Amazon.com Q4 2007 Earnings Call Transcript

Amazon.com, Inc. (NASDAQ:AMZN) Q4 2007 Earnings Call January 30, 2008 5:00 PM ET

Executives

Rob Eldridge - Vice President, Investor Relations

Thomas J. Szkutak - Chief Financial Officer, Senior Vice President

Jeffrey P. Bezos - Chairman of the Board, President, Chief Executive Officer

Analysts

Brian Pitz - Banc of America

Heath Terry - Credit Suisse

Scott Devitt - Stifel Nicolaus

Mark Mahaney - Citigroup

David Joseph - Morgan Stanley

Jeetil Patel - Deutsche Bank

Robert Peck - Bear Stearns

Imran Khan - J.P. Morgan

Jennifer Watson - Goldman Sachs

Doug Anmuth - Lehman Brothers

Justin Post - Merrill Lynch

Aaron Kessler - Piper Jaffray

Operator

Good day, everyone and welcome to the Amazon.com fourth quarter 2007 financial results teleconference. (Operator Instructions) For opening remarks, I’ll turn the conference over to the Vice President of Investor Relations, Mr. Rob Eldridge. Please go ahead, sir.

Rob Eldridge

Hello and welcome to our Q407 financial results conference call. Joining us today is Tom Szkutak, our CFO. Jeff Bezos, our founder and CEO, and Tom will both be available for Q&A.

The following discussion and responses to your questions reflect management’s views as of today, January 30, 2008 only and will include forward-looking statements. Actual results may differ materially.

Additional information about factors that could potentially impact our financial results is included in today’s press release and our filings with the SEC, including our 2006 annual report on Form 10-K.

As you listen to today’s call, we encourage you to have our press release in front of you, which includes our financial results as well as metrics and commentary on the quarter.

During this call, we will discuss certain non-GAAP financial measures. In our press release, slides accompanying this webcast and our filings with the SEC, each of which is posted on our IR website, you will find additional disclosures regarding these non-GAAP measures, including reconciliations of these measures with comparable GAAP measures.

Finally, unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2006.

Now I’ll turn the call over to Tom.

Thomas J. Szkutak

Thanks, Rob. This was another successful year for Amazon.com. Let me start by reviewing 2007 financial results.

Free cash flow grew 143% to $1.18 billion. The combination of common stock and stock-based awards outstanding was 435 million shares compared with 436 million shares.

Return on invested capital was 55%, up from 28%. ROIC is TTM free cash flow divided by average total assets minus current liabilities over five quarter ends.

Revenue grew 39% to $14.84 billion, or 35% excluding the $399 million favorable impact from year-over-year changes in foreign exchange rates. This was our fastest annual growth rate since 2000.

North America revenue grew 38% to $8.1 billion and international grew 39% to $6.74 billion. 31% year over year, excluding the year-over-year changes in FX. Additionally, EGM revenue surpassed $3 billion in North America and $2 billion in international for the first time.

Consolidated segment operating income, or CSOI, grew 70% to $849 million, or 64% excluding $29 million of favorable year over year impact from foreign exchange and operating margin increased 105 basis points to 5.7%.

GAAP operating income grew 69% to $655 million, or 4.4% of net sales.

Now I’ll discuss the fourth quarter. Worldwide revenue grew 42% to $5.67 billion, or 37% excluding the $195 million favorable impact from year-over-year changes in foreign exchange rates.

Media revenue increased to $3.33 billion, up 33% or 28% excluding FX. EGM revenue increased to $2.21 billion, up 58% or 54% excluding FX. Worldwide EGM increased to 39% of worldwide sales, up from 35%. Worldwide unit growth was 33%.

Active customer accounts exceeded 76 million, up 19%. Worldwide active seller accounts were approximately 1.3 million, up 15%. Seller units were 26% of total units versus 25%.

Worldwide gross profit was $1.17 billion, up 38%. Gross margin decreased 70 basis points to 20.6%, primarily due to lowering prices for customers and change in product mix, partially offset by increases in our seller business.

Now I’ll discuss operating expenses excluding stock-based compensation. Fulfillment marketing, tech and content and G&A combined was $842 million, or 14.8% of sales, an improvement of 75 basis points year over year. Tech and content was $190 million, or 3.4% of revenue compared with 4.1%.

Now I’ll talk about our segment results and consistent with prior periods, we do not allocate to segments our stock-based compensation or other operating expense line item.

