Edgar Filing: PayPal Holdings, Inc.

10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q



ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2015.



o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from to .

Commission file number 001-36859

PayPal Holdings, Inc.

(Exact Name of Registrant as Specified in Its Charter)



Delaware	47-2989869
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)

2211 North First Street San Jose, California	95131
(Address of Principal Executive Offices)	(Zip Code)

(408) 967-1000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [x] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):



Large accelerated filer	ý	Accelerated filer	o

Non-accelerated filer	o (Do not check if a smaller reporting company)	Smaller reporting company	o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [x]

As of October 23, 2015, there were 1,221,690,060 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


Item 1:	Financial Statements

PayPal Holdings, Inc.

CONDENSED COMBINED AND CONSOLIDATED BALANCE SHEET



	September 30, 2015		December 31, 2014
	(In millions, except par value)
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	1,880	$	2,201
Short-term investments	2,419		29
Accounts receivable, net	173		65
Loans and interest receivable, net	3,602		3,586
Funds receivable and customer accounts	11,802		10,612
Notes and receivables from affiliates	—		694
Other current assets	678		378
Total current assets	20,554		17,565
Long-term investments	2,392		31
Property and equipment, net	1,298		922
Goodwill	3,415		3,189
Intangible assets, net	174		156
Other assets	63		54
Total assets	$	27,896	$	21,917
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable	$	114	$	115
Funds payable and amounts due to customers	11,802		10,612
Notes and payables to affiliates	—		1,093
Accrued expenses and other current liabilities	1,089		1,434
Income taxes payable	67		29
Total current liabilities	13,072		13,283
Long-term liabilities	1,610		386
Total liabilities	14,682		13,669
Commitments and contingencies (Note 10)
Equity:
Net parent investment	—		8,138
Common stock, $0.0001 par value; 4,000 shares authorized; 1,221 and 1,218 outstanding	—		—
Additional paid-in-capital	12,910		—
Retained earnings	301		—
Accumulated other comprehensive income	3		110
Total equity	13,214		8,248
Total liabilities and equity	$	27,896	$	21,917

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



	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
	(In millions, except per share data)
	(Unaudited)
Net revenues	$	2,258	$	1,975	$	6,692	$	5,832
Operating expenses:
Transaction expense	651		537		1,860		1,576
Transaction and loan losses	201		180		564		453
Customer support and operations	317		257		900		775
Sales and marketing	235		267		716		735
Product development	230		232		695		651
General and administrative	141		101		414		338
Depreciation and amortization	153		129		444		384
Restructuring	—		—		49		—
Total operating expenses	1,928		1,703		5,642		4,912
Operating income	330		272		1,050		920
Other income (expense), net	20		4		20		(6		)
Income before income taxes	350		276		1,070		914
Income tax expense	49		42		209		781
Net income	$	301	$	234	$	861	$	133

Net income per share:
Basic	$	0.25	$	0.19	$	0.71	$	0.11
Diluted	$	0.25	$	0.19	$	0.70	$	0.11

Weighted average shares:
Basic	1,221		1,218		1,221		1,218
Diluted	1,227		1,224		1,227		1,224

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



	Three Months Ended September 30,						Nine Months Ended September 30,
	2015			2014			2015			2014
	(In millions)
	(Unaudited)
Net income	$	301		$	234		$	861		$	133
Other comprehensive income (loss), net of reclassification adjustments:
Foreign currency translation	(9		)	(23		)	(33		)	(25		)
Unrealized losses on investments, net	(6		)	—			(8		)	—
Tax expense on unrealized gains (losses) on investments, net	1			—			1			—
Unrealized gains (losses) on hedging activities, net	(7		)	140			(67		)	161
Tax expense on unrealized gains (losses) on hedging activities, net	—			(2		)	—			(5		)
Other comprehensive income (loss), net of tax	(21		)	115			(107		)	131
Comprehensive income	$	280		$	349		$	754		$	264

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



	Nine Months Ended September 30,
	2015			2014
	(In millions)
	(Unaudited)
Cash flows from operating activities:
Net income	$	861		$	133
Adjustments:
Transaction and loan losses	564			453
Depreciation and amortization	444			384
Stock-based compensation	256			218
Deferred income taxes	87			677
Excess tax benefits from stock-based compensation	(24		)	(35		)
Premium received on sale of principal loans receivable held for sale	(35		)	—
Changes in assets and liabilities:
Accounts receivable	(98		)	2
Notes and receivable from affiliates, net	121			24
Changes in principal loans receivable held for sale, net	9			—
Accounts payable	2			28
Notes payable to affiliates	(217		)	(116		)
Income taxes payable and other tax liabilities	89			26
Other assets and liabilities	(241		)	(205		)
Net cash provided by operating activities	1,818			1,589
Cash flows from investing activities:
Purchases of property and equipment	(558		)	(369		)
Proceeds from sales of property and equipment	26			—
Changes in principal loans receivable, net	(146		)	(495		)
Purchases of investments	(6,722		)	(65		)
Maturities and sales of investments	1,976			389
Acquisitions, net of cash acquired	(283		)	(1		)
Notes and receivables from affiliates	575			(348		)
Net cash used in investing activities	(5,132		)	(889		)
Cash flows from financing activities:
Proceeds from issuance of common stock	36			—
Excess tax benefits from stock-based compensation	24			35
Contribution from (to) parent	3,858			(2		)
Tax withholdings related to net share settlements of restricted stock units and restricted stock awards	(7		)	—
Repayments under financing arrangements, net	(877		)	(61		)
Funds receivable and customer accounts	(1,190		)	(698		)
Funds payable and amounts due to customers	1,190			698
Net cash provided by (used in) financing activities	3,034			(28		)
Effect of exchange rate changes on cash and cash equivalents	(41		)	(17		)
Net increase (decrease) in cash and cash equivalents	(321		)	655
Cash and cash equivalents at beginning of period	2,201			1,604
Cash and cash equivalents at end of period	$	1,880		$	2,259
Supplemental cash flow disclosures:
Cash paid for interest	$	14		$	13
Cash paid for income taxes	$	56		$	33

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 increase our relevance for consumers, merchants, friends and family to move and manage 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 our 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

On July 17, 2015 (the "distribution date"), PayPal became an independent publicly-traded company through the pro rata distribution by eBay Inc. ("eBay") of 100% of the outstanding common stock of PayPal to eBay stockholders (which we refer to as the "separation" or the "distribution"). Each eBay stockholder of record as of the close of business on July 8, 2015 received one share of PayPal common stock for every share of eBay common stock held on the record date. Approximately 1.2 billion shares of PayPal common stock were distributed on July 17, 2015 to eBay stockholders. PayPal's common stock began "regular way" trading under the ticker symbol "PYPL" on The NASDAQ Stock Market on July 20, 2015.

