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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
Form 10-Q
 
 
[x]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2011
 
OR
 
[ ]    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _______ to _______
   
Commission file number 000-24821
 
 
 
 
 
eBay Inc.
 
(Exact name of registrant as specified in its charter)
 
 
 
 
Delaware
77-0430924
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
 
 
2145 Hamilton Avenue
San Jose, California
95125
(Address of principal executive offices)
(Zip Code)
(408) 376-7400
(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.
 
Large accelerated filer
[x]
 
Accelerated filer
[ ]
Non-accelerated filer
[ ]
(Do not check if a smaller reporting company)
Smaller reporting company
[ ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  [ ]    No  [x]
 
As of April 25, 2011, there were 1,297,898,817 shares of the registrant's common stock, $0.001 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
eBay Inc.
CONDENSED CONSOLIDATED BALANCE SHEET
 
 
December 31,
2010
 
March 31,
2011
 
(In thousands, except par value amounts)
 
(Unaudited)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
5,577,411
 
 
$
5,464,582
 
Short-term investments
1,045,403
 
 
1,300,026
 
Accounts receivable, net
454,366
 
 
447,810
 
Loans and interest receivable, net
956,189
 
 
952,615
 
Funds receivable and customer accounts
2,550,731
 
 
2,746,079
 
Other current assets
481,238
 
 
603,716
 
Total current assets
11,065,338
 
 
11,514,828
 
Long-term investments
2,492,012
 
 
2,715,363
 
Property and equipment, net
1,523,333
 
 
1,547,943
 
Goodwill
6,193,163
 
 
6,445,103
 
Intangible assets, net
540,711
 
 
582,372
 
Other assets
189,205
 
 
199,251
 
Total assets
$
22,003,762
 
 
$
23,004,860
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
Current liabilities:
 
 
 
 
 
Short term debt
$
300,000
 
 
$
300,000
 
Accounts payable
184,963
 
 
152,023
 
Funds payable and amounts due to customers
2,550,731
 
 
2,746,079
 
Accrued expenses and other current liabilities
1,343,888
 
 
1,424,343
 
Deferred revenue
96,464
 
 
101,689
 
Income taxes payable
40,468
 
 
39,415
 
Total current liabilities
4,516,514
 
 
4,763,549
 
Deferred and other tax liabilities, net
645,457
 
 
752,597
 
Long term debt
1,494,227
 
 
1,494,482
 
Other liabilities
45,385
 
 
49,819
 
Total liabilities
6,701,583
 
 
7,060,447
 
Commitments and contingencies (Note 9)
 
 
 
Stockholders' equity:
 
 
 
 
 
Common stock, $0.001 par value; 3,580,000 shares authorized; 1,297,710 and 1,297,655 shares outstanding
1,513
 
 
1,524
 
Additional paid-in capital
10,480,709
 
 
10,616,354
 
Treasury stock at cost, 215,082 and 226,087 shares
(6,091,435
)
 
(6,447,978
)
Retained earnings
10,160,078
 
 
10,635,943
 
Accumulated other comprehensive income
751,314
 
 
1,138,570
 
Total stockholders' equity
15,302,179
 
 
15,944,413
 
Total liabilities and stockholders' equity
$
22,003,762
 
 
$
23,004,860
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

2

 

eBay Inc.
CONDENSED CONSOLIDATED STATEMENT OF INCOME
 
 
Three Months Ended March 31,
 
2010
 
2011
 
(In thousands, except per share amounts)
 
(Unaudited)
Net revenues
$
2,196,057
 
 
$
2,545,609
 
Cost of net revenues
606,555
 
 
728,978
 
Gross profit
1,589,502
 
 
1,816,631
 
Operating expenses:
 
 
 
Sales and marketing
446,161
 
 
532,679
 
Product development
210,139
 
 
274,782
 
General and administrative
276,743
 
 
293,478
 
Provision for transaction and loan losses
106,029
 
 
107,091
 
Amortization of acquired intangible assets
53,252
 
 
44,096
 
Restructuring
8,569
 
 
(149
)
Total operating expenses
1,100,893
 
 
1,251,977
 
Income from operations
488,609
 
 
564,654
 
Interest and other income (expense), net
6,046
 
 
3,692
 
Income before income taxes
494,655
 
 
568,346
 
Provision for income taxes
(97,002
)
 
(92,481
)
Net income
$
397,653
 
 
$
475,865
 
Net income per share:
 
 
 
Basic
$
0.31
 
 
$
0.37
 
Diluted
$
0.30
 
 
$
0.36
 
Weighted average shares:
 
 
 
Basic
1,301,248
 
 
1,297,278
 
Diluted
1,326,021
 
 
1,320,151
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 

3

 

eBay Inc.
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
 
 
Three Months Ended March 31,
 
2010
 
2011
 
(In thousands)
 
(Unaudited)
Net income
$
397,653
 
 
$
475,865
 
Other comprehensive income (loss):
 
 
 
 
 
Foreign currency translation
(154,715
)
 
354,021
 
Unrealized gains (losses) on investments, net
(27,887
)
 
121,874
 
Unrealized gains (losses) on hedging activities
28,123
 
 
(43,537
)
Tax benefit (provision) on above items
10,875
 
 
(45,102
)
Net change in accumulated other comprehensive income (loss)
(143,604
)
 
387,256
 
Comprehensive income (loss)
$
254,049
 
 
$
863,121
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 

4

 

eBay Inc.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
 
 
Three Months Ended March 31,
 
2010
 
2011
 
(In thousands)
 
(Unaudited)
Cash flows from operating activities:
 
 
 
Net income
$
397,653
 
 
$
475,865
 
Adjustments:
 
 
 
Provision for transaction and loan losses
106,029
 
 
107,091
 
Depreciation and amortization
188,022
 
 
193,089
 
Stock-based compensation
102,069
 
 
118,857
 
Changes in assets and liabilities, net of acquisition effects
(375,511
)
 
(195,292
)
Net cash provided by operating activities
418,262
 
 
699,610
 
Cash flows from investing activities:
 
 
 
 
 
Purchases of property and equipment, net
(152,256
)
 
(148,568
)
Changes in principal loans receivable, net
15,650
 
 
(3,816
)
Purchases of investments
(944,393
)
 
(484,951
)
Maturities and sales of investments
259,446
 
 
230,358
 
Acquisitions, net of cash acquired
 
 
(190,537
)
Repayment of Skype note receivable
125,000
 
 
 
Other
(4,416
)
 
941
 
Net cash used in investing activities
(700,969
)
 
(596,573
)
Cash flows from financing activities:
 
 
 
 
 
Proceeds from issuance of common stock
42,117
 
 
72,742
 
Repurchases of common stock
 
 
(356,543
)
Excess tax benefits from stock-based compensation
20,993
 
 
53,905
 
Tax withholdings related to net share settlements of restricted stock awards and units
(70,500
)
 
(108,696
)
Funds receivable and customer accounts
(157,215
)
 
(195,348
)
Funds payable and amounts due to customers
157,215
 
 
195,348
 
Net cash used in financing activities
(7,390
)
 
(338,592
)
Effect of exchange rate changes on cash and cash equivalents
(116,718
)
 
122,726
 
Net decrease in cash and cash equivalents
(406,815
)
 
(112,829
)
Cash and cash equivalents at beginning of period
3,999,818
 
 
5,577,411
 
Cash and cash equivalents at end of period
$
3,593,003
 
 
$
5,464,582
 
Supplemental cash flow disclosures:
 
 
 
 
 
Cash paid for income taxes
$
311,442
 
 
$
23,655
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 

5

 

eBay Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1 — The Company and Summary of Significant Accounting Policies
 
The Company
 
eBay Inc. (“eBay”) was incorporated in California in May 1996, and reincorporated in Delaware in April 1998. eBay's purpose is to pioneer new communities around the world, built on commerce, sustained by trust and inspired by opportunity. eBay brings together millions of buyers and sellers every day on a local, national and international basis through an array of websites. eBay provides online marketplaces for the sale of goods and services as well as other online commerce, or ecommerce, platforms and online payment services to a diverse community of individuals and businesses.
 
We currently have two business segments: Marketplaces and Payments. Our Marketplaces segment provides the infrastructure to enable global online commerce on a variety of platforms, including the eBay.com platform and its localized counterparts and our other online platforms, such as our online classifieds businesses (including our apartment listing service platform, Rent.com), our secondary tickets marketplace (StubHub), our online shopping comparison website (Shopping.com), and our fixed price media marketplace (Half.com). Our Payments segment is comprised of our online payment solutions PayPal and Bill Me Later.
 
When we refer to “we,” “our,” “us” or “eBay” in this document, we mean the current Delaware corporation (eBay Inc.) and its California predecessor, as well as all of our consolidated subsidiaries.
 
Use of estimates
 
The preparation of condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles (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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates, including those related to provisions for transaction and loan losses, legal contingencies, income taxes, revenue recognition, stock-based compensation and the recoverability of goodwill and intangible assets. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ from those estimates.
 
Principles of consolidation and basis of presentation
 
The accompanying condensed financial statements are consolidated and include the financial statements of eBay Inc. and our majority-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. We have evaluated all subsequent events through the date the financial statements were issued.
 
The condensed consolidated financial statements include 100% of the assets and liabilities of our majority-owned subsidiaries and the ownership interests of minority investors are recorded as a noncontrolling interest. Investments in private entities where we hold 20% or more but less than a 50% ownership interest and exercise significant influence are accounted for using the equity method of accounting, and our share of the investees' results of operations is included in interest and other income (expense), net. Investments in private entities where we hold less than a 20% ownership interest and where we do not have the ability to significantly influence the operations of the investee are accounted for using the cost method of accounting, where our share of the investees' results of operations is not included in our condensed consolidated statement of income, except to the extent of earnings distributions actually received from the investee. Our investment balance in private entities is included in long-term investments.
 
 
Note 2 — Net Income Per Share
 
Basic net income per share is computed by dividing the net income for the period by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing the net income for the period by the weighted average number of shares of common stock and potentially dilutive common stock outstanding during the period. The dilutive effect of outstanding options and restricted stock is reflected in diluted earnings per share by

6

eBay Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

application of the treasury stock method. The calculation of diluted net income per share excludes all anti-dilutive shares. The following table sets forth the computation of basic and diluted net income per share for the periods indicated:
 
 
Three Months Ended March 31,
 
2010
 
2011
 
(In thousands, except per share amounts)
Numerator:
 
 
 
Net income
$
397,653
 
 
$
475,865
 
Denominator:
 
 
 
Weighted average common shares - basic
1,301,248
 
 
1,297,278
 
Dilutive effect of equity incentive plans
24,773
 
 
22,873
 
Weighted average common shares - diluted
1,326,021
 
 
1,320,151
 
Net income per share:
 
 
 
Basic
$
0.31
 
 
$
0.37
 
Diluted
$
0.30
 
 
$
0.36
 
Common stock equivalents excluded from income per diluted share because their effect would have been anti-dilutive
31,039
 
 
17,873
 
 
 
 
 
 

7

 

Note 3 - Business Combinations:
During the three months ended March 31, 2011, we completed the acquisition of brands4friends, Germany's largest online shopping club for fashion and lifestyle, for aggregate purchase consideration of approximately $193.2 million, consisting primarily of cash. This company is included in our Marketplaces segment. Allocation of the purchase consideration resulted in net tangible liabilities of $33.1 million, purchased intangible assets of $76.1 million and goodwill of $150.2 million. The allocation of the purchase price for this acquisition has been prepared on a preliminary basis and changes to that allocation may occur as additional information becomes available. The consolidated financial statements include the operating results of brands4friends from the date of acquisition. Pro forma results of operations have not been presented because the effect of the acquisition was not material to our financial results.
Additionally, on March 28, 2011, we announced our agreement to acquire GSI Commerce, Inc. ("GSI"), a leading provider of ecommerce and interactive marketing services, for $29.25 a share, or total consideration of approximately $2.4 billion. This acquisition will be financed with cash and debt and is expected to close in the third quarter of 2011. As part of the acquisition, we plan to divest 100 percent of GSI's licensed sports merchandise business and 70 percent of GSI's ShopRunner and Rue La La businesses. These assets will be sold to a newly formed holding company, which will be led by GSI founder and CEO Michael Rubin, funded in part by a loan receivable totaling $467.0 million and bearing interest at an annual rate equal to 3-month LIBOR plus 1.10%. The acquisition is subject to customary closing conditions, including the receipt and timing of regulatory approval for the transaction and the approval of GSI's stockholders.
 
Note 4 — Goodwill and Intangible Assets
 
Goodwill
 
The following table presents goodwill balances and adjustments to those balances for each of our reportable segments during the three months ended March 31, 2011:
 
 
December 31,
2010
 
Goodwill
Acquired
 
Adjustments
 
March 31,
2011
 
(In thousands)
Reportable segments:
 
 
 
 
 
 
 
Marketplaces
$
4,071,772
 
 
$
150,239
 
 
$
102,037
 
 
$
4,324,048
 
Payments
2,148,752
 
 
 
 
(337
)
 
2,148,415
 
 
$
6,220,524
 
 
$
150,239
 
 
$
101,700
 
 
$
6,472,463
 
 
Investments accounted for under the equity method of accounting are classified on our balance sheet as long-term investments. Such investment balances include any related goodwill. As of December 31, 2010 and March 31, 2011, the goodwill related to our equity investments, included above, was approximately $27.4 million.
 
The adjustments to goodwill during the three months ended March 31, 2011 were due primarily to foreign currency translation.
 
Intangible Assets
 
The components of identifiable intangible assets are as follows:
 

8

eBay Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

 
December 31, 2010
 
March 31, 2011
 
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 thousands, except years)
Intangible assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Customer lists and user base
$
831,806
 
 
$
(625,126
)
 
$
206,680
 
 
6
 
$
879,488
 
 
$
(654,275
)
 
$
225,213
 
 
6
Trademarks and trade names
632,899
 
 
(381,456
)
 
251,443
 
 
5
 
690,974
 
 
(411,277
)
 
279,697
 
 
5
Developed technologies
231,312
 
 
(192,421
)
 
38,891
 
 
3
 
236,209
 
 
(202,817
)
 
33,392
 
 
3
All other
156,306
 
 
(112,609
)
 
43,697
 
 
4
 
162,795
 
 
(118,725
)
 
44,070
 
 
4
 
$
1,852,323
 
 
$
(1,311,612
)
 
$
540,711
 
 
 
 
$
1,969,466
 
 
$
(1,387,094
)
 
$
582,372
 
 
 
 
Aggregate amortization expense for intangible assets was $71.5 million and $57.3 million for the three months ended March 31, 2010 and 2011, respectively.
 

9

eBay Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Note 5 — Segments
 
Operating segments are based upon our internal organization structure, the manner in which our operations are managed and the availability of separate financial information. We have two operating segments: Marketplaces and Payments.
 
The following tables summarize the financial performance of our operating segments:
 
 
Three Months Ended March 31, 2010
 
Marketplaces
 
Payments
 
Consolidated
 
(In thousands)
Net transaction revenues
$
1,172,939
 
 
$
766,572
 
 
$
1,939,511
 
Marketing services and other revenues
213,856
 
 
42,690
 
 
256,546
 
Net revenues from external customers
1,386,795
 
 
809,262
 
 
2,196,057
 
Direct costs
803,964
 
 
626,685
 
 
1,430,649
 
Direct contribution
$
582,831
 
 
$
182,577
 
 
765,408
 
Operating expenses and indirect costs of net revenues
 
 
 
 
276,799
 
Income from operations
 
 
 
 
488,609
 
Interest and other income (expense), net
 
 
 
 
6,046
 
Income before income taxes
 
 
 
 
$
494,655
 
 
 
Three Months Ended March 31, 2011
 
Marketplaces
 
Payments
 
Consolidated
 
(In thousands)
Net transaction revenues
$
1,284,755
 
 
$
942,709
 
 
$
2,227,464
 
Marketing services and other revenues
268,507
 
 
49,638
 
 
318,145
 
Net revenues from external customers
1,553,262
 
 
992,347
 
 
2,545,609
 
Direct costs
923,790
 
 
771,302
 
 
1,695,092
 
Direct contribution
$
629,472
 
 
$
221,045
 
 
850,517
 
Operating expenses and indirect costs of net revenues
 
 
 
 
285,863
 
Income from operations
 
 
 
 
564,654
 
Interest and other income (expense), net
 
 
 
 
3,692
 
Income before income taxes
 
 
 
 
$
568,346
 
 
Direct contribution consists of net revenues from external customers less direct costs. Direct costs include specific costs of net revenues, sales and marketing expenses, and general and administrative expenses, such as advertising and marketing programs, customer support expenses, bank charges, internal interest charges related to Bill Me Later, site operations expenses, product development expenses, billing operations, certain technology and facilities expenses, transaction expenses and provision for transaction and loan losses. Expenses such as our corporate center costs (consisting of certain costs such as corporate management, human resources, finance and legal), amortization of intangible assets, restructuring charges and stock-based compensation expense are excluded from direct costs as they are not included in the measurement of segment performance.
 

10

eBay Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Note 6 — Fair Value Measurement of Assets and Liabilities
 
The following tables summarize our financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2010 and March 31, 2011:
 
Description
 
Balance as of
December 31, 2010
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1) 
 
Significant Other
Observable Inputs
(Level 2)
 
 
(In thousands)
Assets:
 
 
 
 
 
 
Cash and cash equivalents
 
$
5,577,411
 
 
$
5,577,411
 
 
$
 
Short-term investments:
 
 
 
 
 
 
Restricted cash
 
20,351
 
 
20,351
 
 
 
Corporate debt securities
 
372,225
 
 
 
 
372,225
 
Government and agency securities
 
66,534
 
 
 
 
66,534
 
Time deposits
 
44,772
 
 
 
 
44,772
 
Equity instruments
 
541,521
 
 
541,521
 
 
 
Total short-term investments
 
1,045,403
 
 
561,872
 
 
483,531
 
Derivatives
 
37,196
 
 
 
 
37,196
 
Long-term investments:
 
 
 
 
 
 
Restricted cash
 
1,332
 
 
1,332
 
 
 
Corporate debt securities
 
1,605,770
 
 
 
 
1,605,770
 
Government and agency securities
 
150,966
 
 
 
 
150,966
 
Time deposits and other
 
4,541
 
 
 
 
4,541
 
Total long-term investments
 
1,762,609
 
 
1,332
 
 
1,761,277
 
Total financial assets
 
$
8,422,619
 
 
$
6,140,615
 
 
$
2,282,004
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
Derivatives
 
$
4,963
 
 
$
 
 
$
4,963
 
 

11

eBay Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

 Description
 
Balance as of
March 31, 2011
 
Quoted Prices in
Active Markets for
Identical Assets
(Level 1) 
 
Significant Other
Observable Inputs
(Level 2)
 
 
(In thousands)
Assets:
 
 
 
 
 
 
Cash and cash equivalents
 
$
5,464,582
 
 
$
5,464,582
 
 
$
 
Short-term investments:
 
 
 
 
 
 
Restricted cash
 
24,159
 
 
24,159
 
 
 
Corporate debt securities
 
396,595
 
 
 
 
396,595
 
Government and agency securities
 
89,524
 
 
 
 
89,524
 
Time deposits
 
126,418
 
 
 
 
126,418
 
Equity instruments
 
663,330
 
 
663,330
 
 
 
Total short-term investments
 
1,300,026
 
 
687,489
 
 
612,537
 
Derivatives
 
15,665
 
 
 
 
15,665
 
Long-term investments:
 
 
 
 
 
 
Restricted cash
 
2,235
 
 
2,235
 
 
 
Corporate debt securities
 
1,911,448
 
 
 
 
1,911,448
 
Government and agency securities
 
67,845
 
 
 
 
67,845
 
Time deposits and other
 
5,436
 
 
 
 
5,436
 
Total long-term investments
 
1,986,964
 
 
2,235
 
 
1,984,729
 
Total financial assets
 
$
8,767,237
 
 
$
6,154,306
 
 
$
2,612,931
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
Derivatives
 
$
31,093
 
 
$
 
 
$
31,093
 
 
Our financial assets and liabilities are valued using market prices on both active markets (level 1) and less active markets (level 2). Level 1 instrument valuations are obtained from real-time quotes for transactions in active exchange markets involving identical assets. Level 2 instrument valuations are obtained from readily available pricing sources for comparable instruments. As of December 31, 2010 and March 31, 2011, we did not have any assets or liabilities without observable market values that would require a high level of judgment to determine fair value (level 3). Our derivative instruments are valued using pricing models that take into account the contract terms as well as multiple inputs where applicable, such as equity prices, interest rate yield curves, option volatility and currency rates. Our derivative instruments are short-term in nature, typically one month to one year in duration. Cash and cash equivalents are short-term, highly liquid investments with original or remaining maturities of three months or less when purchased and are mainly comprised of bank deposits and money market funds.
 
