10-Q 1 amzn-20140930x10q.htm 10-Q AMZN-2014.09.30-10Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 ____________________________________
Form 10-Q
____________________________________ 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
or
 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from            to             .
Commission File No. 000-22513
____________________________________
Amazon.com, Inc.
(Exact Name of Registrant as Specified in its Charter)
 ____________________________________
Delaware
 
91-1646860
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
410 Terry Avenue North, Seattle, WA 98109-5210
(206) 266-1000
(Address and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)
 ____________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
 
x
Accelerated filer
 
¨
 
 
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
Smaller reporting company
 
¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

463,006,452 shares of common stock, par value $0.01 per share, outstanding as of October 15, 2014
 



AMAZON.COM, INC.
FORM 10-Q
For the Quarterly Period Ended September 30, 2014
INDEX
 


2


PART I. FINANCIAL INFORMATION

Item 1.
Financial Statements

AMAZON.COM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
(unaudited)
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
Twelve Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
$
5,057

 
$
3,704

 
$
8,658

 
$
8,084

 
$
3,872

 
$
2,980

OPERATING ACTIVITIES:
 
 
 
 
 
 
 
 
 
 
 
Net income (loss)
(437
)
 
(41
)
 
(455
)
 
34

 
(216
)
 
132

Adjustments to reconcile net income (loss) to net cash from operating activities:
 
 
 
 
 
 
 
 
 
 
 
Depreciation of property and equipment, including internal-use software and website development, and other amortization
1,247

 
834

 
3,366

 
2,291

 
4,329

 
2,953

Stock-based compensation
377

 
281

 
1,089

 
808

 
1,414

 
1,043

Other operating expense (income), net
31

 
11

 
93

 
74

 
133

 
110

Losses (gains) on sales of marketable securities, net
(3
)
 
1

 
(4
)
 
1

 
(3
)
 

Other expense (income), net
42

 
5

 
(16
)
 
115

 
36

 
214

Deferred income taxes
(270
)
 
11

 
(503
)
 
(47
)
 
(613
)
 
(195
)
Excess tax benefits from stock-based compensation

 

 
(121
)
 

 
(199
)
 
(239
)
Changes in operating assets and liabilities:
 
 
 
 
 
 
 
 
 
 
 
Inventories
(845
)
 
(586
)
 
(54
)
 
(80
)
 
(1,383
)
 
(1,054
)
Accounts receivable, net and other
(362
)
 
(125
)
 
66

 
393

 
(1,173
)
 
(632
)
Accounts payable
1,724

 
947

 
(3,294
)
 
(3,240
)
 
1,834

 
1,686

Accrued expenses and other
4

 
(72
)
 
(742
)
 
(853
)
 
847

 
558

Additions to unearned revenue
1,069

 
672

 
3,055

 
1,872

 
3,874

 
2,417

Amortization of previously unearned revenue
(811
)
 
(550
)
 
(2,353
)
 
(1,471
)
 
(3,175
)
 
(2,016
)
Net cash provided by (used in) operating activities
1,766

 
1,388

 
127

 
(103
)
 
5,705

 
4,977

INVESTING ACTIVITIES:
 
 
 
 
 
 
 
 
 
 
 
Purchases of property and equipment, including internal-use software and website development
(1,378
)
 
(1,038
)
 
(3,748
)
 
(2,565
)
 
(4,628
)
 
(4,589
)
Acquisitions, net of cash acquired, and other
(860
)
 
(1
)
 
(926
)
 
(252
)
 
(986
)
 
(287
)
Sales and maturities of marketable securities and other investments
1,439

 
494

 
2,994

 
1,791

 
3,509

 
2,296

Purchases of marketable securities and other investments
(147
)
 
(518
)
 
(920
)
 
(2,406
)
 
(1,339
)
 
(3,934
)
Net cash provided by (used in) investing activities
(946
)
 
(1,063
)
 
(2,600
)
 
(3,432
)
 
(3,444
)
 
(6,514
)
FINANCING ACTIVITIES:
 
 
 
 
 
 
 
 
 
 
 
Excess tax benefits from stock-based compensation

 

 
121

 

 
199

 
239

Proceeds from long-term debt and other
28

 
25

 
379

 
132

 
628

 
3,189

Repayments of long-term debt, capital lease, and finance lease obligations
(440
)
 
(255
)
 
(1,277
)
 
(728
)
 
(1,547
)
 
(858
)
Net cash provided by (used in) financing activities
(412
)
 
(230
)
 
(777
)
 
(596
)
 
(720
)
 
2,570

Foreign-currency effect on cash and cash equivalents
(207
)
 
73

 
(150
)
 
(81
)
 
(155
)
 
(141
)
Net increase (decrease) in cash and cash equivalents
201

 
168

 
(3,400
)
 
(4,212
)
 
1,386

 
892

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
5,258

 
$
3,872

 
$
5,258

 
$
3,872

 
$
5,258

 
$
3,872

SUPPLEMENTAL CASH FLOW INFORMATION:
 
 
 
 
 
 
 
 
 
 
 
Cash paid for interest on long-term debt
$
7

 
$
8

 
$
56

 
$
60

 
$
93

 
$
70

Cash paid for income taxes (net of refunds)
38

 
23

 
148

 
143

 
173

 
195

Property and equipment acquired under capital leases
1,158

 
526

 
2,794

 
1,313

 
3,347

 
1,552

Property and equipment acquired under build-to-suit leases
343

 
269

 
707

 
663

 
920

 
647

See accompanying notes to consolidated financial statements.

3


AMAZON.COM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)
(unaudited)
 
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Net product sales
$
16,022

 
$
13,808

 
$
46,978

 
$
39,831

Net service sales
4,557

 
3,284

 
12,681

 
9,034

Total net sales
20,579

 
17,092

 
59,659

 
48,865

Operating expenses (1):
 
 
 
 
 
 
 
Cost of sales
14,627

 
12,366

 
42,080

 
35,375

Fulfillment
2,643

 
2,034

 
7,342

 
5,667

Marketing
993

 
694

 
2,806

 
2,001

Technology and content
2,423

 
1,734

 
6,639

 
4,703

General and administrative
406

 
278

 
1,110

 
810

Other operating expense (income), net
31

 
11

 
94

 
74

Total operating expenses
21,123

 
17,117

 
60,071

 
48,630

Income (loss) from operations
(544
)
 
(25
)
 
(412
)
 
235

Interest income
9

 
9

 
31

 
28

Interest expense
(49
)
 
(36
)
 
(136
)
 
(102
)
Other income (expense), net
(50
)
 
9

 
(23
)
 
(107
)
Total non-operating income (expense)
(90
)
 
(18
)
 
(128
)
 
(181
)
Income (loss) before income taxes
(634
)
 
(43
)
 
(540
)
 
54

Benefit (provision) for income taxes
205

 
12

 
38

 
18

Equity-method investment activity, net of tax
(8
)
 
(10
)
 
47

 
(38
)
Net income (loss)
$
(437
)
 
$
(41
)
 
$
(455
)
 
$
34

Basic earnings per share
$
(0.95
)
 
$
(0.09
)
 
$
(0.99
)
 
$
0.08

Diluted earnings per share
$
(0.95
)
 
$
(0.09
)
 
$
(0.99
)
 
$
0.07

Weighted average shares used in computation of earnings per share:
 
 
 
 
 
 
 
Basic
463

 
457

 
461

 
456

Diluted
463

 
457

 
461

 
464

_____________
 
 
 
 
 
 
 
(1)    Includes stock-based compensation as follows:
 
 
 
 
 
 
 
Fulfillment
$
93

 
$
70

 
$
278

 
$
213

Marketing
32

 
23

 
91

 
63

Technology and content
204

 
154

 
579

 
428

General and administrative
48

 
34

 
141

 
104

See accompanying notes to consolidated financial statements.


4


AMAZON.COM, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in millions)
(unaudited)
 
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Net income (loss)
$
(437
)
 
$
(41
)
 
$
(455
)
 
$
34

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustments, net of tax of $(1), $(1), $0 and $(14)
(248
)
 
111

 
(209
)
 
41

Net change in unrealized gains on available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains (losses), net of tax of $2, $(1), $1 and $3
(1
)
 
1

 
2

 
(8
)
Reclassification adjustment for losses (gains) included in “Other income (expense), net,” net of tax of $(1), $0, $(1) and $(1)
(2
)
 
1

 
(2
)
 

Net unrealized gains (losses) on available-for-sale securities
(3
)
 
2

 

 
(8
)
Total other comprehensive income (loss)
(251
)
 
113

 
(209
)
 
33

Comprehensive income (loss)
$
(688
)
 
$
72

 
$
(664
)
 
$
67

See accompanying notes to consolidated financial statements.


