Can Amazon keep the profits flowing?

Wall Street thinks a profit repeat isn't likely but is impressed by the e-tailer's improvement. Free shipping and lower book prices have spurred sales, one analyst says.

Greg Sandoval Former Staff writer
Greg Sandoval covers media and digital entertainment for CNET News. Based in New York, Sandoval is a former reporter for The Washington Post and the Los Angeles Times. E-mail Greg, or follow him on Twitter at @sandoCNET.
Greg Sandoval
5 min read
After racking up a staggering $2.86 billion deficit during the past seven years, Amazon.com surprised skeptics last quarter by reporting a $5 million net profit.

The online retailing giant didn't repeat that performance Tuesday--nor was it expected to--when it reported first-quarter earnings. The company posted a narrower-than-expected loss, with sales up 21 percent from last year.

Analysts and Wall Street were looking carefully at several key areas to gauge whether Amazon can sustain momentum in certain growth areas and reach its goal of at least 10 percent sales growth with positive operating cash flow by the end of the year. It was also the first earnings report since Chief Financial Officer Warren Jenson announced that he would leave the company.

Amazon reported a net loss of $23 million, or 6 cents a share, compared with a net loss of $234 million, or 66 cents per share, in the year-ago quarter. Amazon was expected to report about $805 million in revenue and a loss of 9 cents per share, according to a consensus of analysts surveyed by First Call.

But, as analysts predicted, Amazon reaped the benefits of a yearlong effort to streamline operations, expand its international unit and boost sales of used goods.

"We believe Amazon's lower book prices and new Super Saver free shipping offer have spurred sales," said Lehman Brothers analyst Holly Becker, who added that throughout the first quarter, "traffic growth has been impressive."

Jenson credited those areas in the conference call Tuesday, saying customers were drawn by the free shipping.

"The productivity improvements are really across the board, whether you're looking at technology, in the fulfillment centers or the customer service centers," Jenson said.

The free shipping on most orders $99 and over was initiated during the holidays and retained this year to draw more customers and put pressure on competitors. Since then, a number of other online retailers have started free-shipping deals.

But despite the lure of free shipping, shoppers are known for being tightfisted in the first quarter, when spending drops off dramatically after the holidays. The tough sales environment puts a sharp focus on other areas Amazon has been tapping for revenue.

Room for improvement?
One of the most dramatic changeshas been Amazon's turnaround on inventory management, a key element in reaching profitability in the fourth quarter. But analysts have openly questioned whether those changes, which led to Amazon slashing costs associated with stocking and shipping goods, can be further exploited or whether the company has already realized the bulk of the savings.

There are still many places to cut costs, said Cayce Roy, Amazon's vice president of U.S. fulfillment, who oversaw the reorganization of the company's five warehouses and upgrades to software to better estimate customer demand.

"We still have lots of opportunities for improving," Roy said. "There's no shortage of projects."

Analysts were also watching for any updates on Amazon's partnerships, another area where the company showed robust growth last quarter. Through its Services division, Amazon cut deals in which business partners pay it a fee and sometimes a share of sales; in return, the e-tailer takes on a range of duties, from building Web stores to overseeing fulfillment of orders.

In some cases, it partners with companies to avoid handling inventory, while in other deals Amazon carries the inventory, but the partner covers the cost of the inventory.

Amazon investors have cheered the company's Services deals because the margins are often much higher than those in its retailing business.

On Tuesday, the company reported that Services was up 25 percent to $52.7 million. The company also announced on Tuesday that it had extended its existing relationship with Borders, signing a multiyear deal that allows customers to order books, CDs and DVDs online and to pick them up at Borders stores.

Under the new deal, customers can choose in-store pickup when they place their orders online. They will then be presented with a list of up to five nearby Borders stores, based on ZIP code and product availability.

But there have been some problems with the partnerships, most notably when the business partners aren't making money on the deals, with the exception of bookseller Borders.

No profits, no deal
Lehman Brothers' Becker noted in a recent report that a lack of profits could drive some of the businesses to abandon their online ventures entirely, "which will obviously be problematic for Amazon," she wrote.

At the least, several partners are looking to renegotiate the terms of their partnerships, which if successful will make the deals less profitable for Amazon. Others, such as online liquidation company Overstock.com and auction house Sotheby's, have ended their deals with Amazon in the past year.

In March, CNET News.com reported that online travel sites Expedia and Hotwire were disappointed in the way that Amazon was promoting the travel site they had agreed to jointly operate on Amazon. Sources close to the three companies said that Amazon and Expedia were in talks to resolve the issue, and indeed Amazon has promoted the travel on its front door in recent weeks.

Sources also told News.com that Toys "R" Us was renegotiating its contract with Amazon, which powers Toysrus.com.

Amazon's overseas units were another moneymaker last quarter, with sales of $262.4 million, up 81 percent from a year ago. Specifically, Amazon's Germany and United Kingdom units broke even on cash flow for the quarter. The company's French division struggled, however, and several key executives have left the company in the past year.

Overseas did well again in the first quarter, with sales from Amazon's international operations jumping 71 percent to $226 million.

In both quarters, one of the reasons the overseas units did so well had to do with the favorable exchange rate on the euro. In the fourth quarter Amazon booked a $16 million gain from revaluing its euro-denominated debt, and in the first quarter it booked an additional $6 million.

The resignation of Jenson, who had been CFO since 1999, was not expected to have an effect on the company, according to analysts. Jenson noted in his resignation resignation in March that he had joined Amazon with the goal of seeing the company reach profitability. He said he planned to stay on for several months while the company searched for a successor.

Against this backdrop is the news that e-commerce has been surprisingly strong since the holidays, growing in the first quarter by about 12 percent. Amazon's traffic is up more than 50 percent from last year, according to Jupiter Media Metrix.