10-Q 1 pypl10-qq12017.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 March 31, 2017.
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, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth 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
 
 
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 April 21, 2017, there were 1,201,258,479 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
 
March 31,
2017
 
December 31,
2016
 
(In millions, except par value)
 
(Unaudited)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,240

 
$
1,590

Short-term investments
2,815

 
3,385

Accounts receivable, net
178

 
214

Loans and interest receivable, net of allowances of $364 in 2017 and $339 in 2016
5,354

 
5,348

Funds receivable and customer accounts
14,941

 
14,363

Prepaid expenses and other current assets
897

 
833

Total current assets
25,425

 
25,733

Long-term investments
2,325

 
1,539

Property and equipment, net
1,448

 
1,482

Goodwill
4,060

 
4,059

Intangible assets, net
184

 
211

Other assets
51

 
79

Total assets
$
33,493

 
$
33,103

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
164

 
$
192

Funds payable and amounts due to customers
15,741

 
15,163

Accrued expenses and other current liabilities
1,300

 
1,459

Income taxes payable
81

 
64

Total current liabilities
17,286

 
16,878

Deferred tax liability and other long-term liabilities
1,581

 
1,513

Total liabilities
18,867

 
18,391

Commitments and contingencies (Note 11)

 


Equity:
 
 
 
Common stock, $0.0001 par value; 4,000 shares authorized; 1,196 and 1,207 outstanding

 

Treasury stock at cost, 39 and 27 shares
(1,512
)
 
(995
)
Additional paid-in-capital
13,724

 
13,579

Retained earnings
2,412

 
2,069

Accumulated other comprehensive income
2

 
59

Total equity
14,626

 
14,712

Total liabilities and equity
$
33,493

 
$
33,103

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

3


PayPal Holdings, Inc.
CONDENSED CONSOLIDATED STATEMENT OF INCOME
 
Three Months Ended March 31,
 
2017
 
2016
 
(In millions, except per share data)
 
(Unaudited)
Net revenues
$
2,975

 
$
2,544

Operating expenses:
 
 
 
Transaction expense
987

 
752

Transaction and loan losses
300

 
255

Customer support and operations
317

 
296

Sales and marketing
238

 
233

Product development
214

 
195

General and administrative
265

 
231

Depreciation and amortization
183

 
175

Restructuring
40

 

Total operating expenses
2,544

 
2,137

Operating income
431

 
407

Other income (expense), net
7

 
15

Income before income taxes
438

 
422

Income tax expense
54

 
57

Net income
$
384

 
$
365

 
 
 
 
Net income per share:
 
 
 
Basic
$
0.32

 
$
0.30

Diluted
$
0.32

 
$
0.30

 
 
 
 
Weighted average shares:
 
 
 
Basic
1,203

 
1,216

Diluted
1,216

 
1,225

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


4


PayPal Holdings, Inc.
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
 
Three Months Ended March 31,
 
2017
 
2016
 
(In millions)
 
(Unaudited)
Net income
$
384

 
$
365

Other comprehensive income (loss), net of reclassification adjustments:
 
 
 
Foreign currency translation
13

 
8

Unrealized gains (losses) on investments, net
1

 
12

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

 
(2
)
Unrealized gains (losses) on hedging activities, net
(72
)
 
(36
)
Tax (expense) benefit on unrealized gains (losses) on hedging activities, net
1

 

Other comprehensive income (loss), net of tax
(57
)
 
(18
)
Comprehensive income
$
327

 
$
347

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


5


PayPal Holdings, Inc.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
 
Three Months Ended March 31,
 
2017
 
2016
 
(In millions)
 
(Unaudited)
Cash flows from operating activities:
 
 
 
Net income
$
384

 
$
365

Adjustments:
 
 
 
Transaction and loan losses
300

 
255

Depreciation and amortization
183

 
174

Stock-based compensation
145

 
95

Deferred income taxes
53

 
22

Excess tax benefits from stock-based compensation

 
(1
)
Gain on sale of principal loans receivable held for sale, net
(6
)
 
(6
)
Changes in assets and liabilities:
 
 
 
Accounts receivable
36

 
(22
)
Principal loans receivable held for sale, net
6

 
6

Accounts payable
(1
)
 
13

Income taxes payable
17

 
(5
)
Other assets and liabilities
(366
)
 
(158
)
Net cash provided by operating activities
751

 
738

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(148
)
 
(133
)
Changes in principal loans receivable, net
(136
)
 
(120
)
Purchases of investments
(7,109
)
 
(4,091
)
Maturities and sales of investments
5,581

 
4,196

Acquisitions, net of cash acquired

 
(19
)
Funds receivable and customer accounts
754

 
492

Net cash (used in) and provided by investing activities
(1,058
)
 
325

Cash flows from financing activities:
 
 
 
Proceeds from issuance of common stock
12

 
6

Purchases of treasury stock
(517
)
 
(596
)
Excess tax benefits from stock-based compensation

 
1

Tax withholdings related to net share settlements of equity awards
(101
)
 
(15
)
Repayments under financing arrangements, net

 
(21
)
Funds payable and amounts due to customers
552

 
738

Net cash (used in) and provided by financing activities
(54
)
 
113

Effect of exchange rate changes on cash and cash equivalents
11

 
14

Net change in cash and cash equivalents
(350
)
 
1,190

Cash and cash equivalents at beginning of period
1,590

 
1,393

Cash and cash equivalents at end of period
$
1,240

 
$
2,583

Supplemental cash flow disclosures:
 
 
 
Cash paid for interest
$
1

 
$
1

Cash paid for income taxes
$
48

 
$
24


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

6

PayPal Holdings, Inc.
NOTES TO CONDENSED 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 and digital payments platform company that enables digital and mobile payments on behalf of consumers and merchants worldwide. Our vision is to democratize financial services, as we believe that managing and moving money is a right for all people, not just the affluent. Our goal is to increase our relevance for consumers and merchants to manage and move their money anywhere in the world, anytime, on any platform and using any device. Our combined payment solutions, including our PayPal, PayPal Credit, Braintree, Venmo, Xoom, and Paydiant products, compose our proprietary Payments Platform.

We operate globally and 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. We are subject to regulations that affect the payments industry in the markets in which we operate. Non-compliance with laws and regulations, increased penalties and enforcement actions related to non-compliance, changes in laws and regulations or their interpretation, 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 Consolidation
The accompanying condensed consolidated financial statements include the financial statements of PayPal and our wholly and majority-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. 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 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 consolidated financial statements and accompanying notes should be read in conjunction with the audited consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2016 (the "2016 Form 10-K") filed with the Securities and Exchange Commission.
In the opinion of management, these condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, which are necessary for fair presentation of the condensed 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 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 consolidated financial statements and the reported amounts of revenues and expenses, 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 various other assumptions which we believe to be reasonable under the circumstances. Actual results could differ from those estimates.

