PYPL 10-Q Q2 2015
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2015.
OR
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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 000-24821
PayPal Holdings, Inc.
(Exact Name of Registrant as Specified in Its Charter)
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Delaware | 47-2989869 |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification No.) |
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2211 North First Street San Jose, California | 95131 |
(Address of Principal Executive Offices) | (Zip Code) |
(408) 967-1000(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [x] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer | ý | Accelerated filer | o |
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Non-accelerated filer | o (Do not check if a smaller reporting company) | Smaller reporting company | o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [x]
As of July 23, 2015, there were 1,218,735,605 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.
PART I: FINANCIAL INFORMATION
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Item 1: | Financial Statements |
PayPal Holdings, Inc.
CONDENSED COMBINED AND CONSOLIDATED BALANCE SHEET
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| | | | | | | |
| June 30, 2015 | | December 31, 2014 |
| (In millions) |
| (Unaudited) |
ASSETS | | | |
Current assets: | | | |
Cash and cash equivalents | $ | 2,562 |
| | $ | 2,201 |
|
Short-term investments | 1,846 |
| | 29 |
|
Accounts receivable, net | 81 |
| | 65 |
|
Loans and interest receivable, net | 3,152 |
| | 3,586 |
|
Funds receivable and customer accounts | 11,386 |
| | 10,612 |
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Notes and receivables from affiliates | 103 |
| | 694 |
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Other current assets | 583 |
| | 378 |
|
Total current assets | 19,713 |
| | 17,565 |
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Long-term investments | 2,258 |
| | 31 |
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Property and equipment, net | 1,291 |
| | 922 |
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Goodwill | 3,409 |
| | 3,189 |
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Intangible assets, net | 186 |
| | 156 |
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Other assets | 54 |
| | 54 |
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Total assets | $ | 26,911 |
| | $ | 21,917 |
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LIABILITIES AND EQUITY | | | |
Current liabilities: | | | |
Accounts payable | $ | 188 |
| | $ | 115 |
|
Funds payable and amounts due to customers | 11,386 |
| | 10,612 |
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Notes and payables to affiliates | 102 |
| | 1,093 |
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Accrued expenses and other current liabilities | 877 |
| | 1,434 |
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Income taxes payable | 31 |
| | 29 |
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Total current liabilities | 12,584 |
| | 13,283 |
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Long-term liabilities | 1,587 |
| | 386 |
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Total liabilities | 14,171 |
| | 13,669 |
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Commitments and contingencies (Note 10) |
| |
|
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Equity: | | | |
Accumulated other comprehensive income | 24 |
| | 110 |
|
Net parent investment | 12,716 |
| | 8,138 |
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Total equity | 12,740 |
| | 8,248 |
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Total liabilities and equity | $ | 26,911 |
| | $ | 21,917 |
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The accompanying notes are an integral part of these condensed combined and consolidated financial statements.
PayPal Holdings, Inc.
CONDENSED COMBINED AND CONSOLIDATED STATEMENT OF INCOME
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| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2015 | | 2014 | | 2015 | | 2014 |
| (In millions) |
| (Unaudited) |
Net revenues | $ | 2,297 |
| | $ | 1,983 |
| | $ | 4,434 |
| | $ | 3,857 |
|
Operating expenses: | | | | | | | |
Transaction expense | 634 |
| | 525 |
| | 1,209 |
| | 1,039 |
|
Transaction and loan losses | 185 |
| | 144 |
| | 363 |
| | 273 |
|
Customer support and operations | 308 |
| | 263 |
| | 583 |
| | 518 |
|
Sales and marketing | 245 |
| | 253 |
| | 481 |
| | 468 |
|
Product development | 241 |
| | 221 |
| | 465 |
| | 419 |
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General and administrative | 135 |
| | 122 |
| | 273 |
| | 237 |
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Depreciation and amortization | 150 |
| | 125 |
| | 291 |
| | 255 |
|
Restructuring | 1 |
| | — |
| | 49 |
| | — |
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Total operating expenses | 1,899 |
| | 1,653 |
| | 3,714 |
| | 3,209 |
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Operating income | 398 |
| | 330 |
| | 720 |
| | 648 |
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Other income (expense), net | 1 |
| | (4 | ) | | — |
| | (10 | ) |
Income before income taxes | 399 |
| | 326 |
| | 720 |
| | 638 |
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Income tax expense | 94 |
| | 45 |
| | 160 |
| | 739 |
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Net income/(loss) | $ | 305 |
| | $ | 281 |
| | $ | 560 |
| | $ | (101 | ) |
| | | | | | | |
Net income (loss) per share: | | | | | | | |
Basic | $ | 0.25 |
| | $ | 0.23 |
| | $ | 0.46 |
| | $ | (0.08 | ) |
Diluted | $ | 0.25 |
| | $ | 0.23 |
| | $ | 0.46 |
| | $ | (0.08 | ) |
| | | | | | | |
Weighted average shares: | | | | | | | |
Basic | 1,218 |
| | 1,218 |
| | 1,218 |
| | 1,218 |
|
Diluted | 1,224 |
| | 1,224 |
| | 1,224 |
| | 1,218 |
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The accompanying notes are an integral part of these condensed combined and consolidated financial statements.
PayPal Holdings, Inc.
CONDENSED COMBINED AND CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
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| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2015 | | 2014 | | 2015 | | 2014 |
| (In millions) |
| (Unaudited) |
Net income (loss) | $ | 305 |
| | $ | 281 |
| | $ | 560 |
| | $ | (101 | ) |
Other comprehensive income (loss), net of reclassification adjustments: | | | | | | | |
Foreign currency translation | 9 |
| | (2 | ) | | (24 | ) | | (2 | ) |
Unrealized losses on investments, net | (2 | ) | | — |
| | (2 | ) | | — |
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Unrealized gains (losses) on hedging activities, net | (124 | ) | | 11 |
| | (60 | ) | | 21 |
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Tax expense on unrealized gains (losses) on hedging activities, net | (1 | ) | | — |
| | — |
| | (3 | ) |
Other comprehensive income (loss), net of tax | (118 | ) | | 9 |
| | (86 | ) | | 16 |
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Comprehensive income (loss) | $ | 187 |
| | $ | 290 |
| | $ | 474 |
| | $ | (85 | ) |
The accompanying notes are an integral part of these condensed combined and consolidated financial statements.
PayPal Holdings, Inc.
CONDENSED COMBINED AND CONSOLIDATED STATEMENT OF CASH FLOWS
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| | | | | | | |
| Six Months Ended June 30, |
| 2015 | | 2014 |
| (In millions) |
| (Unaudited) |
Cash flows from operating activities: | | | |
Net income (loss) | $ | 560 |
| | $ | (101 | ) |
Adjustments: | | | |
Transaction and loan losses | 363 |
| | 273 |
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Depreciation and amortization | 291 |
| | 255 |
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Stock-based compensation | 162 |
| | 143 |
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Deferred income taxes | 92 |
| | 695 |
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Excess tax benefits from stock-based compensation | (16 | ) | | (33 | ) |
Premium received on sale of principal loans receivable held for sale | (30 | ) | | — |
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Changes in assets and liabilities: | | | |
Accounts receivable | (13 | ) | | 1 |
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Notes and receivable from affiliates, net | 42 |
| | (87 | ) |
Changes in principal loans receivable held for sale, net | 4 |
| | — |
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Accounts payable | 38 |
| | 27 |
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Notes payable to affiliates | (121 | ) | | (43 | ) |
Income taxes payable and other tax liabilities | 35 |
| | 9 |
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Other assets and liabilities | (241 | ) | | (154 | ) |
Net cash provided by operating activities | 1,166 |
| | 985 |
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Cash flows from investing activities: | | | |
Purchases of property and equipment | (425 | ) | | (196 | ) |
Proceeds from sales of property and equipment | 11 |
| | — |
|
Changes in principal loans receivable, net | 408 |
| | (233 | ) |
Purchases of investments | (4,465 | ) | | (24 | ) |
Maturities and sales of investments | 417 |
| | 381 |
|
Acquisitions, net of cash acquired | (273 | ) | | (1 | ) |
Notes and receivables from affiliates | 575 |
| | (377 | ) |
Net cash used in investing activities | (3,752 | ) | | (450 | ) |
Cash flows from financing activities: | | | |
Excess tax benefits from stock-based compensation | 16 |
| | 33 |
|
Contribution from parent | 3,829 |
| | 11 |
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Repayments under financing arrangements, net | (873 | ) | | (87 | ) |
Funds receivable and customer accounts | (774 | ) | | (774 | ) |
Funds payable and amounts due to customers | 774 |
| | 774 |
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Net cash provided by (used in) financing activities | 2,972 |
| | (43 | ) |
Effect of exchange rate changes on cash and cash equivalents | (25 | ) | | — |
|
Net increase in cash and cash equivalents | 361 |
| | 492 |
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Cash and cash equivalents at beginning of period | 2,201 |
| | 1,604 |
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Cash and cash equivalents at end of period | $ | 2,562 |
| | $ | 2,096 |
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Supplemental cash flow disclosures: | | | |
Cash paid for interest | $ | 12 |
| | $ | 9 |
|
Cash paid for income taxes | $ | 31 |
| | $ | 25 |
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The accompanying notes are an integral part of these condensed combined and consolidated financial statements.
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Overview and Summary of Significant Accounting Policies
Overview and Organization
PayPal Holdings, Inc. ("PayPal", the "Company", "we", "us", or "our") was incorporated in Delaware in January 2015 and is a leading technology platform company that enables digital and mobile payments on behalf of consumers and merchants worldwide. We put our customers at the center of everything we do. We strive to become the most convenient and trusted way for consumers, merchants, friends and family to move and manage money anywhere in the world, anytime and through any device (e.g. mobile, tablets, personal computers or wearables). We provide safer and simpler ways for businesses of all sizes to accept payments from merchant websites, mobile devices and applications, and at offline retail locations through a wide range of payment solutions across our Payments Platform, including PayPal, PayPal Credit, Venmo and Braintree products.