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 throughout the periods presented, nor are the results stated herein indicative of what the Company’s financial position, results of operations and cash flows may be in the future. All intercompany transactions and accounts have been eliminated. Transactions between the Company and eBay are included in these condensed combined and consolidated financial statements for all periods presented.

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. 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 on our condensed combined and consolidated balance sheet. 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

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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 and our investment balance is included in long-term investments on our condensed combined and consolidated balance sheet.

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 registration statement on Form 10, as amended, filed with the Securities and Exchange Commission (the “SEC”).

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

Use of Estimates

The preparation of condensed combined and consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed combined and consolidated financial statements and the reported amounts of revenues and expenses, including allocations from eBay, 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 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 2015, the FASB deferred the effective date to fiscal years, and interim periods within those fiscal years, beginning after December 15, 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, 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.

In 2015, the FASB issued new accounting guidance related to business combinations to simplify the accounting for adjustments made to provisional amounts recognized in a business combination. This amendment eliminates the requirement to retrospectively account for those adjustments. The new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. The amendment should be applied prospectively to adjustments to provisional amounts that occur after

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

the effective date of this amendment with earlier application permitted for financial statements that have not been issued. We are evaluating the impact, if any, of adopting this new accounting guidance on our financial statements.

Note 2 - Net Income Per Share

Basic net income per share is computed by dividing net income for the period by the weighted average number of common shares outstanding during the period. The weighted average number of common shares outstanding for basic and diluted earnings per share for the three and nine months ended September 30, 2015 was based on the weighted average number of common shares outstanding for the period beginning after the distribution date. The weighted average number of common shares outstanding for basic and diluted earnings per share for the three and nine months ended September 30, 2014 was 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 common stock for every share of eBay common stock held as of the record date. Diluted net income per share is computed by dividing net income for the period by the weighted average number of shares of common stock and potentially dilutive common stock outstanding for the period beginning after the distribution date. The dilutive effect of outstanding options and equity incentive awards is reflected in diluted net income per share by application of the treasury stock method. The calculation of diluted net income per share excludes all anti-dilutive common shares. The same number of shares was used to calculate diluted earnings per share for the three and nine months ended September 30, 2014 since the 1.2 billion shares that were distributed on the distribution date were not outstanding for those periods.

The following table sets forth the computation of basic and diluted net income per share for the periods indicated:



	Three Months Ended September 30,				Nine Months Ended September 30,
	2015⁽²⁾		2014⁽¹⁾		2015⁽²⁾		2014⁽¹⁾
	(In millions, except per share amounts)
Numerator:
Net income	$	301	$	234	$	861	$	133
Denominator:
Weighted average shares of common stock - basic	1,221		1,218		1,221		1,218
Dilutive effect of equity incentive awards	6		6		6		6
Weighted average shares of common stock - diluted	1,227		1,224		1,227		1,224
Net income per share:
Basic	$	0.25	$	0.19	$	0.71	$	0.11
Diluted	$	0.25	$	0.19	$	0.70	$	0.11
Common stock equivalents excluded from income per diluted share because their effect would have been anti-dilutive	3		2		3		2

¹ On July 17, 2015, the distribution date, eBay stockholders of record as of the close of business on July 8, 2015 received one share of PayPal common stock for every share of eBay common stock held as of the record date. Basic and diluted net income per share for the three months ended and nine months ended September 30, 2014 is calculated using the number of common shares distributed on July 17, 2015.

² Basic and diluted net income per share for the three months ended and nine months ended September 30, 2015 is calculated using the weighted average number of common shares outstanding for the period beginning after the distribution date.

Note 3 - Business Combinations

2015 Acquisition and Divestiture Activity

During the nine months ended September 30, 2015, we completed three acquisitions:

Paydiant

We completed the acquisition of Paydiant, Inc. ("Paydiant") in April 2015 for total 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 approximately $187 million. We do not expect goodwill to be deductible for income tax purposes. The

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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.

CyActive

We completed the acquisition of CyActive Security, Ltd. ("CyActive") in April 2015 for total consideration of approximately $43 million, net of cash acquired. We acquired CyActive to further enhance our information security capabilities. 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 approximately $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.

Other

During the quarter we completed one other acquisition for total consideration of approximately $10 million. The allocation of the purchase consideration resulted in approximately $3 million of purchased intangible assets and initial goodwill of approximately $7 million. 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 these acquired businesses in our condensed combined and consolidated financial statements from their dates of acquisition. Revenues and expenses related to these acquisitions for the period ending September 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 nine months ended September 30, 2015 (in millions):



	December 31, 2014		Goodwill Acquired		Adjustments			September 30, 2015
Total Goodwill	$	3,189	$	231	$	(5	)	$	3,415

The adjustments to goodwill during the nine months ended September 30, 2015 relate to foreign exchange rate translations.

