(AMZN) Amazon Soars on Solid Q1 Results

Amazon.com’s (AMZN) first quarter earnings blew past the Zacks Consensus Estimate. The company came in 14 cents, or 303.7% higher, surprising the street and sending share prices soaring 13.8% in after-hours trading.


Amazon reported revenue of $13.19 billion, down 24.4% sequentially from the seasonally supported fourth quarter and up 33.8% from the year-ago quarter. The revenue was at the high end of the guidance for the quarter, which was $12.0-13.4 billion (up 27.1% sequentially, or up 28.8% year over year at the mid-point) and higher than consensus expectations by around 2.2%. Year-over-year revenue growth was 34% excluding unfavorable currency impact.

Around 56% of sales were generated in North America, representing a sequential decline of 25.0% and a year-over-year increase of 35.9%. The balance came from the International segment, which dropped 23.5% sequentially and grew 31.1% year over year (32% excluding unfavorable currency impact).

Active customer accounts increased by 9 million to 173 million. Active seller accounts stayed above 2 million. Paid (third-party) units were 39% of total units in the first quarter, compared to 36% in the third.

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.

Segment Details

Amazon’s North America Media business declined just 14.2% from the fourth quarter, much lower than the overall 24% odd for the company, indicating that the segment remains one of the strongest contributors to growth.

Management attributed the strength to increasing consumption of digital content across categories because of the advantageous value proposition Amazon was able to provide. The year-over-year increase was 16.6%, slightly lower than the growth it experienced in the March quarter of 2011. However, this is coming at a much higher level of revenue as there was a huge jump in the September quarter.

The Electronics and General Merchandise (EGM) business in North America was down 30.6% sequentially and up 44.5% from last year. EGM sales are obviously more sensitive to holiday-driven spending, which is reflected in the growth rates. Moreover, since EGM represents a larger percentage of Amazon’s total revenue, it impacts total growth rates more significantly than Media.

The flooding in Taiwan continued to impact supply in some categories, such as cameras, audio/video and office equipment. However, Amazon, with its extensive network typically gets through these glitches much better than other retailers, because it distributes products from a large number of third-party sellers as well (which were up in the last quarter).

Amazon’s International media business (19% of total revenue) was down 27.1% sequentially and up 21.2% year over year. EGM, which was around 24% of total revenue, was down 20.6% sequentially and up 40.2% from last year. New product categories, better selection within categories, competitive prices and free shipping remain drivers.

Gross Margin

The gross margin expanded 329 bps sequentially to 24.0% and 114 bps from the year-ago quarter. The sequential improvement in the last quarter appears to be on account of lower hardware costs, since the Kindle platform grew very strongly in the fourth quarter and would naturally be seasonally down in the first.

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. 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 also doing well, which usually impacts the margin.

Gross profit dollars were down 12.3% due to lower volumes, but increased 40.4% from last year. The increase from last year is very encouraging, indicating that despite its market position, Amazon continues to grow very strongly.

Operating Metrics

Amazon’s operating expenses of $3.0 billion were down 11.2% sequentially and up 53.9% from the year-ago quarter. The sequential decline was volume-related, while the increase from the year-ago quarter is because of Amazon’s heavy investing activities (headcount, fulfillment centers, etc) over the past few quarters.

Specifically, fulfillment, marketing, technology and content, and general and administrative expenses as a percentage of sales were up 30 bps, 24 bps, 222 bps and 46 bps, respectively from the previous quarter and 115 bps, 32 bps, 129 bps and 17 bps, respectively from a year ago.

As a result, the operating margin of 1.5% was flat sequentially and down 181 bps year over year. Operating profit dollars were down 26.2% sequentially (they were up 229.1% in the December quarter) and down 40.3% year over year.

The North America segment operating margin increased 182 bps sequentially and shrunk 61 bps from the year-ago quarter. The International segment operating margin was down 150 bps sequentially and 313 bps from the year-ago quarter (a lot of the investment over the past year was in this segment).

EBITDA was $809 million, up 4.0% sequentially and 27.6% from last year. The cash margin of 6.1% was up from 4.5% in the previous quarter and down from 6.4% the year-ago quarter.

Net Income

Amazon generated first quarter net income of $130 million, or a 1.0% net income margin, compared to $187 million, or 1.1% in the previous quarter and $201 million, or 2.0% net income margin in the same quarter last year. There were no one-time items in the last quarter. Therefore, the GAAP EPS was same as the pro forma EPS of 28 cents compared to 40 cents and 44 cents in the previous and year-ago quarters, respectively.

Balance Sheet and Cash Flow

Amazon ended with a cash and investments balance of $5.72 billion, down $3.86 billion during the quarter. The company used $2.44 billion of cash in operations, and also spent $386 million on fixed assets (including internal-use software and website development costs), $50 million on acquisitions net of cash acquired, $960 million on share repurchases and $153 million to pay down long term obligations.

Amazon saw inventories drop 14.8% sequentially, with turns declining from 11.1X to 9.4X. Receivables dropped in the quarter, due to the lower sales, with DSOs dropping to slightly less than 13 days.


Management provided guidance for the second quarter of 2011. Accordingly, revenue is expected to come in at around $11.9-13.3 billion (down 4.4% sequentially, or up 27.1% year over year at the mid-point), just below consensus expectations of around $12.8 billion. Operating income (including $260 million for stock based compensation and amortization of intangible assets) is expected to come in at approximately ($260) to 40 million.

Our Take

We continue to believe in Amazon’s prospects, especially after the solid beat in the last quarter. 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 in the past 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. Additionally, Prime has helped retain customers.

The Kindle platform, while impacted by seasonality in the last quarter, will remain a major growth platform for Amazon this year. We think that this could be a good strategy to compete against Apple Inc’s (AAPL) iPad, which has been encroaching on Amazon’s digital and ebook sales.

However, Apple got its fingers dirty on price fixation charges from the DOJ, so things could be improving for Amazon already. It will not be so easy for the Kindle to take share from the iPad because the latter offers much more. Of course, one never knows where the future Kindle is headed and for the time being, success rates are encouraging.

Given that there is significant growth potential in domestic and more so in international ecommerce, Amazon may be expected to benefit. However, the next phase of growth is dependent on its own capacity to serve customers, especially in international markets, where growth rates are likely to be higher and its own facilities fewer. As a result, both fulfillment and technology investments will likely continue to grow.

We do not consider this negative, since differentiation among online retailers is very difficult and better experience and support are the things that can drive traffic. Therefore, we cannot fault management’s strategy of investing in the business at this time. Other online players, such as eBay Inc. (EBAY) and Google Inc. (GOOG) have done likewise.

While the increase in operating expenses is hurting the bottom line, we believe this is necessary. We expect the operating leverage to translate into accelerated growth in future quarters. However, we feel that there is some uncertainty regarding the timeline, which is the main reason for our Neutral stand on the shares.

Amazon shares currently carry a Zacks Rank of #3, which translates to a Hold recommendation in the short term (1-3 months).

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