In the North America segment, revenue grew 40% to $3.08 billion, outpacing last year’s Q4 growth of 31%. Media revenue grew 31% to $1.64 billion, where we saw increases in all categories.

EGM revenue grew 53% to $1.34 billion, representing 43% of North America revenues, up from 40%. We saw another quarter of strong sales in electronics, toys and baby, soft goods, which includes jewelry, apparel, shoes, and sporting goods.

North America gross profit grew 31% to $698 million, and gross margin decreased 143 basis points to 22.6%, driven by lower prices for our customers and changes in product mix.

North America segment operating income increased 25% to $153 million, a 5% operating margin.

In the international segment, revenue grew 46% to $2.59 billion. Revenue growth was 35% adjusting for the $188 million year-over-year favorable FX impact during the quarter.

Media revenue grew 36% to $1.69 billion, or 26% excluding FX, and EGM revenue grew 68% to $877 million, or 55% excluding FX. This was the fastest growth rate for international EGM in more than two years. EGM now represents 34% of international revenues, up from 29%.

International gross profit grew 48% to $472 million, or grew 37% excluding foreign exchange rates, while gross margin increased 32 basis points to 18.2%, reflecting an increase in sales of products by sellers, partially offset by lower end prices to customers, including free shipping and changes in product mix.

International segment operating income increased 65% to $175 million, a 6.8% operating margin. Excluding the favorable impact from foreign exchange rates, international operating income increased 49%. CSOI grew 44% to $328 million, or 5.8% of revenue, up six basis points.

The year-ago quarter included an $8 million insurance recovery benefit in G&A. Excluding this benefit, CSOI for the quarter would have grown 49% and been up 26 basis points.

Unlike CSOI, our GAAP operating income includes stock-based compensation and other operating expense.

GAAP operating income grew 38% to $271 million, or 4.8% of net sales.

Our income tax expense was $74 million in Q4, or a 26% rate for the quarter, which includes a $4 million benefit adjusted to reflect our annual effective tax rate of 28%. In 2007, we paid $24 million in cash taxes. The majority of our tax expense is non-cash because we have current tax benefits and NOLs related to excess stock-based compensation.

We expect our effective tax rate in 2008 to be approximately 30% and we estimate cash taxes paid to be less than $75 million. However, there is potential for significant volatility due to several factors, including variability in accurately predicting the amount and mix of taxable income by jurisdiction and business acquisitions or investments.

We are endeavoring to optimize our global taxes on a cash paid basis, not for tax expense on a financial reporting basis.

GAAP net income was $207 million, or $0.48 per diluted share, compared with $98 million and $0.23 per diluted share.

Turning to the balance sheet, cash and marketable securities increased $1.2 billion to $3.31 billion. In Q107, we repurchases $248 million of our common stock, or 6 million shares.

Inventory increased 27% to $1.2 billion and inventory turns were flat at 12.7, even as we expanded selection, improved in-stock levels across product categories and geographies, and introduced new product categories.

Our investment in net fixed assets increased $86 million from a year ago to $543 million. Our 2007 capital expenditures were $224 million.

I’ll conclude my portion of today’s call with guidance. Incorporated into our guidance are the order trends that we’ve seen to date and what we believe today to be appropriately conservative assumptions.

However, there is a high level of uncertainty surrounding exchange rate fluctuations, as well as the global economy and consumer spending. It is not possible to accurately predict demand and therefore our actual results could differ materially from our guidance.

As we describe in more detail in our public filings, issues such as marking our Euro-denominated debt to market quarterly, inter-company balances and foreign currencies that settle amongst subsidiaries, unfavorable resolution of legal matters and changes to our effective tax rates can all have a material effect on guidance.

Our guidance assumes that we don’t record any additional intangibles, any further revisions to stock-based compensation, or our restructuring related estimates, and that foreign exchange rates remain approximately where they’ve been recently.

For Q1, we expect net sales of between $3.95 billion and $4.15 billion, a growth of between 31% and 38%. This guidance anticipates approximately 500 basis points of positive impact of foreign exchange.

GAAP operating income to be between $155 million and $200 million, or between 7% growth and 38% growth. This includes approximately $55 million for stock-based compensation and amortization of intangible assets.

We anticipate consolidated segment income, which excludes stock-based compensation and other operating expense to be between $210 million and $255 million, or between 17% growth and 42% growth.

For calendar 2008, we expect net sales of between $18.75 billion and $19.75 billion, a growth of between 26% and 33%. This guidance anticipates greater than 200 basis points of positive impact from foreign exchange.