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Intangible Assets

The components of identifiable intangible assets are as follows:



	September 30, 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	$	533	$	(492	)	$	41	5	$	520	$	(477	)	$	43	6
Marketing related	181		(141		)	40		3	181		(117		)	64		3
Developed technologies	213		(168		)	45		3	167		(153		)	14		3
All other	146		(98		)	48		5	105		(70		)	35		5
Intangible assets, net	$	1,073	$	(899	)	$	174		$	973	$	(817	)	$	156

During the second and third quarters of 2015, eBay contributed intangible assets with a gross carrying amount of $37 million and a net book value of $18 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 $24 million and $20 million for the three months ended September 30, 2015 and 2014, respectively. Amortization expense for intangible assets was $66 million and $64 million for the nine months ended September 30, 2015 and 2014, respectively.

Expected future intangible asset amortization as of September 30, 2015 is as follows (in millions):



Fiscal years:
Remaining 2015	$	24
2016	88
2017	39
2018	19
2019	4
Thereafter:	—
	$	174

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.

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following tables summarize the allocation of net revenues and long-lived assets based on geography:



	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
	(In millions)
Net revenues:
U.S.	$	1,138	$	949	$	3,338	$	2,834
United Kingdom	294		286		857		839
Rest of world	826		740		2,497		2,159
Total net revenues	$	2,258	$	1,975	$	6,692	$	5,832



	September 30, 2015		December 31, 2014
	(In millions)
Long-lived assets:
U.S.	$	4,472	$	3,784
International	466		401
Total long-lived assets	$	4,938	$	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 nine months ended September 30, 2015 and 2014 is as follows:



	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
	(In millions)
Transaction revenues	$	1,982	$	1,754	$	5,866	$	5,140
Other value added services:	276		221		826		692
Total net revenues	$	2,258	$	1,975	$	6,692	$	5,832

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 6 - Investments

At September 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:



	September 30, 2015
	Gross Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
	(In millions)
Short-term investments:
Restricted cash	$	19	$	—	$	—		$	19
Corporate debt securities	2,212		—		(1		)	2,211
Government and agency securities	180		—		—			180
Time deposits	9		—		—			9
Long-term investments:
Corporate debt securities	2,373		1		(8		)	2,366
Total⁽¹⁾	$	4,793	$	1	$	(9	)	$	4,785

⁽¹⁾Excludes funds receivable and customer accounts of $11.8 billion, of which $6.5 billion of customer account balances was invested primarily in government and agency securities and the remainder was held in cash and cash equivalents. The gross unrealized gains and losses associated with the short-term investments underlying customer account balances were not material for the periods presented.



	December 31, 2014
	Gross Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
	(In millions)
Short-term investments⁽²⁾:
Time deposits	$	29	$	—	$	—	$	29

⁽²⁾ Excludes funds receivable and customer accounts of $10.6 billion, of which $4.2 billion of customer account balances was invested primarily in government and agency securities and the remainder was held in cash and cash equivalents. The gross unrealized gains and losses associated with the short-term investments underlying customer account balances were not material for the periods presented.

In the three months ended September 30, 2015, prior to separation, eBay contributed cash of $16 million that we intend to use to support our global sabbatical program. Balances used to support our global sabbatical program are presented above as restricted cash.

As of September 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 and nine months ended September 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 September 30, 2015 were as follows:



	September 30, 2015
	(In millions)
One year or less (including restricted cash of $19)	$	2,419
One year through two years	1,485
Two years through three years	680
Three years through four years	130
Four years through five years	63
Greater than five years	8
Total⁽³⁾	$	4,785

⁽³⁾ Excludes government and agency securities underlying customer account balances of $6.5 billion, of which $6.0 billion, had a contractual maturity of one year or less. We classify the assets underlying the customer accounts as current based on their purpose and availability to fulfill our direct obligations under amounts due to customers.

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Equity and Cost Method Investments

We have 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 $26 million and $31 million as of September 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 September 30, 2015 and December 31, 2014:



Description	Balances at September 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	$	1,880	$	879	$	1,001
Short-term investments:
Restricted Cash	19		19		—
Corporate debt securities	2,211		—		2,211
Government and agency securities	180		—		180
Time deposits	9		—		9
Total short-term investments	$	2,419	$	19	$	2,400
Funds receivable and customer accounts	6,481		—		6,481
Derivatives	92		—		92
Long-term investments:
Corporate debt securities	2,366		—		2,366
Total financial assets	$	13,238	$	898	$	12,340
Liabilities:
Derivatives	$	25	$	—	$	25



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

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

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

assets. Level 2 instrument valuations are obtained from readily available pricing sources for comparable instruments, identical instruments in less active markets, or models using market observable inputs.

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

We did not have any transfers of financial instruments between valuation levels during the first nine months of 2015. As of September 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 $11.8 billion and $10.6 billion as of September 30, 2015 and December 31, 2014, respectively, of which $6.5 billion and $4.2 billion was invested primarily in short-term investments and the remainder was held in cash and cash equivalents for the respective periods. 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 September 30, 2015, we estimate that $56 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 September 30, 2015 and December 31, 2014 was as follows:



	Balance Sheet Location	September 30, 2015		December 31, 2014
		(In millions)
Derivative Assets:
Foreign exchange contracts designated as cash flow hedges	Other Current Assets	$	65	$	128
Foreign exchange contracts not designated as hedging instruments	Other Current Assets	27		7
Total derivative assets		$	92	$	135

Derivative Liabilities:
Foreign exchange contracts designated as cash flow hedges	Other Current Liabilities	$	6	$	2
Foreign exchange contracts not designated as hedging instruments	Other Current Liabilities	19		5
Total derivative liabilities		$	25	$	7

Net fair value of derivative instruments		$	67	$	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 September 30, 2015, the potential effect of rights of setoff associated with the above foreign exchange contracts would be an offset to both assets and liabilities by $24 million, resulting in net derivative assets of $68 million and net derivative liabilities of $1 million. We are not required to pledge, nor are we entitled to receive, cash collateral related to these derivative transactions.