In addition to the long-term investments noted above, we had approximately $729.4 million and $728.4 million of cost and equity method investments included in long-term investments on our condensed consolidated balance sheet at December 31, 2010 and March 31, 2011, respectively.
 
In Europe, we have two cash pooling arrangements with a financial institution for cash management purposes. These arrangements allow for cash withdrawals from this financial institution based upon our aggregate operating cash balances held in Europe within the same financial institution (“Aggregate Cash Deposits”). These arrangements also allow us to withdraw amounts exceeding the Aggregate Cash Deposits up to an agreed-upon limit. The net balance of the withdrawals and the Aggregate Cash Deposits are used by the financial institution as a basis for calculating our net interest expense or income. As of March 31, 2011, we had a total of $3.6 billion in cash withdrawals offsetting our $3.6 billion in Aggregate Cash Deposits held within the same financial institution under these cash pooling arrangements.
 
Other financial instruments, including accounts receivable, loans and interest receivable, funds receivable, customer accounts, commercial paper, accounts payable, funds payable and amounts due to customers are carried at cost, which approximates their fair value because of the short-term nature of these instruments. Funds receivable include receivables from promotional credit products offered to certain customers that settle within 12 months ($135.0 million as of March 31, 2011).

12

eBay Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

 
Note 7 — Derivative Instruments
 
Fair Value of Derivative Contracts
 
The fair value of our outstanding derivative instruments was as follows:
 
 
Derivative Assets Reported in Other Current Assets 
 
Derivative Liabilities Reported in Other Current Liabilities
 
December 31,
2010
 
March 31,
2011
 
December 31,
2010
 
March 31,
2011
 
(In thousands)
Foreign exchange contracts designated as cash flow hedges
$
35,853
 
 
$
773
 
 
$
4,162
 
 
$
17,430
 
Foreign exchange contracts not designated as hedging instruments
1,343
 
 
14,892
 
 
801
 
 
13,663
 
Total fair value of derivative instruments
$
37,196
 
 
$
15,665
 
 
$
4,963
 
 
$
31,093
 
 
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 December 31, 2010 and March 31, 2011, and the impact of designated derivative contracts on accumulated other comprehensive income for the three months ended March 31, 2011:
 
 
December 31, 2010
 
Amount of gain (loss)
recognized in other
comprehensive income
(effective portion) 
 
Amount of gain (loss)
reclassified from
accumulated other
comprehensive income
to income
(effective portion)
 
March 31, 2011
 
(In thousands)
Foreign exchange contracts designated as cash flow hedges
$
13,560
 
 
$
(42,789
)
 
$
748
 
 
$
(29,977
)
 
Effect of Derivative Contracts on Condensed Consolidated Statement of Income
 
The following table provides the location in our financial statements of the recognized gains or losses related to our derivative instruments:
 
 
Three Months Ended March 31,
 
2010
 
2011
 
(In thousands)
Foreign exchange contracts designated as cash flow hedges recognized in net revenues
$
(2,574
)
 
$
(6,481
)
Foreign exchange contracts not designated as hedging instruments recognized in interest and other income (expense), net
377
 
 
(6,737
)
Total gain (loss) recognized from derivative contracts in the condensed consolidated statement of income
$
(2,197
)
 
$
(13,218
)
 
Note 8 - Debt:
The following table summarizes the carrying value of our outstanding debt (in thousands):

13

 

Long-Term Debt
 
 
 
 
 
 
 
Senior Notes
Coupon Rate
 
December 31, 2010
Effective Interest Rate
 
March 31, 2011
Effective Interest Rate
Senior notes due 2013
0.875
%
 
$
399,220
 
0.946
%
 
$
399,290
 
0.946
%
Senior notes due 2015
1.625
%
 
597,857
 
1.703
%
 
597,969
 
1.703
%
Senior notes due 2020
3.250
%
 
497,150
 
3.319
%
 
497,223
 
3.319
%
Total long-term debt
 
 
$
1,494,227
 
 
 
$
1,494,482
 
 
 
 
 
 
 
 
 
 
Short-Term Debt
 
 
 
 
 
 
 
Commercial paper
 
 
$
300,000
 
 
 
$
300,000
 
 
Total Debt
 
 
$
1,794,227
 
 
 
1,794,482
 
 
Long-Term Debt
The effective rates for the fixed-rate debt include the interest on the notes and the accretion of the discount. Interest on these notes is payable semiannually on April 15 and October 15. Interest expense associated with these notes including amortization of debt issuance costs during the three months ended March 31, 2011 was approximately $8.0 million. At March 31, 2011, the estimated fair value of all notes included in long-term debt was approximately $1.4 billion based on market prices on active markets (Level 1).
Short-Term Debt
Commercial Paper
We implemented a $1.0 billion commercial paper program pursuant to which we may issue commercial paper notes with maturities of up to 397 days from the date of issue. As of March 31, 2011, the weighted average interest rate on our outstanding commercial paper notes was 0.20%, and the weighted average remaining term of our commercial paper notes was 20 days.
Credit Agreement
As of March 31, 2011, no borrowings or letters of credit were outstanding under our $1.8 billion credit agreement. As described above, we have a $1.0 billion commercial paper program and maintain $1.0 billion of available borrowing capacity under our credit agreement in order to repay commercial paper borrowings in the event we are unable to repay those borrowings from other sources when they become due. As a result, at March 31, 2011, $0.8 billion of borrowing capacity was available for other purposes permitted by the credit agreement.  
As of March 31, 2011, we were in compliance with all covenants related to our debt.
 
eBay Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Note 9 — Commitments and Contingencies
 
 
Commitments
 
 As of March 31, 2011, approximately $7.5 billion of unused credit was available to Bill Me Later accountholders. 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 Bill Me Later credit products based on, among other things, account usage and customer creditworthiness. Currently, when a consumer makes a purchase using a Bill Me Later 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 the purchase, bear the risk of loss in the event of loan defaults. Although the chartered financial institution continues to own each customer account, we own the related receivable, and Bill Me Later is responsible for all servicing functions related to the account.
 
 
Litigation and Other Legal Matters
 
In August 2006, Louis Vuitton Malletier and Christian Dior Couture filed two lawsuits in the Paris Court of Commerce

14

eBay Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

against eBay Inc. and eBay International AG. Among other things, the complaint alleged that we violated French tort law by negligently broadcasting listings posted by third parties offering counterfeit items bearing plaintiffs' trademarks and by purchasing certain advertising keywords. Around September 2006, Parfums Christian Dior, Kenzo Parfums, Parfums Givenchy, and Guerlain Société also filed a lawsuit in the Paris Court of Commerce against eBay Inc. and eBay International AG. The complaint alleged that we had interfered with the selective distribution network the plaintiffs established in France and the European Union by allowing third parties to post listings offering genuine perfumes and cosmetics for sale on our websites. In June 2008, the Paris Court of Commerce ruled that eBay and eBay International AG were liable for failing to prevent the sale of counterfeit items on its websites that traded on plaintiffs' brand names and for interfering with the plaintiffs' selective distribution network. The court awarded plaintiffs approximately EUR 38.6 million in damages and issued an injunction (enforceable by daily fines of up to EUR 100,000) prohibiting all sales of perfumes and cosmetics bearing the Dior, Guerlain, Givenchy and Kenzo brands over all worldwide eBay sites to the extent that they are accessible from France. We appealed this decision, and in September 2010, the Paris Court of Appeal reduced the damages award to EUR 5.7 million and modified the injunction. We have further appealed this decision to the French Supreme Court. In 2009, plaintiffs filed an action regarding our compliance with the original injunction, and in November 2009, the court awarded the plaintiffs EUR 1.7 million (the equivalent of EUR 2,500 per day) and indicated that as a large Internet company we could do a better job of enforcing the injunction. Parfums Christian Dior has filed another motion relating to our compliance with the injunction. We have taken measures to comply with the injunction and have appealed these rulings, noting, among other things, the modification of the initial injunction. However, these and similar suits may force us to modify our business practices, which could lower our revenue, increase our costs, or make our websites less convenient to our customers. Any such results could materially harm our business. Other luxury brand owners have also filed suit against us or have threatened to do so in numerous different jurisdictions, seeking to hold us liable for, among other things, alleged counterfeit items listed on our websites by third parties, “tester” and other not for resale consumer products listed on our websites by third parties, alleged misuse of trademarks in listings, alleged violations of selective distribution channel laws, alleged violations of parallel import laws, alleged non-compliance with consumer protection laws or in connection with paid search advertisements. We have prevailed in some of these suits, lost in others, and many are in various stages of appeal. We continue to believe that we have meritorious defenses to these suits and intend to defend ourselves vigorously.
In May 2009, the U.K. High Court of Justice ruled in the case filed by L'Oréal SA, Lancôme Parfums et Beauté & Cie, Laboratoire Garnier & Cie and L'Oréal (UK) Ltd against eBay International AG, other eBay companies, and several eBay sellers (No. HC07CO1978) that eBay was not jointly liable with the seller co-defendants as a joint tortfeasor, and indicated that it would certify to the European Court of Justice questions of liability for the use of L'Oréal trademarks, hosting liability, and the scope of a possible injunction against intermediaries. The U.K. High Court of Justice certified a number of issues to the European Court of Justice and a hearing before the European Court of Justice on the certified issues took place in June 2010. A decision is expected in 2011. The case was originally filed in July 2007. L'Oréal's complaint alleged that we were jointly liable for trademark infringement for the actions of the sellers who allegedly sold counterfeit goods, parallel imports and testers (not for resale products). Additionally, L'Oréal claimed that eBay's use of L'Oréal brands on its website, in its search engine and in sponsored links, and purchase of L'Oréal trademarks as keywords, constitute trademark infringement. The suit sought an injunction preventing future infringement, full disclosure of the identity of all past and present sellers of infringing L'Oréal goods, and a declaration that our Verified Rights Owner (VeRO) program as then operated was insufficient to prevent such infringement. Other damages claimed are to be specified after the liability stage of the proceedings.
In March 2007, a plaintiff filed a purported antitrust class action lawsuit against eBay in the Western District of Texas alleging that eBay and its wholly owned subsidiary PayPal “monopolized” markets through various anticompetitive acts and tying arrangements. The plaintiff alleged claims under sections 1 and 2 of the Sherman Act, as well as related state law claims. In April 2007, the plaintiff re-filed the complaint in the U.S. District Court for the Northern District of California (No. 07-CV-01882-RS), and dismissed the Texas action. The complaint seeks treble damages and an injunction. In 2007, the case was consolidated with other similar lawsuits (No. 07-CV-01882JF). In June 2007, we filed a motion to dismiss the complaint. In March 2008, the court granted the motion to dismiss the tying claims with leave to amend and denied the motion with respect to the monopolization claims. Plaintiffs subsequently decided not to refile the tying claims. The plaintiffs' motion on class certification and our motion for summary judgment were heard by the court in December 2009. In March 2010, the District Court granted our motion for summary judgment, denied plaintiffs' motion for class certification as moot, and entered judgment in our favor. Plaintiffs have appealed the District Court's decision, the matter is fully briefed and oral argument was presented in April 2011 before the Ninth Circuit Court of Appeals. We intend to continue to vigorously oppose plaintiffs' appeal.
 
eBay's Korean subsidiary, IAC, has notified its approximately 20 million users of a January 2008 data breach involving personally identifiable information including name, address, resident registration number and some transaction and refund data (but not including credit card information or real time banking information). Approximately 147,000 users have sued IAC over this breach in several lawsuits in Korean courts and more may do so in the future. Trial for a group of four representative suits

15

eBay Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

began in August 2009 in the Seoul District Court, and trial for a group of 23 other suits began in September 2009 in the Seoul District Court. There is some precedent in Korea for a court to grant “consolation money” for data breaches without a specific finding of harm from the breach. Such precedents have involved payments of up to approximately $200 per user. In January 2010, the Seoul District Court ruled that IAC had met its obligations with respect to defending the site from intrusion and, accordingly, had no liability for the breach. This ruling has been appealed by approximately 34,000 plaintiffs to the Seoul High Court, where it is currently being heard de novo. A decision is expected in 2011.
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 additional patent disputes, and expect that we will increasingly be subject to patent infringement claims as our services expand in scope and complexity. In particular, we expect that we may face additional patent infringement claims involving various aspects of our Marketplaces and Payments businesses. We have in the past been forced to litigate such claims. We may also become more vulnerable to third-party claims as laws such as the Digital Millennium Copyright Act, the Lanham Act and the Communications Decency Act are interpreted by the courts, and as we become subject to laws in jurisdictions where the underlying laws with respect to the potential liability of online intermediaries like ourselves are either unclear or less favorable. We believe that additional lawsuits alleging that we have violated patent, copyright or trademark laws will be filed against us. Intellectual property claims, whether meritorious or not, are time consuming and costly to resolve, could require expensive changes in our methods of doing business, or could require us to enter into costly royalty or licensing agreements.
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 users (individually or as class actions) alleging, among other things, improper disclosure of our prices, rules or policies, that such prices, rules or policies violate applicable law, or that we have not acted in conformity with such prices, rules or policies. The number and significance of these disputes and inquiries are increasing. Any claims or regulatory actions against us, whether meritorious or not, could be time consuming, result in costly litigation, damage awards, 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 have included limited indemnification provisions in certain of our agreements with parties with which we have commercial relations, including our standard marketing, promotions and application-programming-interface license agreements. Under these contracts, we generally indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party in connection with claims by a third party with respect to our domain names, trademarks, logos and other branding elements to the extent that such marks are applicable to our performance under the subject agreement. In a limited number of agreements, we have provided an indemnity for other types of third-party claims, which are indemnities mainly related to various intellectual property rights. In our PayPal business, we have provided an indemnity to our payment processors in the event of certain third-party claims or card association fines against the processor arising out of conduct by PayPal or PayPal customers. In connection with the sale of Skype, we made certain customary warranties to the buyer in the purchase agreement. Our liability to the buyer for inaccuracies in these warranties is generally subject to certain limitations. With respect to certain specified litigation matters involving Skype that were pending as of the closing of the transaction, we also agreed, among other things, to bear 50% of the cost of any monetary judgment that is rendered in respect of those matters. It is not possible to determine the maximum potential loss under these indemnification provisions due to our limited history of prior indemnification claims and the unique facts and circumstances involved in each particular provision. To date, no significant costs have been incurred, either individually or collectively, in connection with our indemnification provisions.
 
Off-Balance Sheet Arrangements
 
Based on differences in regulatory requirements and commercial law in the jurisdictions where PayPal operates, PayPal holds customer balances either as direct claims against PayPal or as an agent or custodian on behalf of PayPal's customers. Customer funds held by PayPal as an agent or custodian on behalf of our customers are not reflected in our condensed consolidated balance sheet. These funds include funds held on behalf of U.S. customers that are deposited in bank accounts insured by the Federal Deposit Insurance Corporation (subject to applicable limits) and funds that U.S. customers choose to invest in The PayPal Money Market Fund, which totaled approximately $3.1 billion and $2.7 billion as of March 31, 2011 and December 31, 2010, respectively. The PayPal Money Market Fund is invested in a portfolio managed by BlackRock Fund Advisors.

16

 

Note 10 — Stock Repurchase Programs
 
In September 2010, our Board authorized a stock repurchase program that provides for the repurchase of up to $2.0 billion of our common stock, with no expiration from the date of authorization, for the purpose of offsetting the impact of dilution from our equity compensation programs. The stock repurchase activity under this stock repurchase program during the first three months of 2011 is summarized as follows (in thousands, except per share amounts):
 
 
Shares Repurchased
 
Average Price per Share
 
Value of Shares Repurchased
 
Remaining Amount Authorized
Balance at January 1, 2011
1,880
 
 
$
29.94
 
 
$
56,293
 
 
$
1,943,707
 
Repurchase of common stock
11,000
 
 
32.38
 
 
356,194
 
 
(356,194
)
Balance at March 31, 2011
12,880
 
 
$
32.03
 
 
$
412,487
 
 
$
1,587,513
 
 
These repurchased shares were recorded as treasury stock and were accounted for under the cost method. No repurchased shares have been retired.
 
 
 

17

eBay Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Note 11 — Stock-Based Plans
 
Stock Option Activity
 
The following table summarizes stock option activity for the three-month period ended March 31, 2011:
 
 
Shares
 
(In thousands)
Outstanding at January 1, 2011
43,907
 
Granted
5,752
 
Exercised
(3,595
)
Forfeited/expired/cancelled
(758
)
Outstanding at March 31, 2011
45,306
 
 
The weighted average exercise price of stock options granted during the period was $32.27 per share and the related weighted average grant date fair value was $9.87 per share.
 
Restricted Stock Unit Activity
 
The following table summarizes restricted stock unit ("RSU") activity for the three-month period ended March 31, 2011:
 
 
Units 
 
(In thousands)
Outstanding at January 1, 2011
38,348
 
Awarded
12,312
 
Vested
(10,732
)
Forfeited
(1,171
)
Outstanding at March 31, 2011
38,757
 
 
The weighted average grant date fair value for RSUs awarded during the period was $32.18 per share.
 
Nonvested Share Activity
 
There was no material activity related to our nonvested shares for the three-month period ended March 31, 2011.
 
 Stock-based Compensation Expense
 
The impact on our results of operations of recording stock-based compensation expense for the three months ended March 31, 2010 and 2011 was as follows:
 
 
Three Months Ended March 31,
 
2010
 
2011
 
(In thousands)
Cost of net revenues
$
13,034
 
 
$
14,094
 
Sales and marketing
28,491
 
 
34,622
 
Product development
27,164
 
 
31,485
 
General and administrative
33,380
 
 
38,656
 
Total stock-based compensation expense
$
102,069
 
 
$
118,857
 
Capitalized in product development
$
2,370
 
 
$
3,414
 
 
 

18

eBay Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

Valuation Assumptions
 
We calculated the fair value of each stock option award on the date of grant using the Black-Scholes option pricing model. The following weighted average assumptions were used for the three months ended March 31, 2010 and 2011:
 
 
Three Months Ended March 31,
 
2010
 
2011
Risk-free interest rate
1.5
%
 
1.25
%
Expected life (in years)
3.4
 
 
3.8
 
Dividend yield
%
 
%
Expected volatility
36
%
 
38
%
 
Our computation of expected volatility is based on a combination of historical and market-based implied volatility from traded options on our common stock. Our computation of expected life is based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. The interest rate for periods within the contractual life of the award is based on the U.S. Treasury yield curve in effect at the time of grant.
 
