08:42am EDT 25-Oct-02 Morgan Stanley (Meeker/Mahaney (212) 761-8042) AMZN AMZN. AMAZON.COM : CQ3:02 - MOMENTUM IS VERY STRONG. /P1

North America: United States of America/PART 1 Internet & PC Applications Software

October 25, 2002 Analysis of Sales Earnings Amazon.com (Reuters: AMZN.O Bloomberg: AMZN NASDAQ: AMZN) CQ3:02 - Momentum is Very Strong.

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Mary Meeker [email protected] 212 761 8042 Mark Mahaney [email protected] 212 761 4864

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- Very Strong CQ3 Results Well Above Estimates AMZN reported CQ3 revenue of $851MM (up 33% Y/Y, 6% Q/Q) vs. our/Street's $805/$809MM. Impressive acceleration from 21% Y/Y growth in CQ2. $27MM operating income vs. our $11MM estimate. Breakeven $0.00 EPS vs. our/Street estimate of ($0.05)/($0.04).

- Raising Estimates for CQ4 and C2003; AMZN Raising Guidance For CQ4: revenue to $1.4B (up 25% Y/Y, up 63% Q/Q) from $1.3B, operating income to $88MM from $78MM, and EPS to $0.14 from $0.12. For C2003: revenue to $4.4B (up 14% Y/Y) from $4.3B, operating income to $241MM from $230MM, and EPS to $0.29 from $0.24. We believe C2003 estimates are conservative.

- Reiterate Overweight-V Rating With CQ3 results, Amazon.com has demonstrated ability to: 1) generate strong and accelerating revenue growth with broadening product line in a tough retail market; 2) show early stage operating leverage -- 3% operating margin vs. negative 4% Y/Y, and 3) to deliver positive free cash flow -- $27MM in CQ3, $120MM on a TTM basis. AMZN results, along with those of YHOO, EBAY, and EXPE, support our core theses of offline- to-online commerce migration and inherent operating leverage for select leaders.

- Internet & PC Applications Software View is Attractive Given still strong 20%+ global growth in Internet users and usage, we believe our stocks could continue to outperform the market over 12-18 months.

Company Description Amazon.com is the leading inventory carrying shop-ping destination on
the Web with 29MM active customers (9/02).
CQ3:02 - Momentum is Very Strong.

Investment Thesis:

Total worldwide online retail sales are expected to grow nicely over
the next 3-5 years, and Amazon.com, with 29MM active customers as of
9/30/02 (customers who have purchased from Amazon.com at least once in
the last 12 months), and one of the strongest e-commerce brands, should
be well positioned to benefit from this growth. In our view, the
challenge for the company, which is not insignificant, is to continue
to demonstrate that its financial model works and truly has impressive
growth and scale/leverage dynamics.

Key Positives:

1. Large and growing market opportunity - Per US Commerce Department,
US online retail sales were $10.2B in CQ2, up 24% Y/Y.

2. Leadership spot in direct online retailing - AMZN accounts for an
estimated 6% of US online retail (excluding travel); during CQ3, AMZN
Y/Y organic unit growth was an estimated 40%, up from an estimated 30%
in CQ2 and CQ1. Impressive growth of third-party sales (Marketplace
and Services) (23% of US units in CQ3) adds another dimension to AMZN's
customer offering.

3. Accelerating revenue growth in each core segment -- Adjusting for
estimated $30MM impact to CQ3:01 results from 9/11, Y/Y "organic"
growth accelerated in CQ3:02 for U.S. BMVD (12% vs. 6% in CQ2), U.S.
ETK (18% vs. 16%), and International (84% vs. 70%).

4. Operating profitability achieved and repeated - AMZN posted its
first pro forma operating profit in CQ4:01, then continued pro forma
operating profitability in the seasonally weaker CQ1:02, CQ2:02, and
CQ3:02. International segment achieved break-even operating margin in
CQ3 for first time. On a trailing twelve month basis, AMZN has
generated $151MM in operating cash flow and $120MM in free cash flow.

5. Consistent profitability of the US BMVD (Books, Music & Video/DVD)
business - Ten consecutive quarters of operating profitability for US
BMVD may bode well for viability of earlier stage segments, such as
International.

6. Strong technology assets - AMZN has created a leading e-commerce
platform that is integrated, feature-rich, scalable, and secure.

7. Continued diversification of revenue - US BMVD accounted for 48%
of CQ3 total revenue, down from 55% Y/Y.

8. Improving inventory management - Annualized inventory turns (using
quarter average inventory) in CQ3:02 of 18 vs. 15 in CQ3:01.

9. Brand strength and customer service (with a focus on convenience)
are especially strong - Brand value ranked No. 76 worldwide by
Interbrand, ahead of Burger King and Shell Oil. AMZN ranked No. 1 in
American Customer Satisfaction Index with record score.

10. Expanded AOL alliance - AOL currently using Amazon e-commerce
platform to power shopping channel.

Key Risks:

1. Interest expense remains a drag on cash flow - Annual cash
interest expense of roughly $112MM on AMZN's $2.2B in debt makes
positive free cash flow bar that much higher.

2. U.S. ETK (Electronics, Tools & Kitchen) segment remains profit-
challenged -- The segment, which accounted for 15% of CQ3:02 revenue,
generated a negative 19% operating margin vs. a negative 14% margin in
CQ2, although improved from negative 32% in CQ3:01. Profitability in
this segment is not expected until late 2003 at the earliest.

3. Business model is still not fully proven - Company still needs to
prove it can ramp its generation of free cash flow on full-year basis;
economy, particularly the possibility of weaker consumer spending,
remains an issue.

4. Big competitors continue to come at Amazon.com from unique vantage
points - Among leading competitors, we would highlight eBay, Yahoo!
Shopping, and MSN. As we have noted before, as eBay has continued to
push its fixed-price initiatives, and Amazon.com has moved aggressively
into used sales via Marketplace, the companies increasingly have
competed more directly.

5. Christmas seasonality boost.happens only once per year - 36% of
annual revenue comes in CQ4.

Stock Catalysts:

1. Demonstration of continued improvement in operating cash flow -
AMZN has focused on liquidity and profitability and now needs to focus
on growth. The platform is built and fixed costs are largely stable;
now we think the company needs to drive more of its customers' products
through its platform to demonstrate scalability.

2. Ability to ramp revenue growth and profitability of ETK - US ETK
growth (up 25% Y/Y in CQ3) has shown strong top-line momentum, but
remains unprofitable. We do not anticipate ETK segment profitability
until late C2003 at the earliest, but we are looking for segment losses
to steadily decline as a percentage of revenue.

3. Successful moves into more "virtual" businesses - Amazon.com
Marketplace is a positive trend, in our view. In addition, we look for
ongoing growth in SKU count to leverage fixed-cost base.

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