Recent Accounting Guidance

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

7

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

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. We have evaluated the impact of this new standard and have concluded that our financial statements will not be materially impacted upon adoption. We will adopt the guidance on January 1, 2018 on a full retrospective basis, reflecting the application of the new standard in each prior reporting period.

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 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 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.

In 2016, the FASB issued new guidance on restricted cash on the statement of cash flows. The new guidance requires the classification and presentation of changes in restricted cash and cash equivalents in the statement of cash flows. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning and ending balances shown on the statement 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.

In 2017, the FASB issued new guidance clarifying the scope and application of the de-recognition of non-financial assets and the sale or transfer of non-financial assets, including partial sales. The new standard is effective for fiscal years, and interim periods

8

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

within those fiscal years, beginning after December 15, 2017, with early adoption permitted. Either of the following transition methods is permitted: (i) a full retrospective approach reflecting the application of the new standard in each prior reporting period, or (ii) a modified retrospective approach with a cumulative-effect adjustment to the opening balance of retained earnings in the year the new standard is first applied. The adoption of this standard is not expected to have a material impact on our financial statements.

In 2017, the FASB issued new guidance that requires certain premiums on callable debt securities to be amortized to the earliest call date. The amortization period for callable debt securities purchased at a discount will not be impacted.  The new standard is effective at the same time as the new revenue recognition standard. Therefore, the new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. Transition is on a modified retrospective basis via a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. We are evaluating the impact this new accounting guidance will have on our financial statements.

Recently Adopted Accounting Guidance

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 put or call 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. We adopted the new guidance effective January 1, 2017. The adoption of this standard did not 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 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. We adopted the new guidance effective January 1, 2017. The adoption of this standard did not 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. We adopted the new guidance effective January 1, 2017. As a result of the adoption, starting in the first quarter of 2017, stock-based compensation ("SBC") excess tax benefits or tax deficiencies are 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. For the three months ended March 31, 2017, we recognized approximately $4 million of SBC net excess tax benefits within the provision for income taxes. Additionally, starting in the first quarter of 2017, we presented the cash flows related to the applicable SBC net excess tax benefits in operating activities along with other income tax cash flows rather than in financing activities. The remaining amendments did not have a material impact on our financial statements.

In 2016, the FASB issued new guidance on the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. The new guidance requires the recognition of the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. Adoption of the new guidance must be made on a modified retrospective basis. We elected to early adopt the new guidance effective January 1, 2017. As a result of the adoption, we recorded a decrease of approximately $41 million in retained earnings as of the beginning of the first quarter of 2017, with a corresponding decrease in prepaid taxes related to the unamortized tax expense attributed to intra-entity transfers of assets previously deferred. Additionally, we did not recognize $4 million of amortization of prepaid taxes for the first quarter of 2017 attributed to prior period intra-entity asset transfers previously deferred within the provision for income taxes. As of adoption, when a new intra-entity transfer of assets occurs, we will recognize the income tax consequences associated with this activity in the consolidated statement of income in the period the transaction takes place.

In 2017, the FASB issued new guidance to clarify the definition of a business to assist companies with evaluating whether transactions should be accounted for as acquisitions of assets or businesses. The new guidance requires a company to evaluate if substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets; if so, the set of assets and activities is not a business. The guidance also requires a business to include at least one substantive process and narrows the definition of outputs by more closely aligning it with how outputs are

9

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

described in the guidance for revenue from contracts with customers. The guidance should be applied prospectively to any transactions occurring within the period of adoption. We elected to early adopt the new guidance effective January 1, 2017. The adoption of this standard did not have an impact on our financial statements.

In 2017, the FASB issued new guidance to simplify the accounting for goodwill impairment. The guidance simplifies the measurement of goodwill impairment by removing step 2 of the goodwill impairment test, which requires the determination of the fair value of individual assets and liabilities of a reporting unit.  The new guidance requires goodwill impairment to be measured as the amount by which a reporting unit’s carrying value exceeds its fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amendments should be applied on a prospective basis.  We have elected to early adopt the new guidance for our annual goodwill impairment test to be performed after January 1, 2017. The adoption of this standard did not have a material impact on our financial statements.

In 2017, the FASB issued guidance that requires a company to evaluate the appropriate financial statement disclosures about the potential material effects that the new accounting guidance related to revenue recognition, measurement of credit losses on financial instruments and accounting for leases will have on its financial statements when adopted. If a company does not know or cannot reasonably estimate the impact that adoption of these new standards is expected to have on the financial statements, then in addition to making a statement to that effect, the company should consider additional qualitative disclosures to assist the reader in assessing the significance of the impact that these new guidance standards will have on the financial statements when adopted. We have considered the guidance and, where possible, have added additional qualitative disclosures on the potential impact to 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. 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 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 March 31,
 
2017
  
2016
 
(In millions, except per share amounts)
Numerator:
 
 
 
Net income
$
384

 
$
365

Denominator:
 
 
 
Weighted average shares of common stock - basic
1,203

 
1,216

Dilutive effect of equity incentive awards
13

 
9

Weighted average shares of common stock - diluted
1,216

 
1,225

Net income per share:
 
 
 
Basic
$
0.32

 
$
0.30

Diluted
$
0.32

 
$
0.30

Common stock equivalents excluded from income per diluted share because their effect would have been anti-dilutive
6

 
5






10

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

Note 3 - Business Combinations

There were no acquisitions or divestitures completed in the three months ended March 31, 2017. There were no acquisitions or divestitures completed in 2016.


Note 4 - Goodwill and Intangible Assets

Goodwill

The following table presents goodwill balances and adjustments to those balances during the three months ended March 31, 2017:
 
December 31,
2016
 
Goodwill
Acquired
 
Adjustments
 
March 31,
2017
 
 (In millions)
Total Goodwill
$
4,059

 
$

 
$
1

 
$
4,060


Intangible Assets

The components of identifiable intangible assets are as follows:
 
March 31, 2017
 
December 31, 2016
 
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
$
590

 
$
(536
)
 
$
54

 
4
 
$
605

 
$
(542
)
 
$
63

 
4
Marketing related
195

 
(189
)
 
6

 
2
 
197

 
(190
)
 
7

 
2
Developed technologies
221

 
(189
)
 
32

 
3
 
245

 
(206
)
 
39

 
3
All other
245

 
(153
)
 
92

 
5
 
245

 
(143
)
 
102

 
5
Intangible assets, net
$
1,251

 
$
(1,067
)
 
$
184

 
 
 
$
1,292

 
$
(1,081
)
 
$
211

 
 
        
Amortization expense for intangible assets was $27 million and $38 million for the three months ended March 31, 2017 and 2016, respectively.

