By Dan Gallagher

Amazon.com Inc. (AMZN) saw its shares slip Friday after the company reported revenue that was slightly below targets due to weakness in the company's core media business.

Specifically, Amazon took a hit from the slowdown in video game sales - an industry that has taken a beating over the last few months as a lack of hit game titles and a slumping economy has weakened demand. The company's bottom line was also affected by a settlement charge stemming from a dispute with ToysRUs.com.

Amazon shares were down nearly 8.6% at $85.79. The stock has surged more than 67% this year and topped out at $94.40 on Thursday ahead of the report.

Jeff Lindsay of Sanford Bernstein said investors "appeared to focus on the company's top line trends, as North American revenues decelerated more than expected, particularly in the media category." He kept his rating on the stock at market perform, or neutral.

"We remain confident in the company's long-term growth story, given Amazon's dominant position in the expanding e-commerce sector," Lindsay wrote in a report. "However, we see limited upside for the stock in the near-term, given decelerating revenue trends and full valuation."

Sandeep Aggarwal of Collins Stewart downgraded Amazon to a hold rating following the report, citing valuation and other concerns.

"Though our downgrade is largely based on valuation, we are also somewhat cautious on Amazon due to the turnaround at eBay's Marketplace, which in our view can negatively impact Prime memberships, growth for third-party merchants, and eventually active-users traffic," Aggarwal wrote.

On Wednesday, eBay Inc. (EBAY) reported a drop in earnings for the second quarter, but showed metrics that indicated an improvement in the company's core auctions business, which has suffered share loss to Amazon.com.

 
  Margins improve

Late Thursday, Amazon said sales for the quarter ended June 30 grew 14% to $4.65 billion. Net income was $142 million, or 32 cents a share, compared to net income of $158 million, or 37 cents, a year earlier, and was inline with analysts' estimates.

Gross margins for the quarter were 24.4% compared to 23.8% for the same period last year, which was noted by several analysts.

"We think a variety of factors, including vendor pricing, inventory management and third-party sales (up to 30% of total units) are contributing to the margin expansion," wrote Imran Khan of J.P. Morgan, who set a $108 price target for the stock.

The bottom line included a $51 million settlement fee related to a dispute with ToysRUs.com. The comparison was also skewed because of a one-time gain of $53 million a year earlier, stemming from the sale of the company's European DVD rental business.

For the current quarter, Amazon predicted sales in the range of $4.75 billion to $5.25 billion. Analysts polled by Thomson Reuters are expecting sales if $4.93 billion for the quarter. Operating margins are expected to come in between 2.5% and 4% for the period.

 
  Flat media sales

Amazon's worldwide media sales - books, CDs, movies and video games - grew slightly to $2.44 billion for the quarter. But North American media sales were flat.

On a conference call, Amazon Chief Financial Officer Tom Szkutak blamed weakness in sales of video-game software and hardware. He noted that last year's second quarter contained three of the year's four top-selling game releases, skewing comparisons for the quarter.

"What you're really seeing is an industry slowdown in video games and consoles," Szkutak said on the call, adding that the company is still "very happy" with the category.

Strong book sales helped offset the drop in game sales, he said.

Sales of electronic goods and other general merchandise jumped 35% to $2.07 billion on a global basis.

The previous day, Amazon announced the acquisition of Zappos.com, an online shoe retailer, for $847 million in cash and stock. Szkutak said the company had about $635 million in revenue last year, but will be operated as a separate entity.

"This acquisition was not about synergies. This was about growing in categories that we are very interested in," said Szkutak, who declined to say when the deal might begin to add to Amazon's earnings.

The company also did not disclose specific sales figures for its Kindle e-reader device, but described demand for the device as "strong."

-Dan Gallagher; 415-439-6400; AskNewswires@dowjones.com