AMZN Company Overview

Amazon is a Fortune 100 company, recording over $61 billion in revenue in the 2012 fiscal year, with a net loss of $39 in that period. The company is a retailer, operating almost exclusively online. Amazon runs a large family of retail websites, several of which are the market leaders. The flagship site Amazon.com is ranked as the #11 website in the world in terms of traffic by Alexa, which itself is an Amazon subsidiary (Alexa.com, 2013). Amazon is the dominant player in online retailing in several countries, including the U.S., the UK, Germany and Canada (Myslewski, 2013).

Amazon was founded in 1994 and is based in Seattle. The company has always focused its efforts on online retailing. Initially, Amazon was focused on books and music, but very quickly began to branch out into other retailing fields. Today, Amazon has a very broad product range, and including its partner retailers it offers millions of different products through its suite of websites. Amazon was founded in the earliest days of the Internet, before it was a mass market medium, and this allowed Amazon to gain first-mover advantage in the online retailing sector. This advantage occurred not only because Amazon was able to build a strong brand in online retailing, but because the company was able to develop technologies that put it ahead of all other competitors in online retailing. Johnson (2010) notes several facets of Amazon's innovation, including the development of new markets and finding new ways to profit in old markets. Amazon's customer relationship management software in particular has been a key success factor (Business Week, no date).

Despite its strong market position, Amazon faces an uncertain operating environment. The pace of technological change in online retailing is rapid, and the space is occupied by companies with strong bricks and mortar presence. Among other major online retailers are Wal-Mart, Apple and Staples, all with significant store networks. Amazon therefore competes against firms by specializing in online, and must maintain technological advantage in order to maintain the advantage that its strong brand and competitive positioning have given it. Amazon's brand has been ranked by Interbrand (2012) as the 20th-most valuable in the world, but Amazon will need to maintain its technological competitive advantage in order to retain this strength.

In recent years, the U.S. economy has struggled, but Amazon did not share in those struggles. Revenue growth has been strong and steady in the past five years, increasing from $19.16 billion in 2008 to $61.0 billion in 2012. Amazon saw a loss last year, however, something it had not been close to in the previous four years. This was the second consecutive year of declining profits. Part of the role of financial analysis is to better understand the dynamics that lead to results like this. By investigating the financials of Amazon, it will be easier to determine why the company's profits have fallen so dramatically in the past couple of years. Operating income has declined in the past couple of years, indicating that at least part of the problem comes at the cost level for the company, but its income tax was also considerably higher in 2012 than in previous years. The first step will be to conduct a thorough review of the financial statements.

Review of Financial Statements

There are several different ways to break down financial statements. The first is through horizontal analysis, which compares recent performance against past performance. Vertical analysis is a means by which changes in percentages of items on the income statement and balance sheet can be identified. These changes will identify some of the changes in the company's finances over time. Finally, ratio analysis will provide further depth to understanding Amazon's financials, and can be used in combination with horizontal and vertical techniques.

Horizontal Analysis

Horizontal analysis compares current results to past results in order to get a sense of trends. Starting with Amazon's income statement, the horizontal analysis for the past three years looks as follows:

Amazon Income Statement

Horizontal Analysis

2012

2011

2010

2009

Total Revenue

61093

48077

34204

24509

COGS

45971

37288

26651

18978

Gross Profit

15122

10789

SGA Exp

R&D

Operating Income

60%

76%

Income Tax

Net Income

-39

-4%

70%

The horizontal analysis reveals a number of things. The top line, revenue, has seen impressive growth over the past three years, steadily increasing. The cost of goods sold has increased at roughly the same rate as the revenue, with just a slightly lower rate of increase in 2012. This is important, because it indicates that any pressure on earnings is not coming from the company's gross margin. What this means is that Amazon has been able to maintain its pricing power over both suppliers and consumers, and may have even increased its pricing power in 2012. The strength of the company's brand and its market share have allowed it to maintain margins. It is expected that as the company grows it should be able to get volume discounts from suppliers, and it is possible that this has happened in 2012. The other implication of this finding is that Amazon's profit problems are...

