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Table of Contents

 
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, 2017
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, Washington 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, smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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
 
¨
 
 
 
 
 
 
 
 
 
Emerging growth company
 
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ¨ 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
481,872,175 shares of common stock, par value $0.01 per share, outstanding as of October 18, 2017
 

Table of Contents

AMAZON.COM, INC.
FORM 10-Q
For the Quarterly Period Ended September 30, 2017
INDEX
 
 
 
Page
PART I. FINANCIAL INFORMATION
 
Item 1
 
 
 
 
 
Item 2
Item 3
Item 4
 
 
PART II. OTHER INFORMATION
 
Item 1
Item 1A
Item 2
Item 3
Item 4
Item 5
Item 6


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Table of Contents

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,
 
2016
 
2017
 
2016

2017
 
2016
 
2017
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
$
12,521

 
$
13,203

 
$
15,890

 
$
19,334

 
$
10,709

 
$
13,656

OPERATING ACTIVITIES:
 
 
 
 
 
 
 
 
 
 
 
Net income
252

 
256

 
1,622

 
1,176

 
2,105

 
1,926

Adjustments to reconcile net income to net cash from operating activities:
 
 
 
 
 
 
 
 
 
 
 
Depreciation of property and equipment, including internal-use software and website development, and other amortization, including capitalized content costs
2,084

 
2,912

 
5,819

 
7,980

 
7,572

 
10,277

Stock-based compensation
776

 
1,085

 
2,088

 
3,036

 
2,694

 
3,923

Other operating expense, net
31

 
43

 
128

 
146

 
163

 
177

Other expense (income), net
(23
)
 
(128
)
 
(41
)
 
(288
)
 
39

 
(267
)
Deferred income taxes
(81
)
 
(74
)
 
36

 
279

 
226

 
(2
)
Changes in operating assets and liabilities:
 
 
 
 
 
 
 
 
 
 
 
Inventories
(1,095
)
 
(1,593
)
 
(383
)
 
(1,328
)
 
(1,726
)
 
(2,371
)
Accounts receivable, net and other
(671
)
 
(1,758
)
 
(1,443
)
 
(2,005
)
 
(2,621
)
 
(3,929
)
Accounts payable
2,540

 
3,046

 
(2,252
)
 
(1,731
)
 
3,887

 
5,551

Accrued expenses and other
441

 
(122
)
 
(531
)
 
(1,778
)
 
1,306

 
476

Additions to unearned revenue
2,802

 
3,762

 
7,956

 
10,862

 
10,377

 
14,837

Amortization of previously unearned revenue
(2,397
)
 
(3,578
)
 
(6,715
)
 
(10,259
)
 
(9,018
)
 
(13,521
)
Net cash provided by (used in) operating activities
4,659

 
3,851

 
6,284

 
6,090

 
15,004

 
17,077

INVESTING ACTIVITIES:
 
 
 
 
 
 
 
 
 
 
 
Purchases of property and equipment, including internal-use software and website development, net
(1,841
)
 
(2,659
)
 
(4,731
)
 
(7,022
)
 
(6,040
)
 
(9,027
)
Acquisitions, net of cash acquired, and other
(84
)
 
(13,213
)
 
(113
)
 
(13,891
)
 
(430
)
 
(13,893
)
Sales and maturities of marketable securities
1,431

 
2,221

 
3,500

 
6,424

 
4,635

 
7,656

Purchases of marketable securities
(2,076
)
 
(5,469
)
 
(4,358
)
 
(11,298
)
 
(5,717
)
 
(14,697
)
Net cash provided by (used in) investing activities
(2,570
)
 
(19,120
)
 
(5,702
)
 
(25,787
)
 
(7,552
)
 
(29,961
)
FINANCING ACTIVITIES:
 
 
 
 
 
 
 
 
 
 
 
Proceeds from long-term debt and other
8

 
16,080

 
83

 
16,170

 
176

 
16,707

Repayments of long-term debt and other
(26
)
 
(79
)
 
(271
)
 
(202
)
 
(1,212
)
 
(285
)
Principal repayments of capital lease obligations
(938
)
 
(1,267
)
 
(2,855
)
 
(3,327
)
 
(3,579
)
 
(4,331
)
Principal repayments of finance lease obligations
(44
)
 
(49
)
 
(105
)
 
(134
)
 
(131
)
 
(175
)
Net cash provided by (used in) financing activities
(1,000
)
 
14,685

 
(3,148
)
 
12,507

 
(4,746
)
 
11,916

Foreign currency effect on cash and cash equivalents
46

 
148

 
332

 
623

 
241

 
79

Net increase (decrease) in cash and cash equivalents
1,135

 
(436
)
 
(2,234
)
 
(6,567
)
 
2,947

 
(889
)
CASH AND CASH EQUIVALENTS, END OF PERIOD
$
13,656

 
$
12,767

 
$
13,656

 
$
12,767

 
$
13,656

 
$
12,767

SUPPLEMENTAL CASH FLOW INFORMATION:
 
 
 
 
 
 
 
 
 
 
 
Cash paid for interest on long-term debt
$
1

 
$
5

 
$
146

 
$
155

 
$
295

 
$
299

Cash paid for interest on capital and finance lease obligations
50

 
112

 
145

 
235

 
188

 
296

Cash paid for income taxes, net of refunds
91

 
172

 
317

 
865

 
390

 
960

Property and equipment acquired under capital leases
1,369

 
2,256

 
3,666

 
6,867

 
4,998

 
8,905

Property and equipment acquired under build-to-suit leases
211

 
750

 
793

 
2,698

 
956

 
3,114

See accompanying notes to consolidated financial statements.

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Table of Contents

AMAZON.COM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)
(unaudited)
 
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2017
 
2016
 
2017
Net product sales
$
22,339

 
$
28,768

 
$
64,036

 
$
77,248

Net service sales
10,375

 
14,976

 
28,210

 
40,165

Total net sales
32,714

 
43,744

 
92,246

 
117,413

Operating expenses:
 
 
 
 
 
 
 
Cost of sales
21,260

 
27,549

 
59,306

 
73,439

Fulfillment
4,335

 
6,420

 
11,900

 
16,275

Marketing
1,738

 
2,479

 
4,720

 
6,629

Technology and content
4,135

 
5,944

 
11,541

 
16,306

General and administrative
639

 
960

 
1,715

 
2,630

Other operating expense, net
32

 
45

 
133

 
155

Total operating expenses
32,139

 
43,397

 
89,315

 
115,434

Operating income
575

 
347

 
2,931

 
1,979

Interest income
26

 
54

 
71

 
137

Interest expense
(118
)
 
(228
)
 
(351
)
 
(510
)
Other income (expense), net
8

 
143

 
75

 
329

Total non-operating income (expense)
(84
)
 
(31
)
 
(205
)
 
(44
)
Income before income taxes
491

 
316

 
2,726

 
1,935

Provision for income taxes
(229
)
 
(58
)
 
(1,012
)
 
(755
)
Equity-method investment activity, net of tax
(10
)
 
(2
)
 
(92
)
 
(4
)
Net income
$
252

 
$
256

 
$
1,622

 
$
1,176

Basic earnings per share
$
0.53

 
$
0.53

 
$
3.43

 
$
2.46

Diluted earnings per share
$
0.52

 
$
0.52

 
$
3.36

 
$
2.39

Weighted-average shares used in computation of earnings per share:
 
 
 
 
 
 
 
Basic
474

 
481

 
473

 
479

Diluted
485

 
494

 
483

 
492

See accompanying notes to consolidated financial statements.


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AMAZON.COM, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions)
(unaudited)
 
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2017
 
2016
 
2017
Net income
$
252

 
$
256

 
$
1,622

 
$
1,176

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustments, net of tax of $6, $10, $18, and $(5)
19

 
104

 
133

 
486

Net change in unrealized gains (losses) on available-for-sale securities:
 
 
 
 
 
 
 
Unrealized gains (losses), net of tax of $(15), $(1), $(32), and $1
29

 
(2
)
 
65

 
(10
)
Reclassification adjustment for losses (gains) included in “Other income (expense), net,” net of tax of $(1), $0, $(2), and $0
2

 
3

 
4

 
8

Net unrealized gains (losses) on available-for-sale securities
31

 
1

 
69

 
(2
)
Total other comprehensive income (loss)
50

 
105

 
202

 
484

Comprehensive income
$
302

 
$
361

 
$
1,824

 
$
1,660

See accompanying notes to consolidated financial statements.


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Table of Contents

AMAZON.COM, INC.
CONSOLIDATED BALANCE SHEETS
(in millions, except per share data)
 
 
December 31, 2016
 
September 30, 2017
 

 
(unaudited)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
19,334

 
$
12,767

Marketable securities
6,647

 
11,543

Inventories
11,461

 
13,711

Accounts receivable, net and other
8,339

 
10,557

Total current assets
45,781

 
48,578

Property and equipment, net
29,114

 
45,335

Goodwill
3,784

 
13,271

Other assets
4,723

 
8,083

Total assets
$
83,402

 
$
115,267

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
25,309

 
$
26,075

Accrued expenses and other
13,739

 
15,844

Unearned revenue
4,768

 
5,153

Total current liabilities
43,816

 
47,072

Long-term debt
7,694

 
24,710

Other long-term liabilities
12,607

 
18,827

Commitments and contingencies (Note 3)


 


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

 
—

Common stock, $0.01 par value:
 
 
 
Authorized shares — 5,000
 
 
 
Issued shares — 500 and 505
 
 
 
Outstanding shares — 477 and 482
5

 
5

Treasury stock, at cost
(1,837
)
 
(1,837
)
Additional paid-in capital
17,186

 
20,212

Accumulated other comprehensive loss
(985
)
 
(501
)
Retained earnings
4,916

 
6,779

Total stockholders’ equity
19,285

 
24,658

Total liabilities and stockholders’ equity
$
83,402

 
$
115,267

See accompanying notes to consolidated financial statements.