GAAP operating income to be between $785 million and $985 million, or between 20% growth and 50% growth. This includes approximately $240 million for stock-based compensation and amortization of intangible assets. We anticipate 2008 consolidated segment operating income, which excludes stock-based compensation and other operating expense to be between $1.025 billion and $1.225 billion, or between 21% growth and 44% growth.

We intend to continue to get operating leverage during 2008 with CSOI growing faster than revenue on a percentage basis.

We anticipate our free cash flow growth rate to trend similar to our operating profit growth rate over time, with some variability, including some changes in working capital and excess tax benefits from stock-based compensation.

We expect capital expenditures, including capitalized software development costs, to be approximately $300 million.

We will continue to strive for year-over-year annual growth in free cash flow and free cash flow per share while investing in our long-term opportunities. We are confident that if we continue to improve customer experience and execute efficiently, our value proposition as well as our free cash flow will expand.

Thanks, and with that, Rob, let’s move to questions.

Rob Eldridge

Great. Thanks, Tom. Let’s move on to the Q&A portion of the call with Jeff and Tom. Operator, will you please remind our listeners how to initiate a question?

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go first to Brian Pitz with Banc of America.

Brian Pitz - Banc of America

I think the question on everyone’s mind is how should we begin to conceptualize the 20 basis points of margin expansion that’s at the midpoint of your guidance for 2008, despite a really significant year-over-year revenue increase? It would seem as if you should be able to drive somewhat better margins, given this type of growth. What’s driving this -- is it prime, higher overall cost of shipping? Any additional color would be really helpful. Thanks.

Thomas J. Szkutak

Sure. We’ve given a -- in terms of the guidance that we’ve given for the total year, you have a range certainly in terms of implied operating margins. If you take the low end of the guidance from a CSOI perspective and the high end, it’s a range of 5.5% to 6.2%, and that compares to 5.7% in 2007, so again it’s a range.

But certainly as you think about our business in 2008, you know, we are going to do more of the same that we did in 2007. We are going to make sure that we focus on the customer experience, which includes making sure that we have great prices across all of our categories and geographies, and you saw that reflected in our Q4 results. We are going to continue to make sure that we have increased selection, have great in-stock levels, so all of those things are included in the guidance that we’ve given.

And we are going obviously still continue to invest appropriately, which is reflected in the guidance.

The other aspect that you see, because you see an effect that’s essentially flat operating margins in Q4 and certainly one of the bigger drivers of that is the gross margin year-over-year decline. And with the great growth rate that we saw in Q4, when that happens, good things happen to us and what I mean by that, there’s an opportunity to go to and work with our supplier base, our vendors, to get even better prices. So that’s something that is certainly an opportunity for us and with the broad breadth of growth that we had across categories in all of our geographies, it’s clearly an opportunity for us.

Brian Pitz - Banc of America

Great, thanks.

Operator

We’ll take our next question from Heath Terry with Credit Suisse.

Heath Terry - Credit Suisse

Thank you. Just to follow-up on what Brian was asking, how does this affect and to what extent does it affect the long-term margin guidance that you’ve given of being able to get to 10% margins in the business?

And as you continue to take the incremental profit dollar that you are getting and file them into top line to drive growth, at what point do you allow some of that margin, or how do you think about timing, the allowance of some of that margin to actually flow to the bottom line? Or is this going to be an ongoing process and we see 6% forever?

Thomas J. Szkutak

In terms of our expectation, nothing has changed. What we’ve said in the past is we think that double-digit operating margins are possible but what we are really focused on is driving free cash flow and free cash flow per share, as you can see that evidence in our 2007 results, total year as well as Q4.

And so again, nothing has changed. We’ve also said that we think double-digits is possible but if a high-single-digit operating margin is the right thing to drive free cash flow, that’s what we’ll do.

So if you look at our Q4 results, and take a look at it, you saw very strong growth, you saw operating margins that were flat year over year but still strong operating profit growth, and then free cash flow was more than doubled year over year.

So again, we’re focused on driving free cash flow per share. It’s certainly our intention to improve operating leverage during 2008 and over time, we think that we can improve our operating margins as well.

Heath Terry - Credit Suisse

Great. Thank you.

Operator

We’ll take our next question from Scott Devitt with Stifel Nicolaus.