Expected future intangible asset amortization as of March 31, 2017 was as follows (in millions):
Fiscal years:
 
Remaining 2017
$
76

2018
68

2019
23

2020
17

2021

 
$
184



11

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

Note 5 - Geographical Information

The following tables summarize the allocation of net revenues and long-lived assets based on geography:
 
Three Months Ended March 31,
 
2017
  
2016
 
(In millions)
Net revenues:
 
 
 
U.S.
$
1,606

 
$
1,343

U.K.
313

 
307

Other Countries
1,056

 
894

Total net revenues
$
2,975

 
$
2,544


 
March 31,
2017
  
December 31,
2016
 
(In millions)
Long-lived assets:
 
 
 
U.S.
$
1,359

 
$
1,391

Other Countries
89

 
91

Total long-lived assets
$
1,448

 
$
1,482


Net revenues are attributed to the 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 as of March 31, 2017 and December 31, 2016 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 March 31, 2017 and December 31, 2016.
 
March 31,
2017
 
December 31,
2016
 
(In millions)
Cash and cash equivalents
$
4,175

 
$
4,319

Government and agency securities
6,873

 
5,625

Time deposits
698

 
522

Corporate debt securities
1,003

 
1,093

Funds receivable
2,192

 
2,804

Total funds receivable and customer accounts
$
14,941

 
$
14,363




12

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

As of March 31, 2017 and December 31, 2016, the estimated fair value of our investments classified as available-for-sale included within funds receivable and customer accounts was as follows:
 
March 31, 2017
 
Gross
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
(In millions)
Government and agency securities
$
6,344

 
$

 
$
(4
)
 
$
6,340

Time deposits
698

 

 

 
698

Corporate debt securities
458

 

 

 
458

Total
$
7,500

 
$

 
$
(4
)
 
$
7,496


 
December 31, 2016
 
Gross
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
(In millions)
Government and agency securities
$
5,198

 
$

 
$
(2
)
 
$
5,196

Time deposits
522

 

 

 
522

Corporate debt securities
531

 

 

 
531

Total
$
6,251

 
$

 
$
(2
)
 
$
6,249


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 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. As of March 31, 2017 and December 31, 2016, the estimated fair value of our investments included within funds receivable and customer accounts under the fair value option was $1.1 billion and $1.0 billion, respectively. In the three months ended March 31, 2017 and 2016, $15 million and $11 million of net gain from fair value changes, respectively, were recognized in other income (expense), net on the condensed consolidated statement of income.

The aggregate fair value of investments in an unrealized loss position was $5.9 billion as of March 31, 2017.  The aggregate gross unrealized loss on our short-term and long-term investments was not material as of March 31, 2017. 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 March 31, 2017, 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 three months ended March 31, 2017 and 2016.

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 March 31, 2017 were as follows:
 
March 31,
2017
 
(In millions)
One year or less
$
7,344

One year through two years
145

Two years through three years
7

Total
$
7,496



13

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


Note 7 - Investments

As of March 31, 2017 and December 31, 2016, the estimated fair value of our short-term and long-term investments classified as available-for-sale was as follows:
 
March 31, 2017
 
Gross
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
(In millions)
Short-term investments(1):
 
  
 
  
 
 
 
Corporate debt securities
$
2,304

 
$
1

 
$
(1
)
 
$
2,304

Government and agency securities
39

 

 

 
39

Time deposits
57

  

  

 
57

Long-term investments:
 
 
 
 
 
 


Corporate debt securities
2,140

 
3

 
(3
)
 
2,140

Government and agency securities
49

 

 

 
49

Total(1)
$
4,589

 
$
4

 
$
(4
)
 
$
4,589

(1) Excludes short-term restricted cash of $19 million that we intend to use to support our global sabbatical program.

 
December 31, 2016
 
Gross
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
(In millions)
Short-term investments(1):
 
  
 
  
 
 
 
Corporate debt securities
$
2,867

 
$
1

 
$
(1
)
 
$
2,867

Government and agency securities
32

 

 

 
32

Time deposits
122

  

  

 
122

Long-term investments:
 
 
 
 
 
 
 
Corporate debt securities
1,473

 
1

 
(4
)
 
1,470

Government and agency securities
10

 

 

 
10

Total(1)
$
4,504

 
$
2

 
$
(5
)
 
$
4,501

(1) Excludes short-term restricted cash of $17 million that we intend to use to support our global sabbatical program.

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 consolidated statement of income to offset certain foreign exchange gains and losses on our foreign denominated customer liabilities. As of March 31, 2017 and December 31, 2016, the estimated fair value of our investments included within short-term investments and long-term investments under the fair value option was $472 million and $356 million, respectively. In the three months ended March 31, 2017, $6 million of net gains from fair value changes were recognized in other income (expense), net on the condensed consolidated statement of income.

As of March 31, 2017, 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 months ended March 31, 2017 and 2016.

14

PayPal Holdings, Inc.
NOTES TO CONDENSED 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 March 31, 2017 were as follows:
 
March 31, 2017
 
(In millions)
One year or less
$
2,400

One year through two years
1,153

Two years through three years
795

Three years through four years
124

Four years through five years
97

Greater than five years
20

Total(1)
$
4,589

(1) Excludes short-term restricted cash of $19 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 $60 million and $50 million as of March 31, 2017 and December 31, 2016, respectively. The increase in our cost method investments was due to an additional investment made in the three months ended March 31, 2017.

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 March 31, 2017 and December 31, 2016:
 Description
 
Balances at
March 31, 2017
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
 
Significant Other
Observable Inputs
(Level 2)
 
 
(In millions)
Assets:
 
 
 
 
 
 
Cash and cash equivalents(1)
 
$
509

 
$

 
$
509

Short-term investments:
 
 
 
 
 
 
Restricted Cash
 
19

 
19

 

Corporate debt securities
 
2,528

 


 
2,528

Government and agency securities
 
211

 


 
211

Time deposits
 
57

 


 
57

Total short-term investments
 
$
2,815

 
$
19

 
$
2,796

Funds receivable and customer accounts(2)
 
8,654

 

 
8,654

Derivatives
 
138

 

 
138

Long-term investments:
 
 
 
 
 
 
Corporate debt securities
 
2,204

 


 
2,204

Government and agency securities
 
61

 


 
61

Total long-term investments
 
2,265

 

 
2,265

Total financial assets
 
$
14,381

 
$
19

 
$
14,362

Liabilities:
 
 
 
 
 
 
Derivatives
 
$
85

 
$

 
$
85

(1) Excludes cash of $731 million.
(2) Excludes cash of $4.1 billion underlying funds receivable and customer accounts.

