PayPal Holdings
PayPal Holdings, Inc. (Form: 10-Q, Received: 10/24/2017 16:48:56)

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 October 18, 2017 , there were 1,201,910,314 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.
 

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PayPal Holdings, Inc.
TABLE OF CONTENTS

 
 
 
Page Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



2

Table of Contents

PART I: FINANCIAL INFORMATION

Item 1: Financial Statements

PayPal Holdings, Inc.
CONDENSED CONSOLIDATED BALANCE SHEET
 
September 30,
2017
 
December 31,
2016
 
(In millions, except par value)
 
(Unaudited)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
2,330

 
$
1,590

Short-term investments
2,591

 
3,385

Accounts receivable, net
301

 
214

Loans and interest receivable, net of allowances of $429 in 2017 and $339 in 2016
6,321

 
5,348

Funds receivable and customer accounts
17,175

 
14,363

Prepaid expenses and other current assets
719

 
833

Total current assets
29,437

 
25,733

Long-term investments
2,217

 
1,539

Property and equipment, net
1,485

 
1,482

Goodwill
4,326

 
4,059

Intangible assets, net
226

 
211

Other assets
70

 
79

Total assets
$
37,761

 
$
33,103

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts and notes payable
$
974

 
$
192

Funds payable and amounts due to customers
17,975

 
15,163

Accrued expenses and other current liabilities
1,665

 
1,459

Income taxes payable
89

 
64

Total current liabilities
20,703

 
16,878

Deferred tax liability and other long-term liabilities
1,626

 
1,513

Total liabilities
22,329

 
18,391

Commitments, Contingencies and Notes Payable (Note 11)

 


Equity:
 
 
 
Common stock, $0.0001 par value; 4,000 shares authorized; 1,202 and 1,207 outstanding

 

Treasury stock at cost, 43 and 27 shares
(1,701
)
 
(995
)
Additional paid-in-capital
14,071

 
13,579

Retained earnings
3,204

 
2,069

Accumulated other comprehensive income (loss)
(142
)
 
59

Total equity
15,432

 
14,712

Total liabilities and equity
$
37,761

 
$
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 September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(In millions, except per share data)
 
(Unaudited)
Net revenues
$
3,239

 
$
2,667

 
$
9,350

 
$
7,861

Operating expenses:
 
 
 
 
 
 
 
Transaction expense
1,102

 
830

 
3,153

 
2,392

Transaction and loan losses
363

 
271

 
971

 
781

Customer support and operations
346

 
325

 
998

 
939

Sales and marketing
278

 
233

 
800

 
716

Product development
240

 
215

 
686

 
619

General and administrative
293

 
261

 
840

 
753

Depreciation and amortization
194

 
184

 
578

 
535

Restructuring

 

 
40

 

Total operating expenses
2,816

 
2,319

 
8,066

 
6,735

Operating income
423

 
348

 
1,284

 
1,126

Other income (expense), net
28

 
12

 
52

 
36

Income before income taxes
451

 
360

 
1,336

 
1,162

Income tax expense
71

 
37

 
161

 
151

Net income
$
380

 
$
323

 
$
1,175

 
$
1,011

 
 
 
 
 
 
 
 
Net income per share:
 
 
 
 
 
 
 
Basic
$
0.32

 
$
0.27

 
$
0.98

 
$
0.83

Diluted
$
0.31

 
$
0.27

 
$
0.96

 
$
0.83

 
 
 
 
 
 
 
 
Weighted average shares:
 
 
 
 
 
 
 
Basic
1,202

 
1,207

 
1,203

 
1,211

Diluted
1,223

 
1,214

 
1,218

 
1,218

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 September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(In millions)
 
(Unaudited)
Net income
$
380

 
$
323

 
$
1,175

 
$
1,011

Other comprehensive income (loss), net of reclassification adjustments:
 
 
 
 
 
 
 
Foreign currency translation
9

 
1

 
38

 
4

Unrealized gains (losses) on investments, net
4

 
(3
)
 
5

 
18

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

 
(2
)
 
(4
)
Unrealized gains (losses) on hedging activities, net
(57
)
 
(13
)
 
(246
)
 
30

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

 
1

 
4

 

Other comprehensive income (loss), net of tax
(44
)
 
(13
)
 
(201
)
 
48

Comprehensive income
$
336

 
$
310

 
$
974

 
$
1,059

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


5


PayPal Holdings, Inc.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
 
Nine Months Ended September 30,
 
2017
 
2016
 
(In millions)
 
(Unaudited)
Cash flows from operating activities:
 
 
 
Net income
$
1,175

 
$
1,011

Adjustments:
 
 
 
Transaction and loan losses
971

 
781

Depreciation and amortization
578

 
535

Stock-based compensation
514

 
313

Deferred income taxes
13

 
71

Excess tax benefits from stock-based compensation

 
(36
)
Gain on sale of principal loans receivable held for sale, net
(16
)
 
(17
)
Changes in assets and liabilities:
 
 
 
Accounts receivable
(5
)
 
