Annual Reports

  • 10-K (Jan 31, 2014)
  • 10-K (Jan 30, 2013)
  • 10-K (Feb 1, 2012)
  • 10-K (Feb 28, 2011)
  • 10-K (Jan 28, 2011)
  • 10-K (Jan 29, 2010)

 
Quarterly Reports

 
8-K

 
Other

Amazon.com 10-K 2011
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, 2010

or

 

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

For the transition period from                     to                     .

Commission File No. 000-22513

AMAZON.COM, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   91-1646860

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

410 Terry Avenue North

Seattle, Washington 98109-5210

(206) 266-1000

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

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark 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   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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, 2010

   $ 39,007,666,822   

Number of shares of common stock outstanding as of January 19, 2011

     451,003,759   

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 2011, 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, 2010

INDEX

 

          Page  
   PART I   

Item 1.

  

Business

     3   

Item 1A.

  

Risk Factors

     6   

Item 1B.

  

Unresolved Staff Comments

     15   

Item 2.

  

Properties

     16   

Item 3.

  

Legal Proceedings

     16   

Item 4.

  

Reserved

     16   
   PART II   

Item 5.

  

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

     17   

Item 6.

  

Selected Consolidated Financial Data

     18   

Item 7.

  

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

     19   

Item 7A.

  

Quantitative and Qualitative Disclosure About Market Risk

     33   

Item 8.

  

Financial Statements and Supplementary Data

     35   

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     68   

Item 9A.

  

Controls and Procedures

     68   

Item 9B.

  

Other Information

     70   
   PART III   

Item 10.

  

Directors, Executive Officers and Corporate Governance

     70   

Item 11.

  

Executive Compensation

     70   

Item 12.

  

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

     70   

Item 13.

  

Certain Relationships and Related Transactions

     70   

Item 14.

  

Principal Accountant Fees and Services

     70   
   PART IV   

Item 15.

  

Exhibits, Financial Statement Schedules

     70   

Signatures

     72   

 

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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 opened its virtual doors on the World Wide Web in July 1995 and offers Earth’s Biggest Selection. We seek to be Earth’s most customer-centric company for three primary customer sets: consumers, sellers, and enterprises. In addition, we generate revenue through other marketing and promotional services, such as online advertising, and co-branded credit card agreements.

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 10—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.

Consumers

We serve consumers through our retail websites, and focus on selection, price, and convenience. We design our websites to enable millions of unique products to be sold by us and by third parties across dozens of product categories. We also manufacture and sell the Kindle e-reader. We strive to offer our customers the lowest prices possible through low everyday product pricing and free shipping offers, including through membership in Amazon Prime, and to improve our operating efficiencies so that we can continue to lower prices for our customers. We also provide easy-to-use functionality, fast and reliable fulfillment, and timely customer service.

We fulfill customer orders in a number of ways, including through the U.S. and international fulfillment centers and warehouses that we operate, through co-sourced and outsourced arrangements in certain countries, and through digital delivery. We operate customer service centers globally, which are supplemented by co-sourced arrangements. See Item 2 of Part I, “Properties.”

Sellers

We offer programs that enable sellers to sell their products on our websites and their own branded websites and to fulfill orders through us. We are not the seller of record in these transactions, but instead earn fixed fees, revenue share fees, per-unit activity fees, or some combination thereof.

Enterprises

We serve developers and enterprises of all sizes through Amazon Web Services (“AWS”), which provides access to technology infrastructure that enables virtually any type of business.

 

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Competition

Our businesses 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 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 businesses include selection, price, and convenience, including fast and reliable fulfillment. Additional competitive factors for our seller and enterprise services include the quality, speed, and reliability of our services and tools. Many of our current and potential competitors have greater resources, longer histories, more customers, and greater brand recognition. They may secure better terms from suppliers, adopt more aggressive pricing and devote more resources to technology, infrastructure, 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, or applied for the registration of, a number of U.S. and international domain names, trademarks, service marks, and copyrights. Additionally, 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 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. We recognized 38%, 39%, and 35% of our annual revenue during the fourth quarter of 2010, 2009, and 2008.

Employees

We employed approximately 33,700 full-time and part-time employees at December 31, 2010. 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. Although we have works councils and statutory employee representation obligations in certain countries, 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 has historically been intense, particularly for software engineers, computer scientists, and other technical staff.

Available Information

Our investor relations website is www.amazon.com/ir and we encourage investors to use it as a way of easily finding information about us. We promptly make available on this website, free of charge, the reports that we file or furnish with the Securities and Exchange Commission (“SEC”), corporate governance information (including our Code of Business Conduct and Ethics), and select press releases and social media postings.

 

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Executive Officers and Directors

The following tables set forth certain information regarding our Executive Officers and Directors as of January 19, 2011:

Executive Officers

 

Name

   Age     

Position

Jeffrey P. Bezos

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

Jeffrey M. Blackburn

     41       Senior Vice President, Business Development

Sebastian J. Gunningham

     48       Senior Vice President, Seller Services

Andrew R. Jassy

     43       Senior Vice President, Web Services

Steven Kessel

     45       Senior Vice President, Worldwide Digital Media

Marc A. Onetto

     60       Senior Vice President, Worldwide Operations

Diego Piacentini

     50       Senior Vice President, International Retail

Shelley L. Reynolds

     46       Vice President, Worldwide Controller, and Principal Accounting Officer

Thomas J. Szkutak

     50       Senior Vice President and Chief Financial Officer

H. Brian Valentine

     51       Senior Vice President, Ecommerce Platform

Jeffrey A. Wilke

     44       Senior Vice President, North America Retail

L. Michelle Wilson

     47       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.

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.

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.

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.

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.

Diego Piacentini.    Mr. Piacentini has served as Senior Vice President, International Retail, since January 2007. From November 2001 to 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.

 

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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.

Jeffrey A. Wilke.    Mr. Wilke has served as Senior Vice President, North America Retail, since January 2007. From January 2002 to 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 July 2003.

Board of Directors

 

Name

   Age     

Position

Jeffrey P. Bezos

     47      

President, Chief Executive Officer, and Chairman of the Board

Tom A. Alberg

     70      

Managing Director, Madrona Venture Group

John Seely Brown

     70      

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

William B. Gordon

     60      

Partner, Kleiner Perkins Caufield & Byers

Alain Monié

     60      

Chief Executive Officer, APRIL Pte. Ltd.

Jonathan J. Rubinstein

     54      

Senior Vice President and General Manager, Palm Global Business Unit, Hewlett-Packard Company

Thomas O. Ryder

     66      

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

Patricia Q. Stonesifer

     54      

Chair, Board of Regents, Smithsonian Institution

 

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, the current global economic climate amplifies many of these risks.

We Face Intense Competition

Our businesses are rapidly evolving and intensely competitive, and we have many competitors in different industries, including retail, e-commerce services, digital content and digital media devices, 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, infrastructure, fulfillment, and marketing.

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 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.

 

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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 offerings. 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, profitability, if any, 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 retain and expand our network of sellers;

 

   

our ability to offer products on favorable terms, manage inventory, and fulfill orders;

 

   

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

 

   

changes in usage or adoption rates of the Internet, e-commerce, digital media devices and web services, 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;

 

   

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;

 

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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. In certain international market segments, we have relatively little operating experience 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, other online services and electronic devices 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 physical and digital distribution of media products and enforcement of intellectual property rights;

 

   

business licensing or certification requirements, such as for imports, exports and electronic devices;

 

   

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;

 

   

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

 

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websites. 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 and other products. In order to meet local ownership and regulatory licensing requirements, Joyo Amazon’s business is operated by PRC companies that are indirectly owned, either wholly of partially, by 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 adequately predict customer demand or otherwise optimize and operate our fulfillment centers successfully, it could result in excess or insufficient inventory or fulfillment capacity, result in increased costs, impairment charges, or both, or harm our business in other ways. 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 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 profitability. 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

 

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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 through our seller programs and 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 agreements terminate, we may be unable to renew or replace these agreements on comparable terms, or at all. 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.