15

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

 Description
 
Balances at
December 31, 2016
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
 
 
Significant Other
Observable Inputs
(Level 2)
 
 
(In millions)
Assets:
 
 
 
 
 
 
Cash and cash equivalents(1)
 
$
268

 
$

 
$
268

Short-term investments:
 
 
 
 
 
 
Restricted Cash
 
17

 
17

 

Corporate debt securities
 
2,882

 

 
2,882

Government and agency securities
 
364

 

 
364

          Time deposits
 
122

 

 
122

Total short-term investments
 
3,385

 
17

 
3,368

Funds receivable and customer accounts(2)
 
7,420

 

 
7,420

Derivatives
 
223

 

 
223

Long-term investments:
 
 
 
 
 
 
Corporate debt securities
 
1,479

 

 
1,479

Government and agency securities
 
10

 

 
10

Total long-term investments
 
1,489

 

 
1,489

Total financial assets
 
$
12,785

 
$
17

 
$
12,768

Liabilities:
 
 
 
 
 
 
Derivatives
 
$
59

 
$

 
$
59

(1) Excludes cash of $1.3 billion.
(2) Excludes cash of $4.1 billion underlying funds receivable and customer accounts.

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.

A 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 three months ended March 31, 2017 and 2016. As of March 31, 2017, 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."


16

PayPal Holdings, Inc.
NOTES TO CONDENSED 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 months ended March 31, 2017 and 2016, 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 March 31, 2017, we estimated that $63 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.


17

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

Fair Value of Derivative Contracts

The fair value of our outstanding derivative instruments as of March 31, 2017 and December 31, 2016 was as follows:
 
Balance Sheet Location
 
March 31,
2017
 
December 31,
2016
 
 
 
(In millions)
Derivative Assets:
 
 
 
 
 
Foreign exchange contracts designated as cash flow hedges
Other Current Assets
 
$
79

 
$
135

Foreign exchange contracts not designated as hedging instruments
Other Current Assets
 
59

 
88

Total derivative assets
 
 
$
138

 
$
223

 
 
 
 
 
 
Derivative Liabilities:
 
 
 
 
 
Foreign exchange contracts designated as cash flow hedges
Other Current Liabilities
 
$
20

 
$
4

Foreign exchange contracts not designated as hedging instruments
Other Current Liabilities
 
65

 
55

Total derivative liabilities
 
 
$
85

 
$
59

 
 
 
 
 
 
Net fair value of derivative instruments
 
 
$
53

 
$
164


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 March 31, 2017, the potential effect of rights of setoff associated with our foreign exchange contracts would be an offset to both assets and liabilities by $69 million, resulting in net derivative assets of $69 million and net derivative liabilities of $16 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 March 31, 2017 and December 31, 2016, and the impact of designated derivative instruments on accumulated other comprehensive income for the three months ended March 31, 2017 and 2016:
 
December 31, 2016
 
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)
 
March 31, 2017
 
(In millions)
Foreign exchange contracts designated as cash flow hedges
$
131

 
$
(32
)
 
$
40

 
$
59



 
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)
 
March 31, 2016
 
(In millions)
Foreign exchange contracts designated as cash flow hedges
$
57

 
$
(4
)
 
$
32

 
$
21

 

18

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

Effect of Derivative Contracts on 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 March 31,
 
2017
 
2016
 
(In millions)
Foreign exchange contracts designated as cash flow hedges recognized in net revenues
$
40

 
$
32

Foreign exchange contracts not designated as cash flow hedges recognized in other income (expense), net
(40
)
 
(9
)
Total gain recognized from derivative contracts in the statement of income
$

 
$
23


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, however, 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:
 
March 31, 2017
 
March 31, 2016
 
(In millions)
Foreign exchange contracts designated as cash flow hedges
$
2,352

 
$
1,900

Foreign exchange contracts not designated as hedging instruments
7,875

 
3,833

Total
$
10,227

 
$
5,733


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 three months ended March 31, 2017 and 2016, we purchased approximately $2.1 billion and $1.9 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 consolidated financial statements. Loans, advances and interest and fees receivable are reported at their outstanding principal balances, net of any participation interest sold, including unamortized deferred origination costs and estimated collectible interest and fees.



19

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

Consumer receivables

As of March 31, 2017 and December 31, 2016, the total outstanding balance in our pool of consumer receivables was $5.1 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 are generally 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 March 31, 2017 and December 31, 2016 was 678 and 682, respectively.

As of March 31, 2017 and December 31, 2016, approximately 50.5% and 52.1%, 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 March 31, 2017 and December 31, 2016, approximately 12.7% and 11.1%, 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 March 31, 2017 and December 31, 2016, approximately 91.3% and 90.0%, 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:
 
March 31, 2017
  
December 31, 2016
 
(In millions)
> 760
$
625

 
$
665

680 - 759
1,897

 
1,938

600 - 679
1,842

 
1,840

< 599
635

 
553

Total
$
4,999

 
$
4,996


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 $135 million and $117 million at March 31, 2017 and December 31, 2016, respectively.

The following tables present the delinquency status of the principal amount of consumer loans and interest receivable. The amounts shown below are based on the number of days past the billing date to the consumer. Current represents balances that are within 30 days of the billing date:
March 31, 2017
(In millions)
Current
 
30 - 59 Days Past Due
 
60 - 89 Days Past Due
 
90 - 180 Days Past Due
 
Total Past Due
 
Total
$
4,685

 
$
173

 
$
75

 
$
201

 
$
449

 
$
5,134


December 31, 2016
(In millions)
Current
 
30 - 59 Days Past Due
 
60 - 89 Days Past Due
 
90 - 180 Days Past Due
 
Total Past Due
 
Total
$
4,601

 
$
219

 
$
82

 
$
211

 
$
512

 
$
5,113




20

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

We charge off consumer loan receivable balances in the month in which a customer balance becomes 180 days past the payment due date. Bankrupt accounts are charged off 60 days after receipt of notification of bankruptcy. Loans receivable past the payment due date continue to accrue interest until such time they are charged off. We record an allowance for loss against the interest and fees receivable.

The following table summarizes the activity in the allowance for consumer loans and interest receivable, net of participation interest sold for the three months ended March 31, 2017 and 2016:
 
March 31, 2017
 
March 31, 2016
 
Consumer Loans Receivable
Interest Receivable
Total Allowance
  
Consumer Loans Receivable
Interest Receivable
Total Allowance
 
(In millions)
Beginning Balance
$
265

$
40

$
305

 
$
179

$
32

$
211

Provisions
120

29

149

 
90

24

114

Charge-offs
(104
)
(32
)
(136
)
 
(75
)
(29
)
(104
)
Recoveries
10


10

 
7


7

Ending Balance
$
291

$
37

$
328

 
$
201

$
27

$
228


The table above excludes receivables from other consumer credit products of $18 million and $16 million at March 31, 2017 and December 31, 2016, respectively, and allowances of $4 million and $3 million at March 31, 2017 and December 31, 2016, 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, an internally developed risk model 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. 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 March 31, 2017 and December 31, 2016, the weighted average PRM score related to our PayPal Working Capital balances outstanding was 633 and 625, respectively.