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, and we are subject to regulations that affect the payments industry in the many countries in which we operate. Changes in or non-compliance with laws and regulations, changes in the interpretation of laws and regulations, and the enactment of new laws and regulations applicable to us could have a material adverse impact on our business, results of operations and financial condition. Therefore, we monitor these areas closely to maintain a compliant system for our customers who depend on us.
Significant Accounting Policies
Basis of Presentation and Principles of Combination and Consolidation
PayPal's Registration Statement on Form 10, as amended ("Form 10"), was declared effective by the U.S. Securities and Exchange Commission ("SEC") on June 29, 2015. On July 17, 2015, PayPal became an independent publicly-traded company through the pro rata distribution by eBay Inc. ("eBay") of 100 percent of the outstanding common stock of PayPal to eBay stockholders (the "separation"). Each eBay stockholder of record as of the close of business on July 8, 2015 received one share of PayPal common stock for every share of eBay common stock held on the record date. Approximately 1.2 billion shares of PayPal common stock were distributed on July 17, 2015 to eBay stockholders. PayPal's common stock began "regular way" trading under the ticker symbol "PYPL" on the NASDAQ Stock Market on July 20, 2015.
Prior to the separation, eBay transferred substantially all of the assets and liabilities and operations of eBay's payments business to PayPal, which was completed in June 2015 (the "Capitalization"). Combined financial statements prior to the Capitalization were prepared on a stand-alone basis and were derived from eBay's consolidated financial statements and accounting records. The combined financial statements reflect our financial position, results of operations, comprehensive income and cash flows as our business was operated as part of eBay prior to the Capitalization of PayPal. Following the Capitalization, the consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All periods presented have been accounted for in conformity with U.S. generally accepted accounting principles ("GAAP").
For periods prior to the Capitalization, the condensed combined financial statements include expenses associated with workplace resources and information technology that were previously allocated to the payments business of eBay, and additional expenses related to certain corporate functions, including senior management, legal, human resources and finance. These expenses also include allocations related to stock-based compensation. The expenses that were incurred by eBay were allocated to us based on direct usage or benefit where identifiable, with the remainder allocated on a pro rata basis of revenue, headcount, or other systematic measure. We consider the expense allocation methodology and results to be reasonable for all periods presented. The condensed combined financial statements also include certain assets and liabilities that were historically held at the eBay corporate level, but which are specifically identifiable and attributable to us. The condensed combined and consolidated financial position, results of operations and cash flows of PayPal may not be indicative of our results had we been a separate stand-alone entity during the periods presented, nor are the results stated herein indicative of what the Company’s financial position, results of operations and cash flows may be in the future. All intercompany transactions and accounts have been eliminated. Transactions between us and eBay are included in these condensed combined and consolidated financial statements.
The accompanying condensed combined and consolidated financial statements include the financial statements of PayPal and our wholly and majority-owned subsidiaries. Investments in entities where we hold at least a 20% ownership interest and have the ability to exercise significant influence, but not control, over the investee are accounted for using the equity method of accounting.
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
For such investments, our share of the investees’ results of operations is included in other income (expense), net and our investment balance is included in long-term investments. 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 in our condensed combined and consolidated statement of income to the extent dividends are received.
These condensed combined and consolidated financial statements and accompanying notes should be read in conjunction with the audited combined financial statements and accompanying notes for the year ended December 31, 2014 included in our Form 10.
In the opinion of management, these condensed combined and consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, which are necessary for fair presentation of the condensed combined and consolidated financial statements for interim periods.
Use of Estimates
The preparation of condensed combined and consolidated financial statements in conformity with U.S. 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 combined and consolidated financial statements and the reported amounts of revenues and expenses, including allocations from eBay, during the reporting period. On an ongoing basis, we evaluate our estimates, including those related to provisions for transaction and loan losses, loss contingencies, income taxes, revenue recognition and the valuation of goodwill and intangible assets. We base our estimates on historical experience and on various other assumptions which we believe to be reasonable under the circumstances. Actual results could differ from those estimates.
Recent Accounting Pronouncements
In 2014, the Financial Accounting Standards Board (FASB) issued new guidance related to pushdown accounting. The new guidance provides an acquired entity with an option to apply pushdown accounting in its separate financial statements upon occurrence of an event in which an acquirer obtains control of the acquired entity. These amendments became effective on November 18, 2014. Additionally, in 2015, the FASB issued new guidance related to pushdown accounting, which removes references to the SEC guidance on pushdown accounting from the FASB Accounting Standards Codification. These amendments therefore conform the FASB's guidance on pushdown accounting with the SEC's guidance. The adoption of both standards did not have a material impact on our combined and consolidated financial statements.
In 2014, the FASB issued new accounting guidance related to revenue recognition. This new standard will replace all current U.S. 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. This guidance can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. In July 2015, the FASB voted to defer the effective date to January 1, 2018 with early adoption beginning January 1, 2017. We are evaluating our approach to adopting this new accounting guidance, as well as its impact on our financial statements.
In 2015, the FASB issued new guidance related to extraordinary and unusual items. The new standard eliminates the concept of extraordinary items from GAAP. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted. We may apply the standard prospectively or retrospectively to all periods presented. The adoption of this standard is not expected to have a material impact on our financial statements.
In 2015, the FASB issued new guidance related to consolidations. The new guidance amends the guidelines for determining whether certain legal entities should be consolidated and reduces the number of consolidation models. The new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted. We are evaluating the impact, if any, of adopting this new accounting guidance on our financial statements.
In 2015, the FASB issued new guidance related to accounting for fees paid in a cloud computing arrangement. The new standard provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license,
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
the customer should account for the arrangement as a service contract. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted. We are evaluating the impact, if any, of adopting this new accounting guidance on our financial statements.
Note 2 — Net Income (loss) Per Share
Basic net income (loss) per share is computed by dividing net income (loss) for the period by the weighted average number of common shares outstanding during the period. The weighted average number of common shares outstanding for basic and diluted earnings per share for the period is based on the number of shares of PayPal common stock outstanding on the distribution date. On July 17, 2015, the distribution date, eBay stockholders of record as of the close of business on July 8, 2015 received one share of PayPal for every share of eBay common stock held as of the record date. Diluted net income (loss) per share is computed by dividing net income (loss) for the period by the number of shares of common stock and potentially dilutive common stock outstanding as of the distribution date. The dilutive effect of outstanding options and equity incentive awards is reflected in diluted net income (loss) per share by application of the treasury stock method. The calculation of diluted net income (loss) per share excludes all anti-dilutive common shares. The same number of shares was used to calculate diluted earnings per share for periods presented since no PayPal equity was outstanding prior to the distribution.
The following table sets forth the computation of basic and diluted net income (loss) per share for the periods indicated:
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| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2015 | | 2014 | | 2015 | | 2014 |
| (In millions, except per share amounts) |
Numerator: | | | | | | | |
Net income (loss) | $ | 305 |
| | $ | 281 |
| | $ | 560 |
| | $ | (101 | ) |
Denominator: | | | | | | | |
Weighted average shares of common stock - basic
| 1,218 |
| | 1,218 |
| | 1,218 |
| | 1,218 |
|
Dilutive effect of equity incentive awards
| 6 |
| | 6 |
| | 6 |
| | — |
|
Weighted average shares of common stock - diluted | 1,224 |
| | 1,224 |
| | 1,224 |
| | 1,218 |
|
Net income (loss) per share: | | | | | | | |
Basic | $ | 0.25 |
| | $ | 0.23 |
| | $ | 0.46 |
| | $ | (0.08 | ) |
Diluted | $ | 0.25 |
| | $ | 0.23 |
| | $ | 0.46 |
| | $ | (0.08 | ) |
Note 3 — Business Combinations
2015 Acquisition and Divestiture Activity
During the three months ended June 30, 2015, we completed two acquisitions for aggregate gross purchase consideration of approximately $281 million, consisting primarily of cash.
We completed the acquisition of Paydiant in April 2015 for total cash consideration of approximately $230 million, net of cash acquired. We acquired Paydiant to expand our capabilities in mobile payments. The allocation of purchase consideration resulted in approximately $49 million of technology and customer-related intangible assets, net liabilities of approximately $6 million, and initial goodwill of $187 million. 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 may occur as additional information becomes available.
We completed the acquisition of CyActive Security, Ltd. in April 2015 for total consideration of approximately $43 million, net of cash acquired. We acquired CyActive to further enhance our risk assessment capabilities used to protect merchants and consumers
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
on our Payments Platform. The allocation of purchase consideration resulted in approximately $8 million of technology-related intangible assets, net liabilities of approximately $2 million, and initial goodwill of $37 million. 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 may occur as additional information becomes available.
We have included the financial results of Paydiant and CyActive in our combined condensed financial statements from the dates of acquisition. Revenues and expenses related to Paydiant and CyActive for the period ending June 30, 2015 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.
2014 Acquisition and Divestiture Activity
There were no acquisitions or divestitures completed in 2014.
Note 4 - Goodwill and Intangible Assets
Goodwill
The following table presents goodwill balances and adjustments to those balances during the six months ended June 30, 2015:
|
| | | | | | | | | | | | | | | |
| December 31, 2014 | | Goodwill Acquired | | Adjustments | | June 30, 2015 |
Total Goodwill | $ | 3,189 |
| | $ | 224 |
| | $ | (4 | ) | | $ | 3,409 |
|
The adjustments to goodwill during the six months ended June 30, 2015 relate to foreign exchange rate translations.
Intangible Assets
The components of identifiable intangible assets are as follows:
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| June 30, 2015 | | December 31, 2014 |
| 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 | $ | 534 |
| | $ | (486 | ) | | $ | 48 |
| | 5 | | $ | 520 |
| | $ | (477 | ) | | $ | 43 |
| | 6 |
Marketing related | 181 |
| | (133 | ) | | 48 |
| | 3 | | 181 |
| | (117 | ) | | 64 |
| | 3 |
Developed technologies | 210 |
| | (162 | ) | | 48 |
| | 3 | | 167 |
| | (153 | ) | | 14 |
| | 3 |
All other | 137 |
| | (95 | ) | | 42 |
| | 5 | | 105 |
| | (70 | ) | | 35 |
| | 5 |
Intangible assets, net | $ | 1,062 |
| | $ | (876 | ) | | $ | 186 |
| | | | $ | 973 |
| | $ | (817 | ) | | $ | 156 |
| | |
During the period, eBay contributed intangible assets with a gross carrying amount of $31 million and a net book value of $13 million. All identifiable intangible assets are subject to amortization and no significant residual value is estimated for the intangible assets. Amortization expense for intangible assets was $23 million and $20 million for the three months ended June 30, 2015 and 2014, respectively. Amortization expense for intangible assets was $42 million and $44 million for the six months ended June 30, 2015 and 2014, respectively.