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;

 

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the potential impairment of tangible assets, such as inventory, and intangible assets and goodwill acquired in the acquisitions;

 

   

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.

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. In addition, valuations supporting our acquisitions and strategic investments could change rapidly given the current global economic climate. We could determine that such valuations have experienced impairments or other-than-temporary declines in fair value which could adversely impact our financial results.

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. We also hold cash equivalents and/or marketable securities primarily in Euros, Japanese Yen, and British Pounds. 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.

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.

We Face Risks Related to System Interruption and Lack of Redundancy

We experience occasional system interruptions and delays that make our websites and services 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

 

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interruption, delays, and loss of critical data, and could prevent us from accepting and fulfilling customer orders and providing services, which could make our product and service offerings less attractive and subject us to liability. 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 for any related losses. Any of these events could damage our reputation and be expensive to remedy.

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 affect our operating results as a result of seasonality, new product launches, rapid changes in product cycles and pricing, defective merchandise, changes in consumer demand and consumer spending patterns, changes in consumer tastes with respect to our products and other factors. We endeavor to accurately predict these trends and avoid overstocking or understocking 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.

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. 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. These risks have been amplified by the increase in third parties whose sole or primary business is to assert such claims.

 

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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;

 

   

changes in the valuation methodology of, or performance by, other e-commerce or technology 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 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, e-commerce, and electronic devices. Existing and future laws and regulations may impede our growth. These regulations and laws may cover taxation, privacy, data protection, pricing, content, copyrights, distribution, mobile communications, electronic device certification, electronic waste, electronic contracts and other communications, consumer protection, web services, 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, e-commerce, digital content and web services. 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.

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

 

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U.S. Congress, have been considering or adopted initiatives that could limit or supersede the Supreme Court’s position regarding sales and use taxes on Internet sales. If these initiatives are successful, we could be required to collect sales and use taxes in additional states or change our business practices. 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 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. Additional foreign countries may seek to impose sales or other tax collection obligations on us.

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.

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 foreign currency exchange 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 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 Supplier Relationships Subject Us to a Number of Risks

We have significant suppliers, including licensors, 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 suppliers to guarantee availability of merchandise, content, components or services, particular payment terms, or the extension of credit limits. If our current suppliers were to stop selling or licensing merchandise, content, components or services to us on acceptable terms, including as a result of one or more supplier bankruptcies due to poor economic conditions, we may be unable to procure alternatives from other suppliers in a timely and efficient manner and on acceptable terms, or at all.

We May be Subject to Risks Related to Government Contracts and Related Procurement Regulations

Our contracts with U.S., as well as state, local and foreign, government entities are subject to various procurement regulations and other requirements relating to their formation, administration and performance. We may be subject to audits and investigations relating to our government contracts and any violations could result in various civil and criminal penalties and administrative sanctions, including termination of contract, refunding or suspending of payments, forfeiture of profits, payment of fines and suspension or debarment from future government business. In addition, such contracts may provide for termination by the government at any time, without cause.

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 environmental 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

 

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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, consumer invoicing, 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 profitability. 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. 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.

We Could Be Liable for Breaches of Security

Although we have developed systems and processes that are designed to protect customer information and prevent fraudulent transactions, data loss and other security breaches, failure to prevent or mitigate such 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 other seller sites 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.

 

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Item 2. Properties

As of December 31, 2010, we operated the following facilities:

 

Description of Use

   Square
Footage (1)
    

Operating
Segments

   Lease
Expirations (1)
 
     (in thousands)              

Corporate office facilities

     2,351      

North America

    
 
From 2011
through 2025
  
  

Corporate office facilities

     650      

International

    
 
From 2011
through 2016
  
  
              

Sub-total

     3,001         
              

Fulfillment and warehouse operations

     15,761      

North America

    
 
From 2011
through 2021
  
  

Fulfillment and warehouse operations

     10,339      

International

    
 
From 2011
through 2025
  
  
              

Sub-total

     26,100         
              

Data center, customer service and other

     775      

North America

    
 
From 2011
through 2024
  
  

Data center, customer service and other

     209      

International

    
 
From 2011
through 2020
  
  
              

Sub-total

     984         
              

Total

     30,085         
              

 

(1) Represents the total leased space excluding sub-leased space.

We lease our corporate headquarters in Seattle, Washington. Additionally, we lease corporate office, fulfillment and warehouse operations, data center, customer service, and other facilities, principally in North America, Europe, and Asia.

 

Item 3. Legal Proceedings

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

 

Item 4. Reserved

Not applicable.

 

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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 per share sale prices for our common stock for the periods indicated, as reported by the Nasdaq Global Select Market.

 

     High      Low  

Year ended December 31, 2009

     

First Quarter

   $ 75.61       $ 47.63   

Second Quarter

     88.56         71.71   

Third Quarter

     94.50         75.41   

Fourth Quarter

     145.91         88.27   

Year ended December 31, 2010

     

First Quarter

   $ 138.19       $ 113.82   

Second Quarter

     151.09         106.01   

Third Quarter

     161.78         105.80   

Fourth Quarter

     185.65         151.40   

Holders

As of January 19, 2011, there were 3,383 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,  
     2010     2009     2008     2007     2006  
     (in millions, except per share data)  

Income Statement:

          

Net sales

   $ 34,204      $ 24,509      $ 19,166      $ 14,835      $ 10,711   

Income from operations

     1,406        1,129        842        655        389   

Net income

     1,152        902        645        476        190   

Basic earnings per share (1)

   $ 2.58      $ 2.08      $ 1.52      $ 1.15      $ 0.46   

Diluted earnings per share (1)

   $ 2.53      $ 2.04      $ 1.49      $ 1.12      $ 0.45   

Weighted average shares used in computation of earnings per share:

          

Basic

     447        433        423        413        416   

Diluted

     456        442        432        424        424   

Cash Flow Statement:

          

Net cash provided by operating activities

   $ 3,495      $ 3,293      $ 1,697      $ 1,405      $ 702   

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

     (979     (373     (333     (224     (216
                                        

Free cash flow (2)

   $ 2,516      $ 2,920      $ 1,364      $ 1,181      $ 486   
                                        
     December 31,  
     2010     2009     2008     2007     2006  
     (in millions)  

Balance Sheet:

          

Total assets

   $ 18,797      $ 13,813      $ 8,314      $ 6,485      $ 4,363   

Long-term debt

     184        109        409        1,282        1,247   

 

(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, the outcomes of legal proceedings and claims, fulfillment center optimization, risks of inventory management, seasonality, the degree to which the Company enters into, maintains, and develops commercial agreements, acquisitions, and strategic transactions, payments risks, and risks of fulfillment throughput and productivity. In addition, the current global economic climate amplifies many of these risks. These risks and uncertainties, as well as other risks and uncertainties that could cause our actual results to differ significantly from management’s expectations, are described in greater detail in Item 1A of Part I, “Risk Factors.”

Overview

Our primary source of revenue is the sale of a wide range of products and services to customers. The products offered on our consumer-facing websites primarily include merchandise and content we have purchased for resale from vendors and those offered by third party sellers, and we also manufacture and sell the Kindle e-reader. 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 AWS, fulfillment, miscellaneous marketing and promotional agreements, such as online advertising, and co-branded credit cards.

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 of products and services 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 sales of products and services, we focus on improving all aspects of the customer experience, including lowering prices, improving availability, offering faster delivery and performance times, increasing selection, increasing product categories and service offerings, expanding product information, improving ease of use, improving reliability, and earning customer trust. We also seek to efficiently manage shareholder dilution while maintaining the flexibility to issue shares for strategic purposes, such as financings, acquisitions, 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 measuring shareholder dilution, we include all vested and unvested stock awards outstanding, without regard to estimated forfeitures. Total shares outstanding plus outstanding stock awards were 465 million and 461 million at December 31, 2010 and 2009.

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

 

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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preparing orders for shipment, transportation, customer service support, and a portion of our marketing costs. Our fixed costs include the costs necessary to run our technology infrastructure and AWS; to build, enhance, and add features to our websites and our Kindle e-reader; and to 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 sourcing, increase 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 consumers before our payments to suppliers come due. Inventory turnover3 was 11, 12, and 12 for 2010, 2009, and 2008. 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 72, 68, and 62 for 2010, 2009, and 2008. 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.

