10-K 1 d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2007

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.)

1200 12th Avenue South, Suite 1200

Seattle, Washington 98144-2734

(206) 266-1000

(Address and telephone number, including area code, of registrant’s principal executive offices)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, par value $.01 per share   Nasdaq Global Select Market

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  x  No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes  ¨  No  x

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x  Accelerated filer  ¨  Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨  No  x

 

Aggregate market value of voting stock held by non-affiliates of the registrant as of June 30, 2007

   $21,097,741,621

Number of shares of common stock outstanding as of February 1, 2008

   416,817,690

DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III of this Report, to the extent not set forth herein, is incorporated herein by reference from the registrant’s definitive proxy statement relating to the Annual Meeting of Shareholders to be held in 2008, which definitive proxy statement shall be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this Report relates.

 

 

 


Table of Contents

AMAZON.COM, INC.

FORM 10-K

For the Fiscal Year Ended December 31, 2007

INDEX

 

         Page
  PART I   

Item 1.

 

Business

   3

Item 1A.

 

Risk Factors

   8

Item 1B.

 

Unresolved Staff Comments

   18

Item 2.

 

Properties

   18

Item 3.

 

Legal Proceedings

   19

Item 4.

 

Submission of Matters to a Vote of Security Holders

   19
  PART II   

Item 5.

 

Market for the Registrant’s Common Stock, Related Shareholder Matters and Issuer Purchases of Equity Securities

   20

Item 6.

 

Selected Consolidated Financial Data

   21

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   22

Item 7A.

 

Quantitative and Qualitative Disclosure About Market Risk

   40

Item 8.

 

Financial Statements and Supplementary Data

   43

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   77

Item 9A.

 

Controls and Procedures

   77

Item 9B.

 

Other Information

   79
  PART III   

Item 10.

 

Directors and Executive Officers of the Registrant

   79

Item 11.

 

Executive Compensation

   79

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

   79

Item 13.

 

Certain Relationships and Related Transactions

   79

Item 14.

 

Principal Accountant Fees and Services

   79
  PART IV   

Item 15.

 

Exhibits, Financial Statement Schedules

   79

Signatures

   82

 

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AMAZON.COM, INC.

PART I

Item 1.    Business

This Annual Report on Form 10-K and the documents incorporated herein by reference contain forward-looking statements based on expectations, estimates, and projections as of the date of this filing. Actual results may differ materially from those expressed in forward-looking statements. See Item 1A of Part I—“Risk Factors.”

Amazon.com, Inc. was incorporated in 1994 in the state of Washington and reincorporated in 1996 in the state of Delaware. Our principal corporate offices are located in Seattle, Washington. We completed our initial public offering in May 1997 and our common stock is listed on the Nasdaq Global Select Market under the symbol “AMZN.”

As used herein, “Amazon.com,” “we,” “our” and similar terms include Amazon.com, Inc. and its subsidiaries, unless the context indicates otherwise.

General

Amazon.com, a Fortune 500 company, opened its virtual doors on the World Wide Web in July 1995. We offer Earth’s Biggest Selection and seek to be Earth’s most customer-centric company for three primary customer sets: consumer customers, seller customers and developer customers. In addition, we generate revenue through co-branded credit card agreements and other marketing and promotional services, such as online advertising.

We have organized our operations into two principal segments: North America and International. See Item 8 of Part II, “Financial Statements and Supplementary Data—Note 13—Segment Information.” See Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Supplemental Information” for supplemental information about our net sales.

Consumer Customers

We serve consumer customers through our retail websites, which include www.amazon.com, www.amazon.ca, www.amazon.de, www.amazon.fr, www.amazon.co.jp, www.amazon.co.uk, www.shopbop.com, www.endless.com and the Joyo Amazon websites at www.joyo.cn and www.amazon.cn. We seek to enable our consumer customers to find and discover anything they might want to buy online, and endeavor to offer the lowest possible prices. We source and sell a broad range of products worldwide across dozens of product categories, including digital media. We also design, manufacture, market and sell a wireless e-reading device, the Amazon Kindle. Our customer-facing businesses relentlessly focus on customer experience by offering a wide selection of merchandise, low prices, and convenience.

Selection

We endeavor to provide the widest possible selection for customers worldwide, while continuing to focus on in-stock inventory availability. We have designed our websites to enable millions of unique products to be sold by us and by third parties across dozens of product categories, such as:

 

•     Books

 

•     Electronics & Computers

 

•     Toys, Kids & Baby

 

•     Sports & Outdoors

 

•     Movies, Music & Games

 

•     Home & Garden

 

•     Apparel, Shoes & Jewelry

 

•     Tools, Auto & Industrial

 

•     Digital Downloads

 

•     Grocery

 

•     Health & Beauty

 

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Price

We endeavor to offer our customers the lowest prices possible through low everyday product pricing and free shipping offers. We also strive to improve our operating efficiencies so that we can continue to lower prices for our customers. We enable sellers to offer their products on our sites, in many instances alongside our product selection, and to set their own retail prices.

Convenience

Our software engineers, computer scientists, merchandisers, and management team focus on continuous innovation to enhance convenience. We work to earn repeat purchases by providing easy-to-use functionality, fast and reliable fulfillment, timely customer service, feature-rich and authoritative content, and a trusted transaction environment. Key features of our websites include editorial and customer reviews; manufacturer product information; gift guides; Web pages tailored to individual preferences, such as recommendations and notifications; 1-Click technology; secure payment systems; digital content; searching; browsing; and the ability to view selected interior pages and citations, and search the entire contents of many of the books we offer with our “Search Inside the Book” feature. Our community of online customers also creates feature-rich content, including product reviews, online recommendation lists, wish lists, image uploads, video reviews, buying guides, customer discussions, and wedding and baby registries.

We endeavor to fulfill customer orders quickly and accurately, and to provide intuitive self-service features that assist our customers when they have questions. We communicate our fulfillment promise in several ways, such as presenting up-to-date inventory availability information, delivery date estimates, and options for expedited delivery, as well as delivery shipment notifications. Customers can use the “Your Account” website features to track order and shipment status, review estimated delivery dates, cancel items not yet shipped, change delivery instructions and payment options, combine orders, edit gift options, and return items. Additionally, when customers have questions, we provide an email address and phone number to contact customer service directly and an intuitive click-to-call feature on our help pages so customers can quickly and conveniently speak with a customer service representative.

We fulfill customer orders in a number of ways, including through the U.S. and international fulfillment centers and warehouses that we operate; through fulfillment centers operated under co-sourcing arrangements, including our fulfillment center supporting www.amazon.co.jp; through outsourced fulfillment providers, including our fulfillment providers supporting www.amazon.ca; and through fulfillment arrangements with other sellers. We operate customer service centers globally, which are supplemented by several co-sourcing customer service arrangements with third parties. See Item 2 of Part I, “Properties,” for additional information about fulfillment centers and customer service locations.

Marketing and Promotion

Our marketing strategy is designed to increase customer traffic to our websites, drive awareness of products and services we offer, promote repeat purchases, develop incremental product and service revenue opportunities, and strengthen and broaden the Amazon.com brand name. We believe our most effective marketing efforts result from our focus on continuously improving the customer experience, which drives word-of-mouth promotion and repeat customer visits. We also deliver personalized Web pages and services and employ a variety of media, business development activities, and promotional methods. We employ various means of advertising, which consist primarily of online advertising, including through our Associates program, sponsored search, portal advertising, e-mail campaigns, and other initiatives. Our Associates program directs customers to our websites by enabling independent websites to make millions of products available to their audiences with fulfillment performed by us or third parties. We pay commissions to participants in our Associates program for click-through customer referrals and customer referrals resulting in product sales, subject to the terms of the specific commission agreement.

 

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We offer everyday free shipping options worldwide. We also offer Amazon Prime, a membership program in which members receive free or discounted express shipping, in the United States, the United Kingdom, Germany and Japan. Although marketing expenses do not include the costs of our free shipping or promotional offers, we view such offers as effective marketing tools.

Seller Customers

Through Amazon Services, we offer programs that enable seller customers to sell their products on our websites and fulfill orders through us, allow consumer customers to shop for products owned by sellers using our features and technologies, and allow individual customers to complete transactions that include multiple sellers in a single checkout process. We are not the seller of record in these transactions, but instead earn fixed fees, sales commissions, per-unit activity fees, or some combination thereof.

Our seller programs serve individuals, small businesses, and large branded businesses, enabling them to offer their new and used products for sale on our websites alongside our products and products made available by other sellers. We also offer fulfillment-related services to sellers through Fulfillment by Amazon.

In addition, Amazon Enterprise Solutions offers sellers e-commerce expertise, proven technology, and operational infrastructure to enable e-commerce businesses operating under their own brand name and website address (e.g. www.target.com).

Developer Customers

We serve developer customers through Amazon Web Services, which provides access to technology infrastructure that developers can use to enable virtually any type of business.

These services include:

 

   

Amazon Simple Storage Service (Amazon S3), which provides a simple web services interface for storing and retrieving data from anywhere on the web;

 

   

Amazon Elastic Compute Cloud (Amazon EC2), which provides a scalable up and down virtual computing environment, allowing developers to use web service interfaces to requisition machines for use and load them with their custom application environment, making web-scale computing easier for developers;

 

   

Amazon Simple Queue Service (Amazon SQS), which offers a reliable, highly scalable hosted queue for storing messages as they travel between computers;

 

   

Amazon SimpleDB, which provides a web service to create and store multiple data sets, query data easily, and return the results;

 

   

Amazon Flexible Payments Service (Amazon FPS), which provides a payments service designed specifically for developers, providing greater flexibility in the movement of money;

 

   

Amazon Mechanical Turk, which provides a web service for computers to integrate a network of humans directly into their processes; and

 

   

Alexa’s Web Services, which offer a platform for creating innovative web solutions and services based on Alexa’s vast repository of information about the web.

Competition

Our market segments are rapidly evolving and intensely competitive. Our current and potential competitors include: (1) physical-world retailers, publishers, vendors, distributors, manufacturers and producers of our products; (2) other online e-commerce and mobile e-commerce sites, including sites that sell or distribute digital content; (3) a number of indirect competitors, including media companies, Web portals, comparison shopping websites, and Web search engines, either directly or in collaboration with other retailers; (4) companies that

 

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provide e-commerce services, including website development; fulfillment and customer service; (5) companies that provide infrastructure web services or other information storage or computing services or products; and (6) companies that design, manufacture, market or sell digital media devices. We believe that the principal competitive factors in our retail market segments include selection, price, availability, convenience, information, discovery, brand recognition, personalized services, accessibility, customer service, reliability, speed of fulfillment, ease of use, and ability to adapt to changing conditions, as well as our customers’ overall experience and trust in transactions with us and facilitated by us on behalf of sellers. For our seller and web services, additional competitive factors include the quality of our services and tools, the speed and reliability of our services and our ability to build technology infrastructure while remaining competitive with our services from a cost perspective. Many of our current potential competitors have greater resources, longer histories, more customers, and greater brand recognition. They may secure better terms from vendors, adopt more aggressive pricing and devote more resources to technology, fulfillment, and marketing. Other companies also may enter into business combinations or alliances that strengthen their competitive positions.

Intellectual Property

We regard our trademarks, service marks, copyrights, patents, domain names, trade dress, trade secrets, proprietary technologies, and similar intellectual property as critical to our success, and we rely on trademark, copyright and patent law, trade-secret protection, and confidentiality and/or license agreements with our employees, customers, partners, and others to protect our proprietary rights. We have registered a number of domain names and been issued a number of trademarks, service marks, patents, and copyrights by U.S. and foreign governmental authorities. We also have applied for the registration of other trademarks, service marks, domain names, and copyrights in the U.S. and internationally, and we have filed U.S. and international patent applications covering certain of our proprietary technology. We have licensed in the past, and expect that we may license in the future, certain of our proprietary rights, such as trademarks, patents, technologies or copyrighted materials, to third parties.

Seasonality

Our business is affected by seasonality, which historically has resulted in higher sales volume during our fourth quarter, which ends December 31.

Employees

We employed approximately 17,000 full-time and part-time employees at December 31, 2007. However, employment levels fluctuate due to seasonal factors affecting our business. Additionally, we utilize independent contractors and temporary personnel to supplement our workforce, particularly on a seasonal basis. Our employees are not represented by a labor union and we consider our employee relations to be good. Competition for qualified personnel in our industry is intense, particularly for software engineers, computer scientists, and other technical staff. We believe that our future success will depend in part on our continued ability to attract, hire, and retain qualified personnel.

Available Information

Our investor relations website is www.amazon.com/ir. We make available on this website under “Financial Documents,” free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as reasonably practicable after we electronically file or furnish such materials to the U.S. Securities and Exchange Commission (“SEC”). We also make available on this website under the heading “Corporate Governance” our Code of Business Conduct and Ethics.

 

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Executive Officers and Directors

The following tables set forth certain information regarding our Executive Officers and Directors as of February 8, 2008:

Executive Officers

 

Name

   Age   

Position

Jeffrey P. Bezos

   44    President, Chief Executive Officer, and Chairman of the Board

Jeffrey M. Blackburn

   38    Senior Vice President, Business Development

Sebastian J. Gunningham

   45    Senior Vice President, Seller Services

Andrew R. Jassy

   40    Senior Vice President, Web Services

Steven Kessel

   42    Senior Vice President, Worldwide Digital Media

Marc A. Onetto

   57    Senior Vice President, Worldwide Operations

Diego Piacentini

   47    Senior Vice President, International Retail

Shelley L. Reynolds

   43    Vice President, Worldwide Controller, and Principal Accounting Officer

Thomas J. Szkutak

   47    Senior Vice President and Chief Financial Officer

H. Brian Valentine

   48    Senior Vice President, Ecommerce Platform

Jeffrey A. Wilke

   41    Senior Vice President, North America Retail

L. Michelle Wilson

   45    Senior Vice President, General Counsel, and Secretary

Jeffrey P. Bezos.    Mr. Bezos has been Chairman of the Board of Amazon.com since founding it in 1994 and Chief Executive Officer since May 1996. Mr. Bezos served as President of the Company from founding until June 1999 and again from October 2000 to the present.

Jeffrey M. Blackburn.    Mr. Blackburn has served as Senior Vice President, Business Development, since April 2006. From June 2004 to April 2006, he was Vice President, Business Development, from July 2003 to June 2004, he was Vice President, European Customer Service and from November 2002 to July 2003, Mr. Blackburn was Vice President, Operations Integration.

Sebastian J. Gunningham.    Mr. Gunningham has served as Senior Vice President, Seller Services, since joining Amazon.com in March 2007. Prior to joining Amazon.com, Mr. Gunningham was President of First Data Utilities from August 2006 to February 2007, following First Data’s acquisition of Peace Software, Inc., where he was Chief Executive Officer from February 2004 to August 2006 and President and Chief Operating Officer from April 2002 to March 2003. From March 2003 to February 2004, he served as Vice President of Enterprise Sales at Apple, Inc.

Andrew R. Jassy.    Mr. Jassy has served as Senior Vice President, Web Services, since April 2006. From January 2005 to April 2006, he was Vice President, Web Services, from August 2003 to January 2005, he was Vice President, Associates and Web Services, and, from November 2002 to August 2003, he was Vice President and Technical Assistant.

Steven Kessel.    Mr. Kessel has served as Senior Vice President, Worldwide Digital Media, since April 2006. From April 2004 to April 2006, he was Vice President, Digital and, from July 2002 to April 2004, he was Vice President, U.S. Books, Music, Video and DVD.

Marc A. Onetto.    Mr. Onetto has served as Senior Vice President, Worldwide Operations, since joining Amazon.com in December 2006. Prior to joining Amazon.com, Mr. Onetto was Executive Vice President, Worldwide Operations, at Solectron Corporation, an electronics manufacturing and technology company, from June 2003 to June 2006, and, prior to Solectron, he held various positions at GE, including Vice President, European Operations, GE Europe, from September 2002 to June 2003.

 

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Diego Piacentini.    Mr. Piacentini has served as Senior Vice President, International Retail, since January 2007. From November 2001 until December 2006, Mr. Piacentini served as Senior Vice President, Worldwide Retail and Marketing.

Shelley L. Reynolds.    Ms. Reynolds has served as Vice President, Worldwide Controller, and Principal Accounting Officer since April 2007. From February 2006 to April 2007, she was Vice President, Finance and Controller. Prior to joining Amazon.com, Ms. Reynolds was a partner at Deloitte & Touche LLP since 1998.

Thomas J. Szkutak.    Mr. Szkutak has served as Senior Vice President and Chief Financial Officer since joining Amazon.com in October 2002.

H. Brian Valentine.    Mr. Valentine has served as Senior Vice President, Ecommerce Platform, since joining Amazon.com in September 2006. Prior to joining Amazon.com, Mr. Valentine held various positions with Microsoft Corporation, including Senior Vice President, Windows Core Operating System Division, from January 2004 to September 2006 and Senior Vice President, Windows, from December 1999 to January 2004.

Jeffrey A. Wilke.    Mr. Wilke has served as Senior Vice President, North America Retail, since January 2007. From January 2002 until December 2006, he was Senior Vice President, Worldwide Operations.

L. Michelle Wilson.    Ms. Wilson has served as Senior Vice President, General Counsel, and Secretary since June 2003. From March 2001 until June 2003, she was Senior Vice President, Human Resources, General Counsel, and Secretary.

Board of Directors

 

Name

   Age   

Position

Jeffrey P. Bezos

   44   

President, Chief Executive Officer, and Chairman of the Board

Tom A. Alberg

   67   

Managing Director, Madrona Venture Group

John Seely Brown

   67   

Visiting Scholar and Advisor to the Provost, University of Southern California

L. John Doerr

   56   

General Partner, Kleiner Perkins Caufield & Byers

William B. Gordon

   58   

Executive Vice President and Chief Creative Officer, Electronic Arts, Inc.

Myrtle S. Potter

   49   

Chief Executive Officer, Chapman Properties, Inc., and Consultant, Myrtle Potter and Company, LLC

Thomas O. Ryder

   63   

Retired, Former Chairman, Reader’s Digest Association, Inc.

Patricia Q. Stonesifer

   51   

Chief Executive Officer, Bill & Melinda Gates Foundation

Item 1A.    Risk Factors

Please carefully consider the following risk factors. If any of the following risks occur, our business, financial condition, operating results, and cash flows could be materially adversely affected. In addition, these risks are not the only ones we face.

We Face Intense Competition

Our market segments are rapidly evolving and intensely competitive, and we have many competitors in different industries, including retail, e-commerce services, digital and web services. Many of our current and potential competitors have greater resources, longer histories, more customers, and greater brand recognition. They may secure better terms from vendors, adopt more aggressive pricing and devote more resources to technology, fulfillment, and marketing.

 

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Competition may intensify as our competitors enter into business combinations or alliances and established companies in other market segments expand into our market segments. In addition, new and enhanced technologies, including search, web services, and digital, may increase our competition. The Internet facilitates competitive entry and comparison shopping and renders e-commerce inherently more competitive than other retail. Increased competition may reduce our sales and profits.

Our Expansion Places a Significant Strain on our Management, Operational, Financial and Other Resources

We are rapidly and significantly expanding our global operations, including increasing our product and service offerings and scaling our infrastructure to support our retail and services businesses. This expansion increases the complexity of our business and places significant strain on our management, personnel, operations, systems, technical performance, financial resources, and internal financial control and reporting functions. We may not be able to manage growth effectively, which could damage our reputation, limit our growth and negatively affect our operating results.

Our Expansion into New Products, Services, Technologies and Geographic Regions Subjects Us to Additional Business, Legal, Financial and Competitive Risks

We may have limited or no experience in our newer market segments, and our customers may not adopt our new product or service offerings, which include seller services, digital, web services and electronic devices. These offerings may present new and difficult technology challenges, and we may be subject to claims if customers of these offerings experience service disruptions or failures or other quality issues. In addition, our gross profits in our newer activities may be lower than in our older activities, and we may not be successful enough in these newer activities to recoup our investments in them. If any of this were to occur, it could damage our reputation, limit our growth and negatively affect our operating results.

We May Experience Significant Fluctuations in Our Operating Results and Growth Rate

We may not be able to accurately forecast our growth rate. We base our expense levels and investment plans on sales estimates. A significant portion of our expenses and investments is fixed, and we may not be able to adjust our spending quickly enough if our sales are less than expected.

Our revenue growth may not be sustainable, and our percentage growth rates may decrease. Our revenue and operating profit growth depends on the continued growth of demand for the products and services offered by us or our sellers, and our business is affected by general economic and business conditions worldwide. A softening of demand, whether caused by changes in customer preferences or a weakening of the U.S. or global economies, may result in decreased revenue or growth.