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Expected future intangible asset amortization as of June 30, 2015 is as follows (in millions):
|
| | | |
Fiscal years: | |
Remaining 2015 | $ | 46 |
|
2016 | 83 |
|
2017 | 37 |
|
2018 | 17 |
|
2019 | 3 |
|
Thereafter: | — |
|
| $ | 186 |
|
Note 5 - Segment and Geographical Information
We determine operating segments based on how our chief operating decision maker manages the business, including making operating decisions, deciding how to allocate resources and evaluating operating performance. Our chief operating decision-maker is our Chief Executive Officer who reviews our operating results on a consolidated basis. Accordingly, we operate in one segment and have one reportable segment.
The following tables summarize the allocation of net revenues based on geography:
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2015 | | 2014 | | 2015 | | 2014 |
| (In millions) |
Net revenues: | | | | | | | |
U.S. | $ | 1,170 |
| | $ | 982 |
| | $ | 2,200 |
| | $ | 1,885 |
|
United Kingdom | 286 |
| | 283 |
| | 563 |
| | 553 |
|
Rest of world | 841 |
| | 718 |
| | 1,671 |
| | 1,419 |
|
Total net revenues | $ | 2,297 |
| | $ | 1,983 |
| | $ | 4,434 |
| | $ | 3,857 |
|
|
| | | | | | | |
| June 30, 2015 | | December 31, 2014 |
| (In millions) |
Long-lived assets: | | | |
U.S. | $ | 4,393 |
| | $ | 3,784 |
|
International | 462 |
| | 401 |
|
Total long-lived assets | $ | 4,855 |
| | $ | 4,185 |
|
Net revenues are attributed to U.S. and international geographies primarily based upon the country in which the merchant is located, or in the case of a cross border transaction, may be earned from both countries in which the consumer and merchant reside. Net revenues earned from other value added services are typically attributed to the country in which either the consumer or the merchant resides, depending on the type of service provided. Long-lived assets attributed to the U.S. and international geographies are based upon the country in which the asset is located or owned.
Information regarding net revenues by major products and services for three and six months ended June 30, 2015 and 2014 is as follows:
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2015 | | 2014 | | 2015 | | 2014 |
| (In millions) |
Transaction revenues | $ | 1,970 |
| | $ | 1,712 |
| | $ | 3,884 |
| | $ | 3,386 |
|
Other value added services: | 327 |
| | 271 |
| | 550 |
| | 471 |
|
Total net revenues | $ | 2,297 |
| | $ | 1,983 |
| | $ | 4,434 |
| | $ | 3,857 |
|
Note 6 - Investments
At June 30, 2015 and December 31, 2014, the estimated fair value of our short-term and long-term investments classified as available for sale, was as follows:
|
| | | | | | | | | | | | | | | |
| June 30, 2015 |
| Gross Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Estimated Fair Value |
| (In millions) |
Short-term investments: | | | | | | | |
Corporate debt securities | $ | 1,251 |
| | $ | — |
| | $ | (1 | ) | | $ | 1,250 |
|
Government and agency securities | $ | 590 |
| | $ | — |
| | $ | — |
| | $ | 590 |
|
Time deposits | $ | 6 |
| | $ | — |
| | $ | — |
| | $ | 6 |
|
Long-term investments: | | | | | | |
|
|
Corporate debt securities | $ | 2,232 |
| | $ | 1 |
| | $ | (2 | ) | | $ | 2,231 |
|
Total | $ | 4,079 |
| | $ | 1 |
| | $ | (3 | ) | | $ | 4,077 |
|
|
| | | | | | | | | | | | | | | |
| December 31, 2014 |
| Gross Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Estimated Fair Value |
| (In millions) |
Short-term investments: | | | | | | | |
Time deposits | $ | 29 |
| | $ | — |
| | $ | — |
| | $ | 29 |
|
As of June 30, 2015, we had no material long-term or short-term investments that have been in a continuous unrealized loss position for greater than 12 months. Amounts reclassified to earnings from unrealized gains and losses were not material for the three months ended and six months ended June 30, 2015 and 2014.
The estimated fair values of our short-term and long-term investments classified as available for sale by date of contractual maturity at June 30, 2015 are as follows:
|
| | | |
| June 30, 2015 |
| (In millions) |
One year or less | $ | 1,846 |
|
One year through two years | 1,358 |
|
Two years through three years | 718 |
|
Three years through four years | 122 |
|
Four years through five years | 22 |
|
Greater than five years | 11 |
|
Total | $ | 4,077 |
|
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Equity and Cost Method Investments
We have made multiple equity and cost method investments which are reported in long-term investments on our condensed combined and consolidated balance sheet. Our equity and cost method investments totaled $27 million and $31 million as of June 30, 2015 and December 31, 2014, respectively.
Note 7 - Fair Value Measurement of Assets and Liabilities
The following table summarizes our financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2015 and December 31, 2014:
|
| | | | | | | | | | | | |
Description | | Balances at June 30, 2015 | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) |
| | (In millions) |
Assets: | | | | | | |
Cash and cash equivalents | | $ | 2,562 |
| | $ | 1,842 |
| | $ | 720 |
|
Short-term investments: | | | | | | |
Corporate debt securities | | 1,250 |
| | — |
| | 1,250 |
|
Government and agency securities | | 590 |
| | — |
| | 590 |
|
Time deposits | | 6 |
| | — |
| | 6 |
|
Total short-term investments | | 1,846 |
| | — |
| | 1,846 |
|
Funds receivable and customer accounts | | 5,839 |
| | — |
| | 5,839 |
|
Derivatives | | 87 |
| | — |
| | 87 |
|
Long-term investments: | | | | | | |
Corporate debt securities | | $ | 2,231 |
| | $ | — |
| | $ | 2,231 |
|
Total financial assets | | $ | 12,565 |
| | $ | 1,842 |
| | $ | 10,723 |
|
Liabilities: | | | | | | |
Derivatives | | $ | 23 |
| | $ | — |
| | $ | 23 |
|
|
| | | | | | | | | | | | |
Description | | Balances at December 31, 2014 | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) |
| | (In millions) |
Assets: | | | | | | |
Cash and cash equivalents | | $ | 2,201 |
| | $ | 2,201 |
| | $ | — |
|
Short-term investments: | | | | | | |
Time deposits | | 29 |
| | — |
| | 29 |
|
Total short-term investments | | 29 |
| | — |
| | 29 |
|
Funds receivable and customer accounts | | 4,161 |
| | — |
| | 4,161 |
|
Derivatives | | 135 |
| | — |
| | 135 |
|
Total financial assets | | $ | 6,526 |
| | $ | 2,201 |
| | $ | 4,325 |
|
Liabilities: | | | | | | |
Derivatives | | $ | 7 |
| | $ | — |
| | $ | 7 |
|
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Our financial assets and liabilities are valued using market prices on both active markets (level 1) and less active markets (level 2). Level 1 instrument valuations are obtained from real-time quotes for transactions in active exchange markets involving identical assets. Level 2 instrument valuations are obtained from readily available pricing sources for comparable instruments, identical instruments in less active markets, or models using market observable inputs.
The majority of our derivative instruments are valued using pricing models that take into account the contract terms as well as multiple inputs where applicable, such as equity prices, interest rate yield curves, option volatility and currency rates. 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 first six months of 2015. As of June 30, 2015 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 or remaining maturities of three months or less when purchased and are comprised primarily of bank deposits and commercial paper. We had total funds receivable and customer accounts of $11.4 billion and $10.6 billion as of June 30, 2015 and December 31, 2014, respectively, of which $5.8 billion and $4.2 billion, respectively, was invested primarily in short-term investments. We elect to account for certain customer accounts, including foreign-currency denominated available-for-sale investments, under the fair value option. Election of the fair value option allows us to significantly reduce the accounting asymmetry that would otherwise arise when recognizing foreign exchange gains and losses relating to available-for-sale investments and the corresponding customer liabilities.
Note 8 - Derivative Instruments
Summary of Derivative Instruments
Our primary objective in holding derivatives is to reduce the volatility of 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 use foreign currency exchange contracts, generally with maturities of 18 months or less, to reduce the volatility of cash flows primarily related to forecasted revenues, expenses, assets and liabilities 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. For derivative instruments that are designated as cash flow hedges, the effective portion of the derivative’s gain or loss is initially reported as a component of accumulated other comprehensive income 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. We do not use any foreign exchange contracts for trading 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. As of June 30, 2015, we estimate that $70 million of net derivative gains related to our cash flow hedges included in accumulated other comprehensive income will be reclassified into earnings within the next 12 months.
Fair Value of Derivative Contracts
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The fair value of our outstanding derivative instruments as of June 30, 2015 and December 31, 2014 was as follows: |
| | | | | | | | | |
| Balance Sheet Location | | June 30, 2015 | | December 31, 2014 |
| | | (In millions) |
Derivative Assets: | | | | | |
Foreign exchange contracts designated as cash flow hedges | Other Current Assets | | $ | 81 |
| | $ | 128 |
|
Foreign exchange contracts not designated as hedging instruments | Other Current Assets | | 6 |
| | 7 |
|
Total derivative assets | | | $ | 87 |
| | $ | 135 |
|
| | | | | |
Derivative Liabilities: | | | | | |
Foreign exchange contracts designated as cash flow hedges | Other Current Liabilities | | $ | 15 |
| | $ | 2 |
|
Foreign exchange contracts not designated as hedging instruments | Other Current Liabilities | | 8 |
| | 5 |
|
Total derivative liabilities | | | $ | 23 |
| | $ | 7 |
|
| | | | | |
Total fair value of derivative instruments | | | $ | 64 |
| | $ | 128 |
|
Under the master netting agreements with the respective counterparties to our foreign exchange contracts, subject to applicable requirements, we are allowed to net settle transactions of the same type with a single net amount payable by one party to the other. However, we have elected to present the derivative assets and derivative liabilities on a gross basis in our balance sheet. As of June 30, 2015, the potential effect of rights of off-set associated with the above foreign exchange contracts would be an offset to both assets and liabilities by $15 million, resulting in net derivative assets of $72 million and net derivative liabilities of $8 million. We are not required to pledge, nor are we entitled to receive, cash collateral related to these derivative transactions.
