Amazon.com Inc shares hit a record on Tuesday after it reported better-than-expected quarterly profit, fueled by the growth of higher-margin businesses during the fiercely competitive holiday quarter.
A box from Amazon.com is pictured on the porch of a house in Golden, Colorado. Credit: Reuters/Rick Wilking
The world's largest Internet retailer said that its cloud computing services, video content sales and its aggressive expansion in e-books helped increase profitability.
In addition, a growing network of warehouses or fulfillment centers closer to customers held down shipping costs as it vied with Wal-Mart Stores Inc and other major retailers for consumer dollars over the holidays.
Chief Executive Jeff Bezos highlighted the Kindle's e-book business, calling it a multi-billion dollar category that grew about 70 percent in 2012. Its traditional physical book business rose about five percent in the same period, he noted.
"We're now seeing the transition we've been expecting," Bezos said in the company's results statement.
Profits have shrunk in recent years as the company invested for longer-term growth, building massive fulfillment centers, developing a Kindle Fire tablet hardware and digital content business in competition with Apple Inc, and expanding into Internet-based cloud services.
The fourth-quarter profit results suggested that Amazon may be able to generate attractive returns from such spending, analysts said.
"The fourth-quarter operating income was up more than expected," said R.J. Hottovy, an equity analyst at Morningstar. "This supports the bull case that Amazon can monetize its growth over the longer term."
The Seattle-based company said operating income jumped 56 percent to $405 million in the fourth quarter, compared with $260 million in the fourth quarter of 2011.
Amazon's stock climbed 9 percent to $284 in after-hours trading and touched $288 earlier in the session. It hit a record of $284.72 in regular trading on January 25.
The company also said fourth-quarter revenue rose 22 percent to $21.27 billion as it grabbed a big share of online spending during the holidays. But it was the profit that initially caught Wall Street's eye.
"It was a much better-than-expected gross margin, a strong forward indicator to drive margin expansion. What is really important is gross profit dollars and that line is stronger," said Ken Sena at Evercore Partners.
The gross profit margins were 24 percent in the fourth quarter, compared with Wall Street expectations of about 22 percent.
"Incredibly strong margins," said Jordan Rohan, an analyst at Stifel Nicolaus. Amazon generated the highest quarterly gross margin in its North America business in more than three years, he noted.
Amazon mainly operates as a retailer, buying physical products at wholesale prices, storing them and then selling at a slight mark-up to consumers online.
But the company has expanded into other businesses that are potentially more profitable, including cloud computing, digital content and acting as an online marketplace for other merchants.
These newer businesses are growing faster than the company's original retail operations, boosting profitability.
The improved profitability was partly driven by the growth of Amazon's online marketplace for third-party merchants, known as 3P.
This business accounted for 39 percent of total unit sales in the fourth quarter, up from 36 percent a year earlier. Total unit sales rose 32 percent in the holiday quarter, while 3P unit sales climbed more than 40 percent, compared with the fourth quarter of 2011, according to Amazon Chief Financial Officer Tom Szkutak.
When Amazon sells products itself, it reports the total value of the sale as revenue. The cost of that product is then subtracted for a gross profit margin. When a third-party merchant sells products on Amazon's marketplace, the company gets a cut of that sale. That commission is reported as revenue, and most of it falls straight to its bottom line as profit.
"That shift means lower revenue numbers but much higher profit margins," said Rohan.
AWS, ADS, Digital goods
Amazon's cloud computing business, Amazon Web Services, or AWS, is also thought to be higher margin than the company's original retail business.
Amazon also runs an online advertising business that is also considered a lot more profitable.
These businesses are in the company's North America Other category, which generated fourth-quarter revenue of $769 million, up 68 percent from a year earlier.
"AWS is growing very fast and that is certainly impacting our operating profit," said CFO Szkutak.
The financial chief also highlighted Amazon's newer digital content businesses, particularly its video streaming offering.
Amazon has invested heavily in TV shows and movies to stream over the Internet. It has partly packaged this as a free service to consumers who have subscribed to its Prime two-day shipping service. But customers can also pay to stream other video, often newer movies.
"The percentage of Prime customers who were watching free content through Prime instant video has gone up dramatically year-over-year," Szkutak said during a conference call with analysts. "We've also increased Prime membership dramatically year-over-year. They are also purchasing paid content."
Shipping costs fall
One of Amazon's biggest investments in recent years has been focused on building lots of fulfillment centers closer to shoppers.
It costs a lot to set up these giant warehouses, but over the long term, Amazon hopes they will help the company reduce its shipping costs.
That strategy shows signs of success in the fourth quarter. Net shipping costs were 4.5 percent of sales in the period, down from 5.4 percent a year early, the company reported.
"Over the past few years, we have expanded our fulfillment network to the point where we are closer to customers and you're seeing that reflected in our transportation costs," Szkutak CFO said.