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10-Q
AMAZON COM INC filed this Form 10-Q on 10/25/2013
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AMZN-2013.09.30-10Q
 
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, 2013
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

457,733,620 shares of common stock, par value $0.01 per share, outstanding as of October 11, 2013
 



AMAZON.COM, INC.
FORM 10-Q
For the Quarterly Period Ended September 30, 2013
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,
 
2013
 
2012
 
2013
 
2012
 
2013
 
2012
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
$
3,704

 
$
2,335

 
$
8,084

 
$
5,269

 
$
2,980

 
$
2,823

OPERATING ACTIVITIES:
 
 
 
 
 
 
 
 
 
 
 
Net income (loss)
(41
)
 
(274
)
 
34

 
(137
)
 
132

 
40

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
834

 
554

 
2,291

 
1,497

 
2,953

 
1,856

Stock-based compensation
281

 
217

 
808

 
597

 
1,043

 
756

Other operating expense (income), net
11

 
40

 
74

 
118

 
110

 
161

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

 
(4
)
 
1

 
(8
)
 

 
(8
)
Other expense (income), net
5

 
157

 
115

 
153

 
214

 
137

Deferred income taxes
11

 
(36
)
 
(47
)
 
(117
)
 
(195
)
 
(50
)
Excess tax benefits from stock-based compensation

 
(66
)
 

 
(190
)
 
(239
)
 
(191
)
Changes in operating assets and liabilities:
 
 
 
 
 
 
 
 
 
 
 
Inventories
(586
)
 
(647
)
 
(80
)
 
(25
)
 
(1,054
)
 
(1,285
)
Accounts receivable, net and other
(125
)
 
(416
)
 
393

 
164

 
(632
)
 
(913
)
Accounts payable
947

 
1,223

 
(3,240
)
 
(2,856
)
 
1,686

 
1,828

Accrued expenses and other
(72
)
 
96

 
(853
)
 
(373
)
 
558

 
703

Additions to unearned revenue
672

 
472

 
1,872

 
1,251

 
2,417

 
1,609

Amortization of previously unearned revenue
(550
)
 
(373
)
 
(1,471
)
 
(975
)
 
(2,016
)
 
(1,275
)
Net cash provided by (used in) operating activities
1,388

 
943

 
(103
)
 
(901
)
 
4,977

 
3,368

INVESTING ACTIVITIES:
 
 
 
 
 
 
 
 
 
 
 
Purchases of property and equipment, including internal-use software and website development
(1,038
)
 
(716
)
 
(2,565
)
 
(1,759
)
 
(4,589
)
 
(2,310
)
Acquisitions, net of cash acquired, and other
(1
)
 
(37
)
 
(252
)
 
(711
)
 
(287
)
 
(759
)
Sales and maturities of marketable securities and other investments
494

 
742

 
1,791

 
3,731

 
2,296

 
4,643

Purchases of marketable securities and other investments
(518
)
 
(358
)
 
(2,406
)
 
(1,774
)
 
(3,934
)
 
(3,556
)
Net cash provided by (used in) investing activities
(1,063
)
 
(369
)
 
(3,432
)
 
(513
)
 
(6,514
)
 
(1,982
)
FINANCING ACTIVITIES:
 
 
 
 
 
 
 
 
 
 
 
Excess tax benefits from stock-based compensation

 
66

 

 
190

 
239

 
191

Common stock repurchased

 

 

 
(960
)
 

 
(1,237
)
Proceeds from long-term debt and other
25

 
109

 
132

 
300

 
3,189

 
343

Repayments of long-term debt, capital lease, and finance lease obligations
(255
)
 
(144
)
 
(728
)
 
(437
)
 
(858
)
 
(537
)
Net cash provided by (used in) financing activities
(230
)
 
31

 
(596
)
 
(907
)
 
2,570

 
(1,240
)
Foreign-currency effect on cash and cash equivalents
73

 
40

 
(81
)
 
32

 
(141
)
 
11

Net increase (decrease) in cash and cash equivalents
168

 
645

 
(4,212
)
 
(2,289
)
 
892

 
157

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
3,872

 
$
2,980

 
$
3,872

 
$
2,980

 
$
3,872

 
$
2,980

SUPPLEMENTAL CASH FLOW INFORMATION:
 
 
 
 
 
 
 
 
 
 
 
Cash paid for interest on long-term debt
$
8

 
$
7

 
$
60

 
$
21

 
$
70

 
$
25

Cash paid for income taxes (net of refunds)
23

 
21

 
143

 
60

 
195

 
75

Property and equipment acquired under capital leases
526

 
207

 
1,313

 
564

 
1,552

 
751

Property and equipment acquired under build-to-suit leases
269

 
14

 
663

 
46

 
647

 
85

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,
 
2013
 
2012
 
2013
 
2012
Net product sales
$
13,808

 
$
11,546

 
$
39,831

 
$
33,586

Net services sales
3,284

 
2,260

 
9,034

 
6,239

Total net sales
17,092

 
13,806

 
48,865

 
39,825

Operating expenses (1):
 
 
 
 
 
 
 
Cost of sales
12,366

 
10,319

 
35,375

 
29,834

Fulfillment
2,034

 
1,510

 
5,667

 
4,161

Marketing
694

 
540

 
2,001

 
1,557

Technology and content
1,734

 
1,192

 
4,703

 
3,219

General and administrative
278

 
230

 
810

 
662

Other operating expense (income), net
11

 
43

 
74

 
121

Total operating expenses
17,117

 
13,834

 
48,630

 
39,554

Income (loss) from operations
(25
)
 
