Amazon.com 2005 Annual Report Download - page 33

fulfillment center optimization, seasonality, the degree to which the Company enters into, maintains, and
develops commercial agreements, acquisitions, and strategic transactions, risks of inventory management, and
risks of fulfillment throughput and productivity. These risks and uncertainties, as well as other risks and
uncertainties that could cause our actual results to differ significantly from management’s expectations, are
described in greater detail in Item 1A. of Part I, “Risk Factors,” which, along with the previous discussion,
describes some, but not all, of the factors that could cause actual results to differ significantly from
management’s expectations.
Overview
Our primary source of revenue is the sale of a wide range of products and services to customers.The
products offered on our websites include products we have purchased from distributors, publishers, and
manufacturers and products offered by third parties on our websites. Generally, we recognize gross revenue from
items we sell from our inventory and recognize our net share of revenue of items sold by third parties. We offer
services such as Amazon Enterprise Solutions, co-branded credit cards, and miscellaneous marketing and
promotional offers.
Our financial focus is on long-term, sustainable growth in free cash flow1.Free cash flow is driven
primarily by increasing operating income and efficiently managing working capital and capital expenditures.
Increases in operating income result from increases in sales through our websites and a focus on keeping our
operating costs low, offset by investments we make in longer-term strategic initiatives including hiring additional
software engineers and computer scientists. To increase sales, we focus on improving all aspects of the customer
experience, including lowering prices, improving availability, offering faster delivery times, increasing selection,
expanding product information, improving ease of use, and earning customer trust. We generally focus on gross
profit and operating profit dollars rather than margin percentages. Because we have deferred tax assets from net
operating loss carryforwards, the free cash flow impact from income taxes paid is less than our income tax
provision.
We also seek to efficiently manage shareholder dilution while maintaining the flexibility to issue shares for
strategic purposes, such as financings and aligning employee interests with shareholders’. We moved to restricted
stock units as our primary vehicle for equity compensation in late 2002 because we believe they better align the
interests of our shareholders and employees. Restricted stock units result in charges to our income statement
based on the fair value of the awards at the grant date recorded over the underlying service periods, net of
estimated cancellations. Total shares outstanding plus outstanding stock awards were 438 million at
December 31, 2005, compared with 434 million at December 31, 2004 and 433 million at December 31, 2003.
These totals include all stock awards outstanding, without regard for estimated forfeitures, consisting of vested
and unvested awards, and in-the-money and out-of-the-money stock options.
We seek to reduce our customer experience variable costs per unit and work to leverage our customer
experience fixed costs. Our customer experience variable costs include product costs, payment processing and
related transaction costs, picking, packaging, and preparing orders for shipment, transportation, customer service
support, and most aspects of our marketing costs. Our customer experience fixed costs include the costs
necessary to build, enhance, and add features to our websites and build and optimize our fulfillment centers.
Variable costs generally change directly with sales volume, while fixed costs generally increase depending on the
timing of capacity needs, geographic expansion, and other factors. To decrease our variable costs on a per unit
basis and enable us to lower prices for customers, we seek to increase our direct to publisher and manufacturer
sourcing, maximize discounts available to us from suppliers and reduce defects in our processes. To minimize
growth in fixed costs, we seek to improve process efficiencies and maintain a lean culture.
1Free 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.
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