AMAZON COM INC 10-Q

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 customer spending, world events, the rate of growth of the Internet, online commerce, and cloud services, the amount that Amazon.com invests in new business opportunities and the timing of those investments, the mix of products and services sold to customers, the mix of net sales derived from products as compared with services, the extent to which we owe income or other taxes, competition, management of growth, potential fluctuations in operating results, international growth and expansion, the outcomes of claims, litigation, government investigations, and other proceedings, fulfillment, sortation, delivery, and data center optimization, risks of inventory management, seasonality, the degree to which we enter into, maintain, and develop commercial agreements, proposed and completed acquisitions and strategic transactions, payments risks, and risks of fulfillment throughput and productivity. In addition, the global economic climate and additional or unforeseen effects from the COVID-19 pandemic amplify 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 2019 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 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 2019 Annual Report on Form 10-K and Item 1 of Part I, “Financial Statements — Note 1 — Accounting Policies and Supplemental Disclosures,” of this Form 10-Q. Although we believe that our estimates, assumptions, and judgments are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates under different assumptions, judgments, or conditions. Inventories Inventories, consisting of products available for sale, are primarily accounted for using the first-in first-out method, and are valued at the lower of cost and net realizable value. This valuation requires us to make judgments, based on currently available information, about the likely method of disposition, such as through sales to individual customers, returns to product vendors, or liquidations, and expected recoverable values of each disposition category. These assumptions about future disposition of inventory are inherently uncertain and changes in our estimates and assumptions may cause us to realize material write-downs in the future. As a measure of sensitivity, for every 1% of additional inventory valuation allowance as of September 30, 2020, we would have recorded an additional cost of sales of approximately $265 million. In addition, we enter into supplier commitments for certain electronic device components and certain products. These commitments are based on forecasted customer demand. If we reduce these commitments, we may incur additional costs. Income Taxes We are subject to income taxes in the U.S. (federal and state) and numerous foreign jurisdictions. Tax laws, regulations, administrative practices, principles, and interpretations in various jurisdictions may be subject to significant change, with or without notice, due to economic, political, and other conditions, and significant judgment is required in evaluating and estimating our provision and accruals for these taxes. There are many transactions that occur during the ordinary course of business for which the ultimate tax determination is uncertain. In addition, our actual and forecasted earnings are subject to 19 Table of Contents change due to economic, political, and other conditions, such as the COVID-19 pandemic, and significant judgment is required in determining our ability to use our deferred tax assets. Our effective tax rates could be affected by numerous factors, such as changes in our business operations, acquisitions, investments, entry into new businesses and geographies, intercompany transactions, the relative amount of our foreign earnings, including earnings being lower than anticipated in jurisdictions where we have lower statutory rates and higher than anticipated in jurisdictions where we have higher statutory rates, losses incurred in jurisdictions for which we are not able to realize related tax benefits, the applicability of special tax regimes, changes in foreign currency exchange rates, changes in our stock price, changes to our forecasts of income and loss and the mix of jurisdictions to which they relate, changes in our deferred tax assets and liabilities and their valuation, changes in the laws, regulations, administrative practices, principles, and interpretations related to tax, including changes to the global tax framework, competition, and other laws and accounting rules in various jurisdictions. In addition, a number of countries are actively pursuing changes to their tax laws applicable to corporate multinationals, such as the U.S. tax reform legislation commonly known as the U.S. Tax Cuts and Jobs Act of 2017 (the “U.S. Tax Act”). Finally, foreign governments may enact tax laws in response to the U.S. Tax Act that could result in further changes to global taxation and materially affect our financial position and results of operations. We are also currently subject to tax controversies in various jurisdictions, and these jurisdictions may assess additional income tax liabilities against us. Developments in an audit, investigation, or other tax controversy 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. We regularly assess the likelihood of an adverse outcome resulting from these proceedings to determine the adequacy of our tax accruals. Although we believe our tax estimates are reasonable, the final outcome of audits, investigations, and any other tax controversies could be materially different from our historical income tax provisions and accruals. 