Note 12 — Restructuring
 
2009 Customer Service Consolidation
 
In 2009, we began the consolidation of certain customer service facilities in North America and Europe to streamline our operations and deliver better and more efficient customer support to our users. The consolidation impacted approximately 1,000 employees. We have completed this consolidation and have incurred aggregate costs of approximately $47.3 million, primarily related to employee severance and benefits.
 
The following table summarizes by segment the restructuring costs recognized during the three months ended March 31, 2010 and 2011:
 
 
Three Months Ended March 31, 2010
 
Three Months Ended March 31, 2011
 
Employee
Severance and
Benefits
 
Facilities
 
Total
 
Employee
Severance and
Benefits
 
Facilities
 
Total
 
(In thousands)
Marketplaces
$
8,531
 
 
$
38
 
 
$
8,569
 
 
$
323
 
 
$
(472
)
 
$
(149
)
 
 
The following table summarizes the restructuring reserve activity during the three months ended March 31, 2011:
 
 
Employee Severance
and Benefits
 
Facilities
 
Total
 
(In thousands)
Accrued liability as of January 1, 2011
$
2,425
 
 
$
3,559
 
 
$
5,984
 
Charges (benefit)
323
 
 
(472
)
 
(149
)
Payments
(1,713
)
 
(493
)
 
(2,206
)
Adjustments
22
 
 
459
 
 
481
 
Accrued liability as of March 31, 2011
$
1,057
 
 
$
3,053
 
 
$
4,110
 
 
In the table above, adjustments primarily reflect the impact of foreign currency translation.
 
Note 13 — Income Taxes
 

19

eBay Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)

The following table reflects changes in unrecognized tax benefits for the three-month period ended March 31, 2011:
 
 
(In thousands)
Gross amounts of unrecognized tax benefits as of January 1, 2011
$
428,344
 
Decreases related to prior period tax positions
(958
)
Increases related to current period tax positions
3,980
 
Gross amounts of unrecognized tax benefits as of March 31, 2011
$
431,366
 
 
As of December 31, 2010 and March 31, 2011, our liabilities for unrecognized tax benefits were included in deferred and other tax liabilities, net. The total liabilities for unrecognized tax benefits and the increase in these liabilities in 2011 relate primarily to the allocations of revenue and costs among our global operations.
 
We recognize interest and/or penalties related to uncertain tax positions in income tax expense. The amount of interest and penalties accrued as of December 31, 2010 and March 31, 2011 was approximately $92.3 million and $101.8 million, respectively.
 
We are subject to both direct and indirect taxation in the U.S. and various states and foreign jurisdictions. We are under examination by certain tax authorities for the 2003 to 2008 tax years. We believe that adequate amounts have been reserved for any adjustments that may ultimately result from these examinations. The material jurisdictions where we are subject to potential examination by tax authorities for tax years after 2002 include, among others, the U.S. (Federal and California), France, Germany, Italy, Korea, Israel, Switzerland, Singapore and Canada. We believe that adequate amounts have been reserved for any adjustments that may ultimately result from these examinations.
 
Although the timing of the resolution and/or closure of audits is highly uncertain, it is reasonably possible that the balance of gross unrecognized tax benefits could significantly change in the next 12 months. However, given the number of years remaining subject to examination and the number of matters being examined, we are unable to estimate the full range of possible adjustments to the balance of gross unrecognized tax benefits.
 
During the quarter ended March 31, 2011, we provided for U.S. income and foreign withholding taxes on approximately 15% of our non-U.S. subsidiaries' undistributed earnings. The remaining portion of our non-U.S. subsidiaries undistributed earnings are intended to be indefinitely reinvested in our international operations. Upon distribution of those earnings in the form of dividends or otherwise, we would be subject to U.S. income taxes (subject to adjustments for foreign tax credits). It is not practicable to determine the income tax liability that might be incurred if the indefinitely reinvested earnings were to be distributed.
 
 
 
 
Note 14 - Loans and Interest Receivable, Net
Loans and interest receivable represent purchased consumer receivables arising from loans made by a partner chartered financial institution to individual consumers in the U.S. to purchase goods and services through our Bill Me Later merchant network. Loans and interest receivable are reported at their outstanding principal balances, including unamortized deferred origination costs and net of allowance, and include the estimated collectible interest and fees. We use a consumer's FICO score, among other measures, in evaluating the credit quality of our consumer receivables. A FICO score is a type of credit score that lenders use to assess an applicant's credit risk and whether to extend credit. Individual FICO scores are obtained each quarter the consumer has a loan receivable owned by Bill Me Later outstanding. The weighted average consumer FICO score related to our loans and interest receivable balance outstanding at March 31, 2011 was 693. As of December 31, 2010 and March 31, 2011, approximately 63.6% and 59.9%, respectively, of our loans and interest receivable balance was due from consumers with FICO scores greater than 680, which is generally considered "prime" by the consumer credit industry.
The following table summarizes the activity in the allowance for loans and interest receivable (in thousands):

20

 

 
 
Three Months Ended
 
 
March 31, 2011
Balance at beginning of period
 
$
42,340
 
Charge-offs
 
(19,054
)
Recoveries
 
1,922
 
Provision
 
15,314
 
Balance at end of period
 
$
40,522
 
 
 
The allowance for loans and interest receivable represents management's estimate of probable losses inherent in our Bill Me Later portfolio of receivables from loans. Management's evaluation of probable losses is subject to numerous estimates and judgment, primarily forecasted principal balance delinquency rates ("roll rates"). Roll rates are the percentage of balances that we estimate will migrate from one stage of delinquency to the next based on our historical experience, as well as external factors such as estimated bankruptcies and levels of unemployment. The roll rates are applied to principal balances for each stage of delinquency, from current to 180 days past due, in order to estimate the principal loans that are probable to be charged off by the end of 180 days.
 
We charge off loans and interest receivable in the month in which the customer balance becomes 180 days past due. Bankrupt accounts are charged off within 60 days of receiving notification of customer bankruptcy from the courts. Past due loans receivable continue to accrue interest until such time as they are charged-off, though portions of the interest are reserved. As of March 31, 2011, approximately 92% of our loans and interest receivable portfolio were current.
 
 
 
Item 2:    Management's Discussion and Analysis of Financial Condition and Results of Operations
 
FORWARD-LOOKING STATEMENTS
 
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements that involve expectations, plans or intentions (such as those relating to future business or financial results, new 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 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 condensed consolidated financial statements, related notes, and the other financial 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 consolidated financial statements and the related notes that appear elsewhere in this report.
 
Overview
 
We have two business segments: Marketplaces and Payments. Our Marketplaces segment provides the infrastructure to enable global online commerce on a variety of platforms, including the eBay.com platform and its localized counterparts and our other online platforms, such as our online classifieds businesses (including our apartment listing service platform, Rent.com), our secondary tickets marketplace (StubHub), our online shopping comparison website (Shopping.com), and our fixed price media marketplace (Half.com). Our Payments segment is comprised of our online payment solutions PayPal and Bill Me Later (BML).
 
Net revenues for the three months ended March 31, 2011 increased 16% to $2.5 billion, compared to the same period of the prior year, driven primarily by a 38% increase in PayPal Merchant Services net total payment volume (TPV) and a 8% increase in Marketplaces gross merchandise volume (GMV) excluding vehicles. For the three months ended March 31, 2011,

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our operating margin remained flat at 22%, the same as in the comparable period of the prior year. Our Payments segment margin for the three months ended March 31, 2011 was consistent with the comparable period of the prior year, as a stable transaction margin and operating leverage was partially offset by investments in digital goods, platform, mobile and user experience. Our Marketplaces segment margin for the three months ended March 31, 2011 decreased 1.5 percentage points compared to the same period of the prior year due primarily to the impact of acquisitions. For the three months ended March 31, 2011, our diluted earnings per share increased to $0.36, a $0.06 increase compared to the same period of the prior year, driven primarily by an increase in revenue and a lower effective tax rate. For the three months ended March 31, 2011, we generated cash flow from operations of approximately $699.6 million, compared to $418.3 million for the same period of the prior year. The increase in operating cash flow was due primarily to cash paid for taxes of $311.4 million in the first quarter of 2010, primarily related to a legal entity restructuring completed in the fourth quarter of 2009, compared to $23.7 million paid for taxes in the first quarter of 2011.
 
Some key operating metrics that members of our senior management regularly review to evaluate our financial results include net promoter score (NPS), market share, GMV, GMV excluding vehicles, number of sold items, net TPV, net number of payments, free cash flow (which we define as net cash provided by operating activities less purchases of property and equipment, net), and revenue excluding acquisitions and foreign currency impact.
 
Outlook
 
We expect growth in the second quarter of 2011 to be led by continued strength in our Payments business, driven by year-over-year growth in net TPV as we execute against our long-term growth strategies and priorities. For the second quarter of 2011, we expect our Marketplaces business to continue its momentum from strength in the U.S. We expect to continue to realize solid operating leverage which we plan to reinvest in the business to position us for future growth in commerce and payments.
 
Results of Operations
 
Summary of Net Revenues
 
We generate two types of net revenues: net transaction revenues and marketing services and other revenues. Our net transaction revenues are derived principally from listing fees and final value fees (which are fees payable on transactions completed on our Marketplaces trading platforms), and fees paid by merchants for payment processing services. Our marketing services revenues are derived principally from the sale of advertisements, revenue sharing arrangements, classifieds fees and lead referral fees. Other revenues are derived principally from interest earned on certain PayPal customer account balances, interest and fees earned on the Bill Me Later portfolio of receivables from loans and from contractual arrangements with third parties that provide services to our users.
 
We generate the majority of our revenue internationally. Accordingly, fluctuations in foreign currency exchange rates impact our results of operations. We have a foreign exchange risk management program that is designed to reduce our exposure to fluctuations in foreign currencies; however, the effectiveness of this program in mitigating the impact of foreign currency fluctuations on our results of operations varies from period to period, and in any given period, our operating results are usually affected, sometimes significantly, by changes in currency exchange rates. Fluctuations in exchange rates also directly affect our cross border revenue. We calculate the year-over-year impact of foreign currency movements on our business using prior period foreign currency rates applied to current year transactional currency amounts.
 
For the three months ended March 31, 2011, foreign currency movements relative to the U.S. dollar positively impacted net revenues by approximately $12.5 million (net of the $6.5 million negative impact from hedging activities relating to PayPal's net revenue) compared to the same period of the prior year. On a business segment basis for the three months ended March 31, 2011, foreign currency movements relative to the U.S. dollar positively impacted Marketplaces net revenues by approximately $13.2 million compared to the same period of the prior year and negatively impacted Payments net revenues by approximately $0.7 million compared to the same period of the prior year (including the impact of hedging activities, noted above).
 
The following table sets forth the breakdown of net revenues by type, segment and geography for the periods presented. In addition, we have provided a table of certain key operating metrics that we believe are significant factors affecting our net revenues.

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Three Months Ended March 31,
 
Percent
 
2010
 
2011
 
Change
 
(In thousands, except percentage changes)
Net Revenues by Type:
 
 
 
 
 
Net transaction revenues
 
 
 
 
 
Marketplaces
$
1,172,939
 
 
$
1,284,755
 
 
10
%
Payments
766,572
 
 
942,709
 
 
23
%
Total net transaction revenues
1,939,511
 
 
2,227,464
 
 
15
%
Marketing services and other revenues
 
 
 
 
 
 
Marketplaces
213,856
 
 
268,507
 
 
26
%
Payments
42,690
 
 
49,638
 
 
16
%
Total marketing services and other revenues
256,546
 
 
318,145
 
 
24
%
Total net revenues
$
2,196,057
 
 
$
2,545,609
 
 
16
%
Net Revenues by Segment:
 
 
 
 
 
 
Marketplaces
$
1,386,795
 
 
$
1,553,262
 
 
12
%
Payments
809,262
 
 
992,347
 
 
23
%
Total net revenues
$
2,196,057
 
 
$
2,545,609
 
 
16
%
Net Revenues by Geography:
 
 
 
 
 
 
U.S.
$
1,004,211
 
 
$
1,141,051
 
 
14
%
International
1,191,846
 
 
1,404,558
 
 
18
%
Total net revenues
$
2,196,057
 
 
$
2,545,609
 
 
16
%
 
Revenues are attributed to U.S. and international geographies based primarily upon the country in which the seller, payment recipient, customer, website that displays advertising, or other service provider, as the case may be, is located.
 
 
 
Three Months Ended March 31,
 
Percent
 
2010
 
2011
 
Change
 
(In millions, except percentage changes)
Supplemental Operating Data:
 
 
 
 
 
Marketplaces Segment:  (1)
 
 
 
 
 
GMV excluding vehicles  (2)
$
13,371
 
 
$
14,496
 
 
8
%
GMV vehicles only  (3)
2,021
 
 
2,050
 
 
1
%
Total GMV  (4)
$
15,392
 
 
$
16,546
 
 
7
%
Payments Segment:
 
 
 
 
 
Net TPV  (5)
$
21,342
 
 
$
27,362
 
 
28
%
 
(1)
eBay's classifieds websites (including Rent.com) and Shopping.com are not included in these metrics.
(2)
Total value of all successfully closed items between users on eBay Marketplaces trading platforms during the period, regardless of whether the buyer and seller actually consummated the transaction, excluding vehicles GMV.
(3)
Total value of all successfully closed vehicle transactions between users on eBay Marketplaces trading platforms during the period, regardless of whether the buyer and seller actually consummated the transaction.
(4)
Total value of all successfully closed items between users on eBay Marketplaces trading platforms during the period, regardless of whether the buyer and seller actually consummated the transaction.
(5)
Total dollar volume of payments, net of payment reversals, successfully completed through our Payments network and on Bill Me Later accounts during the period, excluding PayPal's payment gateway business.
 

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Seasonality
 
The following table sets forth, for the periods presented, our total net revenues and the sequential quarterly movements of these net revenues:
 
 
Quarter Ended
 
March 31
 
June 30
 
September 30
 
December 31
 
(In thousands, except percentage changes)
2009*
 
 
 
 
 
 
 
 
 
 
 
Net revenues
$
2,020,586
 
 
$
2,097,992
 
 
$
2,237,852
 
 
2,370,932
 
Percent change from prior quarter
(1
)%
 
4
%
 
7
%
 
6
%
2010*
 
 
 
 
 
 
 
 
 
 
 
Net revenues
$
2,196,057
 
 
$
2,215,379
 
 
2,249,488
 
 
2,495,350
 
Percent change from prior quarter
(7
)%
 
1
%
 
2
%
 
11
%
2011*
 
 
 
 
 
 
 
Net revenues
2,545,609
 
 
 
 
 
 
 
Percent change from prior quarter
2
 %
 
 
 
 
 
 
*    On November 19, 2009, we completed the sale of Skype to an investor group. Accordingly, Skype's revenue is not consolidated in our 2010 and 2011 results. However, Skype's results of operations are consolidated in our 2009 results through the date of sale.
 
We expect transaction activity patterns on our websites to mirror general consumer buying patterns.
 
Marketplaces Net Transaction Revenues
 
Marketplaces net transaction revenues increased $111.8 million, or 10%, while GMV excluding vehicles increased 8% during the first quarter of 2011 compared to the same period in the prior year. The increase in net transaction revenue was due primarily to growth in the number of sold items and continued growth at StubHub. GMV excluding vehicles increased year-over-year due to strong growth in the U.S. and continued stable growth in Europe, partially offset by a decline in Korea. Vehicles GMV stabilized at 1% growth year-over-year, however, vehicles GMV will continue to be less relevant going forward as we shift to a lead generation format in this category.
 
Marketplaces net transaction revenues earned internationally totaled $677.5 million and $725.4 million during the first quarter of 2010 and 2011, respectively, representing 58% and 56% of total Marketplaces net transaction revenues during those respective periods. The increase in international net transaction revenues in dollars was due primarily to growth in our existing international markets and foreign currency movements against the U.S. dollar.
 
Payments Net Transaction Revenues
 
Payments net transaction revenues increased $176.1 million, or 23%, during the first quarter of 2011 compared to the same period of the prior year. The increase was due primarily to net TPV growth of 28% during the first quarter of 2011, compared to the same period of the prior year, partially offset by lower take rates due primarily to a shift to larger merchants in our Merchant Services business. The increase in net TPV during the first quarter of 2011 was due primarily to growth in consumer and merchant adoption of PayPal. Our Merchant Services net TPV increased 38% during the first quarter of 2011, compared to the same period of the prior year, and represented 63% of PayPal's net TPV in the first quarter of 2011, compared with 59% in the first quarter of 2010. The increase in our Merchant Services net TPV was due primarily to an increase in the number of online merchants offering PayPal as a payment option, as well as an increase in the share of checkout of PayPal's existing customer base of merchants.
 
Payments net transaction revenues earned internationally totaled $359.9 million and $475.8 million during the first quarter of 2010 and 2011, respectively, representing 47% and 50% of total Payments net transaction revenues during those respective periods. The increase in international net transaction revenues was due primarily to the growth of our Merchant Services business and increased penetration on eBay Marketplaces platforms internationally.
 
 
 
Marketing Services and Other Revenues

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Marketing services and other revenues increased $61.6 million, or 24% during the first quarter of 2011 compared to the same periods of the prior year, and represented 12% of total net revenues in both periods. The increase in marketing services and other revenues during the first quarter of 2011 was due primarily to the acquisition of brands4friends and an increase in revenues attributable to our advertising business and our classifieds business, as well as interest earned on our BML portfolio of receivables from loans.
 
Summary of Cost of Net Revenues
 
The following table summarizes changes in cost of net revenues for the periods presented:
 
 
Three Months Ended March 31,
 
Change from
2010 to 2011
 
2010
 
2011
 
in Dollars
 
in %
Cost of net revenues:
(In thousands, except percentages)
Marketplaces
$
260,887
 
 
$
295,822
 
 
$
34,935
 
 
13
%
As a percentage of total Marketplaces net revenues
18.8
%
 
19.0
%
 
 
 
 
Payments
345,668
 
 
433,156
 
 
87,488
 
 
25
%
As a percentage of total Payments net revenues
42.7
%
 
43.6
%
 
 
 
 
Total cost of net revenues
$
606,555
 
 
$
728,978
 
 
$
122,423
 
 
20
%
As a percentage of net revenues
27.6
%
 
28.6
%
 
 
 
 
 
Cost of Net Revenues
 
Cost of net revenues consist primarily of costs associated with payment processing, customer support, site operations and inventory. Significant components of these costs include bank transaction fees, credit card interchange and assessment fees, interest expense on indebtedness incurred to finance the purchase of consumer loans receivable by Bill Me Later, employee compensation, contractor costs, facilities costs, depreciation of equipment and amortization expense.
 