(50
)
Principal loans receivable held for sale, net
16

 
17

Accounts payable
4

 
28

Income taxes payable
24

 
51

Other assets and liabilities
(596
)
 
(469
)
Net cash provided by operating activities
2,678

 
2,235

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(487
)
 
(517
)
Changes in principal loans receivable, net
(1,154
)
 
(884
)
Purchases of investments
(14,227
)
 
(16,984
)
Maturities and sales of investments
13,027

 
14,614

Acquisitions, net of cash acquired
(323
)
 
(19
)
Funds receivable and customer accounts
(1,236
)
 
620

Net cash (used in) investing activities
(4,400
)
 
(3,170
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of common stock
100

 
58

Purchases of treasury stock
(706
)
 
(945
)
Excess tax benefits from stock-based compensation

 
36

Tax withholdings related to net share settlements of equity awards
(140
)
 
(95
)
Borrowings under financing arrangements, net of repayments
620

 
(21
)
Funds payable and amounts due to customers
2,553

 
1,862

Net cash provided by financing activities
2,427

 
895

Effect of exchange rate changes on cash and cash equivalents
35

 
16

Net change in cash and cash equivalents
740

 
(24
)
Cash and cash equivalents at beginning of period
1,590

 
1,393

Cash and cash equivalents at end of period
$
2,330

 
$
1,369

Supplemental cash flow disclosures:
 
 
 
Cash paid for interest
$
3

 
$
3

Cash paid for income taxes
$
88

 
$
43


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 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, Paydiant, and TIO 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; however, we expect to expand certain disclosures as required. 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 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 and on a prospective basis to all outstanding equity investments without a readily determinable fair value . We will adopt the guidance on January 1, 2018 and prospectively apply the measurement alternative to our cost method investments, which will require us to measure these equity investments at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for an identical or similar investment in the same issuer. The amount of the impact to long-term investments will depend on any price changes observed after adoption on January 1, 2018.

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 12 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 will require changes in cash and cash equivalents

8

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

underlying customer accounts and restricted cash to be included in the reconciliation of beginning and ending balances shown on the statement of cash flows.

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 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.  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 with 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.

In 2017, the FASB issued new guidance clarifying which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. Specifically, an entity would apply modification accounting only if the fair value, vesting conditions, or classification of the awards changes as a result of changes in the terms or conditions. 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 will be applied prospectively upon adoption. The amount of the impact to share-based compensation expense will depend on the terms specified in any new changes to the share-based payment awards.

In 2017, the FASB issued new guidance intended to better align the results of hedge accounting with an entity’s risk management activities. This guidance updates the designation and measurement guidance for qualifying hedging relationships by expanding hedge accounting for both nonfinancial and financial risk components and by refining the measurement of hedge results to better reflect an entity’s hedging strategies. The amendments will also align the recognition and presentation of the effects of the hedge results in the financial statements to increase the understandability of the results of an entity’s intended hedging strategies. Additionally, the guidance includes certain targeted improvements to ease the operational burden of applying hedge accounting. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted.  We are required to apply the guidance with a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year in which the guidance is adopted and prospectively apply the presentation and disclosure guidance. 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 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 and nine months ended September 30, 2017, we recognized approximately $6 million and $30 million , respectively, 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

9

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

prepaid taxes related to the unamortized tax expense attributed to intra-entity transfers of assets previously deferred. Additionally, for the three and nine months ended September 30, 2017 we did not recognize approximately $4 million and $12 million , respectively, of amortization of prepaid taxes 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. For both the three and nine months ended September 30, 2017, we recognized $23 million of income tax expense associated with intra-entity asset transfers which occurred during the periods.

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 September 30,
 
Nine Months Ended September 30,
 
2017
  
2016
 
2017
  
2016
 
(In millions, except per share amounts)
Numerator:
 
 
 
 
 
 
 
Net income
$
380

 
$
323

 
$
1,175

 
$
1,011

Denominator:
 
 
 
 
 
 
 
Weighted average shares of common stock - basic
1,202

 
1,207

 
1,203

 
1,211

Dilutive effect of equity incentive awards
21

 
7

 
15

 
7

Weighted average shares of common stock - diluted
1,223

 
1,214

 
1,218

 
1,218

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.32

 
$
0.27

 
$
0.98

 
$
0.83

Diluted
$
0.31

 
$
0.27

 
$
0.96

 
$
0.83

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

 
11

 
2

 
9


Note 3 - Business Combinations

During the three and nine months ended September 30, 2017, we completed two acquisitions, reflecting 100% of the equity interests of the acquired companies, for an aggregate purchase price of $421 million :

TIO Networks Corp.

