10-Q 1 pypl10-qq32016.htm 10-Q Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016.
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from             to             .
Commission file number 001-36859
   
 
PayPal Holdings, Inc.
(Exact Name of Registrant as Specified in Its Charter)
 
 
Delaware
47-2989869
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
 
 
2211 North First Street
San Jose, California
95131
(Address of Principal Executive Offices)
(Zip Code)
(408) 967-1000
(Registrant’s telephone number, including area code)
  
 
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 (§232.405 of this chapter) 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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
ý 
Accelerated filer
o
 
 
 
 
Non-accelerated filer
o  (Do not check if a smaller reporting company)
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  [ ]    No  [x]

As of October 19, 2016, there were 1,206,645,916 shares of the registrant's common stock, $0.0001 par value, outstanding, which is the only class of common or voting stock of the registrant issued.
 


1


PayPal Holdings, Inc.
TABLE OF CONTENTS




2


PART I: FINANCIAL INFORMATION

Item 1:
Financial Statements

PayPal Holdings, Inc.
CONDENSED CONSOLIDATED BALANCE SHEET
 
September 30,
2016
 
December 31,
2015
 
(In millions, except par value)
 
(Unaudited)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,369

 
$
1,393

Short-term investments
3,719

 
2,018

Accounts receivable, net
187

 
137

Loans and interest receivable, net of allowances of $314 in 2016 and $233 in 2015
4,815

 
4,184

Funds receivable and customer accounts
13,320

 
12,261

Prepaid expenses and other current assets
751

 
655

Total current assets
24,161

 
20,648

Long-term investments
1,339

 
2,348

Property and equipment, net
1,451

 
1,344

Goodwill
4,068

 
4,069

Intangible assets, net
245

 
358

Other assets
92

 
114

Total assets
$
31,356

 
$
28,881

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
174

 
$
145

Funds payable and amounts due to customers
14,120

 
12,261

Accrued expenses and other current liabilities
1,272

 
1,179

Income taxes payable
50

 
32

Total current liabilities
15,616

 
13,617

Deferred tax liability and other long-term liabilities
1,548

 
1,505

Total liabilities
17,164

 
15,122

Commitments and contingencies (Note 11)

 


Equity:
 
 
 
Common stock, $0.0001 par value; 4,000 shares authorized; 1,206 and 1,224 outstanding

 

Treasury stock at cost, 26 shares as of September 30, 2016
(945
)
 

Additional paid-in-capital
13,419

 
13,100

Retained earnings
1,679

 
668

Accumulated other comprehensive income (loss)
39

 
(9
)
Total equity
14,192

 
13,759

Total liabilities and equity
$
31,356

 
$
28,881

The accompanying notes are an integral part of these condensed combined and consolidated financial statements.

3


PayPal Holdings, Inc.
CONDENSED COMBINED AND CONSOLIDATED STATEMENT OF INCOME
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(In millions, except per share data)
 
(Unaudited)
Net revenues
$
2,667

 
$
2,258

 
$
7,861

 
$
6,692

Operating expenses:
 
 
 
 
 
 
 
Transaction expense
830

 
651

 
2,392

 
1,860

Transaction and loan losses
271

 
201

 
781

 
564

Customer support and operations
325

 
284

 
939

 
811

Sales and marketing
233

 
226

 
716

 
682

Product development
215

 
197

 
619

 
584

General and administrative
261

 
216

 
753

 
648

Depreciation and amortization
184

 
153

 
535

 
444

Restructuring

 

 

 
49

Total operating expenses
2,319

 
1,928

 
6,735

 
5,642

Operating income
348

 
330

 
1,126

 
1,050

Other income (expense), net
12

 
20

 
36

 
20

Income before income taxes
360

 
350

 
1,162

 
1,070

Income tax expense
37

 
49

 
151

 
209

Net income
$
323

 
$
301

 
$
1,011

 
$
861

 
 
 
 
 
 
 
 
Net income per share:
 
 
 
 
 
 
 
Basic
$
0.27

 
$
0.25

 
$
0.83

 
$
0.71

Diluted
$
0.27

 
$
0.25

 
$
0.83

 
$
0.70

 
 
 
 
 
 
 
 
Weighted average shares:
 
 
 
 
 
 
 
Basic
1,207

 
1,221

 
1,211

 
1,221

Diluted
1,214

 
1,227

 
1,218

 
1,227

The accompanying notes are an integral part of these condensed combined and consolidated financial statements.


4


PayPal Holdings, Inc.
CONDENSED COMBINED AND CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(In millions)
 
(Unaudited)
Net income
$
323

 
$
301

 
$
1,011

 
$
861

Other comprehensive income (loss), net of reclassification adjustments:
 
 
 
 
 
 
 
Foreign currency translation
1

 
(9
)
 
4

 
(33
)
Unrealized gains (losses) on investments, net
(3
)
 
(6
)
 
18

 
(8
)
Tax (expense) benefit on unrealized gains (losses) on investments, net
1

 
1

 
(4
)
 
1

Unrealized gains (losses) on hedging activities, net
(13
)
 
(7
)
 
30

 
(67
)
Tax (expense) benefit on unrealized gains (losses) on hedging activities, net
1

 

 

 

Other comprehensive income (loss), net of tax
(13
)
 
(21
)
 
48

 
(107
)
Comprehensive income
$
310

 
$
280

 
$
1,059

 
$
754

The accompanying notes are an integral part of these condensed combined and consolidated financial statements.


5


PayPal Holdings, Inc.
CONDENSED COMBINED AND CONSOLIDATED STATEMENT OF CASH FLOWS
 
Nine Months Ended September 30,
 
2016
 
2015
 
(In millions)
 
(Unaudited)
Cash flows from operating activities:
 
 
 
Net income
$
1,011

 
$
861

Adjustments:
 
 
 
Transaction and loan losses
781

 
564

Depreciation and amortization
535

 
444

Stock-based compensation
313

 
256

Deferred income taxes
71

 
87

Excess tax benefits from stock-based compensation
(36
)
 
(24
)
Gain on sale of principal loans receivable held for sale, net
(17
)
 
(35
)
Changes in assets and liabilities:
 
 
 
Accounts receivable
(50
)
 
(98
)
Receivable from eBay

 
121

Changes in principal loans receivable held for sale, net
17

 
9

Accounts payable
28

 
2

Payable to eBay

 
(217
)
Income taxes payable
51

 
75

Other assets and liabilities
(469
)
 
(227
)
Net cash provided by operating activities
2,235

 
1,818

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(517
)
 
(558
)
Proceeds from sales of property and equipment

 
26

Changes in principal loans receivable, net
(884
)
 
(146
)
Purchases of investments
(16,984
)
 
(17,253
)
Maturities and sales of investments
14,614

 
11,003

Acquisitions, net of cash acquired
(19
)
 
(283
)
Funds receivable and customer accounts
620

 
314

Notes and receivables from eBay

 
575

Net cash used in investing activities
(3,170
)
 
(6,322
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of common stock
58

 
36

Purchases of treasury stock
(945
)
 

Excess tax benefits from stock-based compensation
36

 
24

Contribution from eBay

 
3,858

Tax withholdings related to net share settlements of equity awards
(95
)
 
(7
)
Repayments under financing arrangements, net
(21
)
 
(877
)
Funds payable and amounts due to customers
1,862

 
1,190

Net cash provided by financing activities
895

 
4,224

Effect of exchange rate changes on cash and cash equivalents
16

 
(41
)
Net change in cash and cash equivalents
(24
)
 
(321
)
Cash and cash equivalents at beginning of period
1,393

 
2,201

Cash and cash equivalents at end of period
$
1,369

 
$
1,880

Supplemental cash flow disclosures:
 
 
 
Cash paid for interest
$
3

 
$
14

Cash paid for income taxes
$
43

 
$
56

The accompanying notes are an integral part of these condensed combined and consolidated financial statements.

6

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Note 1 - Overview and Summary of Significant Accounting Policies

Overview and Organization
PayPal Holdings, Inc. ("PayPal," the "Company," "we," "us," or "our") was incorporated in Delaware in January 2015 and is a leading technology platform company that enables digital and mobile payments on behalf of consumers and merchants worldwide. We put our customers at the center of everything we do. We strive to increase our relevance for consumers, merchants, friends and family to access and move their money anywhere in the world, anytime, on any platform and through any device (e.g., mobile, tablets, personal computers or wearables). We provide safer and simpler ways for businesses of all sizes to accept payments from merchant websites, mobile devices and applications, and at offline retail locations through a wide range of payment solutions. We also facilitate person to person payments through PayPal, Venmo and Xoom. Our combined payment solution capabilities, including our PayPal, PayPal Credit, Braintree, Venmo, and Xoom products, comprise our proprietary Payments Platform.
We operate globally in a rapidly evolving regulatory environment characterized by a heightened regulatory focus on all aspects of the payments industry. Government regulation impacts key aspects of our business, and we are subject to regulations that affect the payments industry in the many countries in which we operate. Changes in or non-compliance with laws and regulations, changes in the interpretation of laws and regulations, and the enactment of new laws and regulations applicable to us could have a material adverse impact on our business, results of operations and financial condition.