5


AMAZON.COM, INC.
CONSOLIDATED BALANCE SHEETS
(in millions, except per share data)
 
 
September 30, 2014
 
December 31, 2013
 
(unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
5,258

 
$
8,658

Marketable securities
1,625

 
3,789

Inventories
7,316

 
7,411

Accounts receivable, net and other
4,373

 
4,767

Total current assets
18,572

 
24,625

Property and equipment, net
15,702

 
10,949

Goodwill
3,332

 
2,655

Other assets
2,813

 
1,930

Total assets
$
40,419

 
$
40,159

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
11,811

 
$
15,133

Accrued expenses and other
7,217

 
6,688

Unearned revenue
1,814

 
1,159

Total current liabilities
20,842

 
22,980

Long-term debt
3,099

 
3,191

Other long-term liabilities
6,142

 
4,242

Commitments and contingencies (Note 3)


 


Stockholders’ equity:
 
 
 
Preferred stock, $0.01 par value:
 
 
 
Authorized shares — 500
 
 
 
Issued and outstanding shares — none

 

Common stock, $0.01 par value:
 
 
 
Authorized shares — 5,000
 
 
 
Issued shares — 487 and 483
 
 
 
Outstanding shares — 463 and 459
5

 
5

Treasury stock, at cost
(1,837
)
 
(1,837
)
Additional paid-in capital
10,827

 
9,573

Accumulated other comprehensive loss
(394
)
 
(185
)
Retained earnings
1,735

 
2,190

Total stockholders’ equity
10,336

 
9,746

Total liabilities and stockholders’ equity
$
40,419

 
$
40,159

See accompanying notes to consolidated financial statements.


6


AMAZON.COM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Note 1 — ACCOUNTING POLICIES
Unaudited Interim Financial Information
We have prepared the accompanying consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for interim financial reporting. These consolidated financial statements are unaudited and, in our opinion, include all adjustments, consisting of normal recurring adjustments and accruals necessary for a fair presentation of our consolidated balance sheets, operating results, and cash flows for the periods presented. Operating results for the periods presented are not necessarily indicative of the results that may be expected for 2014 due to seasonal and other factors. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been omitted in accordance with the rules and regulations of the SEC. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes in Item 8 of Part II, “Financial Statements and Supplementary Data,” of our 2013 Annual Report on Form 10-K.
Principles of Consolidation
The consolidated financial statements include the accounts of Amazon.com, Inc., its wholly-owned subsidiaries, and those entities in which we have a variable interest and of which we are the primary beneficiary (collectively, the “Company”). Intercompany balances and transactions between consolidated entities are eliminated.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent liabilities in the consolidated financial statements and accompanying notes. Estimates are used for, but not limited to, determining the selling price of products and services in multiple element revenue arrangements and determining the lives of these elements, incentive discount offers, sales returns, vendor funding, stock-based compensation forfeiture rates, income taxes, valuation and impairment of investments, inventory valuation and inventory purchase commitments, collectability of receivables, valuation of acquired intangibles and goodwill, depreciable lives of property and equipment, internal-use software and website development costs, acquisition purchase price allocations, investments in equity interests, and contingencies. Actual results could differ materially from those estimates.
Earnings per Share
Basic earnings per share is calculated using our weighted-average outstanding common shares. Diluted earnings per share is calculated using our weighted-average outstanding common shares including the dilutive effect of stock awards as determined under the treasury stock method. In periods when we have a net loss, stock awards of 18 million and 17 million in Q3 2014 and Q3 2013, and 17 million in the nine months ended September 30, 2014, were excluded as their inclusion would have an antidilutive effect.
The following table shows the calculation of diluted shares (in millions):
 
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Shares used in computation of basic earnings per share
463

 
457

 
461

 
456

Total dilutive effect of outstanding stock awards

 

 

 
8

Shares used in computation of diluted earnings per share
463

 
457

 
461

 
464



7


Equity-method Investments
Equity investments are accounted for using the equity method of accounting if the investment gives us the ability to exercise significant influence, but not control, over an investee. The total of our investments in equity-method investees, including identifiable intangible assets, deferred tax liabilities, and goodwill, is included within “Other assets” on our consolidated balance sheets. Our share of the earnings or losses as reported by equity-method investees, amortization of the related intangible assets, and related gains or losses, if any, are classified as “Equity-method investment activity, net of tax” on our consolidated statements of operations. Our share of the net income or loss of our equity-method investees includes operating and non-operating gains and charges, which can have a significant impact on our reported equity-method investment activity and the carrying value of those investments. In the event that net losses of the investee reduce our equity-method investment carrying amount to zero, additional net losses may be recorded if other investments in the investee, not accounted for under the equity method, are at-risk even if we have not committed to provide financial support to the investee. We regularly evaluate these investments, which are not carried at fair value, for other-than-temporary impairment. We also consider whether our equity-method investments generate sufficient cash flows from their operating or financing activities to meet their obligations and repay their liabilities when they come due.

We record purchases, including incremental purchases, of shares in equity-method investees at cost. Reductions in our ownership percentage of an investee, including through dilution, are generally valued at fair value, with the difference between fair value and our recorded cost reflected as a gain or loss in our equity-method investment activity. In the event we no longer have the ability to exercise significant influence over an equity-method investee, we would discontinue accounting for the investment under the equity method.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board issued an Accounting Standard Update (“ASU”) amending revenue recognition guidance and requiring more detailed disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The guidance is effective for annual and interim reporting periods beginning after December 15, 2016, with early adoption prohibited. We are currently evaluating the impact this ASU will have on our consolidated financial statements.
Note 2 — CASH, CASH EQUIVALENTS, AND MARKETABLE SECURITIES
As of September 30, 2014, and December 31, 2013, our cash, cash equivalents, and marketable securities primarily consisted of cash, U.S. and foreign government and agency securities, AAA-rated money market funds, and other investment grade securities. Cash equivalents and marketable securities are recorded at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. To increase the comparability of fair value measures, the following hierarchy prioritizes the inputs to valuation methodologies used to measure fair value:
Level 1—Valuations based on quoted prices for identical assets and liabilities in active markets.
Level 2—Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Level 3—Valuations based on unobservable inputs reflecting our own assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.
We measure the fair value of money market funds and equity securities based on quoted prices in active markets for identical assets or liabilities. All other financial instruments were valued either based on recent trades of securities in inactive markets or based on quoted market prices of similar instruments and other significant inputs derived from or corroborated by observable market data. We did not hold any cash, cash equivalents, or marketable securities categorized as Level 3 assets as of September 30, 2014, or December 31, 2013.

8


The following table summarizes, by major security type, our cash, cash equivalents, and marketable securities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy (in millions):
 
 
September 30, 2014
 
December 31, 2013
  
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Total
Estimated
Fair Value
 
Total
Estimated
Fair Value
Cash
$
3,022

 
$

 
$

 
$
3,022

 
$
3,008

Level 1 securities:
 
 
 
 
 
 
 
 
 
Money market funds
2,608

 

 

 
2,608

 
5,914

Equity securities
2

 
1

 

 
3

 
4

Level 2 securities:
 
 
 
 
 
 
 
 
 
Foreign government and agency securities
78

 
1

 

 
79

 
758

U.S. government and agency securities
1,069

 
1

 
(2
)
 
1,068

 
2,222

Corporate debt securities
392

 
1

 

 
393

 
741

Asset-backed securities
68

 

 

 
68

 
65

Other fixed income securities
35

 

 

 
35

 
36

 
$
7,274

 
$
4

 
$
(2
)
 
$
7,276

 
$
12,748

Less restricted cash, cash equivalents, and marketable securities (1)
 
 
 
 
 
 
(393
)
 
(301
)
Total cash, cash equivalents, and marketable securities
 
 
 
 
 
 
$
6,883

 
$
12,447

___________________
(1)
We are required to pledge or otherwise restrict a portion of our cash, cash equivalents, and marketable securities as collateral for standby and trade letters of credit, guarantees, debt, real estate leases, and amounts due to third-party sellers in certain jurisdictions. We classify cash, cash equivalents and marketable securities with use restrictions of less than twelve months as “Accounts receivable, net and other” and of twelve months or longer as non-current “Other assets” on our consolidated balance sheets. See “Note 3 — Commitments and Contingencies.”