We expect spending in technology and content will increase over time as we add computer scientists, software engineers, and merchandising employees. We seek to efficiently invest in several areas of technology and content, including seller platforms, 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 AWS. We believe that advances in technology, specifically the speed and reduced cost of processing power, the improved consumer 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 consumer experience on the Internet and increase its ubiquity in people’s lives. We are investing in AWS, which provides technology services that give developers and enterprises of all sizes access to technology infrastructure that enables virtually any type of business, and in our Kindle e-reader. A continuing challenge is 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, and operating expenses will be 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, 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 useful to evaluate our operating results and growth rates before and after the effect of currency changes.

In addition, the remeasurement of our 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.

 

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 trailing-twelve-month cost of sales to average inventory over five quarter-ends.

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

 

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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.

Inventories

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

These assumptions about future disposition of inventory are inherently uncertain. As a measure of sensitivity, for every 1% of additional inventory valuation allowance at December 31, 2010 we would have recorded an additional cost of sales of approximately $33 million.

Goodwill

We evaluate goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicates that the carrying value may not be recoverable. Our annual testing date is October 1. We test goodwill for impairment by first comparing the book value of net assets to the fair value of the reporting units. If the fair value is determined to be less than the book value, a second step is performed to compute the amount of impairment as the difference between the estimated fair value of goodwill and the carrying value. We estimate the fair value of the reporting units using discounted cash flows. Forecasts of future cash flow are based on our best estimate of future net sales and operating expenses, based primarily on expected category expansion, pricing, market segment share, and general economic conditions. Certain estimates of discounted cash flows involve businesses and geographies with limited financial history and developing revenue models. Changes in these forecasts could significantly change the amount of impairment recorded, if any.

During the year, management monitored the actual performance of the business relative to the fair value assumptions used during our annual goodwill impairment test. For the periods presented, no triggering events were identified that required an update to our annual impairment test. As a measure of sensitivity, a 10% decrease in the fair value of any of our reporting units as of December 31, 2010 would have had no impact on the carrying value of our goodwill.

Financial and credit market volatility directly impacts our fair value measurement through our weighted average cost of capital that we use to determine our discount rate and through our stock price that we use to determine our market capitalization. During times of volatility, significant judgment must be applied to

 

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determine whether credit or stock price changes are a short term swing or a longer-term trend. As a measure of sensitivity, a prolonged 20% decrease from our December 31, 2010 closing stock price would not be an indicator of possible impairment.

Stock-Based Compensation

We measure compensation cost for stock awards at fair value and recognize it as compensation expense over the service period for awards expected to vest. The fair value of restricted stock units is determined based on the number of shares granted and the quoted price of our common stock. The estimation of stock awards that will ultimately vest requires judgment for the amount that will be forfeited, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. We consider many factors when estimating expected forfeitures, including employee class, economic environment, and historical experience. We update our estimated forfeiture rate quarterly. A 1% change to our estimated forfeiture rate would have had an approximately $17 million impact on our 2010 operating income. Our estimated forfeiture rates at December 31, 2010 and 2009, were 29.7% and 33.1%.

We utilize the accelerated method, rather than the straight-line method, for recognizing compensation expense. Under this method, over 50% of the compensation cost is expensed in the first year of a four year vesting term. The accelerated method also adds a higher level of sensitivity of 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. 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 foreign currency exchange 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 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.

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.

Recent Accounting Pronouncements

See Item 8 of Part II, “Financial Statements and Supplementary Data—Note 1—Description of Business and Accounting Policies—Recent Accounting Pronouncements.”

 

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Liquidity and Capital Resources

Cash flow information is as follows:

 

     Year Ended December 31,  
     2010     2009     2008  
     (in millions)  

Cash provided by (used in):

      

Operating activities

   $ 3,495      $ 3,293      $ 1,697   

Investing activities

     (3,360     (2,337     (1,199

Financing activities

     181        (280     (198

Our financial focus is on long-term, sustainable growth in free cash flow. Free cash flow, a non-GAAP financial measure, was $2.52 billion for 2010, compared to $2.92 billion and $1.36 billion for 2009 and 2008. See “Results of Operations—Non-GAAP Financial Measures” below for a reconciliation of free cash flow to cash provided by operating activities. The decrease in free cash flow in 2010 was primarily due to increased capital expenditures, changes in working capital, and utilization of excess stock-based compensation deductions, partially offset by increases in operating income. The increase in free cash flow in 2009 primarily resulted from changes in working capital, increased operating income, and increased deferred revenue. Tax benefits relating to excess stock-based compensation deductions are presented in the statement of cash flows as financing cash inflows; accordingly, as such tax benefits decline, a greater amount of cash is classified as operating cash inflow. Operating cash flows and free cash flows can be volatile and are sensitive to many factors, including changes in working capital 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 $8.8 billion, $6.4 billion, and $3.7 billion, at December 31, 2010, 2009, and 2008. Amounts held in foreign currencies were $3.4 billion, $2.8 billion, and $1.7 billion at December 31, 2010, 2009, and 2008, and were primarily Euros, British Pounds, and Japanese Yen.

Cash provided by operating activities was $3.5 billion, $3.3 billion, and $1.7 billion in 2010, 2009, and 2008. Our operating cash flows result primarily from cash received from our consumer, seller, and enterprise customers, miscellaneous marketing and promotional agreements, and our co-branded credit card agreements, offset by cash payments we make for products and services, employee compensation (less amounts capitalized related to internal use software that are reflected as cash used in investing activities), payment processing and related transaction costs, operating leases, and interest payments on our long-term obligations. Cash received from our consumer, seller, and enterprise customers, and other activities generally corresponds to our net sales. Because consumers primarily use credit cards to buy from us, our receivables from customers settle quickly. Changes to our operating cash flows have historically been driven primarily by changes in operating income and changes to the components of working capital, including changes to receivable and payable days and inventory turns, as well as changes to non-cash items such as excess stock-based compensation and deferred taxes.

Cash provided by (used in) investing activities corresponds with purchases, sales, and maturities of marketable securities, capital expenditures, including leasehold improvements, internal-use software and website development costs, and cash outlays for acquisitions, investments in other companies and intellectual property rights. Cash provided by (used in) investing activities was $(3.4) billion, $(2.3) billion, and $(1.2) billion in 2010, 2009, and 2008, with the variability caused primarily by increased capital expenditures, increases in cash paid for acquisitions, and purchases, maturities, and sales of marketable securities and other investments. Capital expenditures were $979 million, $373 million, and $333 million in 2010, 2009, and 2008, with the sequential increases primarily reflecting additional investments in support of continued business growth, including investments in technology infrastructure including AWS, additional capacity to support our fulfillment operations, and, in 2010, investments in corporate office space. We expect this trend to continue over time.

 

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Capital expenditures included $176 million, $146 million, and $128 million for internal-use software and website development during 2010, 2009, and 2008. Stock-based compensation capitalized for internal-use software and website development costs does not affect cash flows. In 2010, 2009, and 2008, we made cash payments, net of acquired cash, related to acquisition and investment activity of $352 million, $40 million, and $494 million.

Cash provided by (used in) financing activities was $181 million, $(280) million, and $(198) million in 2010, 2009, and 2008. Cash outflows from financing activities result from payments on obligations related to capital leases and leases accounted for as financing arrangements, repayments of long-term debt, and repurchases of common stock. Payments on obligations related to capital leases and leases accounted for as financing arrangements, and repayments of long-term debt, were $221 million, $472 million, and $355 million in 2010, 2009, and 2008. We repurchased 2.2 million shares of common stock for $100 million in 2008 under the $1 billion repurchase program authorized by our Board of Directors in February 2008. Cash inflows from financing activities primarily result from proceeds from tax benefits relating to excess stock-based compensation deductions and proceeds from long-term debt. Proceeds from long-term debt and other were $143 million, $87 million, and $98 million in 2010, 2009, and 2008. Tax benefits relating to excess stock-based compensation deductions are presented as financing cash flows. Cash inflows (outflows) from tax benefits related to stock-based compensation deductions were $259 million, $105 million, and $159 million in 2010, 2009, and 2008.

