Amazon Gains as It Improves Distribution Network

July 26 (Bloomberg) -- Sheila Dharmarajan reports on Amazon's second-quarter earnings and third-quarter forecast. She speaks on Bloomberg Television's "Street Smart." (Source: Bloomberg)

Amazon.com Inc. (AMZN), the largest Internet retailer, gained the most in three months as investors bet that investments in its distribution network will pay off by the holiday season.

Amazon rose 7.9 percent to $237.32 at the close in New York, for the biggest gain since April 27. The Seattle-based company’s stock has advanced 37 percent this year.

Chief Executive Officer Jeff Bezos has opened six fulfillment centers and plans to add 12 more in 2012 to speed up online-purchase deliveries and bring down shipping costs, helping Amazon siphon shoppers from physical stores. The company also stepped up investment in technology, such as its Kindle reader.

“They’ve got to continue to invest, and that forgoes short-term profits for long-term gains,” said Kerry Rice, a San Francisco-based analyst at Needham & Co.

The investments took a toll on profit during the second quarter.

Net income fell 96 percent to $7 million, or 1 cent a share, the steepest drop since 2002, Amazon said in a statement yesterday. That missed the 3-cent average estimate of analysts compiled by Bloomberg. Sales rose 29 percent to $12.8 billion.

Amazon said it expects a third-quarter operating loss of $350 million to $50 million, compared with the average analyst estimate of a gain of $119.6 million. Sales in the current period will be $12.9 billion to $14.3 billion, Amazon said, while analysts on average projected $14.1 billion.

Operating Income

“The guidance for the third-quarter operating income is lower than it’s probably ever been and the stock’s up,” Rice said. “This is not an earnings story. This is a demand, top- line-driven story.”

Amazon is pouring resources into Kindle Fire, a tablet that lets it sell digital books, movies and music. It’s also investing in website support and marketing to prepare for the fourth quarter, when there’s a rush of holiday sales, Chief Financial Officer Thomas Szkutak said on a conference call.

“Our operating expenses are growing at a faster rate than revenue,” Szkutak said. “It’s a number of areas, including our fulfillment expense line item, marketing, as well as technology and content. We’re investing across the business.”

Operating expenses climbed 31 percent to $12.7 billion in the second quarter, boosted in part by a 44 percent increase in fulfillment spending to $1.36 billion. Income from operations was $107 million in the second quarter, Amazon said in the statement. Analysts on average had projected $45 million.

Warehouses

Amazon has costs associated with the fulfillment centers it has already opened this year, which take time to stock, staff and reach scale, as well as those in progress, said Mark Harding, an analyst at JMP Securities. Those expenses factored into the third quarter loss projection.

“When you add on additional capacity so quickly, it takes a little bit of time for that additional volume to run through those fulfillment centers and scale up,” Harding said.

Sales from third-party retailers increased to 40 percent of total units sold, compared with 36 percent in the previous quarter. Those purchases boost margins because Amazon collects a commission on any item sold by an outside vendor and books that income as 100 percent profit. The company charges about 12 percent of each third-party sale, estimates Carlos Kirjner, an analyst at Sanford C. Bernstein & Co.

Planned upgrades to the Kindle Fire may have curbed sales of Amazon’s top-selling product. The tablet’s share of the market slipped to 4 percent in the first quarter, from 17 percent in December, according to IDC.

Amazon may have sold about 670,000 units of the device in the second quarter, fewer than in the previous three months, as customers held off on buying in anticipation of a newer version, Harding said. Amazon doesn’t break out device sales.

The company also is spending money on digital content, pushing sales of music, books and movies on the tablet. LOVEFiLM U.K. Ltd., Amazon’s European online video streaming service, struck a deal with Universal Pictures Ltd. for rights to films such as “Bridesmaids” and “Despicable Me” in May.

To contact the reporter on this story: Danielle Kucera in San Francisco at dkucera6@bloomberg.net

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net

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