Significant Accounting Policies

Basis of Presentation and Principles of Combination and Consolidation

On July 17, 2015 (the "distribution date"), PayPal became an independent publicly-traded company through the pro rata distribution by eBay Inc. ("eBay") of 100% of the outstanding common stock of PayPal to eBay stockholders (which we refer to as the "separation" or the "distribution"). Each eBay stockholder of record as of the close of business on July 8, 2015 received one share of PayPal common stock for every share of eBay common stock held on the record date. Approximately 1.2 billion shares of PayPal common stock were distributed on July 17, 2015 to eBay stockholders. PayPal's common stock began "regular way" trading under the ticker symbol "PYPL" on The NASDAQ Stock Market on July 20, 2015.
Prior to the separation, eBay transferred substantially all of the assets and liabilities and operations of eBay's payments business to PayPal, which was completed in June 2015 (the "capitalization"). The combined financial statements prior to the capitalization were prepared on a stand-alone basis and were derived from eBay's consolidated financial statements and accounting records. The combined financial statements reflect our financial position, results of operations, comprehensive income and cash flows as our business was operated as part of eBay prior to the capitalization. Following the capitalization, the consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All periods presented have been accounted for in conformity with U.S. generally accepted accounting principles ("GAAP").
For periods prior to the capitalization, the condensed combined financial statements include expenses associated with real estate and information technology that were previously allocated to the payments business of eBay, and additional expenses related to certain corporate functions, including senior management, legal, human resources and finance. These expenses also include allocations related to stock-based compensation. The expenses that were incurred by eBay were allocated to us based on direct usage or benefit where identifiable, with the remainder allocated on a pro rata basis of revenue, headcount, or other systematic measure. We consider the expense allocation methodology and results to be reasonable for all periods presented. The condensed combined financial statements also include certain assets and liabilities that were historically held at the eBay corporate level, but which are specifically identifiable and attributable to us. The condensed combined and consolidated financial position, results of operations and cash flows of PayPal, prior to the distribution, may not be indicative of our results had we been a separate stand-alone entity throughout the periods presented, nor are the results stated herein indicative of what the Company’s financial position, results of operations and cash flows may be in the future. All intercompany transactions and accounts have been eliminated. Transactions between the Company and eBay are included in these condensed combined and consolidated financial statements for all periods presented.

Beginning with the first quarter of 2016, we reclassified certain operating expenses in our condensed combined and consolidated statements of income to better align our external and internal financial reporting. These classification changes relate primarily to real estate and information technology operating expenses that were previously allocated among customer support and operations

7

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

expense, sales and marketing expense and product development expense. As of the first quarter of 2016, our management did not allocate these operating expenses for internal financial reporting and general management of the business and has therefore discontinued this allocation for external financial reporting purposes. As a result, starting with the first quarter of 2016, these operating expenses were reported as part of general and administrative expenses. These changes have no impact on the previously reported condensed combined and consolidated net income for prior periods, including total operating expenses, financial position or cash flows for any periods presented, and do not eliminate any of the costs allocated to us by eBay for any periods prior to the separation. Prior period amounts have been reclassified to conform to the current period presentation.
The following table presents the effects of the changes on the presentation of operating expenses to the previously reported condensed combined and consolidated statement of income:
 
Three Months Ended September 30, 2015
In millions
As Reported
 
Adjustments
 
Revised
Transaction expense
$
651

 
$

 
$
651

Transaction and loan losses
201

 

 
201

Customer support and operations
317

 
(33
)
 
284

Sales and marketing
235

 
(9
)
 
226

Product development
230

 
(33
)
 
197

General and administrative
141

 
75

 
216

Depreciation and amortization
153

 

 
153

Restructuring

 

 

Total operating expenses
$
1,928

 
$

 
$
1,928

 
 
 
 
 
 
 
Nine Months Ended September 30, 2015
In millions
As Reported
 
Adjustments
 
Revised
Transaction expense
$
1,860

 
$

 
$
1,860

Transaction and loan losses
564

 

 
564

Customer support and operations
900

 
(89
)
 
811

Sales and marketing
716

 
(34
)
 
682

Product development
695

 
(111
)
 
584

General and administrative
414

 
234

 
648

Depreciation and amortization
444

 

 
444

Restructuring
49

 

 
49

Total operating expenses
$
5,642

 
$

 
$
5,642

 
 
 
 
 
 
The accompanying condensed combined and consolidated financial statements include the financial statements of PayPal and our wholly and majority-owned subsidiaries. Investments in entities where we hold less than a 20% ownership interest are generally accounted for using the cost method of accounting, and our share of the investees’ results of operations is included in other income (expense), net on our condensed combined and consolidated statement of income to the extent dividends are received. Our investment balance is included in long-term investments on our condensed consolidated balance sheet.
These condensed combined and consolidated financial statements and accompanying notes should be read in conjunction with the audited combined and consolidated financial statements and accompanying notes for the year ended December 31, 2015 included in our Annual Report on Form 10-K for the year ended December 31, 2015 filed with the Securities and Exchange Commission.

8

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

In the opinion of management, these condensed combined and consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, which are necessary for fair presentation of the condensed combined and consolidated financial statements for interim periods. We have evaluated all subsequent events through the date the financial statements were issued.

Use of Estimates

The preparation of condensed combined and consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed combined and consolidated financial statements and the reported amounts of revenues and expenses, including allocations from eBay for periods presented prior to the separation, during the reporting period. On an ongoing basis, we evaluate our estimates, including those related to provisions for transaction and loan losses, loss contingencies, income taxes, revenue recognition and the valuation of goodwill and intangible assets. We base our estimates on historical experience and on various other assumptions which we believe to be reasonable under the circumstances. Actual results could differ from those estimates.

Cash and cash equivalents

Cash and cash equivalents are short-term, highly liquid investments with original maturities of three months or less when purchased and are comprised primarily of bank deposits, government and agency securities and commercial paper.

Customer accounts

We hold all customer balances (both in the U.S. and internationally) as direct claims against us which are reflected on our consolidated balance sheet as a liability classified as amounts due to customers. Various jurisdictions where PayPal operates require us to hold eligible liquid assets, as defined by the regulators in these jurisdictions, equal to at least 100% of the aggregate amount of all customer balances. Therefore, we use the assets underlying the customer balances to meet these regulatory requirements and separately classify the assets as customer accounts in our condensed consolidated balance sheet. We classify the assets underlying the customer balances as current based on their purpose and availability to fulfill our direct obligation under amounts due to customers.

In March 2016, as approved by management and our Luxembourg banking subsidiary Supervisory Board and as permitted within regulations set forth by the Luxembourg Commission de Surveillance du Secteur Financier (the “CSSF”), we designated $800 million of European customer balances held in our Luxembourg banking subsidiary to be used to extend credit to our European customers. This is consistent with our strategy of diversifying funding sources for our credit business and does not represent a change in our credit business development strategy or risk appetite. These funds are classified as cash and cash equivalents in our condensed consolidated balance sheet and represent approximately 20% of European customer balances potentially available for corporate use by the Company at September 30, 2016 as determined by applying financial regulations maintained by the CSSF. The remaining assets underlying the customer balances remain separately classified as customer accounts in our condensed consolidated balance sheet. We do not commingle these customer accounts with corporate funds and maintain these assets separately in interest and non-interest bearing bank deposits, time deposits, corporate debt securities and U.S. and foreign government and agency securities. See “Note 6—Funds Receivable and Customer Accounts” for additional information related to customer accounts. Due to the above approved plan, we have presented changes in funds receivable and customer accounts as cash flows from investing activities in our condensed combined and consolidated statements of cash flows based on the nature of the activity underlying our customer accounts. We have elected to conform the prior year statement of cash flows to the current period presentation to provide comparability.

The following table presents the effects of the changes on the presentation of the statement of cash flows to the previously reported cash flows from investing activities and cash flows from financing activities in the condensed combined statement of cash flows for the nine months ended September 30, 2015. These changes have no impact on the previously reported total net cash flows:

9

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
Nine Months Ended September 30, 2015
In millions
As Reported
 
Adjustments
 
Revised
Cash flows from investing activities:
 
 
 
 
 
Purchases of investments
$
(6,722
)
 
$
(10,531
)
 
$
(17,253
)
Maturities and sales of investments
1,976

 
9,027

 
11,003

Funds receivable and customer accounts

 
314

 
314

 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
Funds receivable and customer accounts
(1,190
)
 
1,190

 

 
 
 
 
 
 
Net change
$
(5,936
)
 
$

 
$
(5,936
)

Recent Accounting Pronouncements

In 2014, the Financial Accounting Standards Board (FASB) issued new accounting guidance related to revenue recognition. This new standard will replace all current GAAP guidance on this topic and eliminate all industry-specific guidance. The new revenue recognition guidance provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. In 2015, the FASB deferred the effective date to fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. In 2016, the FASB updated the guidance for reporting revenue gross versus net to improve the implementation guidance on principal versus agent considerations, and for identifying performance obligations and the accounting of intellectual property licenses. In addition, the FASB introduced practical expedients and made narrow scope improvements to the new accounting guidance. This guidance can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. We are evaluating the impact and approach to adopting this new accounting guidance on our financial statements.

In 2016, the FASB issued new accounting guidance related to the classification and measurement of financial instruments. This new standard makes limited amendments to the guidance in GAAP by requiring equity investments to be measured at fair value with changes in fair value recognized in net income. This new standard also amends the presentation of certain fair value changes for financial liabilities measured at fair value and it also amends certain disclosure requirements associated with the fair value of financial instruments. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted in limited situations. We are required to apply the new guidance on a modified retrospective basis to all outstanding instruments, with a cumulative effect adjustment as of the date of adoption. We are evaluating the impact and approach to adopting this new accounting guidance on our financial statements.

In 2016, the FASB issued new accounting guidance related to accounting for leases, which will require lessees to recognize lease assets and lease liabilities on the balance sheet for the rights and obligations created by all leases with terms greater than twelve months. As we are not a lessor, other changes in the standard applicable to lessors do not apply. The standard is effective for fiscal years and interim periods within those years beginning after December 15, 2018, with early adoption permitted. We are required to adopt the guidance using a modified retrospective basis and can elect to apply optional practical expedients. We are evaluating the impact and approach to adopting this new accounting guidance on our financial statements.