The following table presents the principal amount of PayPal Working Capital advances and fees receivable segmented by our internal PRM score range:
 
March 31, 2017
  
December 31, 2016
 
(In millions)
> 610
$
409

 
$
378

526-609
88

 
108

<525
69

 
72

Total
$
566

 
$
558


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

21

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

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. 

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.
March 31, 2017
(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
$
471

 
$
31

 
$
20

 
$
31

 
$
13

 
$
95

 
$
566


December 31, 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
$
462

 
$
35

 
$
19

 
$
30

 
$
12

 
$
96

 
$
558


The following table summarizes the activity in the allowance for PayPal Working Capital advances and fees receivable, for the three months ended March 31, 2017 and 2016:
 
March 31, 2017
 
March 31, 2016
 
PayPal Working Capital Advances
Fees Receivable
Total Allowance
  
PayPal Working Capital Advances
Fees Receivable
Total Allowance
 
(In millions)
Beginning Balance
$
28

$
3

$
31

 
$
19

$
3

$
22

Provisions
9

2

11

 
8


8

Charge-offs
(10
)
(2
)
(12
)
 
(5
)
(1
)
(6
)
Recoveries
2


2

 
1


1

Ending Balance
$
29

$
3

$
32

 
$
23

$
2

$
25


We charge off the receivable when the repayments are 180 days past our expectation of repayments and the merchant has not made a payment in the last 60 days. We also charge off the receivable when the repayments are 360 days past due regardless of whether or not the merchant has made a payment within the last 60 days. 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.

Note 11 - Commitments and Contingencies

Commitments

As of March 31, 2017 and December 31, 2016, approximately $28.2 billion and $28.8 billion, respectively, of unused credit was available to PayPal Credit account holders. While this amount represents the total unused credit available, we have not experienced,

22

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

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 March 31, 2017, 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 March 31, 2017, no borrowings or letters of credit were outstanding under the Credit Agreement. Accordingly, at March 31, 2017, $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 three months ended March 31, 2017. 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.


23

PayPal Holdings, Inc.
NOTES TO CONDENSED 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 in a manner 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 the manner in which we operate Venmo.

Legal Proceedings

On December 28, 2016, a putative securities class action captioned Cho v. PayPal Holdings, Inc., et al., Case No. 3:16-cv-07371 (the “Securities Case”), was filed in the U.S. District Court for the Northern District of California (the “Court”). The Securities Case asserts claims relating to our disclosure in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2016, that on March 28, 2016, we received a Civil Investigative Demand from the 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 Securities Case purports to be brought on behalf of purchasers of eBay’s stock on or after December 19, 2013 who subsequently received the Company’s stock pursuant to eBay’s spin-off of the Company, effective as of July 17, 2015, and/or purchasers of the Company’s stock between July 20, 2015 and April 28, 2016, and asserts claims for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) against the Company, its Chief Executive Officer, Chief Financial Officer, and former interim Chief Financial Officer, and eBay and certain of its former officers, including the Chairman of our Board of Directors. The Securities Case alleges that defendants made materially false and misleading statements or omissions regarding our compliance with applicable laws and regulations, including the failure to disclose that we were purportedly engaging in unfair trade practices through our Venmo service and that as a result of alleged false and misleading statements or omissions, our stock traded at artificially inflated prices.  The Securities Case seeks unspecified compensatory damages on behalf of the putative class members.  On March 23, 2017, the Court appointed a lead plaintiff and lead counsel to represent the putative class. Pursuant to the Court’s scheduling order, lead plaintiff will have until May 12, 2017 to file an amended complaint. We believe the claims and allegations in the Securities Case are without merit and intend to defend the action vigorously.

On January 12, 2017, a putative shareholder derivative action captioned Silverman v. Schulman, et al., Case No. 5:17-cv-00162, was filed in the U.S. District Court for the Northern District of California based on substantially similar allegations underlying the Securities Case described above (the “California Derivative Case”). On February 8, 2017, the Court entered an order formally relating the California Derivative Case to the Securities Case and assigning the case to the same judge handling the Securities Case. On the same day, the Court also entered an order staying the California Derivative Case pending resolution of the defendants’ anticipated motions to dismiss the Securities Case. On March 24, 2017, a second derivative action substantially similar to the California Derivative Case captioned Seeman v. Schulman, et al., Case No. 1:17-cv-00318-UNA, was filed in the U.S. District Court for the District of Delaware (the “Delaware Derivative Case,” and together with the California Derivative Case, the “Derivative Cases”). On April 19, 2017, the Court in the Delaware Derivative Case issued an order adopting a stipulation filed by the parties transferring the Delaware Derivative Case to the U.S. District Court for the Northern District of California so that the Delaware Derivative Case can be consolidated with the pending California Derivative Case. The Derivative Cases are purportedly brought on behalf of the Company and allege that the Company’s Chief Executive Officer, Chief Financial Officer, former interim Chief Financial Officer, and members of its Board of Directors breached their fiduciary duties to the Company, violated Section 14(a) of the Exchange Act, and were unjustly enriched by, among other things, causing or permitting the Company to issue materially false and misleading statements or omissions regarding the Company’s compliance with applicable laws and regulation with respect to its Venmo service, as alleged in the Securities Case, and by permitting or causing the Company to engage in unfair trade practices through its Venmo service.  The Derivative Cases seek, among other things, to recover unspecified compensatory damages on

24

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

behalf of the Company arising out of the individual defendants’ alleged wrongful conduct. Although plaintiffs in the Derivative Cases do not seek relief against the Company, we have certain indemnification obligations to the individual defendants.

We have received subpoenas from the U.S. Department of Justice (“DOJ”) seeking the production of certain information related to our historical anti-money laundering program. We are cooperating with the DOJ in providing information in response to the subpoenas. We are unable to predict the outcome of the government's investigation.
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 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.

25

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


Off-Balance Sheet Arrangements

As of March 31, 2017 and December 31, 2016, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our 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 March 31, 2017 and December 31, 2016:
 
March 31, 2017
  
December 31, 2016
 
(In millions)
Maximum potential exposure
$
137,998

 
$
131,739


The following table provides the amount of allowance for transaction losses related to our protection programs as of March 31, 2017 and December 31, 2016:
 
March 31, 2017
  
December 31, 2016
 
(In millions)
Allowance for transaction losses
$
213

 
$
222


Note 12 - Related Party Transactions

As of March 31, 2017 and December 31, 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 presented, there were no material related party transactions.


