updated 7/26/2006 11:24:27 AM ET 2006-07-26T15:24:27

Shares of Amazon.com Inc. plummeted to their lowest level in more than three years Wednesday after the online retailer said its second-quarter earnings fell nearly 58 percent due to its focus on giving customers cheap or free shipping deals and its spending to develop new technologies.

In morning trading on the Nasdaq Stock Market, Amazon’s share price fell to a level it has not traded near since April 2003. The company also sliced its profit outlook for 2006.

Amazon insists its hefty investment in things like free shipping and a new toy store is the right strategy for long-term growth and customer loyalty.

Increasingly, however, some investors are wondering when they’ll begin to see the results of those expenditures.

But despite the hefty drop in income, sales rose 22 percent, which the company attributed to its focus on providing customers with things they want — such as the shipping deals.

Amazon also said it planned to invest heavily in its new toy sales strategy and cut prices on many products to continue to lure in and keep customers.

“In some respects it’s kind of one thing after another,” said Dan Geiman, an analyst with McAdams Wright Ragen.

But analyst Bob Toomey with E.K. Riley Advisors said the hefty investments are consistent with how Amazon.com operates.

“People who follow the stock closely know or should know that Amazon’s strategy is and has been to be investing in the business for the long term,” he said.

For the three months ended June 30, the Seattle-based company reported a profit of $22 million, or 5 cents per share, compared with earnings of $52 million, or 12 cents per share, in the same period a year earlier.

In a conference call, Chief Financial Officer Tom Szkutak said net income was hurt by approximately $10 million because of the termination of a contract with Toys R Us Inc. Without that cost, Szkutak said the company would have earned about 7 cents per share for the quarter.

Sales for the quarter were $2.14 billion, a 22 percent increase over the $1.75 billion a year earlier. The company said sales would have grown 23 percent if not for the negative effect of foreign exchange rates.

Analysts polled by Thomson Financial were expecting second-quarter earnings of 7 cents per share on revenue of $2.1 billion.

Executives defended their spending plans as a way to build and maintain customer loyalty.

Amazon.com Chief Executive Jeff Bezos said the company remains committed to Amazon Prime, which for $79 per year gives people unlimited two-day free shipping.

“While this is certainly an expensive investment, it really does build what will be a more important and bigger company over the long term,” he said in a call with analysts.

Going forward, Szkutak said the Internet retailing giant, which now sells everything from groceries to televisions, expects to lower costs in many product areas.

Szkutak also said the company plans to invest in building up its new toy store, which it launched after the partnership with Toys R Us was severed.

In March, a New Jersey Superior Court judge found that Amazon.com breached a deal that was supposed to give Toys R Us exclusive rights to supply some toy products on Amazon.com. Amazon.com is appealing the decision in an effort to reinstate the retailing deal, but it also has launched its own toy store.

On the other hand, the company said its hefty investments in technology — which it has declined to provide many details on — were expected to slow in the last six months of the year, as compared to a year earlier.

For the current third quarter, Amazon.com said it expects net sales of between $2.17 billion and $2.33 billion.

For the full year, the company is expecting sales of $10.15 billion to $10.65 billion. Previously, it had forecast sales of between $9.95 billion and $10.5 billion.

For the six months ended June 30, profits were $73 million or 17 cents per share, compared with net income of $130 million, or 31 cents per share, in the first six months of 2005. Sales for the first two quarters were $4.42 billion, compared with $3.66 billion a year earlier.

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