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(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 (Address of principal executive offices)
95125 (Zip Code)
(Registrant’s telephone number, including area code)
(408) 376-7400
Securities registered pursuant to Section 12(b) of the
Securities Exchange Act of 1934:
None
Securities registered pursuant to Section 12(g) of the
Securities Exchange Act of 1934:
Common Stock
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes þ No o
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Exchange
Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Exchange Act 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 þ No o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K is
not contained herein, and will not be contained, to the best of
the registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K or any
amendment to this
Form 10-K. Yes þ No o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of “accelerated filer and large
accelerated filer” in
Rule 12b-2 of the
Exchange Act.
Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2 of the
Exchange
Act). Yes o No þ
As of June 30, 2005, the aggregate market value of the
registrant’s common stock held by non-affiliates of the
registrant was $33,589,500,000 based on the closing sale price
as reported on the National Association of Securities Dealers
Automated Quotation System National Market System.
Indicate the number of shares outstanding of each of the
registrant’s classes of common stock, as of the latest
practicable date.
This report contains statements that involve expectations,
plans or intentions (such as those relating to future business
or financial results, new features or services, or management
strategies). These statements are forward-looking and are
subject to risks and uncertainties, so actual results may vary
materially. You can identify these forward-looking statements by
words such as “may,”“will,”“should,”“expect,”“anticipate,”“believe,”“estimate,”“intend,”“plan” and other similar expressions. You should
consider our forward-looking statements in light of the risks
discussed in “Item 1A: Risk Factors,” as well as
our 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 assume no obligation to update any
forward-looking statements.
ITEM 1:
BUSINESS
Overview
eBay Inc. was formed as a sole proprietorship in September 1995
and was incorporated in California in May 1996. In April 1998,
we reincorporated in Delaware and in September 1998 we completed
the initial public offering of our common stock. Our principal
executive offices are located at 2145 Hamilton Avenue,
San Jose, California, 95125, and our telephone number is
(408) 376-7400. When we refer to “we,”“our” or “eBay” in this Annual Report on
Form 10-K, we mean
the current Delaware corporation (eBay Inc.) and its California
predecessor, as well as all of our consolidated subsidiaries.
When we refer to “eBay.com” we mean the online
marketplace located at www.ebay.com and its localized
counterparts. When we refer to “PayPal” we mean the
online payments platform located at www.paypal.com. When
we refer to “Skype” we mean the Voice over Internet
Protocol (VoIP) offerings provided by our subsidiary Skype
Technologies S.A. (“Skype”) located at
www.skype.com. Skype’s offerings utilize VoIP
technology to convert voice signals into digital data packets
for transmission over the Internet.
Our purpose is to pioneer new communities around the world built
on commerce, sustained by trust, and inspired by opportunity. We
bring together millions of buyers and sellers every day on a
local, national and international basis through an array of
websites. We provide online marketplaces for the sale of goods
and services, online payments services and online communication
offerings to a diverse community of individuals and businesses.
We currently have three primary businesses: the eBay
Marketplaces, Payments and Communications. Our eBay Marketplaces
provide the infrastructure to enable online commerce in a
variety of formats, including the traditional auction platform,
along with our other online platforms, such as Rent.com,
Shopping.com, Kijiji, mobile.de, and Marktplaats.nl. Our
Payments business, which consists of our PayPal business,
enables individuals or businesses to securely, easily and
quickly send and receive payments online. Our Communications
business, which consists of our Skype business, enables VoIP
calls between Skype users, and also provides Skype users
low-cost connectivity to traditional fixed-line and mobile
telephones. Together, we believe eBay Marketplaces, PayPal and
Skype provide unparalleled e-commerce and communications
offerings for buyers and sellers around the world.
During 2005, we made a number of strategic acquisitions in order
to expand and enhance our offerings to our user community. In
February 2005, we acquired Rent.com, which facilitated our
expansion into the online apartment rentals market and is
consistent with our strategy of expanding the breadth of our
global online marketplaces. During the second quarter of 2005,
we acquired three international classifieds websites, which we
believe will create a more efficient place for local consumers
to come together online. In August 2005, we acquired
Shopping.com, a premier online comparison shopping resource. In
October 2005, we acquired Skype, which we believe can open up
new lines of businesses, create significant new monetization
opportunities, and accelerate commerce on our websites. In
November 2005, we acquired VeriSign’s payment gateway
business, which provides a real-time scalable Internet payment
platform that allows merchants to authorize, process, and manage
online payments.