Effect of Derivative Contracts on Accumulated Other Comprehensive Income
The following table summarizes the activity of derivative contracts that qualify for hedge accounting as of June 30, 2015 and December 31, 2014, and the impact of designated derivative instruments on accumulated other comprehensive income for the six months ended June 30, 2015:
|
| | | | | | | | | | | | | | | |
| December 31, 2014 | | Amount of gain recognized in other comprehensive income (effective portion) | | Amount of gain reclassified from accumulated other comprehensive income to net revenue (effective portion) | | June 30, 2015 |
| (In millions) |
Foreign exchange contracts designated as cash flow hedges | $ | 126 |
| | $ | 52 |
| | $ | 112 |
| | $ | 66 |
|
The following table summarizes the activity of derivative contracts that qualify for hedge accounting as of June 30, 2014 and December 31, 2013, and the impact of designated derivative instruments on accumulated other comprehensive income for the six months ended June 30, 2014:
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
|
| | | | | | | | | | | | | |
| December 31, 2013 | | Amount of (loss) recognized in other comprehensive income (effective portion) | | Amount of (loss) reclassified from accumulated other comprehensive income to net revenue (effective portion) | | June 30, 2014 |
| (In millions) |
Foreign exchange contracts designated as cash flow hedges | $ | (91 | ) | | (19 | ) | | (40 | ) | | $ | (70 | ) |
Effect of Derivative Contracts on Combined and Consolidated Statements of Income
The following table provides the location in the financial statements of the recognized gains or losses related to our derivative instruments:
|
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2015 | | 2014 | | 2015 | | 2014 |
| (In millions) |
Foreign exchange contracts designated as cash flow hedges recognized in net revenues | $ | 62 |
| | $ | (23 | ) | | $ | 112 |
| | $ | (40 | ) |
Foreign exchange contracts not designated as cash flow hedges recognized in other income (expense), net | (11 | ) | | (4 | ) | | — |
| | (8 | ) |
Total gain (loss) recognized from derivative contracts in the combined statement of income | $ | 51 |
| | $ | (27 | ) | | $ | 112 |
| | $ | (48 | ) |
Notional Amounts of Derivative Contracts
Derivative transactions are measured in terms of the notional amount, but this amount is not recorded on the balance sheet and is not, when viewed in isolation, a meaningful measure of the risk profile of the derivative instruments. The notional amount is generally not exchanged, but is used only as the 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:
|
| | | | | | | |
| June 30, 2015 | | June 30, 2014 |
| (In millions) |
Foreign exchange contracts designated as cash flow hedges | $ | 1,514 |
| | $ | 2,082 |
|
Foreign exchange contracts not designated as hedging instruments | 1,039 |
| | 657 |
|
Total | $ | 2,553 |
| | $ | 2,739 |
|
Note 9 - Loans and Interest Receivable, Net
Loans and interest receivable primarily represent consumer receivables arising from loans made by our partner chartered financial institution to individual consumers using our PayPal Credit products. We purchase the related consumer receivables and are responsible for all servicing functions related to the customer accounts. During the six months ended June 30, 2015 and June 30, 2014, we purchased approximately $2.9 billion and $2.3 billion, respectively, in consumer receivables. As part of the arrangement with our partner chartered financial institution, we sell a participation interest in the entire pool of consumer receivables outstanding under the customer accounts.
In May 2015, we completed an arrangement with certain investors under which we sold additional participation interests in certain consumer loans receivable originated using our PayPal Credit products with a gross book value of approximately $708 million, resulting in an initial premium received of $26 million. Under this arrangement, we sell these investors a participation interest in
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
certain consumer loans receivable that we purchased, which resulted in additional premiums received of $4 million during the three months ended June 30, 2015. As of June 30, 2015, the total outstanding balance in our pool of consumer receivables was $3.1 billion, net of participation interest sold to chartered financial institution and other investors of $876 million. The chartered financial institution and other investors have no recourse 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.
Loans and interest receivable are reported at their outstanding principal balances, net of participation interest sold and pro-rata allowances, including unamortized deferred origination costs and estimated collectible interest and fees. We use a consumer's FICO score, among other measures, in evaluating the credit quality of our consumer receivables. A FICO score is a type of credit score that lenders use to assess an applicant's credit risk and whether to extend credit. Individual FICO scores generally are obtained each quarter the consumer has an outstanding consumer receivable owned by PayPal Credit. The weighted average consumer FICO scores related to our loans and interest receivable balance outstanding at June 30, 2015 and December 31, 2014 were 687.
As of June 30, 2015 and December 31, 2014, approximately 54.2%, respectively, of the pool of consumer receivables and interest receivable balance was due from consumers with FICO scores greater than 680, which is generally considered "prime" by the consumer credit industry. As of June 30, 2015 and December 31, 2014, approximately 9.6% and 9.3%, respectively, of the pool of consumer receivables and interest receivable balance was due from customers with FICO scores below 599. As of June 30, 2015 and December 31, 2014, approximately 90.0% and 89.8%, respectively, of the portfolio of consumer receivables and interest receivable was current.
The following table presents the principal amount of loans and interest receivable segmented by a FICO score range:
|
| | | | | | | |
| June 30, 2015 | | December 31, 2014 |
| (In millions) |
> 760 | $ | 446 |
| | $ | 553 |
|
680 - 759 | 1,226 |
| | 1,439 |
|
600 - 679 | 1,118 |
| | 1,344 |
|
< 599 | 296 |
| | 341 |
|
Total | $ | 3,086 |
| | $ | 3,677 |
|
The following tables presents the delinquency status of the principal amount of loans and interest receivable:
|
| | | | | | | | | | | | | | | | |
June 30, 2015 |
(In millions) |
Current | | 30 - 59 Days Past Due | | 60 - 89 Days Past Due | | 90 - 180 Days Past Due | | Total Past Due | | Total Financing Receivables |
2,777 |
| | 143 |
| | 54 |
| | 112 |
| | 309 |
| | 3,086 |
|
|
| | | | | | | | | | | | | | | | |
December 31, 2014 |
(In millions) |
Current | | 30 - 59 Days Past Due | | 60 - 89 Days Past Due | | 90 - 180 Days Past Due | | Total Past Due | | Total Financing Receivables |
3,303 |
| | 163 |
| | 62 |
| | 149 |
| | 374 |
| | 3,677 |
|
We charge off loan receivable balances in the month in which a customer balance becomes 180 days past due. Bankrupt accounts are charged off within 60 days of receiving notification from the bankruptcy courts. Past due loans receivable continue to accrue interest until such time they are charged off.
The following table summarizes the activity in the allowance for loans and interest receivable, net of participating interest sold for the period indicated:
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
|
| | | | | | | |
| Six Months Ended June 30, |
| 2015 | | 2014 |
| (In millions) |
Balance as of January 1 | $ | 195 |
| | $ | 146 |
|
Reclassification from loans receivable to loans held for sale | (22 | ) | | — |
|
Charge-offs | (164 | ) | | (139 | ) |
Recoveries | 14 |
| | 13 |
|
Provisions | 162 |
| | 140 |
|
Balance as of June 30 | $ | 185 |
| | $ | 160 |
|
We also partner with a chartered financial institution to offer working capital advances to select merchant sellers in the U.S. We subsequently purchase the related merchant receivable from the chartered financial institution. Under the program, participating merchants can borrow a certain percentage of their annual payment volume processed by PayPal and are charged a fixed fee for the loan. In 2014, we have extended this program to a limited number of international markets whereby we grant working capital advances to merchants directly through our Luxembourg bank subsidiary or through other affiliates. The total net receivable outstanding as of June 30, 2015 and December 31, 2014 was approximately $226 million and $99 million, respectively.
Note 10 - Commitments and Contingencies
Commitments
As of June 30, 2015, approximately $22.1 billion of unused credit was available to PayPal Credit accountholders. While this amount represents the total unused credit available, we have not experienced, and do not anticipate, that all of our PayPal Credit accountholders 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 institutions that are 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 remits 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 the 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 and are responsible for all servicing functions related to the account.
In June 2014, we agreed, subject to certain conditions, that we, one of our affiliates or a third party partner will purchase a portfolio of consumer loan receivables relating to the customer accounts arising out of our current credit program agreement with Synchrony (formerly GE Capital Retail Bank) for a price based on the book value of the consumer loan receivables portfolio at the time of the purchase (expected to be October 2016), subject to certain adjustments and exclusions. As of June 30, 2015, Synchrony had a net receivables portfolio under the credit program agreement of approximately $1.5 billion.
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,
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 10, 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 six months ended June 30, 2015. Except as otherwise noted for the proceedings described in this Note 10, 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 routinely report to the U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) on payments we have rejected or blocked pursuant to OFAC sanctions regulations and on any possible violations of those regulations. We have cooperated with OFAC in recent years regarding our review process over transaction monitoring and have self-reported a large number of small dollar amount transactions that could possibly be in violation of OFAC sanctions regulations. In March 2015, we reached a settlement with OFAC regarding possible violations arising from our practices between 2009 and 2013, before our implementation of real-time monitoring processes. The settlement did not have a material impact on our financial statements. In addition, we continue to cooperate with OFAC regarding other transactions that could also possibly be in violation of OFAC sanctions regulations. Such transactions could result in claims or actions against us including litigation, injunctions, damage awards or require us to change our business practices that could result in a material loss, require significant management time, result in the diversion of significant operational resources or otherwise harm our business.