Effect of Derivative Contracts on Accumulated Other Comprehensive Income

The following table summarizes the activity of derivative contracts that qualify for hedge accounting as of September 30, 2015 and December 31, 2014, and the impact of designated derivative instruments on accumulated other comprehensive income for the nine months ended September 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)	September 30, 2015
	(In millions)
Foreign exchange contracts designated as cash flow hedges	$	126	83	150	$	59

The following table summarizes the activity of derivative contracts that qualify for hedge accounting as of September 30, 2014 and December 31, 2013, and the impact of designated derivative instruments on accumulated other comprehensive income for the nine months ended September 30, 2014:



	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)		September 30, 2014
	(In millions)
Foreign exchange contracts designated as cash flow hedges	$	(91	)	105	(56	)	$	70

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Effect of Derivative Contracts on Combined and Consolidated Statements of Income

The following table provides the location in the financial statements of the recognized gains or losses related to our derivative instruments:



	Three Months Ended September 30,					Nine Months Ended September 30,
	2015		2014			2015		2014
	(In millions)
Foreign exchange contracts designated as cash flow hedges recognized in net revenues	$	38	$	(16	)	$	150	$	(56	)
Foreign exchange contracts not designated as cash flow hedges recognized in other income (expense), net	14		(1		)	14		(9		)
Total gain (loss) recognized from derivative contracts in the combined statement of income	$	52	$	(17	)	$	164	$	(65	)

Notional Amounts of Derivative Contracts

Derivative transactions are measured in terms of the notional amount, but this amount is not recorded on the balance sheet and is not, when viewed in isolation, a meaningful measure of the risk profile of the derivative instruments. The notional amount is generally not exchanged, but is used only as the underlying basis on which the value of foreign exchange payments under these contracts is determined. The following table provides the notional amounts of our outstanding derivatives:



	September 30, 2015		September 30, 2014
	(In millions)
Foreign exchange contracts designated as cash flow hedges	$	1,198	$	2,131
Foreign exchange contracts not designated as hedging instruments	1,999		396
Total	$	3,197	$	2,527

Note 9 - Loans and Interest Receivable, Net

We offer credit products to consumers who choose PayPal Credit as their funding source at checkout and working capital advances to certain small and medium-sized PayPal merchants through our PayPal Working Capital product. In the U.S., we work with an independent chartered financial institution that extends credit to the consumer or merchant using our credit products. For our consumer products outside the U.S., we extend credit through our Luxembourg banking subsidiary. For our merchant credit products outside the U.S., we extend working capital advances in the U.K. through our Luxembourg banking subsidiary, and we extend working capital advances in Australia through an Australian subsidiary. We purchase the related receivables extended by the independent chartered financial institution and are responsible for servicing functions related to all our credit products. During the nine months ended September 30, 2015 and September 30, 2014, we purchased or extended approximately $5.3 billion and $3.8 billion, respectively, in credit receivables. As part of the arrangement with the independent chartered financial institution in the U.S. that we work with, we sell a participation interest in the pool of consumer receivables outstanding under PayPal Credit consumer accounts. Loans, advances and interest and fees receivable are reported at their outstanding principal balances, net of any participation interest sold and pro-rata allowances, including unamortized deferred origination costs and estimated collectible interest and fees.

Consumer receivables

In May 2015, we completed an arrangement with certain investors under which we sold 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 to these investors a participation interest in certain consumer loans receivable that we purchased, which resulted in additional premiums received of $5 million and $9 million during the three months and nine months ended September 30, 2015, respectively. As of September 30, 2015, the total outstanding balance in our pool of consumer receivables was $3.4 billion, net of participation interest sold to the chartered financial institution and other investors of $892 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

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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.

We use a consumer's FICO score, where available, among other measures, in evaluating the credit quality of our U.S. PayPal Credit consumer receivables. A FICO score is a type of credit score that lenders use to assess an applicant's credit risk and whether to extend credit. Individual FICO scores generally are obtained each quarter the U.S. consumer has an outstanding consumer receivable owned by PayPal Credit. The weighted average U.S. consumer FICO scores related to our loans and interest receivable balance outstanding at September 30, 2015 and December 31, 2014 were 686 and 687, respectively.

As of September 30, 2015 and December 31, 2014, approximately 53.5% and 54.2%, respectively, of the pool of U.S. consumer receivables and interest receivable balance was due from U.S. consumers with FICO scores greater than 680, which is generally considered "prime" by the consumer credit industry. As of September 30, 2015 and December 31, 2014, approximately 10.0% and 9.3%, respectively, of the pool of U.S. consumer receivables and interest receivable balance was due from U.S. customers with FICO scores below 599. As of September 30, 2015 and December 31, 2014, approximately 89.6% and 89.8%, respectively, of the portfolio of consumer receivables and interest receivable was current.

The following table presents the principal amount of U.S. consumer loans and interest receivable segmented by a FICO score range:



	September 30, 2015		December 31, 2014
	(In millions)
> 760	$	495	$	553
680 - 759	1,332		1,439
600 - 679	1,245		1,344
< 599	342		341
Total	$	3,414	$	3,677

The table above excludes certain outstanding consumer loans outside of the U.S., for which no FICO scores are available, with an outstanding balance of $31 million and $8 million at September 30, 2015 and December 31, 2014, respectively.

The following tables present the delinquency status of the principal amount of consumer loans and interest receivable:



September 30, 2015
(In millions)
Current		30 - 59 Days Past Due		60 - 89 Days Past Due		90 - 180 Days Past Due		Total Past Due		Total Consumer Receivables
$	3,085	$	160	$	62	$	138	$	360	$	3,445



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 Consumer Receivables
$	3,303	$	163	$	62	$	149	$	374	$	3,677

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

The following table summarizes the activity in the allowance for consumer loans and interest receivable, net of participation interest sold for the period indicated:

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



	Nine Months Ended September 30,
	2015			2014
	(In millions)
Balance as of January 1	$	188		$	145
Reclassification from loans receivable to loans held for sale	(22		)	—
Provisions	231			215
Charge-offs	(227		)	(209		)
Recoveries	18			20
Balance as of September 30	$	188		$	171