Marketplaces
 
Marketplaces cost of net revenues increased $34.9 million, or 13%, during the first quarter of 2011 compared to the same period of the prior year. The increase was due primarily to the impact of acquiring brands4friends during the quarter and increased customer support costs associated with our volume growth.
 
Marketplaces cost of net revenues as a percentage of Marketplaces net revenues increased slightly during the first quarter of 2011 compared to the same period of the prior year due primarily to the impact of acquisitions, partially offset by operating leverage in our site operation infrastructure.
 
Payments
 
Payments cost of net revenues increased $87.5 million, or 25%, during the first quarter of 2011 compared to the same period of the prior year. The increase in Payments cost of net revenues was due primarily to the impact of growth in net TPV.
 
Payments cost of net revenues as a percentage of Payments net revenues increased slightly during the first quarter of 2011 compared to the same period of the prior year due primarily to a lower take rate, partially offset by a lower transaction expense rate. The improvement in our transaction expense rate was driven primarily by the impact of certain new payment processing arrangements, a favorable mix shift to lower cost international markets and a small improvement in funding mix.
 
 
Summary of Operating Expenses, Non-Operating Items and Provision for Income Taxes
 
The following table summarizes changes in operating expenses, non-operating items and provision for income taxes for the periods presented:
 

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Three Months Ended March 31,
 
Change from
2010 to 2011
 
2010
 
2011
 
in Dollars
 
in %
 
(In thousands, except percentage changes)
Sales and marketing
$
446,161
 
 
$
532,679
 
 
$
86,518
 
 
19
 %
Product development
210,139
 
 
274,782
 
 
64,643
 
 
31
 %
General and administrative
276,743
 
 
293,478
 
 
16,735
 
 
6
 %
Provision for transaction and loan losses
106,029
 
 
107,091
 
 
1,062
 
 
1
 %
Amortization of acquired intangible assets
53,252
 
 
44,096
 
 
(9,156
)
 
(17
)%
Restructuring
8,569
 
 
(149
)
 
(8,718
)
 
(102
)%
Interest and other income (expense), net
6,046
 
 
3,692
 
 
(2,354
)
 
(39
)%
Provision for income taxes
(97,002
)
 
(92,481
)
 
4,521
 
 
(5
)%
 
Sales and Marketing
 
Sales and marketing expenses consist primarily of advertising costs and marketing programs (both online and offline), employee compensation, contractor costs, facilities costs and depreciation on equipment. Online marketing expenses represent traffic acquisition costs in various channels such as paid search, affiliates marketing and display advertising. Offline advertising includes brand campaigns, buyer/seller communications and general public relations expenses.
 
Sales and marketing expenses increased $86.5 million, or 19%, during the first quarter of 2011, compared to the same period of the prior year. The increase in sales and marketing expense was due primarily to higher marketing program costs, employee-related expenses (including consultant costs, facility costs and equipment-related costs) and the impact from the acquisition of brands4friends. A significant portion of our sales and marketing expense is attributable to our online marketing programs, primarily paid search, which include keyword advertising and third party lead generation costs, in order to drive traffic to our Marketplaces and Payments websites.
 
Product Development
 
Product development expenses consist primarily of employee compensation, contractor costs, facilities costs and depreciation on equipment. Product development expenses are net of required capitalization of major site and other product development efforts, including the development of our next generation platform architecture, migration of certain platforms, seller tools and Payments services projects. Capitalized site and product development costs were $27.1 million and $36.9 million in the first quarter of 2010 and 2011, respectively, and are primarily reflected as a cost of net revenues when amortized in future periods.
 
Product development expenses, net of capitalized amounts, increased $64.6 million, or 31%, during the first quarter of 2011, compared to the same period of the prior year. The increase was due primarily to higher employee-related costs (including consultant costs, facility costs and equipment-related costs) driven by increased investment in our top technology priorities (search, catalog, mobile, platform, and user experience) and the impact from the acquisitions of Milo.com and Critical Path Software in the fourth quarter of 2010.
 
General and Administrative
 
General and administrative expenses consist primarily of employee compensation, contractor costs, facilities costs, depreciation of equipment, employer payroll taxes on employee stock-based compensation, legal expenses, insurance premiums and professional fees. Our legal expenses, including those related to various ongoing legal proceedings, may fluctuate substantially from period to period.
 
General and administrative expenses increased $16.7 million, or 6%, during the first quarter of 2011, compared to the same period of the prior year. The increase was due primarily to an increase in payroll and related expenses, professional service fees and the impact of acquiring brands4friends.
 
Provision for Transaction and Loan Losses
 
Provision for transaction and loan losses consists primarily of transaction loss expense associated with our customer

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protection programs as well as fraud, chargebacks, and merchant credit losses, bad debt expense associated with our accounts receivable balance, and loan reserves associated with our principal loan receivable balance.
Provision for transaction and loan losses increased $1.1 million, or 1%, during the first quarter of 2011 compared to the same period of the prior year. This increase was due primarily to higher transaction volume, partially offset by improvements in BML loan loss rates, bad debt rates and transaction loss rates. BML loan loss rates declined due to a lower charge-off rate and improved delinquency rates. Our bad debt rates declined due to continued improvement in charge-off rates. Transaction loss rates declined due to improvements in fraud loss detection and recoveries. We continue to expect our provision for transaction and loan loss expense to fluctuate depending on many factors, including macroeconomic conditions, our customer protection programs and regulatory changes.
 
Amortization of Acquired Intangible Assets
From time to time we have purchased, and we expect to continue to purchase, assets and businesses. These purchase transactions generally result in the creation of acquired intangible assets with finite lives and lead to a corresponding increase in our amortization expense in future periods. We amortize intangible assets over the period of estimated benefit, using the straight-line method and estimated useful lives ranging from one to eight years. Amortization of acquired intangible assets is also impacted by our sales of assets and businesses and timing of acquired intangible assets becoming fully amortized.
 
Amortization of acquired intangible assets decreased by $9.2 million, or 17%, during the first quarter of 2011, compared to the same period of the prior year. The decrease in amortization of acquired intangible assets was due primarily to the timing of acquired intangible assets becoming fully amortized, partially offset by amortization of newly acquired intangible assets.
 
Restructuring
 
In 2009, we began the consolidation of certain customer service facilities in North America and Europe to streamline our operations and deliver better and more efficient customer support to our users. We completed these activities during the first quarter of 2011. The consolidation impacted approximately 1,000 employees. In connection with the consolidation, we incurred aggregate restructuring costs of approximately $47.3 million. See “Note 12— Restructuring” to the condensed consolidated financial statements included in this report.
 
Restructuring expenses decreased $8.7 million, or 102%, during the first quarter of 2011, compared to the same period of the prior year due to the completion of these activities during the period.
 
Interest and Other Income (Expense), Net
 
Interest and other income (expense), net, consists of interest earned on cash, cash equivalents and investments, as well as foreign exchange transaction gains and losses, our portion of operating results from investments accounted for under the equity method of accounting, and interest expense consisting of interest charges on the amount drawn under our credit agreement and on our outstanding commercial paper and debt securities. Interest and other income, net excludes interest expense related to Bill Me Later, which is included in cost of net revenues.
 
Interest and other income (expense), net decreased $2.4 million, or (39)% during the first quarter of 2011 compared to the same period of the prior year. The decrease in interest and other income (expense), net was due primarily to foreign currency losses and higher interest expense, partially offset by higher interest income and higher first quarter 2010 net losses associated with Skype. See “Note 7 — Derivative Instruments” to the condensed consolidated financial statements for more information related to foreign currency hedging activities impacting interest and other income (expense), net.
 
Provision for Income Taxes
 
The provision for income taxes differs from the amount computed by applying the statutory U.S. federal rate due primarily to foreign income with lower tax rates and tax credits, offset by state taxes and other factors.
 
Our effective tax rate was 16% for the first quarter of 2011, compared to 20% for the same period in the prior year. The decrease in our effective tax rate during the first quarter of 2011 compared to the same period of the prior year was due primarily to a favorable change in our geographic mix of earnings, partially offset by the provision for U.S. income and foreign withholding taxes on a portion of our non-U.S. subsidiaries' undistributed earnings.
 
From time to time, we engage in certain intercompany transactions and legal entity restructurings. We consider many

27

 

factors when evaluating these transactions, including the alignment of our corporate structure with our organizational objectives and the operational and tax efficiency of our corporate structure, as well as the long-term cash flows and cash needs of our different businesses. These transactions may impact our overall tax rate and/or result in additional cash tax payments. The impact in any period may be significant. These transactions may be complex and the impact of such transactions on future periods may be difficult to estimate.
 
We are regularly under examination by tax authorities both domestically and internationally. We believe that adequate amounts have been reserved for any adjustments that may ultimately result from these examinations, although we cannot assure you that this will be the case given the inherent uncertainties in these examinations. Due to the ongoing tax examinations, we believe it is impractical to determine the amount and timing of these adjustments.
 
Liquidity and Capital Resources
 
Cash Flows
 
 
Three Months Ended March 31,
 
2010
 
2011
 
(In thousands)
Net cash provided by (used in):
 
 
 
Operating activities
$
418,262
 
 
$
699,610
 
Investing activities
(700,969
)
 
(596,573
)
Financing activities
(7,390
)
 
(338,592
)
Effect of exchange rates on cash and cash equivalents
(116,718
)
 
122,726
 
Net decrease in cash and cash equivalents
$
(406,815
)
 
$
(112,829
)
 
Operating Activities
 
We generated cash from operating activities in amounts greater than net income in the three months ended March 31, 2010 and March 31, 2011, due primarily to non-cash charges to earnings and changes in working capital. Non-cash charges to earnings included depreciation and amortization on our long-term assets, stock-based compensation and the provision for transaction and loan losses. The increase in cash provided by operating activities during the three months ended March 31, 2011 compared to the same period of the prior year was due primarily to cash paid in the first quarter of 2010 for taxes of $311.4 million primarily related to a legal entity restructuring completed in the fourth quarter of 2009, compared to $23.7 million paid for taxes in the first quarter of 2011.
 
Investing Activities
 
The net cash used in investing activities of $596.6 million in the three months ended March 31, 2011 was due primarily to cash paid for the purchases of investments of $485.0 million, acquisition of a business of $190.5 million and purchases of property and equipment of $148.6 million, partially offset by proceeds of $230.4 million from the maturities and sale of investments.
 
The net cash used in investing activities of $701.0 million in the three months ended March 31, 2010 was due primarily to net cash paid for the purchase of investments of $944.4 million and purchases of property and equipment of $152.3 million, partially offset by proceeds of $259.4 million from the maturities and sale of investments and $125.0 million from the repayment of a Skype note receivable.
 
Financing Activities
 
The net cash used in financing activities of $338.6 million in the three months ended March 31, 2011 was due primarily to cash outflows of $356.5 million to repurchase common stock, as well as cash paid for tax withholdings in the amount of $108.7 million related to net share settlements of restricted stock awards and units. These cash outflows were partially offset by proceeds of $72.7 million from the issuance of common stock in connection with the exercise of stock options and $53.9 million of excess tax benefits from stock-based compensation.
 
The net cash used in financing activities of $7.4 million in the three months ended March 31, 2010 was due primarily to $70.5 million in cash paid for tax withholdings related to net share settlements of restricted stock units and nonvested share

28

 

awards, partially offset by proceeds of $42.1 million from the issuance of common stock in connection with the exercise of stock options and $21.0 million in excess tax benefits from stock-based compensation.
 
The positive effect of exchange rate movements on cash and cash equivalents during the three months ended March 31, 2011 was due to the weakening of the U.S. dollar against other currencies, primarily the Euro. The negative effect of exchange rate movements on cash and cash equivalents during the three months ended March 31, 2010 was due to the strengthening of the U.S. dollar against other currencies, primarily the Euro.
 
Stock Repurchases
 
In September 2010, our Board authorized a stock repurchase program that provides for the repurchase of up to $2.0 billion of our common stock, with no expiration from the date of authorization, for the purpose of offsetting the impact of dilution from our equity compensation programs. During the three months ended March 31, 2011, we repurchased approximately $356.2 million of our common stock under this stock repurchase program. As of March 31, 2011, approximately $1.6 billion remained for further repurchases of our common stock under this stock repurchase program
Shelf Registration Statement
At March 31, 2011, we had an effective shelf registration statement on file with the Securities and Exchange Commission that allows us to issue various types of debt securities, such as fixed or floating rate notes, U.S. dollar or foreign currency denominated notes, redeemable notes, global notes, and dual currency or other indexed notes. Issuances under the shelf registration will require the filing of a prospectus supplement identifying the amount and terms of the securities to be issued. The registration statement does not limit the amount of debt securities that may be issued thereunder. Our ability to issue debt securities is subject to market conditions and other factors impacting our borrowing capacity, including compliance with the covenants in our credit agreement.
 
Commercial Paper
We have a $1.0 billion commercial paper program pursuant to which we may issue commercial paper notes with maturities of up to 397 days from the date of issue in an aggregate principal amount of up to $1.0 billion at any time outstanding. As of March 31, 2011, $300.0 million aggregate principal amount of commercial paper was outstanding, the weighted average interest rate on those notes was 0.20% per annum and the weighted average remaining term on our commercial paper notes was 20 days.
Credit Agreement
As of March 31, 2011, no borrowings or letters of credit were outstanding under our $1.8 billion credit agreement. However, as described above, we have a $1.0 billion commercial paper program and we maintain $1.0 billion of available borrowing capacity under our credit agreement in order to repay commercial paper borrowings in the event we are unable to repay those borrowings from other sources when they become due. As a result, at March 31, 2011, $0.8 billion of borrowing capacity was available for other purposes permitted by the credit agreement.  
Commitments
 
As of March 31, 2011, approximately $7.5 billion of unused credit was available to Bill Me Later accountholders. 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 Bill Me Later credit products based on, among other things, account usage and customer creditworthiness.  Currently, when a consumer makes a purchase using a Bill Me Later 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 the purchase, bear the risk of loss in the event of loan defaults. Although the chartered financial institution continues to own each customer account, we own the related receivable, and Bill Me Later is responsible for all servicing functions related to the account.
 
Liquidity and Capital Resource Requirements
 
At March 31, 2011, we had assets classified as cash and cash equivalents, as well as time deposits and fixed income securities classified as short-term investments, in an aggregate amount of $8.1 billion, compared to $7.8 billion at December 31, 2010. At March 31, 2011, we held assets of these types outside the U.S. in certain of our foreign operations totaling approximately $5.5 billion. If these cash and cash equivalents were distributed to the U.S., we may be subject to

29

 

additional U.S. taxes in certain circumstances. We actively monitor the third-party depository institutions and money market funds that hold these assets, primarily focusing on the safety of principal and secondarily maximizing yield on these assets. We diversify our cash and cash equivalents and investments among various financial institutions and money market funds in order to reduce our exposure should any one of these financial institutions or money market funds fail or encounter difficulties. To date, we have not experienced any material loss or lack of access to our invested cash, cash equivalents or short-term investments; however, we can provide no assurances that access to our invested cash, cash equivalents or short-term investments will not be impacted by adverse conditions in the financial markets.
 
 On March 28, 2011, we announced our agreement to acquire GSI Commerce, Inc. ("GSI"), a leading provider ecommerce and interactive marketing services, for $29.25 a share, or total consideration of approximately $2.4 billion. This acquisition will be financed with cash and debt and is expected to close in the third quarter of 2011. As part of the acquisition, we plan to divest 100 percent of GSI's licensed sports merchandise business and 70 percent of GSI's ShopRunner and Rue La La businesses. These assets will be sold to a newly formed holding company, which will be led by GSI founder and CEO Michael Rubin, funded in part by a loan receivable totaling $467.0 million and bearing interest at an annual rate equal to 3-month LIBOR plus 1.10%. The acquisition is subject to customary closing conditions, including the receipt and timing of regulatory approval for the transaction and the approval of GSI's stockholders.
 
We believe that our existing cash, cash equivalents and short-term investments, together with cash expected to be generated from operations, borrowings available under our credit agreement and commercial paper program, and our access to capital markets will be sufficient to fund our operating activities, anticipated capital expenditures, Bill Me Later portfolio of receivables from loans and stock repurchases for the foreseeable future.
 
In the second quarter of 2011, we anticipate paying taxes of approximately $200 million in conjunction with repatriating approximately $450 million in cash as a result of settling multiple uncertain tax positions with tax authorities in 2010.
Off-Balance Sheet Arrangements
 
As of March 31, 2011, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures or capital resources. In Europe, we have two cash pooling arrangements with a financial institution for cash management purposes. These arrangements allow for cash withdrawals from this financial institution based upon our aggregate operating cash balances held in Europe within the same financial institution (“Aggregate Cash Deposits”). These arrangements also allow us to withdraw amounts exceeding the Aggregate Cash Deposits up to an agreed-upon limit. The net balance of the withdrawals and the Aggregate Cash Deposits are used by the financial institution as a basis for calculating our net interest expense or income. As of March 31, 2011, we had a total of $3.6 billion in cash withdrawals offsetting our $3.6 billion in Aggregate Cash Deposits held within the same financial institution under these cash pooling arrangements.
 
 
Based on differences in regulatory requirements and commercial law in the jurisdictions where PayPal operates, PayPal holds customer balances either as direct claims against PayPal or as an agent or custodian on behalf of PayPal's customers. Customer funds held by PayPal as an agent or custodian on behalf of our customers are not reflected in our condensed consolidated balance sheet. These funds include funds held on behalf of U.S. customers that are deposited in bank accounts insured by the Federal Deposit Insurance Corporation (subject to applicable limits) and funds that U.S. customers choose to invest in The PayPal Money Market Fund, which totaled approximately $3.1 billion and $2.7 billion as of March 31, 2011 and December 31, 2010, respectively. The PayPal Money Market Fund is invested in a portfolio managed by BlackRock Fund Advisors.
 
 
Indemnification Provisions
 
In the ordinary course of business, we have included limited indemnification provisions in certain of our agreements with parties with which we have commercial relations, including our standard marketing, promotions and application-programming-interface license agreements. Under these contracts, we generally indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party in connection with claims by a third party with respect to our domain names, trademarks, logos and other branding elements to the extent that such marks are applicable to our performance under the subject agreement. In a limited number of agreements, we have provided an indemnity for other types of third-party claims, which are indemnities mainly related to various intellectual property rights. In our PayPal business, we have provided an indemnity to our payment processors in the event of certain third-party claims or card association fines against the processor arising out of conduct by PayPal or PayPal customers. In connection with the sale of Skype, we made certain

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customary warranties to the buyer in the purchase agreement. Our liability to the buyer for inaccuracies in these warranties is generally subject to certain limitations. With respect to certain specified litigation matters involving Skype that were pending as of the closing of the transaction, we also agreed, among other things, to bear 50% of the cost of any monetary judgment that is rendered in respect of those matters. It is not possible to determine the maximum potential loss under these indemnification provisions due to our limited history of prior indemnification claims and the unique facts and circumstances involved in each particular provision. To date, no significant costs have been incurred, either individually or collectively, in connection with our indemnification provisions.
 
 
 
Item 3:    Quantitative and Qualitative Disclosures About Market Risk
 
The information in this section should be read in connection with the information on financial market risk related to changes in interest rates and non-U.S. currency exchange rates in Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in our Annual Report on Form 10-K for the year ended December 31, 2010. Our market risk profile has not changed significantly during the first three months of 2011.
 