(28
)
 
235

 
271

Interest income
9

 
10

 
28

 
32

Interest expense
(36
)
 
(22
)
 
(102
)
 
(65
)
Other income (expense), net
9

 
18

 
(107
)
 
(31
)
Total non-operating income (expense)
(18
)
 
6

 
(181
)
 
(64
)
Income (loss) before income taxes
(43
)
 
(22
)
 
54

 
207

Benefit (provision) for income taxes
12

 
(83
)
 
18

 
(234
)
Equity-method investment activity, net of tax
(10
)
 
(169
)
 
(38
)
 
(110
)
Net income (loss)
$
(41
)
 
$
(274
)
 
$
34

 
$
(137
)
Basic earnings per share
$
(0.09
)
 
$
(0.60
)
 
$
0.08

 
$
(0.30
)
Diluted earnings per share
$
(0.09
)
 
$
(0.60
)
 
$
0.07

 
$
(0.30
)
Weighted average shares used in computation of earnings per share:
 
 
 
 
 
 
 
Basic
457

 
452

 
456

 
452

Diluted
457

 
452

 
464

 
452

_____________
 
 
 
 
 
 
 
(1)    Includes stock-based compensation as follows:
 
 
 
 
 
 
 
Fulfillment
$
70

 
$
56

 
$
213

 
$
149

Marketing
23

 
16

 
63

 
43

Technology and content
154

 
112

 
428

 
310

General and administrative
34

 
33

 
104

 
95



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,
 
2013
 
2012
 
2013
 
2012
Net income (loss)
$
(41
)
 
$
(274
)
 
$
34

 
$
(137
)
Other comprehensive income:
 
 
 
 
 
 
 
Foreign currency translation adjustments, net of tax of $(1), $4, $(14), and $(17)
111

 
30

 
41

 
16

Net change in unrealized gains on available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains (losses), net of tax of $(1), $(1), $3, and $(4)
1

 
5

 
(8
)
 
11

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

 
(3
)
 

 
(7
)
Net unrealized gains (losses) on available-for-sale securities
2

 
2

 
(8
)
 
4

Total other comprehensive income
113

 
32

 
33

 
20

Comprehensive income (loss)
$
72

 
$
(242
)
 
$
67

 
$
(117
)
See accompanying notes to consolidated financial statements.


5


AMAZON.COM, INC.
CONSOLIDATED BALANCE SHEETS
(in millions, except per share data)
 
 
September 30, 2013
 
December 31, 2012
 
(unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
3,872

 
$
8,084

Marketable securities
3,817

 
3,364

Inventories
6,068

 
6,031

Accounts receivable, net and other
3,057

 
3,364

Deferred tax assets
520

 
453

Total current assets
17,334

 
21,296

Property and equipment, net
9,991

 
7,060

Deferred tax assets
128

 
123

Goodwill
2,635

 
2,552

Other assets
1,773

 
1,524

Total assets
$
31,861

 
$
32,555

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
10,037

 
$
13,318

Accrued expenses and other
6,098

 
5,684

Total current liabilities
16,135

 
19,002

Long-term debt
3,043

 
3,084

Other long-term liabilities
3,596

 
2,277

Commitments and contingencies


 


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 — 481 and 478
 
 
 
Outstanding shares — 458 and 454
5

 
5

Treasury stock, at cost
(1,837
)
 
(1,837
)
Additional paid-in capital
9,175

 
8,347

Accumulated other comprehensive loss
(206
)
 
(239
)
Retained earnings
1,950

 
1,916

Total stockholders’ equity
9,087

 
8,192

Total liabilities and stockholders’ equity
$
31,861

 
$
32,555

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 2013 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 2012 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, 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, internally-developed software, 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 recognize a net loss, we exclude the impact of outstanding stock awards from the diluted loss per share calculation 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,
 
2013
 
2012
 
2013
 
2012
Shares used in computation of basic earnings per share
457

 
452

 
456

 
452

Total dilutive effect of outstanding stock awards

 

 
8

 

Shares used in computation of diluted earnings per share
457

 
452

 
464

 
452

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

7


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.
Note 2 — Cash, Cash Equivalents, and Marketable Securities
As of September 30, 2013, and December 31, 2012, 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 as of September 30, 2013 or December 31, 2012.

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, 2013
 
December 31, 2012
  
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Total
Estimated
Fair Value
 
Total
Estimated
Fair Value
Cash
$
2,392

 
$

 
$

 
$
2,392

 
$
2,595

Level 1 securities:
 
 
 
 
 
 
 
 
 
Money market funds
1,760

 

 

 
1,760

 
5,561

Equity securities
3

 

 

 
3

 
2

Level 2 securities:
 
 
 
 
 
 
 
 
 
Foreign government and agency securities
761

 
3

 
(1
)
 
763

 
772

U.S. government and agency securities
2,245

 
2

 
(2
)
 
2,245

 
1,810

Corporate debt securities
708

 
3

 
(1
)
 
710

 
725

Asset-backed securities
66

 

 

 
66

 
49

Other fixed income securities
40

 

 

 
40

 
33

 
$
7,975

 
$
8

 
$
(4
)
 
$
7,979

 
$
11,547

Less: Restricted cash, cash equivalents, and marketable securities (1)
 
 
 
 
 
 
(290
)
 
(99
)
Total cash, cash equivalents, and marketable securities
 
 
 
 
 
 
$
7,689

 
$
11,448

___________________
(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, and real estate lease agreements. We classify cash 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 equivalent and marketable fixed-income securities as of September 30, 2013 (in millions):

 
Amortized
Cost
 
Estimated
Fair Value
Due within one year
$
2,901

 
$
2,902

Due after one year through five years
2,258

 
2,262

Due after five years through ten years
151

 
150

Due after ten years
270

 
270

 
$
5,580

 
$
5,584

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 $197 million and $146 million for Q3 2013 and Q3 2012, and $545 million and $390 million for the nine months ended September 30, 2013 and 2012.