Our net sales and operating results will also fluctuate for many other reasons, including due to risks described elsewhere in this section and the following:

 

   

our ability to retain and increase sales to existing customers, attract new customers, and satisfy our customers’ demands;

 

   

our ability to expand our network of sellers;

 

   

our ability to acquire merchandise, manage inventory, and fulfill orders;

 

   

the introduction of competitive websites, products, services, price decreases, or improvements;

 

   

changes in usage of the Internet and e-commerce, including in non-U.S. markets;

 

   

timing, effectiveness, and costs of expansion and upgrades of our systems and infrastructure;

 

   

the success of our geographic, service and product line expansions;

 

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the outcomes of legal proceedings and claims;

 

   

variations in the mix of products and services we sell;

 

   

variations in our level of merchandise and vendor returns;

 

   

the extent to which we offer free shipping, continue to reduce product prices worldwide, and provide additional benefits to our customers;

 

   

the extent to which we invest in technology and content, fulfillment and other expense categories;

 

   

increases in the prices of fuel and gasoline, as well as increases in the prices of other energy products and commodities like paper and packing supplies;

 

   

the extent to which operators of the networks between our customers and our websites successfully charge fees to grant our customers unimpaired and unconstrained access to our online services;

 

   

our ability to collect amounts owed to us when they become due;

 

   

the extent to which use of our services is affected by spyware, viruses, “phishing” and other spam emails, “denial of service” attacks, data theft, computer intrusions and similar events; and

 

   

terrorist attacks and armed hostilities.

We May Not Be Successful in Our Efforts to Expand into International Market Segments

Our international activities are significant to our revenues and profits, and we plan to further expand internationally. We have relatively little experience operating in these or future market segments and may not benefit from any first-to-market advantages or otherwise succeed. It is costly to establish, develop and maintain international operations and websites and promote our brand internationally. Our international operations may not be profitable on a sustained basis.

In addition to risks described elsewhere in this section, our international sales and operations are subject to a number of risks, including:

 

   

local economic and political conditions;

 

   

government regulation of e-commerce or other online services and restrictive governmental actions (such as trade protection measures, including export duties and quotas and custom duties and tariffs), nationalization and restrictions on foreign ownership;

 

   

restrictions on sales or distribution of certain products or services and uncertainty regarding liability for products, services and content, including uncertainty as a result of less Internet-friendly legal systems, local laws, lack of legal precedent, and varying rules, regulations, and practices regarding the distribution of media products and enforcement of intellectual property rights;

 

   

import, export, or other business licensing requirements;

 

   

limitations on the repatriation and investment of funds and foreign currency exchange restrictions;

 

   

limited fulfillment and technology infrastructure;

 

   

shorter payable and longer receivable cycles and the resultant negative impact on cash flow;

 

   

laws and regulations regarding consumer and data protection, privacy, network security, encryption, and restrictions on pricing or discounts;

 

   

lower levels of use of the Internet;

 

   

lower levels of consumer spending and fewer opportunities for growth compared to the U.S.;

 

   

lower levels of credit card usage and increased payment risk;

 

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difficulty in staffing, developing and managing foreign operations as a result of distance, language and cultural differences;

 

   

different employee/employer relationships and the existence of workers’ councils and labor unions;

 

   

laws and policies of the U.S. and other jurisdictions affecting trade, foreign investment, loans and taxes; and

 

   

geopolitical events, including war and terrorism.

As the international e-commerce channel grows, competition will intensify. Local companies may have a substantial competitive advantage because of their greater understanding of, and focus on, the local customer, as well as their more established local brand names. We may not be able to hire, train, retain, and manage required personnel, which may limit our international growth.

In 2004, we acquired Joyo.com Limited, which is organized under the laws of the British Virgin Islands and through a People’s Republic of China (“PRC”) entity, provides technology and services for the Joyo Amazon websites at www.joyo.cn and www.amazon.cn. The PRC regulates Joyo Amazon’s business through regulations and license requirements restricting (i) foreign investment in the Internet, retail and delivery sectors, (ii) Internet content and (iii) the sale of media products. In order to meet local ownership and regulatory licensing requirements, Joyo Amazon’s business is operated by PRC companies owned by nominee shareholders who are PRC nationals. Although we believe Joyo Amazon’s structure complies with existing PRC laws, it involves unique risks. There are substantial uncertainties regarding the interpretation of PRC laws and regulations, and it is possible that the PRC government will ultimately take a view contrary to ours. If Joyo Amazon (including its subsidiary and affiliates) were found to be in violation of any existing or future PRC laws or regulations or if interpretations of those laws and regulations were to change, the business could be subject to fines and other financial penalties, have its licenses revoked or be forced to shut down entirely. In addition, if Joyo Amazon were unable to enforce its contractual relationships with respect to management and control of its business, it might be unable to continue to operate the business.

If We Do Not Successfully Optimize and Operate Our Fulfillment Centers, Our Business Could Be Harmed

If we do not successfully operate our fulfillment centers, it could significantly limit our ability to meet customer demand. Because it is difficult to predict demand, we may not manage our facilities in an optimal way, which may result in excess or insufficient inventory or warehousing, fulfillment, and distribution capacity. A failure to optimize inventory will increase our net shipping cost by requiring long-zone or partial shipments. Orders from several of our websites are fulfilled primarily from a single location, and we have only a limited ability to reroute orders to third parties for drop-shipping. We and our co-sourcers may be unable to adequately staff our fulfillment and customer service centers. As we continue to add fulfillment and warehouse capability or add new businesses with different fulfillment requirements, our fulfillment network becomes increasingly complex and operating it becomes more challenging. If the other businesses on whose behalf we perform inventory fulfillment services deliver product to our fulfillment centers in excess of forecasts, we may be unable to secure sufficient storage space and may be unable to optimize our fulfillment centers. There can be no assurance that we will be able to operate our network effectively.

We rely on a limited number of shipping companies to deliver inventory to us and completed orders to our customers. If we are not able to negotiate acceptable terms with these companies or they experience performance problems or other difficulties, it could negatively impact our operating results and customer experience. In addition, our ability to receive inbound inventory efficiently and ship completed orders to customers also may be negatively affected by inclement weather, fire, flood, power loss, earthquakes, labor disputes, acts of war or terrorism, acts of God and similar factors.

Third parties either drop-ship or otherwise fulfill an increasing portion of our customers’ orders, and we are increasingly reliant on the reliability, quality and future procurement of their services. Under some of our

 

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commercial agreements, we maintain the inventory of other companies, thereby increasing the complexity of tracking inventory and operating our fulfillment centers. Our failure to properly handle such inventory or the inability of these other companies to accurately forecast product demand would result in unexpected costs and other harm to our business and reputation.

The Seasonality of Our Business Places Increased Strain on Our Operations

We expect a disproportionate amount of our net sales to occur during our fourth quarter. If we do not stock or restock popular products in sufficient amounts such that we fail to meet customer demand, it could significantly affect our revenue and our future growth. If we overstock products, we may be required to take significant inventory markdowns or write-offs, which could reduce gross profits. We may experience an increase in our net shipping cost due to complimentary upgrades, split-shipments, and additional long-zone shipments necessary to ensure timely delivery for the holiday season. If too many customers access our websites within a short period of time due to increased holiday demand, we may experience system interruptions that make our websites unavailable or prevent us from efficiently fulfilling orders, which may reduce the volume of goods we sell and the attractiveness of our products and services. In addition, we may be unable to adequately staff our fulfillment and customer service centers during these peak periods and delivery and other fulfillment companies and customer service co-sourcers may be unable to meet the seasonal demand. We also face risks described elsewhere in this Item 1A relating to fulfillment center optimization and inventory.

We generally have payment terms with our vendors that extend beyond the amount of time necessary to collect proceeds from our customers. As a result of holiday sales, at December 31 of each year, our cash, cash equivalents, and marketable securities balances typically reach their highest level (other than as a result of cash flows provided by or used in investing and financing activities). This operating cycle results in a corresponding increase in accounts payable at December 31. Our accounts payable balance generally declines during the first three months of the year, resulting in a corresponding decline in our cash, cash equivalents, and marketable securities balances.

Our Business Could Suffer if We Are Unsuccessful in Making, Integrating, and Maintaining Commercial Agreements, Strategic Alliances, and Other Business Relationships

We provide e-commerce services to other businesses, such as through our marketplace programs, Amazon Enterprise Solutions, Website by Amazon and Fulfillment by Amazon program initiatives, as well as other commercial agreements, strategic alliances and business relationships. Under these agreements, we provide technology, fulfillment and other services, as well as enable sellers to offer products or services through our websites and power their websites. These arrangements are complex and require substantial personnel and resource commitments by us, which may limit the agreements we are able to enter into and our ability to integrate and deliver services under them. If we fail to implement, maintain, and develop the components of these commercial relationships, which may include fulfillment, customer service, inventory management, tax collection, payment processing, licensing of third-party software, hardware, and content, and engaging third parties to perform hosting and other services, these initiatives may not be viable. The amount of compensation we receive under certain of these agreements is partially dependent on the volume of the other company’s sales. Therefore, if the other company’s offering is not successful, the compensation we receive may be lower than expected or the agreement may be terminated. Moreover, we may not be able to enter into additional commercial relationships and strategic alliances on favorable terms. We also may be subject to claims from businesses to which we provide these services if we are unsuccessful in implementing, maintaining or developing these services.

As our commercial agreements terminate, we may be unable to renew or replace these agreements on comparable terms, or at all. Some of our agreements involve high margin services, such as marketing and promotional agreements, and as they expire they may be replaced, if at all, by agreements involving lower margin services. We may in the future enter into amendments on less favorable terms or encounter parties that have difficulty meeting their contractual obligations to us, which could adversely affect our operating results.

 

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Our present and future e-commerce services agreements, other commercial agreements, and strategic alliances create additional risks such as:

 

   

disruption of our ongoing business, including loss of management focus on existing businesses;

 

   

impairment of other relationships;

 

   

variability in revenue and income from entering into, amending, or terminating such agreements or relationships; and

 

   

difficulty integrating under the commercial agreements.

Our Business Could Suffer if We Are Unsuccessful in Making, Integrating, and Maintaining Acquisitions and Investments

We have acquired and invested in a number of companies, and we may acquire or invest in or enter into joint ventures with additional companies. These transactions create risks such as:

 

   

disruption of our ongoing business, including loss of management focus on existing businesses;

 

   

problems retaining key personnel;

 

   

additional operating losses and expenses of the businesses we acquired or in which we invested;

 

   

the potential impairment of amounts capitalized as intangible assets as part of the acquisition;

 

   

the potential impairment of customer and other relationships of the company we acquired or in which we invested or our own customers as a result of any integration of operations;

 

   

the difficulty of incorporating acquired technology and rights into our offerings and unanticipated expenses related to such integration;

 

   

the difficulty of integrating a new company’s accounting, financial reporting, management, information, human resource and other administrative systems to permit effective management, and the lack of control if such integration is delayed or not implemented;

 

   

the difficulty of implementing at companies we acquire the controls, procedures and policies appropriate for a larger public company;

 

   

potential unknown liabilities associated with a company we acquire or in which we invest; and

 

   

for foreign transactions, additional risks related to the integration of operations across different cultures and languages, and the economic, political, and regulatory risks associated with specific countries.

Finally, as a result of future acquisitions or mergers, we might need to issue additional equity securities, spend our cash, or incur debt, contingent liabilities, or amortization expenses related to intangible assets, any of which could reduce our profitability and harm our business.

We Have Foreign Exchange Risk

The results of operations of, and certain of our intercompany balances associated with, our international websites are exposed to foreign exchange rate fluctuations. Upon translation, operating results may differ materially from expectations, and we may record significant gains or losses on the remeasurement of intercompany balances. As we have expanded our international operations, our exposure to exchange rate fluctuations has increased.

In addition, our 6.875% Premium Adjustable Convertible Securities due 2010 (“6.875% PEACS”) are denominated in Euros and increases in the Euro relative to the U.S. Dollar increase the U.S. Dollar amount we owe as interest and principal on the 6.875% PEACS. We also hold cash equivalents and/or marketable securities primarily in Euros, British Pounds, and Japanese Yen. If the U.S. Dollar strengthens compared to these currencies, cash equivalents and marketable securities balances, when translated, may be materially less than expected and vice versa.

 

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The Loss of Key Senior Management Personnel Could Negatively Affect Our Business

We depend on our senior management and other key personnel, particularly Jeffrey P. Bezos, our President, CEO, and Chairman. We do not have “key person” life insurance policies. The loss of any of our executive officers or other key employees could harm our business.

System Interruption and the Lack of Integration and Redundancy in Our Systems May Affect Our Sales

Customer access to our websites and the speed with which a customer navigates and makes purchases on our websites affect our net sales, operating results and the attractiveness of our products and services. We experience occasional system interruptions and delays that make our websites unavailable or slow to respond and prevent us from efficiently fulfilling orders or providing services to third parties, which may reduce our net sales and the attractiveness of our products and services. If we are unable to continually add software and hardware, effectively upgrade our systems and network infrastructure and take other steps to improve the efficiency of our systems, it could cause system interruptions or delays and adversely affect our operating results.

Our computer and communications systems and operations could be damaged or interrupted by fire, flood, power loss, telecommunications failure, earthquakes, acts of war or terrorism, acts of God, computer viruses, physical or electronic break-ins, and similar events or disruptions. Any of these events could cause system interruption, delays, and loss of critical data, and could prevent us from accepting and fulfilling customer orders and providing services, which would make our product and service offerings less attractive. Our systems are not fully redundant and our disaster recovery planning may not be sufficient. In addition, we may have inadequate insurance coverage to compensate us for any related losses. Any of these events could damage our reputation and be expensive to remedy.

We Have Significant Indebtedness

We have significant debt and may incur substantial additional debt in the future. A significant portion of our future cash flow from operating activities may be dedicated to the payment of interest and the repayment of principal on our indebtedness. There is no guarantee that we will be able to meet our debt service obligations. If we are unable to generate sufficient cash flow or obtain funds for required payments, or if we fail to comply with our debt covenants, we will be in default. In addition, we may not be able to refinance our debt on terms acceptable to us, or at all. Our indebtedness could limit our ability to obtain additional financing for working capital, capital expenditures, debt service requirements, acquisitions or other purposes in the future, as needed; to plan for, or react to, changes in technology and in our business and competition; and to react in the event of an economic downturn.

We Face Significant Inventory Risk

In addition to risks described elsewhere in this Item 1A relating to fulfillment center and inventory optimization by us and third parties, we are exposed to significant inventory risks that may adversely effect our operating results as a result of seasonality, new product launches, rapid changes in product cycles, changes in consumer tastes with respect to our products and other factors. We must accurately predict these trends and avoid overstocking or under-stocking products we manufacture and/or sell. Demand for products, however, can change significantly between the time inventory or components are ordered and the date of sale. In addition, when we begin selling or manufacturing a new product, it may be difficult to establish vendor relationships, determine appropriate product or component selection, and accurately forecast demand. The acquisition of certain types of inventory or components may require significant lead-time and prepayment and they may not be returnable. We carry a broad selection and significant inventory levels of certain products, such as consumer electronics, and we may be unable to sell products in sufficient quantities or during the relevant selling seasons. Any one of the inventory risk factors set forth above may adversely affect our operating results.

 

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We May Not Be Able to Adequately Protect Our Intellectual Property Rights or May Be Accused of Infringing Intellectual Property Rights of Third Parties

We regard our trademarks, service marks, copyrights, patents, trade dress, trade secrets, proprietary technology, and similar intellectual property as critical to our success, and we rely on trademark, copyright, and patent law, trade secret protection, and confidentiality and/or license agreements with our employees, customers, and others to protect our proprietary rights. Effective intellectual property protection may not be available in every country in which our products and services are made available. We also may not be able to acquire or maintain appropriate domain names in all countries in which we do business. Furthermore, regulations governing domain names may not protect our trademarks and similar proprietary rights. We may be unable to prevent third parties from acquiring domain names that are similar to, infringe upon, or diminish the value of our trademarks and other proprietary rights.

We may not be able to discover or determine the extent of any unauthorized use of our proprietary rights. Third parties that license our proprietary rights also may take actions that diminish the value of our proprietary rights or reputation. The protection of our intellectual property may require the expenditure of significant financial and managerial resources. Moreover, the steps we take to protect our intellectual property may not adequately protect our rights or prevent third parties from infringing or misappropriating our proprietary rights. We also cannot be certain that others will not independently develop or otherwise acquire equivalent or superior technology or other intellectual property rights.

Other parties also may claim that we infringe their proprietary rights. We have been subject to, and expect to continue to be subject to, claims and legal proceedings regarding alleged infringement by us of the intellectual property rights of third parties. The ready availability of damages, royalties and the potential for injunctive relief has increased the costs associated with the litigation and settlement of patent infringement claims, especially those asserted by third parties whose sole or primary business is to assert such claims. Such claims, whether or not meritorious, may result in the expenditure of significant financial and managerial resources, injunctions against us or the payment of damages. We may need to obtain licenses from third parties who allege that we have infringed their rights, but such licenses may not be available on terms acceptable to us or at all. In addition, we may not be able to obtain or utilize on terms that are favorable to us, or at all, licenses or other rights with respect to intellectual property we do not own in providing e-commerce services to other businesses and individuals under commercial agreements.

Our digital content offerings depend in part on effective digital rights management technology to control access to digital content. If the digital rights management technology that we use is compromised or otherwise malfunctions, we could be subject to claims, and content providers may be unwilling to include their content in our service.

We Have a Rapidly Evolving Business Model and Our Stock Price Is Highly Volatile

We have a rapidly evolving business model. The trading price of our common stock fluctuates significantly in response to, among other risks, the risks described elsewhere in this Item 1A, as well as:

 

   

changes in interest rates;

 

   

conditions or trends in the Internet and the e-commerce industry;

 

   

quarterly variations in operating results;

 

   

fluctuations in the stock market in general and market prices for Internet-related companies in particular;

 

   

changes in financial estimates by us or securities analysts and recommendations by securities analysts;

 

   

changes in our capital structure, including issuance of additional debt or equity to the public;

 

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changes in the valuation methodology of, or performance by, other e-commerce companies; and

 

   

transactions in our common stock by major investors and certain analyst reports, news, and speculation.

Volatility in our stock price could adversely affect our business and financing opportunities and force us to increase our cash compensation to employees or grant larger stock awards than we have historically, which could hurt our operating results or reduce the percentage ownership of our existing stockholders, or both.

Government Regulation of the Internet and E-commerce Is Evolving and Unfavorable Changes Could Harm Our Business

We are subject to general business regulations and laws, as well as regulations and laws specifically governing the Internet and e-commerce. Existing and future laws and regulations may impede the growth of the Internet or online services. These regulations and laws may cover taxation, privacy, data protection, pricing, content, copyrights, distribution, mobile communications, electronic contracts and other communications, consumer protection, the provision of online payment services, unencumbered Internet access to our services, the design and operation of websites, and the characteristics and quality of products and services. It is not clear how existing laws governing issues such as property ownership, libel, and personal privacy apply to the Internet and e-commerce. Jurisdictions may regulate consumer-to-consumer online businesses, including certain aspects of our seller programs. Unfavorable regulations and laws could diminish the demand for our products and services and increase our cost of doing business.

Taxation Risks Could Subject Us to Liability for Past Sales and Cause Our Future Sales to Decrease

We do not collect sales or other taxes on shipments of most of our goods into most states in the U.S. Under some of our commercial agreements, the other company is the seller of record, and we are obligated to collect sales tax in accordance with that company’s instructions. We may enter into additional agreements requiring similar tax collection obligations. Our fulfillment center and customer service center networks, and any future expansion of them, along with other aspects of our evolving business, may result in additional sales and other tax obligations. We collect consumption tax (including value added tax, goods and services tax, and provincial sales tax) as applicable on goods and services sold by us that are ordered on our international sites. One or more states or foreign countries may seek to impose sales or other tax collection obligations on out-of-jurisdiction e-commerce companies. A successful assertion by one or more states or foreign countries that we should collect sales or other taxes on the sale of merchandise or services could result in substantial tax liabilities for past sales, decrease our ability to compete with traditional retailers, and otherwise harm our business.

Currently, U.S. Supreme Court decisions restrict the imposition of obligations to collect state and local sales and use taxes with respect to sales made over the Internet. However, a number of states, as well as the U.S. Congress, have been considering initiatives that could limit or supersede the Supreme Court’s position regarding sales and use taxes on Internet sales. If any of these initiatives were successful, we could be required to collect sales and use taxes in additional states. The imposition by state and local governments of various taxes upon Internet commerce could create administrative burdens for us, put us at a competitive disadvantage if they do not impose similar obligations on all of our online competitors and decrease our future sales.