20 Table of Contents 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, 2019 2020 2019 2020 2019 2020 Cash provided by (used in): Operating activities $ 7,892 $ 11,964 $ 18,855 $ 35,633 $ 35,332 $ 55,292 Investing activities (5,074) (15,876) (20,745) (42,574) (24,317) (46,110) Financing activities (1,960) (4,105) (6,495) 712 (8,255) (2,859) 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 $55.0 billion and $68.4 billion as of December 31, 2019 and September 30, 2020. Amounts held in foreign currencies were $15.3 billion and $15.6 billion as of December 31, 2019 and September 30, 2020, and were primarily Euros, British Pounds, and Japanese Yen. Cash provided by (used in) operating activities was $7.9 billion and $12.0 billion for Q3 2019 and Q3 2020, and $18.9 billion and $35.6 billion for the nine months ended September 30, 2019 and 2020. Our operating cash flows result primarily from cash received from our consumer, seller, developer, enterprise, and content creator customers, and advertisers, offset by cash payments we make for products and services, employee compensation, payment processing and related transaction costs, operating leases, and interest payments on our long-term obligations. Cash received from our 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, 2020, compared to the comparable prior year period, was primarily due to the increase in net income, excluding non-cash expenses, and changes in working capital. 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. Cash provided by (used in) investing activities corresponds with cash capital expenditures including leasehold improvements, incentives received from property and equipment vendors, proceeds from asset sales, 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 $(5.1) billion and $(15.9) billion for Q3 2019 and Q3 2020, and $(20.7) billion and $(42.6) billion for the nine months ended September 30, 2019 and 2020, with the variability caused primarily by our decision to purchase or lease property and equipment and purchases, maturities, and sales of marketable securities. Cash capital expenditures were $3.4 billion and $9.8 billion during Q3 2019 and Q3 2020, and $8.7 billion and $21.9 billion for the nine months ended September 30, 2019 and 2020, which primarily reflect investments in additional capacity to support our fulfillment operations and in support of continued business growth in technology infrastructure (the majority of which is to support AWS), which investments we expect to continue over time. We made cash payments, net of acquired cash, related to acquisition and other investment activity of $398 million and $1.7 billion during Q3 2019 and Q3 2020, and $1.7 billion and $1.9 billion for the nine months ended September 30, 2019 and 2020. Cash provided by (used in) financing activities was $(2.0) billion and $(4.1) billion for Q3 2019 and Q3 2020, and $(6.5) billion and $712 million for the nine months ended September 30, 2019 and 2020. Cash inflows from financing activities resulted from proceeds of short-term debt, and other and long-term debt of $702 million and $1.3 billion for Q3 2019 and Q3 2020, and $1.2 billion and $14.4 billion for the nine months ended September 30, 2019 and 2020. Cash outflows from financing activities resulted from payments of short-term debt, and other, long-term debt, finance leases, and financing obligations of $2.7 billion and $5.4 billion in Q3 2019 and Q3 2020, and $7.7 billion and $13.6 billion for the nine months ended September 30, 2019 and 2020. Property and equipment acquired under finance leases was $3.6 billion during Q3 2019 and Q3 2020, and $9.5 billion and $8.9 billion for the nine months ended September 30, 2019 and 2020, reflecting investments in support of continued business growth primarily due to investments in technology infrastructure for AWS. We had no borrowings outstanding under the Credit Agreement, $725 million of borrowings outstanding under the Commercial Paper Program, and $413 million of borrowings outstanding under our Credit Facility as of September 30, 2020. See Item 1 of Part I, “Financial Statements — Note 5 — Debt” for additional information. We recorded net tax provisions of $494 million and $569 million in Q3 2019 and Q3 2020, and $1.6 billion and $2.3 billion for the nine months ended September 30, 2019 and 2020. Certain foreign subsidiary earnings are subject to U.S. taxation under the U.S. Tax Act, which also repeals U.S. taxation on the subsequent repatriation of those earnings. We intend to invest substantially all of our foreign subsidiary earnings, as well as our capital in our foreign subsidiaries, indefinitely outside of the U.S. in those jurisdictions in which we would incur significant, additional costs upon repatriation of such amounts. Tax benefits relating to excess stock-based compensation deductions and accelerated depreciation deductions are reducing our U.S. taxable income. The U.S. Tax Act enhanced and extended accelerated depreciation deductions by allowing 21 Table of Contents full expensing of qualified property, primarily equipment, through 2022. Cash taxes paid (net of refunds) were $241 million and $502 million for Q3 2019 and Q3 2020, and $692 million and $1.3 billion for the nine months ended September 30, 2019 and 2020. As of December 31, 2019, we had approximately $1.7 billion of federal tax credits potentially available to offset future tax liabilities. Our federal tax credits are primarily