On August 7, 2013 and January 13, 2014, eBay, PayPal and certain wholly owned subsidiaries of PayPal received Civil Investigative Demands (“CIDs”) from the Consumer Financial Protection Bureau ("CFPB") requesting that we provide testimony, produce documents and provide information relating primarily to the acquisition, management, and operation of our PayPal Credit products, including online credit products and services, advertising, loan origination, customer acquisition, servicing, debt collection, and complaints handling practices. We have cooperated with the CFPB throughout the course of the investigation. In May 2015, we entered into a Consent Order with the CFPB in which we settled potential allegations arising from PayPal Credit practices between 2011 and 2015. The Consent Order includes obligations on PayPal to $15 million in redress to consumers, a $10 million civil monetary penalty, and requires PayPal to make various changes to our disclosures and business practices. We will continue to cooperate and engage with the CFPB and work to ensure compliance with the Consent Order. Violation of the Consent Order could result in claims or actions against us, including litigation, injunctions, or damage awards or require us to change our business practices that could result in a material loss, require significant management time, result in the diversion of significant operational resources or otherwise harm our business.
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 recent 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.
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
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
and/or not acted in conformity with such prices, rules, policies or agreements. In addition to these types of disputes and regulatory inquiries, our operations are also subject to regulatory and/or legal review and/or challenges that tend to reflect the increasing global regulatory focus to which the payments industry is subject and, when taken as a whole with other regulatory and legislative action, such actions could result in the imposition of costly new compliance burdens on our business and customers and may lead to increased costs and decreased transaction volume and revenue. Further, the number and significance of these disputes and inquiries are increasing as our Company has grown larger, our business has expanded in scope (both in terms of the range of products and services that we offer and our geographical operations) and our products and services have increased in complexity. Any claims or regulatory actions against us, whether meritorious or not, could be time consuming, result in costly litigation, damage awards (including statutory damages for certain causes of action in certain jurisdictions), 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
In the ordinary course of business, we include limited indemnification provisions in certain of our agreements with parties with whom we have commercial relations, including our standard marketing, promotions, and application-programming-interface license 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 applicable to our performance under 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 provision. To date, no significant costs have been incurred, either individually or collectively, in connection with our indemnification provisions.
Off-Balance Sheet Arrangements
As of June 30, 2015, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our combined 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, except for transactions using our gateway products. 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 June 30, 2015 and December 31, 2014:
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
|
| | | | | | | |
| June 30, 2015 | | December 31, 2014 |
| (In millions) |
Maximum potential exposure | $ | 73,250 |
| | $ | 75,833 |
|
The following table provides the amount of allowance for transaction losses related to our protection programs as of June 30, 2015 and December 31, 2014:
|
| | | | | | | |
| June 30, 2015 | | December 31, 2014 |
| (In millions) |
Allowance for transaction losses | $ | 190 |
| | $ | 166 |
|
Note 11 - Related Party Transactions
In August 2009, we entered into a two-way Cash Management and Zero Balance Cash Sharing Agreement (“Cash Sharing Agreement”) with eBay in which our excess U.S. funds are swept to eBay on a daily basis. The main purpose of the Cash Sharing Agreement was to implement a centralized cash management structure to effectively manage U.S. Dollar cash, to leverage administrative efficiencies, and to centralize the investment/borrowing of cash and settlement of payables and receivables at the eBay level. Since the Cash Sharing Agreement was two-way, we could receive funds back from eBay as needed. The rate earned on funds lent to eBay was the average daily LIBOR USD 1-month rate plus 20 basis points. Following separation, we will no longer participate in cash management arrangements with eBay. Accordingly, the balance due from eBay was settled in June 2015. Interest income earned on the arrangement is reported in other income (expense), net but was not material for the six months ended June 30, 2015 and 2014.
In November 2008, we entered into an intercompany loan agreement with eBay in which the acquisition of receivables related to PayPal Credit accounts were funded through eBay’s existing financing arrangements at an interest rate of 1.2% for the three months ended June 30, 2015. Following separation, we will no longer participate in intercompany funding arrangements with eBay. Accordingly, the balance due from eBay was settled in June 2015. The interest expense incurred during the three months ended June 30, 2015 and 2014 was $4 million and $3 million, respectively. The interest expense incurred during the six months ended June 30, 2015 and 2014 was $8 million and $5 million, respectively.
In September 2014, we entered into an intercompany loan agreement with eBay whereby we borrowed 130 million Brazilian Real for one year at an interest rate of 11% plus a spread of 0.5% per annum during the term of the loan. The loan was used to fund our installment payments product in Brazil. The loan was repaid in March 2015. The interest expense incurred on the arrangement is reported in other income (expense), net but was not material for the three and six months ended June 30, 2015 and 2014.
In September 2014, we entered into an intercompany loan agreement with eBay whereby we borrowed $10 million from eBay for 6 months at an interest rate of 1.2% per annum. The loan was repaid in March 2015. Interest expense on the arrangement is reported in other income (expense), net but was not material for the three and six months ended June 30, 2015.
In October 2014, we entered into an intercompany loan agreement with eBay whereby we loaned eBay 580 million Indian Rupee for 6 months at an interest rate of 9.4% per annum. The balance due from eBay was settled in June 2015. Interest income earned on the arrangement is reported in other income (expense), net but was not material for the three and six months ended June 30, 2015.
In December 2014, we entered into an intercompany loan agreement with eBay whereby we loaned eBay 500 million Indian Rupee for 6 months at an interest rate of 9.0% per annum. The balance due from eBay was settled in June 2015. Interest income earned on the arrangement is reported in other income (expense) but was not material for the three and six months ended June 30, 2015.
All other 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. There were no other material related party transactions in the periods presented. As of June 30, 2015, there were no other material amounts payable to or amounts receivable from related parties.
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Net revenues include $28 million and $27 million earned from eBay and its subsidiaries for the three months ended June 30, 2015 and 2014, respectively. Net revenues include $56 million and $55 million earned from eBay and its subsidiaries for the six months ended June 30, 2015 and 2014, respectively.
We recover certain amounts from eBay related to customer protection programs offered on eligible eBay purchases made with PayPal. These costs include the actual transaction losses associated with customer filed claims as well as an allocation of salary related expenses for customer support teams working on customer claims and disputes related to eligible eBay purchases. Recoveries associated with transaction losses incurred on eligible eBay purchases during the three months ended June 30, 2015 and 2014 were $12 million and $10 million, respectively, which were recorded as a reduction to transaction and loan loss. Recoveries associated with transaction losses incurred on eligible eBay purchases during the six months ended June 30, 2015 and 2014 were $22 million for both periods, which were recorded as a reduction to transaction and loan loss. Other costs recovered from eBay related to the customer protection program for the three months ended June 30, 2015 and 2014 were $6 million and $5 million, respectively, and are included as a reduction to customer support and operations and general and administrative expenses in our combined statement of income. Other costs recovered from eBay related to the customer protection program for the six months ended June 30, 2015 and 2014 were $11 million and $10 million, respectively, and are included as a reduction to customer support and operations and general and administrative expenses in our combined statement of income. Following the distribution, eBay's customer protection programs will no longer be administered by us, and therefore these costs will not be reimbursed by eBay.
We incur user acquisition fees from eBay on payment volume which we process from purchases made on eBay’s platform. User acquisition fees for the three months ended June 30, 2015 and 2014 were $30 million and $29 million, respectively. User acquisition fees for the six months ended June 30, 2015 and 2014 were $60 million and $59 million, respectively. Following the distribution, we will incur user acquisitions fees from eBay based on a fixed rate per new user. User acquisition fees for the three and six months ended June 30, 2015 and 2014 are included within sales and marketing expenses.
These condensed combined and consolidated financial statements include expenses associated with workplace resources and information technology that were previously allocated to the Payments segment of eBay, and additional expenses related to certain corporate functions, including senior management, legal, human resources and finance. These expenses also include allocations related to share based compensation. The expenses that have been allocated to us by eBay are based on direct usage or benefit where identifiable, with the remainder allocated on a pro rata basis of revenue, headcount, or other systematic measure. We consider the expense allocation methodology and results to be reasonable for all periods presented. The corporate costs and allocation of expenses to us from eBay included within customer support and operations, sales and marketing, product development, and general and administrative expenses were $143 million and $132 million for the three months ended June 30, 2015 and 2014, respectively, of which $60 million and $53 million were included in general and administrative expenses. The corporate costs and allocation of expenses to us from eBay included within customer support and operations, sales and marketing, product development, and general and administrative expenses were $303 million and $268 million for the six months ended June 30, 2015 and 2014, respectively, of which $121 million and $113 million were included in general and administrative expenses.
In the three months ended June 30, 2015, pursuant to the Separation and Distribution agreement between eBay and us dated as of June 26, 2015, eBay transferred substantially all of the assets and liabilities and operations of eBay's payments business to PayPal, which was completed in June 2015 (the "Capitalization"). As part of the Capitalization, we received from eBay a contribution of cash of approximately $3.8 billion, as well as a related deferred tax liability of $236 million associated with the foreign cash contributed that is not considered indefinitely reinvested. During the period, eBay also contributed property and equipment with a net book value of approximately $208 million and intangible assets with a net book value of approximately $13 million. Additionally, we sold certain property and equipment to eBay with a net book value and proceeds of approximately $15 million. The contribution from eBay resulted in an increase to net parent investment within stockholders' equity.
Note 12 - Stock-Based and Employee Savings Plans
Prior to separation, PayPal employees participated in eBay's equity incentive plans, including stock options, restricted stock units and performance-based restricted stock units. In addition, certain PayPal employees participated in eBay's employee stock purchase plan.
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following disclosures represent the portion of eBay's incentive plans in which PayPal employees participated prior to separation for the periods indicated. Prior to separation, all awards granted under the plans consisted of eBay common shares. PayPal's combined and consolidated statement of income reflects compensation expense for these stock-based plans associated with the portion of eBay's incentive plans in which PayPal employees participated. Accordingly, the amounts presented below are for that of eBay's incentive plans and not necessarily indicative of future performance and do not necessarily reflect the equity of PayPal.
Following separation, outstanding awards granted to PayPal employees under eBay's equity incentive plans will be converted into PayPal awards based on a conversion ratio. This conversion ratio will be determined as the closing per-share price of eBay shares on the last regular trading session prior to separation divided by the opening per-share price of PayPal shares on the first regular trading session after separation.