We Could be Subject to Additional Income Tax Liabilities

We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in evaluating our worldwide provision for income taxes. During the ordinary course of business, there are many transactions for which the ultimate tax determination is uncertain. For example, our effective tax rates could be adversely affected by earnings being lower than anticipated in countries where we have lower statutory rates and higher than anticipated in countries where we have higher statutory rates, by changes in the valuation of our deferred tax assets and liabilities, or by changes in the relevant tax, accounting and other laws, regulations, principles and interpretations. We are subject to audit in various jurisdictions, and

 

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such jurisdictions may assess additional income tax against us. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different from our historical income tax provisions and accruals. The results of an audit or litigation could have a material effect on our operating results or cash flows in the period or periods for which that determination is made.

Our Vendor Relationships Subject Us to a Number of Risks

We have significant vendors that are important to our sourcing, manufacturing and any related ongoing servicing of merchandise and content. We do not have long-term arrangements with most of our vendors to guarantee availability of merchandise, content, components or services, particular payment terms, or the extension of credit limits. If our current vendors were to stop selling merchandise, content, components or services to us on acceptable terms, we may be unable to procure from other vendors in a timely and efficient manner and on acceptable terms, or at all.

We May Be Subject to Product Liability Claims if People or Property Are Harmed by the Products We Sell

Some of the products we sell or manufacture may expose us to product liability claims relating to personal injury, death, or property damage, and may require product recalls or other actions. Certain third parties also sell products using our e-commerce platform that may increase our exposure to product liability claims, such as if these sellers do not have sufficient protection from such claims. Although we maintain liability insurance, we cannot be certain that our coverage will be adequate for liabilities actually incurred or that insurance will continue to be available to us on economically reasonable terms, or at all. In addition, some of our agreements with our vendors and sellers do not indemnify us from product liability.

We Are Subject to Payments-Related Risks

We accept payments using a variety of methods, including credit card, debit card, credit accounts (including promotional financing), gift certificates, direct debit from a customer’s bank account, physical bank check and payment upon delivery. As we offer new payment options to our customers, we may be subject to additional regulations, compliance requirements, and fraud. For certain payment methods, including credit and debit cards, we pay interchange and other fees, which may increase over time and raise our operating costs and lower our profit margins. We rely on third parties to provide payment processing services, including the processing of credit cards, debit cards, electronic checks, and promotional financing, and it could disrupt our business if these companies become unwilling or unable to provide these services to us. We are also subject to payment card association operating rules, certification requirements and rules governing electronic funds transfers, which could change or be reinterpreted to make it difficult or impossible for us to comply. If we fail to comply with these rules or requirements, we may be subject to fines and higher transaction fees and lose our ability to accept credit and debit card payments from our customers, process electronic funds transfers, or facilitate other types of online payments, and our business and operating results could be adversely affected. We also offer co-branded credit card programs that represent a significant component of our services revenue and generate high margins. If one or more of these agreements are terminated and we are unable to replace them on similar terms, or at all, it could adversely affect our operating results.

In addition, we qualify as a money services business in certain jurisdictions because we enable customers to keep account balances with us and transfer money to third parties, and because we provide services to third parties to facilitate payments on their behalf. In these jurisdictions, we may be subject to requirements for licensing, regulatory inspection, bonding, the handling of transferred funds and consumer disclosures. We are also subject to or voluntarily comply with a number of other laws and regulations relating to money laundering, international money transfers, privacy and information security and electronic fund transfers. If we were found to be in violation of applicable laws or regulations, we could be subject to civil and criminal penalties or forced to cease our payments services business.

 

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We Could Be Liable for Breaches of Security on Our Websites

Although we have developed systems and processes that are designed to protect consumer information and prevent fraudulent payment transactions and other security breaches, failure to prevent or mitigate such fraud or breaches may adversely affect our operating results.

We Could Be Liable for Fraudulent or Unlawful Activities of Sellers

The law relating to the liability of providers of online payment services is currently unsettled. In addition, governmental agencies could require changes in the way this business is conducted. Under our seller programs, we may be unable to prevent sellers from collecting payments, fraudulently or otherwise, when buyers never receive the products they ordered or when the products received are materially different from the sellers’ descriptions. Under our A2Z Guarantee, we reimburse buyers for payments up to certain limits in these situations, and as our marketplace seller sales grow, the cost of this program will increase and could negatively affect our operating results. We also may be unable to prevent sellers on our sites or through Amazon Enterprise Solutions, and certain other programs, from selling unlawful goods, from selling goods in an unlawful manner, or violating the proprietary rights of others, and could face civil or criminal liability for unlawful activities by our sellers.

Item 1B.     Unresolved Staff Comments

None.

Item 2.     Properties

We do not own any real estate. As of December 31, 2007, we operated the following facilities:

 

Description of Use

   Square
Footage (1)
  

Operating
Segments

   Lease
Expirations (1)(2)
     (in thousands)          

Corporate office facilities

   1,266   

North America

   From 2008
through 2017

Corporate office facilities

   425   

International

   From 2008
through 2016
          

Sub-total

   1,691      
          

Fulfillment and warehouse operations (3)

   8,905   

North America

   From 2008
through 2018

Fulfillment and warehouse operations

   4,729   

International

   From 2008
through 2025
          

Sub-total

   13,634      
          

Customer service and other

   368   

North America

   From 2008
through 2021

Customer service and other

   144   

International

   From 2008
through 2016
          

Sub-total

   512      
          

Total

   15,837      
          

 

(1) Represents the total leased space excluding sub-leased space.
(2) Most leases expiring in 2008 have renewal features at our option.
(3) Excludes a facility operated under an outsourced arrangement in Canada.

 

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We lease our corporate headquarters in Seattle, Washington. We also lease additional corporate office, fulfillment and warehouse operations, customer service, and other facilities throughout the United States, principally in Arizona, California, Delaware, Florida, Indiana, Kansas, Kentucky, Michigan, Nevada, New Hampshire, North Dakota, Pennsylvania, South Carolina, Texas, Virginia, Washington, West Virginia, and Wisconsin. Outside of the United States, we also lease corporate office, fulfillment and warehouse operations, customer service, and other facilities, principally in China, France, Germany, India, Ireland, Japan, Luxembourg, and the United Kingdom.

We believe our properties are suitable and adequate for our present needs, and we periodically evaluate whether additional facilities are necessary.

Item 3.     Legal Proceedings

See Item 8 of Part II, “Financial Statements and Supplementary Data—Note 6—Commitments and Contingencies—Legal Proceedings.”

Item 4.     Submission of Matters to a Vote of Security Holders

No matters were submitted for a vote of our shareholders during the fourth quarter of 2007.

 

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PART II

Item 5.     Market for the Registrant’s Common Stock, Related Shareholder Matters and Issuer Purchases of Equity Securities

Market Information

Our common stock is traded on the Nasdaq Global Select Market under the symbol “AMZN.” The following table sets forth the high and low closing prices for our common stock for the periods indicated, as reported by the Nasdaq Global Select Market.

 

     High    Low

Year ended December 31, 2006

     

First Quarter

   $ 47.87    $ 35.25

Second Quarter

     38.68      31.61

Third Quarter

     38.61      26.07

Fourth Quarter

     42.96      30.87

Year ended December 31, 2007

     

First Quarter

   $ 41.51    $ 36.43

Second Quarter

     73.65      40.42

Third Quarter

     93.48      68.73

Fourth Quarter

     100.82      77.00

Holders

As of February 1, 2008, there were 3,587 shareholders of record of our common stock, although there are a much larger number of beneficial owners.

Dividends

We have never declared or paid cash dividends on our common stock. See Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

Recent Sales of Unregistered Securities

None.

Issuer Purchases of Equity Securities

None.

 

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Item 6.     Selected Consolidated Financial Data

The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and the notes thereto in Item 8 of Part II, “Financial Statements and Supplementary Data,” and the information contained in Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Historical results are not necessarily indicative of future results.

 

     Year Ended December 31,  
     2007     2006     2005     2004     2003  
     (in millions, except per share data)  

Income Statement:

          

Net sales

   $ 14,835     $ 10,711     $ 8,490     $ 6,921     $ 5,264  

Income from operations

     655       389       432       440       270  

Income before change in accounting principle

     476       190       333       588       35  

Cumulative effect of change in accounting principle

     —         —         26       —         —    

Net income

     476       190       359       588       35  

Basic earnings per share (1):

          

Prior to cumulative effect of change in accounting principle

   $ 1.15     $ 0.46     $ 0.81     $ 1.45     $ 0.09  

Cumulative effect of change in accounting principle

     —         —         0.06       —         —    
                                        

Basic earnings per share (1)

   $ 1.15     $ 0.46     $ 0.87     $ 1.45     $ 0.09  
                                        

Diluted earnings per share (1):

          

Prior to cumulative effect of change in accounting principle

   $ 1.12     $ 0.45     $ 0.78     $ 1.39     $ 0.08  

Cumulative effect of change in accounting principle

     —         —         0.06       —         —    
                                        

Diluted earnings per share (1)

   $ 1.12     $ 0.45     $ 0.84     $ 1.39     $ 0.08  
                                        

Weighted average shares used in computation of earnings per share:

          

Basic

     413       416       412       406       395  

Diluted

     424       424       426       425       419  

Cash Flow Statement:

          

Net cash provided by operating activities

   $ 1,405     $ 702     $ 733     $ 566     $ 393  

Purchases of fixed assets, including internal-use software and website development

     (224 )     (216 )     (204 )     (89 )     (46 )
                                        

Free cash flow (2)

   $ 1,181     $ 486     $ 529     $ 477     $ 347  
                                        
     December 31,  
     2007     2006     2005     2004     2003  
     (in millions)  

Balance Sheet:

          

Total assets

   $ 6,485     $ 4,363     $ 3,696     $ 3,248     $ 2,162  

Long-term debt

     1,282       1,247       1,480       1,835       1,919  

 

(1) For further discussion of earnings per share, see Item 8 of Part II, “Financial Statements and Supplementary Data—Note 1—Description of Business and Accounting Policies.”
(2) Free cash flow, a non-GAAP financial measure, is defined as net cash provided by operating activities less purchases of fixed assets, including capitalized internal-use software and website development, both of which are presented on our consolidated statements of cash flows. See Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Non-GAAP Financial Measures.”

 

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Item 7.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Annual Report on Form 10-K 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 Annual Report on Form 10-K are forward-looking. We use words such as anticipates, believes, expects, future, intends, and similar expressions to identify forward-looking statements. Forward-looking statements reflect management’s current expectations and are inherently uncertain. Actual results could differ materially for a variety of reasons, including, among others, fluctuations in foreign exchange rates, changes in global economic conditions and consumer spending, world events, the rate of growth of the Internet and online commerce, the amount that Amazon.com invests in new business opportunities and the timing of those investments, the mix of products sold to customers, the mix of net sales derived from products as compared with services, the extent to which we owe income taxes, competition, management of growth, potential fluctuations in operating results, international growth and expansion, outcomes of legal proceedings and claims, fulfillment center optimization, risks of inventory management, seasonality, the degree to which the Company enters into, maintains, and develops commercial agreements, acquisitions, and strategic transactions, payments risks, and risks of fulfillment throughput and productivity. 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 I, “Risk Factors,” which, along with the previous discussion, describes some, but not all, of the factors that could cause actual results to differ significantly from management’s expectations.

Overview

Our primary source of revenue is the sale of a wide range of products and services to customers. The products offered on our customer-facing websites primarily include merchandise and content we have purchased for resale from vendors and products offered by marketplace sellers. Generally, we recognize gross revenue from items we sell from our inventory and recognize our net share of revenue of items sold by other sellers. We also offer services such as Amazon Web Services, Amazon Enterprise Solutions, co-branded credit cards, fulfillment, and miscellaneous marketing and promotional offers.

Our financial focus is on long-term, sustainable growth in free cash flow1 per share. Free cash flow is driven primarily by increasing operating income and efficiently managing working capital and capital expenditures. Increases in operating income primarily result from increases in sales through our websites and efficiently managing our operating costs, offset by investments we make in longer-term strategic initiatives, which generally require us to hire additional software engineers, computer scientists, and merchandisers. To increase product sales, we focus on improving all aspects of the customer experience, including lowering prices, improving availability, offering faster delivery times, increasing selection, increasing product categories, expanding product information, improving ease of use, and earning customer trust. We generally focus on growing gross profit and operating profit dollars rather than maximizing margin percentages.

We also seek to efficiently manage shareholder dilution while maintaining the flexibility to issue shares for strategic purposes, such as financings and aligning employee compensation with shareholders’ interests. We utilize restricted stock units as our primary vehicle for equity compensation because we believe they align the interests of our shareholders and employees. In managing shareholder dilution, we include all stock awards outstanding, without regard to estimated forfeitures, consisting of vested and unvested awards and in-the-money

 

 

1

Free cash flow, a non-GAAP financial measure, is defined as net cash provided by operating activities less purchases of fixed assets, including capitalized internal-use software and website development, both of which are presented on our consolidated statements of cash flows. See “Results of Operations—Non-GAAP Financial Measures” below.

 

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and out-of-the-money stock options. Total shares outstanding plus outstanding stock awards were 435 million and 436 million at December 31, 2007 and 2006. These amounts exclude 14 million shares issuable upon conversion of our long-term debt. In 2007, we repurchased 6 million shares of our common stock under a repurchase program authorized by our Board of Directors.

We seek to reduce our variable costs per unit and work to leverage our fixed costs. Our variable costs include product and content costs, payment processing and related transaction costs, picking, packaging, and preparing orders for shipment, transportation, customer service support, and most aspects of our marketing costs. Our fixed costs include the costs necessary to run our technology infrastructure, build, enhance, and add features to our websites and build and optimize our fulfillment centers. Variable costs generally change directly with sales volume, while fixed costs generally increase depending on the timing of capacity needs, geographic expansion, category expansion, and other factors. To decrease our variable costs on a per unit basis and enable us to lower prices for customers, we seek to increase our direct to publisher and manufacturer sourcing, maximize discounts available to us from suppliers and reduce defects in our processes. To minimize growth in fixed costs, we seek to improve process efficiencies and maintain a lean culture.

Because of our model we are able to turn our inventory quickly and have a cash-generating operating cycle2. On average, our high inventory velocity means we generally collect from our customers before our payments to suppliers come due. Inventory turnover3 was 13, 13, and 14 for 2007, 2006, and 2005. Inventory turnover has declined slightly over the last several years, primarily due to category expansion and changes in product mix, and our continuing focus on in-stock inventory availability. We expect some variability in inventory turnover over time since it is affected by several factors, including our product mix, the mix of sales by us and by other sellers, our continuing focus on in-stock inventory availability, our investment in new geographies and product lines, and the extent to which we choose to utilize outsource fulfillment providers. Accounts payable days4 were 57, 53, and 54 for 2007, 2006 and 2005. We expect some variability in accounts payable days over time since they are affected by several factors, including the mix of product sales, the mix of sales by other sellers, the mix of suppliers, seasonality, and changes in payment terms over time, including the effect of balancing pricing and timing of payment terms with suppliers.

Our spending in technology and content will increase as we add computer scientists, software engineers, and employees involved in category expansion, editorial content, buying, merchandising selection, and systems support. We will continue to invest in several areas of technology and content, including seller platforms, web services, digital initiatives, and expansion of new and existing product categories, as well as in technology infrastructure to enhance the customer experience, improve our process efficiencies and support our infrastructure web services. We believe that advances in technology, specifically the speed and reduced cost of processing power, the improved customer experience of the Internet outside of the workplace through lower-cost broadband service to the home, and the advances of wireless connectivity, will continue to improve the customer experience on the Internet and increase its ubiquity in people’s lives. Amazon Web Services provides technology services that give developers access to technology infrastructure that they can use to enable virtually any type of business. Our challenge will be to continue to build and deploy innovative and efficient software that will best take advantage of continued advances in technology.

Our financial reporting currency is the U.S. Dollar and changes in exchange rates significantly affect our reported results and consolidated trends. For example, if the U.S. Dollar weakens year-over-year relative to currencies in our international locations, our consolidated net sales, gross profit, and operating expenses will be

 

 

2

The operating cycle is number of days of sales in inventory plus number of days of sales in accounts receivable minus accounts payable days.

3

Inventory turnover is the quotient of annualized cost of sales to average inventory over five quarters.

4

Accounts payable days, calculated as the quotient of accounts payable to cost of sales, multiplied by the number of days in the period.

 

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higher than if currencies had remained constant. Likewise, if the U.S. Dollar strengthens year-over-year relative to currencies in our international locations, our consolidated net sales, gross profit, and operating expenses will be lower than if currencies had remained constant. We believe that our increasing diversification beyond the U.S. economy through our growing international businesses benefits our shareholders over the long term. We also believe it is important to evaluate our operating results and growth rates before and after the effect of currency changes.

In addition, the remeasurement of our 6.875% PEACS and intercompany balances can result in significant gains and charges associated with the effect of movements in currency exchange rates. Currency volatilities may continue, which may significantly impact (either positively or negatively) our reported results and consolidated trends and comparisons.

For additional information about each line item summarized above, refer to Item 8 of Part II, “Financial Statements and Supplementary Data—Note 1—Description of Business and Accounting Policies.”

Critical Accounting Judgments

The preparation of financial statements in conformity with generally accepted accounting principles of the United States (“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.” 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.

Revenue Recognition

We recognize revenue from product sales or services rendered when the following four revenue recognition criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable, and collectibility is reasonably assured. Additionally, revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: the delivered item has value to the customer on a standalone basis; there is objective and reliable evidence of the fair value of undelivered items; and delivery of any undelivered item is probable.

We evaluate the criteria of Emerging Issues Task Force (EITF) Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent, in determining whether it is appropriate to record the gross amount of product sales and related costs or the net amount earned as commissions. Generally, when we are the primary party obligated in a transaction, are subject to inventory risk, have latitude in establishing prices and selecting suppliers, or have several but not all of these indicators, revenue is recorded gross. If we are not primarily obligated and amounts earned are determined using a percentage, a fixed-payment schedule, or a combination of the two, we generally record the net amounts as commissions earned.

Product sales and shipping revenues, net of promotional discounts, rebates, and return allowances, are recorded when the products are shipped and title passes to customers. Retail items sold to customers are made pursuant to sales contracts that generally provide for transfer of both title and risk of loss upon our delivery to the

 

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carrier. Return allowances, which reduce product revenue by our best estimate of expected product returns, are estimated using historical experience. Revenue from product sales and services rendered is recorded net of sales taxes. Amounts paid in advance for subscription services, including amounts received for Amazon Prime and other membership programs, are deferred and recognized as revenue over the subscription term. For our products with multiple elements, where a standalone value for each element cannot be established, we recognize the revenue and related cost over the estimated economic life of the product.

We periodically provide incentive offers to our customers to encourage purchases. Such offers include current discount offers, such as percentage discounts off current purchases, inducement offers, such as offers for future discounts subject to a minimum current purchase, and other similar offers. Current discount offers, when accepted by our customers, are treated as a reduction to the purchase price of the related transaction, while inducement offers, when accepted by our customers, are treated as a reduction to purchase price based on estimated future redemption rates. Redemption rates are estimated using our historical experience for similar inducement offers. Current discount offers and inducement offers are classified as an offsetting amount in “Net sales.”

Commissions and per-unit fees received from sellers and similar amounts earned through Amazon Enterprise Solutions are recognized when the item is sold by the seller and our collectibility is reasonably assured. When we are responsible for fulfillment-related services, commissions are recognized when risk of loss and title transfer to the customer. We record an allowance for estimated refunds on such commissions using historical experience.

Inventories

Inventories, consisting of products available for sale, are accounted for using the first-in first-out (“FIFO”) method, and are valued at the lower of cost or market value. This valuation requires us to make judgments, based on currently-available information, about the likely method of disposition, such as through sales to individual customers, returns to product vendors, or liquidations, and expected recoverable values of each disposition category. Based on this evaluation, we adjust the carrying amount of our inventories to lower of cost or market value.

We provide fulfillment-related services in connection with certain of our agreements. In those arrangements, as well as other product sales by other sellers, the seller maintains ownership of the related products. As such, these amounts are not included in our consolidated balance sheets.

Internal-Use Software and Website Development

Included in fixed assets is the capitalized cost of internal-use software and website development, including software used to upgrade and enhance our websites and processes supporting our business. As required by Statement of Position (SOP) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” we capitalize costs incurred during the application development stage of internal-use software and amortize these costs over the estimated useful life of two years. Costs incurred related to design or maintenance of internal-use software are expensed as incurred.

Currency Effect on Intercompany Balances

Gains and losses arising from intercompany foreign currency transactions are included in net income.

Stock-Based Compensation

We measure compensation cost for stock awards at fair value and recognize compensation over the service period for awards expected to vest. The fair value of restricted stock and restricted stock units is determined

 

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based on the number of shares granted and the quoted price of our common stock. Since we primarily issue restricted stock units to our employees, the complexity of valuation issues for stock compensation is greatly reduced. The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. We consider many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Actual results and future estimates may differ substantially from our current estimates.