related to the U.S. federal research and development credit. As we utilize our federal tax credits we expect cash paid for taxes to increase. We endeavor to manage our global taxes on a cash basis, rather than on a financial reporting basis. In connection with the European Commission’s October 2017 decision against us on state aid, Luxembourg tax authorities computed an initial recovery amount, consistent with the European Commission’s decision, of approximately €250 million, that we deposited into escrow in March 2018, subject to adjustment pending conclusion of all appeals. Our liquidity is also affected by restricted cash balances that are pledged as collateral for real estate leases, amounts due to third-party sellers in certain jurisdictions, debt, and standby and trade letters of credit. To the extent we process payments for third-party sellers or offer certain types of stored value to our customers, some jurisdictions may restrict our use of those funds. These restrictions would result in the reclassification of a portion of our cash and cash equivalents from “Cash and cash equivalents” to restricted cash, which is classified within “Accounts receivable, net and other” and “Other assets” on our consolidated balance sheets. As of December 31, 2019 and September 30, 2020, restricted cash, cash equivalents, and marketable securities were $321 million and $275 million. See Item 1 of Part I, “Financial Statements — Note 4 — Commitments and Contingencies” and “Financial Statements — Note 5 — Debt” for additional discussion of our principal contractual commitments, as well as our pledged assets. Additionally, purchase obligations and open purchase orders, consisting of inventory and significant non-inventory commitments, were $31.4 billion as of September 30, 2020. These purchase obligations and open purchase orders are generally cancellable in full or in part through the contractual provisions. We believe that cash flows generated from operations and our cash, cash equivalents, and marketable securities balances, as well as our borrowing arrangements, will be sufficient to meet our anticipated operating cash needs for at least the next twelve 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, obtain finance and operating lease arrangements, enter into financing obligations, repurchase common stock, pay dividends, or repurchase, refinance, or otherwise restructure our debt for strategic reasons or to further strengthen our financial position. The COVID-19 pandemic and resulting global disruptions have caused significant market volatility. This disruption can contribute to defaults in our accounts receivable, affect asset valuations resulting in impairment charges, and affect the availability of lease and financing credit as well as other segments of the credit markets. We have utilized a range of financing methods to fund our operations and capital expenditures and expect to continue to maintain financing flexibility in the current market conditions. However, due to the rapidly evolving global situation, it is not possible to predict whether unanticipated consequences of the pandemic are reasonably likely to materially affect our liquidity and capital resources in the future. 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, capital infrastructure, and technologies, which might affect our liquidity requirements or cause us to secure additional financing, or issue additional equity or debt securities. There can be no assurance that additional credit lines or financing instruments will be available in amounts or on terms acceptable to us, if at all. 22 Table of Contents Results of Operations We have organized our operations into three segments: North America, International, and AWS. These segments reflect the way the Company evaluates its business performance and manages its operations. See Item 1 of Part I, “Financial Statements — Note 8 — Segment Information.” Effects of COVID-19 The COVID-19 pandemic and resulting global disruptions have continued to affect our businesses, as well as those of our customers, suppliers, and third-party sellers. To serve our customers while also providing for the safety of our employees and service providers, we have adapted numerous aspects of our logistics, transportation, supply chain, purchasing, and third-party seller processes. Beginning in Q1 2020, we made numerous process updates across our operations worldwide, and adapted our fulfillment network, to implement employee and customer safety measures, such as enhanced cleaning and physical distancing, personal protective gear, disinfectant spraying, and temperature checks. Since February 2020, we have hired over 250,000 full-time and part-time employees to increase our fulfillment network capacity. We incurred more than $2.5 billion in COVID-19 related costs in Q3 2020, for a total of more than $7.5 billion in the first three quarters of 2020. We will continue to prioritize employee and customer safety and comply with evolving federal, state, and local standards as well as to implement standards or processes that we determine to be in the best interests of our employees, customers, and communities. As reflected in the discussion below, the impact of the pandemic and actions taken in response to it had varying effects on our Q3 2020 results of operations. Higher net sales in the North America and International segments reflect increased demand, particularly as people are staying at home, including for household staples and other essential and home products, partially