Scott Devitt - Stifel Nicolaus

Thank you. Just on this same subject, but a little bit more detailed -- the international gross margin in the quarter on a year-over-year basis was actually up, and so the decline was in the domestic margins, so there were a lot of moving parts in your gross margin numbers related to these volume price trade-offs that you talk about but also the product mix in the direct business and then the benefit from third-party sales.

So I was just wondering if you could talk about whether third-party mix is becoming a less relevant driver of gross margin in the domestic business and so possibly pricing decisions and the mix shift toward EGM and the direct business is maybe what’s pressuring the domestic gross margin? Thank you.

Thomas J. Szkutak

Our seller business globally is very strong. We are continuing to try to work on that experience for sellers to make it even better. Certainly our goal is to have sellers increase their sales on our platform and so we continue to do a number of different things to make it easier for them to sell, including FBA.

And so again, we are pleased with our seller business and -- I don’t know if that answers your question. Did you have a -- was there a second part?

Scott Devitt - Stifel Nicolaus

The second part is I’m just wondering how much the mix shift towards EGM, which I believe is lower margin than the historical BMV direct business, if that’s driving the domestic margins down a bit, the mix shift.

Thomas J. Szkutak

I would probably describe the margin structure more like this -- we have, and this is globally, we’ve entered into a lot of new categories over the past few years and when we enter those new categories, we’re pricing very competitively day one, making sure we upgrade prices for customers. And it takes us a while to get the scale in those individual categories in those geographies, so when that happens, certainly you should expect that very often times when we have a newer category, that those are lower gross margins and then, as we get the scale and those individual categories, good things happen. We get more traffic, which helps our third party business. It also helps us get better prices with our suppliers.

And so that’s one of the reasons why we are excited about what we have seen throughout the course of 2007 and in Q4, is that we’ve gotten great growth and now the opportunity that we have in front of us is how do we work better with, even more closely with suppliers to get better prices. And that’s something that’s not an immediate thing. It’s just something that evolves over time as we continue to grow, so it’s a good opportunity for us.

Operator

We’ll take our next question from Mark Mahaney with Citigroup.

Mark Mahaney - Citigroup

Thank you. Two questions -- first, a top line question; are you seeing any signs of consumer softness in spending? You organically showed revenue growth acceleration. It seemed to fly in the face of what most in-store retailers are seeing, obviously there’s secular growth on the Internet but are you seeing anything perhaps in the March quarter that indicates softness, or maybe a mix shift to lower priced products?

And then secondly, a quick question for you, Jeff; last quarter you said that you didn’t think R&D cycles going forward would have the same step function impact on margins that they had between ’04 and ’06. Is any of the ’08 guidance, is there an implication in there that there’s another major R&D cycle coming? Thank you.

Thomas J. Szkutak

Sure. In terms of the economic piece, as you can see from our results, our business is fine, so we really can’t add much in terms of the economic piece.

Jeffrey P. Bezos

And then to your second question, I think what you are referring to is that we’ve said over the last year or so that we expect to grow into the fixed expense that we very deliberately built in 2005 and the first part of 2006. And our intention at this point is to continue to demonstrate to ourselves this business model. So as Tom said, we intend to continue to get operating leverage during 2008 with CSOI growing faster than revenue on a percentage basis.

Thomas J. Szkutak

And along with that, as it relates to technology and content, we certainly would expect the technology and content growth to be somewhat less than revenue growth for 2008.

Jeffrey P. Bezos

And we believe we can do that, with respect to the step function part of your question, we believe we can do that while continuing to make investments in our digital businesses and Amazon Kindle, and new category expansion, continue to invest in China as we are doing, fulfillment by Amazon in our seller business. We have our Amazon web services business is another area of investment for us.

So when we look at -- that’s what we mean by not necessarily having to take the same kind of step function increase that you saw in 2005 and the first part of 2006.

Operator

We’ll take our next question from David Joseph with Morgan Stanley.

David Joseph - Morgan Stanley

Thank you for taking my question. It seems that you saw active customers accelerate again and active revenue per customer accelerate as well as units accelerate yet again 33% year over year, and our guess, our ongoing assumption is that a lot of this is coming through Amazon Prime, not only because that’s where you have free shipping but that’s also where one-click shopping is merchandised pretty effectively.

I’m just wondering if you can give us a little bit of color in terms of where this incremental growth is coming from, where the acquisition, where the activity is coming from. Is it really coming through Amazon Prime mainly or is there something else that we might be missing here?

