Amazon Spends More to Kindle Its Sales

By STEVEN D. JONES

Now we know why Amazon.com Inc. announced a few days ago that sales of e-books now exceed sales of print volumes. The e-tailer didn't want the news to be overshadowed by its earnings miss.

Seattle-based Amazon has shrewdly positioned the Kindle--its e-book reader--as the story of its growth. Amazon shares surged on the promise that e-books would supplant old fashioned paperbacks and hardbacks.

It's a compelling story for this digital age. Since the Kindle first went on sale, Amazon has slyly dripped out news about the product and strategically cut prices, although it's never told investors how many devices it's actually sold.

The reality, however, is that Amazon isn't a book story anymore. Though books are still a big part of its business, Amazon has morphed into a retailer of consumer electronic products and general merchandise, and the costs of keeping up with those sales cut into earnings in the second quarter.

The company generated more than half of its revenue from electronics and other merchandise. Media--books, both digital and physical--plus music and DVDs made up 44%.

On Thursday, Amazon reported earning $207 million, or 45 cents a share, fully diluted, or about 9 cents a share below analysts' expectations. In after-hours trading Thursday, Amazon shares fell 14% to about $102 and shares are down another 3% on Friday to $116.43.

While Amazon's sales were up 41% over the prior year, marketing and advertising expense climbed by nearly two thirds. Amazon is facing off against brick-and-mortar retailers, as well as online upstarts, and marketing costs are rising to address the challenge. A large part of the increased spending was for advertising the Kindle, executives said on the earnings call.

All of that spending ate into Amazon's bottom line. Of course, there were other reasons Amazon's expenses rose. Capital spending more than doubled in the quarter. It is building 13 new facilities to fulfill orders and building more capacity for Web services.

Finance Chief Tom Szkutak told reporters the company had hired an additional 2,200 employees by the end of the second quarter, as well.

Income tax expense was $88 million, more than double the year-ago level, largely because of a tax agreement with Japan concerning Amazon's business there.

Combined, Amazon spent more than $1.2 billion, or more than 18 cents of every dollar of revenue on marketing and getting goods in the hands of customers.

An argument can be made that Amazon will benefit from all the investment, particularly in technology that lets customers download any of 630,000 books to Kindle readers. Once the infrastructure is paid for, downloads cost Amazon a lot less to deliver than a hardback book.

But Amazon's second-quarter earnings remind investors that for all its Kindle news, Amazon is a much broader retailer. It sells stuff. The cost of marketing, handling and shipping those orders is real. And it's growing.

The Kindle is a great story, but Amazon's other businesses are the ones investors need to keep an eye on.

Write to Steven D. Jones at steve-d.jones@dowjones.com

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