Amazon delivered very good quarterly results and surpassed expectations for the third quarter in a row. Revenue of $23.2 billion increased 20% year over year and 27% when currency is taken into account. Amazon Web Services or AWS generated $6.1 billion or 26% of total revenue and rose a reported 49% year over year.
Besides seeing Amazon’s constant currency revenue growth rate accelerate from 22% in the March quarter to 27% in the June quarter the company reported its highest non-GAAP operating margin of 4.4% since at least 2011 (the earliest that I have my model detailed by quarter).  Investors are also looking at how much Amazon beat its June quarter operating income guidance by (actual of $1.03 billion vs. a guidance range of $100 to $650 million) and ratcheting up their second half projections.
Free cash flow on decided upturn
Below is a chart from Amazon’s presentation that shows how its trailing twelve months free cash flow has increased from just over $1 billion a year ago to almost $4.4 billion in this quarter. While this is a rough calculation if Amazon’s second half non-GAAP operating income comes in at $3.3 billion vs. last years $1 billion and capital expenditures in this years second half are the same as last year (along with all the other cash flow line items) the company’s free cash flow for the year would come to $6.7 billion compared to just under $2 billion.
While this would still make Amazon’s shares very expensive at 39x free cash flow given the growth rate of the company and the potential that margins could still move higher investors are willing to pay up for it.
Source: Amazon June 2015 financial results presentation
Source: Amazon June 2015 financial results presentation
Operating margins being driven by gross margins
From 2009 to 2011 Amazon’s gross margins were relatively stable at 22.6%. In 2012 they increased 220 basis points to 24.8% and have continued to increase each year. In 2013 they were 27.2% (up 240 basis points), in 2014 they were 29.7% (up 250 basis points) and for the first half this year they have averaged about 33.5%, a huge jump of 380 basis points if it is sustained in the second half this year.
The increase in gross margins has finally overwhelmed Amazon’s increased investments in its operations. In 2009 non-GAAP operating margins were 6.0% with operating expenses running at 16.6% of revenue. Fast forward to 2014 after operating margins had fallen for 5 years in a row to 2.1% with operating expenses at 27.6% of revenue.
While gross margins had increased 710 basis points from 2009 to 2014 operating expenses as a percent of revenue had gone up by 1,100 basis points. Operating expenses are still increasing faster than revenue but the company’s gross margins grew more in the first half this year.
Stock jumped for the third time after reported results
This is the third quarter in a row that Amazon handily beat its non-GAAP operating income guidance and by an increasing amount. In December last year it beat by $99 million, in March by $162 million and in this past quarter by $377 million. Operating income guidance for the September quarter is the same as it gave for the June quarter but given the trajectory Amazon seems to be on investors are probably modeling another substantial beat.