Interest Rate Risk
 
The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents and short-term and long-term investments in a variety of available for sale securities, including government and corporate securities and money market funds. As of March 31, 2011, approximately 58% of our total cash and investment portfolio was held in bank deposits and money market funds. As such, changes in interest rates will impact interest income. Fixed rate securities may have their fair market value adversely affected due to a rise in interest rates, and we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates. Additionally, changes in interest rates will impact our interest rate sensitive credit agreement and accordingly, impact interest expense or cost of net revenues. As of March 31, 2011, we held no direct investments in auction rate securities, collateralized debt obligations, structured investment vehicles or mortgage-backed securities.
 
 
Investment Risk
 
As of March 31, 2011, our cost and equity method investments totaled $728.4 million, which represented approximately 8% of our total cash and investment portfolio and was primarily related to our retained equity interest in Skype. These investments relate primarily to equity-method investments in private companies. We review our investments for impairment when events and circumstances indicate a decline in fair value of such assets below carrying value is other-than-temporary. Our analysis includes review of recent operating results and trends, recent sales/acquisitions of the investee securities, and other publicly available data.
 
Equity Price Risk
We are exposed to equity price risk on marketable equity instruments due to market volatility. At March31, 2011, the total fair value of our marketable equity instruments was $663.3 million, which represented approximately 7% of our total cash and investment portfolio and was primarily related to our equity holdings in MercadoLibre.
 
Foreign Currency Risk
 
We have significant international revenues as well as costs denominated in foreign currencies, primarily the Euro, British pound, Korean won and Australian dollar, subjecting us to foreign currency risk. We have a foreign exchange exposure management program to identify material foreign currency exposures and to manage these exposures to minimize the potential effects of currency fluctuations on our reported consolidated cash flow and results of operations through the purchase of foreign currency exchange contracts. These foreign currency exchange contracts are accounted for as derivative instruments, for additional details related to our derivative instruments, please see “Note 7 – Derivative Instruments” to the condensed consolidated financial statements included in this report.
 

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Item 4:    Controls and Procedures
 
(a) Evaluation of disclosure controls and procedures. Based on the evaluation of our disclosure controls and procedures (as defined in Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) required by Securities Exchange Act Rules 13a-15(b) or 15d-15(b), our Chief Executive Officer and our Chief Financial Officer have concluded that as of the end of the period covered by this report, our disclosure controls and procedures were effective.
 
(b) Changes in internal controls. There were no changes in our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
PART II: OTHER INFORMATION
 
Item 1:    Legal Proceedings
 
The information set forth under “Note 9 — Commitments and Contingencies — Litigation and Other Legal Matters” to the condensed consolidated financial statements included in Part I, Item 1 of this report is incorporated herein by reference.
 
Item 1A:    Risk Factors
 
Risk Factors That May Affect Results of Operations and Financial Condition
The risks and uncertainties described below are not the only ones facing us. Other events that we do not currently anticipate or that we currently deem immaterial also may adversely affect our results of operations and financial condition.
Our operating results have varied on a quarterly basis during our operating history. Our operating results may fluctuate significantly as a result of a variety of factors, many of which are outside our control. Factors that may affect our operating results include the following:
 
general economic conditions, including the possibility of a prolonged period of limited economic growth in the U.S. and Europe; disruptions to the credit and financial markets in the U.S. and worldwide; adverse effects of the ongoing sovereign debt crisis in Europe; contractions or limited growth in consumer spending or consumer credit; and adverse economic conditions that may be specific to the Internet, ecommerce and payments industries;
our ability to retain an active user base, attract new users, and encourage existing users to list items for sale, purchase items through our websites, or use our payment services, especially when consumer spending is weak;
the primary and secondary effects of previously announced and possible future changes to our pricing, products and policies, including, among other changes, restrictions or holds on payments made to sellers or in connection with certain categories of higher-risk transactions; changes to performance standards and/or rewards for sellers, including taking into account cases filed through the eBay and PayPal buyer protection programs in evaluating individual seller performance ratings; changes to the dispute resolution process, including directing eBay buyers to resolve disputes with sellers through eBay instead of through PayPal; the adoption of a single fixed price format, which includes making listings previously available under our store inventory format accessible through our search algorithms; upgrades to eBay checkout services, including the introduction of a new eBay shopping cart that enables buyers to add items from multiple sellers and pay in a single checkout; and, effective July 2011, the discontinuation of support for third party checkout services;
consumer confidence in the safety and security of transactions using our websites or technology and the effect of any changes in our practices and policies designed to foster improved confidence;
our ability to meet existing and new regulatory requirements as we expand the range and geographical scope of our services and as we grow larger, especially for our Payments business;
our ability to manage the costs of and effectively implement our user protection programs;
the volume, velocity, size, timing, monetization, and completion rates of transactions using our websites or technology;
regulatory and legal actions imposing obligations on our businesses or our users, including the injunction related to certain cosmetic and perfume brands (see “Item 1 - Legal Proceedings” above);
our ability to improve the quality of the user experience on our websites (including our customer support in the event of a problem) in light of the improved quality generally of the user experience offered by competitive Internet merchants;
our ability to reduce the loss of active buyers and sellers and increase activity of the users of our Marketplaces business, especially with respect to our top buyers and sellers;

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changes to our use of advertising on our sites, including changes in ad placement;
the impact on PayPal or Bill Me Later of regulations enacted pursuant to new laws regulating financial institutions, including the Dodd-Frank Wall Street Reform and Consumer Protection Act in the U.S.;
other new laws or regulations, or interpretations of existing laws or regulations, that impose liability on us for actions of our users or otherwise harm our business models or restrict the Internet, ecommerce, online payments or online advertising;
the actions of our competitors, including the introduction of new sites, services, products and functionality;
the costs and results of litigation that involves us;
our ability to develop product enhancements, programs, and features on different platforms (e.g., mobile) at a reasonable cost and in a timely manner;
our ability to upgrade and develop our systems, infrastructure, and customer service capabilities to accommodate growth and to improve our websites at a reasonable cost while maintaining 24/7 operations;
technical difficulties or service interruptions involving our websites or services provided to us or our users by third parties;
our ability to manage the transaction loss rate in our Marketplaces and Payments business;
our ability to manage funding costs and losses associated with our Bill Me Later business;
our ability to successfully and cost-effectively integrate and manage businesses that we acquire, including our expected acquisition of GSI Commerce, Inc., our need to manage credit risks and bad debts following our acquisition of Bill Me Later in November 2008, and our planned combination of competing marketplaces in Korea following our acquisition of Gmarket in June 2009;
the amount and timing of operating costs and capital expenditures relating to the maintenance and expansion of our businesses, operations, and infrastructure;
our ability to comply with the requirements of entities whose services are required for our operations, such as credit card networks and banks;
the cost and availability of online and traditional advertising, and the success of our brand building and marketing campaigns;
our ability to attract new personnel in a timely and effective manner and to retain key employees;
the continued healthy operation of our technology suppliers and other parties with which we have commercial relations;
continued consumer acceptance of the Internet as a medium for ecommerce and payments in the face of increasing publicity about fraud, spoofing, phishing, viruses, spyware, malware and other dangers of the Internet; and
macroeconomic and geopolitical events affecting commerce generally.
 
It is difficult for us to forecast the level or source of our revenues or earnings accurately. In view of the rapidly evolving nature of our business, we believe that period-to-period comparisons of our operating results may not be meaningful, and you should not rely upon them as an indication of future performance. We do not have backlog, and substantially all of our net revenues each quarter come from transactions involving sales or payments during that quarter. Due to the inherent difficulty in forecasting revenues, it is also difficult to forecast income statement expenses as a percentage of net revenues. Quarterly and annual income statement expenses as a percentage of net revenues may be significantly different from historical or projected rates. Our operating results in one or more future quarters may fall below the expectations of securities analysts and investors. In that event, the trading price of our common stock would almost certainly decline.
We invest heavily in technology, marketing and promotion, customer support, protection programs and further development of the operating infrastructure for our core and non-core operations. Some of this investment entails long-term contractual commitments. As a result, we may be unable to adjust our spending rapidly enough to compensate for any unexpected revenue shortfall, which may harm our profitability.
Growth rates of our Marketplaces businesses in some of our most established markets have been slower than that for ecommerce generally and have declined in certain periods. Despite our efforts to stem this loss of market share in these and other markets, we may not be successful. As our growth rates in established markets slow, we will increasingly need to focus on keeping existing users, especially our top buyers and sellers, active and increasing their activity level on our websites in order to continue to grow our business. In addition, our Marketplaces business is facing increased competitive pressure. In particular, the competitive norm for, and the expected level of service from, Internet ecommerce websites has significantly increased, due to, for example, improved user experience, greater ease of buying goods, lower (or no) shipping costs, faster shipping times and more favorable return policies. If we are unable to change our services in ways that reflect the changing demands of the ecommerce marketplace, particularly the higher growth of sales of fixed-price items and higher service levels (some of which depend on services provided by sellers on our platforms), our business will suffer.
We have announced changes to our Marketplaces business intended to drive more sales and improve seller efficiency. For

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example, in the U.S. and the U.K., we have begun testing the efficacy of improving seller performance and increasing buyer satisfaction by requesting that PayPal place temporary holds on seller funds in certain instances (e.g., for sellers with a limited selling history or below-standard performance ratings), and we may expand the scope of such programs in the future and introduce other programs with similar aims in these and other countries. Some of the changes that we have announced to date have been controversial with, and led to dissatisfaction among, our sellers, and additional changes that we announce in the future may also be negatively received by some of our sellers. This may not only impact the supply of items listed on our websites, but because many sellers also buy from our sites, it may adversely impact demand as well. Given the number of recent changes that we have made to our policies and pricing, it may take our sellers some time to fully assess and adjust to these changes, and sellers may elect to reduce volume while making such assessments and adjustments or in response to these changes. If any of these changes cause sellers to move their business (in whole or in part) away from our websites or otherwise fail to improve gross merchandise volume or the number of successful listings, our operating results and profitability will be harmed. We believe that the mix of sales under our traditional auction-style listing format and fixed-price listing format will continue to shift towards our fixed-price format. Accordingly, we have eliminated some of the features related to our traditional auction-style format and expect others will become less meaningful to, and used less frequently by, our sellers, which would result in a corresponding decrease in revenues from such features. In addition, we expect that the costs associated with our seller discount programs will increase as more sellers will become eligible for such discounts.
In addition, because a large percentage of PayPal transactions originate on the eBay platform, declines in growth rates in major Marketplaces markets also adversely affect PayPal's growth. The expected future growth of our PayPal, StubHub, and other lower margin businesses may also cause downward pressure on our profit margins because those businesses have lower gross margins than our Marketplaces platforms.
The economic downturn could harm our business.
Our Marketplaces and Payments businesses are dependent on consumer purchases. The economic downturn has resulted in reduced buyer demand and reduced selling prices and may reduce the volume of purchases on our Marketplaces platforms and the volume of transactions paid for using our Payment services, all of which would adversely affect our business. In addition, the economic downturn has adversely affected our advertising revenues and may require us to increase our reserves for bad debt and transaction and loan losses. Continuing poor economic conditions would likely continue or exacerbate these trends. In the event of the bankruptcy of a merchant that sells goods or services in advance of the date of their delivery or use (such as airline, cruise or concert tickets), PayPal could be liable to the buyers of such goods or services either through its buyer protection program or through chargebacks on payment cards used by customers to fund their payment through PayPal.
We are exposed to fluctuations in currency exchange rates and interest rates.
Because we conduct the majority of our business outside the United States but report our financial results in U.S. dollars, we face exposure to adverse movements in currency exchange rates. In connection with its multi-currency service, PayPal fixes exchange rates twice per day, and may face financial exposure if it incorrectly fixes the exchange rate or if exposure reports are delayed. PayPal also holds some corporate and customer funds in non-U.S. currencies, and thus its financial results are affected by the translation of these non-U.S. currencies into U.S. dollars. In addition, the results of operations of many of our internationally focused websites are exposed to foreign exchange rate fluctuations as the financial results of the applicable subsidiaries are translated from the local currency into U.S. dollars upon consolidation. If the U.S. dollar weakens against foreign currencies, the translation of these foreign currency denominated transactions will result in increased net revenues, operating expenses and net income. Similarly, our translation of foreign currency denominated transactions will result in lower net revenues, operating expenses and net income if the U.S. dollar strengthens against foreign currencies, as happened in the first half of 2010. Net revenues in the three months ended March 31, 2011 were positively impacted by foreign currency translation of $12.5 million compared to the same period of the prior fiscal year. As exchange rates vary, net revenues and other operating results, when translated, may differ materially from expectations. In particular, to the extent the U.S. dollar strengthens against the Euro, British pound, Korean won, or Australian dollar, our foreign revenues and profits will be reduced as a result of these translation adjustments. While from time to time we enter into transactions to hedge portions of our foreign currency translation exposure, it is impossible to perfectly predict or completely eliminate the effects of this exposure. In addition, to the extent the U.S. dollar strengthens against the Euro, the British pound, the Australian dollar or other currencies, cross-border trade related to purchases of dollar-denominated goods by non-U.S. purchasers will likely decrease, and that decrease will likely not be offset by a corresponding increase in cross-border trade involving purchases by U.S. buyers of goods denominated in other currencies, adversely affecting our business.
In addition, we face exposure to fluctuations in interest rates. For example, relatively low interest rates have continued to limit our investment income, including income we earn on PayPal customer balances, which in turn has lowered our net interest income and net revenue.

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Bill Me Later's operations depend on lending services provided by an unaffiliated lender.
We acquired Bill Me Later, a company that facilitates credit services offered by an unaffiliated bank, in November 2008. Bill Me Later is neither a chartered financial institution nor is it licensed to make loans in any state. Accordingly, Bill Me Later must rely on a bank or licensed lender to issue the Bill Me Later credit products and extend credit to customers in order to offer the Bill Me Later service. Currently, when a consumer makes a purchase using a Bill Me Later 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 extensions of credit made by the chartered financial institution and, as a result of the purchase, bear the risk of loss in the event of loan defaults. Although the chartered financial institution continues to own each customer account, we own the related receivable, and Bill Me Later is responsible for all servicing functions related to the account.
In September 2010, WebBank became the issuer of the Bill Me Later credit products. WebBank is an industrial bank chartered by the State of Utah. Any termination or interruption of WebBank's ability to lend could result in our being unable to originate any new transactions for the Bill Me Later service. Under those circumstances, we would be required to either reach a similar arrangement with another chartered financial institution, which may not be available on favorable terms, if at all, or to obtain our own bank charter, which would be a time-consuming and costly process and would subject us to a number of additional laws and regulations.
A lawsuit has been filed against Bill Me Later, PayPal and eBay and is pending in the U.S. District Court for the Central District of California, alleging that in its relationship with the chartered financial institution, Bill Me Later is acting as the true lender to customers in violation of various California laws, including the state's usury law. The court dismissed the usury claims in December 2010, but breach of contract and other claims remain. We believe that these allegations are without merit and intend to defend ourselves vigorously. However, this area of law is uncertain and if the lawsuit is successful, Bill Me Later may be required to change its methods of operations, pay substantial damages and reduce some of its charges and fees, which would likely adversely affect our business.
If our Payments business is found to be subject to or in violation of any laws or regulations, including those governing money transmission, electronic funds transfers, money laundering, counter-terrorist financing, banking and lending, it could be subject to liability, licensure and regulatory approval and may be forced to change its business practices.
While PayPal currently allows its customers with credit cards to send payments from 190 markets, PayPal only allows customers in 104 of those markets (including the U.S.) to receive payments, in some cases with significant restrictions on the manner in which customers can withdraw funds. These limitations may affect PayPal's ability to grow in these markets.
Of the 190 markets whose residents can use the PayPal service, 31 (27 countries plus four French overseas departments) are members of the European Union , or EU. Since 2007, PayPal has provided localized versions of its service to customers in the EU through PayPal (Europe) S.A.R.L. et Cie, SCA, a wholly-owned subsidiary of PayPal that is licensed and subject to regulation as a bank in Luxembourg. Accordingly, PayPal (Europe) is subject to significant fines or other enforcement action if it violates the disclosure, reporting, anti-money laundering, capitalization, funds management, corporate governance or other requirements imposed on Luxembourg banks. PayPal has limited experience in operating as a bank, and any fines or other enforcement actions imposed by the Luxembourg regulator could adversely affect PayPal's business. PayPal (Europe) implements its localized services in EU countries through a “passport” notification process through the Luxembourg regulator to regulators in other EU member states pursuant to EU Directives, and has completed the “passport” notice process in all EU member countries. The regulators in these countries could notify PayPal (Europe) of local consumer protection laws that will apply to its business, in addition to Luxembourg consumer protection law, and could also seek to persuade the Luxembourg regulator to order PayPal (Europe) to conduct its activities in the local country through a branch office. These or similar actions by these regulators could increase the cost of, or delay, PayPal's plans for expanding its business in EU countries. In addition, the EU Payments Service Directive, which established a new regulatory regime for payment services providers, formally took effect in November 2009. The interpretation of regulations implementing the EU Payments Service Directive remains uncertain.
In Australia, PayPal serves its customers through PayPal Australia Pty. Ltd., which is licensed by the Australian Prudential Regulatory Authority as a purchased payment facility provider, which is a type of authorized depository institution. Accordingly, PayPal Australia is subject to significant fines or other enforcement action if it violates the disclosure, reporting, anti-money laundering, capitalization, corporate governance or other requirements imposed on Australian depository institutions. In China, PayPal is affiliated with Shanghai Wangfuyi Information Technology Ltd., which is licensed as an Internet Content Provider and operates a payments service only for Chinese customers and only for transactions denominated in Chinese currency. The People's Bank of China (PBOC) has recently enacted regulations to establish a new type of license, called a Payment Settlement Organization (PSO) license, which will be required for non-bank payment services. The PBOC

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regulations leave unclear whether a foreign-owned company such as PayPal can control or invest in a Payment Settlement Organization, and whether Wangfuyi would be eligible to obtain a PSO license.
 