The following table summarizes the contractual maturities of our cash equivalents and marketable fixed-income securities as of September 30, 2014 (in millions):

 
Amortized
Cost
 
Estimated
Fair Value
Due within one year
$
3,101

 
$
3,102

Due after one year through five years
819

 
820

Due after five years through ten years
121

 
121

Due after ten years
209

 
208

Total
$
4,250

 
$
4,251

Actual maturities may differ from the contractual maturities because borrowers may have certain prepayment conditions.
Note 3 — COMMITMENTS AND CONTINGENCIES
Commitments
We have entered into non-cancellable operating, capital, and financing leases for equipment and office, fulfillment center, and data center facilities. Rental expense under operating lease agreements was $252 million and $197 million for Q3 2014 and Q3 2013, and $700 million and $545 million for the nine months ended September 30, 2014 and 2013.

9


The following summarizes our principal contractual commitments, excluding open orders for purchases that support normal operations, as of September 30, 2014 (in millions):
 
 
Three Months Ended December 31,
 
Year Ended December 31,
 
 
 
 
 
2014
 
2015
 
2016
 
2017
 
2018
 
Thereafter
 
Total
Operating and capital commitments:
 
 
 
 
 
 
 
 
 
 
 
 
 
Debt principal and interest
$
222

 
$
1,519

 
$
82

 
$
1,081

 
$
69

 
$
1,375

 
$
4,348

Capital leases, including interest
820

 
2,006

 
958

 
327

 
135

 
141

 
4,387

Financing lease obligations, including interest
27

 
95

 
96

 
98

 
99

 
943

 
1,358

Operating leases
225

 
798

 
745

 
667

 
582

 
2,470

 
5,487

Unconditional purchase obligations (1)
167

 
475

 
375

 
300

 
123

 
28

 
1,468

Other commitments (2) (3)
304

 
714

 
296

 
168

 
125

 
1,140

 
2,747

Total commitments
$
1,765

 
$
5,607

 
$
2,552

 
$
2,641

 
$
1,133

 
$
6,097

 
$
19,795

___________________
(1)
Includes unconditional purchase obligations related to long-term agreements to acquire and license digital content that are not reflected on the consolidated balance sheets. For those agreements with variable terms, we do not estimate the total obligation beyond any minimum quantities and/or pricing as of the reporting date. Purchase obligations associated with renewal provisions solely at the option of the content provider are included to the extent such commitments are fixed or a minimum amount is specified.
(2)
Includes the estimated timing and amounts of payments for rent and tenant improvements associated with build-to-suit lease arrangements that have not been placed in service and digital content liabilities associated with long-term digital content assets with initial terms greater than one year.
(3)
Excludes $626 million of tax contingencies for which we cannot make a reasonably reliable estimate of the amount and period of payment, if any.
Pledged Assets
As of September 30, 2014, and December 31, 2013, we have pledged or otherwise restricted $549 million and $482 million of our cash, cash equivalents, and marketable securities, and certain property and equipment as collateral for standby and trade letters of credit, guarantees, debt, real estate leases, and amounts due to third-party sellers in certain jurisdictions.
Legal Proceedings
The Company is involved from time to time in claims, proceedings, and litigation, including the matters described in Item 8 of Part II, “Financial Statements and Supplementary Data — Note 8 — Commitments and Contingencies — Legal Proceedings” of our 2013 Annual Report on Form 10-K and in Item 1 of Part I, “Financial Statements — Note 3 — Commitments and Contingencies — Legal Proceedings” of our Quarterly Reports on Form 10-Q for the Periods Ended March 31, 2014, and June 30, 2014, as supplemented by the following:
In April 2011, Walker Digital LLC filed several complaints against Amazon.com, Inc. for patent infringement in the United States District Court for the District of Delaware.  The complaints allege that we infringe several of the plaintiff’s U.S. patents by, among other things, providing “cross benefits” to customers through our promotions (U.S. Patent Nos. 7,831,470 and 7,827,056), using a customer’s identified original product to offer a substitute product (U.S. Patent No. 7,236,942), using our product recommendations and personalization features to offer complementary products together (U.S. Patent Nos. 6,601,036 and 6,138,105), enabling customers to subscribe to a delivery schedule for products they routinely use at reduced prices (U.S. Patent No. 5,970,470), and offering personalized advertising based on customers’ preferences identified using a data pattern (U.S. Patent No. 7,933,893).  Another complaint, filed in the same court in October 2011, alleges that we infringe plaintiff’s U.S. Patent No. 8,041,711 by offering personalized advertising based on customer preferences that associate data with resource locators. Another complaint, filed in the same court in February 2012, alleges that we infringe plaintiff’s U.S. Patent No. 8,112,359 by using product information received from customers to identify and offer substitute products using a manufacturer database.  In January 2013, the plaintiff filed another complaint in the same court alleging that we infringe U.S. Patent No. 6,381,582 by allowing customers to make local payments for products ordered online. All of the complaints seek monetary damages, interest, injunctive relief, costs, and attorneys’ fees.  In March 2013, the complaints asserting U.S. Patent Nos. 7,236,942 and 7,933,893 were voluntarily dismissed with prejudice. In April 2013, the case asserting U.S. Patent No.

10


8,041,711 was stayed pending final resolution of the reexamination of that patent. In June 2013, the court granted defendants’ motions to dismiss the complaints asserting U.S. Patent Nos. 7,831,470, 7,827,056, and 8,112,359 for lack of standing.  In July 2013, we filed motions seeking entry of a final judgment dismissing those claims with prejudice and for attorneys’ fees, and plaintiff filed notices of appeal from the June 2013 order granting the motions to dismiss.  In October 2013, the court ruled that its dismissals are with prejudice, and Walker has appealed those rulings. In March 2014, the court stayed the case asserting U.S. Patent Nos. 6,601,036 and 6,138,105 pending the appeal of the cases asserting U.S. Patent Nos. 7,831,470, 7,827,056, and 8,112,359. In September 2014, the court dismissed the matter asserting U.S. Patent No. 6,381,582 with prejudice.  We dispute the remaining allegations of wrongdoing and intend to defend ourselves vigorously in these matters.
The outcomes of our legal proceedings are inherently unpredictable, subject to significant uncertainties, and could be material to our operating results and cash flows for a particular period.  In addition, for some matters for which a loss is probable or reasonably possible, an estimate of the amount of loss or range of loss is not possible and we may be unable to estimate the possible loss or range of loss that could potentially result from the application of non-monetary remedies.
See also “Note 8 — Income Taxes.”
Note 4 — ACQUISITIONS, GOODWILL, AND ACQUIRED INTANGIBLE ASSETS
On September 25, 2014, we acquired Twitch Interactive, Inc. (“Twitch”) for approximately $842 million in cash, as adjusted for the assumption of options and other items. During the nine months ended September 30, 2014, we acquired certain other companies for an aggregate purchase price of $20 million. Acquisition activity for the nine months ended September 30, 2013 was not material. We acquired Twitch because of its community and the live streaming experience it provides. The primary reasons for our other 2014 acquisitions were to acquire technologies and know-how to enable Amazon to serve customers more effectively.
Acquisition-related costs were expensed as incurred and not significant. Due to the limited amount of time since the acquisition of Twitch, the valuation of certain assets and liabilities is preliminary and subject to change. The aggregate purchase price of these acquisitions was allocated as follows (in millions):
 
Purchase Price
 
Cash paid, net of cash acquired
$
813

Stock options assumed
44

Indemnification holdback
5

 
$
862

Allocation
 
Goodwill
$
702

Intangible assets (1):
 
Marketing-related
23

Contract-based
1

Technology-based
33

Customer-related
174

 
231

Property and equipment
21

Deferred tax assets
65

Other assets acquired
34

Deferred tax liabilities
(90
)
Other liabilities assumed
(101
)
 
$
862

 ___________________
(1)
Acquired intangible assets have estimated useful lives of between one and five years, with a weighted-average amortization period of five years.
The fair value of assumed stock options of $39 million, estimated using the Black-Scholes model, will be expensed over the remaining service period. We determined the estimated fair value of identifiable intangible assets acquired primarily by using the income approach. These assets are included within “Other assets” on our consolidated balance sheets and are being amortized to operating expenses on a straight-line or accelerated basis over their estimated useful lives.