We utilize the accelerated method, rather than a straight-line method, for recognizing compensation expense. Under this method, over 50% of the compensation cost would be expensed in the first year of a four year vesting term. The accelerated method also adds a level of complexity in estimating forfeitures. If forfeited early in the life of an award, the forfeited amount is much greater under an accelerated method than under a straight-line method.

Income Taxes

We are subject to income taxes in both the U.S. and numerous foreign jurisdictions. Significant judgment is required in evaluating our tax positions and determining our provision for income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. We establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. These reserves for tax contingencies are established when we believe that certain positions might be challenged despite our belief that our tax return positions are fully supportable. We adjust these reserves in light of changing facts and circumstances, such as the outcome of tax audit. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate.

Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when taxes are actually paid or recovered. The majority of our gross deferred tax assets relate to net operating loss carryforwards that related to differences in stock-based compensation between the financial statements and our tax returns.

Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, requires that deferred tax assets be evaluated for future realization and reduced by a valuation allowance to the extent we believe a portion will not be realized. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative earnings experience and expectations of future taxable income by taxing jurisdiction, the carry-forward periods available to us for tax reporting purposes, and other relevant factors. In accordance with the provisions of SFAS No. 109, we allocate our valuation allowance to current and long-term deferred tax assets on a pro-rata basis.

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

Effective January 1, 2007, we adopted the provisions of FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109. FIN 48 contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS No. 109. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes.

 

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Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We do not expect the adoption of SFAS No. 157 to have a material impact on our consolidated financial statements. The FASB may delay a portion of this standard.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We do not expect the adoption of SFAS No. 159 to have a material impact on our consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141 (R), Business Combinations, and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements. SFAS No. 141 (R) requires an acquirer to measure the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at their fair values on the acquisition date, with goodwill being the excess value over the net identifiable assets acquired. SFAS No. 160 clarifies that a noncontrolling interest in a subsidiary should be reported as equity in the consolidated financial statements. The calculation of earnings per share will continue to be based on income amounts attributable to the parent. SFAS No. 141 (R) and SFAS No. 160 are effective for financial statements issued for fiscal years beginning after December 15, 2008. Early adoption is prohibited. We have not yet determined the effect on our consolidated financial statements, if any, upon adoption of SFAS No. 141 (R) or SFAS No. 160.

Liquidity and Capital Resources

Cash flow information is as follows:

 

     Year Ended December 31,  
     2007    2006     2005  
     (in millions)  

Cash provided by (used in):

       

Operating activities

   $ 1,405    $ 702     $ 733  

Investing activities

     42      (333 )     (778 )

Financing activities

     50      (400 )     (193 )

Free cash flow, a non-GAAP financial measure, was $1.18 billion for 2007, compared to $486 million and $529 million for 2006 and 2005. See “Results of Operations—Non-GAAP Financial Measures” below for a reconciliation of free cash flow to cash provided by operating activities. The increase in free cash flow in 2007 primarily resulted from the increased growth rate of our revenue and gross profit relative to operating expenses. The decrease in free cash flow in 2006 was primarily driven by our increased expenditure in technology and content and excess tax benefits from stock-based compensation deductions now classified as financing cash flows. Free cash flow for 2005 included the effect of our payment of a $40 million patent litigation settlement. Operating cash flows and free cash flows can be volatile and are sensitive to many factors, including changes in working capital, and the timing and magnitude of capital expenditures. Working capital at any specific point in time is subject to many variables, including seasonality, inventory management and category expansion, the timing of cash receipts and payments, vendor payment terms, and fluctuations in foreign exchange rates.

Our principal sources of liquidity are cash flows generated from operations and our cash, cash equivalents, and marketable securities balances, which, at fair value, were $3.1 billion, $2.0 billion, and $2.0 billion at December 31, 2007, 2006 and 2005. Amounts held in foreign currencies were $1.2 billion, $623 million, and

 

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$905 million at December 31, 2007, 2006, and 2005 and were primarily Euros, British Pounds, and Japanese Yen.

Cash provided by operating activities was $1.4 billion, $702 million, and $733 million in 2007, 2006, and 2005. Our operating cash flows result primarily from cash received from our customers, from sellers, and from non-retail activities such as our co-branded credit card agreements, Amazon Enterprise Solutions, and miscellaneous marketing and promotional agreements, offset by cash payments we make for products and services, employee compensation (less amounts capitalized pursuant to SOP 98-1 that are reflected as cash used in investing activities), payment processing and related transaction costs, operating leases, and interest payments on our long-term debt obligations. Cash received from customers, sellers, developers, and other activities generally corresponds to our net sales. Because our customers primarily use credit cards to buy from us, our receivables from customers settle quickly.

Cash provided by (used in) investing activities corresponds with purchases, sales, and maturities of marketable securities, cash outlays for acquisitions and intellectual property rights, and purchases of fixed assets, including internal-use software and website development costs. Cash provided by (used in) investing activities was $42 million, $(333) million, and $(778) million in 2007, 2006, and 2005, with the variability caused primarily by purchases, maturities, and sales of marketable securities. Capital expenditures were $224 million, $216 million and $204 million in 2007, 2006 and 2005, with the sequential increases primarily reflecting additional investments in technology infrastructure, fulfillment-related assets and the development of new features and product offerings on our websites. Capital expenditures included $108 million, $108 million and $79 million for internal-use software and website development during 2007, 2006 and 2005. Stock-based compensation capitalized for internal-use software and website development costs does not affect cash flows. We made payments for the acquisition of certain companies and intellectual property rights, resulting in cash payments, net of acquired cash, of $75 million, $32 million, and $24 million in 2007, 2006 and 2005 attributable to cash provided by investing activities.

Cash provided by (used in) financing activities was $50 million, $(400) million, and $(193) million in 2007, 2006, and 2005. Cash outflows from financing activities result from repurchases of common stock, repayments of long-term debt, and payments on capital lease obligations. We repurchased 6 million shares of common stock for $248 million in 2007, and 8 million shares of common stock for $252 million in 2006, under a $500 million repurchase program authorized by our Board of Directors in 2006. Repayments on long-term debt and payments on capital lease obligations were $74 million, $383 million, and $270 million in 2007, 2006, and 2005. Repayments on long-term debt include €250 million and €200 million of our 6.875% PEACS for $300 million and $265 million in 2006 and 2005. See Item 8 of Part II, “Financial Statements and Supplementary Data—Note 4—Long-Term Debt.” Cash inflows from financing activities primarily result from proceeds from tax benefits relating to excess stock-based compensation deductions and exercises of employee stock options. SFAS No. 123(R), Accounting for Stock Based Compensation, requires tax benefits relating to excess stock-based compensation deductions be presented as financing cash flows. Cash inflows from tax benefits related to stock-based compensation deductions were $257 million, $102 million and $7 million in 2007, 2006, and 2005. Cash inflows from proceeds from exercise of employee stock options were $91 million, $35 million, and $59 million in 2007, 2006, and 2005. We expect cash proceeds from exercises of stock options will decline over time as we continue issuing restricted stock units as our primary vehicle for stock-based awards.

In 2007, 2006 and 2005 we recorded net tax provisions of $184 million, $187 million, and $95 million. A majority of this provision is non-cash. We have current tax benefits and net operating losses relating to excess stock-based compensation deductions that are being utilized to reduce our U.S. taxable income. As such, cash taxes paid were $24 million, $15 million, and $12 million for 2007, 2006, and 2005. We endeavor to optimize our global taxes on a cash basis, rather than on a financial reporting basis.

In February 2008, our Board of Directors authorized a debt repurchase program, replacing our previous debt repurchase authorization in its entirety, pursuant to which we may from time to time repurchase (through open

 

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market repurchases or private transactions), redeem, or otherwise retire up to all of our outstanding 4.75% Convertible Subordinated Notes due 2009 (“4.75% Convertible Subordinated Notes”) and 6.875% PEACS. The outstanding principal of our 4.75% Convertible Subordinated Notes as of this authorization was $899 million, and the outstanding principal amount of our 6.875% PEACS was €240 million. In August 2006, our Board of Directors authorized a 24-month program to repurchase up to $500 million of our common stock, pursuant to which we repurchased $252 million and $248 million of our common stock in 2006 and 2007, respectively. In April 2007, our Board authorized a new 24-month program to repurchase up to $500 million of our common stock, which was replaced in February 2008 by a 24-month program to repurchase up to $1 billion of our common stock.

Since our 6.875% PEACS, which are due in 2010, are denominated in Euros, our U.S. Dollar equivalent interest payments and principal obligations fluctuate with the Euro to U.S. Dollar exchange rate. As a result, any fluctuations in the exchange rate will have an effect on our interest expense and, to the extent we make principal payments, the amount of U.S. Dollar equivalents necessary for principal settlement. Additionally, since our interest payable on our 6.875% PEACS is due in Euros, the balance of interest payable is subject to gains or losses on currency movements until the date of the interest payment. Gains or losses on the remeasurement of our Euro-denominated interest payable are classified as “Other income (expense), net” on our consolidated statements of operations.

On average, our high inventory velocity means we collect from our customers before our payments to suppliers come due. Inventory turnover was 13, 13, and 14 for 2007, 2006, and 2005. Inventory turnover has declined slightly over the last several years, primarily due to category expansion and changes in product mix, and our continuing focus on in-stock inventory availability, which enables faster delivery of products to our customers. We expect some variability in inventory turnover over time as it is affected by several factors, including our product mix, the mix of sales by us and by other sellers, our continuing focus on in-stock inventory availability, our investment in new geographies and product lines, and the extent to which we choose to utilize outsource fulfillment providers.

The following summarizes our principal contractual commitments as of December 31, 2007:

 

     2008    2009    2010    2011    2012    Thereafter    Total
     (in millions)

Operating and capital commitments:

                    

Debt principal (1)

   $ 17    $ 932    $ 350    $ —      $ —      $ —      $ 1,299

Debt interest (1)

     69      46      24      —        —        —        139

Capital leases, including interest

     32      29      23      6      6      5      101

Operating leases

     132      107      89      69      52      201      650

Other commitments (2)(3)

     60      64      80      60      43      579      886

Purchase obligations (4)

     485      —        —        —        —        —        485
                                                

Total commitments

   $ 795    $ 1,178    $ 566    $ 135    $ 101    $ 785    $ 3,560
                                                

 

(1) At December 31, 2007, the Euro to U.S. Dollar exchange rate was 1.459. Due to changes in the Euro/U.S. Dollar exchange ratio, our remaining principal debt obligation under the 6.875% PEACS since issuance in February 2000 has increased by $114 million as of December 31, 2007. The principal and interest commitments reflect the partial redemptions of the 6.875% PEACS and 4.75% Convertible Subordinated Notes.
(2)

Includes the estimated timing and amounts of payments for rent, operating expenses, and tenant improvements associated with approximately 800,000 square feet of corporate office space in Seattle, Washington. We also have the right to occupy up to an additional approximately 800,000 square feet subject to a termination fee, estimated to be up to approximately $40 million, if we do not elect to occupy this additional space. The amount of space available and our financial and other obligations under the lease agreements are affected by various factors, including government approvals and permits, interest rates, development costs and other expenses and our exercise of certain rights under the lease agreements. See

 

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Item 8 of Part II, “Financial Statements and Supplementary Data—Note 6—Commitments and Contingencies—Commitments.”

(3) Includes commitments to acquire intellectual property and unrecognized tax benefits under FIN 48, but excludes $105 million of such unrecognized tax benefits for which we cannot make a reasonably reliable estimate of the amount and period of payment. See Item 8 of Part II, “Financial Statements and Supplementary Data—Note 12—Income Taxes.”
(4) Consists of legally-binding commitments to purchase inventory and significant non-inventory commitments.

In January 2008 we closed or entered into agreements, subject to regulatory approvals and other conditions, to acquire or invest in certain companies. These acquisitions and investments result in aggregate cash payments of approximately $400 million, net of cash acquired.

Pledged Securities

We are required to pledge or otherwise restrict a portion of our cash and marketable securities as collateral for standby letters of credit, guarantees, debt, and real estate leases. We classify cash and marketable securities with use restrictions of twelve months or longer as non-current “Other assets” on our consolidated balance sheets. The balance of pledged securities at December 31, 2007 consisted of $14 million in “Cash and cash equivalents” and “Marketable securities,” and $197 million in “Other assets.” The amount required to be pledged for certain real estate lease agreements changes over the life of our leases based on our credit rating and changes in our market capitalization (common shares outstanding multiplied by the closing price of our common stock). Information about collateral required to be pledged under these agreements is as follows:

 

     Standby and Trade
Letters of Credit
and Guarantees
   Debt (1)    Real Estate
Leases (2)
    Total
     (in millions)

Balance at December 31, 2006

   $ 60    $ 56    $ 20     $ 136

Net change in collateral pledged

     78      4      (7 )     75
                            

Balance at December 31, 2007

   $ 138    $ 60    $ 13     $ 211
                            

 

(1) Represents collateral for certain debt related to our international operations.
(2) At December 31, 2006, our market capitalization was $38.6 billion. The required amount of collateral to be pledged will increase by $5 million if our market capitalization is equal to or below $18 billion and by an additional $6 million if our market capitalization is equal to or below $13 billion.

We believe that current cash, cash equivalents, and marketable securities balances will be sufficient to meet our anticipated operating cash needs for at least the next 12 months. However, any projections of future cash needs and cash flows are subject to substantial uncertainty. See Item 1A of Part I, “Risk Factors.” We continually evaluate opportunities to sell additional equity or debt securities, obtain credit facilities, repurchase common stock, pay dividends, or repurchase, refinance, or otherwise restructure our long-term debt for strategic reasons or to further strengthen our financial position. The sale of additional equity or convertible debt securities would likely be dilutive to our shareholders. In addition, we will, from time to time, consider the acquisition of, or investment in, complementary businesses, products, services, and technologies, which might affect our liquidity requirements or cause us to issue additional equity or debt securities. There can be no assurance that additional lines-of-credit or financing instruments will be available in amounts or on terms acceptable to us, if at all.

 

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Results of Operations

We have organized our operations into two principal segments: North America and International. We present our segment information along the same lines that our chief executive reviews our operating results in assessing performance and allocating resources.

Net Sales and Gross Profit

Net sales information is as follows:

 

     Year Ended December 31,  
     2007     2006     2005  
     (in millions)  

Net Sales:

      

North America

   $ 8,095     $ 5,869     $ 4,711  

International

     6,740       4,842       3,779  
                        

Consolidated

   $ 14,835     $ 10,711     $ 8,490  
                        

Year-over-year Percentage Growth:

      

North America

     38 %     25 %     22 %

International

     39       28       23  

Consolidated

     39       26       23  

Year-over-year Percentage Growth, excluding effect of exchange rates:

      

North America

     38 %     24 %     22 %

International

     31       28       25  

Consolidated

     35       26       24  

Net Sales Mix:

      

North America

     55 %     55 %     55 %

International

     45       45       45  
                        

Consolidated

     100 %     100 %     100 %
                        

Revenue increased 39% in 2007, reflecting revenue growth in both our North America and International segments. Additionally, changes in currency exchange rates positively affected net sales by $399 million for 2007. For a discussion of the effect on revenue growth of exchange rates, see “Effect of Exchange Rates” below.

The North America revenue growth rate was 38% in 2007. This revenue growth primarily reflects increased unit sales driven largely by our continued efforts to reduce prices for our customers, including from our free shipping offers and Amazon Prime, a larger base of sales in faster growing categories such as electronics and other general merchandise, increased in-stock inventory availability, and increased selection of product offerings.

The International revenue growth rate was 39% in 2007. This revenue growth reflects increased unit sales driven largely by our continued efforts to reduce prices for our customers, including from our free shipping offers, a larger base of sales in faster growing categories such as electronics and other general merchandise, increased in-stock inventory availability, and increased selection of product offerings. Additionally, changes in currency exchange rates positively affected International net sales by $390 million in 2007.

We expect that, over time, our International segment will represent 50% or more of our consolidated net sales. Additionally, as we continue to offer increased selection, lower prices, and additional product lines within our electronics and other general merchandise category, we expect to see the relative mix of sales from this category increase. See “Supplemental Information” below.

 

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Gross profit information is as follows:

 

     Year Ended December 31,  
     2007     2006     2005  
     (in millions)  

Gross Profit:

      

North America

   $ 2,031     $ 1,525     $ 1,267  

International

     1,322       931       772  
                        

Consolidated

   $ 3,353     $ 2,456     $ 2,039  
                        

Gross Profit Growth Rate:

      

North America

     33 %     20 %     24 %

International

     42       21       33  

Consolidated

     37       20       27  

Gross Margin:

      

North America

     25.1 %     26.0 %     26.9 %

International

     19.6       19.2       20.4  

Consolidated

     22.6       22.9       24.0  

The increase in gross profit in absolute terms during 2007, compared to 2006 and 2005, corresponds with increases in sales, offset by lower prices for customers including from free shipping offers and Amazon Prime. Generally, our gross margins fluctuate based on several factors, including our product, service, and geographic mix of sales; sales volumes by marketplace sellers; changes in vendor pricing, including the extent to which we receive discounts and allowances; lowering prices for customers, including from competitive pricing decisions; improvements in product sourcing and inventory management; and the extent to which our customers accept our free shipping and Amazon Prime offers. Such free shipping and Amazon Prime offers reduce shipping revenue and reduce our gross margins on retail sales. We view our shipping offers as an effective worldwide marketing tool and intend to continue offering them indefinitely.

Sales of products by marketplace sellers on our websites represented 28% of unit sales in 2007, 2006, and 2005. Since revenues from these sales are recorded as a net amount, they generally result in lower revenues but higher gross margin per unit. Since we focus on profit dollars rather than margins, we are largely neutral on whether an item is sold by us or by another seller .

Gross profit growth is also affected by changes in exchange rates—see “Effect of Exchange Rates” below.

North America segment gross margins in 2007 decreased by 90 basis points compared to 2006 resulting primarily from our efforts to continue reducing prices for our customers, including from our free shipping offers and Amazon Prime, and a larger percent of overall sales in lower margin categories such as electronics.

North America segment gross margins in 2006 decreased by 92 basis points compared to 2005 resulting primarily from changes in our revenue mix, as revenue in our retail business grew faster than revenue from marketplace sellers. In addition, sales from electronics and other general merchandise grew faster than sales from media and we continued our efforts to reduce prices for our customers, including from our free shipping offers and Amazon Prime.

International segment gross margins in 2007 increased by 38 basis points compared to 2006 resulting primarily from increases in sales of products by marketplace sellers, offset partially by our efforts to continue reducing prices for our customers, including from our free shipping offers and Amazon Prime, and a larger percent of overall sales in lower margin categories such as electronics.

International segment gross margins in 2006 decreased by 120 basis points compared to 2005 resulting primarily from changes in our revenue mix as sales from electronics and other general merchandise grew faster than sales from media.

 

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Supplemental Information

Supplemental information about shipping results is as follows:

 

     December 31,  
     2007     2006     2005  
     (in millions)  

Shipping Activity:

      

Shipping revenue (1)(2)

   $ 740     $ 567     $ 511  

Outbound shipping costs

     (1,174 )     (884 )     (750 )
                        

Net shipping cost

   $ (434 )   $ (317 )   $ (239 )
                        

Year-over-year Percentage Growth:

      

Shipping revenue

     31 %     11 %     22 %

Outbound shipping costs

     33       18       22  

Net shipping cost

     37       32       22  

Percent of Net Sales:

      

Shipping revenue

     5.0 %     5.3 %     6.0 %

Outbound shipping costs

     (7.9 )     (8.3 )     (8.8 )
                        

Net shipping cost

     (2.9 )%     (3.0 )%     (2.8 )%
                        

 

(1) Excludes amounts earned on shipping activities by sellers where we do not provide the fulfillment service.
(2) Includes amounts earned from Amazon Prime membership and Fulfillment by Amazon programs.

We believe that offering low prices to our customers is fundamental to our future success. One way we offer lower prices is through free-shipping offers that result in a net cost to us in delivering products, as well as through membership in Amazon Prime. To the extent our customers accept and use our free shipping offers at an increasing rate, including memberships in Amazon Prime, our net cost of shipping will increase. We seek to partially mitigate the costs of lowering prices over time through achieving higher sales volumes, negotiating better terms with our suppliers, and achieving better operating efficiencies.