9


The following summarizes our principal contractual commitments, excluding open orders for purchases that support normal operations, as of September 30, 2013 (in millions):
 
 
Three Months Ended December 31,
 
Year Ended December 31,
 
 
 
 
 
2013
 
2014
 
2015
 
2016
 
2017
 
Thereafter
 
Total
Operating and capital commitments:
 
 
 
 
 
 
 
 
 
 
 
 
 
Debt principal and interest
$
156

 
$
633

 
$
867

 
$
43

 
$
1,043

 
$
1,407

 
$
4,149

Capital leases, including interest
214

 
779

 
710

 
225

 
56

 
115

 
2,099

Financing lease obligations, including interest
8

 
40

 
41

 
42

 
43

 
470

 
644

Operating leases
186

 
649

 
595

 
552

 
493

 
2,424

 
4,899

Unconditional purchase obligations (1)
32

 
477

 
291

 
63

 
35

 
49

 
947

Other commitments (2) (3)
267

 
360

 
245

 
151

 
117

 
1,242

 
2,382

Total commitments
$
863

 
$
2,938

 
$
2,749

 
$
1,076

 
$
1,787

 
$
5,707

 
$
15,120

___________________
(1)
Includes unconditional purchase obligations related to agreements to acquire and license digital video content that represent long-term liabilities or that are not reflected on the consolidated balance sheets.
(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.
(3)
Excludes $336 million of tax contingencies for which we cannot make a reasonably reliable estimate of the amount and period of payment, if any.
Pledged Securities
As of September 30, 2013, and December 31, 2012, we have pledged or otherwise restricted $290 million and $99 million of our cash and marketable securities as collateral for standby and trade letters of credit, guarantees, debt related to our international operations, and real estate leases.
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 2012 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 Forms 10-Q for the Periods Ended March 31, 2013, and June 30, 2013, as supplemented by the following:
In December 2009, Nazomi Communications, Inc. filed a complaint against Amazon.com, Inc. for patent infringement in the United States District Court for the Eastern District of Texas. The complaint alleges, among other things, that the processor core in Kindle devices infringes two patents owned by Nazomi purporting to cover “Java virtual machine hardware for RISC and CISC processors” and “Java hardware accelerator using microcode engine” (U.S. Patent Nos. 7,080,362 and 7,225,436) and seeks monetary damages, injunctive relief, costs, and attorneys’ fees. In October 2010, the case was transferred to the United States District Court for the Northern District of California. In January 2012, Nazomi added Amazon.com, Inc. to a second lawsuit that alleges, among other things, that certain Kindle devices infringe a patent owned by Nazomi purporting to cover a “Constant Pool Reference Resolution Method” (U.S. Patent No. 6,338,160) and also seeks monetary damages, injunctive relief, costs, and attorneys’ fees. In June 2013, the court granted summary judgment of noninfringement on the ‘362 and ‘436 patents.  In August 2013, the court granted summary judgment of noninfringement on the ‘160 patent.  The plaintiff is appealing both rulings to the Court of Appeals for the Federal Circuit.  We continue to dispute the allegations of wrongdoing and intend to vigorously defend ourselves in this matter.
In July 2010, Positive Technologies Inc. filed a complaint against Amazon.com, Inc. for patent infringement in the United States District Court for the Eastern District of Texas. The complaint alleges, among other things, that certain of our products, including Kindle devices, infringe three patents owned by the plaintiff purporting to cover a “DC Integrating Display Driver Employing Pixel Status Memories” (U.S. Patent Nos. 5,444,457, 5,627,558, and 5,831,588) and seeks monetary damages, injunctive relief, costs, and attorneys’ fees. In April 2011, the case was transferred to the United States District Court for the