11


Pro Forma Financial Information (unaudited)
The acquired companies were consolidated into our financial statements starting on their respective acquisition dates. The aggregate net sales and operating loss of the companies acquired was $12 million and $3 million for the nine months ended September 30, 2014. The following pro forma financial information presents our results as if the current year acquisitions had occurred at the beginning of 2013 (in millions):
  
  
Nine Months Ended 
 September 30,
 
2014
 
2013
Net sales
$
59,712

 
$
48,900

Net income (loss)
$
(501
)
 
$
(50
)
Goodwill
The goodwill of the acquired companies is generally not deductible for tax purposes and is primarily related to expected improvements in sales growth from future product and service offerings and new customers, together with certain intangible assets that do not qualify for separate recognition. The following summarizes our goodwill activity in the first nine months of 2014 by segment (in millions):
 
 
North
America
 
International
 
Consolidated
Goodwill - January 1, 2014
$
2,033

 
$
622

 
$
2,655

New acquisitions (1)
544

 
158

 
702

Other adjustments (2)

 
(25
)
 
(25
)
Goodwill - September 30, 2014
$
2,577

 
$
755

 
$
3,332

 ___________________
(1)
Primarily includes the goodwill of Twitch.
(2)
Primarily includes changes in foreign exchange rates.
Note 5 — EQUITY-METHOD INVESTMENTS
LivingSocial’s summarized condensed financial information, as provided to us by LivingSocial, is as follows (in millions):
 
  
Nine Months Ended 
 September 30,
 
2014
 
2013
Statements of Operations:
 
 
 
Revenue
$
215

 
$
289

Gross profit
169

 
225

Operating expenses
261

 
283

Operating loss from continuing operations
(92
)
 
(58
)
Net loss from continuing operations
(75
)
 
(50
)
Net income (loss) from discontinued operations (1)
206

 
(54
)
Net income (loss)
$
131

 
$
(104
)
___________________
(1)
In January 2014, LivingSocial completed the sale of its Korean operations for approximately $260 million and, in Q1 2014, recognized a gain on disposal of $205 million, net of tax. The statement of operations information above has been recast to present the Korean operations as discontinued operations.
As of September 30, 2014, our total investment in LivingSocial is approximately 31% of voting stock and has a book value of $84 million.

12


Note 6 — LONG-TERM DEBT
In November 2012, we issued $3.0 billion of unsecured senior notes in three tranches as described in the table below (collectively, the “Notes”). As of September 30, 2014, and December 31, 2013, the unamortized discount on the Notes was $20 million and $23 million. We also have other long-term debt with a carrying amount, including the current portion, of $983 million and $967 million as of September 30, 2014, and December 31, 2013. The face value of our total long-term debt obligations is as follows (in millions):

 
September 30, 2014
 
December 31, 2013
0.65% Notes due on November 27, 2015
$
750

 
$
750

1.20% Notes due on November 29, 2017
1,000

 
1,000

2.50% Notes due on November 29, 2022
1,250

 
1,250

Other long-term debt
983

 
967

Total debt
3,983

 
3,967

Less current portion of long-term debt
(864
)
 
(753
)
Face value of long-term debt
$
3,119

 
$
3,214

The effective interest rates of the 2015, 2017, and 2022 Notes were 0.84%, 1.38%, and 2.66%. Interest on the Notes is payable semi-annually in arrears in May and November. We may redeem the Notes at any time in whole, or from time to time, in part at specified redemption prices. We are not subject to any financial covenants under the Notes. We used the net proceeds from the issuance of the Notes for general corporate purposes. The estimated fair value of the Notes was approximately $2.9 billion as of September 30, 2014, and December 31, 2013, which is based on quoted prices for our publicly-traded debt as of those dates.
The other debt, including the current portion, had a weighted average interest rate of 5.6% and 5.5% as of September 30, 2014, and December 31, 2013. We used the net proceeds from the issuance of the debt to primarily fund certain international operations. The estimated fair value of the other long-term debt, which is based on Level 2 inputs, approximated its carrying value as of September 30, 2014, and December 31, 2013.
On September 5, 2014, we entered into an unsecured revolving credit facility (the “Credit Agreement”) with a syndicate of lenders that provides us with a borrowing capacity of up to $2.0 billion. The Credit Agreement has a term of two years, but it may be extended for up to three additional one-year terms if approved by the lenders. The initial interest rate applicable to outstanding balances under the Credit Agreement is the London interbank offered rate (“LIBOR”) plus 0.625%, under our current credit ratings. If our credit ratings are downgraded this rate could increase to as much as LIBOR plus 1.00%. There were no borrowings outstanding under the Credit Agreement as of September 30, 2014.
Note 7 — STOCKHOLDERS’ EQUITY
Stock Repurchase Activity
In January 2010, our Board of Directors authorized the Company to repurchase up to $2.0 billion of our common stock with no fixed expiration. We have $763 million remaining under the $2.0 billion repurchase program.
Stock Award Activity
Common shares outstanding plus shares underlying outstanding stock awards totaled 481 million as of September 30, 2014, and 476 million as of December 31, 2013. These totals include all vested and unvested stock awards outstanding, including those awards we estimate will be forfeited. The following table summarizes our restricted stock unit activity for the nine months ended September 30, 2014 (in millions):
 
Number of Units
 
Weighted Average
Grant-Date
Fair Value
Outstanding as of December 31, 2013
16.3

 
$
233

Units granted
6.6

 
335

Units vested
(3.6
)
 
196

Units forfeited
(1.8
)
 
259

Outstanding as of September 30, 2014
17.5

 
$
276


13


Scheduled vesting for outstanding restricted stock units as of September 30, 2014, is as follows (in millions):
 
Three Months Ended December 31,
 
Year Ended December 31,
 
 
 
 
 
2014
 
2015
 
2016
 
2017
 
2018
 
Thereafter
 
Total
Scheduled vesting—restricted stock units
1.6

 
5.8

 
5.9

 
2.8

 
1.1

 
0.3

 
17.5

As of September 30, 2014, there was $2.2 billion of net unrecognized compensation cost related to unvested stock-based compensation arrangements. This compensation is recognized on an accelerated basis with approximately half of the compensation expected to be expensed in the next twelve months, and has a weighted average recognition period of 1.2 years.
Note 8 — INCOME TAXES
Our tax provision or benefit from income taxes for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items, if any, that are taken into account in the relevant period. Each quarter we update our estimate of the annual effective tax rate, and if our estimated tax rate changes, we make a cumulative adjustment.
Our quarterly tax provision, and our quarterly estimate of our annual effective tax rate, is subject to significant variation due to several factors, including variability in accurately predicting our pre-tax and taxable income and loss and the mix of jurisdictions to which they relate, changes in how we do business, acquisitions (including integrations) and investments, audit developments, foreign currency gains (losses), changes in law, regulations, and administrative practices, and relative changes of expenses or losses for which tax benefits are not recognized. Additionally, our effective tax rate can be more or less volatile based on the amount of pre-tax income or loss. For example, the impact of discrete items and non-deductible expenses on our effective tax rate is greater when our pre-tax income is lower.
In 2014, our effective tax rate will be significantly affected by the favorable impact of earnings in lower tax rate jurisdictions and the adverse effect of losses incurred in certain foreign jurisdictions for which we may not realize a tax benefit. Income earned in lower tax jurisdictions is primarily related to our European operations, which are headquartered in Luxembourg. Losses for which we may not realize a related tax benefit, primarily due to losses of foreign subsidiaries, reduce our pre-tax income without a corresponding reduction in our tax expense, and therefore increase our effective tax rate. We have recorded valuation allowances against the deferred tax assets associated with losses for which we may not realize a related tax benefit. Our effective tax rate may also be adversely impacted by the amount of our pretax income, or loss, relative to our income tax expense, nondeductible expenses, and changes in tax law such as the expiration of the U.S. federal research and development credit at the end of 2013.
Our tax benefit for the nine months ended September 30, 2014 was $38 million, which included $82 million of discrete tax expense primarily attributable to audit-related developments. In the nine months ended September 30, 2013, we recognized an income tax benefit of $18 million, which included $54 million of discrete tax benefits primarily resulting from the retroactive reinstatement of the federal research and development credit that was enacted in January 2013.
Cash paid for income taxes (net of refunds) was $38 million and $23 million in Q3 2014 and Q3 2013, and $148 million and $143 million for the nine months ended September 30, 2014 and 2013.
As of September 30, 2014, and December 31, 2013, tax contingencies were $626 million and $407 million. We expect the total amount of tax contingencies will grow in 2014. In addition, changes in state, federal, and foreign tax laws may increase our tax contingencies. The timing of the resolution of income tax examinations is highly uncertain, and the amounts ultimately paid, if any, upon resolution of the issues raised by the taxing authorities may differ from the amounts accrued. It is reasonably possible that within the next 12 months we will receive additional assessments by various tax authorities or possibly reach resolution of income tax examinations in one or more jurisdictions. These assessments or settlements may or may not result in changes to our contingencies related to positions on prior years’ tax filings.
We are under examination, or may be subject to examination, by the Internal Revenue Service (“IRS”) for the calendar year 2005 or thereafter. These examinations may lead to ordinary course adjustments or proposed adjustments to our taxes or our net operating losses. As previously disclosed, we have received Notices of Proposed Adjustment from the IRS for the 2005 and 2006 calendar years relating to transfer pricing with our foreign subsidiaries. The IRS is seeking to increase our U.S. taxable income by an amount that would result in additional federal tax over a seven year period beginning in 2005, totaling approximately $1.5 billion, subject to interest. To date, we have not resolved this matter administratively and, in December

