Amazon.com (AMZN) reported a 45 cent profit, blowing past the Zacks Consensus Estimate of 24 cents. Shares soared more than 12% in extended trading following the report.
Amazon played smart right from the start, providing a weak outlook for the seasonally strong fourth quarter and coming back to beat those numbers very strongly. Not just that — it suddenly got sensitive to shareholder concerns, providing Prime subscription numbers and growth rates, and promising to break out AWS revenue from the current quarter.
Amazon also said that its investments were yielding desired results but pointed out that the strong growth in AWS and the rest of the business would necessitate increased capex this year. Content costs remain high and may be expected to grow.
The street appears to be discounting the revenue miss and disappointing (conservative?) guidance.
The numbers in detail:
Revenue
Amazon reported revenue of $29.32 billion, up 42.5% sequentially and 14.6% from the year-ago quarter. This was within the guidance range of $27.3-30.3 billion (up 39.9% sequentially and 12.6% year over year at the mid-point) but slightly short of our expectations of $29.96 billion.
Both product and service sales grew double-digits sequentially although services also grew double-digits year over year. Revenue distribution between the two was 79%/21%.
Around 64% of sales was generated in North America, representing sequential and year-over-year growth of 45.7% and 22.3%, respectively. The balance came from the International segment, which grew 37.2% sequentially and 3.2% year over year (12% excluding favorable currency impact).
Active customer accounts increased 10 million to around 270 million. Active seller accounts stayed above 2 million and fulfillment by Amazon (FBA) was more than 40% of total seller units. Paid (third-party) units were 43% of total units in the quarter, up 1 percentage point from the previous quarter. Worldwide Prime memberships increased 53% from last year and were up 50% in the U.S., positively impacting EGM sales.
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 up 29.6% sequentially and 0.9% from last year to 12% of total revenue. Growth continues to be driven by the consumption of digital content across categories (books, music, video). Year-over-year comps were difficult because of new game consoles from Microsoft (MSFT) and Sony in the year-ago quarter that significantly spurred content sales.
The Electronics and General Merchandise (EGM) business in North America (43% revenue share) was up 53.9% sequentially and 27.1% 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.
Amazon’s International media business (12% of total revenue) was up 35.7% sequentially and down 8.3% year over year. EGM, which was around 24% of total revenue was up 37.8% sequentially and 9.7% from the year-ago quarter. New product categories, better selection within categories, competitive prices and free shipping remain drivers.
The Other segment is still small (around 6% of total revenue, mostly in North America) and includes Amazon Web Services (AWS). Amazon said that worldwide AWS active customers were more than a million in the last quarter. It also intends to rename the segment AWS starting from the current quarter. The North America business was up 43.1% sequentially and 5.7% from the year-ago quarter. The International contribution was up 3.1% from the previous quarter and consistent with the year-ago quarter. AWS continues to launch new services and enhance the security of its services.
Gross Margin
The gross margin expanded 60 bps sequentially and expanded 302 bps year over year to 29.5%. Sequential variations in gross margins are usually largely mix-related, although AWS growth in having a positive impact. Pricing is an important factor however, given the increase in product categories all over the world and Amazon’s strategy of heavily discounting products and services when it is building a position in any market. Third party sites are doing better than retail, which is having a positive impact.
Gross profit dollars were up 45.4% sequentially and 27.7% from last year. 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 $8.07 billion were up 24.2% sequentially and 28.6% 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 27 bps, 78 bps, 171 bps and 26 bps, respectively, with only marketing increasing sequentially (by 38 bps).
As a result, the operating margin of 2.0% expanded 466 bps sequentially and just 2 bps from the year-ago quarter. Amazon reported an operating profit of $591 million compared to a loss of $544 million in the previous quarter and profit of $510 million in the year-ago quarter.
The North America segment operating margin expanded 475 bps sequentially and 70 bps from the year-ago quarter. The International segment operating margin expanded 309 bps sequentially but shrank 128 bps from the year-ago quarter.
EBITDA was $2.38 billion, up 120.2% sequentially and 32.2% from last year. The cash margin of 8.1% jumped from 5.2% in the previous quarter and 7.0% in the year-ago quarter.
Net Income
Amazon generated fourth quarter net income of $214 million, or 0.7% of sales, compared to loss of $437 million, or 2.1% in the previous quarter and income of $239 million, or 0.9% in the same quarter last year. There were no one-time items in in the last quarter. Therefore, the GAAP EPS was the same as the pro forma EPS of $0.45 compared to -$0.94 in the previous quarter and $0.51 in the year-ago quarter.
Balance Sheet and Cash Flow
Amazon ended with a cash and investments balance of $17.42 billion, up $10.53 billion during the quarter helped by a debt issue. The company generated $6.72 billion of cash from operations, spending $1.14 billion on fixed assets (including internal-use software and website development costs) and $53 million on acquisitions.
Amazon saw inventories rise 13.4% sequentially, with turns down from 8.0X to 10.0X. Receivables grew in the quarter, with DSOs going from 19 to 17.
Guidance
Management provided guidance for the first quarter of 2015. Accordingly, revenue is expected to come in at around $20.9-22.9 billion (down 25.3% sequentially and 10.9% year over year at the mid-point), slightly below seasonality and lower than the street. Operating income (including $450 million for stock based compensation and amortization of intangible assets) is expected to come in at approximately -$450 to $50 million.
Recommendation
Amazon has taken a very aggressive stand to maintain supremacy in its chosen markets and fourth quarter numbers indicate that it is making progress.
The company’s strategy to boost media consumption is two-fold. On the one hand, it is aggressively acquiring and creating new content, whether it is books, music or other video. On the other hand, it is trying to get consumption onto a common platform such as Prime Music, Prime Instant Video and Kindle Unlimited.
The platform model will be a natural boost to consumption, since the more a person consumes, the cheaper it gets for him/her on a per-unit basis. This would attract more users, which in turn would give Amazon leverage against content providers and help it drive down costs. The ultimate winner is the consumer with Amazon’s benefits largely coming from scale.
The challenge to this business model comes from competing ecosystems from Google (GOOGL) and Apple (AAPL). Apple is leveraging its high-quality devices and Google its operating systems to drive media sales. Apple is more of a competitor for Amazon at the moment because it already accounts for a chunk of ecommerce sales. But Google should also not be discounted because its Play sales are growing rapidly.
So Amazon needs to have competing devices to provide suitable options to its loyal customers and also, hopefully, draw more customers to its own ecosystem. This is the reason it was quick to get into the tablet market and also tried its luck with a phone. We should expect more devices from Amazon (think Glass, smartwatch, etc) and increased execution risk.
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). But uncertainty regarding its investment plans and the probability of continuing losses in the near term leads us to recommend investors to avoid the shares.
Amazon shares carry a Zacks Rank #3 (Hold).
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