offset by fulfillment network capacity and supply chain constraints. Other effects in the North America and International segments include increased cost of sales and fulfillment costs as a percentage of net sales, primarily due to the impact of lower productivity, costs to maintain safe workplaces, and increased employee hiring and benefits. We expect the effects of fulfillment network capacity and supply chain constraints, elevated collection risk in our accounts receivable, and increased cost of sales and fulfillment costs as a percentage of net sales to continue into all or portions of Q4 2020. However, it is not possible to determine the duration and scope of the pandemic, including any recurrence, the actions taken in response to the pandemic, the scale and rate of economic recovery from the pandemic, any ongoing effects on consumer demand and spending patterns, or other impacts of the pandemic, and whether these or other currently unanticipated consequences of the pandemic are reasonably likely to materially affect our results of operations. 23 Table of Contents Net Sales Net sales include product and service sales. Product sales represent revenue from the sale of products and related shipping fees and digital media content where we record revenue gross. Service sales primarily represent third-party seller fees, which includes commissions and any related fulfillment and shipping fees, AWS sales, Amazon Prime membership fees, advertising services, and certain digital content subscriptions. Net sales information is as follows (in millions): Three Months Ended September 30, Nine Months Ended September 30, 2019 2020 2019 2020 Net Sales: North America $ 42,638 $ 59,373 $ 117,104 $ 160,936 International 18,348 25,171 50,910 66,945 AWS 8,995 11,601 25,072 32,628 Consolidated $ 69,981 $ 96,145 $ 193,086 $ 260,509 Year-over-year Percentage Growth: North America 24 % 39 % 20 % 37 % International 18 37 13 31 AWS 35 29 38 30 Consolidated 24 37 20 35 Year-over-year Percentage Growth, excluding the effect of foreign exchange rates: North America 24 % 39 % 21 % 38 % International 21 33 18 32 AWS 35 29 38 30 Consolidated 25 36 22 35 Net sales mix: North America 61 % 62 % 61 % 62 % International 26 26 26 26 AWS 13 12 13 12 Consolidated 100 % 100 % 100 % 100 % Sales increased 37% in Q3 2020 and 35% for the nine months ended September 30, 2020 compared to the comparable prior year periods. Changes in foreign currency exchange rates impacted net sales by $691 million for Q3 2020 and by $(278) million for the nine months ended September 30, 2020. For a discussion of the effect on sales growth of foreign exchange rates, see “Effect of Foreign Exchange Rates” below. North America sales increased 39% in Q3 2020, and 37% for the nine months ended September 30, 2020 compared to the comparable prior year periods. The sales growth primarily reflects increased unit sales, including sales by third-party sellers. Increased unit sales were driven largely by our continued efforts to reduce prices for our customers, including from our shipping offers, and increased demand, including for household staples and other essential and home products, partially offset by fulfillment network capacity and supply chain constraints. International sales increased 37% in Q3 2020 and 31% for the nine months ended September 30, 2020 compared to the comparable prior year periods. The sales growth primarily reflects increased unit sales, including sales by third-party sellers. Increased unit sales were driven largely by our continued efforts to reduce prices for our customers, including from our shipping offers, and increased demand, including for household staples and other essential and home products, partially offset by fulfillment network capacity and supply chain constraints. Changes in foreign currency exchange rates impacted International net sales by $747 million for Q3 2020, and by $(59) million for the nine months ended September 30, 2020. AWS sales increased 29% in Q3 2020 and 30% for the nine months ended September 30, 2020 compared to the comparable prior year periods. The sales growth primarily reflects increased customer usage, partially offset by pricing changes. Pricing changes were driven largely by our continued efforts to reduce prices for our customers. 24 Table of Contents Operating Income (Loss) Operating income (loss) by segment is as follows (in millions): Three Months Ended September 30, Nine Months Ended September 30, 2019 2020 2019 2020 Operating Income (Loss): North America $ 1,282 $ 2,252 $ 5,133 $ 5,704 International (386) 407 (1,076) 355 AWS 2,261 3,535 6,605 9,967 Consolidated $ 3,157 $ 6,194 $ 10,662 $ 16,026 Operating income increased from $3.2 billion in Q3 2019 to $6.2 billion in Q3 2020, and increased from $10.7 billion for the nine months ended September 30, 2019, to $16.0 billion for the nine months ended September 30, 2020. We believe that operating income (loss) is a more meaningful measure than gross profit and gross margin due to the diversity of our product catego ries and services. The increase in North America operating income in absolute dollars in Q3 2020 and for the nine months ended September 30, 2020, compared to the comparable prior year periods, is primarily due to increased unit sales, including sales by third-party sellers, and advertising sales and slower growth in certain operating expenses, partially offset by increased shipping and fulfillment costs due in part to COVID-19. We expect North America operating income to continue to be negatively impacted