Shoots Higher on Earnings - TheStreet Shoots Higher on Earnings

The e-tailer beats Wall Street expectations and its own guidance on operating income.
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Updated from July 22

Investors and analysts alike were showering their favor on

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Wednesday after the company posted a strong second quarter and raised its outlook.

The Tuesday night report helped assuage investors' nervousness over a stock that has more than doubled over the last year. But with Amazon still trading at nearly 73 times projected 2003 pro forma earnings, the company still has little room for error going forward.

Recently, the shares were up $4.06, or 11.6%, to $38.93. The stock was the subject of much analyst praise Wednesday morning, including upgrades from J.P. Morgan Chase and CSFB and a higher price target at Deutsche Bank.

Amazon lost $43.3 million, or 11 cents a share, in the second quarter. Although the quarter continued its losing streak -- Amazon has never reported a quarterly profit outside a fourth quarter since it became a public company -- the company's results were sunk by a host of noncash charges. Despite those charges, the company narrowed its loss from the year-ago period, when it was $93.6 million, or 25 cents a share, in the red.

Meanwhile, Amazon's revenue jumped 36.5% to $1.1 billion over the same time period.

On a pro forma basis, which excludes a rash of charges, the company earned $42 million, or 10 cents a share. The company's operating income grew to $41.8 million from $1.5 million in the year-ago quarter. Pro forma operating income, which excludes noncash operating charges, increased to $67.2 million from $26 million in the year-ago quarter.

The results beat the expectations of Wall Street analysts, who were looking for Amazon to post earnings of 6 cents a share on $1.03 billion in sales.

To be sure, Amazon's revenue and pro forma income benefited from a decline of the dollar in the quarter vs. foreign currency. If the dollar had stayed constant vs. the euro and other currencies, Amazon's revenue would have been about $1.04 billion. Meanwhile, the company would have posted pro forma operating income of about $64.2 million.

Still, even correcting for the foreign exchange rates, Amazon's results would have come in at the top of its own guidance. Amazon had projected that it would post pro forma operating income of $45 million to $60 million on sales of $1 billion to $1.05 billion.

Following its strong report, Amazon encouraged analysts to up their third-quarter estimates and raised its guidance for the full year.

The company now expects to post operating income of $40 million to $55 million in the third quarter on sales of between $1.075 billion and $1.15 billion. For the full year, Amazon expects to record operating income of $215 million to $255 million, on sales of $4.9 billion to $5.1 billion. The company expects to record full-year consolidated segment -- i.e., pro forma -- operating income of $300 million to $340 million.

Analysts had been expecting the company to earn 7 cents a share on a pro forma basis on $1.03 billion in revenue in the third quarter, according to Thomson First Call. The company had previously projected that it would post pro operating income of at least $275 million for the full year on sales of $4.7 billion.

All of the company's estimates assume no changes in the company's restructuring expenses and that the company's stock price stays constant at $36.22. Amazon, which has elected to expense stock-based compensation, awarded restricted shares as severance pay to terminated employees during a restructuring in 2001. The company records changes in the value of those shares as an expense each quarter. Amazon also reserves the right to readjust lease expenses related to that restructuring.

In addition to raising earnings estimates, Amazon answered critics who have been scrutinizing its revenue growth. In recent years, as the company has focused on improving its bottom line, Amazon's revenue rate slowed. Sales in North America of media products such as books and CDs -- Amazon's oldest and most important businesses -- grew by just 7% in the first half of last year, for instance.

But helped in part by the latest installment in the Harry Potter franchise, of which Amazon sold 1.4 million copies in the quarter, the company's revenue in North American media products grew 14% in the second quarter. Overall, the company's core North American sales grew 20%.

Overseas sales grew by 81% -- 57% on a constant currency basis -- to $397.4 million. Such sales now account for 36.1% of Amazon's overall revenue, up from 27.2% in the second quarter last year.

Amazon also answered some skeptics' questions about sales by third parties through its Web site. Companies such as


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, as well as a slew of small business owners, sell books, clothes and other products through Amazon's Web site.

Such sales are more profitable for Amazon on a percentage basis than products it sells directly to customers because Amazon doesn't have to carry inventory, instead simply charging a commission on its partners' revenue. However, Amazon sees less overall revenue from a third-party sale than from products it sells directly. Some analysts have questioned the extent to which such transactions have cannibalized sales of Amazon's own products and whether they might be having an effect on the company's overall revenue.

But in the second quarter, even as Amazon's revenue surged, its third-party sales also jumped. Some 20% of the units sold on Amazon in the second quarter were sold by third parties, up from the year-ago period, in which third parties accounted for 14%.

Amazon also turned around its free cash flow in the quarter, after posting declines in the widely watched figure in the first quarter this year and in the year-ago quarter. In the second quarter, Amazon gained $118.9 million in free cash flow, which represents the difference between cash generated by operations and purchases of fixed assets.

In the second quarter last year, Amazon's free cash flow declined by $2.8 million. In the first quarter this year, the company's free cash flow fell by $258.2 million.

The company's free cash flow did benefit from the Harry Potter sales. Although the company booked revenue from sales of the book, it won't start paying vendors for the book until this quarter, Amazon officials said in a conference call.

Meanwhile, the company's net earnings were hit with a $60.2 million charge related to re-evaluating its euro-denominated debt. That noncash charge was subtracted from the company's operating cash flow.