To date, PayPal has obtained licenses to operate as a money transmitter in 43 U.S. states and territories and interpretations in six other states that licensing is not required under their existing statutes. PayPal is also licensed as an escrow agent in one U.S. state. The remaining U.S. state and territories do not currently regulate money transmitters. As a licensed money transmitter, PayPal is subject to restrictions on its investment of customer funds, reporting requirements, bonding requirements, and inspection by state regulatory agencies. If PayPal were found to be in violation of money services laws or regulations, PayPal could be subject to liability, forced to cease doing business with residents of certain states, forced to change its business practices, or required to obtain additional licenses or regulatory approvals that could impose a substantial cost on PayPal. Any change to PayPal's business practices that makes the service less attractive to customers or prohibits its use by residents of a particular jurisdiction could decrease the velocity of trade on eBay, which would further harm our business.
In markets other than the U.S., the EU, Australia and the China domestic business, PayPal serves its customers through PayPal Private Ltd., a wholly-owned subsidiary of PayPal that is based in Singapore. In many of these markets, it is not clear whether PayPal's Singapore-based service is subject only to Singaporean law or, if it were subject to local laws, whether such local law would require a payment processor like PayPal to be licensed as a bank or financial institution or otherwise. In such markets, the business may rely on partnerships with local banks to process payments and conduct foreign exchange in local currency. Local regulators who do not have direct jurisdiction over Singapore-based PayPal Private Ltd. may use their local regulatory power to slow or halt payments to local merchants conducted through the local banking partner. Such regulatory actions impacting local banking partner arrangements could impose substantial costs and involve considerable delay to the provision or development of PayPal services in that market, or could prevent PayPal from providing any services in a given market. The Reserve Bank of India has asserted that PayPal's offering of payment services to customers outside of India to send personal, non-commercial payments to recipients in India requires a license from the Reserve Bank. For a period of time in 2010, the Reserve Bank directed the Indian affiliate of PayPal's processing bank to suspend withdrawals to the Indian bank accounts of PayPal customers for both personal and business customers. PayPal has suspended personal non-commercial payments to and from Indian accounts, and has also stopped offering certain commercial payments between Indian buyers and Indian sellers. In November 2010, the Reserve Bank of India issued guidelines to Indian banks on the requirements for processing export-related transactions for online payment gateway service providers such as PayPal, including a limitation on the amount of individual transactions to no more than $500. The Reserve Bank may again impose a suspension if it is not satisfied with PayPal's and its partner bank's actions to comply with these guidelines. In the event of any non-compliance, PayPal could be subject to fines from the Reserve Bank, and PayPal's prospects for future business in India, both cross-border and domestic, could be materially and adversely affected.
Even if PayPal is not currently required to be licensed in some jurisdictions, future localization or targeted marketing of PayPal's service in those countries, or expansion of the financial products offered by PayPal in new jurisdictions (either alone, through a commercial alliance or through an acquisition), could subject PayPal to additional licensure requirements, laws and regulations and increased regulatory scrutiny, any of which may harm PayPal's business. These factors could impose substantial costs and involve considerable delay to the provision or development of its products. Delay or failure to receive such a license or regulatory approval could require PayPal to change its business practices or features in ways that would adversely affect PayPal's international expansion plans, and could require PayPal to suspend providing products and services to customers in one or more countries.
PayPal is also subject to various anti-money laundering and counter-terrorist financing laws and regulations around the world that prohibit, among other things, its involvement in transferring the proceeds of criminal activities. Although PayPal has implemented a program to comply with these laws and regulations, any errors or failure to comply with federal, state or foreign money laundering and counter-terrorist financing laws could result in significant criminal and civil lawsuits, penalties, and forfeiture of significant assets. In the United States, PayPal is subject to regulations that require it to report suspicious activities involving transactions of $2,000 or more, and may be required to obtain and keep more detailed records on the senders and recipients in certain transfers of $3,000 or more. The interpretation of suspicious activities in this context is uncertain. Pending regulations may require PayPal to revise the procedures it uses to verify the identity of its customers and to monitor international transactions more closely.
Several countries in which PayPal is regulated, including Australia, Luxembourg and Singapore, have implemented new anti-money laundering and counter-terrorist financing laws and regulations, and PayPal has had to make changes to its procedures in response. In November 2009, the Australian anti-money laundering and counter-terrorist financing regulator (AUSTRAC) accepted an enforceable undertaking from PayPal Australia pursuant to which PayPal Australia agreed, among other things, to appoint an independent auditor to assess PayPal Australia's anti-money laundering compliance policies and procedures and issue a report identifying any unremediated deficiencies accompanied by a plan by PayPal to remedy any such

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deficiencies. In the enforceable undertaking, AUSTRAC expressed concern that PayPal Australia did not have systems and controls in place to manage adequately its money laundering and terrorist financing risk. In September 2010, the independent auditor completed its review and issued its report, and PayPal Australia submitted a remediation plan. PayPal Australia is in the process of investing in improvements to its anti-money laundering and counter-terrorist financing systems, policies and operations as part of its remediation plan. In addition, PayPal Australia will be required to obtain additional information from customers, verify that information, and monitor its customers' activities more closely. As PayPal continues to localize its services in additional jurisdictions, it could be required to meet standards similar to those in Australia. These requirements could impose significant costs on PayPal, cause delay to other planned product improvements, make it more difficult for new customers to join its network and reduce the attractiveness of its products.
Although there have been no definitive interpretations to date, PayPal has taken actions as though its service is subject to the Electronic Fund Transfer Act and Regulation E of the U.S. Federal Reserve Board. Under such regulations, among other things, PayPal is required to provide advance disclosure of changes to its service, to follow specified error resolution procedures and to reimburse consumers for losses from certain transactions not authorized by the consumer. PayPal seeks to pass most of these losses on to the relevant merchants, but PayPal incurs losses if the merchant does not have sufficient funds in its PayPal account. Additionally, even technical violations of these laws can result in penalties of up to $1,000 for each non-compliant transaction or up to $500,000 per violation in any class action, and we could also be liable for plaintiffs' attorneys fees. In the second quarter of 2010, two putative class-action lawsuits (Devinda Fernando and Vadim Tsigel v. eBay Inc. and PayPal, Inc.; and Moises Zepeda v. PayPal, Inc.) were filed in the U.S. District Court in the Northern District of California. These lawsuits contain allegations related to violations of aspects of the Electronic Fund Transfer Act and Regulation E and violations of a previous settlement agreement related to Regulation E, and/or allege that PayPal improperly held users' funds or otherwise improperly limited user's accounts. These lawsuits seek damages as well as changes to PayPal's practices among other remedies. A determination that there have been violations of the Electronic Fund Transfer Act, Regulation E or violations of other laws relating to PayPal's practices could expose PayPal to significant liability. Changes to PayPal's practices that may result from these lawsuits could require PayPal to incur significant costs and to expend product resources, which could cause delay to other planned product improvements, which would further harm our business.
Our Bill Me Later service is similarly subject to a variety of laws and regulations. Although we do not originate loans under the Bill Me Later service, we do purchase receivables related to the consumer loans extended by the bank which originates them, and one or more jurisdictions may conclude that the eBay company which purchases those receivables is a lender or money transmitter or loan broker, which could subject us to liability or regulation in one or more jurisdictions. As described under the caption “Bill Me Later's operations depend on lending services provided by an unaffiliated lender” above, a lawsuit has been filed against Bill Me Later in the U.S. District Court for the Northern District of California alleging that in its relationship with the former issuer of the Bill Me Later credit products, Bill Me Later was acting as the true lender to customers in violation of various California laws, including the state's usury law.
Additionally, federal regulators could mandate changes to the relationship between us and the issuing bank of the Bill Me Later credit products. Any termination or interruption of the issuing bank's lending services to consumers could result in an interruption of Bill Me Later services, as described under the caption “Bill Me Later's operations depend on lending services provided by an unaffiliated lender” above. Also, effective in three stages in February 2010, July 2010 and August 2010, certain provisions of the Credit Card Accountability Responsibility and Disclosure Act of 2009, or the CARD Act, and certain changes to Regulation Z of the U.S. Federal Reserve Board require the issuing bank and us to make fundamental changes to many of the practices we and the issuing bank currently use with respect to Bill Me Later consumer accounts, including marketing, pricing (including finance charges, promotional programs and late fees assessed on receivables purchased by us from the bank) and billing, which could in turn adversely affect this business.
The listing or sale by our users of pirated or counterfeit items may harm our business.
We have received in the past, and we anticipate receiving in the future, communications alleging that certain items listed or sold through our service by our users infringe third-party copyrights, trademarks and trade names, or other intellectual property rights. See “Item 1 - Legal Proceedings” above. Although we have sought to work actively with the owners of intellectual property rights to eliminate listings offering infringing items on our websites, some rights owners have expressed the view that our efforts are insufficient. Content owners and other intellectual property rights owners have been active in asserting their purported rights against online companies, including eBay. Allegations of infringement of intellectual property rights have resulted in threats of litigation and actual litigation against us from time to time by rights owners, including litigation brought by luxury brand owners such as Tiffany & Co. in the U.S., Rolex S.A. and Coty Prestige Lancaster Group GmbH in Germany, Louis Vuitton Malletier and Christian Dior Couture in France and L'Oréal SA, Lancôme Parfums et Beauté & Cie and Laboratoire Garnier & Cie in several European countries. The plaintiffs in these cases seek to hold eBay liable for alleged counterfeit items listed on our sites by third parties, for “tester” and other consumer products labeled in a

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manner to prevent resale and for unboxed and other allegedly nonconforming products listed on our sites by third parties, for the alleged misuse of trademarks or copyrights in listings or otherwise on our sites, or in connection with paid search advertisements, or for alleged violations of selective distribution channel laws or parallel import laws for listings of authentic items, or for alleged non-compliance with consumer protection laws. Such plaintiffs seek, among other things, injunctive relief and damages. In the aggregate, these suits could result in significant damage awards and injunctions that could adversely affect our business. These and similar suits may force us to modify our business practices, which could lower our revenue, increase our costs or make our websites less convenient to our customers. Any such results could materially harm our business. In addition, rights owners have aggressively sought to reduce the applicability of limitations to intellectual property rights such as copyright exhaustion and the first sales doctrine in cases such as Vernor v. Autodesk Inc. (Ninth Circuit Court of Appeals) and Costco Wholesale Corp. vs. Omega S.A. To the extent such doctrine are limited, the supply of goods available for resale on eBay may be adversely affected.
In addition to litigation from rights owners, we may be subject to regulatory, civil or criminal proceedings and penalties if governmental authorities believe we have aided in the sale of counterfeit goods. While we have had some early success in defending against such litigation, more recent cases have been based, at least in part, on different legal theories than those of earlier cases, and there is no guarantee that we will continue to be successful in defending against such litigation. Plaintiffs in recent cases have argued that we are not entitled to safe harbors under the Digital Millennium Copyright Act in the U.S. or as a hosting provider in the European Union under the Electronic Commerce Directive because of the alleged active nature of our involvement with our sellers, and that, whether or not such safe harbors are available, we should be found liable because we supposedly have not adequately removed listings that are counterfeit or are authentic but allegedly violate trademark or copyright law or effectively suspended users who have created such listings. We are continuously seeking to improve and modify our efforts to eliminate counterfeit and pirated items. These improvements are in response to ongoing business initiatives designed to reduce bad buyer experiences and improve customer satisfaction as well as in response to new patterns we are seeing among counterfeiters and others committing fraud on our users. Notwithstanding these efforts, we believe that the legal climate, especially in Europe, is becoming more adverse to our positions, which may require us to take actions which could lower our revenues, increase our costs, or make our websites less convenient to our customers, which may materially harm our business. In addition, a public perception that counterfeit or pirated items are commonplace on our sites, even if factually incorrect, could damage our reputation and our business.
Content owners and other intellectual property rights owners may also seek to bring legal action against entities that are peripherally involved in the sale of infringing items, such as payment companies. To the extent that intellectual property rights owners bring legal action against PayPal based upon the use of PayPal's payment services in a transaction involving the sale of infringing items, including on our websites, our business could be harmed.
We are subject to patent litigation.
We have repeatedly been sued for allegedly infringing other parties' patents. We are a defendant in a number of patent suits and we have been notified of several other potential patent disputes, and expect that we will increasingly be subject to patent infringement claims involving various aspects of our Marketplaces and Payments segments as our services expand in scope and complexity. These claims, whether meritorious or not, are time consuming and costly to resolve, and could require expensive changes in our methods of doing business, could require us to enter into costly royalty or licensing agreements, or could require us to cease conducting certain operations.
Use of our services for illegal purposes could harm our business.
We may be unable to prevent our users from selling unlawful or stolen goods or unlawful services, or selling goods or services in an unlawful manner, and we may be subject to allegations of civil or criminal liability for unlawful activities carried out by users through our services. We have been subject to several lawsuits based upon such allegations. In December 2004, an executive of Baazee.com, our Indian subsidiary, was arrested in connection with a user's listing of a pornographic video clip on that website. We continue to contest the charges related to this arrest. Similarly, one of our Korean subsidiaries (IAC) and one of its employees were found criminally liable for listings (which occurred prior to our acquisition of IAC) on IAC's website. The German Federal Supreme Court has ruled that we may have a duty to take reasonable measures to prevent prohibited DVDs from being sold on our site to minors and that competitors may be able to enforce this duty. In a number of circumstances, third parties, including government regulators and law enforcement officials, have alleged that our services aid and abet certain violations of certain laws, including antiscalping laws with respect to the resale of tickets, laws regarding the sale of counterfeit items, the fencing of stolen goods, selective distribution channel laws, distance selling laws and the sale of items outside of the U.S. that are regulated by U.S. export controls.
Although we have prohibited the listing of illegal and stolen goods and certain high-risk items and implemented other protective measures, we may be required to spend substantial resources to take additional protective measures or discontinue

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certain service offerings, any of which could harm our business. Any costs incurred as a result of potential liability relating to the alleged or actual sale of unlawful goods or the unlawful sale of goods could harm our business. Certain manufacturers and large retailers have sought new U.S. federal and state legislation regarding stolen goods that could limit our ability to allow sellers to use our sites without confirming the source of, and their legal rights to sell, the underlying goods. In addition, from time to time we have received significant media attention relating to the listing or sale of illegal goods and stolen goods using our services. This negative publicity could damage our reputation, diminish the value of our brand names and make users reluctant to use our services.
PayPal's payment system is also susceptible to potentially illegal or improper uses. These may include illegal online gambling, fraudulent sales of goods or services, illicit sales of prescription medications or controlled substances, piracy of software and other copyrighted or trademarked goods, money laundering, terrorist financing, bank fraud, child pornography trafficking, prohibited sales of alcoholic beverages or tobacco products, online securities fraud and encouraging, promoting, facilitating or instructing others to engage in illegal activities. There has been an increased focus by rights owners and U.S. government officials on the role payments systems play in the sale of, and payment for, pirated digital goods on the Internet. Recent changes in law have increased the penalties for intermediaries providing payment services for certain illegal activities, and additional payments-related proposals are under active consideration by government policymakers. Despite measures PayPal has taken to detect and lessen the risk of this kind of conduct, illegal activities could still be funded using PayPal. Any resulting claims or liabilities could harm our business.
We are subject to risks associated with information disseminated through our service.
As discussed above with respect to certain specific issues, the law relating to the liability of online services companies for information carried on or disseminated through their services is often unsettled. Claims could be made against online services companies under both U.S. and foreign law for defamation, libel, invasion of privacy, negligence, copyright or trademark infringement, or other theories based on the nature and content of the materials disseminated through their services. Several private lawsuits seeking to impose liability under a number of these theories have been brought against us, as well as other online service companies. In addition, domestic and foreign legislation has been proposed that would prohibit or impose liability for the transmission over the Internet of certain types of information. Our service features a Feedback Forum, which includes information from users regarding other users. Although all such feedback is generated by users and not by us, claims of defamation or other injury have been made in the past and could be made in the future against us for not removing content posted in the Feedback Forum.
Furthermore, several court decisions arguably have narrowed the scope of the immunity provided to Internet service providers like us under the Communications Decency Act. For example, the Ninth Circuit has held that certain immunity provisions under the Communications Decency Act might not apply to the extent that a website owner materially contributes to the development of unlawful content on its website. As our websites evolve, challenges to the applicability of these immunities can be expected to continue. In addition, the Paris Court of Appeal has ruled in the Louis Vuitton Malletier and Christian Dior Couture cases that applicable laws protecting passive internet “hosts” from liability are inapplicable to eBay given that eBay actively promotes bidding on its sellers' listings and receives a commission on successful transactions, and is therefore a broker. This trend, if continued, may increase our potential liability to third parties for the user-provided content on our sites, particularly in jurisdictions outside the U.S. where laws governing Internet transactions are unsettled. If we become liable for information provided by our users and carried on our service in any jurisdiction in which we operate, we could be directly harmed and we may be forced to implement new measures to reduce our exposure to this liability, including expending substantial resources or discontinuing certain service offerings, which would negatively affect our financial results. In addition, the increased attention focused upon liability issues as a result of these lawsuits and legislative proposals could require us to incur additional costs and harm our reputation and our business.
Government inquiries may lead to charges or penalties.
A large number of transactions occur on our websites on a daily basis. Government regulators have received a significant number of consumer complaints about both eBay and PayPal, which, while small as a percentage of our total transactions, are large in aggregate numbers. As a result, from time to time we have been contacted by various foreign and domestic governmental regulatory agencies that have questions about our operations and the steps we take to protect our users from fraud. PayPal has received inquiries regarding its restriction and disclosure practices from the Federal Trade Commission and regarding these and other business practices from the attorneys general of a number of states. In September 2006, PayPal entered into a settlement agreement with the attorneys general of a number of states under which it agreed to pay $1.7 million to the attorneys general, shorten and streamline its user agreement, increase educational messaging to users about funding choices, and communicate more information regarding protection programs to users. From time to time, we face inquiries from government regulators in various jurisdictions related to actions that we have taken that are designed to improve the security of transactions and the quality of the user experience on our websites and we may face similar inquires from other government

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regulators in the future. For example, both the Australian Competition and Consumer Commission and the Reserve Bank of Australia recently reviewed our policies requiring sellers to offer PayPal as a payment alternative on most transactions on our localized Australian website and precluding sellers from imposing a surcharge or any other fee for accepting PayPal or other payment methods. Other regulators have requested information concerning PayPal's limitations of customer accounts. Similarly, Bill Me Later has from time to time received customer complaints that could result in investigations into Bill Me Later's business practices by state or federal regulators. As a result of the recent credit crisis, new laws have been passed, and we expect additional new laws and regulations to be adopted that impose, among other requirements, additional obligations and restrictions on the provision of credit. We are likely to receive additional inquiries from regulatory agencies in the future, including under existing or new credit laws or regulations, which may lead to action against us. We have responded to all inquiries from regulatory agencies by describing our current and planned antifraud efforts, customer support procedures, operating procedures and disclosures. If one or more of these agencies is not satisfied with our response to current or future inquiries, we could be subject to enforcement actions, fines or other penalties, or forced to change our operating practices in ways that could harm our business.
We are subject to general litigation and regulatory disputes.
From time to time, we are involved in other disputes or regulatory inquiries that arise in the ordinary course of business. The number and significance of these disputes and inquiries have increased as our business has expanded and our company has grown larger. We have in the past been forced to litigate such claims. We may also become more vulnerable to third-party claims as laws such as the Digital Millennium Copyright Act, the Lanham Act and the Communications Decency Act are interpreted by the courts and as we expand geographically into jurisdictions where the underlying laws with respect to the potential liability of online intermediaries such as ourselves are either unclear or less favorable. We are also subject to federal, state, local and foreign laws of general applicability, including laws regulating working conditions (e.g., the Fair Labor Standards Act). Any claims or regulatory actions against us, whether meritorious or not, could be time consuming, result in costly litigation, damage awards, 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.
Changes to our dispute resolution process could increase our costs and loss rate.
In April 2009, we announced plans to change the dispute resolution process (which we refer to as “resolutions”) for transactions on eBay.com and eBay.co.uk in which a buyer claims the item was not received or the item they received was different from that described in the listing. We implemented these plans beginning in the fourth quarter of 2009. Previously, buyers with an issue on our eBay.com and eBay.co.uk platform were generally required to contact the seller directly and, if they were unable to resolve the issue, to start the resolutions process online via PayPal's resolution center. We have transitioned to a new, on-eBay resolutions process provided by eBay customer support, which now serves as the primary entry point for buyers on eBay.com and eBay.co.uk who are unable to resolve their disputes with eBay sellers. Among other things, the new resolutions process provides that eBay will generally reimburse the buyer for the full amount of an item's purchase price (including original shipping costs), in cases where the item was not received or the item they received was different from that described in the listing, and the seller does not provide adequate resolution to the buyer. eBay then attempts to recoup amounts paid to the buyer from the seller's PayPal accounts or other payment methods. We have recently introduced a similar resolutions program in Germany.
Our costs associated with resolutions have increased as a result of these changes to our resolutions policies and process. These changes, together with any further changes that we may make to our resolutions process in the future, may be negatively received by, and lead to dissatisfaction on the part of, some of our sellers. These changes may also result in an increase in buyer fraud and associated transaction losses. In addition, eBay does not have the same level of rights of recoupment against sellers as PayPal, which may result in higher costs to operate the program.
Failure to deal effectively with bad transactions and customer disputes would increase our loss rate and harm our business.
Over the last several years, we have enhanced the buyer and seller protections offered by PayPal in certain eBay marketplaces, and in certain countries for transactions outside of eBay marketplaces. These changes to PayPal's buyer and seller protection program could result in future increases and fluctuations in our Payments transaction loss rate. For the fiscal year ended December 31, 2010 and the three months ended March 31, 2011, our Payments transaction losses (including both direct losses and buyer protection payouts) totaled $153.1 million and $46.6 million, representing 0.17% of our net total payment volume in each period. We have also recently changed the dispute resolution process for transactions on eBay.com and eBay.co.uk, as described in greater detail above under the caption “Changes to our dispute resolution process could increase our costs and loss rate,” which could result in an increase in our combined eBay and PayPal transaction losses. PayPal's highly