Our eBay Marketplaces enable online commerce in a variety of
different formats, including the traditional eBay.com format,
the classifieds format and the comparison shopping format. Our
significant eBay classifieds formats include Kijiji,
Marktplaats.nl, Rent.com, and mobile.de. Our marketplaces exist
as online commerce platforms that enable a global community of
buyers and sellers to interact and trade with one another. Our
role is to create, maintain, and expand the functionality,
safety, ease-of-use,
and reliability of our commerce platforms while, at the same
time, supporting the growth and success of our community of
users.
Our eBay.com format websites (accessible at eBay.com,
eBay.co.uk, and similar localized URLs in
over 20 countries) are fully automated, topically
arranged, and
easy-to-use online
services that seek to provide availability 24 hours a day,
seven days a week, enabling sellers to list items for sale in
either auction or fixed-price formats, buyers to bid for and
purchase items of interest, and all eBay users to browse through
listed items from any place in the world at any time. The
platforms include software tools and services, available either
for no charge or for a fee, that allow buyers and sellers to
trade with one another more easily and efficiently. These tools
and services include: Turbo Lister, eBay Blackthorne, ProStores,
Selling Manager and Selling Manager Pro, which help automate the
selling process; Picture Services, which enables sellers to
include pictures in their listings; the Shipping Calculator,
which makes it easier for buyers and sellers to calculate
shipping costs; Shipping Labels, which allows sellers to print
U.S. Postal Service postage and UPS labels; Shipment
Tracking, which enables sellers to track their shipped packages;
the eBay Toolbar, which helps eBay users stay connected with
eBay wherever they are on the Internet; eBay Sales Reports and
eBay Sales Reports Plus, which provide sales and fee information
to sellers; eBay Market Research, which enables sellers to
analyze sales in categories across the site; Reviews and Guides,
which assists shoppers in making more informed choices; and
PayPal, which facilitates the online exchange of funds. Whether
provided by us or our commercial partners, services such as
PayPal and our trust and safety programs, user verification,
buyer protection and assurance programs, postage and other
shipping services, vehicle inspections, escrow, authentication
and appraisal services, are all intended to create a faster,
easier and safer commerce environment.
Community
Our community of users is the largest and one of the most loyal
online commerce communities on the Internet. We have aggregated
a significant number of buyers, sellers, and items listed for
sale, which, in turn, has resulted in a vibrant commerce
environment. Our sellers generally enjoy high conversion rates
and our buyers enjoy an extensive selection of broadly priced
goods and services. Key components of our community philosophy
are maintaining honest and open marketplaces and treating
individual users with respect. We seek to maintain the
satisfaction and loyalty of our frequent buyers and sellers by
offering a variety of community and support features such as
announcement and bulletin boards, customer support boards and
personal pages, as well as other topical or category-specific
information exchanges. By applying a consistent set of policies
and fees to our community, we seek to create a level playing
field that lets individuals and businesses of all types and
sizes access broad markets and compete equally.
Our success has been largely dependent upon the success of our
community of confirmed registered users on our eBay.com format
websites, which has grown from approximately two million at the
end of 1998 to more than 135 million at the end of 2004 and
to more than 181 million at December 31, 2005. In
addition, at December 31, 2005, we had approximately
72 million active users, compared to approximately
56 million at the end of 2004. We define an active user as
any user who bid on, bought, or listed an item during the prior
12-month period.
We seek to attract buyers and sellers to our community by
offering:
Buyers
Sellers
• Selection
• Access to broad markets
• Value
• Efficient marketing and distribution costs
• Convenience
• Ability to maximize prices
• Entertainment
• Opportunity to increase sales
eBay Marketplaces Value Proposition
We believe our online marketplaces make inefficient markets more
efficient.
Traditional offline marketplaces can be inefficient because:
•
They are fragmented and regional, making it difficult and
expensive for buyers and sellers to meet, exchange information
and complete transactions;
•
They offer a limited variety and breadth of goods;
•
They often have high transaction costs due to
intermediaries; and
•
They are information inefficient, as buyers and sellers lack a
reliable and convenient means of setting prices.
We believe we make these inefficient marketplaces more efficient
because:
•
Our global community of users can easily and inexpensively
communicate, exchange information and complete transactions;
•
Our marketplaces include tens of millions of items, creating a
wide variety and selection of goods;
•
We bring buyers and sellers together for lower fees than
traditional intermediaries; and
•
Our marketplaces provide for efficient information exchange.