Merchant receivables

As discussed above, we offer credit products to certain existing small and medium-sized merchants through our PayPal Working Capital product. We closely monitor credit quality for all working capital advances that we extend or purchase through that product to manage and evaluate our related exposure to credit risk. To assess a merchant who wishes to obtain a PayPal Working Capital advance, we use, among other indicators, a risk model that we have internally developed that we refer to as our PayPal Working Capital Risk Model (“PRM”), as a credit quality indicator to help predict the merchant's ability to repay the principal balance and fixed fee related to the working capital advance. The PRM uses multiple variables as predictors of the merchant's ability to repay a working capital advance. Primary drivers of the model include the merchant's annual payment volume and payment processing history with PayPal, prior repayment history with the PayPal Working Capital product, and other measures. Merchants are assigned a PRM credit score within the range of 350 to 750. We generally expect that merchants to which we extend a working capital advance will have PRM scores greater than 525. We generally consider scores above 610 to be very good and to pose less credit risk. We assess a participating merchant’s PRM score on a recurring basis for all outstanding working capital advances owned by PayPal. At September 30, 2015 and December 31, 2014, the weighted average PRM score related to our PayPal Working Capital balances outstanding was 641 and 622, respectively.

The following table presents the principal amount of PayPal Working Capital advances and fees receivable segmented by our internal PRM score range:



	September 30, 2015		December 31, 2014
	(In millions)
> 630	$	232	$	58
566-629	73		23
<565	47		22
Total	$	352	$	103

Through our PayPal Working Capital product, merchants can borrow a certain percentage of their annual payment volume processed by PayPal and are charged a fixed fee for the advance, which targets an APR based on the overall credit assessment of the merchant. Advances are repaid through a fixed percentage of the merchant's future payment volume that PayPal processes. The fee is fixed at the time the advance is extended and we estimate the repayment period based on PayPal's payment processing history with the merchant. There is no stated interest rate and there is a general requirement that at least 10% of the original amount advanced plus the fixed fee must be repaid every 90 days. We generally calculate the repayment rate of the merchant's future payment volume so that repayment of the advance and fixed fee is expected to occur within 9 to 12 months from the date of the advance. On a monthly basis, we recalculate the repayment period based on the repayment activity on the receivable. As such, actual repayment periods are dependent on actual payment processing volumes. We monitor receivables with repayment periods greater than the original expected repayment period. We charge off the receivable when the updated repayment period is 180 days past the original expected repayment period and the merchant has not repaid a minimum of 5% of the original advance in the past 90 days. The total PayPal Working Capital advances and fees receivable outstanding as of September 30, 2015 and December 31, 2014 were approximately $352 million and $103 million, respectively.

The following tables present the current repayment periods of the principal amount of PayPal Working Capital advances and fees receivable as compared to their original expected repayment period:

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



September 30, 2015
(In millions)
Within Original Period		30 - 59 Days Greater		60 - 89 Days Greater		90 - 180 Days Greater		180+ Days with minimum payment in last 90 days		Total Past Original Expected Repayment		Total Merchant Receivables
$	284	$	36	$	15	$	15	$	2	$	68	$	352



December 31, 2014
(In millions)
Within Original Period		30 - 59 Days Greater		60 - 89 Days Greater		90 - 180 Days Greater		180+ Days with minimum payment in last 90 days		Total Past Original Expected Repayment		Total Merchant Receivables
$	79	$	10	$	5	$	7	$	2	$	24	$	103

The following table summarizes the activity in the allowance for PayPal Working Capital advances and fees receivable, for the period indicated:



	Nine Months Ended September 30,
	2015			2014
	(In millions)
Balance as of January 1	$	7		$	1
Provisions	19			7
Charge-offs	(10		)	(1		)
Recoveries	1			—
Balance as of September 30	$	17		$	7

Note 10 - Commitments and Contingencies

Commitments

As of September 30, 2015, approximately $24.3 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 institution that is the issuer of PayPal Credit products based on, among other things, account usage and customer creditworthiness. When a consumer funds a purchase in the U.S. using a PayPal Credit product issued by a chartered financial institution, the chartered financial institution extends credit to the consumer, funds the extension of credit at the point of sale and advances funds to the merchant. We subsequently purchase the receivables related to the consumer loans extended by the chartered financial institution and, as a result of such purchase, bear the risk of loss in the event of loan defaults. Although the chartered financial institution continues to own each customer account, we own the related receivable (excluding participation interests sold) and are responsible for all servicing functions related to the account.

In June 2014, we agreed, subject to certain conditions, that we, one of our affiliates or a designated third party would purchase a portfolio of consumer loan receivables relating to the customer accounts arising out of our credit program agreement with Synchrony Bank (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, subject to certain adjustments and exclusions. In September 2015, PayPal and Synchrony Bank agreed to amend and extend the existing credit card program agreement on new terms. As part of the amended agreement, PayPal’s obligation to purchase the portfolio of consumer loan receivables relating to the customer accounts arising out of the credit program agreement with Synchrony was terminated. PayPal retains an option to purchase the portfolio at the end of the new contract term.

Litigation and Regulatory Matters

Overview

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

We are involved in legal and regulatory proceedings on an ongoing basis. Many of these proceedings are in early stages, and may seek an indeterminate amount of damages. If we believe that a loss arising from such matters is probable and can be reasonably estimated, we accrue the estimated liability in our financial statements. If only a range of estimated losses can be determined, we accrue an amount within the range that, in our judgment, reflects the most likely outcome; if none of the estimates within that range is a better estimate than any other amount, we accrue the low end of the range. For those proceedings in which an unfavorable outcome is reasonably possible but not probable, we have disclosed an estimate of the reasonably possible loss or range of losses or we have concluded that an estimate of the reasonably possible loss or range arising directly from the proceeding (i.e., monetary damages or amounts paid in judgment or settlement) are not material. If we cannot estimate the probable or reasonably possible loss or range of losses arising from a legal proceeding, we have disclosed that fact. In assessing the materiality of a legal proceeding, we evaluate, among other factors, the amount of monetary damages claimed, as well as the potential impact of non-monetary remedies sought by plaintiffs (e.g., injunctive relief) that may require us to change our business practices in a manner that could have a material adverse impact on our business. With respect to the matters disclosed in this Note 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 nine months ended September 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 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 Stipulated Final Judgment and Consent Order ("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 pay $15 million in redress to consumers and a $10 million civil monetary penalty, and requires PayPal to make various changes to the PayPal Credit disclosures and related business practices. As required by the Consent Order, we have submitted compliance and redress plans to the CFPB, but we cannot predict the outcome of the CFPB's review of those plans. We will continue to cooperate and engage with the CFPB and work to ensure compliance with the Consent Order, which may result in us incurring additional costs associated with compliance or redress. 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

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

Off-Balance Sheet Arrangements

As of September 30, 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 and consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources.