In 2010, 2009, and 2008 we recorded net tax provisions of $352 million, $253 million, and $247 million. A majority of this provision is non-cash. We have current tax benefits and net operating loss carryforwards relating to excess stock-based compensation deductions that are being utilized to reduce our U.S. taxable income. Cash taxes paid, net of refunds, were $75 million, $48 million, and $53 million for 2010, 2009, and 2008. We used substantially all of our federal net operating loss carryforwards in 2010 and have available federal tax credits of $227 million. Once we use our credits, we expect cash paid for taxes to significantly increase. We endeavor to optimize our global taxes on a cash basis, rather than on a financial reporting basis.

In January 2010, our Board of Directors authorized a program to repurchase up to $2 billion of our common stock, which replaces the prior February 2008 repurchase authorization described above. We did not repurchase any of our common stock in 2010 or 2009.

Additionally, in November 2010 and January 2011, we signed agreements to acquire Quidsi, Inc. and LOVEFiLM International Limited for aggregate consideration of approximately $660 million, primarily in cash, and the assumption of debt. We expect the acquisitions to close in 2011, subject to regulatory approvals and closing conditions.

See Item 8 of Part II, “Financial Statements and Supplementary Data—Note 6—Commitments and Contingencies” for additional discussion of our principal contractual commitments, as well as our pledged securities. Purchase obligations and open purchase orders, consisting of inventory and significant non-inventory commitments, were $1.5 billion at December 31, 2010.

On average, our high inventory turnover means we collect from our customers before our payments to suppliers come due. Inventory turnover was 11, 12, and 12 for 2010, 2009, and 2008. We expect some variability in inventory turnover over time as it is affected by several factors, including category expansion and changes in our product mix, the mix of sales by us and by other sellers, our continuing focus on in-stock inventory availability, our investment in new geographies and product lines, and the extent to which we choose to utilize outsource fulfillment providers.

We believe that 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 debt for strategic reasons or to further

 

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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.

Results of Operations

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

Net Sales

Net sales information is as follows:

 

     Year Ended December 31,  
     2010     2009     2008  
     (in millions)  

Net Sales:

      

North America

   $ 18,707      $ 12,828      $ 10,228   

International

     15,497        11,681        8,938   
                        

Consolidated

   $ 34,204      $ 24,509      $ 19,166   
                        

Year-over-year Percentage Growth:

      

North America

     46     25     26

International

     33        31        33   

Consolidated

     40        28        29   

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

      

North America

     46     26     26

International

     34        33        31   

Consolidated

     40        29        28   

Net Sales Mix:

      

North America

     55     52     53

International

     45        48        47   
                        

Consolidated

     100     100     100
                        

Sales increased 40%, 28%, and 29% in 2010, 2009, and 2008. Changes in currency exchange rates positively (negatively) affected net sales by $(86) million, $(182) million, and $127 million for 2010, 2009, and 2008. For a discussion of the effect on sales growth of exchange rates, see “Effect of Exchange Rates” below.

The North America sales growth rate was 46%, 25%, and 26% in 2010, 2009, and 2008. The sales growth in each year primarily reflects increased unit sales, a larger base of sales in faster growing categories such as electronics and other general merchandise, and, in 2010, our adoption of the new accounting standard update (“ASU”) 2009-13 (see Item 8 of Part II, “Financial Statements and Supplementary Data—Note 1—Description of Business and Accounting Policies”). Increased unit sales were driven largely by our continued efforts to reduce prices for our customers, including from our free shipping offers and Amazon Prime, by increased in-stock inventory availability and increased selection of product offerings, and by the impact of Zappos, which we acquired in the fourth quarter of 2009.

 

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The International sales growth rate was 33%, 31%, and 33% in 2010, 2009, and 2008. The sales growth in each year primarily reflects increased unit sales and a larger base of sales in faster growing categories such as electronics and other general merchandise. Increased unit sales were driven largely by our continued efforts to reduce prices for our customers, including from our free shipping offers and Amazon Prime, and by increased in-stock inventory availability and increased selection of product offerings. Additionally, changes in currency exchange rates positively (negatively) affected International net sales by $(107) million, $(174) million, and $131 million in 2010, 2009, and 2008. We expect that, over time, our International segment will represent 50% or more of our consolidated net sales.

Sales of products by marketplace sellers on our websites represented 31%, 30%, and 28% of unit sales in 2010, 2009, and 2008. Revenues from these sales are recorded as a net amount. Because we focus on operating profits, we are largely neutral on whether an item is sold by us or by another seller.

Supplemental Information

Supplemental information about shipping results is as follows:

 

    December 31,  
    2010     2009     2008  
    (in millions)  

Shipping Activity:

     

Shipping revenue (1)(2)

  $ 1,193      $ 924      $ 835   

Outbound shipping costs

    (2,579     (1,773     (1,465
                       

Net shipping cost

  $ (1,386   $ (849   $ (630
                       

Year-over-year Percentage Growth:

     

Shipping revenue

    29     11     13

Outbound shipping costs

    45        21        25   

Net shipping cost

    63        35        45   

Percent of Net Sales:

     

Shipping revenue

    3.5     3.8     4.4

Outbound shipping costs

    (7.5     (7.2     (7.6
                       

Net shipping cost

    (4.0 )%      (3.4 )%      (3.2 )% 
                       

 

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

We expect our net cost of shipping to continue to increase to the extent our customers accept and use our free-shipping offers at an increasing rate, including through membership in Amazon Prime; to the extent our product mix shifts to the electronics and other general merchandise category; to the extent we reduce shipping rates; and to the extent we use more expensive shipping methods. We seek to mitigate costs of shipping over time in part through achieving higher sales volumes, negotiating better terms with our suppliers, and achieving better operating efficiencies. We believe that offering low prices to our customers is fundamental to our future success. One way we offer lower prices is through free-shipping offers, as well as through membership in Amazon Prime.

 

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Supplemental information about our net sales is as follows:

 

    Year Ended December 31,  
    2010     2009     2008  
    (in millions)  

Net Sales:

     

North America

     

Media

  $ 6,881      $ 5,964      $ 5,350   

Electronics and other general merchandise

    10,998        6,314        4,430   

Other (1)

    828        550        448   
                       

Total North America

  $ 18,707      $ 12,828      $ 10,228   
                       

International

     

Media

  $ 8,007      $ 6,810      $ 5,734   

Electronics and other general merchandise

    7,365        4,768        3,110   

Other (1)

    125        103        94   
                       

Total International

  $ 15,497      $ 11,681      $ 8,938   
                       

Consolidated

     

Media

  $ 14,888      $ 12,774      $ 11,084   

Electronics and other general merchandise

    18,363        11,082        7,540   

Other (1)

    953        653        542   
                       

Total consolidated

  $ 34,204      $ 24,509      $ 19,166   
                       

Year-over-year Percentage Growth:

     

North America

     

Media

    15     11     16

Electronics and other general merchandise

    74        43        41   

Other

    50        23        38   

Total North America

    46        25        26   

International

     

Media

    18     19     24

Electronics and other general merchandise

    54        53        50   

Other

    22        9        65   

Total International

    33        31        33   

Consolidated

     

Media

    17     15     20

Electronics and other general merchandise

    66        47        45   

Other

    46        20        42   

Total consolidated

    40        28        29   

Year-over-year Percentage Growth:

     

Excluding the effect of exchange rates

     

International

     

Media

    18     20     22

Electronics and other general merchandise

    57        56        49   

Other

    24        19        67   

Total International

    34        33        31   

Consolidated

     

Media

    16     16     19

Electronics and other general merchandise

    67        48        44   

Other

    46        22        42   

Total consolidated

    40        29        28   

Consolidated Net Sales Mix:

     

Media

    43     52     58

Electronics and other general merchandise

    54        45        39   

Other

    3        3        3   
                       

Total consolidated

    100     100     100
                       

 

(1) Includes non-retail activities, such as AWS, miscellaneous marketing and promotional activities, other seller sites, and our co-branded credit card agreements.

