up 11.7% sequentially and 35.5% 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, marketing, technology & content and G&A costs increased year over year as a percentage of sales by 56 bps, 47 bps, 148 bps and 13 bps, respectively.
As a result, the operating margin of 0.7% shrank 125 bps sequentially and 39 bps over the year-ago margin. The operating profit of $146 million fell from a profit of $510 million in the previous quarter and $181 million in the year-ago quarter.
The North America segment operating margin was flat sequentially and down 13 bps from the year-ago quarter. The International segment operating margin was down 223 bps sequentially and 52 bps from the year-ago quarter.
EBITDA was $1.48 billion, down 17.9% sequentially and up 33.1% from last year. The cash margin of 7.5% increased from 7.0% in the previous quarter and 6.9% in the year-ago quarter.
Net Income
Amazon generated third quarter net income of $108 million, or 0.5% of sales, compared to income of $239 million, or 0.9% in the previous quarter and income of $99 million, or 0.6% in the same quarter last year. There were no one-time items in the last quarter. Therefore, the GAAP EPS was the same as the pro forma EPS of 23 cents a share compared to loss per share of 51 cents in the previous quarter and EPS 21 cents in the year-ago quarter.
Balance Sheet and Cash Flow
Amazon ended with a cash and investments balance of $8.67 billion, down $3.78 billion during the quarter. The company used $2.50 billion of cash in operations and spent $1.08 billion on fixed assets (including internal-use software and website development costs).
Amazon saw inventories fall 9.4% sequentially, with turns down from 10.2X to 8.4X. Receivables fell in the quarter, with DSOs up from 17 to 18.
Guidance
Management provided guidance for the second quarter of 2014. Accordingly, revenue is expected to come in at around $18.1-19.8 billion (down 4.0% sequentially, or up 20.7% year over year at the mid-point), roughly in line with seasonality, but below street estimates. Operating loss (including $455 million for stock based compensation and amortization of intangible assets) is expected to come in at approximately $455 to $55 million.
Our Take
Amazon results did not disappoint, but the business is getting more competitive and margins even thinner. The March quarter was seasonally slower, with the gross margin benefiting from a lower mix of hardware sales. Amazon remains extremely competitive when it comes to prices and practically gives away its services for free. The company still manages to gain because of the scale at which it operates.
The online retail scene is changing rapidly, with devices playing an increasingly important role. Since Google and Apple have their own stores, they are easily picking up some digital goods sales. Amazon anticipated this trend correctly, which is what led to the creation of the Kindle tablets.
Now the company is venturing into more crowded markets like smartphones and groceries, where competition is likely to be stiffer. Therefore, there is a certain amount of execution risk. The other thing it’s doing is selling Prime subscriptions, which tends to keep consumers on the Amazon platform. This strategy has worked really well and the company was even able to raise subscription fees.
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.
Amazon shares carry a Zacks Rank #3 (Hold).
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