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Table of Contents

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 2017 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 2016 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, including certain entities in India and China and that support our seller lending financing activities (collectively, the “Company”). Intercompany balances and transactions between consolidated entities are eliminated. The financial results of Whole Foods Market, Inc. (“Whole Foods Market”) have been included in our consolidated financial statements from the date of acquisition on August 28, 2017.
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 amortization period of these elements, incentive discount offers, sales returns, vendor funding, stock-based compensation forfeiture rates, income taxes, valuation and impairment of investments, inventory valuation and inventory purchase commitments, collectability of receivables, valuation of acquired intangibles and goodwill, depreciable lives of property and equipment, internal-use software and website development costs, acquisition purchase price allocations, investments in equity interests, and contingencies. Actual results could differ materially from those estimates.
Earnings per Share
Basic earnings per share is calculated using our weighted-average outstanding common shares. Diluted earnings per share is calculated using our weighted-average outstanding common shares including the dilutive effect of stock awards as determined under the treasury stock method. In periods when we have a net loss, stock awards are excluded from our calculation of earnings per share 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,
 
2016
 
2017
 
2016
 
2017
Shares used in computation of basic earnings per share
474

 
481

 
473

 
479

Total dilutive effect of outstanding stock awards
11

 
13

 
10

 
13

Shares used in computation of diluted earnings per share
485

 
494

 
483

 
492

Accounting Pronouncements Recently Adopted
In July 2015, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update (“ASU”) modifying the accounting for inventory. Under this ASU, the measurement principle for inventory changed from lower of cost or market value to lower of cost and net realizable value. The ASU defines net realizable value as the estimated selling price in

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the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The ASU is applicable to inventory that is accounted for under the first-in, first-out method. We adopted this ASU in Q1 2017 with no material impact to our consolidated financial statements.
In March 2016, the FASB issued an ASU amending the accounting for stock-based compensation and requiring excess tax benefits and deficiencies to be recognized as a component of income tax expense rather than equity. The inclusion of excess tax benefits and deficiencies as a component of our income tax expense will increase volatility within our provision for income taxes as the amount of excess tax benefits or deficiencies from stock-based compensation awards depends on our stock price at the date the awards vest. This guidance also requires excess tax benefits to be presented as an operating activity on the statement of cash flows and allows an entity to make an accounting policy election to either estimate expected forfeitures or to account for them as they occur. We adopted this ASU in Q1 2017 by recording the cumulative impact through an increase in retained earnings of $687 million, and we will continue to estimate expected forfeitures. Additionally, we retrospectively adjusted our consolidated statements of cash flows to reclassify excess tax benefits of $173 million, $493 million and $401 million for the three months, nine months, and twelve months ended September 30, 2016 from financing activities to operating activities.
Accounting Pronouncements Not Yet Adopted
In May 2014, the FASB issued an ASU amending revenue recognition guidance and requiring more detailed disclosures to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. We will adopt this ASU on January 1, 2018 with a cumulative adjustment that will increase retained earnings as opposed to retrospectively adjusting prior periods. The adjustment will primarily relate to the unredeemed portion of our gift cards, which we will begin to recognize over the expected customer redemption period, which is substantially within nine months, rather than waiting until gift cards expire or when the likelihood of redemption becomes remote, generally two years from the date of issuance. Prospectively, revenue related to Amazon-branded electronic devices sold through retailers will be recognized upon sale to the retailer rather than to end customers. We also anticipate a change to the recognition and classification of Amazon Prime memberships, which are currently considered arrangements with multiple deliverables that are allocated among products sales and service sales. Upon adoption of the ASU, Amazon Prime memberships will be accounted for as a single performance obligation recognized ratably over the membership period and will be classified as service sales. Other changes that we have identified relate primarily to the presentation of revenue. Certain advertising services will be classified as revenue rather than a reduction in cost of sales, and sales of apps and in-app content will primarily be presented on a net basis. Our assessment of policy changes resulting from this ASU is substantially complete and we are currently evaluating the quantitative impact of these changes in both recognition and presentation and the related disclosures.
In February 2016, the FASB issued an ASU amending the accounting for leases. The new guidance requires the recognition of lease assets and liabilities for operating leases with terms of more than 12 months, in addition to those currently recorded, on our consolidated balance sheets. Presentation of leases within the consolidated statements of operations and consolidated statements of cash flows will be generally consistent with the current lease accounting guidance. The ASU is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. We plan to adopt this ASU beginning in Q1 2019. We are currently evaluating the impact and expect the ASU will have a material impact on our consolidated financial statements, primarily to the consolidated balance sheets and related disclosures.
In October 2016, the FASB issued an ASU amending the accounting for income taxes. The new guidance requires the recognition of the income tax consequences of an intercompany asset transfer, other than transfers of inventory, when the transfer occurs. For intercompany transfers of inventory, the income tax effects will continue to be deferred until the inventory has been sold to a third party. The ASU is effective for reporting periods beginning after December 15, 2017, with early adoption permitted. We will adopt this ASU beginning in Q1 2018. We estimate the ASU will have an impact of approximately $400 million on our consolidated financial statements, including retained earnings and deferred taxes. This estimate takes into account valuation allowances that we anticipate recording against certain material deferred tax assets. However, the final impact will depend on the balance of property transferred among subsidiaries as of the adoption date. We will recognize incremental deferred tax expense as these deferred tax assets are utilized. Any change in our assessment of the likelihood of our ability to realize deferred tax assets will be reflected as an income tax benefit during the quarter of such change.
In November 2016, the FASB issued an ASU amending the presentation of restricted cash within the statement of cash flows. The new guidance requires that restricted cash be included within cash and cash equivalents on the statement of cash flows. The ASU is effective retrospectively for reporting periods beginning after December 15, 2017, with early adoption permitted. We will adopt this ASU beginning in Q1 2018.

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Table of Contents

Note 2 — CASH, CASH EQUIVALENTS, AND MARKETABLE SECURITIES
As of December 31, 2016, and September 30, 2017, our cash, cash equivalents, and marketable securities primarily consisted of cash, U.S. and foreign government and agency securities, AAA-rated money market funds, and other investment grade securities. Cash equivalents and marketable securities are recorded at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. To increase the comparability of fair value measures, the following hierarchy prioritizes the inputs to valuation methodologies used to measure fair value:
Level 1—Valuations based on quoted prices for identical assets and liabilities in active markets.
Level 2—Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.
Level 3—Valuations based on unobservable inputs reflecting our own assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.
We measure the fair value of money market funds and equity securities based on quoted prices in active markets for identical assets or liabilities. All other financial instruments were valued either based on recent trades of securities in inactive markets or based on quoted market prices of similar instruments and other significant inputs derived from or corroborated by observable market data. We did not hold any cash, cash equivalents, or marketable securities categorized as Level 3 assets as of December 31, 2016, and September 30, 2017.
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):
 
 
December 31, 2016
 
September 30, 2017
  
Total
Estimated
Fair Value
 
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Total
Estimated
Fair Value
Cash
$
6,883

 
$
8,658

 
$
—

 
$
—

 
$
8,658

Level 1 securities:
 
 
 
 
 
 
 
 
 
Money market funds
11,940

 
4,625

 
—

 
—

 
4,625

Equity securities
51

 
34

 
33

 
—

 
67

Level 2 securities:
 
 
 
 
 
 
 
 
 
Foreign government and agency securities
337

 
807

 
—

 
—

 
807

U.S. government and agency securities
4,816

 
5,400

 
2

 
(9
)
 
5,393

Corporate debt securities
2,104

 
4,403

 
2

 
(3
)
 
4,402

Asset-backed securities
353

 
853

 
—

 
(2
)
 
851

Other fixed income securities
97

 
701

 
—

 
—

 
701

 
$
26,581

 
$
25,481

 
$
37

 
$
(14
)
 
$
25,504

Less: Restricted cash, cash equivalents, and marketable securities (1)
(600
)
 
 
 
 
 
 
 
(1,194
)
Total cash, cash equivalents, and marketable securities
$
25,981

 
 
 
 
 
 
 
$
24,310

___________________
(1)
We are required to pledge or otherwise restrict a portion of our cash, cash equivalents, and marketable securities as collateral for real estate leases, workers’ compensation obligations, amounts due to third-party sellers in certain jurisdictions, debt, and standby and trade letters of credit.
(2)
We classify cash, cash equivalents, and marketable securities with use restrictions of less than twelve months as “Accounts receivable, net and other” and of twelve months or longer as non-current “Other assets” on our consolidated balance sheets. See “Note 3 — Commitments and Contingencies.”