 

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Operating Expenses

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

 

    Year ended December 31, 2010     Year ended December 31, 2009     Year ended December 31, 2008  
    As
Reported
    Stock-Based
Compensation
    Net     As
Reported
    Stock-Based
Compensation
    Net     As
Reported
    Stock-Based
Compensation
    Net  

Operating Expenses:

                 

Cost of Sales

  $ 26,561      $ —        $ 26,561      $ 18,978      $ —        $ 18,978      $ 14,896      $ —        $ 14,896   

Fulfillment

    2,898        (90     2,808        2,052        (79     1,973        1,658        (61     1,597   

Marketing

    1,029        (27     1,002        680        (20     660        482        (13     469   

Technology and content

    1,734        (223     1,511        1,240        (182     1,058        1,033        (151     882   

General and administrative

    470        (84     386        328        (60     268        279        (50     229   

Other operating expense (income), net

    106        —          106        102        —          102        (24     —          (24
                                                                       

Total operating expenses

  $ 32,798      $ (424   $ 32,375      $ 23,380      $ (341   $ 23,039      $ 18,324      $ (275   $ 18,049   
                                                                       

Year-over-year Percentage Growth:

                 

Fulfillment

    41       42     24       24     28       27

Marketing

    51          52        41          41        40          39   

Technology and content

    40          43        20          20        26          23   

General and administrative

    44          45        17          17        19          15   

Percent of Net Sales:

                 

Fulfillment

    8.5       8.2     8.4       8.1     8.6       8.3

Marketing

    3.0          2.9        2.8          2.7        2.5          2.4   

Technology and content

    5.1          4.4        5.1          4.3        5.4          4.6   

General and administrative

    1.4          1.1        1.3          1.1        1.5          1.2   

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.”

Cost of Sales

Cost of sales consists of the purchase price of consumer products and content where we are the seller of record, inbound and outbound shipping charges, and packaging supplies. 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.

The increase in cost of sales in absolute dollars in 2010 and 2009 compared to the comparable prior year periods is primarily due to increased product and shipping costs resulting from increased sales.

 

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Consolidated gross profit and gross margin for each of the periods presented were as follows:

 

     Year Ended December 31,  
     2010     2009     2008  

Gross Profit (in millions)

   $ 7,643      $ 5,531      $ 4,270   

Gross Margin

     22.3     22.6     22.3

Gross margin for 2010 remained relatively consistent with the prior year periods. We believe that income from operations is a more meaningful measure than gross profit and gross margin due to the diversity of our product categories and services.

Fulfillment

Fulfillment costs as a percentage of net sales may vary due to several factors, such as payment processing and related transaction costs, our level of productivity and accuracy, changes in volume, size, and weight of units received and fulfilled, the extent 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 sales versus our retail sales, sales by our sellers have higher fulfillment costs as a percent of net sales.

The increase in fulfillment costs in absolute dollars in 2010 and 2009 compared to the comparable prior year periods is primarily due to variable costs corresponding with sales volume, inventory levels, and product sales mix; payment processing and related transaction costs; and costs from expanding fulfillment capacity.

We seek to expand our fulfillment capacity 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 services. We evaluate our facility requirements as necessary.

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, email marketing campaigns, and other initiatives. 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.

The increase in marketing costs in absolute dollars in 2010 and 2009 compared to the comparable prior year periods is primarily due to increased spending on online marketing channels, such as sponsored search programs and our Associates program, and, in 2010, on television advertising.

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 seek to efficiently invest in several areas of technology and content including seller platforms, digital initiatives, and expansion of new and existing product categories, as well as technology infrastructure so that we can continue to enhance the customer experience, improve our process efficiency and support AWS. See “Overview” for a discussion of how management views advances in technology and the importance of innovation.

 

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The increase in technology and content costs in absolute dollars in 2010 and 2009 compared to the comparable prior year periods is primarily due to increases in payroll and related expenses and increased spending on technology infrastructure. We expect these trends to continue over time.

For the years ended 2010, 2009, and 2008, we capitalized $213 million, $187 million, and $187 million of costs associated with internal-use software and website development. Amortization of previously capitalized amounts was $184 million, $172 million, and $143 million for 2010, 2009, and 2008.

A majority of our technology costs are incurred in the U.S., most of which are allocated to our North America segment. Infrastructure and other technology costs used to support AWS are included in technology and content.

General and Administrative

The increase in general and administrative costs in absolute dollars in 2010 and 2009 compared to the comparable prior year periods is primarily due to increases in payroll and related expenses, and professional service fees.

Stock-Based Compensation

Stock-based compensation was $424 million, $341 million, and $275 million during 2010, 2009, and 2008. The increase in stock-based compensation in 2010 compared to 2009 is primarily due to an increase in total stock-based compensation value granted to our employees and to a decrease in our estimated forfeiture rate. The increase in stock-based compensation in 2009 compared to 2008 is primarily due to a decrease in our estimated forfeiture rate.

Other Operating Expense (Income), Net

Other operating expense (income), net was $106 million, $102 million, and $(24) million during 2010, 2009 and 2008. In 2010, the amount primarily related to amortization of intangible assets, in 2009, the amount included amortization of intangible assets and a $51 million legal settlement, and in 2008, the balance included amortization of intangible assets and a $53 million noncash gain on the sale of our European DVD rental assets.

Interest Income and Expense

Our interest income was $51 million, $37 million, and $83 million during 2010, 2009, and 2008. We generally invest our excess cash in investment grade short- to intermediate-term fixed income securities and AAA-rated money market funds. Our interest income corresponds with the average balance of invested funds and the prevailing rates we are earning on them, which vary depending on the geographies and currencies in which they are invested.

The primary component of our net interest expense is related to our capital and financing leases and our long-term debt. Interest expense was $39 million, $34 million, and $71 million in 2010, 2009, and 2008. The decline in 2009 primarily relates to principal reductions of long term debt of $319 million.

Our long-term liabilities were $1.6 billion and $1.2 billion at December 31, 2010 and 2009. See Item 8 of Part II, “Financial Statements and Supplementary Data—Note 5—Long-Term Liabilities.”

Other Income (Expense), Net

Other income (expense), net was $79 million, $29 million, and $47 million during 2010, 2009, and 2008. The primary component of other income (expense), net, is related to foreign-currency gain on intercompany balances.

 

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Income Taxes

We recorded a provision for income taxes of $352 million, $253 million, and $247 million in 2010, 2009, and 2008. The effective tax rate in 2010, 2009 and 2008 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.

Our effective tax rate is subject to significant variation due to several factors, including variability in accurately predicting our taxable income, the taxable jurisdictions to which it relates, business acquisitions and investments, and foreign currencies. 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. We used substantially all of our federal net operating loss carryforwards in 2010 and have available federal tax credits of $227 million. As a result of new U.S. legislation that became effective in December 2010, we are able to accelerate our depreciation deductions for qualifying property acquired in the fourth quarter of 2010. This accelerated depreciation deduction will continue for qualifying property acquired in 2011.

Equity–Method Investment Activity, Net of Tax

Equity–method investment activity, net of tax, was $7 million, $(6) million, and $(9) million in 2010, 2009, and 2008. The increase in equity-method investment activity in 2010 compared to 2009 is primarily due to the recognition of a non-cash gain on a previously held equity position in a company that was acquired in 2010.

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, 2010
    Year Ended
December 31, 2009
    Year Ended
December 31, 2008
 
    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

  $ 34,290      $ (86   $ 34,204      $ 24,691      $ (182   $ 24,509        19,039      $ 127      $ 19,166   

Operating expenses

    32,856        (58     32,798        23,522        (142     23,380        18,206        118        18,324   

Income from operations

    1,434        (28     1,406        1,170        (41     1,129        832        10        842   

Net interest income (expense) and other (3)

    17        74        91        6        26        32        17        42        59   

Net income

    1,118        34        1,152        911        (9     902        609        36        645   

Diluted earnings per share

  $ 2.45      $ 0.08      $ 2.53      $ 2.06      $ (0.02   $ 2.04      $ 1.41      $ 0.08      $ 1.49   

 

(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 intercompany balances and 6.875% PEACS, which we redeemed in 2009.
(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 intercompany balances and 6.875% PEACS, which we redeemed in 2009.
(3) Includes foreign currency gains and losses on cross-currency investments, and remeasurement of our intercompany balances and 6.875% PEACS, which we redeemed in 2009.

