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Amazon revenue, spending surge

Jul 27 2011 07:12 Reuters

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San Francisco - Amazon.com will use its surging revenue to boost growth and drive expansion into areas such as Web content and cloud computing rather than boost its margins.

The largest internet retailer reported a jump in quarterly revenue on sales of its Kindle electronic reader and other electronics and forecast better-than-expected revenue for the current quarter, sending its shares up more than 6% late on Tuesday.

Amazon benefited from growth in e-commerce, though margins continued to be pressured by heavy spending on distribution, technology and digital content.

The company is investing to build warehouses and distribution to support rapidly growing e-commerce, its main business.

It's also spending heavily on servers and data centers for its cloud computing business Amazon Web Services, while buying more digital content to bolster media offerings, such as streaming video.

This spending has dented profit margins in recent quarters. Analysts and investors are mostly happy to see such investment by the company - as long as it winds down at some point and lays the foundation for future profit increases.

"They're sacrificing near-term profitability for longer-term revenue growth," said Michael Souers, specialty retail analyst at S&P Equity Research. "As long as they are able to transform growth into profits in the future, investors will be satisfied. The chances are strong."

Amazon on Tuesday reported a 51%t rise in second-quarter revenue to $9.91bn, surpassing Wall Street's expectations for $9.4bn.

The company forecast third-quarter sales of $10.3bn to $11.1bn, compared with the average forecast for $10.35bn, according to Thomson Reuters.

Second-quarter net income fell to $191m, or 41 cents per share, from $207m, or 45 cents per share, in the same period a year earlier. Analysts expected 35 cents per share for the latest second quarter, according to Thomson Reuters.

The operating profit margin fell to 2.0% from 4.1% a year earlier.

Operating income is expected to be between $20m and $170m in the third quarter, the company estimated. The guidance includes about $180m of stock-based compensation expense and amortization of intangible assets. It also assumes no other acquisitions or investments will close in the quarter.

That forecast suggests Amazon's third-quarter pro-forma operating margin will be 1.8% to 3.2%t, according to Aaron Kessler, an analyst at ThinkEquity. That's below his previous estimate.

"Amazon's willing to give up short-term profits for long-term growth and more market share," Kessler told Reuters. "But ultimately they are managing the business for shareholders. We're expecting modest margin expansion next year. Investors would like to see some return on these investments starting next year."

The company is expected to introduce a tablet computer later this year that would compete with Apple Inc's iPad.

Souers reckons thin third-quarter margins suggest Amazon is spending heavily on this new tablet.

"Longer term this is the best move they can make. The world is shifting toward digital from physical media and a tablet will help them cement a position in streaming content like movies and music," the analyst said.

Amazon Chief Financial Officer Tom Szkutak declined to comment on whether the company was working on a new tablet computer. However, he pledged to keep spending and investing to support growth and new businesses.

Amazon said it spent $941m on so-called "fulfillment centers" - warehouses or logistics centers - in the second quarter, compared to $582m a year earlier. Technology and content costs totaled $698m in the latest period, versus $408m in the same period of 2010.

"We're investing in the conversion from physical to digital and we feel very good about the traction we're getting there," he said.

Szkutak also stressed that the company is focused on cash flow and high returns on investment, rather than profit margins.

Amazon's main online retail business is growing so fast that the company needs to spend on a lot of new distribution capacity, he explained during a conference call with analysts.

Amazon has announced 15 new fulfillment centers so far in 2011 and the company will unveil more before the end of this year, he noted.

Amazon Web Services - which hosts computing for corporate clients over the internet - accounts for a "big piece" of Amazon's current and future spending, because it's growing so fast, the CFO added.

Amazon shares, which have risen about 18 percent since the start of 2011, gained 6.1% to $227.35 in after-hours trade.

The company said sales in Worldwide Electronics and Other General Merchandise, which includes the Kindle e-reader, computers, cameras and other consumer electronics, jumped 69% to $5.89 billion in the second quarter.

Excluding currency fluctuations, sales rose 62%.

"That's very strong," said Scot Wingo, chief executive of ChannelAdvisor, a software provider that helps retailers sell more online through channels including Amazon and eBay Inc.

"E-commerce in general is growing at 10% to 14%, so Amazon continues to gobble up market share." Wingo owns Amazon shares, and eBay is an investor in ChannelAdvisor.

At some point, such growth will taper off and this is when Amazon will be able to cut back on spending and increase profitability, S&P's Souers said. He's expecting margins to increase "significantly" in coming years.
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