Stock Option Activity
The following table summarizes stock option activity of our employees under eBay's equity incentive plans for the six months ended June 30, 2015:
|
| | | | | | |
| Options | | Weighted Average Grant-Date Fair Value (per share) |
| (In thousands, except per share amounts) |
Outstanding at January 1, 2015 | 2,409 |
| | |
Granted and assumed | 1,002 |
| | $ | 13.60 |
|
Exercised | (575 | ) | | |
Forfeited/expired/canceled | (84 | ) | | |
Outstanding at June 30, 2015 | 2,752 |
| | |
The weighted average exercise price of stock options granted during the period was $44.02 per share.
Restricted Stock Units Activity and Performance Based Restricted Stock Units Activity
The following table summarizes the restricted stock units granted (including performance‑based restricted stock units that have been earned) under eBay's equity incentive plans for the six months ended June 30, 2015:
|
| | | | | | |
| Units | | Weighted Average Grant-Date Fair Value (per share) |
| (In thousands, except per share amounts) |
Outstanding at January 1, 2015 | 14,715 |
| | |
Awarded and assumed | 7,148 |
| | $ | 57.25 |
|
Vested | (4,150 | ) | | |
Forfeited | (1,102 | ) | | |
Outstanding at June 30, 2015 | 16,611 |
| | |
Expected to vest at June 30, 2015 | 13,797 |
| | |
Stock-based Compensation Expense
For the periods presented we were charged by eBay for stock-based compensation expense related to our direct employees. eBay also charged us for the allocated costs of certain employees of eBay (including stock-based compensation) who provide general and administrative services on our behalf. Information included in this note is strictly limited to stock-based compensation associated with the employees wholly dedicated to PayPal (see Note 11, “Related Party Transactions” for total costs allocated to us by eBay).
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The impact on our results of operations of recording stock-based compensation expense for the three and six months ended June 30, 2015 and 2014 was as follows: |
| | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Six Months Ended June 30, |
| 2015 | | 2014 | | 2015 | | 2014 |
| (In millions) |
Customer support and operations | $ | 16 |
| | $ | 14 |
| | $ | 31 |
| | $ | 30 |
|
Sales and marketing | 11 |
| | 14 |
| | 24 |
| | 26 |
|
Product development | 35 |
| | 27 |
| | 64 |
| | 51 |
|
General and administrative | 16 |
| | 16 |
| | 34 |
| | 28 |
|
Total stock-based compensation expense | $ | 78 |
| | $ | 71 |
| | $ | 153 |
| | $ | 135 |
|
Total stock-based compensation costs capitalized as part of internal use software and website development costs was $2 million and $2 million for the three months ended June 30, 2015 and 2014, respectively. Total stock-based compensation costs capitalized as part of internal use software and website development costs was $4 million and $3 million for the six months ended June 30, 2015 and 2014, respectively.
Note 13 - Income Taxes
For the periods presented, we were a member of the eBay consolidated group and our U.S. taxable income is included in the consolidated U.S. federal income tax return of eBay as well as in returns filed by eBay with certain state and local taxing jurisdictions. Our foreign income tax returns are filed on a separate company basis. Our income tax liability has been computed and presented herein under the “separate return method” as if it were a separate tax paying entity, as modified by the benefits-for-loss approach. Accordingly, our operating losses and other tax attributes are characterized as utilized when those attributes have been utilized by other members of the eBay consolidated group; however, the benefits-for-loss approach does not impact our tax expense. Federal and state income taxes incurred are remitted to eBay pursuant to a tax sharing agreement between the companies.
Our effective tax rate for the three months ended June 30, 2015 was 23.6%. The difference between our effective tax rate and the U.S. federal statutory rate of 35% was primarily the result of foreign income taxed at different rates, partially offset by discrete tax adjustments.
Our effective tax rate for the six months ended June 30, 2015 was 22.2%. The difference between our effective tax rate and the U.S. federal statutory rate of 35% was primarily the result of foreign income taxed at different rates, partially offset by discrete tax adjustments.
During the three months ended June 30, 2015, the Company reclassified approximately $1.2 billion of its deferred tax liability related to unremitted foreign earnings from current to long-term. The Company revised its cash projection needs in the U.S. over the next 12 months as a result of the $3.8 billion of cash contributed from eBay (see Note 16 - Stockholders’ Equity).
Note 14 - Restructuring
In January 2015, at a regular meeting of the eBay board of directors (the "eBay Board"), the eBay Board approved a plan to implement a strategic reduction of its existing global workforce. The reduction was substantially completed in the first half of 2015 and is expected to generate annual savings of more than $130 million across the Company, primarily impacting sales and marketing and product development expenses. The savings in these line items are expected to be offset by the Company's reinvestment back into these areas of the business to drive additional growth.
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following table summarizes the restructuring costs recognized during the three and six months ended June 30, 2015:
|
| | | | | | | |
| Three Months Ended | Six Months Ended |
| (In millions) |
Employee severance and benefits | $ | 1 |
| | $ | 49 |
|
Total | $ | 1 |
| | $ | 49 |
|
No restructuring expenses were recognized in the three and six months ended June 30, 2014.
The following table summarizes the restructuring reserve activity during the six months ended June 30, 2015:
|
| | | | | | | | | | | |
| Employee Severance and Benefits | | Other Associated Costs | | Total |
| (In millions) |
Accrued liability as of January 1, 2015 | $ | — |
| | $ | — |
| | $ | — |
|
Charges | 49 |
| | — |
| | $ | 49 |
|
Payments | (43 | ) | | — |
| | $ | (43 | ) |
Accrued liability as of June 30, 2015 | $ | 6 |
| | $ | — |
| | $ | 6 |
|
Note 15 - Accumulated Other Comprehensive Income
The following table summarizes the changes in accumulated balances of other comprehensive income for the three months ended June 30, 2015:
|
| | | | | | | | | | | | | | | | | | | |
| Unrealized Gains (Losses) on Cash Flow Hedges | | Unrealized Gains (Losses) on Investments | | Foreign Currency Translation | | Estimated tax (expense) benefit | | Total |
| (In millions) |
Beginning balance | $ | 190 |
| | $ | — |
| | $ | (49 | ) | | $ | 1 |
| | $ | 142 |
|
Other comprehensive income (loss) before reclassifications | (62 | ) | | (2 | ) | | 9 |
| | (1 | ) | | $ | (56 | ) |
Amount of gain reclassified from accumulated other comprehensive income | 62 |
| | — |
| | — |
| | — |
| | $ | 62 |
|
Net current period other comprehensive income | (124 | ) | | (2 | ) | | 9 |
| | (1 | ) | | (118 | ) |
Ending balance | $ | 66 |
| | $ | (2 | ) | | $ | (40 | ) | | $ | — |
| | $ | 24 |
|
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following table summarizes the changes in accumulated balances of other comprehensive income for the three months ended June 30, 2014:
|
| | | | | | | | | | | | | | | | | | | |
| Unrealized Gains (Losses) on Cash Flow Hedges | | Unrealized Gains (Losses) on Investments | | Foreign Currency Translation | | Estimated tax (expense) benefit | | Total |
| (In millions) |
Beginning balance | $ | (81 | ) | | $ | — |
| | $ | 26 |
| | $ | 1 |
| | $ | (54 | ) |
Other comprehensive income (loss) before reclassifications | (12 | ) | | — |
| | (2 | ) | | — |
| | $ | (14 | ) |
Amount of gain reclassified from accumulated other comprehensive income | (23 | ) | | — |
| | — |
| | — |
| | $ | (23 | ) |
Net current period other comprehensive income | 11 |
| | — |
| | (2 | ) | | — |
| | 9 |
|
Ending balance | $ | (70 | ) | | $ | — |
| | $ | 24 |
| | $ | 1 |
| | $ | (45 | ) |
The following table summarizes the changes in accumulated balances of other comprehensive income for the six months ended June 30, 2015:
|
| | | | | | | | | | | | | | | | | | | |
| Unrealized Gains (Losses) on Cash Flow Hedges | | Unrealized Gains (Losses) on Investments | | Foreign Currency Translation | | Estimated tax (expense) benefit | | Total |
| (In millions) |
Beginning balance | $ | 126 |
| | $ | — |
| | $ | (16 | ) | | $ | — |
| | $ | 110 |
|
Other comprehensive income (loss) before reclassifications | 52 |
| | (2 | ) | | (24 | ) | | — |
| | $ | 26 |
|
Amount of gain reclassified from accumulated other comprehensive income | 112 |
| | — |
| | — |
| | — |
| | $ | 112 |
|
Net current period other comprehensive income | (60 | ) | | (2 | ) | | (24 | ) | | — |
| | (86 | ) |
Ending balance | $ | 66 |
| | $ | (2 | ) | | $ | (40 | ) | | $ | — |
| | $ | 24 |
|
The following table summarizes the changes in accumulated balances of other comprehensive income for the six months ended June 30, 2014:
|
| | | | | | | | | | | | | | | |
| Unrealized Gains (Losses) on Cash Flow Hedges | | Foreign Currency Translation | | Estimated tax (expense) benefit | | Total |
| (In millions) |
Beginning balance | $ | (91 | ) | | $ | 26 |
| | $ | 4 |
| | $ | (61 | ) |
Other comprehensive loss before reclassifications | (19 | ) | | (2 | ) | | (3 | ) | | $ | (24 | ) |
Amount of loss reclassified from accumulated other comprehensive income | (40 | ) | | — |
| | — |
| | $ | (40 | ) |
Net current period other comprehensive income | 21 |
| | (2 | ) | | (3 | ) | | 16 |
|
Ending balance | $ | (70 | ) | | $ | 24 |
| | $ | 1 |
| | $ | (45 | ) |
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The following table provides details about reclassifications out of accumulated other comprehensive income for the three months ended June 30, 2015 and 2014:
|
| | | | | | | | | | |
Details about Accumulated Other Comprehensive Income Components | | Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income | | Affected Line Item in the Statement of Income |
| | Three Months Ended June 30, | | |
| | 2015 | | 2014 | | |
| | (In millions) | | |
Gains (losses) on cash flow hedges-foreign exchange contracts | | $ | 62 |
| | $ | (23 | ) | | Net revenues |
| | $ | 62 |
| | $ | (23 | ) | | Income before income taxes |
| | — |
| | — |
| | Income tax expense |
Total reclassifications for the period | | $ | 62 |
| | $ | (23 | ) | | Net income/(loss) |
The following table provides details about reclassifications out of accumulated other comprehensive income for the six months ended June 30, 2015 and 2014:
|
| | | | | | | | | | |
Details about Accumulated Other Comprehensive Income Components | | Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income | | Affected Line Item in the Statement of Income |
| | Six Months Ended June 30, | | |
| | 2015 | | 2014 | | |
| | (In millions) | | |
Gains (losses) on cash flow hedges-foreign exchange contracts | | $ | 112 |
| | $ | (40 | ) | | Net revenues |
| | $ | 112 |
| | $ | (40 | ) | | Income before income taxes |
| | — |
| | — |
| | Income tax expense |
Total reclassifications for the period | | $ | 112 |
| | $ | (40 | ) | | Total, net of income taxes |
Note 16 - Stockholders' Equity
In the three months ended June 30, 2015, we received a contribution of approximately $3.8 billion of cash from eBay, as well as a related deferred tax liability of $236 million associated with the foreign cash contributed that is not considered indefinitely reinvested. The contribution resulted in an increase to net parent investment within stockholders' equity.