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The following table summarizes the contractual maturities of our cash equivalents and marketable fixed-income securities as of September 30, 2017 (in millions):
 
Amortized
Cost
 
Estimated
Fair Value
Due within one year
$
11,305

 
$
11,303

Due after one year through five years
4,355

 
4,351

Due after five years through ten years
317

 
316

Due after ten years
812

 
809

Total
$
16,789

 
$
16,779

Actual maturities may differ from the contractual maturities because borrowers may have certain prepayment conditions.
We also hold equity warrant assets giving us the right to acquire stock of other companies. As of December 31, 2016, and September 30, 2017, these warrants had a fair value of $223 million and $455 million, and are recorded within “Other assets” on our consolidated balance sheets. The related gain (loss) recorded in “Other income (expense), net” was $9 million and $76 million in Q3 2016 and Q3 2017, and $(11) million and $145 million for the nine months ended September 30, 2016 and 2017. These assets are primarily classified as Level 2 assets.
Note 3 — COMMITMENTS AND CONTINGENCIES
Commitments
We have entered into non-cancellable operating, capital, and finance leases for equipment and office, fulfillment, sortation, delivery, data center, physical store, and renewable energy facilities. Rental expense under operating lease agreements was $367 million and $553 million for Q3 2016 and Q3 2017, and $1.0 billion and $1.4 billion for the nine months ended September 30, 2016 and 2017.

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The following summarizes our principal contractual commitments, excluding open orders for purchases that support normal operations and are generally cancellable, as of September 30, 2017 (in millions): 
 
Three Months Ended December 31,
 
Year Ended December 31,
 
 
 
 
 
2017
 
2018
 
2019
 
2020
 
2021
 
Thereafter
 
Total
Debt principal and interest
$
1,182

 
$
902

 
$
2,212

 
$
2,087

 
$
1,833

 
$
33,849

 
$
42,065

Capital lease obligations, including interest (1)
1,543

 
5,406

 
4,024

 
1,813

 
514

 
671

 
13,971

Finance lease obligations, including interest (2)
98

 
391

 
406

 
410

 
421

 
3,890

 
5,616

Operating leases
925

 
2,321

 
2,254

 
2,112

 
1,922

 
12,535

 
22,069

Unconditional purchase obligations (3)
817

 
3,571

 
3,412

 
3,115

 
2,984

 
10,895

 
24,794

Other commitments (4) (5)
384

 
1,241

 
849

 
678

 
522

 
4,338

 
8,012

Total commitments
$
4,949

 
$
13,832

 
$
13,157

 
$
10,215

 
$
8,196

 
$
66,178

 
$
116,527

___________________
(1)
Excluding interest, current capital lease obligations of $4.0 billion and $5.3 billion are recorded within “Accrued expenses and other” as of December 31, 2016, and September 30, 2017, and $5.1 billion and $7.6 billion are recorded within “Other long-term liabilities” as of December 31, 2016, and September 30, 2017.
(2)
Excluding interest, current finance lease obligations of $144 million and $239 million are recorded within “Accrued expenses and other” as of December 31, 2016, and September 30, 2017, and $2.4 billion and $4.3 billion are recorded within “Other long-term liabilities” as of December 31, 2016, and September 30, 2017.
(3)
Includes unconditional purchase obligations related to certain products offered in our Whole Foods Market stores and long-term agreements to acquire and license digital media content that are not reflected on the consolidated balance sheets. For those digital media content agreements with variable terms, we do not estimate the total obligation beyond any minimum quantities and/or pricing as of the reporting date. Purchase obligations associated with renewal provisions solely at the option of the content provider are included to the extent such commitments are fixed or a minimum amount is specified.
(4)
Includes the estimated timing and amounts of payments for rent and tenant improvements associated with build-to-suit lease arrangements and equipment lease arrangements that have not been placed in service and digital media content liabilities associated with long-term digital media content assets with initial terms greater than one year.
(5)
Excludes $2.1 billion of accrued tax contingencies for which we cannot make a reasonably reliable estimate of the amount and period of payment, if any.
Pledged Assets
As of December 31, 2016, and September 30, 2017, we have pledged or otherwise restricted $715 million and $1.3 billion of our cash, cash equivalents, and marketable securities, and certain property and equipment as collateral for real estate leases, workers’ compensation obligations, amounts due to third-party sellers in certain jurisdictions, debt, and standby and trade letters of credit.
Other Contingencies
In 2016, we determined that we processed and delivered orders of consumer products for certain individuals and entities located outside Iran covered by the Iran Threat Reduction and Syria Human Rights Act or other United States sanctions and export control laws. The consumer products included books, music, other media, apparel, home and kitchen, health and beauty, jewelry, office, consumer electronics, software, lawn and patio, grocery, and automotive products. Our review is ongoing and we have voluntarily reported these orders to the United States Treasury Department’s Office of Foreign Assets Control and the United States Department of Commerce’s Bureau of Industry and Security. We intend to cooperate fully with OFAC and BIS with respect to their review, which may result in the imposition of penalties. For additional information, see Item 5 of Part II, “Other Information — Disclosure Pursuant to Section 13(r) of the Exchange Act.”
We are subject to claims related to various indirect taxes (such as sales, value added, consumption, service, and similar taxes), including in jurisdictions in which we already collect and remit such taxes. If the relevant taxing authorities were successfully to pursue these claims, we could be subject to significant additional tax liabilities. For example, in June 2017, the State of South Carolina issued an assessment for uncollected sales and use taxes for the period from January 2016 to March 2016, including interest and penalties. South Carolina is alleging that we should have collected sales and use taxes on transactions by our third-party sellers. We believe the assessment is without merit. If South Carolina or other states were successfully to seek additional adjustments of a similar nature, we could be subject to significant additional tax liabilities. We intend to defend ourselves vigorously in this matter.

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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 7 — Commitments and Contingencies — Legal Proceedings” of our 2016 Annual Report on Form 10-K and in Item 1 of Part I, “Financial Statements — Note 3 — Commitments and Contingencies — Legal Proceedings” of our Quarterly Reports on Form 10-Q for the periods ended March 31, 2017 and June 30, 2017, as supplemented by the following:
In March 2014, Kaavo, Inc. filed a complaint against Amazon.com, Inc. and Amazon Web Services, Inc. for patent infringement in the United States District Court for the District of Delaware. The complaint alleges, among other things, that Amazon Web Services’ Elastic Beanstalk and CloudFormation infringe U.S. Patent No. 8,271,974, entitled “Cloud Computing Lifecycle Management For N-Tier Applications.” The complaint seeks injunctive relief, an unspecified amount of damages, costs, and interest. In July 2015, Kaavo Inc. filed another complaint against Amazon.com, Inc. and Amazon Web Services, Inc. in the United States District Court for the District of Delaware. The 2015 complaint alleges, among other things, that CloudFormation infringes U.S. Patent No. 9,043,751, entitled “Methods And Devices For Managing A Cloud Computing Environment.” The 2015 complaint seeks injunctive relief, an unspecified amount of damages, enhanced damages, attorneys’ fees, costs, and interest. In September 2017, the 2015 case was stayed pending resolution of a review petition we filed with the United States Patent and Trademark Office. We dispute the allegations of wrongdoing and intend to defend ourselves vigorously in these matters.
Beginning in September 2015, two cases have been filed alleging that Amazon violated the Fair Credit Reporting Act with regard to processes undertaken to perform criminal background checks on candidates for employment and employees. In September 2015, Hargrett v. Amazon.com LLC and Amazon.comdedc, LLC was filed in the U.S. District Court for the Middle District of Florida. In August 2017, Mathis v. Amazon.comdedc, LLC and Accurate Background, LLC was filed in the U.S. District Court for the Middle District of Florida. The plaintiffs variously purport to represent a nationwide class of certain candidates for employment and employees who were subject to a background check, and allege that Amazon failed either to provide proper disclosures before obtaining background checks or to provide appropriate notice before using background check information in employment decisions. The complaints seek an unspecified amount of statutory damages, punitive damages, costs, and attorneys’ fees. We dispute the allegations of wrongdoing and intend to defend ourselves vigorously in these matters.
In October 2017, SRC Labs, LLC and Saint Regis Mohawk Tribe filed in the United States District Court for the Eastern District of Virginia a complaint for patent infringement against Amazon Web Services, Inc., Amazon.com, Inc., and VADATA, Inc. The complaint alleges, among other things, that EC2 F1 Instances infringe U.S. Patent Nos. 6,434,687, entitled “System and method for accelerating web site access and processing utilizing a computer system incorporating reconfigurable processors operating under a single operating system image”; 7,149,867, entitled “System and method of enhancing efficiency and utilization of memory bandwidth in reconfigurable hardware”; 7,225,324 and 7,620,800, both entitled “Multi-adaptive processing systems and techniques for enhancing parallelism and performance of computational functions”; and 9,153,311, entitled “System and method for retaining DRAM data when reprogramming reconfigurable devices with DRAM memory controllers.” The complaint seeks an unspecified amount of damages, enhanced damages, interest, and a compulsory on-going royalty. We dispute the allegations of wrongdoing and intend to defend ourselves vigorously in this matter.
The outcomes of our legal proceedings and other contingencies are inherently unpredictable, subject to significant uncertainties, and could be material to our operating results and cash flows for a particular period. In addition, for some matters for which a loss is probable or reasonably possible, an estimate of the amount of loss or range of losses is not possible and we may be unable to estimate the possible loss or range of losses that could potentially result from the application of non-monetary remedies.
See also “Note 7 — Income Taxes.”
Note 4 — ACQUISITIONS, GOODWILL, AND ACQUIRED INTANGIBLE ASSETS
2017 Acquisition Activity
On May 12, 2017, we acquired Souq Group Ltd. (“Souq”), an e-commerce company, for approximately $579 million, net of cash acquired, and on August 28, 2017, we acquired Whole Foods Market, a grocery store chain, for approximately $13.2 billion, net of cash acquired. Both acquisitions are intended to expand our retail presence. During the nine months ended September 30, 2017, we also acquired certain other companies for an aggregate purchase price of $126 million. The primary reason for our other 2017 acquisitions was to acquire technologies and know-how to enable Amazon to serve customers more effectively.
Acquisition-related costs were expensed as incurred and were not significant. Due to the limited amount of time since the Whole Foods Market acquisition, the valuation of certain assets and liabilities is preliminary and subject to change. The aggregate purchase price of Whole Foods Market and the other 2017 acquisitions, which primarily includes the acquisition of Souq, was allocated as follows (in millions):