In particular, large markets with broad buyer and seller bases,
wide product ranges, and moderate shipping costs have been
successful on our eBay Marketplaces. Generally speaking, our
marketplaces are most effective, relative to available
alternatives, at addressing markets of new and scarce goods,
end-of-life products
and used and vintage items.
eBay Marketplaces Strategy
We intend to achieve our mission of creating the world’s
online marketplace by improving and expanding across three main
areas: categories, formats, and geographies.
Category growth, both in number and size within the eBay
Marketplaces, is a key element in creating a faster, easier and
safer online trading experience.
As of December 31, 2005, listings on eBay.com were
organized under the following major categories:
• Antiques
• Computers & Networking
• Musical Instruments
• Art
• Consumer Electronics
• Pottery & Glass
• Baby
• Crafts
• Real Estate
• Boats
• Dolls & Bears
• Specialty Services
• Books
• DVDs & Movies
• Sporting Goods
• Business & Industrial
• Entertainment Memorabilia
• Sports Memorabilia, Cards and FanShop
• Camera & Photo
• Everything Else
• Stamps
• Cars, Parts & Vehicles
• Gift Certificates
• Tickets
• Cell Phones
• Health & Beauty
• Toys & Hobbies
• Clothing, Shoes & Accessories
• Home & Garden
• Travel
• Coins
• Jewelry & Watches
• Video Games
• Collectibles
• Music
Formats
We are continually seeking to improve and expand the formats in
which members of our community can interact with one another. At
the core of our marketplaces are our traditional auction format
listings, where a seller will select a minimum price for opening
bids, with the option to set a reserve price for the item, which
is the minimum price at which the seller is willing to sell the
item. In addition, a seller with appropriate feedback ratings
can also choose to use the Buy-It-Now feature at the time of the
listing, which allows sellers to name a price at which they
would be willing to sell the item to any buyer. The Buy-It-Now
feature was introduced in 2000 and is now used on a large number
of our listings. Another format in which a seller with
appropriate feedback ratings can sell is a “Dutch
Auction” format, which allows a seller to sell multiple
identical items to the highest bidders. eBay Stores also
represent another format through which sellers can offer their
goods and services. eBay Stores enable sellers to show all of
their listings and to describe their respective businesses
through customized pages.
In addition to our eBay.com formats, we are continually looking
for ways to better enable members of our community to interact
and transact with one another online. The classifieds format is
one that we have been growing through our acquisitions of
mobile.de, Marktplaats.nl, Rent.com, other international
classifieds businesses as well as our equity investment in
craigslist, Inc. We also added a comparison shopping format with
our acquisition of Shopping.com, which allows shoppers to
compare millions of products from thousands of stores and helps
merchants increase their sales.
Geographies
A key element of our growth strategy is to continually expand
the eBay Marketplaces to new communities around the world.
Providing access to broad markets and reducing the barriers of
global trade creates value for both buyers and sellers and
greatly increases the vibrancy of our marketplaces. As of
December 31, 2005, eBay and its consolidated subsidiaries
had traditional auction-based platform websites directed toward
markets in over 20 countries. Through our equity investment in
MercadoLibre.com, this reach extends to numerous Latin American
countries.
We have developed a number of programs on our eBay platform,
including our Feedback Forum,
SafeHarbortm
Program and eBay Standard Purchase Protection Program, to make
eBay users more comfortable dealing with unknown trading
partners and completing commerce transactions on the Internet.
Feedback Forum: eBay’s Feedback Forum encourages
each user to provide comments on other eBay users with whom he
or she trades and lets every user view other users’
profiles, which include feedback ratings and comments by other
users. Every registered eBay user has a feedback profile that
may contain compliments, criticisms and other comments by users
who have conducted business with such person. The Feedback Forum
requires feedback to be related to specific transactions and
provides an easy tool for users to match specific transactions
with the user names of their trading partners. This information
is recorded in a profile that includes a feedback rating for the
person with feedback sorted according to whether it was given
over the past month, six months, or twelve months. Users who
develop positive reputations have color-coded star symbols
displayed next to their user name to indicate the number of
positive feedback ratings they have received. Before bidding on
items listed for sale, eBay users are encouraged to review a
seller’s feedback profile to check his or her reputation
within the eBay community.
