From good to great to bad. Amazon 2nd second quarter earnings…

  • Amazon’s net unearned revenue was negative for the first time since Q4 2013.
  • What caused the negative net unearned revenue was the drastic slowdown in additions to unearned revenue growth.
  • Because unearned revenue is a forward indicator, the growth decline suggests that either Prime or AWS will be slowing down in the near future.

Yet, pundits that be punditing have been silent on the negative net unearned revenue in this quarter.

What is unearned revenue?

…Due to accrual accounting, revenue can only be recognized during the period in which it is earned. That means any Prime membership fee or AWS booking fee cannot be fully booked as revenue in the period in which the sale is made…

“Unearned revenue is recorded when payments are received in advance of performing our service obligations and is recognized over the service period. Unearned revenue primarily relates to prepayments of Amazon Prime memberships and AWS services.” – Amazon 2016 10-K

…Additions to unearned revenue include cash received for services not yet performed, while amortization of previously unearned revenue represents the revenues actually booked in the period in which the service is rendered…

…Much like how backlog is a forward indicator of an industrial company’s revenue, unearned revenue represents future revenues for the company and should be emphasized when analyzing the company’s actual growth. Furthermore, unearned revenue represents cash inflows to the company, therefore it is critical for valuing the company using DCF…

…As Prime membership and AWS users increase, the portion of unearned revenue, as a percentage of Amazon’s overall revenue, has increased, making it a more important measure of Amazon’s true revenue as time goes on…

For the first time since Q4 of 2013, net unearned revenue was negative:

Even though Q2 had historical been the quarter with the lowest or second lowest net unearned revenue, there has never been a decline as significant as Q2 2017.

Furthermore, because net unearned revenue is increasing as a proportion of GAAP net revenue due to the shift of a higher proportion of their sales to subscription-based (Prime and AWS), the sudden drastic decline in unearned revenue is now much more concerning than ever before because it represents a higher proportion of their business and serves as a forward indicator of future revenues.

What caused the sudden drastic decline? Growth in additions to unearned revenue had historically been in the 50-80% range (which reflects the explosive growth in Prime and AWS), but this growth suddenly slowed to 45% in Q1 2017 and slowed further to 30% in Q2 2017. As a result, growth in additions to unearned revenue was not sufficient to exceed the amortization of previously unrecognized unearned revenue.Because unearned revenue is primarily recognized on Prime membership fees and AWS subscription fees, the reason for the decline must be from the slowdown of one of these two businesses.

  1. Prime subscription revenue is included in “retail subscription services” net sales (along with other retail-related subscription services such as audiobook, e-book, digital video, digital music, etc.)
  2. AWS subscription revenue is included in AWS net sales along revenues from pay-as-you go method sales

Based on results from Q1 and Q2, it can be seen that retail subscription services growth has accelerated, while AWS growth has stayed consistent. It’s unlikely that retail subscription was the cause of the decline in unearned revenue growth, so the decline in growth must have come from AWS.It’s impossible to know the exact source of the decline in unearned revenue growth, because historical net sales is a lagging indicator of unearned revenue. So it is only from future financial reports that we are able to know the source of the decline of unearned revenue in Q2.

And when they come out, I’ll be reading…

h/t to SIC hedge