We completed the acquisition of TIO Networks Corp. (“TIO”) in July 2017 by acquiring all of the outstanding shares of TIO for $2.64 USD per share in cash. We acquired TIO to expand our scale of operations, complement our product portfolio, and to help accelerate our entry into bill payments. The total purchase price of $238 million consisted of cash consideration. The allocation of purchase consideration resulted in approximately $66 million of technology and customer-related intangible assets with an estimated useful life of 1 to 5 years, net assets of approximately $15 million and initial goodwill of approximately $157 million , which is attributable to the workforce of TIO and the synergies expected to arise from the acquisition. We do not expect goodwill to be deductible for income tax purposes. The allocation of the purchase price for this acquisition has been prepared on a preliminary basis and changes to the allocation to certain assets, liabilities and tax estimates may occur as additional information becomes available.


10

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

Swift Financial Corporation

We completed the acquisition of Swift Financial Corporation (“Swift Financial”) in September 2017 by acquiring all of the outstanding shares for a total purchase price of approximately $183 million . We acquired Swift Financial to enable us to enhance our underwriting capabilities and strengthen our business financing offerings, helping us to deepen relationships with our existing merchants and expand services to new merchants. The allocation of purchase consideration resulted in approximately $44 million of technology and customer-related intangible assets with an estimated useful life of 1 to 3 years, $173 million of merchant receivables, net liabilities of approximately $139 million and initial goodwill of approximately $105 million , which is attributable to the workforce of Swift Financial and the synergies expected to arise from the acquisition. We do not expect goodwill to be deductible for income tax purposes. The gross contractual merchant receivables acquired are approximately $213 million . Management estimates that the cash collected will approximate the contractual amounts of merchant receivables. The allocation of the purchase price for this acquisition has been prepared on a preliminary basis and changes to the allocation to certain assets, liabilities and tax estimates may occur as additional information becomes available.

We have included the financial results of TIO and Swift Financial in our consolidated financial statements from their respective date of acquisition. Revenues and expenses related to these acquisitions for the three and nine months ended September 30, 2017 were not material. Pro-forma results of operations have not been presented because the effect of these acquisitions were not material to our financial results.

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 nine months ended September 30, 2017 :
 
December 31,
2016
 
Goodwill
Acquired
 
Adjustments
 
September 30,
2017
 
 (In millions)
Total Goodwill
$
4,059

 
$
262

 
$
5

 
$
4,326


Intangible Assets

The components of identifiable intangible assets are as follows:
 
September 30, 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
$
646

 
$
(555
)
 
$
91

 
4
 
$
605

 
$
(542
)
 
$
63

 
4
Marketing related
198

 
(194
)
 
4

 
1
 
197

 
(190
)
 
7

 
2
Developed technologies
274

 
(204
)
 
70

 
3
 
245

 
(206
)
 
39

 
3
All other
245

 
(184
)
 
61

 
5
 
245

 
(143
)
 
102

 
5
Intangible assets, net
$
1,363

 
$
(1,137
)
 
$
226

 
 
 
$
1,292

 
$
(1,081
)
 
$
211

 
 
        

11

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

Amortization expense for intangible assets was $28 million and $37 million for the three months ended September 30, 2017 and 2016 , respectively. Amortization expense for intangible assets was $96 million and $114 million for the nine months ended September 30, 2017 and 2016 , respectively.

Expected future intangible asset amortization as of September 30, 2017 was as follows (in millions):
Fiscal years:
 
Remaining 2017
$
29

2018
92

2019
52

2020
39

2021
14

 
$
226


Note 5 - Geographical Information

The following tables summarize the allocation of net revenues and long-lived assets based on geography:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
  
2016
 
2017
  
2016
 
(In millions)
Net revenues:
 
 
 
 
 
 
 
U.S.
$
1,743

 
$
1,436

 
$
5,039

 
$
4,186

U.K.
351

 
298

 
998

 
923

Other Countries
1,145

 
933

 
3,313

 
2,752

Total net revenues
$
3,239

 
$
2,667

 
$
9,350

 
$
7,861


 
September 30,
2017
  
December 31,
2016
 
(In millions)
Long-lived assets:
 
 
 
U.S.
$
1,395

 
$
1,391

Other Countries
90

 
91

Total long-lived assets
$
1,485

 
$
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 September 30, 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.


12

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

Note 6 - Funds Receivable and Customer Accounts

The following table summarizes the assets underlying our funds receivable and customer accounts as of September 30, 2017 and December 31, 2016 .
 
September 30,
2017
 
December 31,
2016
 
(In millions)
Cash and cash equivalents
$
5,117

 
$
4,319

Government and agency securities
6,757

 
5,625

Time deposits
568

 
522

Corporate debt securities
1,491

 
1,093

Funds receivable
3,242

 
2,804

Total funds receivable and customer accounts
$
17,175

 
$
14,363


As of September 30, 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:
 
September 30, 2017
 
Gross
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
(In millions)
Government and agency securities
$
6,224

 
$

 
$
(3
)
 
$
6,221

Corporate debt securities
618

 

 

 
618

Total
$
6,842

 
$

 
$
(3
)
 
$
6,839


 
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

Corporate debt securities
531

 

 

 
531

Total
$
5,729

 
$

 
$
(2
)
 
$
5,727


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 September 30, 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 $1.4 billion and $1.0 billion , respectively. In the three months ended September 30, 2017 and 2016 , $49 million and $10 million of net gains from fair value changes, respectively, were recognized in other income (expense), net on the condensed consolidated statement of income. In the nine months ended September 30, 2017 and 2016 , $ 154 million and $3 million of net gains from fair value changes 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 $5.3 billion as of September 30, 2017 and $4.1 billion as of December 31, 2016. The aggregate gross unrealized loss on our investments was not material as of September 30, 2017 and December 31, 2016. We believe the decline in value is due to temporary market conditions and expect to recover the entire amortized cost basis of the securities. We neither intend nor anticipate the need to sell the securities before recovery. We continue to monitor the performance of the investment portfolio and assess market and interest rate risk when evaluating whether other-than-temporary impairment exists.