 

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Supplemental information about our net sales is as follows:

 

     Year Ended December 31,  
     2007     2006     2005  
     (in millions)  

Net Sales:

      

North America

      

Media

   $ 4,630     $ 3,582     $ 3,046  

Electronics and other general merchandise

     3,139       2,024       1,443  

Other (1)

     326       263       222  
                        

Total North America

   $ 8,095     $ 5,869     $ 4,711  
                        

International

      

Media

   $ 4,612     $ 3,485     $ 2,885  

Electronics and other general merchandise

     2,071       1,337       886  

Other (1)

     57       20       8  
                        

Total International

   $ 6,740     $ 4,842     $ 3,779  
                        

Consolidated

      

Media

   $ 9,242     $ 7,067     $ 5,931  

Electronics and other general merchandise

     5,210       3,361       2,329  

Other (1)

     383       283       230  
                        

Total consolidated

   $ 14,835     $ 10,711     $ 8,490  
                        

Year-over-year Percentage Growth:

      

North America

      

Media

     29 %     18 %     18 %

Electronics and other general merchandise

     55       40       28  

Other

     24       18       71  

Total North America

     38       25       22  

International

      

Media

     32 %     21 %     15 %

Electronics and other general merchandise

     55       51       59  

Other

     186       151       234  

Total International

     39       28       23  

Consolidated

      

Media

     31 %     19 %     16 %

Electronics and other general merchandise

     55       44       38  

Other

     35       23       74  

Total consolidated

     39       26       23  

Year-over-year Percentage Growth:

      

Excluding the effect of exchange rates

      

International

      

Media

     25 %     21 %     17 %

Electronics and other general merchandise

     45       49       62  

Other

     165       147       247  

Total International

     31       28       25  

Consolidated

      

Media

     27 %     19 %     17 %

Electronics and other general merchandise

     51       43       39  

Other

     34       23       74  

Total consolidated

     35       26       24  

Consolidated Net Sales Mix:

      

Media

     62 %     66 %     70 %

Electronics and other general merchandise

     35       31       27  

Other

     3       3       3  
                        

Total consolidated

     100 %     100 %     100 %
                        

 

(1) Includes non-retail activities, such as Amazon Enterprise Solutions, our co-branded credit card agreements, and miscellaneous marketing and promotional services.

 

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Information about operating expenses with and without stock-based compensation is as follows (in millions):

 

    Year ended December 31, 2007     Year ended December 31, 2006     Year ended December 31, 2005  
    As
Reported
    Stock-Based
Compensation
    Net     As
Reported
    Stock-Based
Compensation
    Net     As
Reported
    Stock-Based
Compensation
    Net  

Operating Expenses:

                 

Fulfillment

  $ 1,292     $ (39 )   $ 1,253     $ 937     $ (24 )   $ 913     $ 745     $ (16 )   $ 729  

Marketing

    344       (8 )     336       263       (4 )     259       198       (6 )     192  

Technology and content

    818       (103 )     715       662       (54 )     608       451       (45 )     406  

General and administrative

    235       (35 )     200       195       (19 )     176       166       (20 )     146  

Other operating expense

    9       —         9       10       —         10       47       —         47  
                                                                       

Total operating expenses

  $ 2,698     $ (185 )   $ 2,513     $ 2,067     $ (101 )   $ 1,966     $ 1,607     $ (87 )   $ 1,520  
                                                                       

Year-over-year Percentage Growth:

                 

Fulfillment

    38 %       37 %     26 %       25 %     24 %       23 %

Marketing

    31         30       32         34       22         22  

Technology and content

    23         17       47         50       59         62  

General and administrative

    20         13       18         21       34         30  

Percent of Net Sales:

                 

Fulfillment

    8.7 %       8.4 %     8.7 %       8.5 %     8.8 %       8.6 %

Marketing

    2.3         2.3       2.5         2.4       2.3         2.3  

Technology and content

    5.5         4.8       6.2         5.7       5.3         4.8  

General and administrative

    1.6         1.3       1.8         1.6       1.9         1.7  

Operating expenses without stock-based compensation are non-GAAP financial measures. See “Non-GAAP Financial Measures” and Item 8 of Part I, “Financial Statements and Supplementary Data—Note 1—Description of Business and Accounting Policies—Stock-Based Compensation.”

Fulfillment

The increase in fulfillment costs in absolute dollars during 2007 in comparison with the prior years relates to variable costs corresponding with sales volume and inventory levels; our mix of product sales; payment processing and related transaction costs, including mix of payment methods and costs from our guarantee for certain marketplace seller transactions; and costs from expanding fulfillment capacity.

Fulfillment costs as a percentage of net sales may vary due to several factors, such as payment processing and related transaction costs, including those from our guarantee for certain seller transactions, our level of productivity and accuracy, changes in volume, size, and weight of units received and fulfilled, the extent we utilize fulfillment services provided by third parties, 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 costs associated with seller transactions are based on the gross purchase price of underlying transactions, and payment processing and related transaction costs are higher as a percentage of revenue versus our retail sales, our sales by our sellers have higher fulfillment costs as a percent of net sales.

We expanded our fulfillment capacity in 2007, 2006, and 2005 through gains in efficiencies and increases in leased warehouse space. This expansion is designed to accommodate greater selection and in-stock inventory levels and meet anticipated shipment volumes from sales of our own products as well as sales by third parties for which we provide the fulfillment.

Marketing

We direct customers to our websites primarily through a number of targeted online marketing channels, such as our Associates program, sponsored search, portal advertising, e-mail campaigns, and other initiatives.

 

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Our marketing expenses 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 expense or its effect.

Marketing costs increased in absolute dollars in 2007 compared to 2006 and 2005, due to increased spending in variable online marketing channels, such as our Associates program, sponsored search, and other variable marketing initiatives.

While costs associated with free shipping are not included in marketing expense, we view free shipping offers and Amazon Prime as effective worldwide marketing tools, and intend to continue offering them indefinitely.

Technology and Content

We continue to invest in several areas of technology and content including seller platforms, web services, and digital initiatives, as well as expansion of new and existing product categories. We are also investing in technology infrastructure so that we can continue to enhance the customer experience, improve our process efficiency and support our infrastructure web services. See “Overview” above for a discussion of how management views advances in technology and the importance of innovation. The growth rate of our technology and content spending decreased in 2007 compared to the prior year. We intend to continue investing in areas of technology and content as we continue to add employees to our staff and add technology infrastructure.

For the years ended 2007, 2006, and 2005, we capitalized $129 million, $123 million, and $90 million of costs associated with internal-use software and website development. Amortization of previously capitalized amounts was $116 million, $86 million, and $50 million for 2007, 2006, and 2005.

A significant majority of our technology costs are incurred in the U.S. and most of them are allocated to our North America segment.

General and Administrative

The increase in spending in general and administrative in 2007 compared to 2006 and 2005 is primarily due to increases in payroll and related expenses, and professional fees.

Stock-Based Compensation

As of January 1, 2005, we adopted SFAS No. 123(R), which requires measurement of compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of restricted stock and restricted stock units is determined based on the number of shares granted and the quoted price of our common stock. Such value is recognized as expense over the service period, net of estimated forfeitures, using the accelerated method. The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. We consider many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Actual results and future estimates may differ substantially from our current estimates.

The adoption of SFAS No. 123(R) resulted in a cumulative benefit from accounting change of $26 million in 2005, which reflects the net cumulative impact of estimating future forfeitures in the determination of period expense, rather than recording forfeitures when they occur as previously permitted.

Stock-based compensation was $185 million, $101 million and $87 million during 2007, 2006, and 2005. The increase in stock-based compensation is primarily attributable to an increase in total stock compensation value granted to our employees.

 

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Other Operating Expense, Net

Other operating expense, net, was $9 million and $10 million during 2007 and 2006, primarily attributable to amortization of other intangibles. Other operating expense, net, was $47 million in 2005, primarily attributable to our settlement of a patent lawsuit for $40 million, as well as amortization of other intangibles of $5 million.

Income from Operations

Income from operations was $655 million, $389 million, and $432 million during 2007, 2006, and 2005. The increase in 2007 from 2006 is primarily a result of the increased growth rate of our revenue and gross profit relative to operating expenses. The decrease in 2006 from 2005 is primarily a result of an increase in spending for technology and content.

Interest Expense and Income

The primary component of our net interest expense is the interest we incur on our long-term debt instruments, including a $899 million principal balance of our 4.75% Convertible Subordinated Notes and a €240 million ($350 million based on the exchange rate at December 31, 2007) principal balance of our 6.875% PEACS at December 31, 2007. Interest expense was $77 million, $78 million, and $92 million in 2007, 2006, and 2005, with declines primarily relating to principal repayments of $300 million and $265 million in 2006 and 2005.

Our total long-term indebtedness was $1.3 billion at both December 31, 2007 and 2006. See Item 8 of Part II, “Financial Statements and Supplementary Data—Note 4—Long-Term Debt.”

Our interest income was $90 million, $59 million, and $44 million during 2007, 2006, and 2005. We generally invest our excess cash in investment grade short- to intermediate-term fixed income securities and AAA-rated money market mutual funds. Our interest income corresponds with the average balance of invested funds and the prevailing rates we are earning on them, which vary depending on the geographies and currencies in which they are invested.

Other Income (Expense), Net

Other income (expense), net, was $(1) million, $(4) million, and $2 million, in 2007, 2006 and 2005, and consisted primarily of gains and losses on sales of marketable securities, foreign-currency transaction gains and losses, and other miscellaneous losses.

Foreign-currency transaction gains and losses primarily relate to the interest payable on our 6.875% PEACS, as well as foreign-currency gains and losses on cross-currency investments. Since interest payments on our 6.875% PEACS are settled in Euros, the balance of interest payable is subject to gains or losses resulting from changes in exchange rates between the U.S. Dollar and Euro between reporting dates and payment.

Remeasurements and Other

Remeasurements and other consisted of the following:

 

     Year Ended December 31,  
       2007         2006         2005    
     (in millions)  

Foreign-currency gain (loss) on remeasurement of 6.875% PEACS

   $ (33 )   $ (37 )   $ 90  

Loss on redemption of long-term debt

     —         (6 )     (6 )

Foreign-currency gain (loss) on intercompany balances

     32       50       (47 )

Other

     (6 )     4       5  
                        

Total remeasurements and other

   $ (7 )   $ 11     $ 42  
                        

 

(1) Each period the remeasurement of our 6.875% PEACS from Euros to U.S. Dollars results in gains or losses recorded to “Remeasurements and other” on our consolidated statements of operations.

 

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(2) Represents the gains (losses) associated with the remeasurement of intercompany balances due to changes in foreign exchange rates. See Item 8 of Part II, “Financial Statements and Supplementary Data—Note 1—Description of Business and Accounting Policies—Foreign Currency.”

Income Taxes

We recorded a provision for income taxes of $184 million, $187 million, and $95 million, in 2007, 2006 and 2005. The effective tax rate in 2007 was lower than the 35% U.S. federal statutory rate primarily due to earnings of our subsidiaries outside of the U.S. in jurisdictions where our effective tax rate is lower than in the U.S. The effective tax rate in 2006 was higher than the 35% U.S. federal statutory rate resulting from establishment of our European headquarters in Luxembourg, which we expect will benefit our effective tax rate over time. Associated with the establishment of our European headquarters, we transferred certain of our operating assets in 2005 and 2006 from the U.S. to international locations. These transfers resulted in taxable income and exposure to additional taxable income assertions by taxing jurisdictions.

Included in the 2005 provision and reducing the impact of the international restructure is a tax benefit of $90 million, resulting from certain of our deferred tax assets becoming more likely than not realizable. This tax benefit represented $0.22 and $0.21 of basic and diluted earnings per share.

We expect our effective tax rate in 2008 to be approximately 30%. However, our effective tax rate is subject to significant variation due to several factors, including from accurately predicting our taxable income, the taxable jurisdictions to which it relates, and business acquisitions and investments. We have current tax benefits and net operating losses relating to excess stock-based compensation deductions that are being utilized to reduce our U.S. taxable income. As such, we expect a majority of our net tax provision to be non-cash.

Effect of Exchange Rates

The effect on our consolidated statements of operations from changes in exchange rates versus the U.S. Dollar is as follows (in millions, except per share data):

 

    Year Ended
December 31, 2007
    Year Ended
December 31, 2006
    Year Ended
December 31, 2005
 
    At Prior
Year
Rates (1)
    Exchange
Rate
Effect (2)
    As
Reported
    At Prior
Year
Rates (1)
    Exchange
Rate
Effect (2)
    As
Reported
    At Prior
Year
Rates (1)
    Exchange
Rate
Effect (2)
    As
Reported
 

Net sales

  $ 14,436     $ 399     $ 14,835     $ 10,687     $ 24     $ 10,711     $ 8,563     $ (73 )   $ 8,490  

Gross profit

    3,274       79       3,353       2,455       1       2,456       2,052       (13 )     2,039  

Operating expenses

    2,648       50       2,698       2,064       3       2,067       1,612       (5 )     1,607  

Income from operations

    626       29       655       391       (2 )     389       440       (8 )     432  

Net interest income (expense) and other (3)

    11       1       12       (17 )     (6 )     (23 )     (52 )     6       (46 )

Remeasurements and other income (expense) (4)

    (6 )     (1 )     (7 )     (2 )     13       11       1       41       42  

Net income

    456       20       476       188       2       190       328       31       359  

 

(1) Represents the outcome that would have resulted had exchange rates in the reported period been the same as those in effect in the comparable prior year period for operating results, and if we did not incur the variability associated with remeasurements for our 6.875% PEACS and intercompany balances.
(2) Represents the increase or decrease in reported amounts resulting from changes in exchange rates from those in effect in the comparable prior year period for operating results, and if we did not incur the variability associated with remeasurements for our 6.875% PEACS and intercompany balances.

 

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(3) Includes foreign-currency gains and losses on cross-currency investments.
(4) Includes foreign-currency gains and losses on remeasurement of 6.875% PEACS and intercompany balances.

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 measure of “Free cash flow” meets the definition of a non-GAAP financial measure. Free cash flow is used in addition to and in conjunction with results presented in accordance with GAAP and free cash flow should not be relied upon to the exclusion of GAAP financial measures. Free cash flow reflects an additional way of viewing our liquidity that, when viewed with our GAAP results, provides a more complete understanding of factors and trends affecting our cash flows. Management strongly encourages shareholders to review our financial statements and publicly-filed reports in their entirety and not to rely on any single financial measure.

Free cash flow, which we reconcile to “Net cash provided by operating activities,” is cash flow from operations reduced by “Purchases of fixed assets, including internal-use software and website development.” We use free cash flow, and ratios based on it, to conduct and evaluate our business because, although it is similar to cash flow from operations, we believe it is a more conservative measure of cash flows since purchases of fixed assets are a necessary component of ongoing operations. In limited circumstances in which proceeds from sales of fixed assets exceed purchases, free cash flow would exceed cash flow from operations. However, since we do not anticipate being a net seller of fixed assets, we expect free cash flow to be less than operating cash flows.

Free cash flow has limitations due to the fact that it does not represent the residual cash flow available for discretionary expenditures. For example, free cash flow does not incorporate payments made on capital lease obligations or cash payments for business acquisitions. Therefore, we believe it is important to view free cash flow as a complement to our entire consolidated statements of cash flows.

The following is a reconciliation of free cash flow to the most comparable GAAP measure, “Net cash provided by operating activities” for 2007, 2006, and 2005 (in millions):

 

     Year Ended December 31,  
         2007             2006             2005      

Net cash provided by operating activities

   $ 1,405     $ 702     $ 733  

Purchases of fixed assets, including internal-use software and website development

     (224 )     (216 )     (204 )
                        

Free cash flow

   $ 1,181     $ 486     $ 529  
                        

Net cash provided by (used in) investing activities

   $ 42     $ (333 )   $ (778 )
                        

Net cash provided by (used in) financing activities

   $ 50     $ (400 )   $ (193 )
                        

In addition, we provide operating expenses with and without stock-based compensation. We provide this information to show the impact of stock-based compensation, which is non-cash and excluded from our internal operating plans and measurement of financial performance (although we consider the dilutive impact to our shareholders when awarding stock-based compensation and value such awards accordingly). In addition, unlike other centrally-incurred operating costs, stock-based compensation is not allocated to segment results and therefore excluding it from operating expense is consistent with our segment presentation in our footnotes to the consolidated financial statements.

Operating expenses without stock-based compensation have limitations due to the fact that they do not include all expenses primarily related to our workforce. More specifically, if we did not pay out a portion of our compensation in

 

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the form of stock-based compensation, our cash salary expense included in the “Fulfillment,” “Technology and content,” “Marketing,” and “General and administrative” line items would be higher. We compensate for this limitation by providing supplemental information about outstanding stock-based awards in the footnotes to our financial statements. Stock-based compensation programs are an important element of our compensation structure and all forms of stock-based awards are valued and included as appropriate in results of operations.

Guidance

The Company provided guidance on January 30, 2008 in its earnings release furnished on Form 8-K as follows:

First Quarter 2008 Guidance

 

   

Net sales are expected to be between $3.95 billion and $4.15 billion, or to grow between 31% and 38% compared with first quarter 2007.

 

   

Operating income is expected to be between $155 million and $200 million, or to grow between 7% and 38% compared with first quarter 2007. This guidance includes $55 million for stock-based compensation and amortization of intangible assets, and it assumes, among other things, that no additional acquired intangible assets are recorded and that there are no further revisions to stock-based compensation estimates.

Full Year 2008 Expectations

 

   

Net sales are expected to be between $18.75 billion and $19.75 billion, or to grow between 26% and 33% compared with 2007.

 

   

Operating income is expected to be between $785 million and $985 million, or to grow between 20% and 50% compared with 2007. This guidance includes $240 million for stock-based compensation and amortization of intangible assets, and it assumes, among other things, that no additional acquired intangible assets are recorded and that there are no further revisions to stock-based compensation estimates.

These projections are subject to substantial uncertainty. See Item 1A of Part I, “Risk Factors.”

Item 7A.    Quantitative and Qualitative Disclosure About Market Risk

We are exposed to market risk for the effect of interest rate changes, foreign currency fluctuations, and changes in the market values of our investments.

Information relating to quantitative and qualitative disclosure about market risk is set forth below and in Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio and our long-term debt. All of our cash equivalent and marketable fixed income securities are designated as available-for-sale and, accordingly, are presented at fair value on our balance sheets. We generally invest our excess cash in investment grade short- to intermediate-term fixed income securities and AAA-rated money market mutual funds. Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates, and we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates.

 

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The following table provides information about our cash equivalent and marketable fixed income securities, including principal cash flows by expected maturity and the related weighted average interest rates at December 31, 2007 (in millions, except percentages):

 

    2008     2009     2010     2011     2012     Thereafter     Total     Estimated
Fair Value at
December 31,
2007

Money market funds

  $ 1,408     $ —       $ —       $ —       $ —       $ —       $ 1,408     $ 1,408

Weighted average interest rate

    4.42 %     —         —         —         —         —         4.42 %  

Certificates of deposit

    —         —         —         —         —         —         —         —  

Weighted average interest rate

    —         —         —         —         —         —         —      

Corporate debt securities

    6       16       26       49       18       —         115       116

Weighted average interest rate

    5.11 %     4.65 %     4.78 %     4.59 %     4.85 %     —         4.71 %  

U.S. Government and Agency Securities

    120       49       49       33       46       —         297       301

Weighted average interest rate

    4.26 %     3.20 %     3.69 %     3.72 %     3.46 %     —         3.81 %  

Asset backed securities

    10       31       30       28       1       1       101       101

Weighted average interest rate

    5.17 %     4.80 %     4.74 %     4.99 %     4.62 %     4.65 %     4.87 %  

Foreign government and agency securities

    274       30       18       26       9       —         357       357

Weighted average interest rate

    4.28 %     3.49 %     3.71 %     3.89 %     3.83 %     —         4.15 %  

Other securities

    —         4       —         —         —         —         4       4

Weighted average interest rate

    —         4.55 %     —         —         —         —         4.55 %  
                                                             

Cash equivalents and marketable fixed-income securities

  $ 1,818     $ 130     $ 123     $ 136     $ 74     $ 1     $ 2,282     $ 2,287
                                                             

 

The following table provides information about our cash equivalent and marketable fixed income securities, including principal cash flows by expected maturity and the related weighted average interest rates at December 31, 2006 (in millions, except percentages):

 

    2007     2008     2009     2010     2011     Thereafter     Total     Estimated
Fair Value at
December 31,
2006

Money market funds

  $ 763     $ —       $ —       $ —       $ —       $ —       $ 763     $ 763

Weighted average interest rate

    3.92 %     —         —         —         —         —         3.92 %  

Certificates of deposit

    50       —         —         —         —         —         50       50

Weighted average interest rate

    5.25 %     —         —         —         —         —         5.25 %  

Corporate debt securities

    266       45       40       29       39       —         419       419

Weighted average interest rate

    5.47 %     5.43 %     5.23 %     5.04 %     4.83 %     —         5.35 %  

U.S. Government and Agency Securities

    53       32       20       39       27       37       208       207

Weighted average interest rate

    5.24 %     4.77 %     4.88 %     4.85 %     4.95 %     5.46 %     5.06 %  

Asset backed securities

    238       32       40       29       9       —         348       347

Weighted average interest rate

    5.47 %     5.42 %     5.28 %     5.19 %     5.91 %     —         5.43 %  

Foreign government and agency securities

    21       28       21       17       18       —         105       104

Weighted average interest rate

    3.74 %     3.83 %     3.83 %     3.86 %     3.87 %     —         3.82 %  

Other securities

    —         2       2       —         —         —         4       4

Weighted average interest rate

    —         5.08 %     5.12 %     —         —         —         5.10 %  
                                                             

Cash equivalents and marketable fixed-income securities

  $ 1,391     $ 139     $ 123     $ 114     $ 93     $ 37     $ 1,897     $ 1,894
                                                             

At December 31, 2007, we had long-term debt of $1.3 billion primarily associated with our 4.75% Convertible Subordinated Notes and 6.875% PEACS, which are due in 2009 and 2010. The fair value of our long-term debt will fluctuate with movements of interest rates, increasing in periods of declining rates of interest and declining in periods of increasing rates of interest.