10


Northern District of California. In August 2013, we entered into a settlement of the litigation that included, among other things, a payment to the plaintiff.  The settlement was not material to either the current or future years.
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. 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. We dispute the remaining allegations of wrongdoing and intend to vigorously defend ourselves in these matters.
In July 2011, GPNE Corp. filed a complaint against Amazon.com, Inc. for patent infringement in the United States District Court for the District of Hawaii. The complaint alleges, among other things, that certain aspects of our technology, including Kindle devices, infringe three patents owned by the plaintiff purporting to cover a “Network Communication System Wherein a Node Obtains Resources for Transmitting Data by Transmitting Two Reservation Requests” (U.S. Patent No. 7,555,267), a “Communication System Wherein a Clocking Signal from a Controller, a Request from a Node, Acknowledgement of the Request, and Data Transferred from the Node are all Provided on Different Frequencies, Enabling Simultaneous Transmission of these Signals” (U.S. Patent No. 7,570,954) and a “Network Communication System with an Alignment Signal to Allow a Controller to Provide Messages to Nodes and Transmission of the Messages over Four Independent Frequencies” (U.S. Patent No. 7,792,492) and seeks monetary damages, interest, costs, and attorneys’ fees. In June 2012, the case was transferred to the United States District Court for the Northern District of California. In September 2013, we entered into a settlement of the litigation that included, among other things, a payment to the plaintiff.  The settlement was not material to either the current or future years.
In July 2012, Technology Properties Limited, Phoenix Digital Solutions LLC, and Patriot Scientific Corporation filed complaints against Amazon.com, Inc. for patent infringement in the United States International Trade Commission ("ITC") and in the United States District Court for the Northern District of California.  The complaints allege, among other things, that using certain Kindle devices in combination with certain peripheral devices infringes U.S. Patent No. 5,809,336, entitled “High Performance Microprocessor Having Variable Speed System Clock.”  The ITC complaint seeks an exclusion order preventing the importation of certain Kindle devices into the United States.  The district court complaint asserts infringement of two additional patents—U.S. Patent Nos. 5,440,749 and 5,530,890, both entitled “High Performance, Low Cost Microprocessor Architecture”—and seeks an unspecified amount of damages, enhanced damages, attorneys’ fees, interest, and an injunction.  In a November 2012 letter to the Company plaintiff alleged specifically that, if we are found to infringe the patents-in-suit and the patents are found to be valid (both of which we dispute), Amazon and its affiliates should pay damages of approximately $42 million, subject to enhancement, plus $17 million in prejudgment interest. In September 2013, the ITC issued an Initial Determination of non-infringement. We dispute the allegations of wrongdoing and intend to vigorously defend ourselves in this matter.
In May 2013, the Trustees of Boston University filed a complaint against Amazon.com, Inc. aka Amazon.com Auctions, Inc. in the United States District Court for the District of Massachusetts. The complaint alleges, among other things, that certain light-emitting diodes in certain Kindle devices infringe U.S. Patent No. 5,686,738, entitled “Highly Insulating Monocrystalline Gallium Nitride Thin Films.” The complaint seeks an unspecified amount of damages, interest, and an injunction. We dispute the allegations of wrongdoing and intend to vigorously defend ourselves in this matter.

In July 2013, Telebuyer, LLC filed a complaint against Amazon.com, Inc., Amazon Web Services LLC, and VADATA, Inc. in the United States District Court for the Eastern District of Virginia. The complaint alleges, among other things, that certain features used on our retail website—including high resolution video and still images, user-indicated areas of interest,

11


targeted follow-up communications, vendor proposals, on-line chat, Gold Box and Lightning Deals, and vendor ratings—infringe seven U.S. Patents: Nos. 6,323,894, 7,835,508, 7,835,509, 7,839,984, 8,059,796, and 8,098,272, all entitled “Commercial Product Routing System With Video Vending Capability,” and 8,315,364, entitled “Commercial Product Routing System With Mobile Wireless And Video Vending Capability.” The complaint seeks an unspecified amount of damages, interest, and injunctive relief. In September 2013, the case was transferred to the United States District Court for the Western District of Washington. We dispute the allegations of wrongdoing and intend to vigorously defend ourselves in this matter.
In August 2013, Cellular Communications Equipment, LLC filed a complaint against Amazon.com, Inc. in the United States District Court for the Eastern District of Texas. The complaint alleges, among other things, that certain Kindle devices infringe U.S. Patent Nos. 6,819,923 entitled "Method For Communication Of Neighbor Cell Information"; 7,215,962 entitled "Method For An Intersystem Connection Handover"; 7,941,174 "Method For Multicode Transmission By A Subscriber Station"; and 8,055,820 entitled "Apparatus, System, And Method For Designating A Buffer Status Reporting Format Based On Detected Pre-Selected Buffer Conditions." The complaint seeks an unspecified amount of damages and interest.  We dispute the allegations of wrongdoing and intend to vigorously defend ourselves in this matter.
In August 2013, Advanced Escreens, LLC filed a complaint against Amazon.com, Inc., in the United States District Court for the District of Delaware. The complaint alleges, among other things, that the screens used in Kindle devices infringe U.S. Patent No. 6,525,866, entitled "Electrophoretic Displays, Display Fluids For Use Therein, And Methods Of Displaying Images." The complaint seeks an unspecified amount of damages, interest, injunctive relief, and attorneys’ fees. We dispute the allegations of wrongdoing and intend to vigorously defend ourselves in this matter.
In August 2013, Voltstar Technologies, Inc. f/k/a Horizon Technologies, Inc. filed a complaint against Amazon.com, Inc. in the United States District Court for the Northern District of Illinois. The complaint alleges, among other things, that a USB electrical charger sold for use with Kindle devices infringes U.S. Design Patent No. D5 87,192, entitled "Electrical Charger." The complaint seeks an unspecified amount of damages and costs. We dispute the allegations of wrongdoing and intend to vigorously defend ourselves in this matter.
Beginning in August 2013, a number of complaints were filed alleging, among other things, that Amazon.com, Inc. and several of its subsidiaries failed to compensate hourly workers for time spent waiting in security lines and otherwise violated federal and state wage and hour statutes and common law.  In August 2013, Busk v. Integrity Staffing Solutions, Inc. and Amazon.com, Inc. was filed in the United States District Court for the District of Nevada, and Vance v. Amazon.com, Inc., Zappos.com Inc., another affiliate of Amazon.com, Inc., and Kelly Services, Inc. was filed in the United States District Court for the Western District of Kentucky.  In September 2013, Allison v. Amazon.com, Inc. and Integrity Staffing Solutions, Inc. was filed in the United States District Court for the Western District of Washington, and Johnson v. Amazon.com, Inc. and an affiliate of Amazon.com, Inc. was filed in the United States District Court for the Western District of Kentucky.  In October 2013, Davis v. Amazon.com, Inc., an affiliate of Amazon.com, Inc., and Integrity Staffing Solutions, Inc. was filed in the United States District Court for the Middle District of Tennessee. The plaintiffs variously purport to represent a nationwide class of certain current and former employees under the Fair Labor Standards Act and/or state-law-based subclasses for certain current and former employees in states including Arizona, California, Pennsylvania, South Carolina, Kentucky, and Nevada, and one complaint asserts nationwide breach of contract and unjust enrichment claims. The complaints seek an unspecified amount of damages, interest, injunctive relief, and attorneys’ fees.  We have been named in several other similar cases. We dispute the allegations of wrongdoing and intend to vigorously defend ourselves in these matters.
In September 2013, Personalized Media Communications, LLC filed a complaint against Amazon.com, Inc. and Amazon Web Services, LLC in the United States District Court for the District of Delaware.  The complaint alleges, among other things, that the use of certain Kindle devices, Kindle apps, and/or Amazon.com, Inc.’s website to purchase and receive electronic media infringes nine U.S. Patents:  Nos. 5,887,243, 7,801,304, 7,805,749, 7,940,931, 7,769,170, 7,864,956, 7,827,587, 8,046,791, and 7,883,252, all entitled “Signal Processing Apparatus and Methods.” The complaint also alleges, among other things, that CloudFront, S3, and EC2 web services infringe three of those patents, Nos. 7,801,304, 7,864,956, and 7,827,587.  The complaint seeks an unspecified amount of damages, interest, and injunctive relief.  We dispute the allegations of wrongdoing and intend to vigorously defend ourselves in this matter.
We cannot predict the impact (if any) that any of the matters described above or in our 2012 Annual Report on Form 10-K or Forms 10-Q for the Periods Ended March 31, 2013, and June 30, 2013, may have on our business, results of operations, financial position, or cash flows. Because of the inherent uncertainties of such matters, including the early stage and lack of specific damage claims in many of them, we cannot estimate the range of possible losses from them (except as otherwise indicated).
See also “Note 7 — Income Taxes.”