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. This stock repurchase program has no expiration from the date of authorization. This stock repurchase program is intended to offset the 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

26

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

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 three months ended March 31, 2017 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)
Balance as of January 2017
 
 
 
 
 
 
$
1,005

Repurchases of shares of common stock
12.2

 
$
42.38

 
517

 
(517
)
Balance as of March 31, 2017


 
 
 
 
 
$
488

(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 Options

As of March 31, 20173.8 million options to purchase shares of common stock were outstanding with no new options granted in the quarter ended March 31, 2017.

Restricted Stock Units (RSUs) and Performance-Based Restricted Stock Units (PBRSUs)

The following table summarizes the RSU and PBRSU activity under our equity incentive plans for the three months ended March 31, 2017:

 
Units 
 
(In thousands)
Outstanding at January 1, 2017
29,185

Awarded
17,230

Vested
(934
)
Forfeited
(444
)
Outstanding at March 31, 2017
45,037

Expected to vest
39,145


The weighted average grant-date fair value of RSUs and PBRSUs granted during the three months ended March 31, 2017 was $42.28 per share.

In the first quarter of 2017, the Company granted RSUs that vest in equal annual installments over a three-year performance period, 2.7 million PBRSUs with a one-year performance period with cliff vesting following the completion of the performance period in February 2018 (one year from the annual incentive award cycle grant date) and 1.2 million PBRSUs with a three-year performance period. Over the performance period, the number of PBRSUs that may be issued and the 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. Depending on the probability of achieving the pre-established performance targets, the PBRSUs issued could range from 0% to 200% of the target amount.

27

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


Stock-based Compensation Expense

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.

The impact on our results of operations of recording stock-based compensation expense under our equity incentive plans for the three months ended March 31, 2017 and 2016 was as follows:
 
Three Months Ended March 31,
 
2017
 
2016
 
(In millions)
Customer support and operations
$
30

 
$
18

Sales and marketing
28

 
16

Product development
45

 
33

General and administrative
42

 
27

Depreciation and amortization
2

 
1

Total stock-based compensation expense
$
147

 
$
95

Capitalized as part of internal use software and website development costs
$
3

 
$
2



Note 15 - Income Taxes

Our effective tax rate for the three months ended March 31, 2017 and March 31, 2016 was 12% and 14%, 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.


Note 16 - Restructuring

In the first quarter of 2017, management approved a plan to implement a strategic reduction of its existing global workforce. The total cost of this plan is expected to be approximately $40 million. The strategic reduction and timing of cash payments associated with this plan are expected to be substantially completed by the end of 2017.

The following table summarizes the restructuring reserve activity during the three months ended March 31, 2017:
 
Employee Severance and Benefits
 
(In millions)
Accrued liability as of January 1, 2017
$

Charges
40

Payments
(1
)
Accrued liability as of March 31, 2017
$
39

No restructuring expenses were recognized during the three months ended March 31, 2016.



28

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

Note 17 - Accumulated Other Comprehensive (Loss) Income

The following table summarizes the changes in accumulated balances of other comprehensive income for the three months ended March 31, 2017:
 
Unrealized Gains (Losses) on Cash Flow Hedges
 
Unrealized Gains (Losses) on Investments
 
Foreign
Currency
Translation
 
Estimated tax (expense) benefit
 
Total
 
(In millions)
Beginning balance
$
131

 
$
(5
)
 
$
(68
)
 
$
1

 
$
59

Other comprehensive income (loss) before reclassifications
(32
)
 

 
13

 
1

 
(18
)
Less: Amount of gain (loss) reclassified from accumulated other comprehensive income
40

 
(1
)
 

 

 
39

Net current period other comprehensive income (loss)
(72
)
 
1

 
13

 
1

 
(57
)
Ending balance
$
59

 
$
(4
)
 
$
(55
)
 
$
2

 
$
2


The following table summarizes the changes in accumulated balances of other comprehensive income for the three months ended March 31, 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
$
57

 
$
(16
)
 
$
(53
)
 
$
3

 
$
(9
)
Other comprehensive income (loss) before reclassifications
(4
)
 
9

 
8

 
(2
)
 
11

Less: Amount of gain reclassified from accumulated other comprehensive income
32

 
(3
)
 

 

 
29

Net current period other comprehensive income (loss)
(36
)
 
12

 
8

 
(2
)
 
(18
)
Ending balance
$
21

 
$
(4
)
 
$
(45
)
 
$
1

 
$
(27
)
The following table provides details about reclassifications out of accumulated other comprehensive income for the three months ended March 31, 2017 and 2016:
Details about Accumulated Other Comprehensive
Income Components
 
Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income
 
Affected Line Item in the Statement of Income
 
 
Three Months Ended March 31,
 
 
 
 
2017
 
2016
 
 
 
 
(In millions)
 
 
Gains on cash flow hedges-foreign exchange contracts
 
$
40

 
$
32

 
Net revenues
Unrealized losses on investments
 
(1
)
 
(3
)
 
Other income (expense), net
 
 
$
39

 
$
29

 
Income before income taxes
 
 

 

 
Income tax expense
Total reclassifications for the period
 
$
39

 
$
29

 
Net income




29

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

Note 18 - Subsequent Events

In April 2017, our Board of Directors authorized a stock repurchase program that provides for the repurchase of up to $5 billion of our common stock, with no expiration from the date of authorization. This program will become effective upon completion of the January 2016 stock repurchase program. This stock repurchase program is intended to offset the impact of dilution from our equity compensation programs and, subject to market conditions and other factors, to be used to make opportunistic repurchases of our common stock to reduce outstanding share count. Any share repurchases under this 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 this stock repurchase program at any time without notice.




30


Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations


This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements that involve expectations, plans or intentions (such as those relating to future business, future results of operations or financial condition, new or planned features or services, or management strategies). These forward-looking statements can be identified by words such as “may,” “will,” “would,” “should,” “could,” “expect,” “anticipate,” “believe,” “estimate,” “intend,” “plan” and other similar expressions. These forward-looking statements involve risks and uncertainties that could cause our actual results and financial condition to differ materially from those expressed or implied in our forward-looking statements. Such risks and uncertainties include, among others, those discussed in Part I, Item 1A, Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2016 (the "2016 Form 10-K"), as supplemented and, to the extent inconsistent, superseded by some of the information in the risk factors set forth below in Part II, Item 1A, Risk Factors, of this Form 10-Q, as well as in our unaudited condensed consolidated financial statements, related notes, and the other information appearing elsewhere in this report and our other filings with the Securities and Exchange Commission, or the SEC. We do not intend, and undertake no obligation, to update any of our forward-looking statements after the date of this report to reflect actual results or future events or circumstances. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes that appear elsewhere in this report. Unless otherwise expressly stated or the context otherwise requires, references to “we,” “our,” “us,” “the Company” and “PayPal” refer to PayPal Holdings, Inc. and its consolidated subsidiaries.