 

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Based upon quoted market prices, the fair value of the 4.75% Convertible Subordinated Notes was $1.1 billion at December 31, 2007 (outstanding principal of $899 million) and $883 million (outstanding principal of $900 million) at December 31, 2006. The fair value of the 6.875% PEACS was $358 million at December 31, 2007 (outstanding principal of €240 million), and $320 million at December 31, 2006 (outstanding principal of €240 million).

Foreign Exchange Risk

During 2007, net sales from our International segment accounted for 45% of our consolidated revenues. Net sales and related expenses generated from our international websites, as well as those relating to www.amazon.ca (which is included in our North America segment), are denominated in the functional currencies of the corresponding websites and primarily include Euros, British Pounds, and Japanese Yen. The functional currency of our subsidiaries that either operate or support these websites is the same as the corresponding local currency. The results of operations of, and certain of our intercompany balances associated with, our internationally-focused websites are exposed to foreign exchange rate fluctuations. Upon consolidation, as exchange rates vary, net sales and other operating results may differ materially from expectations, and we may record significant gains or losses on the remeasurement of intercompany balances. For example, as a result of fluctuations in foreign exchange rates during 2007, International segment revenues increased $390 million in comparison with the prior year.

We have foreign exchange risk related to foreign-denominated cash, cash equivalents, and marketable securities (“foreign funds”). Based on the balance of foreign funds at December 31, 2007 of $1.2 billion, an assumed 5%, 10%, and 20% negative currency movement would result in fair value declines of $60 million, $120 million, and $240 million. All investments are classified as “available for sale,” as defined by SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Fluctuations in fair value are recorded in “Accumulated other comprehensive income (loss),” a separate component of stockholders’ equity.

We have foreign exchange risk related to our intercompany balances denominated in foreign currency. Based on the net intercompany balances at December 31, 2007 of $250 million, an assumed 5%, 10%, and 20% strengthening of the U.S. Dollar in relation to these foreign currencies would result in losses of $15 million, $25 million, and $50 million, recorded to “Remeasurements and other.”

We have foreign exchange risk related to our 6.875% PEACS, which have an outstanding principal balance at December 31, 2007 of €240 million ($350 million, based on the exchange rate as of December 31, 2007). Due to fluctuations in the Euro/U.S. Dollar exchange ratio, which we cannot predict, our remaining principal debt obligation under the 6.875% PEACS since issuance in February 2000 has increased by $114 million as of December 31, 2007. Based on the outstanding 6.875% PEACS’ principal balance, an assumed 5%, 10%, and 20% weakening of the U.S. Dollar in relation to the Euro would result in additional losses of approximately $20 million, $35 million, and $70 million, recorded to “Remeasurements and other.” Additionally, we have not hedged our interest payments under our 6.875% PEACS to protect against exchange rate fluctuations. Assuming the U.S. Dollar weakens against the Euro by 5%, 10%, and 20% in 2007, we would incur $1 million, $2 million, and $5 million additional annual interest expense due solely to fluctuations in foreign exchange.

See “Effect of Exchange Rates” for additional information on the effect on reported results of changes in exchange rates.

Investment Risk

As of December 31, 2007, our recorded basis in equity securities (including both publicly-traded and private companies) was $29 million, including $12 million classified as “Marketable securities,” and $17 million classified as “Other assets.” We regularly review the carrying value of our investments and identify and record losses when events and circumstances indicate that declines in the fair value of such assets below our accounting basis are other-than-temporary. The fair values of our investments are subject to significant fluctuations due to volatility of the stock market in general, company-specific circumstances, and changes in general economic conditions. Based on the fair value of the publicly-traded equity securities we held at December 31, 2007 of $55 million (recorded basis of $12 million), an assumed 15%, 30%, and 50% adverse change to market prices of these securities would result in a corresponding decline in total fair value of approximately $10 million, $15 million, and $25 million.

 

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Item 8.    Financial Statements and Supplementary Data

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page

Report of Ernst & Young LLP, Independent Registered Public Accounting Firm

   44

Consolidated Statements of Cash Flows

   45

Consolidated Statements of Operations

   46

Consolidated Balance Sheets

   47

Consolidated Statements of Stockholders’ Equity

   48

Notes to Consolidated Financial Statements

   49

 

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Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Amazon.com, Inc.

We have audited the accompanying consolidated balance sheets of Amazon.com, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Amazon.com, Inc. at December 31, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note 1 to the consolidated financial statements, the Company adopted FASB Interpretation No. 48 Accounting for Uncertainty in Income Taxes, effective January 1, 2007.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Amazon.com, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 8, 2008 expressed an unqualified opinion thereon.

/S/    ERNST & YOUNG LLP

Seattle, Washington

February 8, 2008

 

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AMAZON.COM, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

 

     Year Ended December 31,  
     2007     2006     2005  

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

   $ 1,022     $ 1,013     $ 1,303  

OPERATING ACTIVITIES:

      

Net income

     476       190       359  

Adjustments to reconcile net income to net cash from operating activities:

      

Depreciation of fixed assets, including internal-use software and website development, and other amortization

     246       205       121  

Stock-based compensation

     185       101       87  

Other operating expense, net

     9       10       7  

Losses (gains) on sales of marketable securities, net

     1       (2 )     (1 )

Remeasurements and other

     12       (6 )     (37 )

Deferred income taxes

     (99 )     22       70  

Excess tax benefits from stock-based compensation

     (257 )     (102 )     (7 )

Cumulative effect of change in accounting principle

     —         —         (26 )

Changes in operating assets and liabilities:

      

Inventories

     (303 )     (282 )     (104 )

Accounts receivable, net and other

     (255 )     (103 )     (84 )

Accounts payable

     928       402       274  

Accrued expenses and other

     429       241       67  

Additions to unearned revenue

     244       206       156  

Amortization of previously unearned revenue

     (211 )     (180 )     (149 )
                        

Net cash provided by operating activities

     1,405       702       733  

INVESTING ACTIVITIES:

      

Purchases of fixed assets, including internal-use software and website development

     (224 )     (216 )     (204 )

Acquisitions, net of cash acquired, and other

     (75 )     (32 )     (24 )

Sales and maturities of marketable securities and other investments

     1,271       1,845       836  

Purchases of marketable securities and other investments

     (930 )     (1,930 )     (1,386 )
                        

Net cash provided by (used in) investing activities

     42       (333 )     (778 )

FINANCING ACTIVITIES:

      

Proceeds from exercises of stock options

     91       35       59  

Excess tax benefits from stock-based compensation

     257       102       7  

Common stock repurchased

     (248 )     (252 )     —    

Proceeds from long-term debt and other

     24       98       11  

Repayments of long-term debt and capital lease obligations

     (74 )     (383 )     (270 )
                        

Net cash provided by (used in) financing activities

     50       (400 )     (193 )

Foreign-currency effect on cash and cash equivalents

     20       40       (52 )
                        

Net increase (decrease) in cash and cash equivalents

     1,517       9       (290 )
                        

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 2,539     $ 1,022     $ 1,013  
                        

SUPPLEMENTAL CASH FLOW INFORMATION:

      

Cash paid for interest

   $ 67     $ 86     $ 105  

Cash paid for income taxes

     24       15       12  

Fixed assets acquired under capital leases and other financing arrangements

     74       69       6  

Fixed assets acquired under build-to-suit leases

     15       —         —    

See accompanying notes to consolidated financial statements.

 

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AMAZON.COM, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in millions, except per share data)

 

     Year Ended December 31,  
     2007     2006     2005  

Net sales

   $ 14,835     $ 10,711     $ 8,490  

Cost of sales

     11,482       8,255       6,451  
                        

Gross profit

     3,353       2,456       2,039  

Operating expenses (1):

      

Fulfillment

     1,292       937       745  

Marketing

     344       263       198  

Technology and content

     818       662       451  

General and administrative

     235       195       166  

Other operating expense, net

     9       10       47  
                        

Total operating expenses

     2,698       2,067       1,607  
                        

Income from operations

     655       389       432  

Interest income

     90       59       44  

Interest expense

     (77 )     (78 )     (92 )

Other income (expense), net

     (1 )     (4 )     2  

Remeasurements and other

     (7 )     11       42  
                        

Total non-operating income (expense)

     5       (12 )     (4 )
                        

Income before income taxes

     660       377       428  

Provision for income taxes

     184       187       95  
                        

Income before cumulative effect of change in accounting principle

     476       190       333  

Cumulative effect of change in accounting principle

     —         —         26  
                        

Net income

   $ 476     $ 190     $ 359  
                        

Basic earnings per share:

      

Prior to cumulative effect of change in accounting principle

   $ 1.15     $ 0.46     $ 0.81  

Cumulative effect of change in accounting principle

     —         —         0.06  
                        
   $ 1.15     $ 0.46     $ 0.87  
                        

Diluted earnings per share:

      

Prior to cumulative effect of change in accounting principle

   $ 1.12     $ 0.45     $ 0.78  

Cumulative effect of change in accounting principle

     —         —         0.06  
                        
   $ 1.12     $ 0.45     $ 0.84  
                        

Weighted average shares used in computation of earnings per share:

      

Basic

     413       416       412  
                        

Diluted

     424       424       426  
                        

 

      

(1)    Includes stock-based compensation as follows:

      

Fulfillment

   $ 39     $ 24     $ 16  

Marketing

     8       4       6  

Technology and content

     103       54       45  

General and administrative

     35       19       20  

See accompanying notes to consolidated financial statements.

 

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AMAZON.COM, INC.

CONSOLIDATED BALANCE SHEETS

(in millions, except per share data)

 

     December 31,  
     2007     2006  
A S S E T S     

Current assets:

    

Cash and cash equivalents

   $ 2,539     $ 1,022  

Marketable securities

     573       997  

Inventories

     1,200       877  

Accounts receivable, net and other

     705       399  

Deferred tax assets

     147       78  
                

Total current assets

     5,164       3,373  

Fixed assets, net

     543       457  

Deferred tax assets

     260       199  

Goodwill

     222       195  

Other assets

     296       139  
                

Total assets

   $ 6,485     $ 4,363  
                
L I A B I L I T I E S    A N D    S T O C K H O L D E R S’    E Q U I T Y     

Current liabilities:

    

Accounts payable

   $ 2,795     $ 1,816  

Accrued expenses and other

     919       716  
                

Total current liabilities

     3,714       2,532  

Long-term debt

     1,282       1,247  

Other long-term liabilities

     292       153  

Commitments and contingencies

    

Stockholders’ equity:

    

Preferred stock, $0.01 par value:

    

Authorized shares—500

    

Issued and outstanding shares—none

     —         —    

Common stock, $0.01 par value:

    

Authorized shares—5,000

    

Issued shares—431 and 422

    

Outstanding shares—416 and 414

     4       4  

Treasury stock, at cost

     (500 )     (252 )

Additional paid-in capital

     3,063       2,517  

Accumulated other comprehensive income (loss)

     5       (1 )

Accumulated deficit

     (1,375 )     (1,837 )
                

Total stockholders’ equity

     1,197       431  
                

Total liabilities and stockholders’ equity

   $ 6,485     $ 4,363  
                

See accompanying notes to consolidated financial statements.

 

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AMAZON.COM, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in millions)

 

     Common Stock    Treasury
Stock
    Additional
Paid-In
Capital
    Accumulated Other
Comprehensive
Income (Loss)
    Accumulated
Deficit
    Total
Stockholders’
Equity
 
     Shares     Amount           

Balance at January 1, 2005

   410     4    $ —       $ 2,123     $ 32     $ (2,386 )   $ (227 )

Net income

   —       —        —         —         —         359       359  

Foreign currency translation losses, net

   —       —        —         —         (15 )     —         (15 )

Change in unrealized gains on available-for-sale securities, net of tax

   —       —        —         —         (14 )     —         (14 )

Amortization of unrealized loss on terminated Euro Currency Swap, net of tax

   —       —        —         —         3       —         3  
                     

Comprehensive income

                  333  
                     

Exercise of common stock options, net and vesting of restricted stock

   6     —        —         58       —         —         58  

Change in accounting principle

   —       —        —         (26 )     —         —         (26 )

Excess tax benefits from stock-based compensation

   —       —        —         10       —         —         10  

Stock-based compensation and issuance of employee benefit plan stock

   —       —        —         98       —         —         98  
                                                   

Balance at December 31, 2005

   416     4      —         2,263       6       (2,027 )     246  

Net income

   —       —        —         —         —         190       190  

Foreign currency translation losses, net of tax

   —       —        —         —         (13 )     —         (13 )

Change in unrealized losses on available-for-sale securities, net of tax

   —       —        —         —         4       —         4  

Amortization of unrealized loss on terminated Euro Currency Swap, net of tax

   —       —        —         —         2       —         2  
                     

Comprehensive income

                  183  
                     

Exercise of common stock options

   6     —        —         35       —         —         35  

Repurchase of common stock

   (8 )   —        (252 )     —         —         —         (252 )

Excess tax benefits from stock-based compensation

   —       —        —         102       —         —         102  

Stock-based compensation and issuance of employee benefit plan stock

   —       —        —         117       —         —         117  
                                                   

Balance at December 31, 2006

   414     4      (252 )     2,517       (1 )     (1,837 )     431  

Net income

   —       —        —         —         —         476       476  

Foreign currency translation losses, net of tax

   —       —        —         —         (3 )     —         (3 )

Change in unrealized losses on available-for-sale securities, net of tax

   —       —        —         —         8       —         8  

Amortization of unrealized loss on terminated Euro Currency Swap, net of tax

   —       —        —         —         1       —         1  
                     

Comprehensive income

                  482  
                     

Change in accounting principle

   —       —        —         2       —         (14 )     (12 )

Unrecognized excess tax benefits from stock-based compensation

   —       —        —         4       —         —         4  

Exercise of common stock options and conversion of debt

   8     —        —         92       —         —         92  

Repurchase of common stock

   (6 )   —        (248 )     —         —         —         (248 )

Excess tax benefits from stock-based compensation

   —       —        —         257       —         —         257  

Stock-based compensation and issuance of employee benefit plan stock

   —       —        —         191       —         —         191  
                                                   

Balance at December 31, 2007

   416     4    $ (500 )   $ 3,063     $ 5     $ (1,375 )   $ 1,197  
                                                   

See accompanying notes to consolidated financial statements.

 

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AMAZON.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1—DESCRIPTION OF BUSINESS AND ACCOUNTING POLICIES

Description of Business

Amazon.com, a Fortune 500 company, opened its virtual doors on the World Wide Web in July 1995 and today offers Earth’s Biggest Selection. We seek to be Earth’s most customer-centric company. Amazon.com serves three primary customer sets: consumer customers, seller customers and developer customers. We serve consumer customers through our retail websites, which include www.amazon.com, www.amazon.ca, www.amazon.de, www.amazon.fr, www.amazon.co.jp, www.amazon.co.uk, www.shopbop.com, www.endless.com, and the Joyo Amazon websites at www.joyo.cn and www.amazon.cn. We serve seller customers by offering programs and services that enable them to sell products on our websites and operate their e-commerce businesses under their own brand name and website address. We serve developers by offering a suite of web services that provide developer customers with direct access to Amazon.com’s robust technology platform in order to enable them to build innovative applications on their own. In addition, we generate revenue through co-branded credit card agreements and other marketing and promotional services, such as online advertising.

We have organized our operations into two principal segments: North America and International. See “Note 13—Segment Information.”

Principles of Consolidation

The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, and those entities (relating primarily to the Joyo Amazon websites) in which we have a variable interest. Intercompany balances and transactions have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent liabilities in the consolidated financial statements and accompanying notes. Estimates are used for, but not limited to, valuation of investments, receivables valuation, sales returns, incentive discount offers, inventory valuation, depreciable lives of fixed assets, internally-developed software, valuation of acquired intangibles, income taxes, stock-based compensation, 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.

Our convertible debt instruments are excluded from the calculation of diluted earnings per share as their effect under the if-converted method is antidilutive. See “Note 4—Long-Term Debt.”

 

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AMAZON.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The following table shows the calculation of diluted shares (in millions):

 

     Year Ended December 31,
         2007            2006            2005    

Shares used in computation of basic earnings per share

   413    416    412

Total dilutive effect of outstanding stock awards (1)

   11    8    14
              

Shares used in computation of diluted earnings per share

   424    424    426
              

 

(1) Calculated using the treasury stock method that assumes proceeds available to reduce the dilutive affect of outstanding stock awards, which include the exercise price of stock options, the unrecognized deferred compensation of stock awards, and assumed tax proceeds from excess stock-based compensation deductions.

Treasury Stock

We account for treasury stock under the cost method and include treasury stock as a component of stockholders’ equity.

Business Acquisitions

We acquired certain companies during 2007 for an aggregate cash purchase price of $33 million, including cash payments of $24 million and future cash payments of $9 million. We also made principal payments of $13 million on acquired debt in connection with one of these acquisitions. Additional cash consideration for these acquisitions is contingent upon continued employment. This amount is expensed as compensation over the employment period and not included in the purchase price. Acquired intangibles totaled $18 million and have estimated useful lives of between two and ten years. The excess of purchase price over the fair value of the net assets acquired was $21 million and is classified as “Goodwill” on our consolidated balance sheets.

We acquired certain companies during 2006 for an aggregate cash purchase price of $50 million, including cash paid of $30 million and $19 million in 2006 and 2007, and additional cash payments of $1 million due in 2008. Acquired intangibles totaled $17 million and have estimated useful lives of between one and ten years. The excess of purchase price over the fair value of the net assets acquired was $33 million and is classified as “Goodwill” on our consolidated balance sheets.

In 2005, we acquired certain companies for an aggregate cash purchase price of $29 million. Acquired intangibles totaled $10 million and have estimated useful lives of between one and three years. The excess of purchase price over the fair value of the net assets acquired was $19 million and is classified as “Goodwill” on our consolidated balance sheets.

The results of operations of each of the businesses acquired in 2007, 2006, and 2005 have been included in our consolidated results from each transaction closing date forward. The effect of these acquisitions on consolidated net sales and operating income during 2007, 2006, and 2005 was not significant.

Cash and Cash Equivalents

We classify all highly liquid instruments, including money market funds that comply with Rule 2a-7 of the Investment Company Act of 1940, with a remaining maturity of three months or less at the time of purchase as cash equivalents.

 

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AMAZON.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Inventories

Inventories, consisting of products available for sale, are accounted for using the FIFO method, and are valued at the lower of cost or market value. This valuation requires us to make judgments, based on currently-available information, about the likely method of disposition, such as through sales to individual customers, returns to product vendors, or liquidations, and expected recoverable values of each disposition category. Based on this evaluation, we adjust the carrying amount of our inventories to lower of cost or market value.

We provide fulfillment-related services in connection with certain of our marketplace sellers and Amazon Enterprise Solutions programs. In those arrangements, as well as all other product sales by other sellers, the marketplace seller maintains ownership of the related products.

Accounts Receivable, Net and Other Current Assets

Included in “Accounts receivable, net and other current assets” are customer and vendor receivables, as well as prepaid expenses of $23 million and $17 million at December 31, 2007 and 2006, representing advance payments for insurance, licenses, and other miscellaneous expenses.

Allowance for Doubtful Accounts

We estimate losses on receivables based on known troubled accounts, if any, and historical experience of losses incurred. The allowance for doubtful accounts receivable was $64 million and $40 million at December 31, 2007 and 2006.

Internal-use Software and Website Development

Costs incurred to develop software for internal use are required to be capitalized and amortized over the estimated useful life of the software in accordance with Statement of Position (SOP) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. Costs related to design or maintenance of internal-use software are expensed as incurred. For the years ended 2007, 2006, and 2005, we capitalized $129 million (including $21 million of stock-based compensation), $123 million (including $16 million of stock-based compensation), and $90 million (including $11 million of stock-based compensation) of costs associated with internal-use software and website development. Amortization of previously capitalized amounts was $116 million, $86 million, and $50 million for 2007, 2006, and 2005.

