Earnings: Keeping a Long-Term Perspective

Amazon stock is pulling back after the company's second-quarter report. Here's what investors need to know.

Steve Symington
Steve Symington
Jul 26, 2014 at 3:30PM
Technology and Telecom

Amazon stock

"Inherently unpredictable."

That's how (NASDAQ:AMZN) CFO Tom Szkutak described his company's results as he discussed the company's guidance on Thursday's earnings conference call. To be sure, if you're looking to explain Amazon stock's 9.6% drop on Friday, look no further than its unapologetic guidance for an enormous third-quarter operating loss between $810 million and $410 million, compared to a $25 million operating loss in the same year-ago period.

That's not to say its bottom line in the second quarter did it any favors, either. While the Amazon's quarterly net sales increased 23% year over year to $19.34 billion -- or exactly in line with Wall Street's consensus expectation -- the online retail behemoth simultaneously turned in an operating loss of $15 million and a larger than expected net loss of $126 million, or $0.27 per diluted share. Analysts, on average, only expected Amazon to post a net loss of $0.15 per share.

It's all about the cash flow, top-line growth
But let's focus on what really matters, shall we?

First, trailing 12-month operating cash flow jumped 18% year over year to $5.33 billion, while free cash flow came in at $1.04 billion. And in what should come as no surprise to Foolish investors who have watched the same pattern bear out for years, Amazon has no qualms about using that cash to reinvest in and grow its top line. Make no mistake: Amazon knows all too well that it can continue rewarding shareholders for the foreseeable future by growing as big as possible, as quickly as it can, in what has been historically a low-margin business anyway.

Sure enough, current quarter sales are expected to be between $19.7 billion and $21.5 billion -- compared to the consensus estimate for $20.8 billion -- which represents growth of between roughly 15% and 26% over last year's third quarter. As long as that growth remains intact, long-term Amazon investors should have little reason to worry about their company's prospects.

Highlights under the hood
So what's Amazon plowing all that money into? And what's driving its growth?

Management said it would invest $100 million for original content for its Prime streaming service in the third quarter. It's also plowing money into aggressive geographic expansion, including heavy investments to build the business in China and India. 

Amazon Fire TV enjoyed a stronger than expected launch, Credit:

In the meantime, Amazon's core product sales grew a solid 19.6% to $15.25 billion last quarter. This includes the fruits of its investments in driving site traffic for Amazon's everyday retail items, as well as development of its own Kindle and Fire series devices such as Fire TV, which launched in April and which Amazon said has "significantly exceeded our sales forecast." That said, it remains to be seen how Amazon's new Fire Phone will fare, especially considering that it has already suffered from lackluster reviews and only began shipping yesterday.

Next, services sales grew a respectable -- but not overwhelming -- 38.5% to almost $4.1 billion. That includes Amazon Web Services, which saw usage  -- not revenue, mind you -- growth close to 90% year over year in the second quarter. For that, Amazon said investors can thank a whopping 250 "significant service and feature releases" so far in 2014, along with Web Services price reductions in the range of 28% to 51%, depending on the service, which started in the second quarter.

Going forward, these numbers will soon include even more new services, including Amazon Zocalo, a fully managed enterprise storage and sharing service meant to compete with the fast-growing likes of Box, Dropbox, Microsoft OneDrive and Google Drive. Unsurprisingly, Zocalo entered the fray earlier this month with aggressive pricing in an effort to fight for market share.

For now, Web Services revenue is widely estimated to comprise the bulk of Amazon's North American "other" net sales category, which last quarter grew about 38% to roughly $1.2 billion.

Foolish takeaway
All things considered, I can't blame the market for taking a step back today given the sheer magnitude of Amazon's projected operating loss in the third quarter. That said, and assuming those heavy operating losses don't become the norm for the next several quarters, this still doesn't change my view of Amazon as a fantastic long-term investment. I think patient investors would do well to use today's pullback as an opportunity to open or add to a position in Amazon stock.