Amazon (AMZN -4.17%) recently released a third-quarter report that probably disappointed many investors. The e-commerce giant's revenue and earnings missed Wall Street's expectations. Moreover, revenue guidance for the important holiday quarter came in lighter than the analyst consensus estimate.
In the third quarter, Amazon's revenue grew 15% year over year to $127.1 billion. This was a solid showing and only fell slightly short of the $127.5 billion analysts had projected.
Net income was $2.9 billion, or $0.28 per share, compared with $0.31 per share in the year-ago period. This result included a pre-tax valuation gain of $1.1 billion in nonoperating income from Amazon's stock investment in electric vehicle (EV) maker Rivian Automotive. Excluding this gain, earnings per share would have been an estimated $0.17, lower than the consensus estimate of $0.21.
Earnings releases tell only part of the story. Below are two key things management shared on Amazon's Q3 earnings call that you should know.
1. Two Prime Video premieres drove many sign-ups for Prime subscriptions
From CFO Brian Olsavsky's remarks:
We also debuted the two largest Prime Video releases ever. The Lord of the Rings: The Rings of Power attracted more than 25 million global viewers on its first day. And in the first two months since its launch, [it] has driven more Prime sign-ups globally than any other Amazon Original.
NFL Thursday Night Football also premiered in September, averaging more than 15 million viewers during its first broadcast, and driving the three biggest hours of U.S. Prime sign-ups in the history of Amazon.
Amazon benefits in two ways from increases in the number of folks who sign up for its Prime loyalty program, which includes such benefits as fast and free delivery on many items and free streaming of movies and music. First, the company generates more revenue from Prime subscriptions. Second, Prime members spend significantly more money than nonmembers on the company's site.
Beyond helping Amazon obtain new members, the Prime program helps retain existing members. It makes Amazon's business model "sticky."
Amazon only infrequently releases a ballpark number of its global Prime members. Consumer Intelligence Research Partners pegged U.S. Prime members at about 172 million at the end of the second quarter. (One subscription will often have multiple members since many households share one account.)
2. AWS's operating margin decline
As I wrote in my article on Amazon's third-quarter report, "While the cloud computing segment's margin is still strong, it did contract [year over year], as reflected by the percentage growth of its operating income falling short of that of its revenue." This metric also contracted sequentially.
Olsavsky addressed this topic on the earnings call:
[Amazon Web Services' margins will] fluctuate over time as we balance investments versus renegotiating pricing with the long-term customer commitments, all as headwinds to the business, offset by increasing productivity and efficiencies in our data centers, which drive profitability.
[What's happening lately is] we have seen inflation in our wages this year and particularly on our tech employees [and they're] heavily concentrated in AWS.
We're also seeing energy costs that are materially higher than they [were pre-pandemic].
Energy costs have risen sharply around the world and in Europe they've skyrocketed. While pandemic-related factors are still at play, the biggest catalyst over the last year are sanctions on Russia's energy imports stemming from the country's invasion of Ukraine.
Olsavsky said that higher energy costs have hurt AWS's operating margin by 200 basis points (2 percentage points) compared with two years ago. Data centers consume a lot of energy, so it's not surprising that surging energy costs are taking such a bite out of AWS's operating margins. Olsavsky added that the company is continually looking for ways to optimize its operations to use less energy.
Here are AWS's quarterly operating margins (operating income divided by revenue) going back a year: 26.3% (Q3 2022), 29% (Q2 2022), 35.3% (Q1 2022), 29.8% (Q4 2021), 30.3% (Q3 2021).
Long-term investors should keep in mind that Amazon's AWS segment is still very profitable, just not quite as profitable as it's been in recent years. Moreover, the Russia-Ukraine war and high inflation rates will not last forever.