Depreciation of Fixed Assets

Fixed assets include assets such as furniture and fixtures, heavy equipment, technology infrastructure, internal-use software and website development. Depreciation is recorded on a straight-line basis over the estimated useful lives of the assets (generally two years or less for assets such as internal-use software, two or three years for our technology infrastructure, five years for furniture and fixtures, and ten years for heavy equipment). Depreciation expense is generally classified within the corresponding operating expense categories on our consolidated statements of operations, and certain assets are amortized as “Cost of sales.”

Leases and Asset Retirement Obligations

We account for our lease agreements pursuant to Statement of Financial Accounting Standards (SFAS) No. 13, Accounting for Leases, which categorizes leases at their inception as either operating or capital leases depending on certain defined criteria. On certain of our lease agreements, we may receive rent holidays and other incentives. We recognize lease costs on a straight-line basis without regard to deferred payment terms, such as

 

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AMAZON.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

rent holidays that defer the commencement date of required payments. Additionally, incentives we receive are treated as a reduction of our costs over the term of the agreement. Leasehold improvements are capitalized at cost and amortized over the lesser of their expected useful life or the life of the lease, without assuming renewal features, if any, are exercised. We account for build-to-suit lease arrangements in accordance with Emerging Issues Task Force (EITF) 97-10, The Effect of Lessee Involvement in Asset Construction, to the extent we are involved in the construction of structural improvements prior to commencement of a lease.

In accordance with SFAS No. 143, Accounting for Asset Retirement Obligations, we establish assets and liabilities for the present value of estimated future costs to return certain of our leased facilities to their original condition. Such assets are depreciated over the lease period into operating expense, and the recorded liabilities are accreted to the future value of the estimated restoration costs.

Goodwill

We evaluate goodwill for impairment, at a minimum, on an annual basis and whenever events and changes in circumstances suggest that the carrying amount may not be recoverable. Impairment of goodwill is tested at the reporting unit level by comparing the reporting unit’s carrying amount, including goodwill, to the fair value of the reporting unit. The fair values of the reporting units are estimated using discounted projected cash flows. If the carrying amount of the reporting unit exceeds its fair value, goodwill is considered impaired and a second step is performed to measure the amount of impairment loss, if any. We conduct our annual impairment test as of October 1 of each year, and have determined there to be no impairment in 2007 or 2006. There were no events or circumstances from the date of our assessment through December 31, 2007 that would impact this assessment.

At December 31, 2007 and December 31, 2006, approximately 55% and 60% of our acquired goodwill was assigned to our International segment, the majority of which relates to our acquisition of Joyo.com Limited.

Other Assets

Included in “Other assets” on our consolidated balance sheets are amounts primarily related to marketable securities restricted for longer than one year; intellectual property rights; certain equity investments; and intangible assets, net of amortization. At December 31, 2007 and 2006, the cost basis and fair value of marketable securities restricted for longer than one year was $197 million and $86 million, primarily attributable to collateralization of bank guarantees and debt related to our international operations. At December 31, 2007, intellectual property rights were $28 million; at December 31, 2006, these amounts were not significant. At December 31, 2007, and 2006, equity investments were $17 million and $19 million.

Other intangibles, net, included within “Other assets,” were $26 million and $21 million at December 31, 2007 and 2006. Accumulated amortization was $29 million and $16 million at December 31, 2007 and 2006, which excludes the accumulated amortization of fully-amortized intangibles. Amortization expense was $13 million, $10 million, and $5 million in 2007, 2006, and 2005. Amortization expense of intangible assets over the next five years is as follows: $8 million in 2008; $4 million in 2009; $3 million in 2010; $2 million in 2011; $2 million in 2012. The weighted-average amortization period is five years based on useful life assumptions between one and ten years.

Investments

The initial carrying cost of our investments is the price we paid. Investments are accounted for using the equity method of accounting if the investment gives us the ability to exercise significant influence, but not control, over an investee. We classify our investments in equity-method investees on our consolidated balance

 

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sheets as “Other assets” and our share of the investees’ earnings or losses as “Remeasurements and other” on our consolidated statements of operations. Losses from equity-method investees were not significant for any period presented.

All other equity investments consist of investments for which we do not have the ability to exercise significant influence. Under the cost method of accounting, investments in private companies are carried at cost and are adjusted only for other-than-temporary declines in fair value, distributions of earnings, and additional investments. For public companies that have readily determinable fair values, we classify our equity investments as available-for-sale and, accordingly, record these investments at their fair values with unrealized gains and losses, net of tax, included in “Accumulated other comprehensive income (loss),” a separate component of stockholders’ equity.

We generally invest our excess cash in investment grade short to intermediate term fixed income securities and AAA-rated money market mutual funds. Such investments are included in “Cash and cash equivalents,” or “Marketable securities” on the accompanying consolidated balance sheets and are reported at fair value with unrealized gains and losses included in “Accumulated other comprehensive income (loss).” The weighted average method is used to determine the cost of Euro-denominated securities sold, and the specific identification method is used to determine the cost of all other securities.

We periodically evaluate whether declines in fair values of our investments below their cost are other-than-temporary. This evaluation consists of several qualitative and quantitative factors regarding the severity and duration of the unrealized loss as well as our ability and intent to hold the investment until a forecasted recovery occurs. Factors considered include quoted market prices, if available; recent financial results and operating trends; other publicly available information; implied values from any recent purchase/sales offers of investee securities; or other conditions that may affect the value of our investments. At December 31, 2007, gross unrealized losses on our marketable securities were $3 million and were determined to be temporary based on our assessment of the qualitative and quantitative factors discussed above.

Long-Lived Assets

Long-lived assets, other than goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. Conditions that would necessitate an impairment assessment include a significant decline in the observable market value of an asset, a significant change in the extent or manner in which an asset is used, or any other significant adverse change that would indicate that the carrying amount of an asset or group of assets may not be recoverable.

For long-lived assets used in operations, impairment losses are only recorded if the asset’s carrying amount is not recoverable through its undiscounted, probability-weighted future cash flows. We measure the impairment loss based on the difference between the carrying amount and estimated fair value.

Long-lived assets are considered held for sale when certain criteria are met, including: management has committed to a plan to sell the asset, the asset is available for sale in its immediate condition, and the sale is probable within one year of the reporting date. Assets held for sale are reported at the lower of cost or fair value less costs to sell. Assets held for sale were not significant at December 31, 2007 or 2006.

Accrued Expenses and Other

Included in “Accrued expenses and other” at December 31, 2007 and 2006 were liabilities of $240 million and $183 million for unredeemed gift certificates. We recognize revenue from a gift certificate when a customer

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

redeems it. If a gift certificate is not redeemed, we recognize revenue when it expires or, for a certificate without an expiration date, when the likelihood of its redemption becomes remote, generally two years from date of issuance.

Unearned Revenue

Unearned revenue is recorded when payments are received in advance of performing our service obligations and is recognized over the service period. Current unearned revenue is included in “Accrued expenses and other” and non-current unearned revenue is included in “Other long-term liabilities” on our consolidated balance sheets. Current unearned revenue was $91 million and $78 million at December 31, 2007 and 2006.

Income Taxes

Income tax expense includes U.S. and international income taxes. We do not provide for U.S. taxes on our undistributed earnings of foreign subsidiaries, totaling $126 million at December 31, 2007, since we intend to invest such undistributed earnings indefinitely outside of the U.S. If such amounts were repatriated, determination of the amount of U.S. income taxes that would be incurred is not practicable due to the complexities associated with this calculation.

Deferred income tax balances reflect the effects of temporary differences between the carrying amounts of assets and liabilities and their tax bases and are stated at enacted tax rates expected to be in effect when taxes are actually paid or recovered. At December 31, 2007, our deferred tax assets, net of deferred tax liabilities and valuation allowance, were $385 million, which includes $148 million relating to net operating loss carryforwards (“NOLs”) that were primarily attributed to stock-based compensation. The majority of our NOLs begin to expire in 2019 and thereafter.

SFAS No. 109, Accounting for Income Taxes, requires that deferred tax assets be evaluated for future realization and reduced by a valuation allowance to the extent we believe a portion will not be realized. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative earnings experience and expectations of future taxable income by taxing jurisdiction, the carry-forward periods available to us for tax reporting purposes, and other relevant factors. In accordance with SFAS No. 109, we allocate our valuation allowance to current and long-term deferred tax assets on a pro-rata basis.

Effective January 1, 2007, we adopted the provisions of FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109. FIN 48 contains a two-step approach to recognizing and measuring uncertain tax positions (tax contingencies) accounted for in accordance with SFAS No. 109. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and which may not accurately forecast actual outcomes.

Adopting FIN 48 increased long-term assets by $10 million, long-term liabilities by $21 million, accumulated deficit by $14 million and additional paid-in capital by $2 million. These amounts include the associated federal benefit related to unrecognized tax benefits, and interest and penalties which collectively are not material. As of January 1, 2007, we had $110 million of tax contingencies.

 

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AMAZON.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Revenue

We recognize revenue from product sales or services rendered when the following four revenue recognition criteria are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the selling price is fixed or determinable, and collectibility is reasonably assured. Additionally, revenue arrangements with multiple deliverables are divided into separate units of accounting if the deliverables in the arrangement meet the following criteria: the delivered item has value to the customer on a standalone basis; there is objective and reliable evidence of the fair value of undelivered items; and delivery of any undelivered item is probable.

We evaluate the criteria outlined in EITF Issue No. 99-19, Reporting Revenue Gross as a Principal Versus Net as an Agent, in determining whether it is appropriate to record the gross amount of product sales and related costs or the net amount earned as commissions. Generally, when we are primarily obligated in a transaction, are subject to inventory risk, have latitude in establishing prices and selecting suppliers, or have several but not all of these indicators, revenue is recorded gross. If we are not primarily obligated and amounts earned are determined using a fixed percentage, a fixed-payment schedule, or a combination of the two, we generally record the net amounts as commissions earned.

Product sales and shipping revenues, net of promotional discounts, rebates, and return allowances, are recorded when the products are shipped and title passes to customers. Retail sales to customers are made pursuant to a sales contract that provides for transfer of both title and risk of loss upon our delivery to the carrier. Return allowances, which reduce product revenue, are estimated using historical experience. Revenue from product sales and services rendered is recorded net of sales taxes. Amounts received in advance for subscription services, including amounts received for Amazon Prime and other membership programs, are deferred and recognized as revenue over the subscription term. For our products with multiple elements, where a standalone value for each element cannot be established, we recognize the revenue and related cost over the estimated economic life of the product.

We periodically provide incentive offers to our customers to encourage purchases. Such offers include current discount offers, such as percentage discounts off current purchases, inducement offers, such as offers for future discounts subject to a minimum current purchase, and other similar offers. Current discount offers, when accepted by our customers, are treated as a reduction to the purchase price of the related transaction, while inducement offers, when accepted by our customers, are treated as a reduction to purchase price based on estimated future redemption rates. Redemption rates are estimated using our historical experience for similar inducement offers. Current discount offers and inducement offers are presented as a net amount in “Net sales.”

Commissions and per-unit fees received from sellers and similar amounts earned through Amazon Enterprise Solutions are recognized when the item is sold by seller and our collectibility is reasonably assured. We record an allowance for estimated refunds on such commissions using historical experience.

Shipping Activities

Outbound shipping charges to customers are included in “Net sales” and were $740 million, $567 million, and $511 million for 2007, 2006, and 2005. Outbound shipping-related costs are included in “Cost of sales” and totaled $1.2 billion, $884 million, and $750 million for 2007, 2006, and 2005. The net cost to us of shipping activities was $434 million, $317 million, and $239 million for 2007, 2006 and 2005.

Cost of Sales

Cost of sales consists of the purchase price of consumer products and content sold by us, inbound and outbound shipping charges, packaging supplies, and costs incurred in operating and staffing our fulfillment and

 

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AMAZON.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

customer service centers on behalf of other businesses. Shipping charges to receive products from our suppliers are included in our inventory, and recognized as “Cost of sales” upon sale of products to our customers. Payment processing and related transaction costs, including those associated with seller transactions, are classified in “Fulfillment” on our consolidated statements of operations.

Vendor Agreements

We have agreements to receive cash consideration from certain of our vendors, including rebates and cooperative marketing reimbursements. We generally presume amounts received from our vendors are a reduction of the prices we pay for their products and, therefore, we reflect such amounts as either a reduction of “Cost of sales” on our consolidated statements of operations, or, if the product inventory is still on hand, as a reduction of the carrying value of inventory. Vendor rebates are typically dependent upon reaching minimum purchase thresholds. We evaluate the likelihood of reaching purchase thresholds using past experience and current year forecasts. When volume rebates can be reasonably estimated, we record a portion of the rebate as we make progress towards the purchase threshold.

When we receive direct reimbursements for costs incurred by us in advertising the vendor’s product or service, the amount we receive is recorded as an offset to “Marketing” on our consolidated statements of operations.

Fulfillment

Fulfillment costs represent those costs incurred in operating and staffing our fulfillment and customer service centers, including costs attributable to buying, receiving, inspecting, and warehousing inventories; picking, packaging, and preparing customer orders for shipment; payment processing and related transaction costs, including costs associated with our guarantee for certain seller transactions; and responding to inquiries from customers. Fulfillment costs also include amounts paid to third parties that assist us in fulfillment and customer service operations. Certain of our fulfillment-related costs that are incurred on behalf of other businesses, such as Target Corporation, are classified as cost of sales rather than fulfillment.

Marketing

Marketing costs consist primarily of online advertising, including through our Associates program, sponsored search, portal advertising, e-mail campaigns, and other initiatives. We pay commissions to participants in our Associates program when their customer referrals result in product sales and classify such costs as “Marketing” on our consolidated statements of operations.

We also participate in cooperative advertising arrangements with certain of our vendors, and other third parties. To the extent co-operative marketing reimbursements decline in future periods, we may incur additional expenses to continue certain promotions or elect to reduce or discontinue them.

Marketing expenses also consist of public relations expenditures; payroll and related expenses for personnel engaged in marketing, business development, and selling activities; and to a lesser extent, traditional advertising such as newspaper inserts.

Advertising and other promotional costs, which consist primarily of online advertising, are expensed as incurred, and were $306 million, $226 million, and $168 million in 2007, 2006, and 2005. Prepaid advertising costs were not significant at December 31, 2007 and 2006.

 

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AMAZON.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Technology and Content

Technology and content expenses consist principally of payroll and related expenses for employees involved in, application development, category expansion, editorial content, buying, merchandising selection, and systems support, as well as costs associated with the compute, storage and telecommunications infrastructure.

Technology and content costs are expensed as incurred, except for certain costs relating to the development of internal-use software and website development, including software used to upgrade and enhance our websites and processes supporting our business, which are capitalized and amortized over two years.

General and Administrative

General and administrative expenses consist of payroll and related expenses for employees involved in general corporate functions, including accounting, finance, tax, legal, and human relations, among others; costs associated with use by these functions of facilities and equipment, such as depreciation expense and rent; professional fees and litigation costs; and other general corporate costs.

Stock-Based Compensation

As of January 1, 2005, we adopted SFAS No. 123(R), which requires measurement of compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of restricted stock and restricted stock units is determined based on the number of shares granted and the quoted price of our common stock. Such value is recognized as expense over the service period, net of estimated forfeitures, using the accelerated method. The estimation of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. We consider many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Actual results and future estimates may differ substantially from our current estimates.

Foreign Currency

We have the following internationally-focused websites: www.amazon.co.uk, www.amazon.de, www.amazon.fr, www.amazon.co.jp, www.amazon.ca, and services for the Joyo Amazon websites at www.joyo.cn and www.amazon.cn. Net sales generated from internationally-focused websites, as well as most of the related expenses directly incurred from those operations, are denominated in the functional currencies of the resident countries. Additionally, the functional currency of our subsidiaries that either operate or support these international websites is the same as the local currency of the United Kingdom, Germany, France, Japan, Canada, and China. Assets and liabilities of these subsidiaries are translated into U.S. Dollars at period-end exchange rates, and revenues and expenses are translated at average rates prevailing throughout the period. Translation adjustments are included in “Accumulated other comprehensive income (loss),” a separate component of stockholders’ equity, and in the “Foreign currency effect on cash and cash equivalents,” on our consolidated statements of cash flows. Transaction gains and losses arising from transactions denominated in a currency other than the functional currency of the entity involved are included in “Other income (expense), net” on our consolidated statements of operations. See “Note 10—Other Income (Expense), Net.”

Gains and losses arising from intercompany foreign currency transactions are included in net income. In connection with the remeasurement of intercompany balances, we recorded gains of $32 million and $50 million in 2007 and 2006, and a loss of $47 million in 2005.

Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted

 

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accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We do not expect the adoption of SFAS No. 157 to have a material impact on our consolidated financial statements. The FASB may delay a portion of this standard.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 permits companies to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We do not expect the adoption of SFAS No. 159 to have a material impact on our consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141 (R), Business Combinations, and SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements. SFAS No. 141 (R) requires an acquirer to measure the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at their fair values on the acquisition date, with goodwill being the excess value over the net identifiable assets acquired. SFAS No. 160 clarifies that a noncontrolling interest in a subsidiary should be reported as equity in the consolidated financial statements. The calculation of earnings per share will continue to be based on income amounts attributable to the parent. SFAS No. 141 (R) and SFAS No. 160 are effective for financial statements issued for fiscal years beginning after December 15, 2008. Early adoption is prohibited. We have not yet determined the effect on our consolidated financial statements, if any, upon adoption of SFAS No. 141 (R) or SFAS No. 160.

Note 2—CASH, CASH EQUIVALENTS, AND MARKETABLE SECURITIES

We measure our cash, cash equivalents and marketable securities at fair value based on the quoted prices in active markets. The following tables summarize, by major security type, our cash, cash equivalents and marketable securities (in millions):

 

     December 31, 2007
     Cost or
Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses (1)
    Estimated
Fair Value

Cash

   $ 813   $ —     $ —       $ 813

Money market funds

     1,408     —       —         1,408

Corporate debt securities

     116     1     (1 )     116

U.S. government and agency securities

     298     4     (1 )     301

Asset-backed securities

     101     1     (1 )     101

Foreign government and agency securities

     358     —       (1 )     357

Equity securities

     5     7     —         12

Other securities

     4     —       —         4
                          

Total cash, cash equivalents, and marketable securities (2)

   $ 3,103   $ 13   $ (4 )   $ 3,112
                          

 

(1) The fair value of investments with loss positions was $515 million. We evaluated the nature of these investments, which are primarily U.S. Treasury Notes, the duration of the impairments (substantially all less than twelve months), and concluded that such amounts were not “other-than-temporary.”
(2) Includes investments in foreign currencies of $1.2 billion, principally Euros, British Pounds, and Japanese Yen.

 

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     December 31, 2006
     Cost or
Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses (1)
    Estimated
Fair Value

Cash

   $ 118   $ —     $ —       $ 118

Money market funds

     763     —       —         763

Bank of certificates of deposits

     50     —       —         50

Corporate debt securities

     420     —       (1 )     419

U.S. government and agency securities

     208     1     (2 )     207

Asset-backed securities

     348     —       (1 )     347

Foreign government and agency securities

     105     —       (1 )     104

Equity securities

     4     3     —         7

Other securities

     4     —       —         4
                          

Total cash, cash equivalents, and marketable securities (2)

   $ 2,020   $ 4   $ (5 )   $ 2,019
                          

 

(1) The fair value of investments with loss positions was $978 million. We evaluated the nature of these investments, which are primarily U.S. Treasury Notes, the duration of the impairments (all less than twelve months), and the amount of the impairments relative to the underlying portfolio and concluded that such amounts were not “other-than-temporary.”
(2) Includes investments in foreign currencies of $623 million, principally Euros, British Pounds, and Japanese Yen.

The following table summarizes contractual maturities of our cash equivalent and marketable fixed-income securities as of December 31, 2007 (in millions):

 

     Amortized
Cost
   Estimated
Fair Value

Due within one year

   $ 1,818    $ 1,818

Due after one year through five years

     466      469
             
   $ 2,284    $ 2,287
             

Gross gains of $2 million, $18 million, and $7 million and gross losses of $3 million, $16 million and $12 million were realized on sales of available-for-sale marketable securities, including Euro-denominated securities, for 2007, 2006, and 2005.

We are required to pledge a portion of our cash equivalents or marketable securities as collateral for standby letters of credit that guarantee certain of our contractual obligations, a line of credit, and real estate lease agreements. See “Note 6—Commitments and Contingencies.”

 

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AMAZON.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Note 3—FIXED ASSETS

Fixed assets, at cost, consisted of the following (in millions):

 

     December 31,
     2007    2006

Gross Fixed Assets:

     

Fulfillment and customer service

   $ 464    $ 379

Technology infrastructure

     196      153

Internal-use software, content, and website development

     285      230

Construction in progress (1)

     15      —  

Other corporate assets

     63      62
             

Gross fixed assets

     1,023      824
             

Accumulated Depreciation:

     

Fulfillment and customer service

     216      171

Technology infrastructure

     74      55

Internal-use software, content, and website development

     146      108

Other corporate assets

     44      33
             

Total accumulated depreciation

     480      367
             

Total fixed assets, net

   $ 543    $ 457
             

 

(1) We capitalize construction in progress and record a corresponding long-term liability for certain lease agreements related to our Seattle, Washington corporate office space subject to leases scheduled to begin in 2010 and 2011. See “Note 5—Other Long-Term Liabilities” and “Note 6—Commitments and Contingencies” for further discussion.