12


Note 4 — 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,
 
2013
 
2012
Statement of Operations:
 
 
 
Revenue
$
384

 
$
387

Operating expense
494

 
653

Impairment charge

 
501

Operating loss
(110
)
 
(767
)
Net loss (1)
$
(107
)
 
$
(516
)
___________________
(1)
The difference between the operating loss and net loss for the nine months ended September 30, 2012 is primarily due to non-operating, non-cash gains on previously held equity positions in companies that LivingSocial acquired during Q1 2012.
As of September 30, 2013, the book value of our equity-method investment in LivingSocial was $15 million. Additionally, in Q1 2013 we made a $56 million investment in LivingSocial that we have recorded as a cost method investment, bringing our total investment in LivingSocial to approximately 31% of voting stock.
Note 5 — 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, 2013, and December 31, 2012, the unamortized discount on the Notes was $24 million and $27 million. We also have other long-term debt with a carrying amount, including the current portion, of $747 million and $691 million at September 30, 2013 and December 31, 2012. The face value of our total long-term debt obligations is as follows (in millions):

 
September 30, 2013
 
December 31, 2012
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
747

 
691

Total debt
3,747

 
3,691

Less current portion of long-term debt
(680
)
 
(579
)
Face value of long-term debt
$
3,067

 
$
3,112

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 and $3.0 billion at September 30, 2013 and December 31, 2012, which is based on quoted prices for our publicly-traded debt as of that date.
The other debt, including the current portion, had a weighted average interest rate of 6.3% and 6.4% at September 30, 2013 and December 31, 2012. We used the net proceeds from the issuance of the debt to 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 at September 30, 2013 and December 31, 2012.

13


Note 6 — 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 475 million as of September 30, 2013, and 470 million as of December 31, 2012. 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, 2013 (in millions):
 
 
Number of Units
 
Weighted Average
Grant-Date
Fair Value
Outstanding as of December 31, 2012
15.4

 
$
184

Units granted
6.1

 
269

Units vested
(3.1
)
 
154

Units forfeited
(1.5
)
 
204

Outstanding as of September 30, 2013
16.9

 
$
218

Scheduled vesting for outstanding restricted stock units as of September 30, 2013, is as follows (in millions):
 
 
Three Months Ended December 31,
 
Year Ended December 31,
 
 
 
 
 
2013
 
2014
 
2015
 
2016
 
2017
 
Thereafter
 
Total
Scheduled vesting—restricted stock units
1.5

 
5.4

 
5.6

 
2.9

 
1.2

 
0.3

 
16.9

As of September 30, 2013, there was $1.7 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 7 — 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. 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 2013, 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 incurred in foreign jurisdictions for which we may not realize a tax benefit reduce our pre-tax income without a corresponding reduction in our tax expense, and therefore increase our effective tax rate.
The year to date tax benefit as of September 30, 2013 includes $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.

14


Cash paid for income taxes (net of refunds) was $23 million and $21 million in Q3 2013 and Q3 2012, and $143 million and $60 million for the nine months ended September 30, 2013 and 2012.