In 2016, the FASB issued new accounting guidance to simplify the analysis for embedded derivatives. The new guidance clarifies that when assessing whether a contingent call or put option qualifies as a separate derivative from the host contract (e.g., the debt instrument), the nature of the exercise contingency would be excluded from the assessment. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016, with early adoption permitted. We are required to apply the new guidance on a modified retrospective basis to all existing debt instruments as of the beginning of the fiscal year for which the amendments are effective. The adoption of this standard is not expected to have a material impact on our financial statements.

In 2016, the FASB issued new accounting guidance on investments that qualify for the equity method of accounting as a result of an increase in the level of ownership interest or degree of influence. The new guidance eliminates the requirement for retrospective adjustment of the investment, results of operations and retained earnings as if the equity method had been in effect during all the previous periods that the investment had been held. Instead, under the new guidance, the cost of acquiring the additional interest

10

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

in the investee would be added to the current basis of the previously held interest and equity method accounting would be adopted as of the date the investment becomes qualified for equity method accounting. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016 with early adoption permitted. The guidance should be applied prospectively after adoption. The adoption of this standard is not expected to have a material impact on our financial statements.

In 2016, the FASB issued new guidance on the accounting for share-based payment compensation. The new guidance makes amendments to the following areas: accounting for income taxes upon vesting or settlement of awards, presentation of excess tax benefits or tax deficiencies on the statement of cash flows, accounting for forfeitures, minimum statutory withholding requirements and presentation of employee taxes paid on the statement of cash flows when an employer withholds shares to meet minimum statutory withholding requirements. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016 with early adoption permitted. We will adopt the new guidance effective January 1, 2017. As a result of the adoption, stock-based compensation ("SBC") excess tax benefits or tax deficiencies will be reflected in the consolidated statement of income within the provision for income taxes rather than in the consolidated balance sheet within additional paid-in capital. This change will be applied prospectively. The amount of the impact to the provision for income taxes will depend on the difference between the market value of share-based awards at vesting or settlement and the grant date fair value recognized through SBC. Additionally, we will present the cash flows related to the applicable SBC excess tax benefits or tax deficiencies in operating activities along with other income tax cash flows rather than in financing activities on a prospective basis. Finally, we will continue to utilize an estimate of forfeitures as our approach when determining SBC. The remaining amendments are not expected to have a material impact on our combined and consolidated financial statements.

In 2016, the FASB issued new guidance on the measurement of credit losses on financial instruments. Credit losses on loans, trade and other receivables, held-to-maturity debt securities and other instruments will reflect our current estimate of the expected credit losses that generally will result in the earlier recognition of allowances for losses. Credit losses on available-for-sale debt securities with unrealized losses will be recognized as allowances for credit losses limited to the amount by which fair value is below amortized cost. Additional disclosures will be required, including information used to track credit quality by year of origination for most financing receivables. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 with early adoption permitted. We are required to apply the standard’s provisions as a cumulative effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted with impairment of available-for-sale debt securities applied prospectively after adoption. We are evaluating the impact and approach to adopting this new accounting guidance on our financial statements.

In 2016, the FASB issued new guidance on classifying certain cash receipts and cash payments on the statement of cash flows. The new guidance addresses the classification of cash flows related to: debt prepayment or extinguishment costs, settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance, including bank-owned life insurance, distributions received from equity method investees and beneficial interests in securitization transactions. The guidance also clarifies how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017 with early adoption permitted. The guidance should be applied retrospectively after adoption. The adoption of this standard is not expected to have a material impact on our financial statements.


Note 2 - Net Income Per Share
Basic net income per share is computed by dividing net income for the period by the weighted average number of common shares outstanding during the period. The weighted average number of common shares outstanding for basic and diluted earnings per share for the three and nine months ended September 30, 2016 was based on the weighted average number of common shares outstanding for the period. The weighted average number of common shares outstanding for basic and diluted earnings per share for the three and nine months ended September 30, 2015 was based on the weighted average number of common shares outstanding for the period beginning after the distribution date. On the distribution date, eBay stockholders of record as of the close of business on July 8, 2015 received one share of PayPal common stock for every share of eBay common stock held as of the record date. Approximately 1.2 billion shares of PayPal common stock were distributed on July 17, 2015 to eBay stockholders. Diluted net income per share is computed by dividing net income for the period by the weighted average number of shares of common stock and potentially dilutive common stock outstanding for the period. The dilutive effect of outstanding equity incentive awards is

11

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

reflected in diluted net income per share by application of the treasury stock method. The calculation of diluted net income per share excludes all anti-dilutive common shares.
The following table sets forth the computation of basic and diluted net income per share for the periods indicated:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
  
2015(1)
 
2016
  
2015(1)
(In millions, except per share amounts)
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Net income
$
323

 
$
301

 
$
1,011

 
$
861

Denominator:
 
 
 
 
 
 
 
Weighted average shares of common stock - basic
1,207

 
1,221

 
1,211

 
1,221

Dilutive effect of equity incentive awards
7

 
6

 
7

 
6

Weighted average shares of common stock - diluted
1,214

 
1,227

 
1,218

 
1,227

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.27

 
$
0.25

 
$
0.83

 
$
0.71

Diluted
$
0.27

 
$
0.25

 
$
0.83

 
$
0.70

Common stock equivalents excluded from income per diluted share because their effect would have been anti-dilutive
11

 
3

 
9

 
3

1 On July 17, 2015, the distribution date, eBay stockholders of record as of the close of business on July 8, 2015 received one share of PayPal common stock for every share of eBay common stock held as of the record date. Basic and diluted net income per share for the three and nine months ended September 30, 2015 is calculated using the weighted average number of common shares outstanding for the period beginning after the distribution date.



Note 3 - Business Combinations

There were no acquisitions or divestitures completed in the three and nine months ended September 30, 2016. During 2015, we completed four acquisitions, reflecting 100% of the equity interests of the acquired companies, for an aggregate amount of $1.4 billion as described in "Part IV, Item 15, Note 3—Business Combinations" in our Annual Report on Form 10-K for the year ended December 31, 2015. In the three months ended September 30, 2016, we finalized the allocation of the purchase consideration for one of our 2015 acquisitions which did not result in any material changes to the allocation. In the nine months ended September 30, 2016, we finalized the allocation of the purchase consideration for Paydiant, CyActive and one other acquisition which did not result in any material changes to the allocation.


Note 4 - Goodwill and Intangible Assets

Goodwill

The following table presents goodwill balances and adjustments to those balances during the nine months ended September 30, 2016 (in millions):
 
December 31,
2015
 
Goodwill
Acquired
 
Adjustments
 
September 30,
2016
Total Goodwill
$
4,069

 
$

 
$
(1
)
 
$
4,068





12

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Intangible Assets

The components of identifiable intangible assets are as follows:
 
September 30, 2016
 
December 31, 2015
 
Gross Carrying Amount  
 
Accumulated Amortization 
 
Net Carrying Amount
 
Weighted Average Useful Life (Years)
 
Gross Carrying Amount 
 
Accumulated Amortization 
 
Net Carrying Amount
 
Weighted Average Useful Life (Years)
 
(In millions, except years)
Intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Customer lists and user base
$
605

 
$
(533
)
 
$
72

 
4
 
$
605

 
$
(501
)
 
$
104

 
4
Marketing related
197

 
(180
)
 
17

 
2
 
197

 
(150
)
 
47

 
3
Developed technologies
245

 
(198
)
 
47

 
3
 
245

 
(176
)
 
69

 
3
All other
243

 
(134
)
 
109

 
5
 
243

 
(105
)
 
138

 
5
Intangible assets, net
$
1,290

 
$
(1,045
)
 
$
245

 
 
 
$
1,290

 
$
(932
)
 
$
358

 
 
        
Amortization expense for intangible assets was $37 million and $24 million for the three months ended September 30, 2016 and 2015, respectively. Amortization expense for intangible assets was $114 million and $66 million for the nine months ended September 30, 2016 and 2015, respectively.

Expected future intangible asset amortization as of September 30, 2016 was as follows (in millions):
Fiscal years:
 
Remaining 2016
$
35

2017
101

2018
68

2019
24

2020
17

 
$
245


Note 5 - Geographical Information


The following tables summarize the allocation of net revenues and long-lived assets based on geography:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
  
2015
 
2016
  
2015
 
(In millions)
Net revenues:
 
 
 
 
 
 
 
U.S.
$
1,436

 
$
1,138

 
$
4,186

 
$
3,338

U.K.
298

 
294

 
923

 
857

Other Countries
933

 
826

 
2,752

 
2,497

Total net revenues
$
2,667

 
$
2,258

 
$
7,861

 
$
6,692



13

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
September 30,
2016
  
December 31,
2015
 
(In millions)
Long-lived assets:
 
 
 
U.S.
$
1,362

 
$
1,256

Other Countries
89

 
88

Total long-lived assets
$
1,451

 
$
1,344


Net revenues are attributed to U.S., U.K. and other countries primarily based upon the country in which the merchant is located, or in the case of a cross border transaction, may be earned from the country in which the consumer and the merchant respectively reside. Net revenues earned from value added services are typically attributed to the country in which either the customer or partner reside. Tangible long-lived assets for the three and nine months ended September 30, 2016 and 2015 consisted of property and equipment. Long-lived assets attributed to the U.S. and other countries are based upon the country in which the asset is located or owned.


Note 6 - Funds Receivable and Customer Accounts

The following table summarizes the assets underlying our funds receivable and customer accounts as of September 30, 2016 and December 31, 2015.