through at least Q4 2020 by COVID-19 related costs. The International operating income in Q3 2020 and for the nine months ended September 30, 2020 , as compared to the operating loss in the comparable prior year periods, is primarily due to increased unit sales, including sales by third-party sellers, and advertising sales and slower growth in certain operating expenses, partially offset by increased shipp ing and fulfillment costs due in part to COVID-19. We expect International operating income to continue to be negatively impacted through at least Q4 2020 by COVID-19 related costs. Changes in foreign exchange rates impacted operating income (loss) by $152 million for Q3 2020, and by $180 million for the nine months ended September 30, 2020. The increase in AWS operating income in absolute dollars in Q3 2020 and for the nine months ended September 30, 2020, compared to the comparable prior year periods, is primarily due to increased customer usage and cost structure productivity, including a reduction in depreciation and amortization expense from our change in the estimated useful life of our servers, partially offset by increased spending on technology infrastructure and payroll and related expenses, bo th of which were primarily driven by additional investments to support the business growth, and reduced prices for our customers . Changes in foreign exchange rates impacted operating income by $(20) million for Q3 2020, and by $127 million for the nine months ended September 30, 2020. 25 Table of Contents Operating Expenses Information about operating expenses is as follows (in millions): Three Months Ended September 30, Nine Months Ended September 30, 2019 2020 2019 2020 Operating Expenses: Cost of sales $ 41,302 $ 57,106 $ 111,559 $ 154,023 Fulfillment 10,167 14,705 28,040 40,043 Technology and content 9,200 10,976 26,191 30,691 Marketing 4,752 5,434 12,707 14,605 General and administrative 1,348 1,668 3,791 4,700 Other operating expense (income), net 55 62 136 421 Total operating expenses $ 66,824 $ 89,951 $ 182,424 $ 244,483 Year-over-year Percentage Growth: Cost of sales 25 % 38 % 18 % 38 % Fulfillment 23 45 17 43 Technology and content 28 19 24 17 Marketing 44 14 43 15 General and administrative 29 24 18 24 Other operating expense (income), net (19) 12 (35) 209 Percent of Net Sales: Cost of sales 59.0 % 59.4 % 57.8 % 59.1 % Fulfillment 14.5 15.3 14.5 15.4 Technology and content 13.1 11.4 13.6 11.8 Marketing 6.8 5.7 6.6 5.6 General and administrative 1.9 1.7 2.0 1.8 Other operating expense (income), net 0.1 0.1 0.1 0.2 Cost of Sales Cost of sales primarily consists of the purchase price of consumer products, inbound and outbound shipping costs, including costs related to sortation and delivery centers and where we are the transportation service provider, and digital media content costs where we record revenue gross, including video and music. The increase in cost of sales in absolute dollars in Q3 2020 and for the nine months ended September 30, 2020, compared to the comparable prior year periods, is primarily due to increased product and shipping costs resulting from increased sales. We expect cost of sales as a percentage of net sales to continue to be negatively impacted through at least Q4 2020 by COVID-19 related costs. Shipping costs to receive products from our suppliers are included in our inventory and recognized as cost of sales upon sale of products to our customers. Shipping costs, which include sortation and delivery centers and transportation costs, were $9.6 billion and $15.1 billion in Q3 2019 and Q3 2020, and $25.1 billion and $39.7 billion for the nine months ended September 30, 2019 and 2020. We expect our cost of shipping to continue to increase to the extent our customers accept and use our shipping offers at an increasing rate, we reduce shipping rates, we use more expensive shipping methods, including faster delivery, and we offer additional services. We seek to mitigate costs of shipping over time in part through achieving higher sales volumes, optimizing our fulfillment network, 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. Costs to operate our AWS segment are primarily classified as “Technology and content” as we leverage a shared infrastructure that supports both our internal technology requirements and external sales to AWS customers. 26 Table of Contents Fulfillment Fulfillment costs primarily consist of those costs incurred in operating and staffing our North America and International fulfillment centers, physical stores, and customer service centers and payment processing costs. While AWS payment processing and related transaction costs are included in “Fulfillment,” AWS costs are primarily classified as “Technology and content.” Fulfillment costs as a percentage of net sales may vary due to several factors, such as payment processing and related transaction costs, our level of productivity and accuracy, changes in volume, size, and weight of units received and fulfilled, the extent to which third party sellers utilize Fulfillment by Amazon services, timing of fulfillment network and physical store expansion, the extent we utilize fulfillment services provided by third parties, mix of products and services sold, and our ability to affect customer service contacts per unit by implementing improvements in our operations and enhancements to our customer self-service features. Additionally, sales by our sellers have higher payment processing and related transaction costs as a percentage of net sales compared to our