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automated and liquid payment service makes PayPal an attractive target for fraud. In configuring its service, PayPal continually strives to maintain the right balance of appropriate measures to promote both convenience and security for customers. Identity thieves and those committing fraud using stolen credit card or bank account numbers can potentially steal large amounts of money from businesses such as PayPal. We believe that several of PayPal's current and former competitors in the electronic payments business have gone out of business or significantly restricted their businesses largely due to losses from this type of fraud. While PayPal uses advanced anti-fraud technologies, we expect that technically knowledgeable criminals will continue to attempt to circumvent PayPal's anti-fraud systems using increasingly sophisticated methods. In addition, PayPal's service could be subject to employee fraud or other internal security breaches, and PayPal may be required to reimburse customers for any funds stolen as a result of such breaches. Merchants could also request reimbursement, or stop using PayPal, if they are affected by buyer fraud or other types of fraud.
PayPal incurs substantial losses due to claims from buyers that merchants have not performed or that their goods or services do not match the merchant's description, whether those claims arise from merchant fraud or from an unintentional failure to perform by the merchant. PayPal seeks to recover such losses from the merchant, but may not be able to recover in full if the merchant is unwilling or unable to pay. PayPal also incurs losses from claims that the customer did not authorize the purchase, from buyer fraud, from erroneous transmissions, and from customers who have closed bank accounts or have insufficient funds in them to satisfy payments. In addition to the direct costs of such losses, if they are related to credit card transactions and become excessive, they could potentially result in PayPal losing the right to accept credit cards for payment, which would materially and adversely affect our business. In addition, if PayPal were unable to accept credit cards, the velocity of trade on eBay could decrease and result in corresponding decreases in our net total payment volume, in which case our business would further suffer. The Bill Me Later service is similarly subject to the risk of fraudulent activity associated with merchants, users of the Bill Me Later service and third parties handling its user information, which could increase our exposure to transaction losses and adversely affect this business. Our Payments business has taken measures to detect and reduce the risk of fraud, but these measures need to be continually improved and may not be effective against new and continually evolving forms of fraud or in connection with new product offerings. If these measures do not succeed, our business will suffer.
eBay faces similar risks with respect to fraudulent activities on its websites. eBay periodically receives complaints from users who may not have received the goods that they had purchased. In some cases individuals have been arrested and convicted for fraudulent activities using our websites. eBay also receives complaints from sellers who have not received payment for the goods that a buyer had contracted to purchase. Non-payment may occur because of miscommunication, because a buyer has changed his or her mind and decided not to honor the contract to purchase the item, or because the buyer bid on the item maliciously in order to harm either the seller or eBay. In some European and Asian jurisdictions, buyers may also have the right to withdraw from a sale made by a professional seller within a specified time period. While eBay can, in some cases, suspend the accounts of users who fail to fulfill their payment or delivery obligations to other users, eBay does not have the ability to require users to make payment or deliver goods, or otherwise make users whole other than through our limited buyer protection programs. The impact of changes to our dispute resolutions program implemented beginning in 2009 is discussed in more detail above under the caption “Changes to our dispute resolution process could increase our costs and loss rate.”
Our limited eBay and PayPal buyer protection programs represent the means by which we compensate users who believe that they have been defrauded, have not received the item that they purchased, or have received an item different than what was described. However, users who pay through PayPal may have reimbursement rights from their credit card company or bank, which in turn will seek reimbursement from PayPal. eBay also periodically receives complaints from buyers as to the quality of the goods purchased. We expect to continue to receive communications from users requesting reimbursement or threatening or commencing legal action against us if no reimbursement is made. Our liability for these sort of claims is only beginning to be clarified in some jurisdictions and may be higher in some non-U.S. jurisdictions than it is in the U.S. Litigation involving liability for third-party actions could be costly and time consuming for us, divert management attention, result in increased costs of doing business, lead to adverse judgments, or otherwise harm our business. In addition, affected users will likely complain to regulatory agencies that could take action against us, including imposing fines or seeking injunctions.
Negative publicity and user sentiment generated as a result of fraudulent or deceptive conduct by users of our Marketplaces and Payments services could damage our reputation, reduce our ability to attract new users or retain our current users, and diminish the value of our brand names. We believe that negative user experiences are one of the primary reasons users stop using our services.
Governmental regulators worldwide are also looking at approaches intended to reduce online fraud. Some of the current proposals (e.g., two-factor authentication in France to verify a user's identity) could increase our costs and require us to change our business practices in ways that would harm our business.
From time to time, we have considered more active mechanisms designed to combat bad transactions and increase buyer

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satisfaction, including evaluating sellers on the basis of their transaction history and restricting or suspending their activity as a result. For example, in the U.S. and the U.K., we have begun testing the efficacy of improving seller performance and increasing buyer satisfaction by requesting that PayPal hold seller funds in certain instances (e.g., for sellers with a limited selling history or below-standard performance ratings), and we may expand the scope of such programs in the future and introduce other programs with similar aims in these and other countries. Our increased usage of these or other mechanisms to attempt to improve buyer satisfaction could result in dissatisfaction on the part of sellers, loss of share to competing marketplaces, reduced selection of inventory on our sites and other adverse effects.
Any factors that reduce cross-border trade could harm our business.
Cross-border trade has become an increasingly important source of both revenue and profits for us. Cross-border transactions using our websites generally provide higher revenues and gross margins than similar transactions that take place within a single country or market. We generally earn higher transaction fees for cross-border transactions involving PayPal, and our Marketplaces business continues to represent a relatively easy way for buyers and sellers to engage in cross-border trade compared with other alternatives. Any factors that result in a net reduction in cross-border trade, including, among other factors, fluctuations in currency exchange rates, the interpretation and application of specific national or regional laws, such as selective distribution channel laws and parallel import laws, to users in other countries (e.g., the interpretation and application of such laws to the sale of “gray market” goods), the potential interpretation and application of laws of multiple jurisdictions (e.g., the jurisdiction of the buyer, the seller, and/or the location of the item being sold), or any other factors that impose restrictions on, or increase the costs of, purchasing, selling or shipping goods across national borders (including customs enforcement and tariffs) would harm our business.
Our business is subject to online security risks, including security breaches.
Our businesses involve the storage and transmission of users' proprietary information, and security breaches could expose us to a risk of loss or misuse of this information, litigation, and potential liability. An increasing number of websites, including several other large internet companies, have recently disclosed breaches of their security, some of which have involved sophisticated and highly targeted attacks on portions of their sites. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems, change frequently and often are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. If an actual or perceived breach of our security occurs, the market perception of the effectiveness of our security measures could be harmed and we could lose users. A party that is able to circumvent our security measures could misappropriate our or our users' proprietary information, cause interruption in our operations, damage our computers or those of our users, or otherwise damage our reputation and business. Any compromise of our security could result in a violation of applicable privacy and other laws, significant legal and financial exposure, damage to our reputation, and a loss of confidence in our security measures, which could harm our business.
Currently, a significant number of our users authorize us to bill their credit card accounts directly for all transaction fees charged by us. PayPal's users routinely provide credit card and other financial information. We rely on encryption and authentication technology licensed from third parties to provide the security and authentication to effectively secure transmission of confidential information, including customer credit card numbers. Advances in computer capabilities, new discoveries in the field of cryptography or other developments may result in the technology used by us to protect transaction data being breached or compromised. Non-technical means, for example, actions by a suborned employee, can also result in a data breach.
Under payment card rules and our contracts with our card processors, if there is a breach of payment card information that we store, or that is stored by PayPal's direct payment card processing customers, we could be liable to the payment card issuing banks for their cost of issuing new cards and related expenses. In addition, if we fail to follow payment card industry security standards, even if there is no compromise of customer information, we could incur significant fines or lose our ability to give customers the option of using payment cards to fund their payments or pay their fees. If we were unable to accept payment cards, our business would be seriously damaged.
Our servers are also vulnerable to computer viruses, physical or electronic break-ins, and similar disruptions, and we have experienced “denial-of-service” type attacks on our system that have, in certain instances, made all or portions of our websites unavailable for periods of time. In December 2010, PayPal was subject to a series of distributed “denial of service” attacks following PayPal's decision to permanently restrict the account used by WikiLeaks due to a violation of PayPal's Acceptable Use Policy. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches. These issues are likely to become more difficult as we expand the number of places where we operate. Security breaches, including any breach by us or by parties with which we have commercial relationships that result in the unauthorized release of our users' personal information, could damage our reputation and expose us to a risk of loss or

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litigation and possible liability. Our insurance policies carry low coverage limits, which may not be adequate to reimburse us for losses caused by security breaches.
Our users, as well as those of other prominent Internet companies, have been and will continue to be targeted by parties using fraudulent “spoof” and “phishing” emails to misappropriate passwords, credit card numbers, or other personal information or to introduce viruses or other malware through “trojan horse” programs to our users' computers. These emails appear to be legitimate emails sent by eBay, PayPal, or one of our other businesses (e.g., StubHub), or by a user of of one of our businesses, but direct recipients to fake websites operated by the sender of the email or request that the recipient send a password or other confidential information via email or download a program. Despite our efforts to mitigate “spoof” and “phishing” emails through product improvements and user education, “spoof” and “phishing” remain a serious problem that may damage our brands, discourage use of our websites, and increase our costs.
Changes in regulations or user concerns regarding privacy and protection of user data could adversely affect our business.
We are subject to laws relating to the collection, use, retention, security and transfer of personally identifiable information about our users, especially for financial information and for users located outside of the U.S. In addition, as an entity licensed and subject to regulation as a bank in Luxembourg, PayPal (Europe) S.A.R.L. et Cie, SCA is subject to banking secrecy laws. In many cases, these laws apply not only to third-party transactions but also to transfers of information between ourselves and our subsidiaries, and between ourselves, our subsidiaries and other parties with which we have commercial relations. New laws in this area have been passed by several jurisdictions, and other jurisdictions are considering imposing additional restrictions. The interpretation and application of user data protection laws are in a state of flux. These laws may be interpreted and applied inconsistently from country to country and our current data protection policies and practices may not be consistent with those interpretations and applications. Complying with these varying international requirements could cause us to incur substantial costs or require us to change our business practices in a manner adverse to our business. In addition, we have and post on our websites our own privacy policies and practices concerning the collection, use and disclosure of user data. Any failure, or perceived failure, by us to comply with our posted privacy policies or with any regulatory requirements or orders or other federal, state or international privacy or consumer protection-related laws and regulations could result in proceedings or actions against us by governmental entities or others, subject us to significant penalties and negative publicity and adversely affect us. In addition, as noted above, we are subject to the possibility of security breaches, which themselves may result in a violation of these laws.
Our revenue from advertising is subject to factors beyond our control.
We derive significant revenue from advertising on our websites. Revenues from online advertising are sensitive to events and trends that affect advertising expenditures, such as general changes in the economy and changes in consumer spending, as well as the effectiveness of online advertising versus offline advertising media and the value our websites provide to advertisers relative to other websites. Recent economic conditions have adversely impacted our advertising revenue. In addition, major search engine operators have the ability to change from time to time, at their sole discretion, the rules and search algorithms governing the pricing, availability, and placement of online advertising. Any changes in these rules or search algorithms could materially reduce the value that we derive from online advertising on our websites, either directly or indirectly. For example, retailers pay a fee to Shopping.com for online shoppers directed to their websites by Shopping.com. Rule changes made by search engines in 2008 disrupted traffic to our Shopping.com website, which in turn adversely affected click-through traffic to retailers from our Shopping.com website and associated fee revenue. Furthermore, we have recently changed the placement of ads on our sites, which may reduce the amount we are paid. Finally, legislators and regulators in various jurisdictions, including the U.S. and the European Union, are reviewing Internet advertising models and the use of user-related data, and are considering proposals that could restrict or otherwise impact this business model. If we experience a reduction in our advertising revenues due to economic, competitive, regulatory, technological or other factors, including the worldwide economic slowdown, or due to the renegotiation of the terms of our contracts with major advertising companies or due to a reduction in our ability to effectively place advertisements on our sites or otherwise provide value to our advertisers, our business and financial results would suffer.
Our growth will depend on our ability to develop our brands, and these efforts may be costly.
We believe that continuing to strengthen our brands will be critical to achieving widespread acceptance of our services, and will require a continued focus on active marketing efforts across all of our brands. We will need to continue to spend substantial amounts of money on, and devote substantial resources to, advertising, marketing, and other efforts to create and maintain brand loyalty among users. Since 2005, we have significantly increased the number of brands we are supporting, adding Shopping.com, our classified websites (e.g., eBay Classifieds, Kijiji, Marktplaats and Den Blå Avis), StubHub, Bill Me

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Later and Gmarket, among others. Each of these brands requires its own resources, increasing the costs of our branding efforts. Brand promotion activities may not yield increased revenues, and even if they do, any increased revenues may not offset the expenses incurred in building our brands. Also, major search engine operators that we use to advertise our brands have frequently-changing rules that govern their pricing, availability and placement of online advertisement (e.g., paid search, keywords), and changes to these rules could negatively affect our use of online advertising to promote our brands. If we fail to promote and maintain our brands, or if we incur substantial expenses in an unsuccessful attempt to promote and maintain our brands, our business would be harmed.
New and existing regulations could harm our business.
We are subject to the same foreign and domestic laws as other companies conducting business on and off the Internet. It is not always clear how existing laws governing issues such as property ownership, copyrights, trademarks and other intellectual property issues, parallel imports and distribution controls, taxation, libel and defamation, obscenity, and personal privacy apply to online businesses such as ours. The majority of these laws were adopted prior to the advent of the Internet and related technologies and, as a result, do not contemplate or address the unique issues of the Internet and related technologies. Those laws that do reference the Internet, such as the U.S. Digital Millennium Copyright Act and the European Union's Directives on Distance Selling and Electronic Commerce, are being interpreted by the courts, but their applicability and scope remain uncertain. Furthermore, as our activities and the types of goods and services listed on our websites expand, including through acquisitions such as Bill Me Later and StubHub, regulatory agencies or courts may claim or hold that we or our users are subject to licensure or prohibited from conducting our business in their jurisdiction, either generally or with respect to certain actions (e.g., the sale of real estate, event tickets, cultural goods, boats and automobiles). Recent financial and political events may increase the level of regulatory scrutiny on large companies in general and financial services companies in particular.
Our success and increased visibility has driven some existing businesses that perceive our business model to be a threat to their business to raise concerns about our business models to policymakers and regulators. These established businesses and their trade association groups employ significant resources in their efforts to shape the legal and regulatory regimes in countries where we have significant operations. They may employ these resources in an effort to change the legal and regulatory regimes in ways intended to reduce the effectiveness of our businesses and the ability of users to use our products and services. In particular, these established businesses have raised concerns relating to pricing, parallel imports, professional seller obligations, selective distribution networks, stolen goods, copyrights, trademarks and other intellectual property rights, and the liability of the provider of an Internet marketplace for the conduct of its users related to those and other issues. In addition, regulatory agencies may view matters or interpret laws and regulations differently than they have in the past. Changing the legal or regulatory regimes in a manner that would increase our liability for third-party listings could negatively impact our business.
Over the last few years some large retailers and their trade associations have sought legislation in a number of states and the U.S. Congress that would make eBay liable for the sale of stolen property or would ban certain categories of goods from sale on our platform, including gift cards and health and beauty products. No such legislation has passed. Nonetheless, the proponents continue to seek passage of such legislation, and if any of these laws are adopted they could harm our business.
Numerous states and foreign jurisdictions, including the State of California, where our headquarters are located, have regulations regarding “auctions” and the handling of property by “secondhand dealers” or “pawnbrokers.” Several states and some foreign jurisdictions, including France, have attempted, and may attempt in the future, to impose such regulations upon us or our users. Attempted enforcement of these laws against some of our users appears to be increasing and such attempted enforcements could harm our business. In France, we have been sued by Conseil des Ventes, the French auction regulatory authority. The authority alleges that sales on our French website constitute illegal auctions that cannot be performed without its consent. Although we have won this lawsuit in the lower court, this decision is being appealed. A lawsuit alleging similar claims has been brought against us by two associations of French antique dealers, and is now pending on appeal after we won this lawsuit in the first instance. We intend to vigorously defend against these lawsuits. However, these and other regulatory and licensure claims could result in costly litigation and, if successful, could require us to change the way we or our users do business in ways that increase costs or reduce revenues (for example, by forcing us to prohibit listings of certain items for some locations). We could also be subject to fines or other penalties, and any of these outcomes could harm our business.
A number of the lawsuits against us relating to trademark issues seek to have our websites subject to unfavorable local laws. For example, “trademark exhaustion” principles provide trademark owners with certain rights to control the sale of a branded authentic product until it has been placed on the market by the trademark holder or with the holder's consent. The application of “trademark exhaustion” principles is largely unsettled in the context of the Internet, and if trademark owners are able to force us to prohibit listings of certain items in one or more locations, our business could be harmed.
As we expand and localize our international activities, we become obligated to comply with the laws of the countries or