Also, in terms of the Kindle, can you give us an idea of what we can be expecting from that in 2008? Not necessarily -- I mean, if you can provide any kind of information in terms of units or revenue growth but also what can we expect in terms of the margin? Should we expect some pressure to Amazon’s margins from the Kindle? Thank you.

Thomas J. Szkutak

The growth that we are seeing is broad-based. It’s coming from different geographies, different categories, different service offerings. So it’s not any one particular thing. Certainly Amazon Prime is a component of it. It continues to be a successful program.

One of the reasons that fulfillment by Amazon is an important program for our seller customers is that it drives -- the number one thing that sellers want is sales and fulfillment by Amazon drives sales for sellers, so when a seller switches to fulfillment by Amazon, their sales increase.

And one of the reasons for that is that those items, those third-party items immediately become eligible for Amazon Prime, so Prime members can use their Amazon Prime memberships to buy third-party items as soon as that seller joins fulfillment by Amazon. And we shipped half a million items in the fourth quarter on behalf of third-party sellers through fulfillment by Amazon, so we are very excited about that investment.

David Joseph - Morgan Stanley

Can you give us a little color on the Kindle?

Jeffrey P. Bezos

Yeah, Kindle is, in terms of demand, is outpacing our expectations, which is certainly something that we are very grateful for. It’s also on the manufacturing side causing us to scramble. We’re working very hard to increase the number of units that we can build and supply per week, so that we can get back -- our goal is to get into a situation as quickly as we can where when you order a Kindle, we ship it immediately. That’s the standard we want to hold ourselves to and we are working very hard to get there. We are super-excited by the very strong demand.

David Joseph - Morgan Stanley

Thank you.

Operator

We’ll take our next question from Jeetil Patel with Deutsche Bank.

Jeetil Patel - Deutsche Bank

Great. A couple of questions, guys; user and unit growth accelerated again. Can you just talk about how much of this improvement is being driven by I guess price elasticity that’s utilizing on your retail business versus newer services such as third party out there, or initiatives such as Prime?

And the second question on Kindle, it looks like there is a lot of internal components from a build standpoint. It seems to be quite rich from a feature set standpoint. Are there capabilities that have yet to be turned on beyond just the e-book reader and browser functionality inside the Kindle at this point?

Jeffrey P. Bezos

Well, the Kindle has a few experimental features that are -- some of which are visible on the Kindle. It has something call a Now-Now, where you can type in any question and using the Mechanical Turk in the background, which is one of our web services, that question gets answered and the answer to the question gets displayed on the Kindle.

There is an experimental web browser on the Kindle, which is actually, for a mobile device, a pretty good web browser, and of course is has the Whisper Net EVDO connectivity, which gives you broadband wireless access to that web browser.

So there are a number of experimental features and we’ve put those on there and made them accessible to customers so that these early Kindle users can tell us what they think of those features, whether we should continue to invest in them, continue to work on them and make them part of the product.

Thomas J. Szkutak

In terms of the first part of your question related to the growth in units, as I had mentioned, the third party or the seller percentage grew year over year, so seller units were growing at a faster rate. And that goes back to some of the comments Jeff just made a minute ago about what we are doing to improve the seller experience.

And then on the retail side, it’s a lot of the things that we’ve been talking about. It’s -- again, the focus areas are value proposition, making sure we have great prices for customers, selection, convenience, and in-stock levels.

Jeetil Patel - Deutsche Bank

Do you think it’s actually the retail business and your pricing that’s helping to accelerate the unit growth and user growth? Or do you think it is more on the third party selection side?

Thomas J. Szkutak

Well again, both are very strong and certainly pricing is a key, but there’s a lot of other key factors, including Prime, where customers are getting an increased share of wallet, and a number of different factors. The fact that some customers come to our website now, more is in stock than it was 12 months ago or 24 months ago. So when that happens, certainly there’s a benefit from doing that, as well as a lot of the other things that we talked about.

So it’s selection --

Jeffrey P. Bezos

It’s selection expansion.

Thomas J. Szkutak

Selection expansion, exactly. So it’s very -- it’s a lot of the things that we’ve been talking about really over the past several years but we have continued to be focused on them and it’s showing up in our top line.

Jeetil Patel - Deutsche Bank

If I may ask just a quick follow-up, I guess the longer term theme at Amazon has been that you would use price as a way to drive growth in the business and the idea was that you could always lower price because of the cost advantages that you have and the efficiencies that you are getting from economies of scale.