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Whole Foods Market
Other 2017 Acquisitions
Total
Purchase Price
 
 
 
Cash paid, net of cash acquired
$
13,176

$
612

$
13,788

Indemnification holdback
—

93

93

 
$
13,176

$
705

$
13,881

Allocation
 
 

Goodwill
$
8,985

$
446

$
9,431

Intangible assets (1):
 


Marketing-related
1,928

59

1,987

Contract-based
408

33

441

Technology-based
—

129

129

Customer-related
—

48

48

 
2,336

269

2,605

Property and equipment
3,826

16

3,842

Deferred tax assets
96

15

111

Other assets acquired
1,710

130

1,840

Long-term debt
(1,158
)
(7
)
(1,165
)
Deferred tax liabilities
(934
)
(20
)
(954
)
Other liabilities assumed
(1,685
)
(144
)
(1,829
)
 
$
13,176

$
705

$
13,881

 ___________________
(1)
Acquired intangible assets for Whole Foods Market have estimated useful lives of between one and twenty-five years, with a weighted-average amortization period of twenty-four years, primarily driven by the Whole Foods Market tradename, and acquired intangible assets for other 2017 acquisitions have estimated useful lives of between one and seven years, with a weighted-average amortization period of four years.
We determined the estimated fair value of identifiable intangible assets acquired primarily by using the income approach. These assets are included within “Other assets” on our consolidated balance sheets and are being amortized to operating expenses on a straight-line basis over their estimated useful lives.
Pro Forma Financial Information (unaudited)
The acquired companies were consolidated into our financial statements starting on their respective acquisition dates. The aggregate net sales and operating income of Whole Foods Market consolidated into our financial statements since the date of acquisition was $1.3 billion and $21 million for the nine months ended September 30, 2017. The aggregate net sales and operating loss of other acquisitions consolidated into our financial statements since the respective dates of acquisition was $222 million and $(80) million for the nine months ended September 30, 2017. The following financial information, which excludes certain acquired companies for which the pro forma impact is not meaningful, presents our results as if the acquisitions during the nine months ended September 30, 2017 had occurred on January 1, 2016 (in millions):
  
  
Nine Months Ended 
 September 30,
 
2016
 
 
2017
Net sales
$
103,476

 
 
$
127,441

Net income
$
1,597

 
 
$
1,137


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These pro forma results are based on estimates and assumptions, which we believe are reasonable. They are not the results that would have been realized had the acquisitions actually occurred on January 1, 2016 and are not necessarily indicative of our consolidated results of operations in future periods. The pro forma results include adjustments related to purchase accounting, primarily interest expense related to the proceeds from the issuance of the August 2017 Notes used in connection with the acquisition of Whole Foods Market and amortization of intangible assets.
Goodwill
The goodwill of the acquired companies is primarily related to expected improvements in technology performance and functionality, as well as sales growth from future product and service offerings and new customers, together with certain intangible assets that do not qualify for separate recognition. The goodwill of acquired companies is generally not deductible for tax purposes. The following summarizes our goodwill activity in the first nine months of 2017 by segment (in millions):
 
 
North
America
 
International
 
AWS
 
Consolidated
Goodwill - December 31, 2016
$
2,044

 
$
694

 
$
1,046

 
$
3,784

New acquisitions (1)
9,056

 
357

 
18

 
9,431

Other adjustments (2)
5

 
40

 
11

 
56

Goodwill - September 30, 2017
$
11,105

 
$
1,091

 
$
1,075

 
$
13,271

 ___________________
(1)
Primarily includes the acquisition of Whole Foods Market in the North America segment and Souq in the International segment.
(2)
Primarily includes changes in foreign exchange rates.



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Note 5 — LONG-TERM DEBT
In November 2012, December 2014, and August 2017, we issued $3.0 billion, $6.0 billion, and $16.0 billion of unsecured senior notes, and in August 2017, with our acquisition of Whole Foods Market, we assumed $1.0 billion of unsecured senior notes (collectively, the “Notes”). As described in the table below, $25.3 billion was outstanding as of September 30, 2017. As of December 31, 2016, and September 30, 2017, the net unamortized discount and debt issuance costs on the Notes was $90 million and $100 million. We also have other long-term debt with a carrying amount, including the current portion and borrowings under our credit facility, of $588 million and $597 million as of December 31, 2016, and September 30, 2017. The face value of our total long-term debt obligations is as follows (in millions):

 
December 31, 2016
 
September 30, 2017
1.200% Notes due on November 29, 2017 (1)
$
1,000

 
$
1,000

2.600% Notes due on December 5, 2019 (2)
1,000

 
1,000

1.900% Notes due on August 21, 2020 (3)
—

 
1,000

3.300% Notes due on December 5, 2021 (2)
1,000

 
1,000

2.500% Notes due on November 29, 2022 (1)
1,250

 
1,250

2.400% Notes due on February 22, 2023 (3)
—

 
1,000

2.800% Notes due on August 22, 2024 (3)
—

 
2,000

3.800% Notes due on December 5, 2024 (2)
1,250

 
1,250

5.200% Notes due on December 3, 2025 (4)
—

 
1,000

3.150% Notes due on August 22, 2027 (3)
—

 
3,500

4.800% Notes due on December 5, 2034 (2)
1,250

 
1,250

3.875% Notes due on August 22, 2037 (3)
—

 
2,750

4.950% Notes due on December 5, 2044 (2)
1,500

 
1,500

4.050% Notes due on August 22, 2047 (3)
—

 
3,500

4.250% Notes due on August 22, 2057 (3)
—

 
2,250

Credit Facility
495

 
550

Other long-term debt
93

 
47

Total debt
8,838

 
25,847

Less current portion of long-term debt
(1,056
)
 
(1,037
)
Face value of long-term debt
$
7,782

 
$
24,810

_____________________________
(1)
Issued in November 2012, effective interest rates of the 2017 and 2022 Notes were 1.38% and 2.66%.
(2)
Issued in December 2014, effective interest rates of the 2019, 2021, 2024, 2034, and 2044 Notes were 2.73%, 3.43%, 3.90%, 4.92%, and 5.11%.
(3)
Issued in August 2017, effective interest rates of the 2020, 2023, 2024, 2027, 2037, 2047, and 2057 Notes were 2.16%, 2.56%, 2.95%, 3.25%, 3.94%, 4.13%, and 4.33%.
(4)
Assumed in connection with the acquisition of Whole Foods Market, the effective interest rate of the 2025 Notes was 3.03%.
Interest on the Notes issued in 2012 is payable semi-annually in arrears in May and November. Interest on the Notes issued in 2014 is payable semi-annually in arrears in June and December. Interest on the Notes issued in 2017 is payable semi-annually in arrears in February and August. Interest on the 2025 Notes is payable semi-annually in arrears in June and December. 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. The proceeds from the November 2012 and the December 2014 Notes were used for general corporate purposes. The proceeds from the August 2017 Notes were used to fund the consideration for the acquisition of Whole Foods Market and will be used to repay the 1.200% Notes due 2017 and for general corporate purposes. The estimated fair value of the Notes was approximately $8.7 billion and $26.2 billion as of December 31, 2016, and September 30, 2017, which is based on quoted prices for our debt as of those dates.
In October 2016, we entered into a $500 million secured revolving credit facility with a lender that is secured by certain seller receivables, which we subsequently increased to $600 million and may from time to time increase in the future subject to lender approval (the “Credit Facility”). The Credit Facility is available for a term of three years, bears interest at the London interbank offered rate (“LIBOR”) plus 1.65%, and has a commitment fee of 0.50% on the undrawn portion. There were $495