13

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


As of September 30, 2017 and December 31, 2016, we had no material investments that have been in a continuous unrealized loss position for greater than 12 months. Amounts reclassified to earnings from unrealized gains and losses were not material for the three and nine months ended September 30, 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 September 30, 2017 were as follows:
 
September 30,
2017
 
(In millions)
One year or less
$
6,732

One year through two years
50

Two years through three years
57

Total
$
6,839


Note 7 - Investments

As of September 30, 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:
 
September 30, 2017
 
Gross
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
(In millions)
Short-term investments (1)(2) :
 
  
 
  
 
 
 
Corporate debt securities
$
2,020

 
$
1

 
$

 
$
2,021

Government and agency securities
157

 

 

 
157

Long-term investments (1) :
 
 
 
 
 
 


Corporate debt securities
1,943

 
5

 
(2
)
 
1,946

Government and agency securities
106

 
1

 

 
107

Total (1)
$
4,226

 
$
7

 
$
(2
)
 
$
4,231

(1) Excludes short-term restricted cash of $81 million that we intend to use to support our global sabbatical program and a counterparty guarantee, and long-term restricted cash of $2 million .
(2) Excludes time deposits of $71 million , which are not considered available-for-sale securities.

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

 
$
1

 
$
(1
)
 
$
2,867

Government and agency securities
32

 

 

 
32

Long-term investments:
 
 
 
 
 
 
 
Corporate debt securities
1,473

 
1

 
(4
)
 
1,470

Government and agency securities
10

 

 

 
10

Total (1)
$
4,382

 
$
2

 
$
(5
)
 
$
4,379

(1) Excludes short-term restricted cash of $17 million that we intend to use to support our global sabbatical program.
(2) Excludes time deposits of $122 million , which are not considered available-for-sale securities.

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

14

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

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 September 30, 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 $340 million and $356 million , respectively. In the three and nine months ended September 30, 2017 , $10 million and $35 million , respectively, of net gains from fair value changes were recognized in other income (expense), net on the condensed consolidated statement of income. In the three and nine months ended September 30, 2016, $11 million and $26 million , respectively, of net losses from fair value changes 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 $1.7 billion as of September 30, 2017 and $2.2 billion as of December 31, 2016. The aggregate gross unrealized loss on our short-term and long-term investments was not material as of September 30, 2017 and December 31, 2016. We believe the decline in value is due to temporary market conditions and expect to recover the entire amortized cost basis of the securities. We neither intend nor anticipate the need to sell the securities before recovery. We continue to monitor the performance of the investment portfolio and assess market and interest rate risk when evaluating whether other-than-temporary impairment exists.

As of September 30, 2017 and December 31, 2016, we had no material long-term or short-term investments that have been in a continuous unrealized loss position for greater than 12 months. Amounts reclassified to earnings from unrealized gains and losses were not material for the three and nine months ended September 30, 2017 and 2016 .

The estimated fair values of our short-term and long-term investments classified as available-for-sale by date of contractual maturity at September 30, 2017 were as follows:
 
September 30, 2017
 
(In millions)
One year or less
$
2,178

One year through two years
1,092

Two years through three years
675

Three years through four years
146

Four years through five years
127

Greater than five years
13

Total
$
4,231


Other Investments

We have cost method investments which are reported in long-term investments on our condensed consolidated balance sheet. Our cost method investments consist primarily of minority equity interests in privately held companies and totaled $83 million and $50 million as of September 30, 2017 and December 31, 2016 , respectively. The increase in our cost method investments was due to additional investments made in the nine months ended September 30, 2017 .


15

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

Note 8 - Fair Value Measurement of Assets and Liabilities

Financial Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis

The following tables summarize our financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2017 and December 31, 2016 :

 
Balances at
September 30, 2017
 
 
Significant Other
Observable Inputs
(Level 2)
 
 
(In millions)
Assets:
 
 
 
 
 
Cash and cash equivalents (1)
 
$
675

 
 
$
675

Short-term investments (2) :
 
 
 
 
 
Corporate debt securities
 
2,149

 
 
2,149

Government and agency securities
 
290

 
 
290

Total short-term investments
 
$
2,439

 
 
$
2,439

Funds receivable and customer accounts (3)
 
8,248

 
 
8,248

Derivatives
 
80

 
 
80

Long-term investments (2) :
 
 
 
 
 
Corporate debt securities
 
2,012

 
 
2,012

Government and agency securities
 
120

 
 
120

Total long-term investments
 
2,132

 
 
2,132

Total financial assets
 
$
13,574

 
 
$
13,574

Liabilities:
 
 
 
 
 
Derivatives
 
$
214

 
 
$
214

(1) Excludes cash of $1.7 billion not subject to fair value measurement on a recurring basis.
(2) Excludes restricted cash of $83 million and time deposits of $71 million not subject to fair value measurement on a recurring basis.
(3) Excludes cash, time deposits and funds receivable of $8.9 billion underlying funds receivable and customer accounts not subject to fair value measurement on a recurring basis.