Are you at a point now vis-à-vis retail that you can drive prices lower and it’s helping to accelerate the growth and you can always use that lever to control the growth of your overall business as a whole? Or do you think it’s still going to take maybe a couple more years to have that type of capability relative to I guess the retail formula, which is prices will tend to go higher in general because of the inflationary aspect of retail and real estate?

Jeffrey P. Bezos

I’m not sure if this directly answers your question or not -- I think it does but one of the things that’s clearly the case and we’ve observed it over a number of years now is that in certain categories, we are seeing less elasticity from price reductions and that’s something that you would expect to see happen because there’s -- price elasticity curves are not linear. There’s a kind of an elbow in the curve right around where competitive prices are, so you see a lot of elasticity as you lower prices to meet competitive pricing and you don’t see very much elasticity if you go below competitive pricing.

So our focus has always been to be extremely competitive and to get really operationally great at that, so that our pricing is very, very sharp and we are always giving customers the best possible deal.

And at the same time, because we have the scale to have a very efficient cost structure, to be able to do that in a sustainable way that’s healthy for the business. And you can have a very nice fly wheel there where the scale of the company increases, which allows us to be more efficient, to make better use of both our fixed costs and to do more to drive down variable costs, including as Tom mentioned in some of our newer categories where we haven’t been operating as long, we’re still getting to know the vendors in those categories, getting to know our suppliers, figuring out how to work most efficiently with them and we’ll continue to do that.

So there are big opportunities and for us, the way we look at this is lowering prices is easy -- being able to afford to lower prices is what’s difficult and we’ve been working on that for many, many years now and we expect to continue to work on it for our entire corporate existence.

And we know of lots of opportunities to improve our fixed costs, to improve our variable costs, and to improve our COGS through working together with our supplier base. And those opportunities exist in even our -- even the categories that we’ve been doing business in the longest. We still have opportunities in there.

In our newer categories, we have a lot of low-hanging fruit. There’s more obvious pieces just because they are newer and we haven’t done as much in those areas.

Jeetil Patel - Deutsche Bank

Crystal clear. Thanks.

Operator

We’ll go next to Robert Peck with Bear Stearns.

Robert Peck - Bear Stearns

Just a quick question, two parts, on guidance going forward -- eBay made some announcements the other day regarding changes to its platform, which is hoping to sort of bring back some of the third party sellers. Is your current guidance right now accounting for any sort of impact by eBay or do you think there will be any impact by eBay? And then I’ve got one follow-up.

Thomas J. Szkutak

We have a longstanding practice of not talking about any specific company but as it relates to our business, we have been and continue to be in a very competitive environment. And that’s both online and offline, and that’s not anything new. It’s something that we’ve been operating in for quite some time and the way we address that is we focus on the customer, and we have a number of different customers. We have certainly our direct customer that we are always trying to make sure we improve that experience. We have our sellers, which we view as partners and customers and we’re trying to improve that experience as well, and Jeff gave some great examples of that, as well as our developers.

And so we are kind of heads down, focused on improving customer experience and that’s what we have been doing and that’s what we plan on doing going forward?

Robert Peck - Bear Stearns

If you started to see an impact, would you think about reducing your take rate for third-party sellers?

Thomas J. Szkutak

I would just say that this is such an intensely competitive environment and it has been from the very beginning, and we have lots of competitors. So it’s -- for us, the way we think about our seller business, the business you are asking about, is we think of our sellers as a customer set. We try to figure out what they want and we try to figure out how to give it to them.

We know that the number one thing that sellers want is sales. We also know that these -- the market that we operate in, and we are very grateful for this fact, is a very, very large one and in our view, and we’ve always said this, and I don’t think it’s going to change, is that there’s room for lots of winners.

We have a strategy that we are very, very focused on. We’re not changing it. We like our strategy and we are just going to stay heads down. One of the great examples I can give you for trying to drive sales for sellers is the combination of fulfillment by Amazon and Amazon Prime.

I talked about this just a couple of minutes ago but it’s a very good combination for sellers and as sellers continue to sign up for fulfillment by Amazon and as our buyer customers continue to sign up for Amazon Prime, that combination is going to be very good for our buyer customers and it’s going to be very good for our seller customers as well, and we love that.

Robert Peck - Bear Stearns

Just a quick follow-up on guidance here. Could you talk a little bit about your Borders relationship and if your guidance in 2008 accounts for any change there?

Thomas J. Szkutak

Sure. The relationship that we have is reflected in the guidance for 2008.

Operator

We’ll take our next question from Imran Khan with J.P. Morgan.