 

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Non-GAAP Financial Measures

Regulation G, Conditions for Use of Non-GAAP Financial Measures, and other SEC regulations define and prescribe the conditions for use of certain non-GAAP financial information. Our measures of “Free cash flow,” operating expenses with and without stock-based compensation, and the effect of exchange rates on our consolidated statement of operations, meet the definition of non-GAAP financial measures.

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, which we reconcile to “Net cash provided by (used in) 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 typically will present a more conservative measure of cash flows since purchases of fixed assets are a necessary component of ongoing operations.

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 the portion of payments representing principal reductions of obligations related to capital leases and leases accounted for as financing arrangements 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 (used in) operating activities” for 2010, 2009, and 2008 (in millions):

 

     Year Ended December 31,  
     2010     2009     2008  

Net cash provided by (used in) operating activities

   $ 3,495      $ 3,293      $ 1,697   

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

     (979     (373     (333
                        

Free cash flow

   $ 2,516      $ 2,920      $ 1,364   
                        

Net cash provided by (used in) investing activities

   $ (3,360   $ (2,337   $ (1,199
                        

Net cash provided by (used in) financing activities

   $ 181      $ (280   $ (198
                        

Operating expenses with and without stock-based compensation is provided 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 has limitations since it does not include all expenses primarily related to our workforce. More specifically, if we did not pay out a portion of our compensation in 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.

Information regarding the effect of exchange rates, versus the U.S. Dollar, on our consolidated statements of operations is provided to show reported period operating results had the exchange rates remained the same as those in effect in the comparable prior year period.

 

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Guidance

We provided guidance on January 27, 2011 in our earnings release furnished on Form 8-K as follows:

First Quarter 2011 Guidance

 

   

Net sales are expected to be between $9.1 billion and $9.9 billion, or to grow between 28% and 39% compared with first quarter 2010.

 

   

Operating income is expected to be between $260 million and $385 million, or between 34% decline and 2% decline compared with first quarter 2010. This guidance includes approximately $140 million for stock-based compensation and amortization of intangible assets, and it assumes, among other things, that no additional business acquisitions or investments are concluded 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 Disclosures 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 disclosures 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. 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 consolidated balance sheets. We generally invest our excess cash in investment grade short- to intermediate-term fixed income securities and AAA-rated money market 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.

The following table provides information about our current and long-term cash equivalent and marketable fixed income securities, including principal cash flows by expected maturity and the related weighted average interest rates at December 31, 2010 (in millions, except percentages):

 

     2011     2012     2013     2014     2015      Thereafter      Total     Estimated
Fair Value at
December 31,
2010
 

Money market funds

   $ 1,882      $ —        $ —        $ —        $ —         $ —         $ 1,882      $ 1,882   

Weighted average interest rate

     0.11     —          —          —          —           —           0.11  

Corporate debt securities

     90        128        219        1        —           —           438        459   

Weighted average interest rate

     1.11     1.58     2.01     2.57     —           —           1.70  

U.S. Government and Agency Securities

     2,624        950        137        1        —           —           3,712        3,756   

Weighted average interest rate

     0.17     0.72     1.57     2.86     —           —           0.36  

Asset backed securities

     13        12        7          —           —           32        33   

Weighted average interest rate

     2.18     1.83     2.01       —           —           2.01  

Foreign government and agency securities

     1,346        410        337        30        —           —           2,123        2,158   

Weighted average interest rate

     0.37     0.84     1.28     1.66     —           —           0.62  

Other securities

     10        5        1        —          —           —           16        17   

Weighted average interest rate

     1.05     1.34     2.03       —           —           1.22  
                                                            
   $ 5,965      $ 1,505      $ 701      $ 32      $ —         $ —         $ 8,203     
                                                            

Cash equivalents and marketable fixed- income securities

                   $ 8,305   
                        

 

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Foreign Exchange Risk

During 2010, 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 British Pounds, Euros, 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 2010, International segment revenues decreased $107 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, 2010 of $3.4 billion, an assumed 5%, 10%, and 20% negative currency movement would result in fair value declines of $172 million, $345 million, and $689 million. All investments are classified as “available for sale.” 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 various foreign currencies. Based on the intercompany balances at December 31, 2010, an assumed 5%, 10%, and 20% adverse change to foreign currency exchange rates would result in losses of $40 million, $90 million, and $195 million, recorded to “Other income (expense), net.”

See Item 7 of Part II, “Effect of Exchange Rates,” for additional information on the effect on reported results of changes in exchange rates.

Investment Risk

As of December 31, 2010, our recorded basis in equity investments was $279 million. These investments primarily relate to equity-method investments in private companies. We review our investments for impairment when events and circumstances indicate that the decline in fair value of such assets below the carrying value is other-than-temporary. Our analysis includes review of recent operating results and trends, recent sales or acquisitions of the investee securities, and other publicly available data. The current global economic climate provides additional uncertainty. Valuations of private companies are inherently more difficult due to the lack of readily available market data. As such, we believe that market sensitivities are not practicable.

 

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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

     36   

Consolidated Statements of Cash Flows

     37   

Consolidated Statements of Operations

     38   

Consolidated Balance Sheets

     39   

Consolidated Statements of Stockholders’ Equity

     40   

Notes to Consolidated Financial Statements

     41   

 

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

The Board of Directors and Shareholders

Amazon.com, Inc.

We have audited the accompanying consolidated balance sheets of Amazon.com, Inc. as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements 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, 2010 and 2009, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Amazon.com, Inc.’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated January 27, 2011 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Seattle, Washington

January 27, 2011

 

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AMAZON.COM, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions)

 

     Year Ended December 31,  
     2010     2009     2008  

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

   $ 3,444      $ 2,769      $ 2,539   

OPERATING ACTIVITIES:

      

Net income

     1,152        902        645   

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

     568        378        287   

Stock-based compensation

     424        341        275   

Other operating expense (income), net

     106        103        (24

Losses (gains) on sales of marketable securities, net

     (2     (4     (2

Other expense (income), net

     (79     (15     (34

Deferred income taxes

     4        81        (5

Excess tax benefits from stock-based compensation

     (259     (105     (159

Changes in operating assets and liabilities:

      

Inventories

     (1,019     (531     (232

Accounts receivable, net and other

     (295     (481     (218

Accounts payable

     2,373        1,859        812   

Accrued expenses and other

     740        300        247   

Additions to unearned revenue

     687        1,054        449   

Amortization of previously unearned revenue

     (905     (589     (344
                        

Net cash provided by (used in) operating activities

     3,495        3,293        1,697   

INVESTING ACTIVITIES:

      

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

     (979     (373     (333

Acquisitions, net of cash acquired, and other

     (352     (40     (494

Sales and maturities of marketable securities and other investments

     4,250        1,966        1,305   

Purchases of marketable securities and other investments

     (6,279     (3,890     (1,677
                        

Net cash provided by (used in) investing activities

     (3,360     (2,337     (1,199

FINANCING ACTIVITIES:

      

Excess tax benefits from stock-based compensation

     259        105        159   

Common stock repurchased

     —          —          (100

Proceeds from long-term debt and other

     143        87        98   

Repayments of long-term debt and of capital and financing leases

     (221     (472     (355
                        

Net cash provided by (used in) financing activities

     181        (280     (198

Foreign-currency effect on cash and cash equivalents

     17        (1     (70
                        

Net increase in cash and cash equivalents

     333        675        230   
                        

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 3,777      $ 3,444      $ 2,769   
                        

SUPPLEMENTAL CASH FLOW INFORMATION:

      

