Q4 as Never Seen Before

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By howardroark
January 31, 2001

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After some original research, I can pretty much guarantee that Amazon hasn't cut anyone from its IR team yet. A fifteen-page earnings release is a new Amazon best. Let's get down to it.

Revenue Growth

(over which there really was, sadly, not-a-contest)

As I see it, Revenue growth was disappointing, despite Amazon coming in $12 million over its net sales pre-announcement of $960 million. Why? Well, for one, ACN (now called "service") revenues were much higher than I expected, coming in at $72 million. That left around $900 million in product/shipping revenue, which is only a 30.02% improvement from Q4 '99. US BMV growth of only 11.26% underscores the continued declaration. On the call, management tried to emphasize that growth sacrifices were made in the interests of reducing operating expenses.

The real problem with the top line included the look-ahead predictions. Amazon attributed the significant reduction in revenue guidance to the macroeconomic environment, but I imagine the Q4 non-ACN results have something to do with their caution. By expecting 20-30% revenue growth in 2001, Amazon is already guiding below the 28%+ prediction in our e-consensus DCF - and that was 5 year CAGR! I didn't hear any analyst ask what Amazon was expecting in ACN revenue next year, but I wonder if it isn't significantly lower than the $72 million quarterly from Q4. One immediate difference will likely be the $9 million in inventory sales Amazon recorded in Q4, which presumably emptied the last of it out. Maybe the most alarming revenue forecast was the 14.98% growth predicted from Q1 00 to Q1 01. That's as compared to the 95.44% revenue growth from Q1 99 to Q1 00. That's enough to break Gordon's chart. In fact, last Q1 (00), Wal-Mart's sales increased just under 24% year over year.

Fulfillment Costs

These were a significant disappointment, in my estimation, and probably combine with revenue costs and shipping margins to explain the reason for the unusually large layoffs. Fulfillment costs showed less than thrilling improvement, sitting at 13.47% of net sales. But that's a poor benchmark, as we've discussed, because Amazon (as we expected) included topy fulfillment costs in ACN COGS. As a measure of ex-ACN sales, fulfillment costs were 14.55%, only a slight improvement from recent quarters. Another way to look at fulfillment costs is take the ACN COGS of $33 million, subtract the $9 million in service revenue, and assume all but 95% (previous ACN margins) is fulfillment. Using that (flawed) method, total fulfillment costs came to 15.97% of net sales (all but inventory sales to TOY), flat from recent quarters. Overall, not a good performance.

Gross Margins

On a related note, gross margins were mixed. Shipping gross margins, thanks to the promos, were miserable at (14.53%), coming in worse than last year, which had been regarded (at least by me) as the presumable low water mark. That makes this year's intermittent improvements seem questionable. Recent rate hikes by FedEx, UPS, USPS and Airborne Express won't help. Without ACN and shipping, gross margins were 25.8%, which is excellent. Not excellent, however, is the expectation that gross margins will be only 21-23% of sales in Q1. I assume this means that Amazon doesn't expect to sustain the level of ACN margins of Q4. Note that Amazon amortized (recognized as revenue) $42 million of previously received unearned revenue, but only brought in $31 million in unearned revenue, lowering the total and indicating a likelihood of lower ACN revenue in the future.

Other Operating Expenses

All other operating expenses scaled extremely well, accounting for the operating margin improvement. Marketing expense at 5.68% of sales and R&D down to 7.18% of sales look strong in particular and should be compressed even more by the downsizing. This is, however, a bit of a double-edged sword. Marketing costs decreasing as a percentage of sales may be both the result of improved scale and efficiency and a partial cause of slower core revenue growth. Still, judging from these numbers, it's reasonable to predict that by Q4 2001, Amazon should have its fixed operating expenses (marketing, R&D, & G&A) down to 12% of sales or so, which would still leave room for pro forma (Latin for not actual) profitability with fulfillment costs as high at 11%.

Cash Position

With all the less than stellar news, the cash position appeared strong, and I imagine that Suria is unlikely to come out with a note attacking the robustness of Amazon's current assets. Only $36 million of Amazon's $1.1 billion in Cash and investments are in equities. The $155 million write down in investment finally shed the last of the dot-froth, making seem likely that Amazon completed the write down of the likes of at least the ADBL investment and anything else hanging around.

The cash position is actually buoyed by the much lower than expected payables, coming in at only 50% of revenue versus 68% last year, a huge difference. This is good for short term cash management, but bad for long term cash conversion, indicating the flip side to handing over inventory financing to Amazon will not be out of cash by the end of the quarter (or have problems with its suppliers) and the expected $650 million in cash comes even with rather disappointing expected revenues and a $50 million cash restructuring charge. I'll ungracefully take credit for calling this one right.

Finally, I was distracted when something was mentioned on the call about reducing the options overhang by around 20 million without using variable accounting. Did anyone get any details on the method Amazon is using (reloads, shortened maturities etc.) and why it isn't seen as a variable award?

Overall, I'd say that Amazon showed that they can leverage fixed costs (SG&A, R&D) faster than expected, but that variable fulfillment costs and shipping continue to be trouble spots. Most important, growth is slowing faster than expected, leaving perhaps more rooms for a near term viable business but less for extraordinary equity appreciation.