16

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


 
Balances at
December 31, 2016
 
 
Significant Other
Observable Inputs
(Level 2)
 
 
(In millions)
Assets:
 
 
 
 
 
Cash and cash equivalents (1)
 
$
268

 
 
$
268

Short-term investments (2) :
 
 
 
 
 
Corporate debt securities
 
2,882

 
 
2,882

Government and agency securities
 
364

 
 
364

Total short-term investments
 
3,246

 
 
3,246

Funds receivable and customer accounts (3)
 
6,898

 
 
6,898

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
 
$
12,124

 
 
$
12,124

Liabilities:
 
 
 
 
 
Derivatives
 
$
59

 
 
$
59

(1) Excludes cash of $1.3 billion not subject to fair value measurement on a recurring basis.
(2) Excludes restricted cash of $17 million and time deposits of $122 million not subject to fair value measurement on a recurring basis.
(3) Excludes cash, time deposits and funds receivable of $7.5 billion underlying funds receivable and customer accounts not subject to fair value measurement on a recurring basis.

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 nine months ended September 30, 2017 and 2016 . As of September 30, 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."


17

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

Financial Assets and Liabilities Not Measured and Recorded at Fair Value

Our financial instruments, including cash, time deposits, accounts receivable, loans and interest receivable, funds receivable, certain customer accounts, accounts and notes payable, and funds payable and amounts due to customers are carried at cost, which approximates their fair value due to the short-term maturity of these instruments. If these financial instruments were measured at fair value in the financial statements, cash would be classified as Level 1, time deposits, certain customer accounts, and notes payable would be classified as Level 2, and the remaining financial instruments would be classified as Level 3 in the fair value hierarchy.

Note 9 - Derivative Instruments

Summary of Derivative Instruments

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

Foreign Exchange Contracts

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

For our derivative instruments designated as cash flow hedges, the amounts recognized in earnings related to the ineffective portion were not material in each of the periods presented, and we did not exclude any component of the changes in fair value of the derivative instruments from the assessment of hedge effectiveness. During the three and nine months ended September 30, 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 September 30, 2017 , we estimated that $107 million of net derivative losses 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.


18

Table of Contents
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 September 30, 2017 and December 31, 2016 was as follows:
 
Balance Sheet Location
 
September 30,
2017
 
December 31,
2016
 
 
 
(In millions)
Derivative Assets:
 
 
 
 
 
Foreign exchange contracts designated as cash flow hedges
Other current assets
 
$
4

 
$
135

Foreign exchange contracts not designated as hedging instruments
Other current assets
 
76

 
88

Total derivative assets
 
 
$
80

 
$
223

 
 
 
 
 
 
Derivative Liabilities:
 
 
 
 
 
Foreign exchange contracts designated as cash flow hedges
Other current liabilities
 
$
95

 
$
4

Foreign exchange contracts designated as cash flow hedges
Other long-term liabilities
 
7

 

Foreign exchange contracts not designated as hedging instruments
Other current liabilities
 
112

 
55

Total derivative liabilities
 
 
$
214

 
$
59

 
 
 
 
 
 
Net fair value of derivative instruments
 
 
$
(134
)
 
$
164


Master Netting Agreements - Rights of Setoff

Under master netting agreements with 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 condensed consolidated balance sheet. Rights of setoff associated with our foreign exchange contracts represented a potential offset to both assets and liabilities by $53 million as of September 30, 2017 and $44 million as of December 31, 2016. During the three months ended September 30, 2017, we entered into collateral security arrangements that provide for collateral to be received or posted when the net fair value of certain financial instruments fluctuates from contractually established thresholds. We posted $33 million of cash collateral related to our derivative liabilities as of September 30, 2017. This amount, which is recognized in other current assets on our condensed consolidated balance sheet, is related to the right to reclaim cash collateral. We did not post or receive any collateral as of December 31, 2016.