Selling, general and administrative expenses are at 318% of 2009 levels; research & development expenses are at 368% of 2009 levels. Both of these figures represent higher growth than has been experienced on the total revenue side. As a result, while gross income has grown faster than revenue, operating income has declined. It is worth nothing that in 2010, the increases in expenses were not significantly different than the increases in revenue. It is only in the past two years that expenses have increased rapidly. There are a number of potential factors for such increases. The emphasis on technological innovation and maintaining industry-leading technology might explain why Amazon has increased its R&D expenses so quickly. Further, the company's move into tablets with the Kindle has represented a slight shift in business model that could also have resulted in significant R&D increases. While income tax is higher than it used to be, it has not grown as rapidly as revenue. However, it has grown faster than operating income, which is the basis for tax calculation. An increase in tax beyond the increase in operating income has to be disconcerting for management and investors.
A horizontal analysis must also be conducted on the balance sheet. This is as follows, for the past three years:

Amazon Balance Sheet

Horizontal Analysis

2012

2011

2010

Cash

11448

Receivables

Inventories

Current Assets

21296

17490

13747

PPE

Intangibles

1955

Total non-Current

11259

Total Assets

32555

25278

18797

Payables

13318

11145

Current Accrued

Total CL

19002

14896

10372

LT Debt

39.8%

other non-current

Total non-Current

Total Liabilities

24363

17521

11933

Total Equity

The horizontal analysis of Amazon's balance sheet shows that total assets have increased 73.2% in the past two years. Of these, the biggest growth lines have been plant, property and equipment (192.5%) and receivables (112%). However, the increase in total equity has been slower than the increase in total assets. This means that the value of the company has not grown as quickly as its asset base. Equity growth has been a fairly meager 19.3% over the past two years. This is not entirely surprising, since the company lost money last year and has seen two years of decreasing profitability. Amazon has therefore financed its recent growth primarily with debt. Long-term debt has increased 381% in the past two years, the fastest rate of growth of any balance sheet line item. The growth in debt specifically pertains to the 2012 fiscal year, where Amazon added $3 billion in debt. This was the company's first debt issue in a decade, and was done in part to take advantage of very low financing rates, with the highest rate on the debt being 2.5% at the time of issue (Mead, 2012).

Vertical Analysis

Another major form of financial statement analysis is the vertical analysis, which compares line items to a baseline item. For the income statement, revenue is the baseline item and for the balance sheet the total assets represent the baseline item. The vertical analysis data for Amazon's income statement is presented here:

Amazon Income Statement

Vertical Analysis

2012

2011

2010

Total Revenue

61093

48077

34204

COGS

45971

75%

37288

78%

26651

78%

Gross Profit

15122

25%

10789

22%

22%

SGA Exp

16%

14%

13%

R&D

7%

6%

5%

Operating Income

1%

2%

4%

Income Tax

1%

1%

1%

Net Income

-39

0%

1%

3%

This analysis shows the slight decrease in cost of goods sold more clearly. It also highlights the increase in expenses. The percentage figures illustrate that the selling, general and administrative expenses increased from 13% in 2010 to 16% of revenue in 2012. The R&D expense increased from 5% of revenue in 2010 to 7% in 2012. These figures might not seem like much -- just 3% - but the operating income in 2010 was just 4% of total revenue. This means that operating income declined to just 1% of total revenue in 2012, a very fine line that is close to a loss. Combined with the increase income tax, Amazon slipped from profit to loss over the course of two years, just on the increase in the two major expense line items. If the growth in selling, general and administrative expense and the growth in research & development expense cannot be curtailed, the company will continue to lose money, even though it is holding or improving its gross margin.

The vertical analysis technique can also be applied to the balance sheet to analyze how…