Imran Khan - J.P. Morgan

Thank you for taking my questions. Two questions, number one; I was trying to get a better sense about what kind of adoption you are seeing for prime in the international market -- is it similar to U.S., better than U.S. or weaker than U.S.? Any color would be very helpful.

Secondly, international gross profit margin is still substantially lower than the U.S. gross profit margins. How should we think about that difference to narrow over time?

Thomas J. Szkutak

Sure. In terms of international prime, you know, it’s -- we are very excited with what we are seeing in each of the countries. It’s very early but we like what we see and we are going to continue to look at all the associated metrics for that program, but we are very pleased to be able to offer it to customers and we like what we see so far.

In terms of the gross margins, you are right that our gross margins in international are less than North America. Keep in mind that certainly our international segment has a number of different countries and again, there’s nothing really structurally different between the two segments, if you will, and so there’s really opportunities to improve those margins over time.

What we have said in the past is certainly our seller business, if you will, we are pleased with globally but we have certainly a bigger penetration in our North America segment than we do in international, so that’s an opportunity for us. It’s an opportunity in both segments, if you will, but certainly we’re pleased with what we see there.

Again, if you think about also in international, if you look back we’ve launched many new categories over the past year, the past few years and again it goes back to some of my comments at the start of the call. As those categories get larger and we get more traffic to those categories, it helps the third party business. It also helps from an opportunity to work closely with suppliers to get better, to work better with them to improve those prices as well.

So again, that’s the -- that’s certainly what we are working on and that’s what you are seeing in our results.

Imran Khan - J.P. Morgan

If I may ask a follow-up question about the category expansion, I think you talked about, as you continue to grow faster than the broader market, you will have better power with the seller suppliers in terms of improving your gross profit margins. As you continue to expand your category and some of the categories are lower margins than your core media business, do you think you can still maintain the kind of margins that you had in 2007 or 2006?

Jeffrey P. Bezos

We have a wide range of categories. When we enter a new category, we’re focused on first, is it something that we think we can serve customers well in, something that we can add a lot of value to customers, and also do we think we can generate a lot of free cash flow.

We certainly do look at a lot of different characteristics of those categories before entering them, but there certainly are categories, an example would be you know, the diamonds within the jewelry category. That’s something where you know it’s possible to have lower gross margins but have very high contribution profit per unit, for example.

So first we are optimizing for, from an investor standpoint, for free cash flow and free cash flow per share, and the way we do that is by improving the customer experience. So again, it’s a -- we’ve have a mix of different categories, some of which will have higher gross margins and lower gross margins, but our goal is again to maximize free cash flow per share over the long term.

Imran Khan - J.P. Morgan

Thank you.

Operator

We’ll go next to Jennifer Watson with Goldman Sachs.

Jennifer Watson - Goldman Sachs

Thank you. Can you give us some details on the order frequency of Prime users since the introduction of the service, and if incremental prime members are ordering as frequently as the early adopters?

Thomas J. Szkutak

There’s not a lot of data I can share with you except that certainly Prime customers are buying more and we are getting an increased share of wallet. They are buying in more categories, so there’s a lot of cross shopping that is going on and that’s something that we saw early on when we started Prime and it’s something we continue to see with existing and new customers.

Jennifer Watson - Goldman Sachs

Great, and can you give any sort of indication on renewal rates of prime memberships?

Thomas J. Szkutak

Other than it’s very good. We’re not disclosing numbers but the renewal rates are very good, very strong.

Jennifer Watson - Goldman Sachs

Thank you.

Operator

We’ll take our next question from Doug Anmuth with Lehman Brothers.

Doug Anmuth - Lehman Brothers

Thank you. I have two questions. First, can you tell us what is driving your projected 34% increase in CapEx spending in 2008 and how should we think about your free cash flow growth specifically this year?

And then secondly, it looks like you added 1,200 employees during the fourth quarter. What’s the delta there versus the 600 that you added in 4Q06 in terms of the composition of employees? Thank you.

Thomas J. Szkutak

Sure. In terms of the -- I’ll take the employee one first. You know, we did increase our employee base. The largest portion of that was certainly in our operations and fulfillment area, with the growth that we experienced throughout 2007, as well as what you were seeing in Q4. We certainly improved, increased our staffing level to support that.

In terms of CapEx, I think you should probably take a look at it versus the incremental revenue that you are seeing and again, it’s in support of our overall business as we grow, so that’s what we are looking at.