Business Environment

We are a leading technology platform and digital payments company that enables digital and mobile payments on behalf of consumers and merchants worldwide. Our vision is to democratize financial services, as we believe that managing and moving money is a right for all people, not just the affluent. Our goal is to increase our relevance for consumers and merchants to manage and move their money anywhere in the world, anytime, on any platform and using any device. Our combined payment solutions, including our PayPal, PayPal Credit, Braintree, Venmo, Xoom, and Paydiant products, compose our proprietary Payments Platform.

We operate globally and 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. We are subject to regulations that affect the payments industry in the markets in which we operate. Non-compliance with laws and regulations, increased penalties and enforcement actions related to non-compliance, changes in laws and regulations or their interpretation, 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.

The United Kingdom (U.K.) held a referendum on June 23, 2016 in which a majority of voters approved an exit from the European Union (EU) (“Brexit”). The outcome of this referendum caused volatility in global stock markets and foreign currency exchange rate fluctuations and uncertainty about the terms and impact of Brexit may continue to do so in the future. On March 29, 2017, the U.K. government gave formal notice of its intention to leave the EU and started the process of negotiating the future terms of the U.K.'s relationship with the EU. Brexit could adversely affect U.K., regional (including European) and worldwide economic and market conditions and could contribute to instability in global financial and foreign exchange markets, including volatility in the value of the British Pound and Euro. We have foreign exchange exposure management programs designed to help minimize the impact from foreign currency rate movements. For the three months ended March 31, 2017 and 2016, net revenues generated from our U.K. operations constituted 11% and 12%, respectively, of total net revenues. During each of these periods, net revenues generated from the EU (excluding the U.K.) constituted less than 20% of total net revenues. For additional information on how Brexit could affect our business, see Part II, Item 1A—Risk Factors—“The United Kingdom’s departure from the European Union could adversely affect us” in this Form 10-Q.


31


Overview of Results of Operations

The following table provides a summary of our consolidated GAAP financial measures for the three months ended March 31, 2017 and 2016:
 
Three Months Ended March 31,
 
Percent Increase/(Decrease)
 
2017
 
2016
 
 
(In millions, except percentages and per share data)
Net revenues
$
2,975

 
$
2,544

 
17
 %
Operating expenses
2,544

 
2,137

 
19
 %
Operating income
431

 
407

 
6
 %
Operating margin
14
%
 
16
%
 
**

Income tax expense
54

 
57

 
(5
)%
Effective tax rate
12
%
 
14
%
 
**

Net income
$
384

 
$
365

 
5
 %
Net income per diluted share
$
0.32

 
$
0.30

 
6
 %
Net cash provided by operating activities
$
751

 
$
738

 
2
 %
All amounts in tables are rounded to the nearest millions, except as otherwise noted. As a result, certain amounts may not recalculate using the rounded amounts provided.
** Not Meaningful

Net revenues increased $431 million, or 17%, in the three months ended March 31, 2017 compared to the same period of the prior year primarily driven by growth in TPV (as defined below under "Net Revenues") of 23% compared to the same period of the prior year.

Total operating expenses increased $407 million, or 19%, in the three months ended March 31, 2017 compared to the same period of the prior year due primarily to increases in transaction expense, transaction and loan losses, restructuring and general and administrative expenses.

Operating income increased $24 million, or 6%, in the three months ended March 31, 2017 compared to the same period of the prior year due to the increase in net revenues partly offset by the growth in operating expenses. Our operating margin was 14% and 16% in the three months ended March 31, 2017 and 2016, respectively. Operating margin decreased primarily due to growth in transaction expense and transaction and loan losses, which increased 28% in the three months ended March 31, 2017 compared to net revenues which increased 17% in the three months ended March 31, 2017 and restructuring expense of $40 million recognized in the three months ended March 31, 2017. The decrease in operating margin was partially offset by operating efficiencies in our business, which resulted in other expenses, including customer support and operations, sales and marketing, product development, general and administrative, depreciation and amortization and restructuring expenses, increasing 11%, or lower than the growth in net revenues in the three months ended March 31, 2017.
 
Net income increased by $19 million, or 5%, in the three months ended March 31, 2017 compared to the same period of the prior year due to the increase in operating income of $24 million and a decrease in income tax expense of $3 million partially offset by a decrease in other income (expense), net of $8 million. For the three months ended March 31, 2017, our diluted net income per share was $0.32, a $0.02 increase compared to the same period of the prior year.

32



Non-GAAP financial measures

The following table provides a summary of our consolidated non-GAAP financial measures for the three months ended March 31, 2017 and 2016:
 
Three Months Ended March 31,
 
Percent Increase/(Decrease)
 
2017
 
2016
 
 
(In millions, except percentages and per share data)
Non-GAAP operating income
$
643

 
$
537

 
20
 %
Non-GAAP operating margin
22
%
 
21
%
 
**

Non-GAAP income tax expense
$
116

 
$
100

 
16
 %
Non-GAAP net income
$
534

 
$
452

 
18
 %
Non-GAAP net income per diluted share
$
0.44

 
$
0.37

 
19
 %
Free cash flow
$
603

 
$
605

 
0
 %
All amounts in tables are rounded to the nearest millions, except as otherwise noted. As a result, certain amounts may not recalculate using the rounded amounts provided.
** Not meaningful

Non-GAAP operating income, non-GAAP operating margin, non-GAAP income tax expense, non-GAAP net income, non-GAAP net income per diluted share and free cash flow are not financial measures prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). For information on how we compute these non-GAAP financial measures and a reconciliation to the most directly comparable financial measures prepared in accordance with GAAP, please refer to “Non-GAAP Financial Information” below.