retail sales because payment processing costs are based on the gross purchase price of underlying transactions. The increase in fulfillment costs in absolute dollars in Q3 2020 and for the nine months ended September 30, 2020, compared to the comparable prior year periods, is primarily due to variable costs corresponding with increased product and service sales volume and inventory levels, costs from expanding our fulfillment network, and the COVID-19 related impact of lower productivity, costs to maintain safe workplaces, and increased employee hiring and benefits. We expect fulfillment costs as a percentage of net sales to continue to be negatively impacted through at least Q4 2020 by COVID-19 related costs. We seek to expand our fulfillment network to accommodate a greater selection and in-stock inventory levels and to meet anticipated shipment volumes from sales of our own products as well as sales by third parties for which we provide the fulfillment services. We regularly evaluate our facility requirements. Technology and Content Technology and content costs include payroll and related expenses for employees involved in the research and development of new and existing products and services, development, design, and maintenance of our stores, curation and display of products and services made available in our online stores, and infrastructure costs. Infrastructure costs include servers, networking equipment, and data center related depreciation and amortization, rent, utilities, and other expenses necessary to support AWS and other Amazon businesses. Collectively, these costs reflect the investments we make in order to offer a wide variety of products and services to our customers. We seek to invest efficiently in numerous areas of technology and content so we may continue to enhance the customer experience and improve our process efficiency through rapid technology developments, while operating at an ever increasing scale. Our technology and content investment and capital spending projects often support a variety of product and service offerings due to geographic expansion and the cross-functionality of our systems and operations. We expect spending in technology and content to increase over time as we continue to add employees and technology infrastructure. These costs are allocated to segments based on usage. The increase in technology and content costs in absolute dollars in Q3 2020 and for the nine months ended September 30, 2020, compared to the comparable prior year periods, is primarily due to increased payroll and related costs associated with technical teams responsible for expanding our existing products and services and initiatives to introduce new products and service offerings and an increase in spending on technology infrastructure, offset by a reduction in depreciation and amortization expense from our change in the estimated useful life of our servers. See Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview” of our 2019 Annual Report on Form 10-K for a discussion of how management views advances in technology and the importance of innovation. See Item 1 of Part I, “Financial Statements — Note 1 — Accounting Policies and Supplemental Disclosures — Use of Estimates” for additional information on our change in the estimated useful life of our servers. Marketing Marketing costs include advertising and payroll and related expenses for personnel engaged in marketing and selling activities, including sales commissions related to AWS. We direct customers to our stores primarily through a number of marketing channels, such as our sponsored search, third party customer referrals, social and online advertising, television advertising, and other initiatives. Our marketing costs are largely variable, based on growth in sales and changes in rates. To the extent there is increased or decreased competition for these traffic sources, or to the extent our mix of these channels shifts, we would expect to see a corresponding change in our marketing costs. The increase in marketing costs in absolute dollars in Q3 2020 and for the nine months ended September 30, 2020, compared to the comparable prior year periods, is primarily due to increased payroll and related expenses for personnel engaged in marketing and selling activities, partially offset by lower spending on marketing channels as a result of COVID-19. We expect marketing costs as a percentage of net sales to continue to be favorably impacted through at least Q4 2020 by COVID-19. While costs associated with Amazon Prime memberships and other shipping offers are not included in marketing expense, we view these offers as effective worldwide marketing tools, and intend to continue offering them indefinitely. 