15
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million and $550 million of borrowings outstanding under the Credit Facility as of December 31, 2016, and September 30, 2017, with weighted-average interest rates of 2.3% and 2.6% as of December 31, 2016, and September 30, 2017. As of December 31, 2016, and September 30, 2017, we have pledged $579 million and $639 million of our cash and seller receivables as collateral for debt related to our Credit Facility. The estimated fair value of the Credit Facility, which is based on Level 2 inputs, approximated its carrying value as of December 31, 2016, and September 30, 2017.
The other debt, including the current portion, had a weighted-average interest rate of 3.4% and 1.9% as of December 31, 2016, and September 30, 2017. We used the net proceeds from the issuance of this debt primarily to fund certain business operations. The estimated fair value of the other long-term debt, which is based on Level 2 inputs, approximated its carrying value as of December 31, 2016, and September 30, 2017.
In May 2016, we entered into an unsecured revolving credit facility (the “Credit Agreement”) with a syndicate of lenders that provides us with a borrowing capacity of up to $3.0 billion. The Credit Agreement has a term of three years, but it may be extended for up to three additional one-year terms if approved by the lenders. The initial interest rate applicable to outstanding balances under the Credit Agreement is LIBOR plus 0.60%, with a commitment fee of 0.05% on the undrawn portion of the credit facility, under our current credit ratings. If our credit ratings are downgraded these rates could increase to as much as LIBOR plus 1.00% and 0.09%, respectively. There were no borrowings outstanding under the credit agreements as of December 31, 2016, and September 30, 2017.
Note 6 — STOCKHOLDERS’ EQUITY
Stock Repurchase Activity
In February 2016, the Board of Directors authorized a program to repurchase up to $5.0 billion of our common stock, with no fixed expiration. This stock repurchase authorization replaced the previous $2.0 billion stock repurchase authorization, approved by the Board of Directors in 2010. There were no repurchases of common stock in Q3 2016 or Q3 2017.
Stock Award Activity
Common shares outstanding plus shares underlying outstanding stock awards totaled 497 million and 503 million as of December 31, 2016, and September 30, 2017. These totals include all vested and unvested stock awards outstanding, including those awards we estimate will be forfeited. Stock-based compensation expense is as follows (in millions):
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2017
 
2016
 
2017
Cost of sales (1)
$
7

 
$
13

 
$
7

 
$
33

Fulfillment
165

 
230

 
467

 
655

Marketing
85

 
135

 
221

 
363

Technology and content
434

 
595

 
1,171

 
1,668

General and administrative
85

 
112

 
222

 
317

Total stock-based compensation expense
$
776

 
$
1,085

 
$
2,088

 
$
3,036

___________________
(1)
Beginning in Q3 2016, stock-based compensation expense was recorded to cost of sales for eligible employees providing delivery services.
The following table summarizes our restricted stock unit activity for the nine months ended September 30, 2017 (in millions):
 
Number of Units
 
Weighted-Average
Grant-Date
Fair Value
Outstanding as of December 31, 2016
19.8

 
$
506

Units granted
7.2

 
918

Units vested
(4.6
)
 
387

Units forfeited
(1.3
)
 
620

Outstanding as of September 30, 2017
21.1

 
$
666


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Scheduled vesting for outstanding restricted stock units as of September 30, 2017, is as follows (in millions):
 
Three Months Ended December 31,
 
Year Ended December 31,
 
 
 
 
 
2017
 
2018
 
2019
 
2020
 
2021
 
Thereafter
 
Total
Scheduled vesting—restricted stock units
2.2

 
7.3

 
7.0

 
3.1

 
1.1

 
0.4

 
21.1

As of September 30, 2017, there was $6.3 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 1.1 years. The estimated forfeiture rate as of December 31, 2016 and September 30, 2017, was 28%. Changes in our estimates and assumptions relating to forfeitures may cause us to realize material changes in stock-based compensation expense in the future.
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-related developments, changes in our stock price, foreign currency gains (losses), tax law developments (including changes in statutes, regulations, case law, and administrative practices), and relative changes of expenses or losses for which tax benefits are not recognized. Additionally, our effective tax rate can be more or less volatile based on the amount of pre-tax income or loss. For example, the impact of discrete items and non-deductible expenses on our effective tax rate is greater when our pre-tax income is lower.
For 2017, we estimate that our effective tax rate will be favorably affected by the impact of excess tax benefits from stock-based compensation and the U.S. federal research and development credit and adversely affected by the recording of valuation allowances against the deferred tax assets related to net operating losses generated in Luxembourg and state income taxes.
Our income tax provision for the nine months ended September 30, 2016 was $1.0 billion, which included $50 million of discrete tax benefits primarily attributable to audit-related and tax law developments. Our income tax provision for the nine months ended September 30, 2017 was $755 million, which included $422 million of net discrete tax benefits primarily attributable to excess tax benefits from stock-based compensation, partially offset by a valuation allowance we recorded against the deferred tax assets related to net operating losses generated in Luxembourg and the estimated impact of audit-related developments.
We regularly assess whether it is more likely than not that we will realize our deferred tax assets in each taxing jurisdiction in which we operate. In performing this assessment with respect to each jurisdiction, we review all available evidence, including recent cumulative loss experience and expectations of future earnings, capital gains, and investment in such jurisdiction, the carry-forward periods available to us for tax reporting purposes, and other relevant factors. In Q2 2017, we recognized an estimated charge to tax expense of $600 million to record a valuation allowance against the net deferred tax assets in Luxembourg.
Cash paid for income taxes, net of refunds was $91 million and $172 million in Q3 2016 and Q3 2017, and $317 million and $865 million for the nine months ended September 30, 2016 and 2017.
As of December 31, 2016, and September 30, 2017, tax contingencies were $1.7 billion and $2.1 billion. We expect the total amount of tax contingencies will grow in 2017. 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 could result in changes to our contingencies related to positions on tax filings 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 and thereafter. These examinations may lead to ordinary course adjustments or proposed adjustments to our taxes or our net operating losses with respect to years under examination as well as subsequent periods. As previously disclosed, we have received Notices of Proposed Adjustment (“NOPAs”) from the IRS for transactions undertaken in the 2005 and 2006

17
Table of Contents

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 of approximately $1.5 billion, subject to interest. On March 23, 2017, the U.S. Tax Court issued its decision regarding the issues raised in the IRS NOPAs. The Tax Court rejected the approach from the IRS NOPAs in determining transfer pricing adjustments in 2005 and 2006 for the transactions undertaken with our foreign subsidiaries and adopted, with adjustments, our suggested approach. On September 29, 2017, the IRS filed a notice of appeal to the U.S. Court of Appeals for the Ninth Circuit. We will continue to defend ourselves vigorously in this matter. If the Tax Court decision were reversed on appeal or if the IRS were to successfully assert transfer pricing adjustments of a similar nature to the NOPAs for transactions in subsequent years, we could be subject to significant additional tax liabilities.
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 and thereafter. These examinations may lead to ordinary course adjustments or proposed adjustments to our taxes. In September 2012, we received proposed tax assessment notices for calendar years 2006 through 2010 relating to the allocation of income between foreign jurisdictions. In June 2015, we received final tax collection notices for these years assessing additional French tax of €196 million, including interest and penalties through September 2012. We disagree with the assessment and intend to contest it vigorously. We plan to pursue all available administrative remedies, and if we are not able to resolve this matter, we plan to pursue judicial remedies. In addition to the risk of additional tax for years 2006 through 2010, if this litigation is adversely determined or if the FTA were to seek adjustments of a similar nature for subsequent years, we could be subject to significant additional tax liabilities. In addition, in October 2014, the European Commission opened a formal investigation to examine whether decisions by the tax authorities in Luxembourg with regard to the corporate income tax paid by certain of our subsidiaries comply with European Union rules on state aid. On October 4, 2017, the European Commission announced its decision that determinations by the tax authorities in Luxembourg did not comply with European Union rules on state aid. This decision orders Luxembourg to calculate and recover additional taxes from us for the period May 2006 through June 2014. We believe this decision to be without merit and will consider our legal options, including an appeal. While the European Commission announced an estimated recovery amount of approximately €250 million, plus interest, the actual amount of additional taxes subject to recovery is to be calculated by the Luxembourg tax authorities in accordance with the European Commission’s guidance. Once the recovery amount is computed by Luxembourg, we anticipate funding it, including interest, into escrow, where it will remain pending conclusion of all appeals. We are also subject to taxation in various states and other foreign jurisdictions including Canada, China, Germany, India, Italy, Japan, Luxembourg, and the United Kingdom. We are under, or may be subject to, audit or examination and additional assessments by the relevant authorities in respect of these particular jurisdictions primarily for 2008 and thereafter.
Note 8 — SEGMENT INFORMATION
We have organized our operations into three segments: North America, International, and AWS. We allocate to segment results the operating expenses “Fulfillment,” “Marketing,” “Technology and content,” and “General and administrative” based on usage, which is generally reflected in the segment in which the costs are incurred. The majority of technology infrastructure costs are allocated to the AWS segment based on usage. The majority of the remaining non-infrastructure technology costs are incurred in the U.S. and are allocated to our North America segment. In Q1 2017, we combined stock-based compensation and “Other operating expense, net” with operating expenses in our presentation of segment results. While we continue to evaluate the integration of Whole Foods Market within our segments, we have included Whole Foods Market in our North America and International segments based on physical location. There are no internal revenue transactions between our reportable segments. These segments reflect the way our chief operating decision maker evaluates the Company’s business performance and manages its operations.
North America
The North America segment primarily consists of amounts earned from retail sales of consumer products (including from sellers) and subscriptions through North America-focused websites, such as www.amazon.com, www.amazon.ca, and www.amazon.com.mx, and physical stores. This segment includes export sales from these websites.
International
The International segment primarily consists of amounts earned from retail sales of consumer products (including from sellers) and subscriptions through internationally-focused websites such as www.amazon.com.au, www.amazon.com.br, www.amazon.cn, www.amazon.fr, www.amazon.de, www.amazon.in, www.amazon.it, www.amazon.co.jp, www.amazon.nl, www.amazon.es, and www.amazon.co.uk. This segment includes export sales from these internationally-focused websites (including export sales from these sites to customers in the U.S., Mexico, and Canada), but excludes export sales from our North American websites.