Impact of Foreign Currency Exchange Rates
We have significant operations internationally that are denominated in foreign currencies, primarily the British Pound, Euro, Australian Dollar and Canadian Dollar, subjecting us to foreign currency risk which may adversely impact our financial results. The strengthening or weakening of the U.S. dollar versus the British Pound, Euro, Australian Dollar and Canadian Dollar, as well as other currencies in which we conduct our international operations, impacts the translation of our net revenues and expenses generated in these foreign currencies into the U.S. dollar. In the three months ended March 31, 2017 and 2016, we generated approximately 46% and 47% of our net revenues from customers domiciled outside of the United States (U.S.), respectively. Other than the U.S., the United Kingdom (U.K.) was the only country where we generated more than 10% of total net revenues in the three months ended March 31, 2017 and 2016. During each of these periods, net revenues generated from the EU (excluding the U.K.) constituted less than 20% of total net revenues. Because we have generated substantial net revenues internationally in recent periods, including during the periods presented, we are subject to the risks of doing business in foreign countries. See Part I, Item 1A, Risk Factors in our 2016 Form 10-K, as supplemented and, to the extent inconsistent, superseded below in Part II, Item 1A, Risk Factors in this Form 10-Q.
We calculate the year-over-year impact of foreign currency movements on our business using prior period foreign currency exchange rates applied to current period transactional currency amounts. While changes in foreign currency exchange rates affect our reported results, we have a foreign currency exchange exposure management program whereby we designate certain foreign currency exchange contracts as cash flow hedges to help minimize the impact on earnings from foreign currency rate movements. Gains and losses from these foreign currency exchange contracts are recognized as a component of transaction revenues in the same period the forecasted transactions impact earnings.


33


In the three months ended March 31, 2017 and March 31, 2016, the year-over-year foreign currency movements relative to the U.S. dollar had the following impact on our reported results:
 
Three Months Ended March 31, 2017
 
(In millions)
Unfavorable impact to net revenues (exclusive of hedging impact)
$
(56
)
Hedging impact
40

Unfavorable impact to net revenues
(16
)
Favorable impact to operating expense
15

Net impact to operating income
$
(1
)

 
Three Months Ended March 31, 2016
 
(In millions)
Unfavorable impact to net revenues (exclusive of hedging impact)
$
(47
)
Hedging impact
32

Unfavorable impact to net revenues
(15
)
Favorable impact to operating expense
30

Net impact to operating income
$
15


While we enter into foreign currency exchange contracts to minimize the impact on earnings from foreign currency rate movements, it is impossible to predict or eliminate the effects of this exposure.
Additionally, in connection with our services in multiple currencies, we generally set our foreign currency exchange rates twice per day, and may face financial exposure if we incorrectly set our foreign currency exchange rates or as a result of fluctuations in foreign currency exchange rates between the times that we set our foreign currency exchange rates. Given that we also have foreign exchange risk on our assets and liabilities denominated in currencies other than the functional currency of our subsidiaries, we have an additional foreign currency exchange exposure management program whereby we use foreign currency exchange contracts to offset 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 are offset by the gains and losses on the foreign currency exchange contracts. These foreign exchange contracts reduce, but do not entirely eliminate, the impact of currency exchange rate movements on our assets and liabilities.

Financial Results

Net revenues

We earn revenue from the following types of transactions:

Transaction revenues: Net transaction fees charged to consumers and merchants primarily based on the volume of activity, or Total Payments Volume (“TPV”), processed through our Payments Platform. We define TPV as the value of payments, net of payment reversals, successfully completed through our Payments Platform, excluding transactions processed through our gateway and Paydiant products. Growth in TPV is directly impacted by the number of payment transactions that we enable on our Payments Platform. Payment transactions are the total number of payments, net of payment reversals, successfully completed through our Payments Platform, excluding transactions processed through our gateway and Paydiant products. We earn additional fees on transactions settled in foreign currencies when we enable cross-border transactions (i.e., transactions where the merchant or consumer were in different countries).

Other value added services: Net revenues derived principally from interest and fees earned on our PayPal Credit loans receivable portfolio, subscription fees, gateway fees, gain on sale of participation interests in certain consumer loans receivable, revenue share we earn through partnerships, interest earned on certain PayPal customer account balances, fees earned through our Paydiant products and other services that we provide to consumers and merchants.

34


Net revenue analysis

The components of our net revenue for the three months ended March 31, 2017 and 2016 were as follows:
 
Three Months Ended March 31,
 
Percent Increase/(Decrease)
 
2017
 
2016
 
 
(In millions, except percentages)
Transaction revenues
$
2,599

 
$
2,238

 
16
%
Other value-added services
376

 
306

 
23
%
Net revenues
$
2,975

 
$
2,544

 
17
%

Transaction revenue grew by $361 million, or 16%, for the three months ended March 31, 2017. The increase in transaction revenues in the three months ended March 31, 2017 was due primarily to the growth in TPV primarily from our PayPal and Braintree products.

The following table provides a summary of our active customer accounts, number of payment transactions, TPV and related metrics:
 
Three Months Ended March 31,
 
Percent Increase/(Decrease)
 
2017
 
2016
 
 
(In millions, except percentages)
Active customer accounts1
203

 
184

 
11
%
Number of payment transactions2
1,732

 
1,414

 
23
%
Payment transactions per active account3
31.7

 
28.4

 
12
%
Total TPV4
$
99,327

 
$
81,056

 
23
%
Percent of cross-border TPV
21
%
 
23
%
 
**

All amounts in tables are rounded to the nearest millions, except as otherwise noted. As a result, certain amounts may not recalculate using the rounded amounts provided.
1 An active customer account is a registered account that successfully sent or received at least one payment or payment reversal through our Payments Platform, excluding transactions processed through our gateway and Paydiant products, in the past 12 months.
2 Payment transactions are the total number of payments, net of payment reversals, successfully completed through our Payments Platform, excluding transactions processed through our gateway and Paydiant products.
3 Number of payment transactions per active customer account reflects the total number of payment transactions within the previous 12 month period, divided by active customer accounts at the end of the period
4 Total Payment Volume or “TPV” is the value of payments, net of payment reversals, successfully completed through our Payments Platform, excluding transactions processed through our gateway and Paydiant products.
** Not meaningful

Transaction revenues grew more slowly than both TPV and payment transactions for the three months ended March 31, 2017 due to a higher portion of person-to-person ("P2P") transactions, primarily from our PayPal P2P and Venmo products for which we earn lower rates, and a higher portion of TPV generated by large merchants who generally pay lower rates with higher transaction volume. Changes in prices charged to our customers did not significantly impact revenue growth for the three months ended March 31, 2017.

For the three months ended March 31, 2017, net revenues from other value-added services increased $70 million, or 23%, compared to the same period in the prior year due primarily to interest and fee income earned on our PayPal Credit loans receivable portfolio. The total consumer and merchant loans receivable balance as of March 31, 2017 and March 31, 2016 was $5.7 billion and $4.5 billion, respectively, reflecting a year-over-year increase of 27%.

35




Operating Expenses

The following table summarizes our operating expenses and related metrics we use to assess the trend in each:
 
Three Months Ended March 31,
 
Percent Increase/(Decrease)
 
2017
 
2016
 
 
(In millions, except percentages)
Transaction expense
$
987

 
$
752

 
31
%
Transaction and loan losses
300

 
255

 
18
%
Customer support and operations
317

 
296

 
7
%
Sales and marketing
238

 
233

 
2
%
Product development
214

 
195