Note 17 - Subsequent Events
In June 2015, the eBay Board approved the separation of eBay's payments business through the distribution of 100 percent of the outstanding common stock of PayPal to eBay's stockholders. PayPal's Registration Statement on Form 10, as amended, was declared effective by the U.S. Securities and Exchange Commission on June 29, 2015. On July 17, 2015, PayPal became an independent publicly-traded company through the pro rata distribution by eBay of 100 percent of the outstanding common stock of PayPal to eBay stockholders. Each eBay stockholder of record as of the close of business on July 8, 2015 received one share of PayPal
PayPal Holdings, Inc.
NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
common stock for every share of eBay common stock held on the record date. Approximately 1.2 billion shares of PayPal common stock were distributed on July 17, 2015 to eBay stockholders. PayPal's common stock began "regular way" trading on the NASDAQ Stock Market under the ticker symbol "PYPL" on July 20, 2015.
In connection with the Distribution, eBay and PayPal entered into a separation and distribution agreement as well as various other agreements that will govern the relationships between the parties going forward, including an operating agreement, transition services agreement, tax matters agreement, employee matters agreement, intellectual property matters agreement and colocation services agreements. The separation and distribution agreement was entered into on June 26, 2015. The other agreements were entered into on the Distribution Date. Under the tax matters agreement, eBay generally will be responsible for all taxes (and will be entitled to all related refunds of taxes) imposed on eBay and its subsidiaries (including subsidiaries that will be transferred to PayPal pursuant to the separation) with respect to the taxable periods (or portions thereof) ending on or prior to the Distribution Date.
In July 2015, we entered into a credit agreement that provides for a senior unsecured $2 billion five-year revolving credit facility. Funds borrowed under the credit agreement may be used for general corporate purposes.
As of July 20, 2015, we were rated investment grade by Standard and Poor's Financial Services, LLC and Fitch Ratings, Inc. Our liquidity and access to capital could be impacted by our credit rating, financial performance, and global credit market conditions. We expect that these credit rating agencies will continue to monitor developments after our separation from eBay, including our capital structure.
In July 2015, we announced an agreement to acquire Xoom Corporation (NASDAQ:XOOM) for approximately $890 million net of cash. This acquisition is subject to customary closing conditions, including regulatory approvals, and is expected to close in the fourth quarter of 2015. Xoom allows users to transfer money, pay bills, and reload prepaid mobile phones domestically and internationally through its web and mobile platforms. The acquisition of Xoom is intended to offer a broader range of services to our global customer base, increase customer engagement, and expand our presence in key international markets.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Please read the following discussion in conjunction with the audited combined financial statements, which are comprised of the payments business of eBay Inc., including PayPal, Inc. and certain other assets and liabilities that have historically been held at the eBay Inc. corporate level, but are specifically identifiable and attributable to the payments business, and corresponding notes, and the unaudited pro forma condensed combined financial statements and corresponding notes included in our registration statement on Form 10, as amended, filed with the Securities and Exchange Commission. This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements. The matters discussed in these forward-looking statements are subject to risk, uncertainties, and other factors that could cause actual results to differ materially from those projected or implied in the forward-looking statements. Please see “Risk Factors” and “Cautionary Statement Concerning Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions associated with these statements.
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements that involve expectations, plans or intentions (such as those relating to future business, future results of operations or financial condition, new or planned features or services, or management strategies). You can identify these forward-looking statements by words such as “may,” “will,” “would,” “should,” “could,” “expect,” “anticipate,” “believe,” “estimate,” “intend,” “plan” and other similar expressions. These forward-looking statements involve risks and uncertainties that could cause our actual results and financial condition to differ materially from those expressed or implied in our forward-looking statements. Such risks and uncertainties include, among others, those discussed in “Part II— Item 1A: Risk Factors” of this Quarterly Report on Form 10-Q as well as in our unaudited condensed combined and consolidated financial statements, related notes, and the other information appearing elsewhere in this report and our other filings with the Securities and Exchange Commission, or the SEC. We do not intend, and undertake no obligation, to update any of our forward-looking statements after the date of this report to reflect actual results or future events or circumstances. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
You should read the following Management's Discussion and Analysis of Financial Condition and Results of Operations in conjunction with the unaudited condensed combined and consolidated financial statements and the related notes that appear elsewhere in this report.
The Separation from eBay
On September 30, 2014, eBay Inc. (“eBay”) announced its intent to separate its payments business into an independent, publicly-traded company. To accomplish this separation, in January 2015, eBay incorporated PayPal Holdings, Inc. (“PayPal Holdings”) which is now the parent of PayPal, Inc. and holds directly or indirectly all of the assets and liabilities associated with PayPal, Inc. References to “we,” “our,” “us,” “the Company” or “PayPal” refer to the combined and consolidated entities of the payments business of eBay, including PayPal, Inc. and certain other assets and liabilities that have been historically held at the eBay corporate level, but are specifically identifiable and attributable to the payments business.
In June 2015, the board of directors of eBay approved the separation of eBay's payments business through the distribution of 100% of the outstanding common stock of PayPal to eBay's stockholders. PayPal's registration statement on Form 10, as amended, was declared effective by the U.S. Securities and Exchange Commission on June 29, 2015. On July 17, 2015, PayPal became an independent publicly-traded company through the pro rata distribution by eBay of 100% of the outstanding common stock of PayPal to eBay stockholders. Each eBay stockholder of record as of the close of business on July 8, 2015 received one share of PayPal common stock for every share of eBay common stock held on the record date. Approximately 1.2 billion shares of PayPal common stock were distributed on July 17, 2015 to eBay stockholders. PayPal's common stock began "regular way" trading under the ticker symbol "PYPL" on the NASDAQ Stock Market on July 20, 2015.
Business Environment
We are a leading technology platform company that enables digital and mobile payments on behalf of consumers and merchants worldwide. We put our customers at the center of everything we do. We strive to increase our relevance for consumers, merchants,
friends and family to manage and move their money anywhere in the world, anytime, on any platform and through any device (e.g., mobile, tablets, personal computers or wearables). We provide safer and simpler ways for businesses of all sizes to accept payments from merchant websites, mobile devices and applications, and at offline retail locations through a wide range of payment solutions across our Payments Platform, including PayPal, PayPal Credit, Braintree and Venmo products.
We provide merchants and consumers with protection programs on substantially all transactions completed through our Payments Platform, except for transactions using our gateway products. Our gateway products include our Payflow Payments and certain Braintree products. A payment gateway links a merchant's website to their processing network and merchant account. Our protection programs protect both merchants and consumers from loss primarily due to fraud and counterparty performance. Our ability to protect both consumers and merchants is based largely on our risk management capabilities, which in turn depend on our ability to leverage the data we collect on transactions and our analytical capabilities. The protections we provide are generally much broader than those protections provided by other participants in the payments industry. We believe that as a result of these programs, consumers can be confident that they will only be required to pay if they receive the product in the condition as described, and that merchants can be confident that they will receive payment for the product that they are delivering to the customer.
Our Payments Platform and open application programming interfaces (“APIs”) are designed to allow developers to innovate with ease and to offer cutting edge applications to a large ecosystem of merchants and consumers, while at the same time maintaining the security of our customers’ financial information. We provide developers with easy to use, flexible and powerful tools that are designed to leverage our global reach and payment capabilities. Our software developer kits (“SDKs”) are specifically focused on the mobile application market and are designed to remove friction by not requiring a redirect to PayPal.com or an additional login. We are using a true “mobile first” approach to make payments simple and intuitive.
In April 2015, we completed our acquisition of Paydiant to expand our capabilities in mobile payments. Using Paydiant’s platform, our merchant partners can create their own branded wallets to accelerate mobile-in-store payments and drive consumer engagement through mobile payments, loyalty, offers and the prioritization of preferred payment types, such as store branded credit cards and gift cards.
Information security risks for global payments and technology companies have significantly increased in recent years. Although we have not experienced any material impacts relating to cyber-attacks or other information security breaches on our Payments Platform, there can be no assurance that we are immune to these risks and will not suffer such losses in the future. See our risk factor in “Risk Factors-Risk Factors That May Affect Our Business, Results of Operations and Financial Condition” related to a failure or breach of our security systems or infrastructure as a result of cyber-attacks.
In June 2015, Greece established certain capital control requirements. To comply with these controls we have implemented procedures to temporarily disable certain card and bank funded transactions sent from Greece. As a results, we have experienced volume declines involving certain transactions with Greece. We derive an immaterial amount of TPV (as defined below) and revenue from customers in Greece. We do not expect that the impact of these capital controls will have a material impact on our financial statements.
Overview of Results of Operations
Three months ended June 30, 2015 and 2014
Net revenues increased $314 million, or 16%, in the three months ended June 30, 2015 compared to the same period of the prior year. The increase was primarily driven by growth in TPV (as defined below) of 19%. Operating expenses increased $246 million, or 15%, in the three months ended June 30, 2015 compared to the same period of the prior year. The increase was primarily due to an increase in transaction expense, transaction and loan losses and customer support and operations.