Protection Programs

We provide merchants and consumers with protection programs on substantially all transactions completed through our Payments Platform, 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

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

protection programs. We record a liability with respect to losses under these protection programs when they are probable and the amount can be reasonably estimated.

The following table provides management's estimate of the maximum potential exposure related to our protection programs as of September 30, 2015 and December 31, 2014:



	September 30, 2015		December 31, 2014
	(In millions)
Maximum potential exposure	$	101,762	$	75,833

The following table provides the amount of allowance for transaction losses related to our protection programs as of September 30, 2015 and December 31, 2014:



	September 30, 2015		December 31, 2014
	(In millions)
Allowance for transaction losses	$	218	$	166

Note 11 - Related Party Transactions

Prior to the distribution, our business comprised the Payments segment of eBay and thus our transactions with eBay were considered related party transactions. In connection with the separation, we entered into a separation and distribution agreement as well as various other agreements that govern our relationships with eBay going forward, including an operating agreement, transition services agreement, tax matters agreement, employee matters agreement, intellectual property matters agreement and colocation services agreements. Information included in this Note 11 with respect to eBay is strictly limited to our related party transactions with eBay prior to the separation (i.e., periods up to July 17, 2015).

We earned net revenues of $3 million and $26 million from eBay and its subsidiaries during the three months ended September 30, 2015 and 2014, respectively. We earned net revenues of $59 million and $81 million from eBay and its subsidiaries during the nine months ended September 30, 2015 and 2014, respectively.

Prior to the distribution, we recovered certain amounts from eBay related to customer protection programs offered on eligible eBay purchases made with PayPal. These costs included the actual transaction losses associated with customer-filed claims as well as an allocation of salary-related expenses for our customer support teams working on customer claims and disputes related to eligible eBay purchases. Recoveries associated with transaction losses incurred on eligible eBay purchases during the three months ended September 30, 2015 and 2014 were $5 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 nine months ended September 30, 2015 and 2014 were $27 million and $32 million, respectively, which were recorded as a reduction to transaction and loan loss. Other costs recovered from eBay related to the customer protection programs during the three months ended September 30, 2015 and 2014 were $1 million and $6 million, respectively, and were 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 programs during the nine months ended September 30, 2015 and 2014 were $12 million and $16 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 are no longer administered by us, and therefore these costs are no longer reimbursed by eBay.

Prior to the distribution, we incurred user acquisition fees from eBay on payment volume which we process from purchases made on eBay’s platform. User acquisition fees during the three months ended September 30, 2015 and 2014 were $4 million and $29 million, respectively. User acquisition fees during the nine months ended September 30, 2015 and 2014 were $64 million and $88 million, respectively. Following the distribution, pursuant to the operating agreement, we incur referral services fees from eBay based on a fixed rate per new user.

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

These condensed combined and consolidated financial statements include expenses associated with workplace resources and information technology that were previously allocated to the Payments segment of eBay, and additional expenses related to certain corporate functions, including senior management, legal, human resources and finance. These expenses also include allocations related to share based compensation. These expenses were 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 was not material during the three months ended September 30, 2015. The corporate costs and allocation of expenses to us from eBay included within customer support and operations, sales and marketing, product development, and general and administrative expenses were $117 million for the three months ended September 30, 2014, of which $37 million was 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 $385 million during the nine months ended September 30, 2015 and 2014, respectively, of which $121 million and $150 million were included in general and administrative expenses for the respective periods.

In the second and third quarter of 2015, pursuant to the Separation and Distribution Agreement between eBay and us, 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 estimated deferred tax liability of $236 million associated with the foreign cash contributed that is not considered indefinitely reinvested. We continue to assess the measurement of the deferred tax liability contributed by eBay. During the periods, eBay also contributed property and equipment with a net book value of approximately $224 million and intangible assets with a net book value of approximately $18 million. Additionally, we sold certain property and equipment to eBay with a net book value and proceeds of approximately $26 million. The contribution from eBay resulted in an increase to net parent investment and additional paid-in-capital within stockholders' equity.

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 September 30, 2015, there were no other material amounts payable to or amounts receivable from related parties. Following separation, transactions with eBay represent third-party transactions on an arms-length basis.

Note 12 - Stock-Based and Employee Savings Plans

Prior to the separation (i.e., periods up to July 17, 2015), 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. All awards granted under these plans consisted of eBay common shares. PayPal's combined and consolidated statement of income reflected compensation expense for these stock-based plans associated with the portion of eBay's incentive plans in which PayPal employees participated.

Following separation, outstanding awards granted to PayPal employees under eBay's equity incentive plans were converted into PayPal awards under PayPal's equity incentive plans based on a conversion ratio. This conversion ratio was 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 and PayPal's equity incentive plans for the nine months ended September 30, 2015:

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)



	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	1,778		$	8.51
Exercised	(3,029	)
Forfeited/expired/canceled	(204	)
Shares granted as a result of conversion and employee transitions	4,658
Outstanding at September 30, 2015	5,612

The weighted average exercise price of stock options granted during the period was $35.11 per share.