Effect of Derivative Contracts on Accumulated Other Comprehensive Income

The following table summarizes the activity of derivative contracts that qualify for hedge accounting as of September 30, 2017 and December 31, 2016 , and the impact of designated derivative instruments on accumulated other comprehensive income for the nine months ended September 30, 2017 and 2016 :
 
December 31, 2016
 
Amount of gain (loss)
recognized in other
comprehensive income
(effective portion)  
 
Less: Amount of gain
reclassified from
accumulated other
comprehensive income
to net revenue
(effective portion)
 
September 30, 2017
 
(In millions)
Foreign exchange contracts designated as cash flow hedges
$
131

 
$
(200
)
 
$
46

 
$
(115
)



19

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

 
December 31, 2015
 
Amount of gain
recognized in other
comprehensive income
(effective portion)  
 
Less: Amount of gain
reclassified from
accumulated other
comprehensive income
to net revenue
(effective portion)
 
September 30, 2016
 
(In millions)
Foreign exchange contracts designated as cash flow hedges
$
57

 
$
99

 
$
69

 
$
87

 
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 September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(In millions)
Foreign exchange contracts designated as cash flow hedges recognized in net revenues
$
(13
)
 
$
28

 
$
46

 
$
69

Foreign exchange contracts not designated as cash flow hedges recognized in other income (expense), net
5

 
11

 
(50
)
 
28

Total gain (loss) recognized from derivative contracts in the statement of income
$
(8
)
 
$
39

 
$
(4
)
 
$
97


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:
 
September 30, 2017
 
December 31, 2016
 
(In millions)
Foreign exchange contracts designated as cash flow hedges
$
2,157

 
$
1,865

Foreign exchange contracts not designated as hedging instruments
4,970

 
4,612

Total
$
7,127

 
$
6,477



20

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

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. 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 and are responsible for servicing functions related to all our credit products. During the nine months ended September 30, 2017 and 2016 , we purchased approximately $7.0 billion and $6.0 billion , respectively, in credit receivables. As part of our arrangements with independent chartered financial institutions in the U.S., we sell back a participation interest in the pool of consumer receivables outstanding under PayPal Credit program for consumers and a participation interest in the pool of merchant receivables outstanding under the PayPal Working Capital program for merchants. We account for the participation interest transfers made with respect to each program as a sale and derecognize the portion of participation interest for which control has been surrendered. The ownership interest in each pool that we retain is included in loans and interest receivable and is accounted for at amortized cost, net of an allowance for loan losses. We maintain the servicing rights of the entire pool of consumer and merchant receivables outstanding and receive a fee approximating fair value for servicing the assets underlying the participation interest sold. Under these arrangements, 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 the pool of 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.

Consumer receivables

As of September 30, 2017 and December 31, 2016 , the total outstanding balance in our pool of consumer receivables was $5.9 billion and $5.1 billion , respectively, 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 pro rata based on participation interests held among 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 September 30, 2017 and December 31, 2016 was 680 and 679 , respectively. The Company has revised its weighted average U.S. consumer FICO score as of December 31, 2016 to conform to the current period presentation.

As of  September 30, 2017  and December 31, 2016 , approximately  50.6% 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 or equal to 680 , which is generally considered "prime" by the consumer credit industry. As of  September 30, 2017  and December 31, 2016 , approximately  11.7%  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  September 30, 2017 and December 31, 2016 , approximately  90.1%  and  90.0% , respectively, of the portfolio of consumer receivables and interest receivable was current.


21

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

The following table presents the principal amount of U.S. consumer loans and interest receivable segmented by a FICO score range:
 
September 30, 2017
  
December 31, 2016
 
(In millions)
> 760
$
710

 
$
665

680 - 759
2,157

 
1,938

600 - 679
2,137

 
1,840

< 599
665

 
553

Total
$
5,669

 
$
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 $215 million and $117 million at September 30, 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:
September 30, 2017
(In millions)
Current
 
30 - 59 Days Past Due
 
60 - 89 Days Past Due
 
90 - 180 Days Past Due
 
Total Past Due
 
Total
$
5,301

 
$
243

 
$
98

 
$
242

 
$
583

 
$
5,884


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


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 nine months ended September 30, 2017 and 2016 :
 
September 30, 2017
 
September 30, 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
354

100

454

 
278

82

360

Charge-offs
(315
)
(94
)
(409
)
 
(232
)
(77
)
(309
)
Recoveries
28


28

 
20


20

Ending Balance
$
332

$
46

$
378

 
$
245

$
37

$
282


The table above excludes receivables from other consumer credit products of $33 million and $16 million at September 30, 2017 and December 31, 2016 , respectively, and allowances of $5 million and $3 million at September 30, 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 provision for interest receivable is recognized in net revenues from other value added services as a reduction in revenue.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Merchant receivables

We offer credit products to certain existing small and medium-sized merchants through our PayPal Working Capital product. As of September 30, 2017, the total outstanding balance in our pool of working capital advances was $660 million , net of the participation interest sold to the independent chartered financial institution of $26 million . As of December 31, 2016, the total outstanding balance in our pool of working capital advances was $558 million . The independent chartered financial institution has no recourse against us related to its participation interest for failure of debtors to pay when due. The participation interest held by the chartered financial institution has the same priority to the interests held by us and is subject to the same credit risk associated with this pool of merchant receivables. All risks of loss are shared pro rata based on the ownership interest held among the stakeholders.