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AWS
The AWS segment consists of amounts earned from global sales of compute, storage, database, and other service offerings for start-ups, enterprises, government agencies, and academic institutions.
Information on reportable segments and reconciliation to consolidated net income is as follows (in millions):
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2017
 
2016
 
2017
North America
 
 
 
 
 
 
 
Net sales
$
18,874

 
$
25,446

 
$
53,544

 
$
68,808

Operating expenses
18,619

 
25,334

 
51,999

 
67,664

Operating income
$
255

 
$
112

 
$
1,545

 
$
1,144

 
 
 
 
 
 
 
 
International
 
 
 
 
 
 
 
Net sales
$
10,609

 
$
13,714

 
$
30,019

 
$
36,259

Operating expenses
11,150

 
14,650

 
30,815

 
38,401

Operating income (loss)
$
(541
)
 
$
(936
)
 
$
(796
)
 
$
(2,142
)
 
 
 
 
 
 
 
 
AWS
 
 
 
 
 
 
 
Net sales
$
3,231

 
$
4,584

 
$
8,683

 
$
12,346

Operating expenses
2,370

 
3,413

 
6,501

 
9,369

Operating income
$
861

 
$
1,171

 
$
2,182

 
$
2,977

 
 
 
 
 
 
 
 
Consolidated
 
 
 
 
 
 
 
Net sales
$
32,714

 
$
43,744

 
$
92,246

 
$
117,413

Operating expenses
32,139

 
43,397

 
89,315

 
115,434

Operating income
575

 
347

 
2,931

 
1,979

Total non-operating income (expense)
(84
)
 
(31
)
 
(205
)
 
(44
)
Provision for income taxes
(229
)
 
(58
)
 
(1,012
)
 
(755
)
Equity-method investment activity, net of tax
(10
)
 
(2
)
 
(92
)
 
(4
)
Net income
$
252

 
$
256

 
$
1,622

 
$
1,176



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Net sales by groups of similar products and services is as follows (in millions):
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2017
 
2016
 
2017
Net Sales:
 
 
 
Online stores (1)
$
21,590

 
$
26,392

 
$
61,883

 
$
72,971

Physical stores (2)
—

 
1,276

 
—

 
1,276

Third-party seller services (3)
5,652

 
7,928

 
15,537

 
21,357

Subscription services (4)
1,532

 
2,441

 
4,264

 
6,544

AWS
3,231

 
4,584

 
8,683

 
12,346

Other (5)
709

 
1,123

 
1,879

 
2,919

Consolidated
$
32,714

 
$
43,744

 
$
92,246

 
$
117,413

____________________________
(1)
Includes product sales and digital media content where we record revenue gross. We leverage our retail infrastructure to offer a wide selection of consumable and durable goods that includes electronics and general merchandise as well as media products available in both a physical and digital format, such as books, music, videos, games, and software. These product sales include digital products sold on a transactional basis. Digital product subscriptions that provide unlimited viewing or usage rights are included in Subscription services.
(2)
Includes product sales where our customers physically select items in a store.
(3)
Includes commissions, related fulfillment and shipping fees, and other third-party seller services.
(4)
Includes annual and monthly fees associated with Amazon Prime membership, as well as audiobook, e-book, digital video, digital music, and other non-AWS subscription services.
(5)
Includes sales not otherwise included above, such as certain advertising services and our co-branded credit card agreements.

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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 legal proceedings and claims, 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 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 2016 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 2016 Annual Report on Form 10-K and Item 1 of Part I, “Financial Statements — Note 1 — Accounting Policies,” of this Form 10-Q. Although we believe that our estimates, assumptions, and judgments are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates under different assumptions, judgments, or conditions.
Inventories
Inventories, consisting of products available for sale, are primarily accounted for using the first-in first-out method, and are valued at the lower of cost 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, 2017, we would have recorded an additional cost of sales of approximately $150 million.
In addition, we enter into supplier commitments for certain electronic device components. These commitments are based on forecasted customer demand. If we reduce these commitments, we may incur additional costs.

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Income Taxes
We are subject to income taxes in the U.S. (federal and state) and numerous foreign jurisdictions. Tax laws, regulations, and administrative practices 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. Our effective tax rates could be affected by 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 the related tax benefit, changes in foreign currency exchange rates, entry into new businesses and geographies and changes to our existing businesses, acquisitions (including integrations) and investments, changes in our stock price, changes in our deferred tax assets and liabilities and their valuation, and changes in the relevant tax, accounting, and other laws, regulations, administrative practices, principles, and interpretations, including fundamental changes to the tax laws applicable to corporate multinationals. The U.S., the European Union and its member states, and a number of other countries are actively pursuing changes in this regard.
Except as required under U.S. tax laws, 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 and our effective tax rate would be adversely affected. We are also currently subject to audit in various jurisdictions, and these jurisdictions may assess additional income tax liabilities against us. 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. For instance, the IRS is seeking to increase our U.S. taxable income related to transfer pricing with our foreign subsidiaries for transactions undertaken in 2005 and 2006, and we have been contesting the matter in U.S. Tax Court. On March 23, 2017, the U.S. Tax Court issued its decision regarding the issues raised in the IRS Notices of Proposed Adjustment (“NOPAs”). The Tax Court rejected the approach from the IRS NOPAs in determining transfer pricing adjustments in 2005 and 2006 for the transactions undertaken with our foreign subsidiaries and adopted, with adjustments, our suggested approach. On September 29, 2017, the IRS filed a notice of appeal to the U.S. Court of Appeals for the Ninth Circuit. We will continue to defend ourselves vigorously in this matter. If the Tax Court decision were reversed on appeal or if the IRS were to successfully assert transfer pricing adjustments of a similar nature to the NOPAs for transactions in subsequent years, we could be subject to significant additional tax liabilities. In addition, in October 2014, the European Commission opened a formal investigation to examine whether decisions by the tax authorities in Luxembourg with regard to the corporate income tax paid by certain of our subsidiaries comply with European Union rules on state aid. On October 4, 2017, the European Commission announced its decision that determinations by the tax authorities in Luxembourg did not comply with European Union rules on state aid. This decision orders Luxembourg to calculate and recover additional taxes from us for the period May 2006 through June 2014. We believe this decision to be without merit and will consider our legal options, including an appeal. While the European Commission announced an estimated recovery amount of approximately €250 million, plus interest, the actual amount of additional taxes subject to recovery is to be calculated by the Luxembourg tax authorities in accordance with the European Commission’s guidance. Although we believe our tax estimates are reasonable, the final outcome of tax audits, investigations, and any related litigation could be materially different from our historical income tax provisions and accruals.
Recent Accounting Pronouncements
See Item 1 of Part I, “Financial Statements — Note 1 — Accounting Policies.”



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Liquidity and Capital Resources
Cash flow information, which reflects retrospective adjustments to our consolidated statements of cash flows as described in Item 1 of Part I, “Financial Statements — Note 1 — Accounting Policies,” is as follows (in millions):
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
Twelve Months Ended 
 September 30,
 
2016
 
2017
 
2016
 
2017
 
2016
 
2017
Cash provided by (used in):
 
 
 
 
 
 
 
 
 
 
 
Operating activities
$
4,659

 
$
3,851

 
$
6,284

 
$
6,090

 
$
15,004

 
$
17,077

Investing activities
(2,570
)
 
(19,120
)
 
(5,702
)
 
(25,787
)
 
(7,552
)
 
(29,961
)
Financing activities
(1,000
)
 
14,685

 
(3,148
)
 
12,507

 
(4,746
)
 