14


2012, we petitioned the U.S. Tax Court to resolve the matter. We continue to disagree with these IRS positions and intend to defend ourselves vigorously in this matter.
Certain of our subsidiaries are under examination or investigation or may be subject to examination or investigation by the French Tax Administration (“FTA”) for calendar year 2006 or thereafter. These examinations may lead to ordinary course adjustments or proposed adjustments to our taxes. While we have not yet received a final assessment from the FTA, in September 2012, we received proposed tax assessment notices for calendar years 2006 through 2010 relating to the allocation of income between foreign jurisdictions. The notices propose additional French tax of approximately $250 million, including interest and penalties through the date of the assessment. We disagree with the proposed assessment and intend to contest it vigorously. We plan to pursue all available administrative remedies at the FTA, and if we are not able to resolve this matter with the FTA, we plan to pursue judicial remedies. In addition, in October 2014, the European Commission opened a formal investigation to examine whether decisions by the tax authorities in Luxembourg with regard to the corporate income tax paid by certain of our subsidiaries comply with European Union rules on state aid. If this matter is adversely resolved, Luxembourg may be required to assess, and we may be required to pay, additional amounts with respect to current and prior periods and our taxes in the future could increase. We are also subject to taxation in various states and other foreign jurisdictions including China, Germany, India, Japan, Luxembourg, and the United Kingdom. We are under, or may be subject to, audit or examination and additional assessments by these particular tax authorities for the calendar year 2003 and thereafter.
Note 9 — SEGMENT INFORMATION
We have organized our operations into two segments: North America and International. We present our segment information along the same lines that our Chief Executive Officer reviews our operating results in assessing performance and allocating resources.
We allocate to segment results the operating expenses “Fulfillment,” “Marketing,” “Technology and content,” and “General and administrative,” but exclude from our allocations the portions of these expense lines attributable to stock-based compensation. We do not allocate the line item “Other operating expense (income), net” to our segment operating results. Our “Technology and content” costs included in our segments are primarily based on the geographic location of where the costs are incurred; the majority of these costs are incurred in the U.S. and included in our North America segment. There are no internal revenue transactions between our reporting segments.


15


Information on reportable segments and reconciliation to consolidated net income (loss) is as follows (in millions):
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
North America
 
 
 
 
 
 
 
Net sales
$
12,867

 
$
10,301

 
$
36,722

 
$
29,186

Segment operating expenses (1)
12,779

 
10,006

 
35,634

 
28,024

Segment operating income
$
88

 
$
295

 
$
1,088

 
$
1,162

International
 
 
 
 
 
 
 
Net sales
$
7,712

 
$
6,791

 
$
22,937

 
$
19,679

Segment operating expenses (1)
7,936

 
6,819

 
23,254

 
19,724

Segment operating income (loss)
$
(224
)
 
$
(28
)
 
$
(317
)
 
$
(45
)
Consolidated
 
 
 
 
 
 
 
Net sales
$
20,579

 
$
17,092

 
$
59,659

 
$
48,865

Segment operating expenses (1)
20,715

 
16,825

 
58,888

 
47,748

Segment operating income (loss)
(136
)
 
267

 
771

 
1,117

Stock-based compensation
(377
)
 
(281
)
 
(1,089
)
 
(808
)
Other operating income (expense), net
(31
)
 
(11
)
 
(94
)
 
(74
)
Income (loss) from operations
(544
)
 
(25
)
 
(412
)
 
235

Total non-operating income (expense)
(90
)
 
(18
)
 
(128
)
 
(181
)
Benefit (provision) for income taxes
205

 
12

 
38

 
18

Equity-method investment activity, net of tax
(8
)
 
(10
)
 
47

 
(38
)
Net income (loss)
$
(437
)
 
$
(41
)
 
$
(455
)
 
$
34

___________________
(1)
Represents operating expenses, excluding stock-based compensation and “Other operating expense (income), net,” which are not allocated to segments.

We have aggregated our products and services into groups of similar product and services and provided the supplemental disclosure of net sales (in millions) below. We evaluate whether additional disclosure is appropriate when a product or service category begins to approach a significant level of net sales. For the periods presented no individual product or service represented more than 10% of net sales.
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Net Sales:
 
 
 
Media
$
5,244

 
$
5,033

 
$
15,555

 
$
14,488

Electronics and other general merchandise
13,953

 
11,048

 
40,248

 
31,677

Other (1)
1,382

 
1,011

 
3,856

 
2,700

 
$
20,579

 
$
17,092

 
$
59,659

 
$
48,865

___________________
(1)
Includes sales from non-retail activities, such as Amazon Web Services (“AWS”), advertising services, and our co-branded credit card agreements.

16


Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical fact, including statements regarding guidance, industry prospects, or future results of operations or financial position, made in this Quarterly Report on Form 10-Q are forward-looking. We use words such as anticipates, believes, expects, future, intends, and similar expressions to identify forward-looking statements. Forward-looking statements reflect management’s current expectations and are inherently uncertain. Actual results could differ materially for a variety of reasons, including, among others, fluctuations in foreign exchange rates, changes in global economic conditions and consumer spending, world events, the rate of growth of the Internet and online commerce, the amount that Amazon.com invests in new business opportunities and the timing of those investments, the mix of products sold to customers, the mix of net sales derived from products as compared with services, the extent to which we owe income taxes, competition, management of growth, potential fluctuations in operating results, international growth and expansion, the outcomes of legal proceedings and claims, fulfillment and data center optimization, risks of inventory management, seasonality, the degree to which the Company enters into, maintains, and develops commercial agreements, acquisitions and strategic transactions, payments risks, and risks of fulfillment throughput and productivity. In addition, the current global economic climate amplifies many of these risks. These risks and uncertainties, as well as other risks and uncertainties that could cause our actual results to differ significantly from management’s expectations, are described in greater detail in Item 1A of Part II, “Risk Factors.”
For additional information, see Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview” of our 2013 Annual Report on Form 10-K.
Critical Accounting Judgments
The preparation of financial statements in conformity with GAAP requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. The SEC has defined a company’s critical accounting policies as the ones that are most important to the portrayal of the company’s financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified the critical accounting policies and judgments addressed below. We also have other key accounting policies, which involve the use of estimates, judgments, and assumptions that are significant to understanding our results. For additional information, see Item 8 of Part II, “Financial Statements and Supplementary Data — Note 1 — Description of Business and Accounting Policies,” of our 2013 Annual Report on Form 10-K and Item 1 of Part I, “Financial Statements — Note 1 — Accounting Policies,” of this Form 10-Q. Although we believe that our estimates, assumptions, and judgments are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates under different assumptions, judgments, or conditions.
Inventories
Inventories, consisting of products available for sale, are primarily accounted for using the first-in first-out method, and are valued at the lower of cost or market value. This valuation requires us to make judgments, based on currently-available information, about the likely method of disposition, such as through sales to individual customers, returns to product vendors, or liquidations, and expected recoverable values of each disposition category. These assumptions about future disposition of inventory are inherently uncertain and changes in our estimates and assumptions may cause us to realize material write-downs in the future. As a measure of sensitivity, for every 1% of additional inventory valuation allowance as of September 30, 2014, we would have recorded an additional cost of sales of approximately $85 million.
In addition, we enter into supplier commitments for certain electronic device components. These commitments are based on forecasted customer demand. If we reduce these commitments, we may incur additional costs.
Goodwill
We evaluate goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate the carrying value may not be recoverable. Our annual testing date is October 1. We test goodwill for impairment by first comparing the book value of net assets to the fair value of the reporting units. If the fair value is determined to be less than the book value or qualitative factors indicate that it is more likely than not that goodwill is impaired, a second step is performed to compute the amount of impairment as the difference between the estimated fair value of goodwill and the carrying value. We estimate the fair value of the reporting units using discounted cash flows. Forecasts of future cash flows are based on our best estimate of future net sales and operating expenses, based primarily on expected category expansion, pricing, market segment