 
September 30,
2016
 
December 31,
2015
 
(In millions)
Cash and cash equivalents
$
4,213

 
$
5,245

Government and agency securities
5,557

 
4,305

Time deposits
445

 
830

Corporate debt securities
991

 
180

Funds receivable
2,114

 
1,701

Total funds receivable and customer accounts
$
13,320

 
$
12,261




14

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

At September 30, 2016 and December 31, 2015, the estimated fair value of our investments classified as available-for-sale included within funds receivable and customer accounts was as follows:
 
September 30, 2016
 
Gross
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
(In millions)
Government and agency securities
$
5,130

 
$
1

 
$
(1
)
 
$
5,130

Time deposits
445

 

 

 
445

Corporate debt securities
317

 

 

 
317

Total
$
5,892

 
$
1

 
$
(1
)
 
$
5,892


 
December 31, 2015
 
Gross
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
(In millions)
Government and agency securities
$
3,299

 
$

 
$
(1
)
 
$
3,298

Time deposits
830

 

 

 
830

Total
$
4,129

 
$

 
$
(1
)
 
$
4,128


We elect to account for certain investments within customer accounts, including foreign-currency denominated available-for-sale investments, under the fair value option. As a result, any gains and losses from fair value changes on such investments are recognized in other income (expense), net on the condensed combined and consolidated statement of income. Election of the fair value option allows us to significantly reduce the accounting asymmetry that would otherwise arise when recognizing the changes in the fair value of available-for-sale investments and the corresponding foreign exchange gains and losses relating to customer liabilities. At September 30, 2016 and December 31, 2015, the estimated fair value of our investments included within funds receivable and customer accounts under the fair value option was $1.1 billion and $1.2 billion, respectively. In the three months ended September 30, 2016 and 2015, $10 million of net gain and $15 million of net loss from fair value changes, respectively, were recognized in other income (expense), net on the condensed combined and consolidated statement of income. In the nine months ended September 30, 2016 and 2015, $3 million of net gain and $36 million of net losses from fair value changes, respectively, were recognized in other income (expense), net on the condensed combined and consolidated statement of income.

The aggregate fair value of investments in an unrealized loss position was $2.6 billion as of September 30, 2016.  The aggregate gross unrealized loss on our short-term and long-term investments was not material as of September 30, 2016. We believe the decline in value is due to temporary market conditions and expect to recover the entire amortized cost basis of the securities.  We neither intend nor anticipate the need to sell the securities before recovery. We continue to monitor the performance of the investment portfolio and assess market and interest rate risk when evaluating whether other-than-temporary impairment exists.

As of September 30, 2016, we had no material investments that have been in a continuous unrealized loss position for greater than 12 months. Amounts reclassified to earnings from unrealized gains and losses were not material for the nine months ended September 30, 2016 and 2015.

The estimated fair values of our investments classified as available-for-sale included within funds receivable and customer accounts by date of contractual maturity at September 30, 2016 were as follows:
 
September 30,
2016
 
(In millions)
One year or less
$
5,638

One year through two years
254

Total
$
5,892



15

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Note 7 - Investments

At September 30, 2016 and December 31, 2015, the estimated fair value of our short-term and long-term investments classified as available-for-sale was as follows:
 
September 30, 2016
 
Gross
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
(In millions)
Short-term investments(1):
 
  
 
  
 
 
 
Corporate debt securities
$
3,104

 
$
1

 
$

 
$
3,105

Government and agency securities
50

 

 

 
50

Time deposits
162

  

  

 
162

Long-term investments:
 
 
 
 
 
 


Corporate debt securities
1,229

 
2

 
(1
)
 
1,230

Government and agency securities
10

 

 

 
10

Total(1)
$
4,555

 
$
3

 
$
(1
)
 
$
4,557

(1) Excludes short-term restricted cash of $18 million.


 
December 31, 2015
 
Gross
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
(In millions)
Short-term investments(1):
 
  
 
  
 
 
 
Corporate debt securities
$
2,000

 
$

 
$
(2
)
 
$
1,998

Time deposits
2

  

  

 
2

Long-term investments(1):
 
 
 
 
 
 
 
Corporate debt securities
2,328

 

 
(14
)
 
2,314

Total(1)
$
4,330

 
$

 
$
(16
)
 
$
4,314

(1) Excludes short-term restricted cash of $18 million and long-term restricted cash of $8 million.

In the second quarter of 2016, we elected to account for foreign denominated available-for-sale investments held in our Luxembourg banking subsidiary under the fair value option. Election of the fair value option allows us to recognize any gains and losses from fair value changes on such investments in other income (expense), net on the condensed combined and consolidated statement of income to offset certain foreign exchange gains and losses on our foreign denominated customer liabilities. As of September 30, 2016, the estimated fair value of our investments included within short term investments and long term investments under the fair value option was $433 million. In the three and nine months ended September 30, 2016, $11 million and $26 million of net losses from fair value changes, respectively, were recognized in other income (expense), net on the condensed combined and consolidated statement of income.

We have short-term restricted cash that we intend to use to support our global sabbatical program. In addition, in connection with the acquisition of Xoom, we have long-term restricted cash required as collateral by payment processors and for licensing rules in India.

As of September 30, 2016, we had no material long-term or short-term investments that have been in a continuous unrealized loss position for greater than 12 months. Amounts reclassified to earnings from unrealized gains and losses were not material for the three and nine months ended September 30, 2016 and 2015.

16

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The estimated fair values of our short-term and long-term investments classified as available-for-sale by date of contractual maturity at September 30, 2016 were as follows:
 
September 30, 2016
 
(In millions)
One year or less
$
3,317

One year through two years
641

Two years through three years
487

Three years through four years
58

Four years through five years
29

Greater than five years
25

Total(1)
$
4,557

(1) Excludes short-term restricted cash of $18 million.

Other Investments

We have cost method investments which are reported in long-term investments on our condensed consolidated balance sheet. Our cost method investments totaled $50 million and $26 million as of September 30, 2016 and December 31, 2015, respectively. The increase in our cost method investments was due to additional investments made in the nine months ended September 30, 2016.

Note 8 - Fair Value Measurement of Assets and Liabilities

The following table summarizes our financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2016 and December 31, 2015:
 Description
 
Balances at
September 30, 2016
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1) 
 
Significant Other
Observable Inputs
(Level 2)
 
 
(In millions)
Assets:
 
 
 
 
 
 
Cash and cash equivalents
 
$
338

 
$

 
$
338

Short-term investments:
 
 
 
 
 
 
Restricted Cash
 
18

 
18

 

Corporate debt securities
 
3,108

 

 
3,108

Government and agency securities
 
431

 

 
431

Time deposits
 
162

 

 
162

Total short-term investments
 
$
3,719

 
$
18

 
$
3,701

Funds receivable and customer accounts
 
7,192

 

 
7,192

Derivatives
 
128

 

 
128

Long-term investments:
 
 
 
 
 
 
Corporate debt securities
 
1,253

 

 
1,253

Government and agency securities
 
36

 

 
36

Total long-term investments
 
1,289

 

 
1,289

Total financial assets
 
$
12,666

 
$
18

 
$
12,648

Liabilities:
 
 
 
 
 
 
Derivatives
 
$
43

 
$

 
$
43


17

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 Description
 
Balances at
December 31, 2015
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1) 
 
Significant Other
Observable Inputs
(Level 2)
 
 
(In millions)
Assets:
 
 
 
 
 
 
Cash and cash equivalents
 
$
406

 
$

 
$
406

Short-term investments:
 
 
 
 
 
 
Restricted Cash
 
18

 
18

 

Corporate debt securities
 
1,998

 

 
1,998

          Time deposits
 
2

 

 
2

Total short-term investments
 
2,018

 
18

 
2,000

Funds receivable and customer accounts
 
6,978

 

 
6,978

Derivatives
 
97

 

 
97

Long-term investments:
 
 
 
 
 
 
Restricted Cash
 
8

 
8

 

Corporate debt securities
 
2,314

 

 
2,314

Total long-term investments
 
2,322

 
8

 
2,314

Total financial assets
 
$
11,821

 
$
26

 
$
11,795

Liabilities:
 
 
 
 
 
 
Derivatives
 
$
25

 
$

 
$
25


Our financial assets and liabilities are valued using market prices on both active markets (Level 1) and less active markets (Level 2). Level 1 instrument valuations are obtained from real-time quotes for transactions in active exchange markets involving identical assets. Level 2 instrument valuations are obtained from readily available pricing sources for comparable instruments, identical instruments in less active markets, or models using market observable inputs.

The majority of our derivative instruments are valued using pricing models that take into account the contract terms as well as multiple inputs where applicable, such as currency rates, interest rate yield curves, option volatility and equity prices. Our derivative instruments are primarily short-term in nature, generally one month to one year in duration. Certain foreign currency contracts designated as cash flow hedges may have a duration of up to 18 months.

We did not have any transfers of financial instruments between valuation levels during the nine months ended September 30, 2016 and 2015. As of September 30, 2016, we did not have any assets or liabilities requiring measurement at fair value without observable market values that would require a high level of judgment to determine fair value (Level 3).

Cash and cash equivalents are short-term, highly liquid investments with original maturities of three months or less when purchased and are comprised primarily of bank deposits, government and agency securities and commercial paper.

We elect to account for foreign currency denominated available-for-sale investments underlying funds receivable and customer accounts, short term investments and long term investments under the fair value option as further discussed in "Note 6—Funds Receivable and Customer Accounts" and "Note 7—Investments."


