When we left e-commerce giant Amazon.com (AMZN 0.25%) three months ago, investors weren't sure what to think. The tech giant had delivered Q2 revenue that grew 20% year over year, but the company's one-day shipping initiative had eaten into profits. While the move was originally estimated to cost $800 million in the second quarter, the reality was worse -- it not only sent profits down, but also resulted in a "cost penalty" in the Q3 guidance.
Apparently, that cost penalty wasn't enough. Earnings declined year over year for the first time since Q2 2017, sending shares down more than 8% in the wake of the company's third-quarter earnings report.
One-day shipping is costly
Amazon reported revenue that grew to $70 billion, up 24% year over year, at the high end of management's guidance and surpassing analysts' consensus estimates of $68.81 billion. Unfortunately, net income of $2.1 billion declined 28%, down from $2.9 billion in the year-ago quarter, resulting in earnings per share (EPS) of $4.23, down more than 26% year over year.
One of the biggest contributors to the tumbling bottom line was worldwide shipping costs, which climbed to $9.6 billion, up 46% compared to the prior-year quarter, after a 36% increase in Q2. To put that into perspective, over the three prior quarters, the year-over-year increase in shipping hovered right around 22%. This illustrates the impact of Amazon's one-day shipping initiative on the bottom line.
Sales are up, but margins are slipping
The company generated growth in each of its major business segments. North American e-commerce sales grew 24% year over year, to $42.6 billion, driving much of Amazon's top-line growth but down from 35% in Q3 18. International sales accelerated its growth rate, producing revenue of $18.3 billion, up 18%, compared to 13% growth in the prior-year quarter.
This was the second successive quarter that operating margins slipped in North America, declining to 3% from nearly 6% a year ago, though margins were essentially flat in the international segment.
Amazon Web Services (AWS) -- the company's cloud-computing operation -- generated the most impressive growth, increasing to nearly $9 billion, up 35%, though it slowed from 46% gains in the year-ago quarter. Operating margins at the cloud unit also slipped, falling to 25% compared to 31% this time last year. Cloud computing is now responsible for 13% of Amazon's revenue and 72% of its operating profit.
The company's "other" category, which primarily includes sales of advertising, grew 45% year over year, to nearly $3.6 billion. This business has become an area of greater focus for Amazon in recent years and generated revenue of $12.7 billion during the trailing-12-month period.
The upcoming holiday quarter is typically among the strongest of the year for Amazon, but investors were less than enthusiastic about the company's guidance. Amazon forecast net sales of between $80 billion and $86.5 billion, or growth of between 11% and 20% year over year, which fell short of analysts' consensus estimates of $87.37 billion.
The company is also guiding for operating income of between $1.2 billion and $2.9 billion -- a much wider range than usual -- and a massive decline of between 68% and 24% compared to Q4 18. The reason for Amazon's holiday blues? On the conference call, CFO Brian Olsavsky said one-day shipping during the holiday quarter would probably cost the company an additional $1.5 billion, more than double the $800 million the company planned to spend in the quarter the program was introduced.
Investors are hoping that once Amazon has made the necessary investments to support its speedier shipping, the incremental costs will begin to decline. Maybe the e-commerce giant knows something we don't.