Restricted Stock Unit Activity and Performance Based Restricted Stock Unit Activity

The following table summarizes the restricted stock units granted (including performance‑based restricted stock units that have been earned) under eBay's and PayPal's equity incentive plans for the nine months ended September 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	12,223		$	35.85
Vested	(7,673	)
Forfeited	(3,592	)
Shares granted as a result of conversion and employee transitions	12,051
Outstanding at September 30, 2015	27,724
Expected to vest	23,482

Stock-based Compensation Expense

Prior to the separation, we were charged by eBay for stock-based compensation expense related to our direct employees. eBay allocated to us costs of certain employees of eBay (including stock-based compensation) who provided general and administrative services on our behalf. For periods prior to the separation, 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). Following the separation, we record stock-based compensation expense for our equity incentive plans in accordance with the provisions of the authoritative accounting guidance, which requires the measurement and recognition of compensation expense based on estimated fair values.

PayPal Holdings, Inc.

NOTES TO CONDENSED COMBINED AND CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The impact on our results of operations of recording stock-based compensation expense under eBay's and PayPal's equity incentive plans for the three and nine months ended September 30, 2015 and 2014 was as follows:



	Three Months Ended September 30,				Nine Months Ended September 30,
	2015		2014		2015		2014
	(In millions)
Customer support and operations	$	16	$	14	$	47	$	44
Sales and marketing	18		14		42		40
Product development	33		27		97		78
General and administrative	25		16		59		44
Depreciation and amortization	2		1		6		3
Total stock-based compensation expense	$	94	$	72	$	251	$	209

Total stock-based compensation costs capitalized as part of internal use software and website development costs was $2 million for both the three months ended September 30, 2015 and 2014. Total stock-based compensation costs capitalized as part of internal use software and website development costs was $6 million and $5 million for the nine months ended September 30, 2015 and 2014, respectively.

Note 13 - Income Taxes

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

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

Our effective tax rate for the three months ended September 30, 2015 was 14.0%. Our effective tax rate for the nine months ended September 30, 2015 was 19.5%. 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.

On July 27, 2015, the U.S.Tax Court, in Altera Corp. v. Commissioner, invalidated part of a Treasury Regulation requiring stock based compensation to be included in a qualified intercompany cost sharing arrangement. There is uncertainty as to whether the Internal Revenue Service will appeal the U.S. Tax Court decision and whether any claim for relief from U.S. Federal tax for past or future years can be sustained. We have reviewed this case and its impact on PayPal and concluded that no adjustment to the consolidated financial statements is appropriate at this time. We will continue to monitor ongoing developments and potential impacts to our consolidated financial statements.

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 was 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 nine months ended September 30, 2015:



	Three Months Ended September 30, 2015		Nine Months Ended September 30, 2015
	(In millions)
Employee severance and benefits	$	—	$	49
Total	$	—	$	49

No restructuring expenses were recognized in the three and nine months ended September 30, 2014.

The following table summarizes the restructuring reserve activity during the nine months ended September 30, 2015:



	Employee Severance and Benefits			Other Associated Costs		Total
	(In millions)
Accrued liability as of January 1, 2015	$	—		$	—	$	—
Charges	49			—		49
Payments	(47		)	—		(47		)
Accrued liability as of September 30, 2015	$	2		$	—	$	2

Note 15 - Accumulated Other Comprehensive Income

The following table summarizes the changes in accumulated balances of other comprehensive income for the three months ended September 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	$	66		$	(2	)	$	(40	)	$	—	$	24
Other comprehensive income (loss) before reclassifications	31			(6		)	(9		)	1		17
Amount of gain reclassified from accumulated other comprehensive income	38			—			—			—		38
Net current period other comprehensive income	(7		)	(6		)	(9		)	1		(21		)
Ending balance	$	59		$	(8	)	$	(49	)	$	1	$	3

The following table summarizes the changes in accumulated balances of other comprehensive income for the three months ended September 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	$	(70	)	$	—	$	24		$	1		$	(45	)
Other comprehensive income (loss) before reclassifications	124			—		(23		)	(2		)	99
Amount of gain reclassified from accumulated other comprehensive income	(16		)	—		—			—			(16		)
Net current period other comprehensive income	140			—		(23		)	(2		)	115
Ending balance	$	70		$	—	$	1		$	(1	)	$	70

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 nine months ended September 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	83			(8		)	(33		)	1		43
Amount of gain reclassified from accumulated other comprehensive income	150			—			—			—		150
Net current period other comprehensive income	(67		)	(8		)	(33		)	1		(107		)
Ending balance	$	59		$	(8	)	$	(49	)	$	1	$	3

The following table summarizes the changes in accumulated balances of other comprehensive income for the nine months ended September 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	$	(91	)	$	—	$	26		$	4		$	(61	)
Other comprehensive income (loss) before reclassifications	105			—		(25		)	(5		)	75
Amount of gain reclassified from accumulated other comprehensive income	(56		)	—		—			—			(56		)
Net current period other comprehensive income	161			—		(25		)	(5		)	131
Ending balance	$	70		$	—	$	1		$	(1	)	$	70

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 September 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 September 30,
	2015		2014
	(In millions)
Gains (losses) on cash flow hedges-foreign exchange contracts	$	38	$	(16	)	Net revenues
	$	38	$	(16	)	Income before income taxes
	—		—			Income tax expense
Total reclassifications for the period	$	38	$	(16	)	Net income/(loss)

The following table provides details about reclassifications out of accumulated other comprehensive income for the nine months ended September 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
	Nine Months Ended September 30,
	2015		2014
	(In millions)
Gains (losses) on cash flow hedges-foreign exchange contracts	$	150	$	(56	)	Net revenues
	$	150	$	(56	)	Income before income taxes
	—		—			Income tax expense
Total reclassifications for the period	$	150	$	(56	)	Total, net of income taxes

Note 16 - Stockholders' Equity

In the nine months ended September 30, 2015, we received a contribution of approximately $3.8 billion of cash from eBay, as well as a related estimated deferred tax liability of $236 million associated with the foreign cash contributed that is not considered indefinitely reinvested. We continue to assess the measurement of the deferred tax liability contributed by eBay. The contribution resulted in an increase to net parent investment and additional paid-in-capital within stockholders' equity.