18

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 9 - Derivative Instruments

Summary of Derivative Instruments

Our primary objective in holding derivatives is to reduce the volatility of earnings and cash flows associated with changes in foreign currency exchange rates. Our derivatives expose us to credit risk to the extent that our counterparties may be unable to meet the terms of the arrangement. We seek to mitigate such risk by limiting our counterparties to, and by spreading the risk across, major financial institutions. In addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored on an ongoing basis.

Foreign Exchange Contracts

We transact business in various foreign currencies and have significant international revenues as well as costs denominated in foreign currencies, which subjects us to foreign currency risk. We have a foreign currency exposure management program whereby we designate certain foreign currency exchange contracts, generally with maturities of 18 months or less, to reduce the volatility of cash flows primarily related to forecasted revenues and expenses denominated in foreign currencies. The objective of the foreign exchange contracts is to help mitigate the risk that the U.S. dollar-equivalent cash flows are adversely affected by changes in the applicable U.S. dollar/foreign currency exchange rate. These derivative instruments are designated as cash flow hedges and accordingly, the effective portion of the derivative’s gain or loss is initially reported as a component of accumulated other comprehensive income (loss) and subsequently reclassified into earnings in the same period the forecasted transaction affects earnings. The ineffective portion of the unrealized gains and losses on these contracts, if any, is recorded immediately in earnings. We evaluate the effectiveness of our foreign exchange contracts on a quarterly basis by comparing the change in the fair value of the derivative instruments with the change in the fair value of the forecasted cash flows of the hedged item. We do not use any foreign exchange contracts for trading or speculative purposes.

For our derivative instruments designated as cash flow hedges, the amounts recognized in earnings related to the ineffective portion were not material in each of the periods presented, and we did not exclude any component of the changes in fair value of the derivative instruments from the assessment of hedge effectiveness. During the three and nine months ended September 30, 2016 and 2015, we did not discontinue any cash flow hedges because it was probable that the original forecasted transaction would not occur and as such, did not reclassify any gains or losses to earnings. As of September 30, 2016, we estimated that $81 million of net derivative gains related to our cash flow hedges included in accumulated other comprehensive income will be reclassified into earnings within the next 12 months.

We have an additional foreign currency exposure management program whereby we use foreign exchange contracts to offset the foreign exchange risk on our assets and liabilities denominated in currencies other than the functional currency of our subsidiaries. These contracts are not designated as hedging instruments and reduce, but do not entirely eliminate, the impact of currency exchange rate movements on our assets and liabilities. The foreign currency gains and losses on our assets and liabilities are recorded in “Other income (expense), net,” which is offset by the gains and losses on the foreign exchange contracts.


19

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Fair Value of Derivative Contracts

The fair value of our outstanding derivative instruments as of September 30, 2016 and December 31, 2015 was as follows:
 
Balance Sheet Location
 
September 30,
2016
 
December 31,
2015
 
 
 
(In millions)
Derivative Assets:
 
 
 
 
 
Foreign exchange contracts designated as cash flow hedges
Other Current Assets
 
$
99

 
$
59

Foreign exchange contracts not designated as hedging instruments
Other Current Assets
 
29

 
38

Total derivative assets
 
 
$
128

 
$
97

 
 
 
 
 
 
Derivative Liabilities:
 
 
 
 
 
Foreign exchange contracts designated as cash flow hedges
Other Current Liabilities
 
$
12

 
$
2

Foreign exchange contracts not designated as hedging instruments
Other Current Liabilities
 
31

 
23

Total derivative liabilities
 
 
$
43

 
$
25

 
 
 
 
 
 
Net fair value of derivative instruments
 
 
$
85

 
$
72


Under the master netting agreements with the respective counterparties to our foreign exchange contracts, subject to applicable requirements, we are allowed to net settle transactions of the same type with a single net amount payable by one party to the other. However, we have elected to present the derivative assets and derivative liabilities on a gross basis in our balance sheet. As of September 30, 2016, the potential effect of rights of setoff associated with our foreign exchange contracts would be an offset to both assets and liabilities by $39 million, resulting in net derivative assets of $89 million and net derivative liabilities of $4 million. We are not required to pledge, nor are we entitled to receive, cash collateral related to these derivative transactions.

Effect of Derivative Contracts on Accumulated Other Comprehensive Income

The following table summarizes the activity of derivative contracts that qualify for hedge accounting as of September 30, 2016 and December 31, 2015, and the impact of designated derivative instruments on accumulated other comprehensive income for the nine months ended September 30, 2016 and 2015:
 
December 31, 2015
 
Amount of gain
recognized in other
comprehensive income
(effective portion) 
 
Less: Amount of gain
reclassified from
accumulated other
comprehensive income
to net revenue
(effective portion)
 
September 30, 2016
 
(In millions)
Foreign exchange contracts designated as cash flow hedges
$
57

 
$
99

 
$
69

 
$
87



 
December 31, 2014
 
Amount of gain
recognized in other
comprehensive income
(effective portion) 
 
Less: Amount of gain
reclassified from
accumulated other
comprehensive income
to net revenue
(effective portion)
 
September 30, 2015
 
(In millions)
Foreign exchange contracts designated as cash flow hedges
$
126

 
$
83

 
$
150

 
$
59


20

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
Effect of Derivative Contracts on Combined and Consolidated Statements of Income

The following table provides the location in the financial statements of the recognized gains or losses related to our derivative instruments:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(In millions)
Foreign exchange contracts designated as cash flow hedges recognized in net revenues
$
28

 
$
38

 
$
69

 
$
150

Foreign exchange contracts not designated as cash flow hedges recognized in other income (expense), net
11

 
14

 
28

 
14

Total gain recognized from derivative contracts in the combined statement of income
$
39

 
$
52

 
$
97

 
$
164


The gains and losses related to foreign exchange contracts not designated as cash flow hedges are offset by the foreign currency gains and losses on our assets and liabilities recognized in “Other income (expense), net.”

Notional Amounts of Derivative Contracts

Derivative transactions are measured in terms of the notional amount, but this amount is not recorded on the balance sheet and is not, when viewed in isolation, a meaningful measure of the risk profile of the derivative instruments. The notional amount is generally not exchanged, but is used only as the underlying basis on which the value of foreign exchange payments under these contracts is determined. The following table provides the notional amounts of our outstanding derivatives:
 
September 30, 2016
 
September 30, 2015
 
(In millions)
Foreign exchange contracts designated as cash flow hedges
$
1,779

 
$
1,198

Foreign exchange contracts not designated as hedging instruments
3,986

 
1,999

Total
$
5,765

 
$
3,197


Note 10 - Loans and Interest Receivable, Net

We offer credit products to consumers who choose PayPal Credit as their funding source at checkout and working capital advances to certain small and medium-sized PayPal merchants through our PayPal Working Capital product. In the U.S., we work with independent chartered financial institutions that extend credit to the consumer or merchant using our credit products. For our consumer credit products outside the U.S., we extend credit through our Luxembourg banking subsidiary. For our merchant credit products outside the U.S., we extend working capital advances in the U.K. through our Luxembourg banking subsidiary, and we extend working capital advances in Australia through an Australian subsidiary. We purchase the related receivables extended by an independent chartered financial institution in the U.S. and are responsible for servicing functions related to all our credit products. During the nine months ended September 30, 2016 and 2015, we purchased approximately $6.0 billion and $5.1 billion, respectively, in credit receivables. As part of the arrangement with an independent chartered financial institution in the U.S., we sell back a participation interest in the pool of consumer receivables outstanding under PayPal Credit consumer accounts. Under this arrangement, we do not recognize gains or losses on the sale of the participation interest as the carrying amount of the participation interest sold approximates the fair value at time of transfer. However, we have a separate arrangement with certain investors under which we sold to these investors a participation interest in certain consumer loans receivable that we purchased, where the consideration received exceeded the carrying amount of the participation interest sold which resulted in a gain reflected as net revenues in our condensed combined and consolidated financial statements. Loans, advances and interest and fees receivable are reported at their outstanding principal balances, net of any participation interest sold and pro-rata allowances, including unamortized deferred origination costs and estimated collectible interest and fees.



21

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Consumer receivables

As of September 30, 2016, the total outstanding balance in our pool of consumer receivables was $4.5 billion, net of the participation interest sold to the independent chartered financial institution and other investors of $0.9 billion. As of December 31, 2015, the total outstanding balance in our pool of consumer receivables was $4.0 billion, net of the participation interest sold to the independent chartered financial institution and other investors of $1.0 billion. The independent chartered financial institution and other investors have no recourse against us related to their participation interests for failure of debtors to pay when due. The participation interests held by the chartered financial institution and other investors have the same priority to the interests held by us and are subject to the same credit, prepayment, and interest rate risk associated with this pool of consumer receivables. All risks of loss are shared equally based on participation interests held amongst all participating stakeholders.

We use a consumer's FICO score, where available, among other measures, in evaluating the credit quality of our U.S. PayPal Credit consumer receivables. A FICO score is a type of credit score that lenders use to assess an applicant's credit risk and whether to extend credit. Individual FICO scores generally are obtained each quarter in which the U.S. consumer has an outstanding consumer receivable owned by PayPal Credit. The weighted average U.S. consumer FICO scores related to our loans and interest receivable balance outstanding at September 30, 2016 and December 31, 2015 were 686.

As of September 30, 2016 and December 31, 2015, approximately 53.7% and 53.6%, respectively, of the pool of U.S. consumer receivables and interest receivable balance was due from U.S. consumers with FICO scores greater than 680, which is generally considered "prime" by the consumer credit industry. As of September 30, 2016 and December 31, 2015, approximately 8.9% and 9.4%, respectively, of the pool of U.S. consumer receivables and interest receivable balance was due from U.S. customers with FICO scores below 599. As of September 30, 2016 and December 31, 2015, approximately 89.9% and 90.1%, respectively, of the portfolio of consumer receivables and interest receivable was current.