As of September 30, 2013, and December 31, 2012, tax contingencies were $336 million and $294 million. We expect the total amount of tax contingencies will grow in 2013. 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 2012, we petitioned the U.S. Tax Court to resolve the matter. We continue to disagree with these IRS positions and intend to vigorously contest them.
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 vigorously contest it. 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. We are also subject to taxation in various states and other foreign jurisdictions including China, Germany, 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 8 — Segment Information
We have organized our operations into two principal 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. A majority of our costs for “Technology and content” are incurred in the United States and most of these costs are allocated to 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,
 
2013
 
2012
 
2013
 
2012
North America
 
 
 
 
 
 
 
Net sales
$
10,301

 
$
7,884

 
$
29,186

 
$
22,638

Segment operating expenses (1)
10,006

 
7,593

 
28,024

 
21,655

Segment operating income
$
295

 
$
291

 
$
1,162

 
$
983

International
 
 
 
 
 
 
 
Net sales
$
6,791

 
$
5,922

 
$
19,679

 
$
17,187

Segment operating expenses (1)
6,819

 
5,981

 
19,724

 
17,181

Segment operating income (loss)
$
(28
)
 
$
(59
)
 
$
(45
)
 
$
6

Consolidated
 
 
 
 
 
 
 
Net sales
$
17,092

 
$
13,806

 
$
48,865

 
$
39,825

Segment operating expenses (1)
16,825

 
13,574

 
47,748

 
38,836

Segment operating income
267

 
232

 
1,117

 
989

Stock-based compensation
(281
)
 
(217
)
 
(808
)
 
(597
)
Other operating income (expense), net
(11
)
 
(43
)
 
(74
)
 
(121
)
Income (loss) from operations
(25
)
 
(28
)
 
235

 
271

Total non-operating income (expense)
(18
)
 
6

 
(181
)
 
(64
)
Benefit (provision) for income taxes
12

 
(83
)
 
18

 
(234
)
Equity-method investment activity, net of tax
(10
)
 
(169
)
 
(38
)
 
(110
)
Net income (loss)
$
(41
)
 
$
(274
)
 
$
34

 
$
(137
)
___________________
(1)
Represents operating expenses, excluding stock-based compensation and “Other operating expense (income), net,” which are not allocated to segments.
Net sales of similar products and services were as follows (in millions):
 
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2013
 
2012
 
2013
 
2012
Net Sales:
 
 
 
Media
$
5,033

 
$
4,600

 
$
14,488

 
$
13,427

Electronics and other general merchandise
11,048

 
8,558

 
31,677

 
24,695

Other (1)
1,011

 
648

 
2,700

 
1,703

 
$
17,092

 
$
13,806

 
$
48,865

 
$
39,825

___________________
(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 2012 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 2012 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 (“FIFO”) 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. As a measure of sensitivity, for every 1% of additional inventory valuation allowance at September 30, 2013, we would have recorded an additional cost of sales of approximately $63 million.
Goodwill
We evaluate goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate that 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 flow are based on our best estimate of future net sales and operating expenses, based primarily on expected category expansion, pricing, market segment share, and general economic conditions. Certain estimates of discounted cash flows involve businesses and

17


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, 2012, would have had no impact on the carrying value of our goodwill.
Financial and credit market volatility directly impacts our fair value measurement through our weighted average cost of capital that we use to determine our 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 a short-term swing or a longer-term trend. As a measure of sensitivity, a prolonged 20% decrease from our September 30, 2013, 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 for 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 class, economic environment, and historical experience. We update our estimated forfeiture rate quarterly. A 1% change to our estimated forfeiture rate would have had an approximately $30 million impact on our Q3 2013 operating income. Our estimated forfeiture rate at September 30, 2013 and December 31, 2012 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. Significant judgment is required in evaluating and estimating our provision and accruals for these taxes. During the ordinary course of business, there are many transactions 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, by losses incurred in jurisdictions for which we are not able to realize the related tax benefit, by changes in foreign currency exchange rates, by entry into new businesses and geographies and changes to our existing businesses, by acquisitions (including integrations) and investments, by changes in the valuation of our deferred tax assets and liabilities, or by 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 United States, many countries in the European Union, and a number of other countries are actively considering changes in this regard. In addition, we are subject to audit in various jurisdictions, and such jurisdictions may assess additional income tax liabilities against us. Although we believe our tax estimates are reasonable, the final outcome of tax audits 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, 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.


18


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,
 
2013
 
2012
 
2013
 
2012
 
2013
 
2012
Operating activities
$
1,388

 
$
943

 
$
(103
)
 
$
(901
)
 
$
4,977

 
$
3,368

Investing activities
(1,063
)
 
(369
)
 
(3,432
)
 
(513
)
 
(6,514
)
 
(1,982
)
Financing activities
(230
)
 
31

 
(596
)
 
(907
)
 