11,916

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 $26.0 billion and $24.3 billion as of December 31, 2016, and September 30, 2017. Amounts held in foreign currencies were $9.1 billion and $7.8 billion as of December 31, 2016, and September 30, 2017, and were primarily Euros, Japanese Yen, and British Pounds.
Cash provided by (used in) operating activities was $4.7 billion and $3.9 billion for Q3 2016 and Q3 2017, and $6.3 billion and $6.1 billion for the nine months ended September 30, 2016 and 2017. Our operating cash flows result primarily from cash received from our consumer, seller, developer, enterprise, and content creator 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 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, 2017, compared to the comparable prior year period, was primarily due to the increase in net income, excluding non-cash charges such as depreciation, amortization, and stock-based compensation. Cash provided by (used in) operating activities is also subject to 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, 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 $(2.6) billion and $(19.1) billion for Q3 2016 and Q3 2017, and $(5.7) billion and $(25.8) billion for the nine months ended September 30, 2016 and 2017, with the variability caused primarily by cash paid for acquisitions, our decision to purchase or lease property and equipment, and purchases, maturities, and sales of marketable securities. Cash capital expenditures were $1.8 billion and $2.7 billion during Q3 2016 and Q3 2017, and $4.7 billion and $7.0 billion for the nine months ended September 30, 2016 and 2017, which primarily reflect additional capacity to support our fulfillment operations and additional investments in support of continued business growth due to investments in technology infrastructure (the majority of which is to support AWS). Capital expenditures included $97 million and $71 million for internal-use software and website development during Q3 2016 and Q3 2017, and $326 million and $235 million for the nine months ended September 30, 2016 and 2017. 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 $84 million and $13.2 billion during Q3 2016 and Q3 2017, and $113 million and $13.9 billion for the nine months ended September 30, 2016 and 2017.
Cash provided by (used in) financing activities was $(1.0) billion and $14.7 billion for Q3 2016 and Q3 2017, and $(3.1) billion and $12.5 billion for the nine months ended September 30, 2016 and 2017. Cash outflows from financing activities result from principal repayments on obligations related to capital leases and finance leases and repayments of long-term debt and other. Principal repayments on obligations related to capital leases and finance leases and repayments of long-term debt and other were $1.0 billion and $1.4 billion in Q3 2016 and Q3 2017, and $3.2 billion and $3.7 billion for the nine months ended September 30, 2016 and 2017. Property and equipment acquired under capital leases was $1.4 billion and $2.3 billion during Q3 2016 and Q3 2017, and $3.7 billion and $6.9 billion for the nine months ended September 30, 2016 and 2017, reflecting investments in support of continued business growth primarily due to investments in technology infrastructure for AWS, which investments we expect to continue over time. Cash inflows from financing activities primarily result from proceeds from long-term debt and other. Proceeds from long-term debt and other were $8 million and $16.1 billion in Q3 2016 and Q3 2017, and $83 million and $16.2 billion for the nine months ended September 30, 2016 and 2017. During 2017, cash inflows from financing activities consisted primarily of proceeds from the issuance of $16.0 billion of senior unsecured notes in seven tranches maturing in 2020 through 2057. The proceeds from the August 2017 Notes were used to fund the consideration for the

23
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acquisition of Whole Foods Market and will be used to repay the 1.200% Notes due 2017 and for general corporate purposes. See Item 1 of Part I, “Notes to Consolidated Financial Statements — Note 5 — Long-Term Debt” for additional discussion of the Notes.
We had no borrowings outstanding under our Credit Agreement and $550 million of borrowings outstanding under our Credit Facility as of September 30, 2017. See Item 1 of Part I, “Financial Statements — Note 5 — Long-Term Debt” for additional information.
We recorded net tax provisions of $229 million and $58 million in Q3 2016 and Q3 2017, and $1.0 billion and $755 million for the nine months ended September 30, 2016 and 2017. Except as required under U.S. tax laws, 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, and our effective tax rate would be adversely affected. We have tax benefits relating to excess stock-based compensation deductions and accelerated depreciation deductions that are being utilized to reduce our U.S. taxable income. In December 2015, U.S. legislation was enacted that extended accelerated depreciation deductions on qualifying property through 2019. Cash taxes paid, net of refunds were $91 million and $172 million for Q3 2016 and Q3 2017, and $317 million and $865 million for the nine months ended September 30, 2016 and 2017. As of December 31, 2016, our federal net operating loss carryforward was approximately $76 million and we had approximately $608 million 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. 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 its October 2017 decision against us on state aid, the European Commission announced an estimated recovery amount of approximately €250 million, plus interest. The actual amount of additional taxes subject to recovery is to be calculated by the Luxembourg tax authorities in accordance with the European Commission's guidance. Once the recovery amount is computed by Luxembourg, we anticipate funding it, including interest, into escrow, where it will remain pending conclusion of all appeals.
Our liquidity is also affected by restricted cash balances that are pledged as collateral for real estate leases, workers’ compensation obligations, 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” on our consolidated balance sheets. As of December 31, 2016, and September 30, 2017, restricted cash, cash equivalents, and marketable securities were $600 million and $1.2 billion. See Item 1 of Part I, “Financial Statements — Note 3 — Commitments and Contingencies” for additional discussion of our principal contractual commitments, as well as our pledged assets. Additionally, purchase obligations and open purchase orders, consisting of inventory and significant non-inventory commitments, were $15.5 billion as of September 30, 2017. 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 borrowing available under our credit agreements, will be sufficient to meet our anticipated operating cash needs for at least the next 12 months. However, any projections of future cash needs and cash flows are subject to substantial uncertainty. See Item 1A of Part II, “Risk Factors.” We continually evaluate opportunities to sell additional equity or debt securities, obtain credit facilities, obtain capital, finance, and operating lease arrangements, 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, 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.






24
Table of Contents

Results of Operations
We have organized our operations into three segments: North America, International, and AWS. Our results reflect the operations of Whole Foods Market from the date of acquisition. In Q1 2017, we combined stock-based compensation and “Other operating expense, net” with operating expenses in our presentation of segment results. 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.”
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 represent retail third-party seller fees earned (including commissions) and related shipping fees, AWS sales, certain digital content subscriptions, certain advertising services, and our co-branded credit card agreements. Amazon Prime membership fees are allocated between product sales and service sales and amortized over the life of the membership according to the estimated delivery of services. Net sales information is as follows (in millions):
  
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2017
 
2016
 
2017
Net Sales:
 
 
 
 
 
 
 
North America
$
18,874

 
$
25,446

 
$
53,544

 
$
68,808

International
10,609

 
13,714

 
30,019

 
36,259

AWS
3,231

 
4,584

 
8,683

 
12,346

Consolidated
$
32,714

 
$
43,744

 
$
92,246

 
$
117,413

Year-over-year Percentage Growth:
 
 
 
 
 
 
 
North America
26
%
 
35
%
 
27
%
 
29
%
International
28

 
29

 
27

 
21

AWS
55

 
42

 
59

 
42

Consolidated
29

 
34

 
29

 
27

Year-over-year Percentage Growth, excluding the effect of foreign exchange rates:
 
 
 
 
 
 
 
North America
26
%
 
35
%
 
27
%
 
28
%
International
28

 
28

 
27

 
24

AWS
55

 
42

 
59

 
42

Consolidated
29

 
33

 
29

 
28

Net sales mix:
 
 
 
 
 
 
 
North America
58
%
 
58
%
 
58
%
 
59
%
International
32

 
31

 
33

 
31

AWS
10

 
11

 
9

 
10

Consolidated
100
%
 
100
%
 
100
%
 
100
%
Sales increased 34% in Q3 2017 and 27% for the nine months ended September 30, 2017, compared to the comparable prior year periods. Changes in foreign currency exchange rates impacted net sales by $124 million for Q3 2017, and by $(869) million for the nine months ended September 30, 2017. For a discussion of the effect on sales growth of foreign exchange rates, see “Effect of Foreign Exchange Rates” below.
North America sales increased 35% in Q3 2017 and 29% for the nine months ended September 30, 2017, compared to the comparable prior year periods. The sales growth primarily reflects increased unit sales, including sales by third-party sellers, and the impact of the acquisition of Whole Foods Market. Increased unit sales were driven largely by our continued efforts to reduce prices for our customers, including from our shipping offers, increased in-stock inventory availability, and increased selection.
International sales increased 29% in Q3 2017 and 21% for the nine months ended September 30, 2017, 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, increased in-stock inventory availability, and increased selection. Changes in foreign currency exchange rates impacted International net sales by $97 million for Q3 2017, and by $(885) million for the nine months ended September 30, 2017.

25
Table of Contents

AWS sales increased 42% in Q3 2017 and the nine months ended September 30, 2017, 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.
Operating Income (Loss)
Operating income (loss) by segment is as follows (in millions):
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2017
 
2016
 
2017
Operating Income (Loss):
 
 
 
 
 
 
 
North America
$
255

 
$
112

 
$
1,545

 
$
1,144

International
(541
)
 
(936
)
 
(796
)
 
(2,142
)
AWS
861

 
1,171

 
2,182

 
2,977

Consolidated
$
575

 
$
347

 
$
2,931

 
$
1,979

Operating income decreased from $575 million in Q3 2016, to $347 million in Q3 2017, and decreased from $2.9 billion for the nine months ended September 30, 2016, to $2.0 billion for the nine months ended September 30, 2017. We believe that operating income is a more meaningful measure than gross profit and gross margin due to the diversity of our product categories and services.
The decrease in North America operating income in absolute dollars in Q3 2017 and for the nine months ended September 30, 2017, compared to the comparable prior year periods, is primarily due to increased levels of operating expenses to expand our fulfillment network and spending on technology and content and marketing efforts, partially offset by increased unit sales, including sales by third-party sellers. Changes in foreign exchange rates impacted operating income by $(12) million for Q3 2017, and by $4 million for the nine months ended September 30, 2017.
The increase in International operating loss in absolute dollars in Q3 2017 and for the nine months ended September 30, 2017, compared to the comparable prior year periods, is primarily due to increased levels of operating expenses to expand our fulfillment network and spending on technology and content and marketing efforts, partially offset by increased unit sales, including sales by third-party sellers. Changes in foreign exchange rates impacted operating income (loss) by $(13) million for Q3 2017, and by $(105) million for the nine months ended September 30, 2017.
The increase in AWS operating income in absolute dollars in Q3 2017 and for the nine months ended September 30, 2017, compared to the comparable prior year periods, is primarily due to increased customer usage and cost structure productivity, partially offset by pricing changes and increased spending on technology infrastructure and payroll and related expenses, which was primarily driven by additional investments to support the business growth. Changes in foreign exchange rates impacted operating income by $(14) million for Q3 2017, and by $(7) million for the nine months ended September 30, 2017.