The following table presents the principal amount of U.S. consumer loans and interest receivable segmented by a FICO score range:
 
September 30, 2016
  
December 31, 2015
 
(In millions)
> 760
$
598

 
$
569

680 - 759
1,786

 
1,529

600 - 679
1,663

 
1,449

< 599
396

 
369

Total
$
4,443

 
$
3,916


The table above excludes certain outstanding consumer loans outside of the U.S., for which no FICO scores are available, with an outstanding balance of $94 million and $70 million at September 30, 2016 and December 31, 2015, respectively.

The following tables present the delinquency status of the principal amount of consumer loans and interest receivable:
September 30, 2016
(In millions)
Current
 
30 - 59 Days Past Due
 
60 - 89 Days Past Due
 
90 - 180 Days Past Due
 
Total Past Due
 
Total
$
4,078

 
$
190

 
$
77

 
$
192

 
$
459

 
$
4,537


December 31, 2015
(In millions)
Current
 
30 - 59 Days Past Due
 
60 - 89 Days Past Due
 
90 - 180 Days Past Due
 
Total Past Due
 
Total
$
3,593

 
$
172

 
$
66

 
$
155

 
$
393

 
$
3,986




22

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

We charge off consumer loan receivable balances in the month in which a customer balance becomes 180 days past due. Bankrupt accounts are charged off 60 days after receipt of notification of bankruptcy. Past due loans receivable continue to accrue interest until such time they are charged off.

The following table summarizes the activity in the allowance for consumer loans and interest receivable, net of participation interest sold for nine months ended September 30, 2016 and 2015:
 
September 30, 2016
 
September 30, 2015
 
Consumer Loans Receivable
Interest Receivable
Total Allowance
  
Consumer Loans Receivable
Interest Receivable
Total Allowance
 
(In Millions)
Beginning Balance
$
179

$
32

$
211

 
$
158

$
30

$
188

Reclassification from loans receivable to loans held for sale



 
(22
)

(22
)
Provisions
278

82

360

 
186

61

247

Charge-offs
(232
)
(77
)
(309
)
 
(182
)
(61
)
(243
)
Recoveries
20


20

 
18


18

Ending Balance
$
245

$
37

$
282

 
$
158

$
30

$
188


The table above excludes receivables from other consumer credit products of $11 million and $8 million at September 30, 2016 and December 31, 2015, respectively, and allowances of $2 million and $1 million at September 30, 2016 and December 31, 2015, respectively.

The provision for loan losses relating to our consumer loans receivable portfolio is recognized in transaction and loan losses and the provisions for interest receivable is recognized in net revenues from other value added services as a reduction in revenue.

Merchant receivables

We offer credit products to certain existing small and medium-sized merchants through our PayPal Working Capital product. We closely monitor credit quality for all working capital advances that we extend or purchase through that product to manage and evaluate our related exposure to credit risk. To assess a merchant who wishes to obtain a PayPal Working Capital advance, we use, among other indicators, a risk model that we have internally developed that we refer to as our PayPal Working Capital Risk Model (“PRM”), as a credit quality indicator to help predict the merchant's ability to repay the principal balance and fixed fee related to the working capital advance. The PRM uses multiple variables as predictors of the merchant's ability to repay a working capital advance. Primary drivers of the model include the merchant's annual payment volume and payment processing history with PayPal, prior repayment history with the PayPal Working Capital product, and other measures. Merchants are assigned a PRM credit score within the range of 350 to 750. We generally expect that merchants to which we extend a working capital advance will have PRM scores greater than 525. We generally consider scores above 610 to be very good and to pose less credit risk. For all outstanding working capital advances that we own, we assess the participating merchant’s PRM score on a recurring basis. At September 30, 2016 and December 31, 2015, the weighted average PRM score related to our PayPal Working Capital balances outstanding was 633 and 630, respectively.

The following table presents the principal amount of PayPal Working Capital advances and fees receivable segmented by our internal PRM score range:
 
September 30, 2016
  
December 31, 2015
 
(In millions)
> 630
$
373

 
$
255

566-629
111

 
94

<565
97

 
72

Total
$
581

 
$
421



23

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Through our PayPal Working Capital product, merchants can borrow a certain percentage of their annual payment volume processed by PayPal and are charged a fixed fee for the advance, which targets an annual percentage rate based on the overall credit assessment of the merchant. The fee is fixed at the time the advance is extended and recognized as deferred revenues in our condensed consolidated balance sheet. Advances plus the fixed fee are repaid through a fixed percentage of the merchant's future payment volume that PayPal processes. The fixed fee is amortized to net revenues from other value added services based on the amount repaid over the repayment period. We estimate the repayment period based on PayPal's payment processing history with the merchant. There is no stated interest rate and there is a general requirement that at least 10% of the original amount advanced plus the fixed fee must be repaid every 90 days. We generally calculate the repayment rate of the merchant's future payment volume so that repayment of the advance and fixed fee is expected to occur within 9 to 12 months from the date of the advance. On a monthly basis, we recalculate the repayment period based on the repayment activity on the receivable. As such, actual repayment periods are dependent on actual payment processing volumes. We monitor receivables with repayment periods greater than the original expected repayment period. We charge off the receivable when the updated repayment period is 180 days past the original expected repayment period and the merchant has not made a payment in the last 60 days. We also charge off the receivable when the updated repayment period is 360 days past the original expected repayment period regardless of whether or not the merchant has made a payment within the last 60 days. The total PayPal Working Capital advances and fees receivable outstanding as of September 30, 2016 and December 31, 2015 were approximately $581 million and $421 million, respectively.

The following tables present our estimate of the principal amount of PayPal Working Capital advances and fees receivable past their original expected repayment period. In the second quarter of 2016, we refined our estimate of the original expected repayment period to take into account the variability in repayment patterns. Prior period amounts have been updated to reflect this change.

September 30, 2016
(In millions)
Within Original Expected Repayment Period
 
30 - 59 Days Greater
 
60 - 89 Days Greater
 
90 - 180 Days Greater
 
180+ Days
 
Total Past Original Expected Repayment Period
 
Total
$
487

 
$
35

 
$
19

 
$
29

 
$
11

 
$
94

 
$
581


December 31, 2015
(In millions)
Within Original Expected Repayment Period
 
30 - 59 Days Greater
 
60 - 89 Days Greater
 
90 - 180 Days Greater
 
180+ Days
 
Total Past Original Expected Repayment Period
 
Total
$
367

 
$
24

 
$
13

 
$
15

 
$
2

 
$
54

 
$
421



The following table summarizes the activity in the allowance for PayPal Working Capital advances and fees receivable, for the nine months ended September 30, 2016 and 2015:
 
September 30, 2016
 
September 30, 2015
 
PayPal Working Capital Advances
Fees Receivable
Total Allowance
  
PayPal Working Capital Advances
Fees Receivable
Total Allowance
 
(In millions)
Beginning Balance
$
19

$
3

$
22

 
$
6

$
1

$
7

Provisions
32

4

36

 
18

1

19

Charge-offs
(27
)
(4
)
(31
)
 
(9
)
(1
)
(10
)
Recoveries
3


3

 
1


1

Ending Balance
$
27

$
3

$
30

 
$
16

$
1

$
17


The provision for loan losses relating to our PayPal Working Capital advances is recognized in transaction and loan losses and the provisions for fees receivable is recognized in deferred revenues in our condensed consolidated balance sheet as a reduction in deferred revenue.

24

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Note 11 - Commitments and Contingencies

Commitments

As of September 30, 2016, approximately $28.7 billion of unused credit was available to PayPal Credit account holders. As of December 31, 2015, approximately $24.8 billion of unused credit was available to PayPal Credit account holders. While this amount represents the total unused credit available, we have not experienced, and do not anticipate, that all of our PayPal Credit account holders will access their entire available credit at any given point in time. In addition, the individual lines of credit that make up this unused credit are subject to periodic review and termination by the chartered financial institution that is the issuer of PayPal Credit products based on, among other things, account usage and customer creditworthiness. When a consumer funds a purchase in the U.S. using a PayPal Credit product issued by a chartered financial institution, the chartered financial institution extends credit to the consumer, funds the extension of credit at the point of sale and advances funds to the merchant. We subsequently purchase the receivables related to the consumer loans extended by the chartered financial institution and, as a result of such purchase, bear the risk of loss in the event of loan defaults. Although the chartered financial institution continues to own each customer account, we own the related receivable (excluding participation interests sold) and are responsible for all servicing functions related to the account.

In the third quarter of 2015, we entered into a credit agreement ("Credit Agreement") that provides for an unsecured $2.0 billion, five-year revolving credit facility that includes a $150 million letter of credit sub-facility and a $150 million swingline sub-facility, with available borrowings under the revolving credit facility reduced by the amount of any letters of credit and swingline borrowings outstanding from time to time. Borrowings and other amounts payable under the Credit Agreement are guaranteed by PayPal, Inc. (the "Guarantor"). We may also, subject to the agreement of the applicable lenders, increase the commitments under the revolving credit facility by up to $500 million. Subject to specified conditions, we may designate one or more of our subsidiaries as additional borrowers under the Credit Agreement provided that we and the Guarantor guarantee all borrowings and other obligations of any such subsidiaries under the Credit Agreement. As of September 30, 2016, no subsidiaries were designated as additional borrowers. Funds borrowed under the Credit Agreement may be used for working capital, capital expenditures, acquisitions and other general corporate purposes. As of September 30, 2016, no borrowings or letters of credit were outstanding under the Credit Agreement. Accordingly, at September 30, 2016, $2.0 billion of borrowing capacity was available for the purposes permitted by the Credit Agreement subject to customary conditions to borrowing.