2,570

 
(1,240
)
Our financial focus is on long-term, sustainable growth in free cash flow1. Free cash flow, a non-GAAP financial measure, was $388 million for the trailing twelve months ended September 30, 2013, compared to $1.1 billion for the trailing twelve months ended September 30, 2012, a decrease of 63%. See “Non-GAAP Financial Measures” below for a reconciliation of free cash flow to cash provided by operating activities. The decrease in free cash flow for the trailing twelve months ended September 30, 2013, compared to the comparable prior year period, was primarily due to increased capital expenditures, including the $1.4 billion purchase of property in December 2012, partially offset by 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, 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 $7.7 billion and $11.4 billion at September 30, 2013, and December 31, 2012. Amounts held in foreign currencies were $3.7 billion and $5.1 billion at September 30, 2013, and December 31, 2012, and were primarily Euros, British Pounds, Japanese Yen, and Chinese Yuan.
Cash provided by (used in) operating activities was $1.4 billion and $943 million for Q3 2013 and Q3 2012, and $(103) million and $(901) million for the nine months ended September 30, 2013 and 2012. 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, 2013, compared to the comparable prior year period, was primarily due to the increase in net income, excluding depreciation, amortization, and stock-based compensation, and 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 $(1.1) billion and $(369) million for Q3 2013 and Q3 2012, and $(3.4) billion and $(513) million for the nine months ended September 30, 2013 and 2012, 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 $1.0 billion and $716 million during Q3 2013 and Q3 2012, and $2.6 billion and $1.8 billion for the nine months ended September 30, 2013 and 2012, with the increases 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 $137 million and $109 million for internal-use software and website development during Q3 2013 and Q3 2012, and $363 million and $276 million for the nine months ended September 30, 2013 and 2012. 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 $1 million and $37 million during Q3 2013 and Q3 2012, and $252 million and $711 million for the nine months ended September 30, 2013 and 2012.
_______________________
(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.


19


Cash provided by (used in) financing activities was $(230) million and $31 million for Q3 2013 and Q3 2012, and $(596) million and $(907) million for the nine months ended September 30, 2013 and 2012. Cash outflows from financing activities result from common stock repurchases, 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 $255 million and $144 million in Q3 2013 and Q3 2012, and $728 million and $437 million for the nine months ended September 30, 2013 and 2012. Property and equipment acquired under capital leases were $526 million and $207 million during Q3 2013 and Q3 2012, and $1.3 billion and $564 million for the nine months ended September 30, 2013 and 2012, with the increases primarily reflecting additional investments in support of continued business growth due to investments in technology infrastructure, including AWS. In Q1 2012, we repurchased $960 million of our common stock under the $2.0 billion repurchase program authorized by our Board of Directors. 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 $25 million and $109 million in Q3 2013 and Q3 2012, and $132 million and $300 million for the nine months ended September 30, 2013 and 2012. Tax benefits relating to excess stock-based compensation deductions are presented as financing cash flows. Cash inflows (outflows) from tax benefits related to stock-based compensation deductions were $0 and $66 million for Q3 2013 and Q3 2012, and $0 and $190 million for the nine months ended September 30, 2013 and 2012.
We recorded a tax benefit of $12 million and tax provision of $83 million in Q3 2013 and Q3 2012, and a tax benefit of $18 million and tax provision of $234 million for the nine months ended September 30, 2013 and 2012. We have tax benefits relating to excess stock-based compensation deductions that are being utilized to reduce our U.S. taxable income. 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. Cash taxes paid (net of refunds) were $23 million and $21 million for Q3 2013 and Q3 2012, and $143 million and $60 million for the nine months ended September 30, 2013 and 2012. As of December 31, 2012, our federal net operating loss carry forward was approximately $89 million and we had approximately $136 million of federal tax credits, potentially available to offset future tax liabilities. As we utilize our federal tax credits, 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.
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 securities. Purchase obligations and open purchase orders, consisting of inventory and significant non-inventory commitments, were $7.1 billion at September 30, 2013. Purchase obligations and open purchase orders are generally cancellable in full or in part through the contractual provisions.
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 and 10 for Q3 2013 and Q3 2012. 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 other 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 outsource fulfillment providers.
We believe that cash flows generated from operations and our cash, cash equivalents, and marketable securities balances 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.


20


Results of Operations
We have organized our operations into two principal 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 are the seller of record. Services sales represent third-party seller fees earned (including commissions) and related shipping fees, digital content subscriptions, and non-retail activities such as AWS. Net sales information is as follows (in millions):
 
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2013
 
2012
 
2013
 
2012
Net Sales:
 
 
 
 
 
 
 
North America
$
10,301

 
$
7,884

 
$
29,186

 
$
22,638

International
6,791

 
5,922

 
19,679

 
17,187

Consolidated
$
17,092

 
$
13,806

 
$
48,865

 
$
39,825

Year-over-year Percentage Growth:
 
 
 
 
 
 
 
North America
31
%
 
33
%
 
29
%
 
35
%
International
15

 
20

 
15

 
24

Consolidated
24

 
27

 
23

 
30

Year-over-year Percentage Growth, excluding effect of exchange rates:
 
 
 
 
 
 
 
North America
31
%
 
33
%
 
29
%
 
35
%
International
20

 
27

 
20

 
29

Consolidated
26

 
30

 
25

 
32

Net Sales Mix:
 
 
 
 
 
 
 
North America
60
%
 
57
%
 
60
%
 
57
%
International
40

 
43

 
40

 
43

Consolidated
100
%
 
100
%
 
100
%
 
100
%
Sales increased 24% in Q3 2013 and 23% for the nine months ended September 30, 2013, compared to the comparable prior year periods. Changes in currency exchange rates impacted net sales by $(332) million and $(348) million for Q3 2013 and Q3 2012, and by $(1.0) billion and $(676) million for the nine months ended September 30, 2013 and 2012. For a discussion of the effect on sales growth of exchange rates, see “Effect of Exchange Rates” below.
North America sales grew 31% in Q3 2013 and 29% for the nine months ended September 30, 2013, 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, 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 grew 15% in Q3 2013 and 15% for the nine months ended September 30, 2013, 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, 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. Additionally, changes in currency exchange rates impacted International net sales by $(327) million and $(347) million for Q3 2013 and Q3 2012, and $(1.0) billion and $(670) million for the nine months ended September 30, 2013 and 2012. We expect that, over time, our International segment will represent 50% or more of our consolidated net sales.


