Consumer Products Operating Expenses Cloud Massive Growth (AMZN)

Jeff Bezos and friends have delivered the Inc. (NASDAQ: AMZN) first quarter earnings figures for 2011.  The online mega-store looks to be a very soft figure, which is puzzling when you consider what happened in the after-hours session initially.  The official figure is $0.44 EPS, a mile short of the Thomson Reuters estimate of $0.61 EPS.  Sales rose by 38% to $9.86 billion, but that would have been a 36% gain if it were not for the favorable impact of currencies.  Thomson Reuters had estimates of $9.52 billion in revenues.

North America sales were $5.47 billion, up 45% from a year ago; international segment sales were up 31% from a year ago to $4.39 billion, but that would be “only” 27% growth if forex changes were not included.

Today’s numbers raise some serious questions.  It is up to you whether or not you trust this or not, but it does look at least possible that all the drag here is from the Japan crisis.  We have a hard time trusting this, but the conference call did break out some international data on the Japan situation.

As far guidance, Amazon sees revenues in the coming quarter of $8.85 billion to $9.65 billion versus Thomson Reuters estimates of $8.85 billion.  The company projected that operating income should be down 9% to 65% year-over-year in a range between $95 million and $245 million.

The problem is this margin figure.  The margin as a percent of worldwide net sales slid down to 3.3% in the latest quarter.  This figure is steady decline: one year ago was 5.5%, then 4.1%, then 3.5%, then 3.7%… now 3.3%.  If you break this down, it is the international segment that is a drag on margins.  International operating margin was 4.0% of relevant sales and the decline there has been as follows (for a year and each quarter): 7.0%, then 6.9%, then 6.2%, then 5.7%, and now 4.0%.

The biggest issue here for Amazon appears to be its costs and operating expenses.  A year ago, the first quarter operating expenses in North America alone were $3.507 billion, but they were $5.175 billion in this last quarter.  The international figure was $3.35 billion a year ago and $4.39 billion this year.  Sales growth of 38% is incredible whether it includes acquired companies or not, but if you have to spend about $1.30 per new dollar in revenue while your expenses are rising and margins are contracting then that is a recipe for disaster.

After digging through the numbers, there are some obvious issues affecting Amazon today.  It is not clear that its efforts to drive more and more Kindle sales is adding to its bottom line as it is losing on per unit sales.  The worldwide shipping costs were up 52% gross and up 69% net, while its shipping revenues were up only 33%. That would appear to be am impact from international shipping costs as well as that “all-you-eat” shipping cost model. The company also has grown its full-time and part-time employee headcount by 45% from a year ago to 37,900 now.  That figure was just 33,700 at the end of 2010.

Maybe Jeff Bezos is just spending everything he can spend now to fend off the competition while still trying to acquire growth.  Maybe this is just a build-out story that the company is sacrificing today so it can have vast rewards later. If so, then our cause for concern will not matter for another year or two.  Eventually, these have to be balanced out because now has to actually make money each quarter.  There are several key observations here that will have to change if Amazon wants to get it financial reports back in the right direction (not in any order)…

1) Treat Kindle unit sales like a business rather than a loss leader to protect market share

2) Rectify shipping costs… Those who abuse the all-you-can-eat model have to be weeded out or have a different deal to be passed on to them

3) Stop growing headcount so much

4) Treat international operations with the same cost measures as domestic.

5) Measure all expense dollars paid out per new operating segment versus the raw revenue dollar potential

6) adding nine new fulfillment centers in 2011 (as it claims) may only lead to more and more imbalances between costs and revenues

7) cloud spending needs to measured incrementally rather than all up front based upon 2014 demand versus 2011 demand

What is amazing is’s stock.  This closed down 1.7% at $182.30 and its 52-week trading range is $105.80 to $191.60.  The after-hours reaction was down initially about $10.00, but now shares are actually back up to positive by 0.2% at $182.57 in the after-hours session.

Maybe it is that the woes were tied to Japan, cutting international growth by 500 basis points, or five full percentage points.

Much of this operating expense appears to be an ongoing build out of the cloud operations.  The move to more and more Kindle services, including sharing features, is also something that is a risk.  These numbers are impressive on the top-line, but it is the operating costs, the headcount growth, and the new fulfillment center expansion that is concerning to us.  Those may increase on efficiency and on time spent between orders and receipt by the customer, but they do not generally drive any direct revenues.