Cash paid for interest

   $ 11      $ 32      $ 64   

Cash paid for income taxes

     75        48        53   

Fixed assets acquired under capital leases

     405        147        148   

Fixed assets acquired under build-to-suit leases

     172        188        72   

Conversion of debt

     —          —          605   

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,  
     2010     2009     2008  

Net sales

   $ 34,204      $ 24,509      $ 19,166   

Operating expenses (1):

      

Cost of sales

     26,561        18,978        14,896   

Fulfillment

     2,898        2,052        1,658   

Marketing

     1,029        680        482   

Technology and content

     1,734        1,240        1,033   

General and administrative

     470        328        279   

Other operating expense (income), net

     106        102        (24
                        

Total operating expenses

     32,798        23,380        18,324   
                        

Income from operations

     1,406        1,129        842   

Interest income

     51        37        83   

Interest expense

     (39     (34     (71

Other income (expense), net

     79        29        47   
                        

Total non-operating income (expense)

     91        32        59   
                        

Income before income taxes

     1,497        1,161        901   

Provision for income taxes

     (352     (253     (247

Equity-method investment activity, net of tax

     7        (6     (9
                        

Net income

   $ 1,152      $ 902      $ 645   
                        

Basic earnings per share

   $ 2.58      $ 2.08      $ 1.52   
                        

Diluted earnings per share

   $ 2.53      $ 2.04      $ 1.49   
                        

Weighted average shares used in computation of earnings per share:

      

Basic

     447        433        423   
                        

Diluted

     456        442        432   
                        

 

      

(1)    Includes stock-based compensation as follows:

      

Fulfillment

   $ 90      $ 79      $ 61   

Marketing

     27        20        13   

Technology and content

     223        182        151   

General and administrative

     84        60        50   

 

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,  
     2010     2009  
A S S E T S     

Current assets:

    

Cash and cash equivalents

   $ 3,777      $ 3,444   

Marketable securities

     4,985        2,922   

Inventories

     3,202        2,171   

Accounts receivable, net and other

     1,587        988   

Deferred tax assets

     196        272   
                

Total current assets

     13,747        9,797   

Fixed assets, net

     2,414        1,290   

Deferred tax assets

     22        18   

Goodwill

     1,349        1,234   

Other assets

     1,265        1,474   
                

Total assets

   $ 18,797      $ 13,813   
                
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

   $ 8,051      $ 5,605   

Accrued expenses and other

     2,321        1,759   
                

Total current liabilities

     10,372        7,364   

Long-term liabilities

     1,561        1,192   

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—468 and 461

    

Outstanding shares—451 and 444

     5        5   

Treasury stock, at cost

     (600     (600

Additional paid-in capital

     6,325        5,736   

Accumulated other comprehensive income (loss)

     (190     (56

Retained earnings

     1,324        172   
                

Total stockholders’ equity

     6,864        5,257   
                

Total liabilities and stockholders’ equity

   $ 18,797      $ 13,813   
                

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)
    Retained
Earnings
(Accumulated
Deficit)
    Total
Stockholders’
Equity
 
    Shares     Amount            

Balance at December 31, 2007

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

Net income

    —          —          —          —            645        645   

Foreign currency translation losses, net of tax

    —          —          —          —          (127     —          (127

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

    —          —          —          —          (1     —          (1
                   

Comprehensive income

    —          —          —          —          —          —          517   
                   

Unrecognized excess tax benefits from stock-based compensation

    —          —          —          (8     —          —          (8

Exercise of common stock options and conversion of debt

    14        —            624        —          —          624   

Repurchase of common stock

    (2     —          (100       —          —          (100

Excess tax benefits from stock-based compensation

    —          —          —          154        —          —          154   

Stock-based compensation and issuance of employee benefit plan stock

    —          —          —          288        —          —          288   
                                                       

Balance at December 31, 2008

    428        4        (600     4,121        (123     (730     2,672   

Net income

    —          —          —          —          —          902        902   

Foreign currency translation gains net of tax

    —          —          —          —          62        —          62   

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

    —          —          —          —          4        —          4   

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

    —          —          —          —          1        —          1   
                   

Comprehensive income

                969   
                   

Exercise of common stock options

    7        —          —          19        —          —          19   

Issuance of common stock for acquisition activity

    9        1        —          1,144        —          —          1,145   

Excess tax benefits from stock-based compensation

    —          —          —          103        —          —          103   

Stock-based compensation and issuance of employee benefit plan stock

    —          —          —          349        —          —          349   
                                                       

Balance at December 31, 2009

    444        5        (600     5,736        (56     172        5,257   

Net income

    —          —          —          —          —          1,152        1,152   

Foreign currency translation gains net of tax

    —          —          —          —          (137     —          (137

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

    —          —          —          —          3        —          3   
                   

Comprehensive income

                1,018   
                   

Exercise of common stock options

    7        —          —          16        —          —          16   

Excess tax benefits from stock-based compensation

    —          —          —          145        —          —          145   

Stock-based compensation and issuance of employee benefit plan stock

    —          —          —          428        —          —          428   
                                                       

Balance at December 31, 2010

    451      $ 5      $ (600   $ 6,325      $ (190   $ 1,324      $ 6,864   
                                                       

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 opened its virtual doors on the World Wide Web in July 1995 and offers Earth’s Biggest Selection. We seek to be Earth’s most customer-centric company for three primary customer sets: consumers, sellers, and enterprises. We serve consumers through our retail websites and focus on selection, price, and convenience. We also manufacture and sell the Kindle e-reader. We offer programs that enable sellers to sell their products on our websites and their own branded websites and to fulfill orders through us. We serve developers and enterprises of all sizes through Amazon Web Services (“AWS”), which provides access to technology infrastructure that enables virtually any type of business. In addition, we generate revenue through other marketing and promotional services, such as online advertising, and co-branded credit card agreements.

We have organized our operations into two principal segments: North America and International. See “Note 10—Segment Information.”

Principles of Consolidation

The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, and those entities in which we have a variable interest and are the primary beneficiary. Intercompany balances and transactions have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent liabilities in the consolidated financial statements and accompanying notes. Estimates are used for, but not limited to, determining the selling price of products and services in multiple element revenue arrangements and determining the lives of these elements, incentive discount offers, sales returns, vendor funding, stock-based compensation, income taxes, valuation of investments and inventory, collectability of receivables, valuation of acquired intangibles and goodwill, depreciable lives of fixed assets and internally-developed software, 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.

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

 

     Year Ended December 31,  
       2010          2009          2008    

Shares used in computation of basic earnings per share

     447         433         423   

Total dilutive effect of outstanding stock awards (1)

     9         9         9   
                          

Shares used in computation of diluted earnings per share

     456         442         432   
                          

 

(1) Calculated using the treasury stock method, which assumes proceeds are used to reduce the dilutive effect of outstanding stock awards. Assumed proceeds include the unrecognized deferred compensation of stock awards, and assumed tax proceeds from excess stock-based compensation deductions.

 

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Cash and Cash Equivalents

We classify all highly liquid instruments with an original maturity of three months or less at the time of purchase as cash equivalents.

Inventories

Inventories, consisting of products available for sale, are accounted for using primarily 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.

We provide fulfillment-related services in connection with certain of our sellers’ programs. Third party sellers maintain ownership of their inventory, regardless of whether fulfillment is provided by us or the third party sellers, and therefore these products are not included in our inventories.

Accounts Receivable, Net, and Other

Included in “Accounts receivable, net, and other” on our consolidated balance sheets are amounts primarily related to vendor and customer receivables. At December 31, 2010 and 2009, vendor receivables, net, were $763 million and $495 million, and customer receivables, net, were $561 million and $341 million.

Allowance for Doubtful Accounts

We estimate losses on receivables based on known troubled accounts and historical experience of losses incurred. The allowance for doubtful customer and vendor receivables was $72 million and $72 million at December 31, 2010 and 2009.