Doug Anmuth - Lehman Brothers

Any commentary on what you could grow free cash flow in ’08?

Thomas J. Szkutak

We have traditionally not given guidance on free cash flow but again, over time, we certainly see that operating profit as well as some adjustments for working capital tracks pretty nicely. But again, we’re not giving specific guidance for 2008 free cash flow.

Doug Anmuth - Lehman Brothers

Okay, great. Thank you.

Operator

We’ll go next to Justin Post with Merrill Lynch.

Justin Post - Merrill Lynch

A couple of questions about your outlook, which I think most people are wondering about. First, it looks like revenue is higher than a lot of people were thinking, but maybe margins lower. Do you anticipate any changes in the mix between third party units and your own units? And then secondly, does your outlook give you room to accelerate either new category launches internationally next year, or new countries or fulfillment centers? What kind of flexibility have you built in there?

Thomas J. Szkutak

In terms of the guidance that we have for 2008 reflects our best view of what’s going to happen in 2008 and as we talked about earlier, we are still investing, going to continue to invest in the business, as Jeff highlighted a number of key areas. But as part of that, we expect it to be appropriate growth in terms of technology and content.

And in terms of some of the other things that you mentioned, you should expect that we’re going to expand capacity as we have over the past few years to fulfill the demand for the range of guidance that we’ve given. You should also expect us to launch new categories as well during 2008.

So those are things that we are going to continue to focus on. In addition to launching new categories, you should expect us to increase selection on our existing categories in each of our geographies.

So those are things that we’ll continue to work on to make that experience better for customers.

Justin Post - Merrill Lynch

And how about that first part, third part ratio? Do you expect that to change much next year?

Thomas J. Szkutak

We’re not giving guidance on what the mix will look like and ultimately, and this is both from 2008 and really any year, we view that nothing has changed and we’ve said this consistently. Ultimately the customer will decide where the mix ends up and that’s both in the current year and long-term.

What we are focused on is making sure that the experience is great for our various customer sets and we do that. We think we have nice opportunities to grow both our seller business as well as our retail business, along with our other customer set as well.

Justin Post - Merrill Lynch

Last question -- the other U.S. revenues were up $30 million year over year. It looks like some nice growth there -- is that a positive lever for margin, gross margins? And what’s really driving that growth?

Thomas J. Szkutak

We haven’t split up the margins of other but certainly we’ve got a number of things going into other that are Amazon Enterprise Solutions business, as we’ve talked about in the past. We’ve launched a number of new merchants, which is certainly helpful. Web services as well, so again, it’s a number of different components of that.

We also have various marketing arrangements. Sometimes it’s higher or lower, depending upon the period. So again, there’s a number of different things that are going into that line item.

Justin Post - Merrill Lynch

Thank you.

Operator

And our final question today will come from Aaron Kessler with Piper Jaffray.

Aaron Kessler - Piper Jaffray

A couple of questions; first, the marketing costs were up slightly on a year-over-year basis as a percent of revenues. I just want to see if there is anything specific to that, and then one follow-up question.

Thomas J. Szkutak

The marketing has been, over the past several years, actually in a pretty tight band as a percentage of revenue and it continues to try to make sure that we make that spend more efficient, so there is nothing -- I don’t think there’s anything unusual with it.

Aaron Kessler - Piper Jaffray

Great, and then in terms of -- maybe a question for Jeff; in terms of your expectation for the digital media business, obviously a lot of traditional media in terms of books, music, movies is going more toward a download basis and you are clearly getting prepared for that day when you see more of that shift happening. Any sense for when you really start to see more of that shift happen and what you think the impact will be on your business? I guess how much can you offset the lower traditional media sales with your increased digital sales would be the question?

Jeffrey P. Bezos

Long term, we are very optimistic about that because when media are physical products, it makes a lot of sense for a large majority of those sales to happen in the physical world. But as media becomes digital and downloaded and sent around wirelessly, et cetera, et cetera, it doesn’t make so much sense to buy those in the physical world.

And so our relative advantage relative to where the bulk of the sales are today, the bulk of the sales today are of course in the physical world, so our relative advantage over time should improve relative to the physical world.

So we’re very -- in sort of the long term, very excited about it.

Aaron Kessler - Piper Jaffray

Great. Thank you.

Rob Eldridge

Thank you for joining us on the call today and for your questions. A replay will be available on our investor relations website at least through the end of the quarter. We appreciate your interest in Amazon.com and look forward to talking with you again next quarter. Thank you.