17


share, and general economic conditions. Certain estimates of discounted cash flows involve businesses and geographies with limited financial history and developing revenue models. Changes in these forecasts could significantly change the amount of impairment recorded, if any.
During the quarter, management monitored the actual performance of the business relative to the fair value assumptions used during our annual goodwill impairment test. For the periods presented, no triggering events were identified that required an update to our annual impairment test. As a measure of sensitivity, a 10% decrease in the fair value of any of our reporting units as of December 31, 2013, would have had no impact on the carrying value of our goodwill.
Financial and credit market volatility directly impacts the fair value measurement through our weighted average cost of capital that we use to determine a discount rate and through our stock price that we use to determine our market capitalization. During times of volatility, significant judgment must be applied to determine whether credit or stock price changes are short-term in nature or a longer-term trend. We have not made any significant changes to the accounting methodology used to evaluate goodwill for impairment. Changes in our estimated future cash flows and asset fair values may cause us to realize material impairment charges in the future. As a measure of sensitivity, a prolonged 20% decrease from our September 30, 2014 closing stock price would not be an indicator of possible impairment.
Stock-Based Compensation
We measure compensation cost for stock awards at fair value and recognize it as compensation expense over the service period for awards expected to vest. The fair value of restricted stock units is determined based on the number of shares granted and the quoted price of our common stock. The estimation of stock awards that will ultimately vest requires judgment of the amount that will be forfeited, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. We consider many factors when estimating expected forfeitures, including employee classification, economic environment, and historical experience. We update our estimated forfeiture rate quarterly. We have not made any significant changes to the accounting methodology used to evaluate stock-based compensation. Changes in our estimates and assumptions may cause us to realize material changes in stock-based compensation expense in the future. As a measure of sensitivity, a 1% change to our estimated forfeiture rate would have had an approximately $35 million impact on our Q3 2014 operating income. Our estimated forfeiture rate as of September 30, 2014, and December 31, 2013 was 27%.
We utilize the accelerated method, rather than the straight-line method, for recognizing compensation expense. For example, over 50% of the compensation cost related to an award vesting ratably over four years is expensed in the first year. If forfeited early in the life of an award, the compensation expense adjustment is much greater under an accelerated method than under a straight-line method.
Income Taxes
We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Tax rates in various jurisdictions may be subject to significant change due to economic, political, and other conditions, and significant judgment is required in evaluating and estimating our provision and accruals for these taxes. There are many transactions that occur during the ordinary course of business for which the ultimate tax determination is uncertain. Our effective tax rates could be adversely affected by earnings being lower than anticipated in countries where we have lower statutory rates and higher than anticipated in countries where we have higher statutory rates, losses incurred in jurisdictions for which we are not able to realize the related tax benefit, changes in foreign currency exchange rates, entry into new businesses and geographies and changes to our existing businesses, acquisitions (including integrations) and investments, changes in our deferred tax assets and liabilities and their valuation, and changes in the relevant tax, accounting, and other laws, regulations, administrative practices, principles, and interpretations, including fundamental changes to the tax laws applicable to corporate multinationals. The U.S., many countries in the European Union, and a number of other countries are actively considering changes in this regard. Except as required under U.S. tax law, we do not provide for U.S. taxes on our undistributed earnings of foreign subsidiaries that have not been previously taxed since we intend to invest such undistributed earnings indefinitely outside of the U.S. If our intent changes or if these funds are needed for our U.S. operations, our effective tax rate would be adversely affected. We are also subject to audit in various jurisdictions, and such jurisdictions may assess additional income tax liabilities against us. In addition, in October 2014, the European Commission opened a formal investigation to examine whether decisions by the tax authorities in Luxembourg with regard to the corporate income tax paid by certain of our subsidiaries comply with European Union rules on state aid. If this matter is adversely resolved, Luxembourg may be required to assess, and we may be required to pay, additional amounts with respect to current and prior periods and our taxes in the future could increase. Although we believe our tax estimates are reasonable, the final outcome of tax audits, investigations, and any related litigation could be materially different from our historical income tax provisions and accruals. Developments in an audit, litigation, or the relevant laws, regulations,

18


administrative practices, principles, and interpretations could have a material effect on our operating results or cash flows in the period or periods for which that development occurs, as well as for prior and subsequent periods.
Recent Accounting Pronouncements
See Item 1 of Part I, “Financial Statements — Note 1— Accounting Policies — Recent Accounting Pronouncements.”

19


Liquidity and Capital Resources
Cash flow information is as follows (in millions):

  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
Twelve Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
Operating activities
$
1,766

 
$
1,388

 
$
127

 
$
(103
)
 
$
5,705

 
$
4,977

Investing activities
(946
)
 
(1,063
)
 
(2,600
)
 
(3,432
)
 
(3,444
)
 
(6,514
)
Financing activities
(412
)
 
(230
)
 
(777
)
 
(596
)
 
(720
)
 
2,570

Our financial focus is on long-term, sustainable growth in free cash flow1. Free cash flow, a non-GAAP financial measure, was $1.1 billion for the trailing twelve months ended September 30, 2014, compared to $388 million for the trailing twelve months ended September 30, 2013. See “Non-GAAP Financial Measures” below for a reconciliation of free cash flow to cash provided by operating activities. The increase in free cash flow for the trailing twelve months ended September 30, 2014, compared to the comparable prior year period, was primarily due to higher operating cash flows. Operating cash flows and free cash flows can be volatile and are sensitive to many factors, including changes in working capital2, the timing and magnitude of capital expenditures, including our decision to finance property and equipment under capital leases and other financing lease arrangements, and our net income (loss). Working capital at any specific point in time is subject to many variables, including seasonality, inventory management and category expansion, the timing of cash receipts and payments, vendor payment terms, and fluctuations in foreign exchange rates.
Our principal sources of liquidity are cash flows generated from operations and our cash, cash equivalents, and marketable securities balances, which, at fair value, were $6.9 billion and $12.4 billion as of September 30, 2014, and December 31, 2013. Amounts held in foreign currencies were $3.6 billion and $5.6 billion as of September 30, 2014, and December 31, 2013, and consisted primarily of British Pounds, Chinese Yuan, Euros, Hong Kong Dollars, and Japanese Yen.
Cash provided by (used in) operating activities was $1.8 billion and $1.4 billion for Q3 2014 and Q3 2013, and $127 million and $(103) million for the nine months ended September 30, 2014 and 2013. Our operating cash flows result primarily from cash received from our consumer, seller, and enterprise customers, advertising agreements, and our co-branded credit card agreements, offset by cash payments we make for products and services, employee compensation (less amounts capitalized related to internal use software that are reflected as cash used in investing activities), payment processing and related transaction costs, operating leases, and interest payments on our long-term obligations. Cash received from our consumer, seller, and enterprise customers, and other activities generally corresponds to our net sales. Because consumers primarily use credit cards to buy from us, our receivables from consumers settle quickly. The increase in operating cash flow for the trailing twelve months ended September 30, 2014, compared to the comparable prior year period, was primarily due to the increase in non-cash charges to net income, including depreciation, amortization, and stock-based compensation, partially offset by changes in working capital.
Cash provided by (used in) investing activities corresponds with capital expenditures, including leasehold improvements, internal-use software and website development costs, cash outlays for acquisitions, investments in other companies and intellectual property rights, and purchases, sales, and maturities of marketable securities. Cash provided by (used in) investing activities was $(946) million and $(1.1) billion for Q3 2014 and Q3 2013, and $(2.6) billion and $(3.4) billion for the nine months ended September 30, 2014 and 2013, with the variability caused primarily by changes in capital expenditures, purchases, maturities, and sales of marketable securities and other investments, and changes in cash paid for acquisitions. Capital expenditures were $1.4 billion and $1.0 billion during Q3 2014 and Q3 2013, and $3.7 billion and $2.6 billion for the nine months ended September 30, 2014 and 2013, with the increase primarily reflecting additional investments in support of continued business growth due to investments in technology infrastructure, including AWS, and additional capacity to support our fulfillment operations. We expect this trend to continue over time. Capital expenditures included $131 million and $137 million for internal-use software and website development during Q3 2014 and Q3 2013, and $400 million and $363 million for the nine months ended September 30, 2014 and 2013. Stock-based compensation capitalized for internal-use software and website development costs does not affect cash flows. We made cash payments, net of acquired cash, related to acquisition and other investment activity of $860 million and $1 million during Q3 2014 and Q3 2013, and $926 million and $252 million for the nine months ended September 30, 2014 and 2013.
______________________
(1) 
Free cash flow, a non-GAAP financial measure, is defined as net cash provided by operating activities less purchases of property and equipment, including internal-use software and website development, both of which are presented on our consolidated statements of cash flows. See “Non-GAAP Financial Measures” below.
(2) 
Working capital consists of accounts receivable, inventory, and accounts payable.

