An overlooked part of Amazon is going to be in the spotlight when it reports earnings

A closer look at Amazon’s deferred revenue, mostly comprised of Prime membership fees that aren’t recognised all at once, shows its annual membership program is growing at a robust pace — albeit causing Amazon’s shipping costs to increase more than expected last quarter.

This typically-overlooked bit of revenue will suddenly be in the investor spotlight when Amazon reports quarterly financial results on Thursday, with investors deeming it a proxy for the growth in increasingly important Amazon’s Prime business.

According to a note by Credit Suisse last week, Amazon’s deferred, or “unearned”, revenue growth picked up pace over the past two quarters. Unearned revenue represents the amount the company receives in advance of providing its service, and a fixed portion of it gets recognised as revenue, as the service gets delivered.

Amazon’s unearned revenue is mostly comprised of the $99 Prime annual fee from both new and renewing subscribers. Amazon collects the annual fee upfront and then recognises 1/12th of the $99 fee every month as revenue.

As seen in this chart by Credit Suisse, Amazon’s unearned revenue growth saw an increase both sequentially and annually last quarter, reaching a 71% growth rate, the highest in more than a year.

Credit Suisse analyst Stephen Ju points out that the sudden spike in this line item over the past two quarters indicates Amazon Prime growth is accelerating. But as a result, it could have increased its shipping costs more than expected, thus pressuring its gross margins.

“Netnet, we believe the acceleration in growth of this line item in 3Q15 — likely as a result of Prime Day in July 2015 — and the continued strength in 4Q15 indicate that Amazon is more rapidly driving Prime adoption,” Ju writes. “There is a near-term impact to gross margin due to a step-up in Prime shipping costs that we believe is often overlooked.”

Ju describes it as an “abnormal step-up” in Prime adoption, and notes that it might have partially caused Amazon to report lower-than-expected gross margins last quarter. Investors drove Amazon shares down more than 12% after earnings last quarter, in part due to concerns over rising shipping costs, which jumped 37% year-over-year.

And as Amazon reports its first quarter earnings Thursday, unearned revenue will draw more attention as it could be a proxy for tracking growth in Prime, a key part of Amazon’s overall business, as Prime members are believed to be more loyal and higher-spenders than non-Prime members. It will also give a hint to how Amazon’s shipping fee fluctuates this quarter.

Here’s what analysts are expecting from Amazon’s earnings, according to Yahoo Finance:

  • Q1 adjusted earnings per share (EPS): $0.58, up from a loss of $0.12 in Q1 2015.
  • Q1 Revenue: $27.99 billion, up about 23.2% from $22.72 billion in the year-ago period.

Long-term, Ju believes unearned revenue growth is a positive because it will drive more transactions and better margins, especially as Amazon figures out a way to find less expensive/more efficient logistics solutions. In fact, Amazon is already rumoured to be working on its own full-blown logistics network that would decrease shipping costs.

Disclosure: Jeff Bezos is an investor in Business Insider through hispersonal investment company Bezos Expeditions.

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