Depreciation expense on fixed assets was $258 million, $200 million, and $113 million, which includes amortization of fixed assets acquired under capital lease obligations of $40 million, $26 million and $4 million for 2007, 2006, and 2005. Gross assets remaining under capital leases were $150 million and $77 million at December 31, 2007 and 2006. Accumulated depreciation associated with capital leases was $64 million and $28 million at December 31, 2007 and 2006.

Note 4—LONG-TERM DEBT

Our long-term debt is summarized as follows:

 

     December 31,  
     2007     2006  
     (in millions)  

4.75% Convertible Subordinated Notes due February 2009

   $ 899     $ 900  

6.875% PEACS due February 2010

     350       317  

Other long-term debt

     50       46  
                
     1,299       1,263  

Less current portion of long-term debt

     (17 )     (16 )
                
   $ 1,282     $ 1,247  
                

4.75% Convertible Subordinated Notes

In February 1999, we completed an offering of $1.25 billion of 4.75% Convertible Subordinated Notes. The 4.75% Convertible Subordinated Notes are convertible into our common stock at the holders’ option at a

 

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conversion price of $78.0275 per share. Total common stock issuable, as of December 31, 2007, upon conversion of our outstanding 4.75% Convertible Subordinated Notes was 11.5 million shares, which is excluded from our calculation of earnings per share as its effect is currently anti-dilutive. Interest on the 4.75% Convertible Subordinated Notes is payable semi-annually in arrears in February and August of each year. The 4.75% Convertible Subordinated Notes are unsecured and are subordinated to any existing and future senior indebtedness as defined in the indenture governing the 4.75% Convertible Subordinated Notes. We have the right to redeem the 4.75% Convertible Subordinated Notes, in whole or in part, by paying the principal plus a redemption premium, plus any accrued and unpaid interest. The redemption premium was 0.950% of the principal at December 31, 2007, and decreased to 0.475% on February 1, 2008 and will decrease to zero at maturity in February 2009.

Upon the occurrence of a “fundamental change” prior to the maturity of the 4.75% Convertible Subordinated Notes, each holder thereof has the right to require us to redeem all or any part of such holder’s 4.75% Convertible Subordinated Notes at a price equal to 100% of the principal amount of the notes being redeemed, together with accrued interest. As defined in the indenture, a “fundamental change” is the occurrence of certain types of transactions in which our stockholders do not receive publicly-traded securities.

The indenture governing the 4.75% Convertible Subordinated Notes contains certain affirmative covenants for us, including making principal and interest payments when due, maintaining our corporate existence and properties, and paying taxes and other claims in a timely manner. We were in compliance with these covenants through December 31, 2007.

Based upon quoted market prices, the fair value of our 4.75% Convertible Subordinated Notes as of December 31, 2007 and 2006 was $1.1 billion and $883 million.

6.875% PEACS

In February 2000, we completed an offering of €690 million of our 6.875% PEACS. The 6.875% PEACS are convertible, at the holder’s option, into our common stock at a conversion price of €84.883 per share ($123.84, based on the exchange rates as of December 31, 2007). Total common stock issuable, as of December 31, 2007, upon conversion of our outstanding 6.875% PEACS was 2.8 million shares, which is excluded from our calculation of earnings per share as its effect is currently anti-dilutive. The U.S. Dollar equivalent principal, interest, and conversion price fluctuate based on the Euro/U.S. Dollar exchange ratio. Interest on the 6.875% PEACS is payable annually in arrears in February of each year. The 6.875% PEACS are unsecured and are subordinated to any existing and future senior indebtedness. The 6.875% PEACS rank equally with our outstanding 4.75% Convertible Subordinated Notes. We have the right to redeem the 6.875% PEACS, in whole or in part, by paying the principal, plus any accrued and unpaid interest. No premium payment is required for early redemption.

Upon the occurrence of a “fundamental change” prior to the maturity of the 6.875% PEACS, each holder thereof has the right to require us to redeem all or any part of such holder’s 6.875% PEACS at a price equal to 100% of the principal amount of the notes being redeemed, together with accrued interest. As defined in the indenture, a “fundamental change” is the occurrence of certain types of transactions in which our stockholders do not receive publicly-traded securities.

The indenture governing the 6.875% PEACS contains certain affirmative covenants for us, including making principal and interest payments when due, maintaining our corporate existence and properties, and paying taxes and other claims in a timely manner. We were in compliance with these covenants through December 31, 2007.

 

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In 2006 and 2005, we redeemed principal amounts of €250 million and €200 million ($300 million and $265 million based on the Euro to U.S. Dollar exchange rate on the date of redemption) of our outstanding 6.875% PEACS. As a result of these redemptions, in 2006 and 2005 we recorded a charge classified in “Remeasurements and other,” of approximately $6 million and $4 million related to the redemption, consisting of $3 million and $2 million in unamortized deferred issuance charges and $3 million and $2 million relating to unrealized losses on our terminated currency swap that previously hedged a portion of our 6.875% PEACS.

Based upon quoted market prices, the fair value of the 6.875% PEACS was $358 million and $320 million (outstanding principal of €240 million) as of December 31, 2007 and 2006.

Debt Repurchase Authorization

In February 2008 our Board of Directors authorized a debt repurchase program, replacing our previous debt repurchase authorization in its entirety, pursuant to which we may from time to time repurchase (through open market repurchases or private transactions), redeem, or otherwise retire up to an aggregate of all of our outstanding 4.75% Convertible Subordinated Notes and 6.875% PEACS. The outstanding principal of our 4.75% Convertible Subordinated Notes as of this authorization was $899 million, and the outstanding principal amount of our 6.875% PEACS was €240 million.

Note 5—OTHER LONG-TERM LIABILITIES

Our other long-term liabilities are summarized as follows:

 

     December 31,
     2007    2006
     (in millions)

Tax contingencies

   $ 98    $ 75

Long-term capital lease obligations

     62      20

Construction liability

     15      —  

Other

     117      58
             
   $ 292    $ 153
             

Tax Contingencies

As of December 31, 2007 and 2006, we have provided tax reserves for tax contingencies of approximately $98 million and $75 million for U.S. and foreign income taxes, which primarily relate to restructuring of certain foreign operations and intercompany pricing between our subsidiaries. See “Note 12—Income Taxes” for discussion of tax contingencies.

Capital Leases

Certain of our equipment fixed assets, primarily related to technology, have been acquired under capital leases. Long-term capital lease obligations were as follows:

 

     December 31,
2007
 
     (in millions)  

Gross capital lease obligations

   $ 101  

Less imputed interest

     (13 )
        

Present value of net minimum lease payments

     88  

Less current portion

     (26 )
        

Total long-term capital lease obligations

   $ 62  
        

 

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AMAZON.COM, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Construction Liability Related to Seattle Campus

We capitalize construction in progress and record a corresponding long-term liability for certain lease agreements related to our Seattle, Washington corporate office space subject to leases scheduled to begin in 2010 and 2011.

In accordance with EITF No. 97-10, for build-to-suit lease arrangements where we are involved in the construction of structural improvements prior to the commencement of the lease or take some level of construction risk, we are considered the owner of the assets during the construction period under generally accepted accounting principles. Accordingly, as the landlord incurs the construction project costs, the assets and corresponding financial obligation are recorded in “Fixed assets, net” and “Other long-term liabilities” on our consolidated balance sheet. Once the construction is completed, if the lease meets certain “sale-leaseback” criteria in accordance with SFAS No. 98, Accounting for Leases, we will remove the asset and related financial obligation from the balance sheet and treat the building lease as an operating lease. If upon completion of construction, the project does not meet the “sale-leaseback” criteria, the leased property will be treated as a capital lease for financial reporting purposes.

The remainder of our other long-term liabilities primarily include deferred tax liabilities, unearned revenue, asset retirement obligations, and deferred rental liabilities.

Note 6—COMMITMENTS AND CONTINGENCIES

Commitments

We lease office and fulfillment center facilities and fixed assets under non-cancelable operating and capital leases. Rental expense under operating lease agreements was $141 million, $132 million, and $84 million for 2007, 2006, and 2005.

In December 2007, we entered into a series of leases and other agreements for the lease of corporate office space to be developed in Seattle, Washington with initial terms of up to 16 years commencing on completion of development in 2010 and 2011 and options to extend for two five year periods. Under the agreements we will occupy approximately 800,000 square feet of office space. We also have the right to occupy up to an additional approximately 800,000 square feet subject to a termination fee, estimated to be up to approximately $40 million, if the Company elects not to occupy the additional space. In addition, we have options to lease up to an additional approximately 500,000 square feet at rates based on fair market values at the time the options are exercised, subject to certain conditions. In addition, if interest rates exceed a certain threshold, we have the option to provide financing for some of the buildings.

The following summarizes our principal contractual commitments, excluding open orders for inventory purchases that support normal operations, as of December 31, 2007:

 

     Year Ended December 31,          
     2008    2009    2010    2011    2012    Thereafter    Total
     (in millions)

Operating and capital commitments:

                    

Debt principal (1)

   $ 17    $ 932    $ 350    $ —      $ —      $ —      $ 1,299

Debt interest (1)

     69      46      24      —        —        —        139

Capital leases, including interest

     32      29      23      6      6      5      101

Operating leases

     132      107      89      69      52      201      650

Other commitments (2)(3)

     60      64      80      60      43      579      886
                                                

Total commitments

   $ 310    $ 1,178    $ 566    $ 135    $ 101    $ 785    $ 3,075
                                                

 

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(1) Under our 6.875% PEACS, the principal payment due in 2010 and the annual interest payments fluctuate based on the Euro/U.S. Dollar exchange ratio. At December 31, 2007, the Euro to U.S. Dollar exchange rate was 1.459. Due to changes in the Euro/U.S. Dollar exchange ratio, our remaining principal debt obligation under this instrument since issuance in February 2000 has increased by $114 million as of December 31, 2007. The principal and interest commitments at December 31, 2007 reflect the partial redemptions of the 6.875% PEACS and 4.75% Convertible Subordinated Notes.
(2) Includes the estimated timing and amounts of payments for rent, operating expenses, and tenant improvements associated with approximately 800,000 square feet of corporate office space in Seattle, Washington. We also have the right to occupy up to an additional approximately 800,000 square feet subject to a termination fee, estimated to be up to approximately $40 million, if we do not elect to occupy this additional space. The amount of space available and our financial and other obligations under the lease agreements are affected by various factors, including government approvals and permits, interest rates, development costs and other expenses and our exercise of certain rights under the lease agreements.
(3) Includes commitments to acquire intellectual property and unrecognized tax benefits under FIN 48, but excludes $105 million of such unrecognized tax benefits for which we cannot make a reasonably reliable estimate of the amount and period of payment. See Item 8 of Part II, “Financial Statements and Supplementary Data—Note 12—Income Taxes.”

In January 2008 we closed or entered into agreements, subject to regulatory approvals and other conditions, to acquire or invest in certain companies. These acquisitions and investments result in aggregate cash payments of approximately $400 million, net of cash acquired.

Pledged Securities

We are required to pledge or otherwise restrict a portion of our cash and marketable securities as collateral for standby letters of credit, guarantees, debt, and real estate leases. We classify cash and marketable securities with use restrictions of twelve months or longer as non-current “Other assets” on our consolidated balance sheets. The balance of pledged securities at December 31, 2007 consisted of $14 million in “Cash and cash equivalents” and “Marketable securities,” and $197 million in “Other assets.” The amount required to be pledged for certain real estate lease agreements changes over the life of our leases based on our credit rating and changes in our market capitalization (common shares outstanding multiplied by the closing price of our common stock). Information about collateral required to be pledged under these agreements is as follows:

 

     Standby and Trade
Letters of Credit
and Guarantees
   Debt (1)    Real Estate
Leases (2)
    Total
     (in millions)

Balance at December 31, 2006

   $ 60    $ 56    $ 20     $ 136

Net change in collateral pledged

     78      4      (7 )     75
                            

Balance at December 31, 2007

   $ 138    $ 60    $ 13     $ 211
                            

 

(1) Represents collateral for certain debt related to our international operations.
(2) At December 31, 2007, our market capitalization was $38.6 billion. The required amount of collateral to be pledged will increase by $5 million if our market capitalization is equal to or below $18 billion and by an additional $6 million if our market capitalization is equal to or below $13 billion.

 

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Legal Proceedings

The Company is involved from time to time in claims, proceedings and litigation, including the following:

In October 2002, Gary Gerlinger, individually and on behalf of all other similarly situated consumers in the United States who, during the period from August 1, 2001 to the present, purchased books online from either Amazon.com or Borders.com, instituted an action against us and Borders in the United States District Court for the Northern District of California. The complaint alleges that the agreement pursuant to which an affiliate of Amazon.com operates Borders.com as a co-branded site violates federal anti-trust laws, California statutory law, and the common law of unjust enrichment. The complaint seeks injunctive relief, damages, including treble damages or statutory damages where applicable, attorneys’ fees, costs, and disbursements, disgorgement of all sums obtained by allegedly wrongful acts, interest, and declaratory relief. In November 2005, the Court dismissed all of the plaintiff’s claims with prejudice. The plaintiff is appealing that dismissal. We dispute the allegations of wrongdoing in this complaint, and we will continue to defend ourselves vigorously in this matter.

Beginning in March 2003, we were served with complaints filed in several different states, including Illinois, by a private litigant, Beeler, Schad & Diamond, P.C., purportedly on behalf of the state governments under various state False Claims Acts. The complaints allege that we (along with other companies with which we have commercial agreements) wrongfully failed to collect and remit sales and use taxes for sales of personal property to customers in those states and knowingly created records and statements falsely stating we were not required to collect or remit such taxes. In December 2006, we learned that one additional complaint was filed in the state of Illinois by a different private litigant, Matthew T. Hurst, alleging similar violations of the Illinois state law. All of the complaints seek injunctive relief, unpaid taxes, interest, attorneys’ fees, civil penalties of up to $10,000 per violation, and treble or punitive damages under the various state False Claims Acts. It is possible that we have been or will be named in similar cases in other states as well. We dispute the allegations of wrongdoing in these complaints and intend to vigorously defend ourselves in these matters.

In May 2004, Toysrus.com LLC filed a complaint against us for breach of contract in the Superior Court of New Jersey. The complaint alleged that we breached our commercial agreement with Toysrus.com LLC by selling, and by permitting other third parties to sell, products that Toysrus.com LLC alleged it has an exclusive right to sell on our website. We disputed the allegations in the complaint and brought counterclaims alleging breach of contract and seeking damages and declaratory relief. The trial of both parties’ claims concluded in November 2005. In March 2006, the Court entered a judgment in favor of Toysrus.com LLC, terminating the contract but declining to award damages to either party. We are pursuing an appeal of the lower court’s rulings terminating the contract, declining to award us damages, and denying our motion to compel Toysrus.com to pay certain fees incurred during the wind-down period.

In December 2005, Registrar Systems LLC filed a complaint against us and Target Corporation for patent infringement in the United States District Court for the District of Colorado. The complaint alleges that our website technology, including the method by which Amazon.com enables customers to use Amazon.com account information on websites that Amazon.com operates for third parties, such as Target.com, infringes two patents obtained by Registrar Systems purporting to cover methods and apparatuses for a “World Wide Web Registration Information Processing System” (U.S. Patent Nos. 5,790,785 and 6,823,327) and seeks injunctive relief, monetary damages in an amount no less than a reasonable royalty, prejudgment interest, costs, and attorneys’ fees. We dispute the allegations of wrongdoing in this complaint and intend to vigorously defend ourselves in this matter. In September 2006, the Court entered an order staying the lawsuit pending the outcome of the Patent and Trademark Office’s re-examination of the patents in suit.

In August 2006, Cordance Corporation filed a complaint against us for patent infringement in the United States District Court for the District of Delaware. The complaint alleges that our website technology, including

 

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our 1-Click ordering system, infringes a patent obtained by Cordance purporting to cover an “Object-Based Online Transaction Infrastructure” (U.S. Patent No. 6,757,710) and seeks injunctive relief, monetary damages in an amount no less than a reasonable royalty, treble damages for alleged willful infringement, prejudgment interest, costs, and attorneys’ fees. In response, we asserted a declaratory judgment counterclaim in the same action alleging that a service that Cordance has advertised its intent to launch infringes a patent owned by us entitled “Networked Personal Contact Manager” (U.S. Patent No. 6,269,369). We dispute Cordance’s allegations of wrongdoing and intend to vigorously defend ourselves in this matter.

In April 2007, SBJ Holdings 1, LLC filed a complaint against us in the United States District Court for the Eastern District of Texas. The complaint alleges that our website technology infringes a patent obtained by SBJ Holdings 1 purporting to cover a “Method, Memory, Product, and Code for Displaying Pre-Customized Content Associated with Visitor Data” (U.S. Patent No. 6,330,592) and seeks injunctive relief, monetary damages, treble damages for alleged willful infringement, prejudgment and post-judgment interest, costs and attorneys’ fees. We dispute the allegations of wrongdoing and intend to vigorously defend ourselves in the matter.

In August 2007, Polaris IP, LLC filed a complaint against us and others in the United States District Court for the Eastern District of Texas. The complaint alleges that our website technology infringes a patent obtained by Polaris purporting to cover an “Automatic Message Interpretation and Routing System” (U.S. Patent No. 6,411,947) and seeks injunctive relief, monetary damages, prejudgment and post-judgment interest, costs and attorneys’ fees. In November 2007, we entered into a settlement of the litigation that included, among other things, a non-exclusive license to the patent in suit.

Depending on the amount and the timing, an unfavorable resolution of some or all of these matters could materially affect our business, results of operations, financial position, or cash flows.

See also “Note 12—Income Taxes.”

Inventory Suppliers

During 2007, no vendor accounted for 10% or more of our inventory purchases. We do not have long-term contracts or arrangements with most of our vendors to guarantee the availability of merchandise, particular payment terms, or the extension of credit limits.

Note 7—STOCKHOLDERS’ EQUITY

Preferred Stock

We have authorized 500 million shares of $0.01 par value Preferred Stock. No preferred stock was outstanding for any period presented.

Stock Repurchase Activity

In August 2006, our Board of Directors authorized a 24-month program to repurchase up to $500 million of our common stock, pursuant to which we repurchased $252 million and $248 million of our common stock in 2006 and 2007, respectively. In April 2007, our Board authorized a new 24-month program to repurchase up to $500 million of our common stock, which was replaced in February 2008 by a 24-month program to repurchase up to $1 billion of our common stock.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Stock Award Plans

Employees vest in restricted stock unit awards and stock options over the corresponding service term, generally between two and five years. Outstanding stock options generally have a term of 10 years from the date of grant. Stock options outstanding have a weighted average exercise life of 3.5 years, with a weighted average exercise price of $17.46.

Stock Award Activity

We granted stock awards, which consist primarily of restricted stock units, representing 7.6 million, 9.1 million, and 6.0 million shares of common stock during 2007, 2006, and 2005 with a per share weighted average fair value of $47.04, $36.48, and $36.50.

Common shares underlying outstanding stock awards were as follows:

 

     Year Ended December 31,
           2007                2006      
     (in millions)

Restricted stock units

   16.3    14.5

Stock options

   1.9    7.4
         

Total outstanding stock awards

   18.2    21.9
         

Common shares outstanding (which includes restricted stock), plus shares underlying outstanding stock options and restricted stock units totaled 435 million, 436 million, and 438 million at December 31, 2007, 2006 and 2005. These totals include all stock-based awards outstanding, without regard for estimated forfeitures, consisting of vested and unvested awards and in-the-money and out-of-the-money stock options. Common shares outstanding decreased in both 2007 and 2006 due to repurchases of common stock, offset by exercises of stock options, vesting of restricted stock units, and matching contributions under our 401(k) savings plan.

The following summarizes our restricted stock unit activity (in millions):

 

     Number of Units  

Outstanding at January 1, 2005

   6.4  

Units granted

   6.0  

Units vested

   (1.2 )

Units cancelled

   (1.3 )
      

Outstanding at December 31, 2005

   9.9  

Units granted

   9.1  

Units vested

   (1.7 )

Units cancelled

   (2.8 )
      

Outstanding at December 31, 2006

   14.5  

Units granted

   7.6  

Units vested

   (3.3 )

Units cancelled

   (2.5 )
      

Outstanding at December 31, 2007

   16.3  
      

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Scheduled vesting for outstanding restricted stock units at December 31, 2007 is as follows (in millions):

 

     Year Ended December 31,