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 September 30, 2017 and December 31, 2016 , the weighted average PRM score related to our PayPal Working Capital balances outstanding was 631 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:
 
September 30, 2017
  
December 31, 2016
 
(In millions)
> 610
$
459

 
$
378

526-609
113

 
108

<525
88

 
72

Total (1)
$
660

 
$
558

(1) Excludes $173 million of receivables acquired from Swift Financial during September 2017.

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 included in other current liabilities in our condensed consolidated balance sheet. Advances plus the fixed fee are repaid through a fixed percentage of the merchant's future payment volume that PayPal processes. The fixed fee is amortized to net revenues from other value added services based on the amount repaid over the repayment period. We estimate the repayment period based on PayPal's payment processing history with the merchant. There is no stated interest rate and there is a general requirement that at least 10% of the original amount advanced plus the fixed fee must be repaid every 90 days. We calculate the repayment rate of the merchant's future payment volume so that repayment of the advance and fixed fee is expected to generally 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. 


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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following tables present our estimate of the principal amount of PayPal Working Capital advances and fees receivable past their original expected repayment period.
September 30, 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
$
555

 
$
38

 
$
22

 
$
33

 
$
12

 
$
105

 
$
660


The table above excludes $173 million of receivables acquired from Swift Financial during September 2017.

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 nine months ended September 30, 2017 and 2016 :
 
September 30, 2017
 
September 30, 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
42

8

50

 
32

4

36

Charge-offs
(34
)
(6
)
(40
)
 
(27
)
(4
)
(31
)
Recoveries
5


5

 
3


3

Ending Balance
$
41

$
5

$
46

 
$
27

$
3

$
30


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 included in other current liabilities in our condensed consolidated balance sheet as a reduction in deferred revenue.

Note 11 - Commitments, Contingencies and Notes Payable

Commitments

As of September 30, 2017 and December 31, 2016 , approximately $27.4 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, 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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


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 our subsidiary PayPal, Inc. (the "Guarantor"). We may also, subject to the agreement of the applicable lenders, increase the commitments under the revolving credit facility by up to $500 million . Subject to specified conditions, we may designate one or more of our subsidiaries as additional borrowers under the Credit Agreement provided that we and the Guarantor guarantee all borrowings and other obligations of any such subsidiaries under the Credit Agreement. As of September 30, 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. During the three months ended September 30, 2017, we drew down $800 million under the revolving credit facility. The borrowing bears interest at the London Interbank Offered Rate ("LIBOR") of one month plus a margin of 1.125% resulting in a weighted-average interest rate of 2.36% . As of September 30, 2017 , $800 million was outstanding under the Credit Agreement. Accordingly, at September 30, 2017 , $1.2 billion of borrowing capacity was available for the purposes permitted by the Credit Agreement subject to customary conditions to borrowing.

Litigation and Regulatory Matters

Overview

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

Amounts accrued for legal and regulatory proceedings for which we believe a loss is probable were not material for the nine months ended September 30, 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.

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

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(Unaudited)

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 asserted 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 CID 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 purported 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 asserted 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 alleged 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 sought 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. On May 12, 2017, the lead plaintiff filed an amended complaint that, among other things, did not name eBay or the former eBay officers as defendants. On June 1, 2017, the lead plaintiff voluntarily dismissed the Securities Case without prejudice.

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 (the "Court") 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”). 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. On April 27 and 28, 2017, two additional shareholder derivative lawsuits substantially similar to the California Derivative Case and Delaware Derivative Case were filed in the U.S. District Court for the Northern District of California. These cases are captioned Sims v. Schulman, et al., Case No. 1:17-cv-02428-HRL and Liss v. Schulman, et al., Case No. 1:17-cv-02446-NC (together with the California Derivative Case and the Delaware Derivative Case, the “Derivative Cases”). 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 regulations with respect to its Venmo service, as alleged in the Securities Case, and/or 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 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. On June 30, 2017, the Court issued an order approving a stipulation filed by the parties in the Derivative Cases that consolidates these cases and appoints co-lead plaintiffs’ counsel for the consolidated case, captioned In re PayPal Holdings, Inc. Shareholder Derivative Litigation, Lead Case No. 5:17-cv-00162-RS (“Consolidated Derivative Case”). The Court’s order states that it applies to each purported derivative action that is subsequently filed in, removed to, or transferred to the Court, arising out of the same or substantially the same transactions or events as the Derivative Cases. On July 31, 2017, plaintiffs’ counsel designated the complaint filed in the Liss action as the operative complaint for the Consolidated Derivative Case.  On September 28, 2017, PayPal Holdings, Inc. filed a motion to dismiss the operative complaint on grounds that plaintiffs lack standing to pursue claims on behalf of the Company because they did not make a pre-suit demand on the Company's Board of Directors prior to filing the Derivative Cases and failed to establish that making such a demand would have been futile. That

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(Unaudited)

motion is currently scheduled to be heard by the Court on December 14, 2017. On October 5, 2017, another putative shareholder derivative suit was filed in the Court captioned Iron Workers Local No. 25 Pension Fund v. John J. Donahoe, et al., Case No. 5:17-cv-05741-NC, that makes s imilar allegations and advances similar claims against the same defendants as those at issue in the Consolidated Derivative Case.   