In connection with the capitalization of the Company, we reclassified the amount in net parent investment within stockholders' equity of $12.7 billion, to additional paid-in-capital within stockholders' equity. This amount in net parent investment within stockholders' equity represented the accumulation of our net earnings before our separation from eBay, including share-based compensation expense recorded and the capital contribution from eBay.

Item 2: 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, which are 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 “Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions associated with these statements.

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. In June 2015, the board of directors of eBay approved the separation (the "separation") of eBay's payments business through the distribution (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 (the "distribution date"), 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.

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. Following the Capitalization, our consolidated financial statements include the accounts of PayPal Holdings, Inc. and its wholly-owned subsidiaries. The condensed combined and consolidated financial position, results of operations and cash flows as of dates and for periods prior to the separation may not be indicative of what our financial position, results of operations and cash flows would have been as a separate stand-alone entity during the periods presented, nor are they indicative of what our financial position, results of operations and cash flows may be in the future. For additional information, see Note 1 to our condensed combined and consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

Unless otherwise expressly stated or the context otherwise requires, references to “we,” “our,” “us,” “the Company” and “PayPal” refer to PayPal Holdings and its consolidated subsidiaries or, in the case of information as of dates or for periods prior to the separation, the combined and consolidated entities of the payments business of eBay, including PayPal, Inc. and certain other assets and liabilities that had been historically held at the eBay corporate level but were specifically identifiable and attributable to the payments business.

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 our 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.

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 “Risk Factors-Risk Factors That May Affect Our Business, Results of Operations and Financial Condition-Our business is subject to online security risks, including security breaches.”

Overview of Results of Operations

Three months ended September 30, 2015 and 2014

Net revenues increased $283 million, or 14%, in the three months ended September 30, 2015 compared to the same period of the prior year. The increase was primarily driven by growth in TPV (as defined below) of 20% compared to the same period of the prior year. Operating expenses increased $225 million, or 13%, in the three months ended September 30, 2015 compared to the same period of the prior year. The increase was primarily due to an increase in transaction expense, customer support and operations expense, and general and administrative expenses.

Operating income increased $58 million, or 21%, in the three months ended September 30, 2015 compared to the same period of the prior year. Non-GAAP operating income increased $86 million, or 24%, in the three months ended September 30, 2015

compared to the same period of the prior year. Our operating margin was 15% and 14% in the three months ended September 30, 2015 and 2014, respectively. Our non-GAAP operating margin was 20% and 18% in the three months ended September 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 $67 million, or 29%, in the three months ended September 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 $79 million, or 27%, in the three months ended September 30, 2015 compared to the same period in the prior year. For the three months ended September 30, 2015, our diluted net income per share was $0.25, a $0.06 increase compared to the same period of the prior year. For the three months ended September 30, 2015 our non-GAAP diluted net income per share was $0.31, a $0.07 increase compared to the same period of the prior year.

We generated net cash flows from operating activities of $652 million for the three months ended September 30, 2015, compared to $604 million for the three months ended September 30, 2014. We generated free cash flow (a non-GAAP financial measure) of $519 million and $431 million in the three months ended September 30, 2015 and 2014, respectively.

In the three months ended September 30, 2015, we amended the terms of our credit program agreement with Synchrony (formerly GE Capital Retail Bank). Additional revenue earned under the program during the three months periods ended September 30, 2015 was $37 million compared to the same period in the prior year, of which $30 million related to our gain share revenue. We expect that the amended agreement will result in quarterly gain share revenue. In addition, as part of the amended agreement, our obligation to purchase the portfolio of consumer loan receivables relating to the customer accounts arising out of the credit program agreement with Synchrony was terminated. PayPal retains an option to purchase the portfolio at the end of the new contract term.

Nine months ended September 30, 2015 and 2014

Net revenues increased $860 million, or 15%, in the nine months ended September 30, 2015 compared to the same period of the prior year. The increase was primarily driven by year-over-year growth in TPV of 19% compared to the same period of the prior year. Operating expenses increased $730 million, or 15%, in the nine months ended September 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 expense.

Operating income increased $130 million, or 14%, in the nine months ended September 30, 2015 compared to the same period of the prior year. Non-GAAP operating income increased $242 million, or 20%, in the nine months ended September 30, 2015 compared to the same period of the prior year. Our operating margin was 16% in the nine months ended September 30, 2015 and 2014. Our non-GAAP operating margin was 22% and 21% in the nine months ended September 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 $728 million, or 547%, in the nine months ended September 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 $572 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 $160 million, or 16%, in the nine months ended September 30, 2015 compared to the same period in the prior year. For the nine months ended September 30, 2015, our diluted net income per share was $0.70, a $0.59 increase compared to the same period of the prior year. For the nine months ended September 30, 2015 our non-GAAP diluted net income per share as $0.93, a $0.13 increase compared to the same period of the prior year.

We generated net cash flows from operating activities of $1.8 billion for the nine months ended September 30, 2015, compared to $1.6 billion for the nine months ended September 30, 2014. We generated free cash flow of $1.3 billion and $1.2 billion in the nine months ended September 30, 2015 and 2014, respectively.

The following table provides a summary of our GAAP financial measures for the three and nine months ended September 30, 2015 and 2014:



	Three Months Ended September 30,						Percent Increase/(Decrease)		Nine Months Ended September 30,						Percent Increase/(Decrease)
	2015			2014			Percent Increase/(Decrease)		2015			2014			Percent Increase/(Decrease)
	(In millions, except percentages)
Net revenues	$	2,258		$	1,975		14	%	$	6,692		$	5,832		15	%
Operating expenses	1,928			1,703			13	%	5,642			4,912			15	%
Operating income	330			272			21	%	1,050			920			14	%
Income tax expense	49			42			17	%	209			781			(73	)%
Effective tax rate	14		%	15		%	**		20		%	85		%	**
Net income	$	301		$	234		29	%	$	861		$	133		547	%
Net income per diluted share⁽¹⁾⁽²⁾	$	0.25		$	0.19		28	%	$