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markets in which we operate. In addition, because our services are accessible worldwide, and we facilitate sales of goods to users worldwide, one or more jurisdictions may claim that we or our users are required to comply with their laws based on the location of our servers or one or more of our users, or the location of the product or service being sold or provided in an ecommerce transaction. For example, we were found liable in France, under French law in the Louis Vuitton Malletier litigation for transactions on some of our websites worldwide that did not involve French buyers or sellers (see “Item 1 - Legal Proceedings” above). Laws regulating Internet and ecommerce companies outside of the U.S. may be less favorable than those in the U.S., giving greater rights to consumers, content owners, competitors, users and other third parties. Compliance may be more costly or may require us to change our business practices or restrict our service offerings, and the imposition of any regulations on our users may harm our business. In addition, we may be subject to overlapping legal or regulatory regimes that impose conflicting requirements on us. Our alleged failure to comply with foreign laws could subject us to penalties ranging from criminal prosecution to significant fines to bans on our services, in addition to the significant costs we may incur in defending against such actions.
In light of the global financial crisis, U.S. federal lawmakers enacted legislation in 2010 overhauling the federal government's oversight of consumer financial products and systemic risk in the U.S. financial system. Although the full effect of the new legislation will be dependent on regulations to be adopted by a number of different agencies, we expect the general effect of the new law will be to require PayPal and Bill Me Later to make additional disclosures to their users and to impose new restrictions on certain of their activities. These new obligations will increase our costs and may result in increased litigation, the need to make expensive product changes and other adverse impacts on our business. In addition, we also expect that the continued implementation of the financial reform law enacted in 2010 will adversely impact some significant traditional revenue streams for banks, such as overdraft fees and debit card interchange fees. As a result, banks may need to revise their business models to remain profitable, which may lead them to charge more for services which were previously provided for free or at lower cost. Any resulting increases in service fees required for PayPal to process transactions (e.g., service fees for automated clearing house transactions) would increase our costs and adversely affect our business.
Changes to payment card networks or bank fees, rules, or practices could harm PayPal's business.
PayPal does not directly access payment card networks, such as Visa and MasterCard, which enable PayPal's acceptance of credit cards and debit cards (including some types of prepaid cards). As a result, PayPal must rely on banks or other payment processors to process transactions, and must pay fees for this service. From time to time, payment card networks have increased, and may increase in the future, the interchange fees and assessments that they charge for each transaction using one of their cards. PayPal's payment card processors have the right to pass any increases in interchange fees and assessments on to PayPal as well as increase their own fees for processing. Changes in interchange fees and assessments could increase PayPal's operating costs and reduce its profit margins. In addition, in some markets, governments have required Visa and MasterCard to reduce interchange fees, or have opened investigations as to whether Visa or MasterCard's interchange fees and practices violate antitrust law. In the United States, the financial reform law enacted in 2010 authorizes the Federal Reserve Board to regulate debit card interchange rates and debit card network exclusivity provisions, and the Federal Reserve Board has proposed rules that include caps on debit card interchange fees at significantly lower rates than Visa or MasterCard currently charge. The Federal Reserve Board's proposal also requests comment on whether non-traditional payment systems such as PayPal should be treated as “payment card networks” subject to the new law on debit card interchange and exclusivity. If PayPal is treated as a “payment card network” for this purpose, PayPal's revenues could be reduced and its business could be adversely affected. Any material reduction in credit or debit card interchange rates in the United States or other markets could jeopardize PayPal's competitive position against traditional credit and debit card processors.
PayPal is required by its processors to comply with payment card network operating rules, and PayPal has agreed to reimburse its processors for any fines they are assessed by payment card networks as a result of any rule violations by PayPal or PayPal's customers. The payment card networks set and interpret the card rules. Payment card networks could adopt new operating rules or re-interpret existing rules that PayPal or its processors might find difficult or even impossible to follow, or expensive to implement. As a result, PayPal could lose its ability to give customers the option of using payment cards to fund their payments, or could lose its ability to give customers the choice of currency in which they would like their card to be charged, which would reduce PayPal's revenues from cross-border trade. If PayPal were unable to accept payment cards, its business would be seriously damaged. In addition, the velocity of trade on eBay could decrease and our business would further suffer.
PayPal is required to comply with payment card networks' special operating rules for Internet payment services. PayPal and its payment card processors have implemented specific business processes for merchant customers in order to comply with these rules, but any failure to comply could result in fines, the amount of which would be within the payment card networks' discretion. PayPal also could be subject to fines from payment card networks if it fails to detect that merchants are engaging in activities that are illegal or that are considered “high risk,” primarily the sale of certain types of digital content. For “high risk”

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merchants, PayPal must either prevent such merchants from using PayPal or register such merchants with payment card networks and conduct additional monitoring with respect to such merchants. PayPal has incurred fines from its payment card processors relating to PayPal's failure to detect the use of its service by “high risk” merchants. The amount of these fines has not been material, but any additional fines in the future would likely be for larger amounts, could become material, and could result in a termination of PayPal's ability to accept payment cards or changes in PayPal's process for registering new customers, which would seriously damage PayPal's business.
Bill Me Later's operations expose us to additional risks.
Risks associated with our reliance on an unaffiliated lender in providing the Bill Me Later service are discussed in detail under the caption “Bill Me Later's operations depend on lending services provided by an unaffiliated lender” above.
The Bill Me Later service relies on third-party merchant processors and payment gateways to process transactions. For the fiscal year ended December 31, 2010 and the three months ended March 31, 2011, approximately 67% and 74%, respectively, of all transaction volume by dollar amount through the Bill Me Later service was settled through the facilities of a single vendor. Any disruption to these third party payment processing and gateway services would adversely affect the Bill Me Later service.
The Bill Me Later service is offered to a wide range of consumers, and the financial success of this business depends on the ability of the issuing bank of the Bill Me Later credit products to manage credit risk related to those products. The lender extends credit using Bill Me Later's proprietary segmentation and credit scoring algorithms and other analytical techniques designed to analyze the credit risk of specific customers based on their past purchasing and payment history as well as their credit scores. Based on these performance criteria, the lender may extend or increase lines of credit to consumers at the point of sale. These algorithms and techniques may not accurately predict the creditworthiness of a consumer due to, among other factors, inaccurate assumptions about a particular consumer or the economic environment. The accuracy of the predictions and the ability of the lender and us to manage credit risk related to the Bill Me Later service may also be affected by legal or regulatory changes (such as bankruptcy laws and minimum payment regulations), competitors' actions, changes in consumer behavior and other factors. The lender may also incorrectly interpret the data produced by these algorithms in setting its credit policies, which may impact the financial performance of the Bill Me Later service. In addition, economic and financial conditions in the U.S. may affect consumer confidence levels and reduce consumers' ability or willingness to use credit, including the credit extended by the lender to consumers who use the Bill Me Later service, which could impair the growth and profitability of this business.
We anticipate that the volume of credit extended by WebBank (the financial institution issuing the Bill Me Later credit products) will increase as we begin to enable qualified buyers with a PayPal account to use Bill Me Later as a payment funding option for transactions on eBay.com and on certain merchant websites that accept PayPal. We purchase the receivables relating to these consumer loans extended by the issuing bank, and therefore bear the risk of loss. Like other businesses with significant exposure to losses from consumer credit, the Bill Me Later service faces the risk that certain account holders will default on their payment obligations, making the receivables uncollectible and creating the risk of potential charge-offs. The rate at which receivables were charged off as uncollectible, or the net charge-off rate, was approximately 7.71% and 4.86%, respectively, for the fiscal year ended December 31, 2010 and the three months ended March 31, 2011. The nonpayment rate among Bill Me Later users may increase due to, among other things, worsening economic conditions, such as the current recession in the U.S., and higher unemployment rates. Consumers who miss payments on their obligations often fail to repay them, and consumers who file for protection under the bankruptcy laws generally do not repay their credit. The age and rate of growth of the receivables related to a consumer credit portfolio also affects the rate of missed payments and accounts charged off as uncollectible.
We currently fund the purchase of receivables related to Bill Me Later accounts through the sale of commercial paper, our cash balances and free cash flow generated from our portfolio of businesses. Effective September 1, 2010, we fund the purchase of receivables generated through new Bill Me Later accounts using funds from our international subsidiaries; this funding is facilitated through our Luxembourg-based bank. A downgrade in our credit ratings, particularly our short-term credit ratings, would likely reduce the amount of commercial paper we could issue (or, in certain circumstances, could prevent us from making commercial paper borrowings), increase our commercial paper borrowing costs, or both. If we are unable to fund our purchase of receivables related to the Bill Me Later business adequately or in a cost-effective manner, the growth and profitability of this business could be significantly and adversely affected.
Additionally, in providing the Bill Me Later service, we face other risks similar to those faced by PayPal, including the risk of system failures, security breaches or other loss of customer data, fraud, intellectual property claims, compliance failures, and changes to regulations relating to credit offerings (including those stemming from the continued implementation of the financial reform law enacted in 2010), as described elsewhere in these Risk Factors, including under the captions “Government

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inquiries may lead to charges or penalties” and “If our Payments business is found to be subject to or in violation of any laws or regulations, including those governing money transmission, electronic funds transfer, money laundering, counter-terrorist financing, banking and lending, it could be subject to liability, licensure and regulatory approval and may be forced to change its business practices.”
Changes in PayPal's funding mix could adversely affect PayPal's results.
PayPal pays significant transaction fees when customers fund payment transactions using credit cards, lower payments when customers fund payments with debit cards, nominal fees when customers fund payment transactions by electronic transfer of funds from bank accounts, and no fees when customers fund payment transactions from an existing PayPal account balance or use buyer credit issued by GE Money Bank. As of October 2009, eligible U.S. customers may also fund payment transactions through a loan originated by an unaffiliated lender as part of the Bill Me Later service, and PayPal will incur no fees for such transactions. Customers fund a significant portion of PayPal's payment volume using credit cards, and PayPal's financial success will remain highly sensitive to changes in the rate at which its senders fund payments using credit cards. Senders may prefer funding using credit cards rather than bank account transfers for a number of reasons, including the ability to dispute and reverse charges directly with their credit card provider if merchandise is not delivered or is not as described, the ability to earn frequent flier miles, cash rebates, or other incentives offered by credit card issuers, the ability to defer payment, or a reluctance to provide bank account information to PayPal. In addition, some of PayPal's offerings, including the ability for buyers to make a limited number of payments without opening an account, have a higher rate of credit card funding than PayPal's basic product offering.
PayPal's failure to manage customer funds properly would harm its business.
PayPal's ability to manage and account accurately for customer funds requires a high level of internal controls. In some of the markets that PayPal serves and currencies that PayPal offers, PayPal has a limited operating history and limited management experience in managing these internal controls. As PayPal's business continues to grow, it must strengthen its internal controls accordingly. PayPal's success requires significant public confidence in its ability to handle large and growing transaction volumes and amounts of customer funds. Any failure to maintain necessary controls or to manage customer funds accurately could severely diminish customer use of PayPal's products.
Our decision to launch our PayPal Developer Platform, which is open to third-party developers, subjects us to additional risks.
In 2009, we launched the PayPal Developer Platform to enable third party developers to access a wide variety of PayPal product and programming code specifications and to connect to select PayPal payment application programming interfaces (APIs). We also began providing a software tool kit for building mobile payments applications. In addition, we provide third party developers with access to certain APIs with respect to our Marketplaces platforms. There is no assurance that third-party developers will develop and maintain applications and services on PayPal's platforms on a timely basis or at all, and a number of factors could cause such third-party developers to curtail or stop development for our platforms. In addition, our business is subject to many regulatory restrictions, which may be contravened by such third party applications. If this were to occur, we would be liable for the regulatory failure and our business could be adversely affected.
System failures could harm our business.
We have experienced system failures from time to time, and any interruption in the availability of our websites will reduce our current revenues and profits, could harm our future revenues and profits, and could subject us to regulatory scrutiny. Our eBay.com website has been interrupted for periods of up to 22 hours. In November 2009, technical systems issues resulted in eBay.com users being unable to search for listed items for a period of several hours. Our PayPal website has suffered intermittent unavailability for periods as long as five days, most recently for approximately two hours in October 2010. Other of our websites (e.g., StubHub) have experienced intermittent unavailability from time to time. Any unscheduled interruption in our services results in an immediate, and possibly substantial, loss of revenues. Frequent or persistent interruptions in our services could cause current or potential users to believe that our systems are unreliable, leading them to switch to our competitors or to avoid our sites, and could permanently harm our reputation and brands. Reliability is particularly critical for PayPal, especially as it seeks to expand its Merchant Services business. Because PayPal is a regulated financial institution, frequent or persistent site interruptions could lead to fines, penalties, or mandatory changes to PayPal's business practices, and ultimately could cause PayPal to lose existing licenses it needs to operate or prevent it from obtaining additional licenses that it needs to expand. Finally, because our customers may use our products for critical transactions, any system failures could result in damage to our customers' businesses. These customers could seek significant compensation from us for their losses. Even if unsuccessful, this type of claim likely would be time-consuming and costly for us to address.
Although our systems have been designed around industry-standard architectures to reduce downtime in the event of

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outages or catastrophic occurrences, they remain vulnerable to damage or interruption from earthquakes, floods, fires, power loss, telecommunication failures, terrorist attacks, cyber attacks, computer viruses, computer denial-of-service attacks, human error, hardware or software defects or malfunctions, and similar events or disruptions. Some of our systems, including our Shopping.com website and the systems related to the Bill Me Later business, are not fully redundant, and our disaster recovery planning is not sufficient for all eventualities. Our systems are also subject to break-ins, sabotage, and intentional acts of vandalism. Despite any precautions we may take, the occurrence of a natural disaster, a decision by any of our third-party hosting providers to close a facility we use without adequate notice for financial or other reasons, or other unanticipated problems at our hosting facilities could cause system interruptions, delays, and loss of critical data, and result in lengthy interruptions in our services. We do not carry business interruption insurance sufficient to compensate us for losses that may result from interruptions in our service as a result of system failures.
There are many risks associated with our international operations.
Our international expansion has been rapid and our international business, especially in Germany, Korea and the U.K., has also become critical to our revenues and profits. Net revenues outside the U.S. accounted for approximately 54% and 55% of our net revenues, respectively, in the fiscal year ended December 31, 2010 and the three months ended March 31, 2011. In April 2011, we announced our agreement to acquire additional shares in GittiGidiyor, a Turkish online marketplace, to increase our ownership stake in GittiGidiyor to approximately 93%.
Expansion into international markets, such as our entry into Turkey upon the completion of our acquisition of additional shares in GittiGidiyor and PayPal's entry into emerging markets, requires management attention and resources and requires us to localize our services to conform to local cultures, standards and policies. The commercial, financial, Internet, and transportation infrastructure in lesser-developed countries may make it more difficult for us to replicate our business models. In many countries, we compete with local companies that understand the local market better than we do, and we may not benefit from first-to-market advantages. We may not be successful in expanding into particular international markets or in generating revenues from foreign operations. For example, in 2002 we withdrew our eBay marketplace offering from the Japanese market, and in 2007 we contributed our business in China to a joint venture with a local Chinese company. Even if we are successful in developing new markets, we often expect the costs of operating new sites to exceed our net revenues from those sites for at least 12 months in most countries.
As we continue to expand internationally, including through the expansion of our businesses, we are increasingly subject to risks of doing business internationally, including the following:
 
strong local competitors;
regulatory requirements, including regulation of Internet services, auctioneering, professional selling, distance selling, privacy and data protection, banking, and money transmitting, that may limit or prevent the offering of our services in some jurisdictions, prevent enforceable agreements between sellers and buyers, prohibit the listing of certain categories of goods, require product changes, require special licensure, subject us to various taxes, penalties or audits, or limit the transfer of information between us and our affiliates;
greater liability or legal uncertainty regarding our liability for the listings and other content provided by our users, including uncertainty as a result of legal systems that are less developed with respect to the Internet, unique local laws, conflicting court decisions and lack of clear precedent or applicable law;
cultural ambivalence towards, or non-acceptance of, online trading or online payments;
laws and business practices that favor local competitors or prohibit or limit foreign ownership of certain businesses;
difficulties in integrating with local payment providers, including banks, credit and debit card networks, and electronic fund transfer systems;
differing levels of retail distribution, shipping, and Internet infrastructures;
different employee/employer relationships and labor laws, and the existence of workers' councils and labor unions;
difficulties in staffing and managing foreign operations;
challenges associated with joint venture relationships and minority investments, including dependence on our joint venture partners;
difficulties in implementing and maintaining adequate internal controls;
longer payment cycles, different accounting practices, and greater problems in collecting accounts receivable;
potentially adverse tax consequences, including local taxation of our fees or of transactions on our websites;
higher Internet service provider costs;
different and more stringent user protection, data protection, privacy and other laws;
seasonal reductions in business activity;
expenses associated with localizing our products, including offering customers the ability to transact business in the local currency;

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restrictions on the repatriation of funds, foreign currency exchange restrictions, and exchange rate fluctuations;
volatility in a specific country's or region's political, economic or military conditions (e.g., in South Korea relating to its disputes with North Korea);
challenges associated with maintaining relationships with local law enforcement and related agencies;
potentially higher incidence of fraud and corruption and higher credit loss risks; and
differing intellectual property laws.
 
Some of these factors may cause our international costs of doing business to exceed our comparable domestic costs. As we expand our international operations and have additional portions of our international revenues denominated in foreign currencies, we also could become subject to increased difficulties in collecting accounts receivable and repatriating money without adverse tax consequences, and increased risks relating to foreign currency exchange rate fluctuations. The impact of currency exchange rate fluctuations is discussed in more detail under the caption “We are exposed to fluctuations in currency exchange rates and interest rates” above.
In addition, we conduct certain functions, including product development, customer support and other operations, in regions outside the U.S., particularly in India and China. We are subject to both U.S. and local laws and regulations applicable to our offshore activities, and any factors which reduce the anticipated benefits, including cost efficiencies and productivity improvements, associated with providing these functions outside of the U.S. could adversely affect our business.
We maintain a portion of Shopping.com's research and development facilities and personnel in Israel, and in 2008 we acquired Fraud Sciences Ltd., an Israeli company. Political, economic and military conditions in Israel affect those operations. The future of peace efforts between Israel and its neighboring countries remains uncertain. Increased hostilities or terrorism within Israel or armed hostilities between Israel and neighboring countries or other entities could make it more difficult for us to continue our operations in Israel, which could increase our costs. In addition, many of our employees in Israel could be required to serve in the military for extended periods of time under emergency circumstances. Our Israeli operations could be disrupted by the absence of employees due to military service, which could adversely affect our business.
Acquisitions, joint ventures and strategic investments could result in operating difficulties, dilution, and other harmful consequences.
We have acquired a number of businesses in the past, including, most recently, Milo.com in the United States and brands4friends, an online shopping club in Germany. The acquisitions of Milo.com and brands4friends expose us to new risks associated with these adjacent businesses, including risks related to merchants continuing their relationships with Milo.com or brands4friends on acceptable terms, if at all, and risks related to the unavailability of safe harbor liability protection as a “hosting provider” under European Union law for the brands4friends business.
On March 28, 2011, we announced that we signed an agreement to acquire GSI Commerce, Inc., which provides ecommerce and interactive marketing services. For a discussion of new risks associated with GSI's business, please see the caption “Our expected acquisition of GSI Commerce, Inc. exposes us to new risks,” below. In April 2011, we announced our agreement to acquire additional shares of in GittiGidiyor, a Turkish online marketplace, to increase our ownership stake in GittiGidiyor to approximately 93%. For a discussion of risks associated with our expansion into Turkey, which represents a new international market for us, please see the risk factor caption "There are many risks associated with our international operations," above.
We expect to continue to evaluate and consider a wide array of potential strategic transactions, including business combinations, acquisitions and dispositions of businesses, technologies, services, products and other assets, as well as strategic investments and joint ventures. At any given time we may be engaged in discussions or negotiations with respect to one or more of these types of transactions. Any of these transactions could be material to our financial condition and results of operations.
The process of integrating any acquired business may create unforeseen operating difficulties and expenditures and is itself risky. The areas where we may face difficulties include:
 
diversion of management time, as well as a shift of focus from operating