Amazon.com’s (AMZN) fourth quarter earnings beat the Zacks Consensus Estimate by 24 cents, or 150%. However, investors were much more concerned about the 4.3% revenue miss, sending shares down 8.71% in after-hours trading.
Revenue
Amazon reported revenue of $17.43 billion, up 60.3% sequentially and 34.6% year over year (in the middle of management’s guided range but missing consensus expectations by around 4.3%). Year-over-year revenue growth was 34%, excluding favorable currency impact.
Around 57% of sales were generated in North America, representing a sequential increase of 66.9% and a year-over-year increase of 37.3%. The balance came from the International segment, which grew 52.3% sequentially and 31.2% year over year (29% excluding favorable currency impact).
Active customer accounts increased by 12 million to 164 million. Active seller accounts stayed above 2 million. Paid (third-party) units were 36% of total units in the fourth quarter, compared to 38% 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 jumped 33.0% and 8.1% from the previous and year-ago quarters, respectively.
The Electronics and General Merchandise (EGM) business in North America was up 89.3% sequentially and 51.0% from last year. The company records ebook sales through Kindle devices under this segment.
Amazon’s International media business (20% of total revenue) was up 54.9% sequentially and 20.3% year over year. EGM, which was around 23% of total revenue was up 50.4% sequentially and 42.3% from last year. New product categories, better selection within categories, competitive prices and free shipping remain drivers.
Gross Margin
The gross margin shrunk 280 bps sequentially to 20.7%, but was up 34 bps from the year-ago quarter. Sequential variations in gross margins are 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. Hardware costs are also on the rise given the strong growth in the Kindle platform (up 177% from the year-ago quarter).
However, gross profit dollars continued to increase, up 41.2% sequentially and 36.9% from last year. The increases were volume related, implying that despite its market position, Amazon continues to grow very strongly.
Operating Metrics
Amazon’s operating expenses of $3.3 billion were up 35.1% sequentially and 54.9% from the year-ago quarter. The headcount increased substantially, as employee additions, particularly in operations and customer services continues to accelerate.
Fulfillment expenses continued to grow from the year-ago quarter (up 110 bps), although it was down 79 bps on a sequential basis. Technology and content costs were up 94 bps from the year-ago quarter although down 213 bps sequentially. Marketing was up 50 bps year over year and flat sequentially.
The operating margin of 1.5% jumped 77 bps sequentially and fell 217 bps year over year. Operating profit dollars were up 229.1% sequentially and down 45.1% year over year.
The North America segment operating margin increased 45 bps sequentially and shrunk 121 bps from the year-ago quarter. The International segment operating margin was flat sequentially, although down 335 bps from the year-ago quarter.
EBITDA was $778 million, up 55.3% sequentially and 2.0% from last year. The cash margin of 1.1% was down from the previous quarter, although up from the year-ago quarter.
Net Income
Amazon generated fourth quarter net income of $187 million, or a 1.1% net income margin, compared to $63 million, or 0.6% in the previous quarter and $416 million, or 3.2% 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 40 cents compared to 14 cents and 91 cents in the previous and year-ago quarters, respectively.
Balance Sheet and Cash Flow
Amazon ended with a cash and investments balance of $9.58 billion, up $3.3 billion during the quarter. The company generated $4.27 billion of cash from operations, spending $550 million on fixed assets (including internal-use software and website development costs), $49 million on acquisitions net of cash acquired, $277 million on share repurchases and $104 million to pay off all its long term debt.
Amazon saw inventories grow 32.4% sequentially, with turns increasing from 8.8X to 11.1X. Receivables grew in the quarter, due to the higher sales, with DSOs increasing slightly from 12 to 13 days.
Guidance
Management provided guidance for the first quarter of 2011. Accordingly, revenue is expected to come in at around $12.0-13.4 billion (up 27.1% sequentially, or up 28.8% year over year at the mid-point), below consensus expectations of around $13.4 billion. Operating income (including $200 million for stock based compensation and amortization of intangible assets) is expected to come in at approximately ($200) to 100 million.
Our Take
We continue to believe in Amazon’s prospects, despite the company missing revenue estimates 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.
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 growing less than many expected 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 is increasingly encroaching on Amazon’s digital and ebook sales. However, it will not be so easy to take share from the market leader because of the extent of software development around Apple products.
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. We think that other online players, such as eBay Inc. (EBAY) and Google Inc (GOOG) are doing 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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