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AMZN > SEC Filings for AMZN > Form 10-Q on 26-Oct-2012All Recent SEC Filings

Show all filings for AMAZON COM INC

Form 10-Q for AMAZON COM INC


26-Oct-2012

Quarterly Report


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 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 2011 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 2011 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, 2012, we would have recorded an additional cost of sales of approximately $52 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 geographies with limited financial history and developing revenue models. Changes in these forecasts could significantly change the amount of impairment recorded, if any.


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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, 2011, 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, 2012, 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 $21 million impact on our Q3 2012 operating income. Our estimated forfeiture rates at September 30, 2012, and December 31, 2011, were 27% and 28%.

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 both the U.S. and numerous foreign jurisdictions. Significant judgment is required in evaluating and estimating our tax positions and determining our provision and accruals for these taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. For example, 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), by changes in the valuation of our deferred tax assets and liabilities, or by changes in the relevant tax, accounting and other laws, regulations, principles and interpretations. We are subject to audit in various jurisdictions, and such jurisdictions may assess additional income tax against us. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different from our historical income tax provisions and accruals. The results of an audit or litigation could have a material effect on our operating results or cash flows in the period or periods for which that determination is made, as well as prior and subsequent periods.

If we determine that additional portions of our deferred tax assets are realizable, the majority of the benefit will come from the assets associated with the stock-based compensation that was not recognized in the financial statements, but was claimed on the tax return. Since this compensation was not recognized in our consolidated statements of operations as expense, the benefit generated will be recorded to stockholders' equity.

Recent Accounting Pronouncements

See Item 1 of Part I, "Financial Statements - Note 1 - Accounting Policies - Recent Accounting Pronouncements."


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Liquidity and Capital Resources

Cash flow information is as follows (in millions):



                                          Three Months  Ended           Nine Months  Ended           Twelve Months  Ended
                                             September 30,                 September 30,                 September 30,
                                           2012            2011         2012            2011          2012            2011
Operating activities                    $      943         $ 797      $    (901 )      $ (366 )    $     3,368      $  3,114
Investing activities                          (369 )         100           (513 )        (461 )         (1,982 )      (1,676 )
Financing activities                            31           (82 )         (907 )        (149 )         (1,240 )        (183 )

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, 2012, compared to $1.5 billion for the trailing twelve months ended September 30, 2011, a decrease of 31%. 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, 2012, compared to the comparable prior year period was primarily due to increased capital expenditures, a decline in net income, and changes in working capital2, partially offset by increases in noncash expenses, increases in deferred revenue, and increases in sales of gift certificates to customers. Tax benefits relating to excess stock-based compensation deductions are presented in the statement of cash flows as financing cash inflows; accordingly, as such tax benefits decline, a greater amount of cash is classified as operating cash inflow. Operating cash flows and free cash flows can be volatile and are sensitive to many factors, including changes in working capital, the timing and magnitude of capital expenditures, and our federal taxable income. 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 $5.2 billion and $9.6 billion at September 30, 2012, and December 31, 2011. Amounts held in foreign currencies were $3.2 billion and $4.1 billion at September 30, 2012, and December 31, 2011, and were primarily Euros, British Pounds, Japanese Yen, and Chinese Yuan.

Cash provided by (used in) operating activities was $943 million and $797 million for Q3 2012 and Q3 2011, and $(901) million and $(366) million for the nine months ended September 30, 2012 and 2011. Our operating cash flows result primarily from cash received from our consumer, seller, and enterprise customers, miscellaneous marketing and promotional 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. Changes to our operating cash flows have historically been driven primarily by changes in operating income and changes to the components of working capital, including changes to receivable and payable days and inventory turns, as well as changes to non-cash items such as excess stock-based compensation and deferred taxes.

(1) Free cash flow, a non-GAAP financial measure, is defined as net cash provided by operating activities less purchases of fixed assets, 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.


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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 $(369) million and $100 million for Q3 2012 and Q3 2011, and $(513) million and $(461) million for the nine months ended September 30, 2012 and 2011, with the variability caused primarily by purchases, maturities, and sales of marketable securities and other investments, increased capital expenditures, and increases in cash paid for acquisitions. Capital expenditures were $716 million and $529 million during Q3 2012 and Q3 2011, and $1.8 billion and $1.3 billion for the nine months ended September 30, 2012 and 2011, 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 $109 million and $71 million for internal-use software and website development during Q3 2012 and Q3 2011, and $276 million and $186 million for the nine months ended September 30, 2012 and 2011. 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 $37 million and $48 million during Q3 2012 and Q3 2011, and $711 million and $656 million during the nine months ended September 30, 2012 and 2011.