Litigation and Regulatory Matters

Overview

We are involved in legal and regulatory proceedings on an ongoing basis. Many of these proceedings are in early stages, and may seek an indeterminate amount of damages. If we believe that a loss arising from such matters is probable and can be reasonably estimated, we accrue the estimated liability in our financial statements. If only a range of estimated losses can be determined, we accrue an amount within the range that, in our judgment, reflects the most likely outcome; if none of the estimates within that range is a better estimate than any other amount, we accrue the low end of the range. For those proceedings in which an unfavorable outcome is reasonably possible but not probable, we have disclosed an estimate of the reasonably possible loss or range of losses or we have concluded that an estimate of the reasonably possible loss or range arising directly from the proceeding (i.e., monetary damages or amounts paid in judgment or settlement) are not material. If we cannot estimate the probable or reasonably possible loss or range of losses arising from a legal proceeding, we have disclosed that fact. In assessing the materiality of a legal proceeding, we evaluate, among other factors, the amount of monetary damages claimed, as well as the potential impact of non-monetary remedies sought by plaintiffs (e.g., injunctive relief) that may require us to change our business practices in a manner that could have a material adverse impact on our business. With respect to the matters disclosed in this Note 11, we are unable to estimate the possible loss or range of losses that could potentially result from the application of such non-monetary remedies.

Amounts accrued for legal and regulatory proceedings for which we believe a loss is probable were not material for the nine months ended September 30, 2016. Except as otherwise noted for the proceedings described in this Note 11, we have concluded, based on currently available information, that reasonably possible losses arising directly from the proceedings (i.e., monetary damages or amounts paid in judgment or settlement) in excess of our recorded accruals are also not material. However, legal and regulatory proceedings are inherently unpredictable and subject to significant uncertainties. If one or more matters were resolved against us in a reporting period for amounts in excess of management’s expectations, the impact on our operating results or financial condition for that reporting period could be material.

25

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Regulatory Proceedings

We are subject to U.S. economic and trade sanctions administered by the U.S. Department of the Treasury’s Office of Foreign Assets Control ("OFAC"). We have self-reported to OFAC certain transactions that were inadvertently processed but subsequently identified as possible violations of U.S. economic and trade sanctions. In March 2015, we reached a settlement with OFAC regarding possible violations arising from our sanctions compliance practices between 2009 and 2013, prior to the implementation of our real-time transaction scanning program. Subsequently, we have self-reported additional transactions as possible violations, and we have received new subpoenas from OFAC seeking additional information about certain of these transactions. Such self-reported transactions could result in claims or actions against us, including litigation, injunctions, damage awards, fines or penalties, or require us to change our business practices that could result in a material loss, require significant management time, result in the diversion of significant operational resources or otherwise harm our business.
On March 28, 2016, we received a Civil Investigative Demand (“CID”) from the Federal Trade Commission (“FTC”) as part of its investigation to determine whether we, through our Venmo service, have been or are engaged in deceptive or unfair practices in violation of the Federal Trade Commission Act.  The CID requests the production of documents and answers to written questions related to our Venmo service. We are cooperating with the FTC in connection with the CID.  The CID could lead to an enforcement action and/or one or more consent orders, which may result in substantial costs, including legal fees, fines, penalties, and remediation expenses and actions, and could require us to change aspects of the manner in which we operate Venmo.

General Matters

Other third parties have from time to time claimed, and others may claim in the future, that we have infringed their intellectual property rights. We are subject to patent disputes, and expect that we will increasingly be subject to additional patent infringement claims involving various aspects of our business as our products and services continue to expand in scope and complexity. Such claims may be brought directly or indirectly against our companies and/or against our customers (who may be entitled to contractual indemnification under their contracts with us), and we are subject to increased exposure to such claims as a result of our acquisitions, particularly in cases where we are entering into new lines of business in connection with such acquisitions. We have in the past been forced to litigate such claims, and we believe that additional lawsuits alleging such claims will be filed against us. Intellectual property claims, whether meritorious or not, are time consuming and costly to defend and resolve, could require expensive changes in our methods of doing business or could require us to enter into costly royalty or licensing agreements on unfavorable terms or make substantial payments to settle claims or to satisfy damages awarded by courts.
From time to time, we are involved in other disputes or regulatory inquiries that arise in the ordinary course of business, including suits by our customers (individually or as class actions) alleging, among other things, improper disclosure of our prices, rules or policies, that our practices, prices, rules, policies or customer/user agreements violate applicable law or that we have acted unfairly and/or not acted in conformity with such prices, rules, policies or agreements. In addition to these types of disputes and regulatory inquiries, our operations are also subject to regulatory and/or legal review and/or challenges that tend to reflect the increasing global regulatory focus to which the payments industry is subject and, when taken as a whole with other regulatory and legislative action, such actions could result in the imposition of costly new compliance burdens on our business and customers and may lead to increased costs and decreased transaction volume and revenue. Further, the number and significance of these disputes and inquiries are increasing as our Company has grown larger, our business has expanded in scope (both in terms of the range of products and services that we offer and our geographical operations) and our products and services have increased in complexity. Any claims or regulatory actions against us, whether meritorious or not, could be time consuming, result in costly litigation, settlement payments, damage awards (including statutory damages for certain causes of action in certain jurisdictions), fines, penalties, injunctive relief or increased costs of doing business through adverse judgment or settlement, require us to change our business practices in expensive ways, require significant amounts of management time, result in the diversion of significant operational resources or otherwise harm our business.

Indemnification Provisions

We entered into a separation and distribution agreement and various other agreements with eBay to govern the separation and relationship of the two companies going forward. These agreements provide for specific indemnity and liability obligations and

26

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

could lead to disputes between us and eBay, which may be significant. In addition, the indemnity rights we have against eBay under the agreements may not be sufficient to protect us and our indemnity obligations to eBay may be significant.
In the ordinary course of business, we include limited indemnification provisions in certain of our agreements with parties with whom we have commercial relationships, including our standard marketing, promotions, and application-programming-interface license (API) agreements. Under these contracts, we generally indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party in connection with claims by any third party with respect to our domain names, trademarks, logos, and other branding elements to the extent that such marks are related to the subject agreement. In a limited number of agreements, we have provided an indemnity for other types of third-party claims, which are indemnities mainly related to intellectual property rights. We have also provided an indemnity to our payments processors in the event of certain third-party claims or card association fines against the processor arising out of conduct by us or our customers. It is not possible to determine the maximum potential loss under these indemnification provisions due to our limited history of prior indemnification claims and the unique facts and circumstances involved in each particular situation. To date, no significant costs have been incurred, either individually or collectively, in connection with our indemnification provisions.

Off-Balance Sheet Arrangements

As of September 30, 2016, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our combined and consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources.

Protection Programs

We provide merchants and consumers with protection programs on substantially all transactions completed through our Payments Platform. These programs protect both merchants and consumers from loss primarily due to fraud and counterparty performance. Our Buyer Protection Program provides protection to consumers for qualifying purchases by reimbursing the consumer for the full amount of the purchase if a purchased item does not arrive or does not match the seller’s description. Our Seller Protection Programs provide protection to merchants against claims that a transaction was not authorized by the buyer or claims that an item was not received by covering the seller for the full amount of the payment on eligible sales.

The maximum potential exposure under our protection programs is estimated to be the portion of total eligible transaction volume (TPV) for which buyer or seller protection claims may be raised under our existing user agreements. Since eligible transactions are typically completed in a period significantly shorter than the period under which disputes may be opened, and based on our historical losses to date, we do not believe that that the maximum potential exposure is representative of our actual potential exposure. The actual amount of potential exposure cannot be quantified as we are unable to determine total eligible transactions where performance by a merchant or customer is incomplete or completed transactions that may result in a claim under our protection programs. We record a liability with respect to losses under these protection programs when they are probable and the amount can be reasonably estimated.

The following table provides management's estimate of the maximum potential exposure related to our protection programs as of September 30, 2016 and December 31, 2015:
 
September 30, 2016
  
December 31, 2015
 
(In millions)
Maximum potential exposure
$
119,880

 
$
109,496



27

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following table provides the amount of allowance for transaction losses related to our protection programs as of September 30, 2016 and December 31, 2015:
 
September 30, 2016
  
December 31, 2015
 
(In millions)
Allowance for transaction losses
$
184

 
$
185


Note 12 - Related Party Transactions

As of September 30, 2016, there were no material amounts payable to or amounts receivable from related parties. All contracts with related parties are at rates and terms that we believe are comparable with those that could be entered into with independent third parties. For all periods subsequent to the distribution, there were no material related party transactions.

Prior to the distribution, our business comprised the Payments segment of eBay and thus our transactions with eBay were considered related party transactions. In connection with the separation, we entered into a separation and distribution agreement as well as various other agreements that govern our relationships with eBay going forward, including an operating agreement, transition services agreement, tax matters agreement, employee matters agreement, intellectual property matters agreement and colocation services agreements. Information included in this Note 12 with respect to eBay is strictly limited to our related party transactions with eBay prior to the separation (i.e., periods up to July 17, 2015). Following separation, transactions with eBay represent third-party transactions on an arms-length basis.

We earned net revenues of $3 million from eBay and its subsidiaries during the three months ended September 30, 2015. We earned net revenues of $59 million from eBay and its subsidiaries during the nine months ended September 30, 2015.