21


Supplemental Information
Supplemental information about shipping results is as follows (in millions):
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2013
 
2012
 
2013
 
2012
Shipping Activity:
 
 
 
 
 
 
 
Shipping revenue (1)(2)(3)
$
721

 
$
517

 
$
1,999

 
$
1,448

Outbound shipping costs
(1,532
)
 
(1,153
)
 
(4,291
)
 
(3,336
)
Net shipping cost
$
(811
)
 
$
(636
)
 
$
(2,292
)
 
$
(1,888
)
Year-over-year Percentage Growth:
 
 
 
 
 
 
 
Shipping revenue
39
 %
 
44
 %
 
38
 %
 
42
 %
Outbound shipping costs
33

 
26

 
29

 
32

Net shipping cost
28

 
14

 
21

 
26

Percent of Net Sales:
 
 
 
 
 
 
 
Shipping revenue
4.2
 %
 
3.7
 %
 
4.1
 %
 
3.7
 %
Outbound shipping costs
(8.9
)
 
(8.3
)
 
(8.8
)
 
(8.4
)
Net shipping cost
(4.7
)%
 
(4.6
)%
 
(4.7
)%
 
(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.
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.

22


Net sales by similar products and services were as follows (in millions):
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2013
 
2012
 
2013
 
2012
Net Sales:
 
 
 
North America
 
 
 
 
 
 
 
Media
$
2,609

 
$
2,215

 
$
7,295

 
$
6,285

Electronics and other general merchandise
6,732

 
5,061

 
19,337

 
14,771

Other (1)
960

 
608

 
2,554

 
1,582

Total North America
$
10,301

 
$
7,884

 
$
29,186

 
$
22,638

International
 
 
 
 
 
 
 
Media
$
2,424

 
$
2,385

 
$
7,193

 
$
7,142

Electronics and other general merchandise
4,316

 
3,497

 
12,340

 
9,924

Other (1)
51

 
40

 
146

 
121

Total International
$
6,791

 
$
5,922

 
$
19,679

 
$
17,187

Consolidated
 
 
 
 
 
 
 
Media
$
5,033

 
$
4,600

 
$
14,488

 
$
13,427

Electronics and other general merchandise
11,048

 
8,558

 
31,677

 
24,695

Other (1)
1,011

 
648

 
2,700

 
1,703

Total consolidated
$
17,092

 
$
13,806

 
$
48,865

 
$
39,825

Year-over-year Percentage Growth:
 
 
 
 
 
 
 
North America
 
 
 
 
 
 
 
Media
18
%
 
15
%
 
16
%
 
16
%
Electronics and other general merchandise
33

 
39

 
31

 
42

Other
58

 
64

 
61

 
63

Total North America
31

 
33

 
29

 
35

International
 
 
 
 
 
 
 
Media
2
%
 
7
%
 
1
%
 
12
%
Electronics and other general merchandise
23

 
30

 
24

 
35

Other
28

 
7

 
21

 
15

Total International
15

 
20

 
15

 
24

Consolidated
 
 
 
 
 
 
 
Media
9
%
 
11
%
 
8
%
 
14
%
Electronics and other general merchandise
29

 
36

 
28

 
39

Other
56

 
59

 
59

 
58

Total consolidated
24

 
27

 
23

 
30

Year-over-year Percentage Growth:
 
 
 
 
 
 
 
Excluding the effect of exchange rates
 
 
 
 
 
 
 
International
 
 
 
 
 
 
 
Media
9
%
 
12
%
 
7
%
 
15
%
Electronics and other general merchandise
28

 
39

 
30

 
41

Other
32

 
13

 
26

 
20

Total International
20

 
27

 
20

 
29

Consolidated
 
 
 
 
 
 
 
Media
13
%
 
14
%
 
12
%
 
16
%
Electronics and other general merchandise
31

 
39

 
30

 
41

Other
56

 
60

 
59

 
59

Total consolidated
26

 
30

 
25

 
32

Consolidated Net Sales Mix:
 
 
 
 
 
 
 
Media
29
%
 
33
%
 
30
%
 
34
%
Electronics and other general merchandise
65

 
62

 
65

 
62

Other
6

 
5

 
5

 
4

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


23


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,
 
2013
 
2012
 
2013
 
2012
  
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
$
12,366

 
$

 
$
12,366

 
$
10,319

 
$

 
$
10,319

 
$
35,375

 
$

 
$
35,375

 
$
29,834

 
$

 
$
29,834

Fulfillment
2,034

 
(70
)
 
1,964

 
1,510

 
(56
)
 
1,454

 
5,667

 
(213
)
 
5,454

 
4,161

 
(149
)
 
4,012

Marketing
694

 
(23
)
 
671

 
540

 
(16
)
 
524

 
2,001

 
(63
)
 
1,938

 
1,557

 
(43
)
 
1,514

Technology and content
1,734

 
(154
)
 
1,580

 
1,192

 
(112
)
 
1,080

 
4,703

 
(428
)
 
4,275

 
3,219

 
(310
)
 
2,909

General and administrative
278

 
(34
)
 
244

 
230

 
(33
)
 
197

 
810

 
(104
)
 
706

 
662

 
(95
)
 
567

Other operating expense (income), net
11

 

 
11

 
43

 

 
43

 
74

 

 
74

 
121