Cash provided by (used in) financing activities was $31 million and $(82) million for Q3 2012 and Q3 2011, and $(907) million and $(149) million for the nine months ended September 30, 2012 and 2011. 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 $144 million and $91 million in Q3 2012 and Q3 2011, and $437 million and $341 million for the nine months ended September 30, 2012 and 2011. In Q1 2012, we repurchased $960 million of our common stock under the $2 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 $109 million and $9 million in Q3 2012 and Q3 2011, and $300 million and $131 million for the nine months ended September 30, 2012 and 2011. 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 $66 million and $0 for Q3 2012 and Q3 2011, and $190 million and $61 million for the nine months ended September 30, 2012 and 2011.

We recorded net tax provisions of $83 million and $67 million in Q3 2012 and Q3 2011, and $234 million and $205 million for the nine months ended September 30, 2012 and 2011. A majority of this provision is non-cash. We have current tax benefits and net operating losses 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. Cash taxes paid (net of refunds) were $21 million and $12 million for Q3 2012 and Q3 2011, and $60 million and $18 million for the nine months ended September 30, 2012 and 2011. As of December 31, 2011, our federal net operating loss carryforward was approximately $384 million and we had approximately $273 million of federal tax credits potentially available to offset future tax liabilities. Once we utilize federal net operating losses and 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.

In January 2010, our Board of Directors authorized a program to repurchase up to $2 billion of our common stock. We repurchased 1.5 million shares of common stock for $277 million in 2011 and 5.3 million shares of common stock for $960 million in Q1 2012.

In October 2012, we entered into purchase and sale agreements to acquire certain of our currently leased corporate office space for approximately $1.16 billion and expect to close the purchase in Q4 2012. See Item 1 of Part I, "Financial Statements - Note 9 - Subsequent Event" for additional discussion. Additionally, as part of a plan to develop additional corporate office space, we have signed a purchase and sale agreement to acquire three city blocks in Seattle, Washington. Subject to the satisfactory conclusion of our due diligence process, status of land use entitlements, and customary closing conditions, we expect to close the purchase in Q4 2012. We are currently assessing whether we will use cash on hand or other financing options for these transactions. 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 $5.1 billion at September 30, 2012. Purchase obligations and open purchase orders are generally cancelable in full or in part through the contractual provisions.


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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 collect from our customers before our payments to suppliers come due. Inventory turnover4 was 10 and 11 for Q3 2012 and Q3 2011. We expect variability in inventory turnover over time as it is affected by several factors, including category expansion and changes in our product mix, the mix of sales by us and by other sellers, our continuing focus on in-stock inventory availability, 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.


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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 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. Net sales information is as follows (in millions):

                                              Three Months Ended               Nine Months Ended
                                                 September 30,                   September 30,
                                             2012             2011            2012            2011
Net Sales:
North America                              $   7,884        $  5,932        $ 22,638        $ 16,804
International                                  5,922           4,944          17,187          13,842

Consolidated                               $  13,806        $ 10,876        $ 39,825        $ 30,646

Year-over-year Percentage Growth:
North America                                     33 %            44 %            35 %            46 %
International                                     20              44              24              42
Consolidated                                      27              44              30              44
Year-over-year Percentage Growth,
excluding effect of exchange rates:
North America                                     33 %            44 %            35 %            46 %
International                                     27              33              29              32
Consolidated                                      30              39              32              40
Net Sales Mix:
North America                                     57 %            55 %            57 %            55 %
International                                     43              45              43              45

Consolidated                                     100 %           100 %           100 %           100 %

Sales increased 27% in Q3 2012 and 30% for the nine months ended September 30, 2012, compared to the comparable prior year periods. Changes in currency exchange rates impacted net sales by $(348) million for Q3 2012 and $371 million for Q3 2011, and by $(676) million and $992 million for the nine months ended September 30, 2012 and 2011. For a discussion of the effect on sales growth of exchange rates, see "Effect of Exchange Rates" below.

North America sales grew 33% in Q3 2012 and 35% for the nine months ended September 30, 2012, compared to the comparable prior year periods. The sales growth primarily reflects increased unit sales, partially offset by a higher percentage of 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 20% in Q3 2012 and 24% for the nine months ended September 30, 2012, compared to the comparable prior year periods. The sales growth primarily reflects increased unit sales, partially offset by a higher percentage of 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 $(347) million for Q3 2012 and by $367 million for Q3 2011, and $(670) million and $981 million for the nine months ended September 30, 2012 and 2011. We expect that, over time, our International segment will represent 50% or more of our consolidated net sales.


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Supplemental Information

Supplemental information about shipping results is as follows (in millions):



                                       Three Months  Ended             Nine Months Ended
                                          September 30,                  September 30,
                                        2012            2011          2012           2011
. . .
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