Prior to the distribution, we recovered certain amounts from eBay related to customer protection programs offered on eligible eBay purchases made with PayPal. These costs included the actual transaction losses associated with customer-filed claims as well as an allocation of salary-related expenses for our customer support teams working on customer claims and disputes related to eligible eBay purchases. Recoveries associated with transaction losses incurred on eligible eBay purchases during the three and nine months ended September 30, 2015 were $5 million and $27 million, respectively, which were recorded as a reduction to transaction and loan loss. Other costs recovered from eBay related to the customer protection programs during the three and nine months ended September 30, 2015 were $1 million and $12 million, respectively, and were included as a reduction to customer support and operations and general and administrative expenses in our condensed combined statement of income. Following the distribution, eBay's customer protection programs are no longer administered by us, and therefore these costs are no longer reimbursed by eBay.

Prior to the distribution, we incurred user acquisition fees from eBay on payment volume which we processed from purchases made on eBay’s platform. User acquisition fees during the three and nine months ended September 30, 2015 were $4 million and $64 million, respectively. Following the distribution, pursuant to the operating agreement, we incur referral services fees from eBay based on a fixed rate per new user.

Prior to the distribution, these condensed combined and consolidated financial statements include expenses associated with workplace resources and information technology that were previously allocated to the Payments segment of eBay, and additional expenses related to certain corporate functions, including senior management, legal, human resources and finance. These expenses also include allocations related to share based compensation. These expenses allocated to us by eBay are based on direct usage or benefit where identifiable, with the remainder allocated on a pro rata basis of revenue, headcount, or other systematic measure. We consider the expense allocation methodology and results to be reasonable for all periods presented.   The corporate costs and allocation of expenses to us from eBay included within customer support and operations, sales and marketing, product development, and general and administrative expenses were not material during the three months ended September 30, 2015. The corporate costs and allocation of expenses to us from eBay included within customer support and operations, sales and marketing, product development, and general and administrative expenses were $303 million for the nine months ended September 30, 2015.

Note 13 - Stock Repurchase Program

In January 2016, our Board of Directors authorized a stock repurchase program that provides for the repurchase of up to $2 billion of our common stock, with no expiration from the date of authorization. This stock repurchase program is intended to offset the

28

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

impact of dilution from our equity compensation programs and, subject to market conditions and other factors, may also be used to make opportunistic repurchases of our common stock to reduce outstanding share count. Any share repurchases under our stock repurchase program may be made through open market transactions, block trades, privately negotiated transactions or other means at times and in such amounts as management deems appropriate and will be funded from our working capital or other financing alternatives. However, any stock repurchases are subject to market conditions and other uncertainties and we cannot predict if or when any stock repurchases will be made. Moreover, we may terminate our stock repurchase program at any time without notice.

The stock repurchase activity under our stock repurchase program during the nine months ended September 30, 2016 is summarized as follows:
 
Shares Repurchased
 
Average Price
Paid per Share
(1)
 
Value of Shares Repurchased
 
Remaining Amount Authorized
 
(In millions, except per share amounts)
Authorization of plan in January 2016

 

 

 
$
2,000

Repurchases of shares of common stock for three months ended March 31, 2016
16.9

 
$
35.27

 
596

 
(596
)
Repurchases of shares of common stock for three months ended June 30, 2016
7.8

 
$
38.67

 
300

 
(300
)
Repurchases of shares of common stock for three months ended September 30, 2016
1.3

 
$
36.80

 
49

 
(49
)
Balance as of September 30, 2016
26.0

 
 
 
$
945

 
$
1,055

(1) Average price paid per share includes broker commissions.

These repurchased shares of common stock were recorded as treasury stock and were accounted for under the cost method. No repurchased shares of common stock have been retired.

Note 14 - Stock-Based Plans

Stock Option Activity

The following table summarizes stock option activity of our employees under our equity incentive plans for the nine months ended September 30, 2016:
 
Options
 
(In thousands)
Outstanding at January 1, 2016
6,008

Granted
124

Exercised
(1,210
)
Forfeited/expired/canceled
(239
)
Outstanding at September 30, 2016
4,683


The weighted average grant-date fair value of stock options granted during the nine months ended September 30, 2016 was $8.79 per share. The weighted average exercise price of stock options granted during the nine months ended September 30, 2016 was $36.32 per share.

29

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Restricted Stock Unit Activity

The following table summarizes the restricted stock units granted under our equity incentive plans for the nine months ended September 30, 2016:
 
Units 
 
(In thousands)
Outstanding at January 1, 2016
28,005

Awarded
11,913

Vested
(8,293
)
Forfeited
(2,895
)
Outstanding at September 30, 2016
28,730

Expected to vest
24,411


The weighted average grant-date fair value of restricted stock units granted during the nine months ended September 30, 2016 was $39.10 per share.

Performance-Based Restricted Stock Units (PBRSUs)

In the first quarter of 2016, we granted PBRSUs under PayPal's 2015 Equity Incentive Award Plan to officers and certain employees providing services to the Company. PBRSUs are equity awards that may be earned based on an initial target number with the final number of PBRSUs that may be vested and settled determined based on the product of the initial target number of PBRSUs multiplied by a performance factor based on measurements of the Company’s performance against pre-established performance metrics over a predefined performance period. Over the performance period, the number of PBRSUs that will be issued and related stock-based compensation expense that is recognized is adjusted upward or downward based upon the probability of achieving the approved performance targets against the performance metrics. As of September 30, 2016, 1.7 million PBRSUs were outstanding which is based on the Company's best estimate of the number of PBRSUs that will vest over the performance period.

Stock-based Compensation Expense

Prior to the separation, we were charged by eBay for stock-based compensation expense related to our direct employees. eBay allocated to us costs of certain employees of eBay (including stock-based compensation) who provided general and administrative services on our behalf. Following the separation, we record stock-based compensation expense for our equity incentive plans in accordance with the provisions of the authoritative accounting guidance, which requires the measurement and recognition of compensation expense based on estimated fair values. Beginning in the first quarter of 2016, we started granting restricted stock units that vest in equal annual installments over a period of three years, subject to the employees' continuing service. Previously our restricted stock units granted to eligible employees under our equity incentive plans vested in equal annual installments over a period of four years, subject to the employees' continuing service.


30

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The impact on our results of operations of recording stock-based compensation expense under eBay's and PayPal's equity incentive plans for the three and nine months ended September 30, 2016 and 2015 was as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(In millions)
Customer support and operations
$
21

 
$
16

 
$
61

 
$
44

Sales and marketing
21

 
18

 
59

 
42

Product development
34

 
33

 
102

 
97

General and administrative
31

 
25

 
91

 
68

Depreciation and amortization
2

 
2

 
4

 
6

Total stock-based compensation expense
$
109

 
$
94

 
$
317

 
$
257

 
 
 
 
 
 
 
 
Capitalized as part of internal use software and website development costs
$
4

 
$
2

 
$
10

 
$
6


Note 15 - Income Taxes

For periods ended on or prior to July 17, 2015, we were a member of the eBay consolidated group and our U.S. taxable income was included in the consolidated U.S. federal income tax return of eBay as well as in returns filed by eBay with certain state and local taxing jurisdictions. Our foreign income tax returns are filed on a separate company basis. For periods ended on or prior to July 17, 2015, our income tax liability has been computed and presented herein under the “separate return method” as if it were a separate tax paying entity, as modified by the benefits-for-loss approach. Accordingly, our operating losses and other tax attributes are characterized as utilized when those attributes have been utilized by other members of the eBay consolidated group; however, the benefits-for-loss approach does not impact our tax expense. Federal and unitary state income taxes incurred for periods ended on or prior to July 17, 2015 are remitted to eBay pursuant to a tax sharing agreement between the companies.

In connection with the distribution, eBay and PayPal entered into various agreements that govern the relationship between the parties going forward, including a tax matters agreement. The tax matters agreement was entered into on the distribution date. Under the tax matters agreement, eBay generally is responsible for all additional taxes (and will be entitled to all related refunds of taxes) imposed on eBay and its subsidiaries (including subsidiaries that were transferred to PayPal pursuant to the separation) arising after the distribution date with respect to the taxable periods (or portions thereof) ended on or prior to July 17, 2015 except for those taxes for which PayPal has reflected an unrecognized tax benefit in its financial statements on the distribution date.

Our effective tax rate for the three and nine months ended September 30, 2016 was 10% and 13%, respectively. The difference between our effective tax rate and the U.S. federal statutory rate of 35% in both periods was primarily the result of foreign income taxed at different rates.

On July 27, 2015, the U.S.Tax Court, in Altera Corp. v. Commissioner, invalidated part of a Treasury Regulation requiring stock based compensation to be included in a qualified intercompany cost sharing arrangement. A final decision was entered by the U.S. Tax Court on December 1, 2015. On February 19, 2016, the Internal Revenue Service filed a notice of appeal to the Ninth Circuit Court of Appeals. On September 9, 2016 Altera filed a brief with the appeals court. We have reviewed this case and its impact on PayPal and concluded that no adjustment to the consolidated financial statements is appropriate at this time. We will continue to monitor ongoing developments and potential impacts to our consolidated financial statements.



31

PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 16 - Accumulated Other Comprehensive (Loss) Income

The following table summarizes the changes in accumulated balances of other comprehensive income for the three months ended September 30, 2016:
Three Months Ended September 30, 2016
Unrealized Gains (Losses) on Cash Flow Hedges
 
Unrealized Gains (Losses) on Investments
 
Foreign
Currency
Translation
 
Estimated tax (expense) benefit
 
Total
 
(In millions)
Beginning balance
$
100

 
$
5

 
$
(50
)
 
$
(3
)
 
$
52

Other comprehensive income (loss) before reclassifications
15

 
(4
)
 
1