Amazon Blames It On Harry

Potter, that is. During Amazon.com’s (AMZN) conference call with analysts Tuesday night, following an underwhelming September quarter earnings report, the first topic of discussion was margin — specifically, a decline in gross profit of half a percentage point, year-over-year, to 23.4% of sales.

Well, three percentage points out of Amazon’s total 41% rise in sales came from the seventh Harry Potter book, and Chief financial officer Tom Szkutak confirmed the book “was a break-even event for us,” and so “lower than average gross margin” for Amazon — to no one’s surprise, given the frantic price chopping of Potter by retailers.

When asked whether this problem would abate in the current quarter, Szkutak said “We won'’t give guidance on individual line items,” but said the impact of Potter “shouldn’t be as big as you’re seeing in [the third quarter].”

But gross profit is complex: on the one hand, even leaving aside Harry, Amazon saw lower gross profit because of the mix of goods it sold, said Szkutak, without elaborating. At the same time, sales of goods sold through Amazon third-party merchants surged 40%, and those sales are typically higher margin for Amazon. But then on the other hand, gross profit from Amazon-affiliated merchants overseas are lower than the overall margin, at about 20%, as one analyst pointed out.

Takes a lot of hands to figure where Amazon’s margin is going. How all these factors will mix in 2008, the company wouldn’t say. All Szkutak would say is, over time, as its international business “scales,” Amazon can get better savings from those sales.

• Operating profit: For the December quarter, Amazon said it expected to have operating profit, excluding stock-options expense and some other charges, in a range whose midpoint would be 5.9% of a project $5.275 billion in sales, the company said. That would be slightly better than the 5.4% last quarter. Consistent with the year-ago fourth quarter, the company expects operating expenses to rise slower than revenue in the current quarter, said Szkutak.

  On the other hand, spending on technology, including software development, sounds like it will continue. When Szkutak was asked whether the company expected to “grow into its spending” of the prior years in 2008, a code for focusing on profitability, he replied, “I think one of the things you should keep in mind which is a little different than where we were back in 2004, when we started this increase in investment, is our base is bigger. So we can afford to invest with this higher base that we have, more so than we did in 2004.” But Founder Jeff Bezos was quick to temper that statement by adding, “The bigger base might allow us to make investments over time with less of a step function change than you’ve seen in the past.”

• Sales growth: Szkutak said sales in North America rose 42% year over year, the highest level in seven years. The fourth quarter forecast means sales for all of 2007 will be in a range of $14.263 billion to 14.613 billion, which would represent year-over-year growth of as much as 36%, and is ahead of estimates of $14.19 billion, on average.
• The consumer: Asked about the effects of the economy on the consumer, Szkutak said “You’re seeing […] customers reacting and responding to just a very good customer experience, continued focus on lower prices […] and, certainly, speed of delivery,” and, he said, “that plays well, as reflected in our guidance for Q4, as we enter into the holiday season.” Bezos added that toys should do strongly this quarter: “This is going to be, by far, our best customer experience in the toy category in the Company’s history. It’s not only Amazon retail toys, but there are also now a very strong network of party toy sellers in the toy category.”
• Digital media: Asked about the company’s “Unbox” digital downloads service, Bezos remarked, “I would just say that we’re very happy with the early results that we’re seeing […] Everybody loves the DRM-free format, so selling MP3s is being very successful for us.” But he added, “The way we look at it, the onus is on us to continue to convince music labels that this is a good way to sell their music.”