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Table of Contents

Operating Expenses
Information about operating expenses is as follows (in millions):
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2017
 
2016
 
2017
Operating Expenses:
 
 
 
 
 
 
 
Cost of sales
$
21,260

 
$
27,549

 
$
59,306

 
$
73,439

Fulfillment
4,335

 
6,420

 
11,900

 
16,275

Marketing
1,738

 
2,479

 
4,720

 
6,629

Technology and content
4,135

 
5,944

 
11,541

 
16,306

General and administrative
639

 
960

 
1,715

 
2,630

Other operating expense, net
32

 
45

 
133

 
155

Total operating expenses
$
32,139

 
$
43,397

 
$
89,315

 
$
115,434

Year-over-year Percentage Growth:
 
 
 
 
 
 
 
Cost of sales
27
 %
 
30
%
 
25
 %
 
24
%
Fulfillment
34

 
48

 
34

 
37

Marketing
37

 
43

 
35

 
40

Technology and content
29

 
44

 
29

 
41

General and administrative
38

 
50

 
26

 
53

Other operating expense, net
(25
)
 
39

 
(2
)
 
16

Percent of Net Sales:
 
 
 
 
 
 
 
Cost of sales
65.0
 %
 
63.0
%
 
64.3
 %
 
62.5
%
Fulfillment
13.3

 
14.7

 
12.9

 
13.9

Marketing
5.3

 
5.7

 
5.1

 
5.6

Technology and content
12.6

 
13.6

 
12.5

 
13.9

General and administrative
2.0

 
2.2

 
1.9

 
2.2

Other operating expense, net
0.1

 
0.1

 
0.1

 
0.1

Cost of Sales
Cost of sales primarily consists of the purchase price of consumer products, digital media content costs where we record revenue gross, including Prime Video and Prime Music, packaging supplies, sortation and delivery center and related equipment costs, and inbound and outbound shipping costs, including where we are the transportation service provider.
The increase in cost of sales in absolute dollars in Q3 2017 and for the nine months ended September 30, 2017, compared to the comparable prior year periods, is primarily due to increased product and shipping costs resulting from increased sales.
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 center and transportation costs, were $3.9 billion and $5.4 billion in Q3 2016 and Q3 2017, and $10.5 billion and $14.4 billion for the nine months ended September 30, 2016 and 2017. 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, 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.
Fulfillment
Fulfillment costs primarily consist of those costs incurred in operating and staffing our North America and International fulfillment centers, customer service centers, and physical stores, 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.”

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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, 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, because payment processing and fulfillment costs associated with seller transactions are based on the gross purchase price of underlying transactions, and payment processing and related transaction and fulfillment costs are higher as a percentage of sales versus our retail sales, sales by our sellers have higher fulfillment costs as a percent of net sales.
The increase in fulfillment costs in absolute dollars in Q3 2017 and for the nine months ended September 30, 2017, compared to the comparable prior year periods, is primarily due to variable costs corresponding with increased product and service sales volume and inventory levels, and costs from expanding our fulfillment network, which includes physical stores.
We seek to expand our fulfillment capacity 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.
Marketing
We direct customers to our websites primarily through a number of targeted online marketing channels, such as our Associates program, sponsored search, 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 2017 and for the nine months ended September 30, 2017, compared to the comparable prior year periods, is primarily due to payroll and related expenses, as well as increased spending on online marketing channels.
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.
Technology and Content
Technology costs consist principally of research and development activities including payroll and related expenses for employees involved in application, production, maintenance, operation, and development of new and existing products and services, as well as AWS and other technology infrastructure costs. Content costs consist principally of payroll and related expenses for employees involved in category expansion, editorial content, buying, and merchandising selection.
We seek to invest efficiently in several 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. The increase in technology and content costs in absolute dollars in Q3 2017 and for the nine months ended September 30, 2017, compared to the comparable prior year periods, is primarily due to increased payroll and related costs associated with expanding our existing products and services and initiatives to introduce new products and service offerings, and an increase in spending on technology infrastructure.
Technology infrastructure costs consist of servers, networking equipment, and data center related depreciation, rent, utilities, and payroll expenses. These costs are allocated to segments based on usage. During Q3 2017, we expanded our technology infrastructure principally by increasing our capacity for AWS service offerings globally, compared to the comparable prior year period. Additionally, the costs associated with operating and maintaining our expanded infrastructure have increased over time, corresponding with increased usage. We expect these trends to continue over time as we invest in technology infrastructure to support increased usage. See Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview” of our 2016 Annual Report on Form 10-K for a discussion of how management views advances in technology and the importance of innovation.
During Q3 2016 and Q3 2017, we capitalized $118 million (including $21 million of stock-based compensation) and $93 million (including $22 million of stock-based compensation) of costs associated with internal-use software and website development. For the nine months ended September 30, 2016 and 2017, we capitalized $399 million (including $72 million of stock-based compensation) and $298 million (including $63 million of stock-based compensation) of costs associated with internal-use software and website development. Amortization of previously capitalized amounts was $160 million and $128 million for Q3 2016 and Q3 2017, and $481 million and $424 million for the nine months ended September 30, 2016 and 2017.

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General and Administrative
The increase in general and administrative costs in absolute dollars in Q3 2017 and for the nine months ended September 30, 2017, compared to the comparable prior year periods, is primarily due to increases in payroll and related expenses and professional service fees.
Other Operating Expense, Net
Other operating expense, net was $32 million and $45 million for Q3 2016 and Q3 2017, and $133 million and $155 million for the nine months ended September 30, 2016 and 2017, and was primarily related to the amortization of intangible assets.
Interest Income and Expense
Our interest income was $26 million and $54 million during Q3 2016 and Q3 2017, and $71 million and $137 million for the nine months ended September 30, 2016 and 2017. We generally invest our excess cash in investment grade short- to intermediate-term fixed income securities and AAA-rated money market funds. 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 $118 million and $228 million during Q3 2016 and Q3 2017, and $351 million and $510 million for the nine months ended September 30, 2016 and 2017. The increase is primarily due to increases in our capital and finance lease arrangements and long-term debt.
Other Income (Expense), Net
Other income (expense), net was $8 million and $143 million during Q3 2016 and Q3 2017, and $75 million and $329 million for the nine months ended September 30, 2016 and 2017. The primary component of other income (expense), net is related to foreign currency, equity warrant valuation, and other investment gains (losses).
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-related developments, changes in our stock price, foreign currency gains (losses), tax law developments (including changes in statutes, regulations, case law, and administrative practices), and relative changes of expenses or losses for which tax benefits are not recognized. Additionally, our effective tax rate can be more or less volatile based on the amount of pre-tax income or loss. For example, the impact of discrete items and non-deductible expenses on our effective tax rate is greater when our pre-tax income is lower.
For 2017, we estimate that our effective tax rate will be favorably affected by the impact of excess tax benefits from stock-based compensation and the U.S. federal research and development credit and adversely affected by the recording of valuation allowances against the deferred tax assets related to net operating losses generated in Luxembourg and state income taxes.
Our income tax provision for the nine months ended September 30, 2016 was $1.0 billion, which included $50 million of discrete tax benefits primarily attributable to audit-related and tax law developments. Our income tax provision for the nine months ended September 30, 2017 was $755 million, which included $422 million of net discrete tax benefits primarily attributable to excess tax benefits from stock-based compensation, partially offset by a valuation allowance we recorded against the deferred tax assets related to net operating losses generated in Luxembourg and the estimated impact of audit-related developments.
We regularly assess whether it is more likely than not that we will realize our deferred tax assets in each taxing jurisdiction in which we operate. In performing this assessment with respect to each jurisdiction, we review all available evidence, including recent cumulative loss experience and expectations of future earnings, capital gains, and investment in such jurisdiction, the carry-forward periods available to us for tax reporting purposes, and other relevant factors. In Q2 2017, we recognized an estimated charge to tax expense of $600 million to record a valuation allowance against the net deferred tax assets in Luxembourg.
Equity-Method Investment Activity, Net of Tax
Equity-method investment activity, net of tax, was $(10) million and $(2) million during Q3 2016 and Q3 2017, and $(92) million and $(4) million for the nine months ended September 30, 2016 and 2017. The primary components of this activity were impairments recorded in Q1 2016 and our equity-method investment losses during the periods.

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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 capital and finance leases. As a result of the adoption of new accounting guidance, we retrospectively adjusted our consolidated statements of cash flows to reclassify excess tax benefits of $401 million for the twelve months ended September 30, 2016 from financing activities to operating activities.
Free Cash Flow
Free cash flow is cash flow from operations reduced by “Purchases of property and equipment, including internal-use software and website development, net,” which is included in cash flow from investing activities. 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, 2016 and 2017 (in millions):
 
 
Twelve Months Ended 
 September 30,
 
2016
 
2017
Net cash provided by (used in) operating activities
$
15,004

 
$
17,077

Purchases of property and equipment, including internal-use software and website development, net
(6,040