27 Table of Contents General and Administrative The increase in general and administrative costs in absolute dollars in Q3 2020 and for the nine months ended September 30, 2020, compared to the comparable prior year periods, is primarily due to increases in payroll and related expenses. Other Operating Expense (Income), Net Other operating expense (income), net was $55 million and $62 million for Q3 2019 and Q3 2020, and $136 million and $421 million for the nine months ended September 30, 2019 and 2020, and was primarily related to a lease impairment in Q2 2020 and the amortization of intangible assets. Interest Income and Expense Our interest income was $224 million and $118 million during Q3 2019 and Q3 2020, and $621 million and $455 million for the nine months ended September 30, 2019 and 2020. We generally invest our excess cash in AAA-rated money market funds and investment grade short- to intermediate-term fixed income securities. Our interest income corresponds with the average balance of invested funds based on the prevailing rates, which vary depending on the geographies and currencies in which they are invested. Interest expense was $396 million and $428 million during Q3 2019 and Q3 2020, and $1.1 billion and $1.2 billion for the nine months ended September 30, 2019 and 2020, and was primarily related to debt and finance leases. Other Income (Expense), Net Other income (expense), net was $(353) million and $925 million during Q3 2019 and Q3 2020, and $(215) million and $1.2 billion for the nine months ended September 30, 2019 and 2020. The primary components of other income (expense), net are related to warrant and equity securities valuations and adjustments and foreign currency. Income Taxes Our income tax provisions for the nine months ended September 30, 2019 and 2020 were $1.6 billion and $2.3 billion, which included $1.0 billion and $1.5 billion of net discrete tax benefits primarily attributable to excess tax benefits from stock-based compensation. See Item 1 of Part I, “Financial Statements — Note 7 — Income Taxes” for additional information. Non-GAAP Financial Measures Regulation G, Conditions for Use of Non-GAAP Financial Measures, and other SEC regulations define and prescribe the conditions for use of certain non-GAAP financial information. Our measures of free cash flows and the effect of foreign exchange rates on our consolidated statements of operations meet the definition of non-GAAP financial measures. We provide multiple measures of free cash flows because we believe these measures provide additional perspective on the impact of acquiring property and equipment with cash and through finance leases and financing obligations. Free Cash Flow Free cash flow is cash flow from operations reduced by “Purchases of property and equipment, net of proceeds from sales and incentives.” The following is a reconciliation of free cash flow to the most comparable GAAP cash flow measure, “Net cash provided by (used in) operating activities,” for the trailing twelve months ended September 30, 2019 and 2020 (in millions): Twelve Months Ended September 30, 2019 2020 Net cash provided by (used in) operating activities $ 35,332 $ 55,292 Purchases of property and equipment, net of proceeds from sales and incentives (11,868) (25,791) Free cash flow $ 23,464 $ 29,501 Net cash provided by (used in) investing activities $ (24,317) $ (46,110) Net cash provided by (used in) financing activities $ (8,255) $ (2,859) 28 Table of Contents Free Cash Flow Less Principal Repayments of Finance Leases and Financing Obligations Free cash flow less principal repayments of finance leases and financing obligations is free cash flow reduced by “Principal repayments of finance leases” and “Principal repayments of financing obligations.” Principal repayments of finance leases and financing obligations approximates the actual payments of cash for our finance leases and financing obligations. The following is a reconciliation of free cash flow less principal repayments of finance leases and financing obligations to the most comparable GAAP cash flow measure, “Net cash provided by (used in) operating activities,” for the trailing twelve months ended September 30, 2019 and 2020 (in millions): Twelve Months Ended September 30, 2019 2020 Net cash provided by (used in) operating activities $ 35,332 $ 55,292 Purchases of property and equipment, net of proceeds from sales and incentives (11,868) (25,791) Free cash flow 23,464 29,501 Principal repayments of finance leases (8,754) (11,054) Principal repayments of financing obligations (129) (68) Free cash flow less principal repayments of finance leases and financing obligations $ 14,581 $ 18,379 Net cash provided by (used in) investing activities $ (24,317) $ (46,110) Net cash provided by (used in) financing activities $ (8,255) $ (2,859) Free Cash Flow Less Equipment Finance Leases and Principal Repayments of All Other Finance Leases and Financing Obligations Free cash flow less equipment finance leases and principal repayments of all other finance leases and financing obligations is free cash flow reduced by equipment acquired under finance leases, which is included in “Property and equipment acquired under finance leases,” principal repayments of all other finance lease liabilities, which is included in “Principal repayments of finance leases,” and “Principal repayments of financing obligations.” All other finance lease liabilities and financing obligations consists of property. In this measure, equipment acquired under finance leases is reflected as if these assets had been purchased with cash, which is not the case as these assets have been leased. The following is a reconciliation of free cash flow less equipment finance leases and principal repayments of all other finance leases and financing obligations to the most comparable GAAP cash flow measure, “Net cash provided by (used in) operating activities,” for the trailing twelve months ended September 30, 2019 and 2020 (in millions): Twelve Months Ended September 30, 2019 2020 Net cash provided by (used in) operating activities $ 35,332 $ 55,292 Purchases of property and equipment, net of proceeds from sales and incentives (11,868) (25,791) Free cash flow 23,464 29,501 Equipment acquired under finance leases (1) (12,580) (11,116) Principal repayments of all other finance leases (2) (302) (413) Principal repayments of financing obligations (129) (68) Free cash flow less equipment finance leases and principal repayments of all other finance leases and financing obligations $ 10,453 $ 17,904 Net cash provided by (used in) investing activities $ (24,317) $ (46,110) Net cash provided by (used in) financing activities $ (8,255) $ (2,859) ___________________ (1) For the twelve months ended September 30, 2019 and 2020, this amount relates to equipment included in “Property and equipment acquired under finance leases” of $13,222 million and $13,075 million. (2) For the twelve months ended September 30, 2019 and 2020, this amount relates to property included in “Principal repayments of finance leases” of $8,754 million and $11,054 million. All of these free cash flows measures have limitations as they omit certain components of the overall cash flow statement and do not represent the residual cash flow available for discretionary expenditures. For example, these measures of free cash flows do 29 Table of Contents not incorporate the portion of payments representing principal reductions of debt or cash payments for business acquisitions. Additionally, our mix of property and equipment acquisitions with cash or other financing options may change over time. Therefore, we believe it is important to view free cash flows measures only as a complement to our entire consolidated statements of cash flows. Effect of Foreign Exchange Rates Information regarding the effect of foreign exchange rates, versus the U.S. Dollar, on our net sales, operating expenses, and operating income is provided to show reported period operating results had the foreign exchange rates remained the same as those in effect in the comparable prior year periods. The effect on our net sales, operating expenses, and operating income from changes in our foreign exchange rates versus the U.S. Dollar is as follows (in millions): Three Months Ended September 30, Nine Months Ended September 30, 2019 2020 2019 2020 As Reported Exchange Rate Effect (1) At Prior Year Rates (2) As Reported Exchange Rate Effect (1) At Prior Year Rates (2) As Reported Exchange Rate Effect (1) At Prior Year Rates (2) As Reported Exchange Rate Effect (1) At Prior Year Rates (2) Net sales $ 69,981 $ 500 $ 70,481 $ 96,145 $ (691) $ 95,454 $ 193,086 $ 2,440 $ 195,526 $ 260,509 $ 278 $ 260,787 Operating expenses 66,824 522 67,346 89,951 (558) 89,393 182,424 2,604 185,028 244,483 585 245,068 Operating income 3,157 (22) 3,135 6,194 (133) 6,061 10,662 (164) 10,498 16,026 (307) 15,719 ___________________ (1) Represents the change in reported amounts resulting from changes in foreign exchange rates from those in effect in the comparable prior year period for operating results. (2) Represents the outcome that would have resulted had foreign exchange rates in the reported period been the same as those in effect in the comparable prior year period for operating results. 30 Table of Contents Guidance We provided guidance on October 29, 2020, in our earnings release furnished on Form 8-K as set forth below. These forward-looking statements reflect Amazon.com’s expectations as of October 29, 2020, and are subject to substantial uncertainty. Our results are inherently unpredictable and may be materially affected by many factors, such as fluctuations in foreign exchange rates, changes in global economic conditions and customer spending, world events, the rate of growth of the Internet, online commerce, and cloud services, as well as thos e outlined in Item 1A of Part II, “Risk Factors.” This guidance reflects our estimates as of October 29, 2020 regarding the impact of the COVID-19 pandemic on our operations, including those discussed above, and is highly dependent on numerous factors that we may not be able to predict or control, including: the duration and scope of the pandemic, including any recurrence; actions taken by governments, businesses, and individuals in response to the pandemic; the impact of the pandemic on global and regional economies and economic activity, workforce staffing and productivity, and our significant and continuing spending on employee safety measures; our ability to continue operations in affected areas; and consumer demand and spending patterns, as well as the effects on suppliers, creditors, and third-party sellers, all of which are uncertain. This guidance also assumes the impacts on consumer demand and spending patterns, including impacts due to concerns over the current economic outlook, will be in line with those experienced during the fourth quarter to date, and the additional assumptions set forth below. However, it is not possible to determine the ultimate impact on our operations for the fourth quarter, or whether other currently unanticipated direct or indirect consequences of the pandemic are reasonably likely to materially affect our operations. Fourth Quarter 2020 Guidance • Net sales are expected to be between $112.0 billion and $121.0 billion, or to grow between 28% and 38% compared with fourth quarter 2019. This guidance anticipates a favorable impact of approximately 90 basis points from foreign exchange rates. • Operating income is expected to be between $1.0 billion and $4.5 billion, compared with $3.9 billion in fourth quarter 2019. This guidance assumes approximately $4.0 billion of costs related to COVID-19. • This guidance assumes, among other things, that no additional business acquisitions, investments, restructurings, or legal settlements are concluded. 31 Table of Contents