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 we have 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.

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(Unaudited)


Off-Balance Sheet Arrangements

As of September 30, 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 September 30, 2017 and December 31, 2016 :
 
September 30, 2017
  
December 31, 2016
 
(In millions)
Maximum potential exposure
$
147,395

 
$
131,739


The following table provides the amount of allowance for transaction losses related to our protection programs as of September 30, 2017 and December 31, 2016 :
 
September 30, 2017
  
December 31, 2016
 
(In millions)
Allowance for transaction losses
$
237

 
$
222


Note 12 - Related Party Transactions

As of September 30, 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 Programs

In January 2016, our Board of Directors authorized a stock repurchase program that provides for the repurchase of up to  $2 billion  of our common stock, with no expiration from the date of authorization. In April 2017, our Board of Directors authorized an additional 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. The stock repurchase programs are 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 programs 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

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(Unaudited)

be funded from our working capital or other financing alternatives. However, any stock repurchases are subject to market conditions and other uncertainties and we cannot predict if or when any stock repurchases will be made. Moreover, we may terminate our stock repurchase programs at any time without notice.

The stock repurchase activity under the January 2016 stock repurchase program during the nine months ended September 30, 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 for three months ended:
 
 
 
 
 
 
 
March 31, 2017
12.2

 
$
42.38

 
517

 
(517
)
June 30, 2017
1.8

 
$
49.41

 
89

 
(89
)
September 30, 2017
1.7

 
$
59.49

 
100

 
(100
)
Balance as of September 30, 2017
15.7

 
 
 
$
706

 
$
299

(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.

No activity has occurred under the April 2017 stock repurchase program.

Note 14 - Stock-Based Plans

Stock Options

As of  September 30, 2017 2.4 million options to purchase shares of common stock were outstanding. No new options were granted in the nine months ended September 30, 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 nine months ended  September 30, 2017 :
 
Units  
 
(In thousands)
Outstanding at January 1, 2017
29,185

Awarded
18,731

Vested
(9,461
)
Forfeited
(3,448
)
Outstanding at September 30, 2017
35,007

Expected to vest
30,604


The weighted average grant-date fair value of RSUs and PBRSUs granted during the nine months ended  September 30, 2017 was  $42.96  per share.

In the nine months ended September 30, 2017, the Company granted RSUs that vest in equal annual installments over a three -year period, 2.8 million PBRSUs with a one -year performance period and cliff vesting following the completion of the performance period in February 2018 (one year from the annual incentive award cycle grant date) and 1.3 million PBRSUs with a three -year performance period. Over the respective 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

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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.

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 and nine months ended September 30, 2017 and  2016 was as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(In millions)
Customer support and operations
$
38

 
$
21

 
$
102

 
$
61

Sales and marketing
36

 
21

 
97

 
59

Product development
64

 
34

 
168

 
102

General and administrative
54

 
31

 
147

 
91

Depreciation and amortization
3

 
2

 
8

 
4

Total stock-based compensation expense
$
195

 
$
109

 
$
522

 
$
317

Capitalized as part of internal use software and website development costs
$
7

 
$
4

 
$
17

 
$
10


Note 15 - Income Taxes

Our effective tax rate for the three and nine months ended September 30, 2017 was 16% and 12% , respectively. The difference between our effective tax rate for these periods and the U.S. federal statutory rate of 35% in both periods was primarily the result of foreign income taxed at different rates.

In accordance with the new accounting guidance that we elected to early adopt effective January 1, 2017, we recognized income tax expense associated with intra-entity asset transfers that occurred during the three and nine months ended September 30, 2017.

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 costs recognized during the three and nine months ended September 30, 2017:
 
Three Months Ended September 30, 2017
 
Nine Months Ended
September 30, 2017
 
(In millions)
Employee severance and benefits
$

 
$
40

Total
$

 
$
40


No restructuring costs were recognized during the three and nine months ended September 30, 2016.


30

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

The following table summarizes the restructuring reserve activity during the nine months ended September 30, 2017 :
 
Employee Severance and Benefits
 
(In millions)
Accrued liability as of January 1, 2017
$

Charges
40

Payments
(32
)
Accrued liability as of September 30, 2017
$
8



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 September 30, 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
$
(58
)
 
$
(4
)
 
$
(39
)
 
$
3

 
$
(98
)
Other comprehensive income (loss) before reclassifications
(70
)
 
4

 
9

 

 
(57
)
Less: Amount of gain reclassified from accumulated other comprehensive income
(13
)
 

 

 

 
(13
)
Net current period other comprehensive income (loss)
(57
)
 
4

 
9

 

 
(44
)
Ending balance
$
(115
)
 
$

 
$
(30
)
 
$
3

 
$
(142
)

The following table summarizes the changes in accumulated balances of other comprehensive income for the three months ended September 30, 2016 :