20


Cash provided by (used in) financing activities was $(412) million and $(230) million for Q3 2014 and Q3 2013, and $(777) million and $(596) million for the nine months ended September 30, 2014 and 2013. Cash outflows from financing activities result from payments on obligations related to capital leases and leases accounted for as financing arrangements and repayments of long-term debt. Payments on obligations related to capital leases and leases accounted for as financing arrangements and repayments of long-term debt were $440 million and $255 million in Q3 2014 and Q3 2013, and $1.3 billion and $728 million for the nine months ended September 30, 2014 and 2013. Property and equipment acquired under capital leases were $1.2 billion and $526 million during Q3 2014 and Q3 2013, and $2.8 billion and $1.3 billion during the nine months ended September 30, 2014 and 2013, with the increase primarily reflecting additional investments in support of continued business growth due to investments in technology infrastructure, including AWS. Cash inflows from financing activities primarily result from proceeds from long-term debt and tax benefits relating to excess stock-based compensation deductions. Proceeds from long-term debt and other were $28 million and $25 million in Q3 2014 and Q3 2013, and $379 million and $132 million for the nine months ended September 30, 2014 and 2013. Tax benefits relating to excess stock-based compensation deductions are presented as financing cash flows. Cash inflows from tax benefits related to stock-based compensation deductions was $0 million for Q3 2014 and Q3 2013, and $121 million and $0 million for the nine months ended September 30, 2014 and 2013.
In September 2014, we entered into the Credit Agreement with a syndicate of lenders that provides us with an unsecured revolving credit facility with a borrowing capacity of up to $2.0 billion. We had no borrowings outstanding under the Credit Agreement as of September 30, 2014. See Item 1 of Part I, “Financial Statements — Note 6 — Long-Term Debt” for additional information. 
We recorded tax benefits of $205 million and $12 million in Q3 2014 and Q3 2013, and tax benefits of $38 million and $18 million for the nine months ended September 30, 2014 and 2013. Except as required under U.S. tax law, we do not provide for U.S. taxes on our undistributed earnings of foreign subsidiaries that have not been previously taxed since we intend to invest such undistributed earnings indefinitely outside of the U.S. If our intent changes or if these funds are needed for our U.S. operations, we would be required to accrue or pay U.S. taxes on some or all of these undistributed earnings. We have tax benefits relating to excess stock-based compensation deductions that are being utilized to reduce our U.S. taxable income. In 2013, we also had accelerated depreciation deductions on qualifying property that reduced our U.S. taxable income as a result of U.S. legislation, which expired in December 2013. Cash paid for income taxes (net of refunds) were $38 million and $23 million for Q3 2014 and Q3 2013, and $148 million and $143 million for the nine months ended September 30, 2014 and 2013. As of December 31, 2013, our federal net operating loss carryforward was approximately $275 million and we had approximately $295 million of federal tax credits potentially available to offset future tax liabilities. The U.S. federal research and development credit expired in December 2013. As we utilize our federal net operating losses and tax credit carryforwards, we expect cash paid for taxes to significantly increase. We endeavor to optimize our global taxes on a cash basis, rather than on a financial reporting basis.
Our liquidity is also affected by restricted cash balances that are pledged as collateral for standby and trade letters of credit, guarantees, debt, and real estate leases. To the extent we process payments for third-party sellers or offer certain types of stored value to our customers, some jurisdictions may restrict our use of those funds. This restriction would result in the reclassification of a portion of our cash and cash equivalents from “Cash and cash equivalents” to “Accounts receivable, net and other” on our consolidated balance sheets. As of September 30, 2014, and December 31, 2013, restricted cash, cash equivalents, and marketable securities were $393 million and $301 million. See Item 1 of Part I, “Financial Statements — Note 3 — Commitments and Contingencies” for additional discussion of our principal contractual commitments, as well as our pledged assets. Purchase obligations and open purchase orders, consisting of inventory and significant non-inventory commitments, were $6.7 billion as of September 30, 2014. Purchase obligations and open purchase orders are generally cancellable in full or in part through the contractual provisions.

21


Because of our model we are able to turn our inventory quickly and have a cash-generating operating cycle3. On average, our high inventory velocity means we generally collect from consumers before our payments to suppliers come due. Inventory turnover4 was 9 for Q3 2014 and Q3 2013. We expect variability in inventory turnover over time since it is affected by several factors, including our product mix, the mix of sales by us and by third-party sellers, our continuing focus on in-stock inventory availability and selection of product offerings, our investment in new geographies and product lines, and the extent to which we choose to utilize third-party fulfillment providers.
We believe that cash flows generated from operations, our cash, cash equivalents, and marketable securities balances, and borrowing available under our credit agreements will be sufficient to meet our anticipated operating cash needs for at least the next 12 months. However, any projections of future cash needs and cash flows are subject to substantial uncertainty. See Item 1A of Part II, “Risk Factors.” We continually evaluate opportunities to sell additional equity or debt securities, obtain credit facilities, repurchase common stock, pay dividends, or repurchase, refinance, or otherwise restructure our debt for strategic reasons or to further strengthen our financial position.
The sale of additional equity or convertible debt securities would likely be dilutive to our shareholders. In addition, we will, from time to time, consider the acquisition of, or investment in, complementary businesses, products, services, and technologies, which might affect our liquidity requirements or cause us to issue additional equity or debt securities. There can be no assurance that additional lines-of-credit or financing instruments will be available in amounts or on terms acceptable to us, if at all.
_______________________
(3) 
The operating cycle is number of days of sales in inventory plus number of days of sales in accounts receivable minus accounts payable days.
(4) 
Inventory turnover is the quotient of trailing twelve month cost of sales to average inventory over five quarter ends.