Internal-use Software and Website Development

Costs incurred to develop software for internal use and our websites are capitalized and amortized over the estimated useful life of the software. Costs related to design or maintenance of internal-use software and website development are expensed as incurred. For the years ended 2010, 2009, and 2008, we capitalized $213 million (including $38 million of stock-based compensation), $187 million (including $35 million of stock-based compensation), and $187 million (including $27 million of stock-based compensation) of costs associated with internal-use software and website development. Amortization of previously capitalized amounts was $184 million, $172 million, and $143 million for 2010, 2009, and 2008.

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 for assets such as internal-use software, three years for our technology infrastructure, five years for furniture and fixtures, and ten years for heavy equipment). Depreciation expense is classified within the corresponding operating expense categories on our consolidated statements of operations.

Leases and Asset Retirement Obligations

We categorize leases at their inception as either operating or capital leases. 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 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

 

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agreement. Leasehold improvements are capitalized at cost and amortized over the lesser of their expected useful life or the non-cancellable term of the lease.

We establish assets and liabilities for the estimated construction costs incurred under build-to-suit lease arrangements to the extent we are involved in the construction of structural improvements or take construction risk prior to commencement of a lease. Upon occupancy of facilities under build-to-suit leases, we assess whether these arrangements qualify for sales recognition under the sale-leaseback accounting guidance. If we continue to be the deemed owner, the facilities are accounted for as financing leases.

We establish assets and liabilities for the present value of estimated future costs to retire long-lived assets at the termination or expiration of a lease. Such assets are depreciated over the lease period into operating expense, and the recorded liabilities are accreted to the future value of the estimated retirement costs.

Goodwill

We evaluate goodwill for impairment annually or more frequently when an event occurs or circumstances change that indicate that the carrying value may not be recoverable. We test goodwill for impairment by first comparing the book value of net assets to the fair value of the reporting units. If the fair value is determined to be less than the book value, a second step is performed to compute the amount of impairment as the difference between the estimated fair value of goodwill and the carrying value. We estimate the fair value of the reporting units using discounted cash flows. Forecasts of future cash flows are based on our best estimate of future net sales and operating expenses, based primarily on estimated category expansion, pricing, market segment share and general economic conditions.

We conduct our annual impairment test as of October 1 of each year, and have determined there to be no impairment for any of the periods presented. There were no events or circumstances from the date of our assessment through December 31, 2010 that would impact this conclusion.

See “Note 4—Acquisitions, Goodwill, and Acquired Intangible Assets.”

Other Assets

Included in “Other assets” on our consolidated balance sheets are amounts primarily related to marketable securities restricted for longer than one year, the majority of which are attributable to collateralization of bank guarantees and debt related to our international operations; acquired intangible assets, net of amortization; deferred costs; certain equity investments; and intellectual property rights, net of amortization.

Investments

We generally invest our excess cash in investment grade short- to intermediate-term fixed income securities and AAA-rated money market funds. Such investments are included in “Cash and cash equivalents,” or “Marketable securities” on the accompanying consolidated balance sheets, classified as available-for-sale, and reported at fair value with unrealized gains and losses included in “Accumulated other comprehensive income (loss).”

Equity 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. The total of these investments in equity-method investees, including identifiable intangible assets, deferred tax liabilities and goodwill, is classified on our consolidated balance sheets as “Other assets.” Our share of the investees’ earnings or losses, amortization of the related intangible assets, and related gains or losses, if any, are classified as “Equity-method investment activity, net of tax” on our consolidated statements of operations.

Equity investments without readily determinable fair values for which we do not have the ability to exercise significant influence are accounted for using the cost method of accounting and classified as “Other assets” on

 

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our consolidated balance sheets. Under the cost method, investments are carried at cost and are adjusted only for other-than-temporary declines in fair value, certain distributions, and additional investments.

Equity investments that have readily determinable fair values are classified as available-for-sale and included in “Marketable securities” in our consolidated balance sheet and are recorded at fair value with unrealized gains and losses, net of tax, included in “Accumulated other comprehensive loss.”

We periodically evaluate whether declines in fair values of our investments below their book value 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. Additionally, we assess whether we have plans to sell the security or it is more likely than not we will be required to sell any investment before recovery of its amortized cost basis. Factors considered include quoted market prices; recent financial results and operating trends; implied values from any recent transactions or offers of investee securities; credit quality of debt instrument issuers; other publicly available information that may affect the value of our investments; duration and severity of the decline in value; and our strategy and intentions for holding the investment.

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 when 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, 2010 or 2009.

Accrued Expenses and Other

Included in “Accrued expenses and other” at December 31, 2010 and 2009 were liabilities of $503 million and $347 million for unredeemed gift certificates. We reduce the liability for a gift certificate when it is applied to an order. 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 the 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 “Long-term liabilities” on our consolidated balance sheets. Current unearned revenue was $461 million and $511 million at December 31, 2010 and 2009. Non-current unearned revenue was $34 million and $201 million at December 31, 2010 and 2009.

Income Taxes

Income tax expense includes U.S. and international income taxes. Except as required under U.S. tax law, we do not provide for U.S. taxes on our undistributed earnings of foreign subsidiaries that have not been previously taxed since we intend to invest such undistributed earnings indefinitely outside of the U.S. Undistributed

 

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earnings of foreign subsidiaries that are indefinitely invested outside of the U.S were $1.6 billion at December 31, 2010. Determination of the unrecognized deferred tax liability that would be incurred if such amounts were repatriated is not practicable.

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.

Deferred tax assets are 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 and capital gains by taxing jurisdiction, the carry-forward periods available to us for tax reporting purposes, and other relevant factors. We allocate our valuation allowance to current and long-term deferred tax assets on a pro-rata basis.

We utilize a two-step approach to recognizing and measuring uncertain tax positions (tax contingencies). 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. 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. We include interest and penalties related to our tax contingencies in income tax expense.

Fair Value of Financial Instruments

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. To increase the comparability of fair value measures, the following hierarchy prioritizes the inputs to valuation methodologies used to measure fair value:

Level 1—Valuations based on quoted prices for identical assets and liabilities in active markets.

Level 2—Valuations based on observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

Level 3—Valuations based on unobservable inputs reflecting our own assumptions, consistent with reasonably available assumptions made by other market participants. These valuations require significant judgment.

We measure the fair value of money market funds and equity securities based on quoted prices in active markets for identical assets or liabilities. All other financial instruments were valued based on quoted market prices of similar instruments and other significant inputs derived from or corroborated by observable market data.

Revenue

We recognize revenue from product sales or services rendered when the following four 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 collectability is reasonably assured. Revenue arrangements with multiple deliverables are divided into separate units and revenue is allocated using estimated selling prices if we do not have vendor-specific objective evidence or third-party evidence of the selling prices of the deliverables. Also, see “Recent Accounting Pronouncements” below.

 

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We evaluate 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 at the gross sales price. If we are not primarily obligated, and do not have latitude in establishing prices, 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 and consumption 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.

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 other seller sites are recognized when items are sold by sellers and our collectability 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.” Outbound shipping-related costs are included in “Cost of sales.”

Cost of Sales

Cost of sales consists of the purchase price of consumer products and content sold by us, inbound and outbound shipping charges, and packaging supplies. Shipping charges to receive products from our suppliers are included in inventory cost, 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 consider amounts received from our vendors as a reduction of the prices we pay for their products and, therefore, record such amounts as a reduction of the cost of inventory we buy from them. 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.

 

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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.

Marketing

Marketing costs consist primarily of targeted online advertising, television advertising, public relations expenditures; and payroll and related expenses for personnel engaged in marketing, business development, and selling activities. 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.

Advertising and other promotional costs, are expensed as incurred, and were $890 million, $593 million, and $420 million in 2010, 2009, and 2008. Prepaid advertising costs were not significant at December 31, 2010 and 2009.

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 used internally and supporting AWS.

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 applications 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

Compensation cost for all stock-based awards expected to vest is measured at fair value on the date of grant and recognized over the service period. The fair value of 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 employee class, economic environment, and historical experience.

Other Operating Expense (Income), Net

Other operating expense (income), net, consists primarily of intangible asset amortization expense, expenses related to legal settlements, and certain gains and losses on the sale of assets.

 

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Other Income (Expense), Net