Operating income increased $68 million, or 21%, in the three months ended June 30, 2015 compared to the same period of the prior year. Non-GAAP operating income increased $95 million, or 22%, in the three months ended June 30, 2015 compared to the same period of the prior year. Our non-GAAP operating margin was 23% and 21% in the three months ended June 30, 2015 and 2014, respectively. Operating income and non-GAAP operating income increased primarily due to the increase in net revenues and other operating efficiencies.
Net income increased by $24 million, or 9%, in the three months ended June 30, 2015 compared to the same period in the prior year. The increase in net income was primarily attributable to an increase in operating income. Non-GAAP net income increased by $58 million, or 17%, in the three months ended June 30, 2015 compared to the same period in the prior year. For the three months ended June 30, 2015, our GAAP diluted earnings per share were $0.25, a $0.02 increase compared to the same period of
the prior year. For the three months ended June 30, 2015 our non-GAAP diluted earnings per share were $0.33, a $0.04 increase compared to the same period of the prior year. The calculation of diluted earnings per share for the period is based on the number of shares of PayPal common stock outstanding on July 17, 2015, the date on which eBay distributed our common stock to eBay’s stockholders. The same number of shares was used to calculate diluted earnings per share for the prior year since no PayPal equity was outstanding prior to the distribution.
We generated net cash flows from operations of $622 million for the three months ended June 30, 2015, compared to $560 million for the three months ended June 30, 2014. We generated free cash flow of $391 million and $464 million in the three months ended June 30, 2015 and 2014, respectively.
Six months ended June 30, 2015 and 2014
Net revenues increased $577 million, or 15%, in the six months ended June 30, 2015 compared to the same period of the prior year. The increase was primarily driven by growth in TPV (as defined below) of 18%. Operating expenses increased $505 million, or 16%, in the six months ended June 30, 2015 compared to the same period of the prior year. The increase was primarily due to an increase in transaction expense, transaction and loan losses and customer support and operations.
Operating income increased $72 million, or 11%, in the six months ended June 30, 2015 compared to the same period of the prior year. Non-GAAP operating income increased $156 million, or 19%, in the six months ended June 30, 2015 compared to the same period of the prior year. Our non-GAAP operating margin was 22% in the six months ended June 30, 2015 and 2014. Operating income and non-GAAP operating income increased primarily due to the increase in net revenues and other operating efficiencies.
Net income increased by $661 million, or 654%, in the six months ended June 30, 2015 compared to the same period in the prior year. The increase in net income was primarily attributable to a decrease in income tax expense of $579 million, primarily resulting from the recognition of deferred tax liabilities in the three months ended March 31, 2014 relating to undistributed foreign earnings of certain foreign subsidiaries for 2013 and prior years. Non-GAAP net income increased by $81 million, or 12%, in the six months ended June 30, 2015 compared to the same period in the prior year. For the six months ended June 30, 2015, our GAAP diluted earnings per share were $0.46, a $0.54 increase compared to the same period of the prior year. For the six months ended June 30, 2015 our non-GAAP diluted earnings per share were $0.63, a $0.07 increase compared to the same period of the prior year. The calculation of diluted earnings per share for the period is based on the number of shares of PayPal common stock outstanding on July 17, 2015, the distribution date. The same number of shares was used to calculate diluted earnings per share for the prior year since no PayPal equity was outstanding prior to the distribution.
We generated net cash flows from operations of $1.2 billion for the six months ended June 30, 2015, compared to $985 million for the six months ended June 30, 2014. We generated free cash flow of $741 million and $789 million in the six months ended June 30, 2015 and 2014, respectively.
The following table provides a summary of our GAAP financial measuresfor the three and six months ended June 30, 2015 and 2014:
|
| | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Percent Increase/(Decrease) | | Six Months Ended June 30, | | Percent Increase/(Decrease) |
| 2015 | | 2014 | | | 2015 | | 2014 | |
| (In millions, except percentages) |
Net revenues | $ | 2,297 |
| | $ | 1,983 |
| | 16 | % | | $ | 4,434 |
| | $ | 3,857 |
| | 15 | % |
Operating expenses | 1,899 |
| | 1,653 |
| | 15 | % | | 3,714 |
| | 3,209 |
| | 16 | % |
Operating income | 398 |
| | 330 |
| | 21 | % | | 720 |
| | 648 |
| | 11 | % |
Income tax expense | 94 |
| | 45 |
| | 109 | % | | 160 |
| | 739 |
| | (78 | )% |
Effective tax rate | 24 | % | | 14 | % | | ** |
| | 22 | % | | 116 | % | | ** |
|
Net income/(loss) | $ | 305 |
| | $ | 281 |
| | 9 | % | | $ | 560 |
| | $ | (101 | ) | | 654 | % |
Net income/ (loss) per diluted share1 | $ | 0.25 |
| | $ | 0.23 |
| | 9 | % | | $ | 0.46 |
| | $ | (0.08 | ) | | 675 | % |
| | | | | | | | | | | |
1 Net income/ (loss) per diluted share is based on the number of shares of PayPal common stock outstanding on the distribution date. The same number of shares was used to calculate the amount for the prior year since no PayPal equity was outstanding prior to the distribution.
** Not Meaningful
The following table provides a summary of our non-GAAP financial measures for the three and six months ended June 30, 2015 and 2014:
|
| | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Percent Increase/(Decrease) | | Six Months Ended June 30, | | Percent Increase/(Decrease) |
| 2015 | | 2014 | | | 2015 | | 2014 | |
| (In millions, except percentages) |
Non-GAAP operating income | $ | 520 |
| | $ | 425 |
| | 22 | % | | $ | 993 |
| | $ | 837 |
| | 19 | % |
Non-GAAP operating margin | 23 | % | | 21 | % | | ** |
| | 22 | % | | 22 | % | | ** |
|
Non-GAAP net income | $ | 408 |
| | $ | 350 |
| | 17 | % | | $ | 768 |
| | $ | 687 |
| | 12 | % |
Non-GAAP net income/ (loss) per diluted share1 | $ | 0.33 |
| | $ | 0.29 |
| | 14 | % | | $ | 0.63 |
| | $ | 0.56 |
| | 13 | % |
Free Cash Flow | $ | 391 |
| | $ | 464 |
| | (16 | )% | | $ | 741 |
| | $ | 789 |
| | (6 | )% |
1 Non-GAAP net income/ (loss) per diluted share is based on the number of shares of PayPal common stock outstanding on the distribution date. The same number of shares was used to calculate the amount for the prior year since no PayPal equity was outstanding prior to the distribution.
** Not Meaningful
Please refer to “Non-GAAP Financial Information” below for information on how we compute the foregoing non-GAAP financial measures and for a reconciliation to the most directly comparable GAAP financial measures.
Impact of Foreign Currency Exchange Rates
We have significant operations internationally that are denominated in foreign currencies, primarily the Euro, British Pound, and Australian Dollar, subjecting us to foreign currency risk which may adversely impact our financial results. The strengthening or weakening of the U.S. dollar versus the Euro, British Pound, Australian Dollar and other currencies impacts the translation of our net revenues generated in these foreign currencies into the U.S. dollar.
In the three months ended June 30, 2015 and 2014, we generated approximately 49% and 50% of net revenues from customers domiciled outside of the United States, respectively. In the six months ended June 30, 2015 and 2014, we generated approximately 50% and 51% of net revenues from customers domiciled outside of the United States, respectively. Other than the United States, the United Kingdom was the only country where we generated more than 10% of total net revenues in these periods. Additionally, in connection with our services in multiple currencies, we set our foreign exchange rates twice per day, and may face financial exposure if we incorrectly set our foreign exchange rates or as a result of fluctuations in foreign exchange rates between the times that we set our foreign exchange rates. Given that we also hold some corporate and customer funds in non-U.S. currencies, our financial results are affected by the translation of these non-U.S. currencies into U.S. dollars. While from time to time we enter into transactions to hedge portions of our foreign currency translation exposure, it is impossible to predict or eliminate the effects of this exposure. Fluctuations in foreign exchange rates could significantly impact our financial results.
In the three months ended June 30, 2015, foreign currency movements relative to the U.S. dollar negatively impacted net revenues by approximately $86 million (inclusive of a $62 million favorable impact from hedging activities) and favorably impacted operating expenses by approximately $84 million. In the six months ended June 30, 2015, foreign currency movements relative to the U.S. dollar negatively impacted net revenues by approximately $166 million (inclusive of a $112 million favorable impact from hedging activities) and favorably impacted operating expenses by approximately $159 million. In the three and six months ended June 30, 2015, foreign currency movements relative to the U.S. dollar, inclusive of hedging activities, did not have a significant impact on net income.
Because we have generated substantial net revenues internationally in recent periods, including the years ended 2014, 2013 and 2012, we are subject to the risks of doing business in foreign countries as discussed under “Risk Factors—Risk Factors That May Affect Our Business, Results of Operations and Financial Condition.”
Financial Results
Net revenues
We earn revenue from the following types of transactions:
| |
• | Transaction revenues: Net transaction fees charged to consumers and merchants based on the volume of activity processed through our Payments Platform, including PayPal, PayPal Credit, Venmo and Braintree products. |
| |
• | Other value added services: Net revenues derived principally from interest and fees earned on our PayPal Credit loans receivable portfolio, subscription fees, gateway fees, revenue share we earn through partnerships and other services that we provide to consumers and merchants. |
Net Revenue Analysis
The following table provides a summary of the significant components of our net revenue for the three and six months ended June 30, 2015 and 2014:
|
| | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | Percent Increase/(Decrease) | | Six Months Ended June 30, | | Percent Increase/(Decrease) |
| 2015 | | 2014 | | | 2015 | | 2014 | |
| (In millions, except percentages) |
Transaction revenues | $ | 1,970 |
| | $ | 1,712 |
| | 15 | % | | $ | 3,884 |
| | $ | 3,386 |
| | 15 | % |
Other value-added services | 327 |
| | 271 |
| | 21 | % | | 550 |
| | $ | 471 |
| | 17 | % |
Net revenues | $ | 2,297 |
| | $ | 1,983 |
| | 16 | % | | $ | 4,434 |
| | $ | |