22


Results of Operations
We have organized our operations into two segments: North America and International. We present our segment information along the same lines that our Chief Executive Officer reviews our operating results in assessing performance and allocating resources.
Net Sales
Net sales include product and services sales. Product sales represent revenue from the sale of products and related shipping fees and digital content where we record revenue gross. Services sales represent third-party seller fees earned (including commissions) and related shipping fees, digital content subscriptions, and non-retail activities such as AWS, advertising services, and our co-branded credit card agreements. Amazon Prime membership fees are allocated between product sales and services sales and amortized over the life of the membership according to the estimated delivery of services. Net sales information is as follows (in millions):
 
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Net Sales:
 
 
 
 
 
 
 
North America
$
12,867

 
$
10,301

 
$
36,722

 
$
29,186

International
7,712

 
6,791

 
22,937

 
19,679

Consolidated
$
20,579

 
$
17,092

 
$
59,659

 
$
48,865

Year-over-year Percentage Growth:
 
 
 
 
 
 
 
North America
25
%
 
31
%
 
26
%
 
29
%
International
14

 
15

 
17

 
15

Consolidated
20

 
24

 
22

 
23

Year-over-year Percentage Growth, excluding effect of foreign exchange rates:
 
 
 
 
 
 
 
North America
25
%
 
31
%
 
26
%
 
29
%
International
13

 
20

 
15

 
20

Consolidated
20

 
26

 
22

 
25

Net Sales Mix:
 
 
 
 
 
 
 
North America
63
%
 
60
%
 
62
%
 
60
%
International
37

 
40

 
38

 
40

Consolidated
100
%
 
100
%
 
100
%
 
100
%
Sales increased 20% in Q3 2014 and 22% for the nine months ended September 30, 2014, compared to the comparable prior year periods. Changes in currency exchange rates impacted net sales by $13 million and $(332) million for Q3 2014 and Q3 2013, and by $259 million and $(1.0) billion for the nine months ended September 30, 2014 and 2013. For a discussion of the effect on sales growth of exchange rates, see “Effect of Foreign Exchange Rates” below.
North America sales increased 25% in Q3 2014 and 26% for nine months ended September 30, 2014, compared to the comparable prior year periods. The sales growth primarily reflects increased unit sales, including sales by marketplace sellers, and AWS, which was partially offset by AWS pricing changes. Increased unit sales were driven largely by our continued efforts to reduce prices for our customers, including from our shipping offers, by sales in faster growing categories such as electronics and other general merchandise, by increased in-stock inventory availability, and by increased selection of product offerings.
International sales increased 14% in Q3 2014 and 17% for the nine months ended September 30, 2014, compared to the comparable prior year periods. The sales growth primarily reflects increased unit sales, including sales by marketplace sellers. Increased unit sales were driven largely by our continued efforts to reduce prices for our customers, including from our shipping offers, from sales in faster growing categories such as electronics and other general merchandise, increased in-stock inventory availability, and increased selection of product offerings. Additionally, changes in currency exchange rates impacted International net sales by $21 million and $(327) million for Q3 2014 and Q3 2013, and $292 million and $(1.0) billion for the nine months ended September 30, 2014 and 2013. We expect that, over time, our International segment will represent 50% or more of our consolidated net sales.


23


Supplemental Information
Supplemental information about outbound shipping results is as follows (in millions):
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Outbound Shipping Activity:
 
 
 
 
 
 
 
Shipping revenue (1)(2)(3)
$
1,048

 
$
721

 
$
2,786

 
$
1,999

Shipping costs(4)
(2,020
)
 
(1,532
)
 
(5,661
)
 
(4,291
)
Net shipping cost
$
(972
)
 
$
(811
)
 
$
(2,875
)
 
$
(2,292
)
Year-over-year Percentage Growth:
 
 
 
 
 
 
 
Shipping revenue
45
 %
 
39
 %
 
39
 %
 
38
 %
Shipping costs
32

 
33

 
32

 
29

Net shipping cost
20

 
28

 
25

 
21

Percent of Net Sales:
 
 
 
 
 
 
 
Shipping revenue
5.1
 %
 
4.2
 %
 
4.7
 %
 
4.1
 %
Shipping costs
(9.8
)
 
(8.9
)
 
(9.5
)
 
(8.8
)
Net shipping cost
(4.7
)%
 
(4.7
)%
 
(4.8
)%
 
(4.7
)%
___________________
(1)
Excludes amounts earned on shipping activities by third-party sellers where we do not provide the fulfillment service.
(2)
Includes a portion of amounts earned from Amazon Prime memberships.
(3)
Includes amounts earned from Fulfillment by Amazon programs related to shipping services.
(4)
Includes sortation center costs.
We expect our net cost of shipping to continue to increase to the extent our customers accept and use our shipping offers at an increasing rate, our product mix shifts to the electronics and other general merchandise category, we reduce shipping rates, we use more expensive shipping methods, and we offer additional services. We seek to mitigate costs of shipping over time in part through achieving higher sales volumes, optimizing placement of fulfillment centers, negotiating better terms with our suppliers, and achieving better operating efficiencies. We believe that offering low prices to our customers is fundamental to our future success, and one way we offer lower prices is through shipping offers.

24


We have aggregated our products and services into groups of similar product and services and provided the supplemental disclosure of net sales (in millions) below. We evaluate whether additional disclosure is appropriate when a product or service category begins to approach a significant level of net sales. For the periods presented no individual product or service represented more than 10% of net sales.
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2014
 
2013
 
2014
 
2013
Net Sales:
 
 
 
North America
 
 
 
 
 
 
 
Media
$
2,734

 
$
2,609

 
$
8,023

 
$
7,295

Electronics and other general merchandise
8,793

 
6,732

 
24,988

 
19,337

Other (1)
1,340

 
960

 
3,711

 
2,554

Total North America
$
12,867

 
$
10,301

 
$
36,722

 
$
29,186

International
 
 
 
 
 
 
 
Media
$
2,510

 
$
2,424

 
$
7,532

 
$
7,193

Electronics and other general merchandise
5,160

 
4,316

 
15,260

 
12,340

Other (1)
42

 
51

 
145

 
146

Total International
$
7,712

 
$
6,791

 
$
22,937

 
$
19,679

Consolidated
 
 
 
 
 
 
 
Media
$
5,244

 
$
5,033

 
$
15,555

 
$
14,488

Electronics and other general merchandise
13,953

 
11,048

 
40,248

 
31,677

Other (1)
1,382

 
1,011

 
3,856

 
2,700

Total consolidated
$
20,579

 
$
17,092

 
$
59,659

 
$
48,865

Year-over-year Percentage Growth:
 
 
 
 
 
 
 
North America
 
 
 
 
 
 
 
Media
5
 %
 
18
%
 
10
 %
 
16
%
Electronics and other general merchandise
31

 
33

 
29

 
31

Other
40

 
58

 
45

 
61

Total North America
25

 
31

 
26

 
29

International
 
 
 
 
 
 
 
Media
4
 %
 
2
%
 
5
 %
 
1
%
Electronics and other general merchandise
20

 
23

 
24

 
24

Other
(17
)
 
28

 
(1
)
 
21

Total International
14

 
15

 
17

 
15

Consolidated
 
 
 
 
 
 
 
Media
4
 %
 
9
%
 
7
 %
 
8
%
Electronics and other general merchandise
26

 
29

 
27

 
28

Other
37

 
56

 
43

 
59

Total consolidated
20

 
24

 
22

 
23

Year-over-year Percentage Growth:
 
 
 
 
 
 
 
Excluding the effect of foreign exchange rates
 
 
 
 
 
 
 
International
 
 
 
 
 
 
 
Media
3
 %
 
9
%
 
4
 %
 
7
%
Electronics and other general merchandise
19

 
28

 
22

 
30

Other
(19
)
 
32

 
(3
)
 
26

Total International
13

 
20

 
15

 
20

Consolidated
 
 
 
 
 
 
 
Media
4
 %
 
13
%
 
7
 %
 
12
%
Electronics and other general merchandise
26

 
31

 
26

 
30

Other
37

 
56

 
43

 
59

Total consolidated
20

 
26

 
22

 
25

Consolidated Net Sales Mix:
 
 
 
 
 
 
 
Media
25
 %
 
29
%
 
26
 %
 
30
%
Electronics and other general merchandise
68

 
65

 
67

 
65

Other
7

 
6

 
7

 
5

Total consolidated
100
 %
 
100
%
 
100
 %
 
100
%
_____________________________
(1)
Includes sales from non-retail activities, such as AWS sales, which are included in the North America segment, and advertising services and our co-branded credit card agreements, which are included in both segments.

25



Operating Expenses
Information about operating expenses with and without stock-based compensation is as follows (in millions):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
  
As
Reported
 
Stock-Based
Compensation
 
Net
 
As
Reported
 
Stock-Based
Compensation
 
Net
 
As
Reported
 
Stock-Based
Compensation
 
Net
 
As
Reported
 
Stock-Based
Compensation
 
Net
Operating Expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of sales
$
14,627

 
$

 
$
14,627

 
$
12,366

 
$

 
$
12,366

 
$
42,080

 
$

 
$
42,080

 
$
35,375

 
$

 
$
35,375

Fulfillment
2,643

 
(93
)
 
2,550

 
2,034

 
(70
)
 
1,964

 
7,342

 
(278
)
 
7,064

 
5,667

 
(213
)
 
5,454

Marketing
993

 
(32
)
 
961

 
694

 
(23
)
 
671

 
2,806

 
(91
)
 
2,715

 
2,001

 
(63