The terms of eBay’s user agreement prohibit actions that
would undermine the integrity of the Feedback Forum, such as a
user leaving positive feedback about himself or herself through
multiple accounts or leaving multiple negative feedback for
others through multiple accounts. The Feedback Forum has several
automated features designed to detect and prevent some forms of
abuse. Users who receive a sufficiently negative net feedback
rating have their registrations suspended and are unable to bid
on or list items for sale. We believe our Feedback Forum is
useful in overcoming initial user hesitancy when trading over
the Internet, as it reduces the anonymity and uncertainty of
dealing with an unknown trading partner.
SafeHarbor Program: In addition to the Feedback Forum, we
offer the SafeHarbor program, which provides guidelines for
trading, provides information to resolve user disputes and
responds to reports of misuse of the eBay service. eBay’s
SafeHarbor staff investigates users’ complaints of possible
misuse of the eBay service and takes appropriate action,
including issuing warnings to users, ending and removing
listings, or suspending users from bidding on or listing items
for sale. Some of the complaints the SafeHarbor staff
investigates include various forms of bid manipulation,
malicious posting of negative feedback and posting of illegal
items for sale. The SafeHarbor group is organized into three
areas: Investigations, Fraud Prevention and Community Watch. The
Investigations team investigates reported trading infractions
and misuse of the eBay service. The Fraud Prevention team
provides information to assist users with disputes over the
quality of the goods sold or potentially fraudulent
transactions. When we receive an officially filed, written claim
of fraud from a user, we will generally suspend the offending
user from the eBay service or take other appropriate action. The
Community Watch team investigates the listing of illegal,
infringing or inappropriate items on the eBay Marketplaces sites
and violations of certain of our policies. When we receive a
valid written notice of claimed infringement of intellectual
property rights by the owner of intellectual property, we remove
the offending listing. Users who repeatedly infringe
intellectual property rights are suspended. In addition, we have
increased the number of people reviewing potentially illegal
items and have developed software programs that scan new
listings for keywords that may indicate illegal, infringing, or
inappropriate items. Our trust and safety initiatives, including
user identity verification, buyer protection, authentication,
and other proactive anti-fraud efforts are key elements of our
effort to make the eBay platform a safer place to trade.
eBay Standard Purchase Protection Program: Disputes over
items not received, or items received but where significantly
not as described in the listing, can usually be resolved by
direct communication between buyers and sellers. To help
transaction partners reach a resolution, eBay offers an online
process through which buyers and sellers can communicate with
each other. If, upon completion of this process, the buyer still
has not resolved the issue, the buyer has the opportunity to
submit a claim. Upon submission of a claim, which is an online
process, eBay’s Trust and Safety team is alerted about the
transaction. If the buyer closes the dispute with this option
and the transaction is eligible, then the buyer may file a claim
under eBay’s Standard Purchase Protection Program, through
which the buyer may be reimbursed up to $200 (minus a $25
processing cost). Additionally, if the eBay Trust and Safety
team believes further action is warranted, the seller’s
account may be restricted or suspended. The buyer can close the
dispute at any time if the buyer’s concerns are resolved.
The buyer can escalate a claim if 30 days have passed since
the transaction date and either the seller has not responded at
least once or has not responded within 10 days of the
dispute being opened. A dispute can only be open for
90 days after the transaction date. If the buyer has not
closed the dispute within 90 days, it will be automatically
closed. When a dispute is automatically closed, the seller is
not reported to eBay’s Trust and Safety team and the buyer
is not eligible to submit a claim under eBay’s Standard
Purchase Protection Program.
In addition to these eBay Marketplaces trust and safety
programs, PayPal also offers a Buyer Protection Program.
PayPal’s Buyer Protection offers increased security for
buyers on eBay.com by covering qualified transactions up to
$1,000 for non-delivery of items, and for the delivery of items
that are significantly not as described. For transactions that
do not qualify for PayPal Buyer Protection, PayPal offers its
buyer complaint process, and eBay provides its standard purchase
protection of $200 coverage with a $25 processing fee.
Customer Support
We devote significant resources to providing personalized,
accurate and timely support services to our community of users.
Buyers and sellers can contact us through a variety of means,
including email, online text chat and, in certain circumstances,
telephone. We are focusing our resources on increasing our
accessibility and capacity, expanding our category-specific
support, extending our online self-help features, and improving
our systems and processes to allow us to provide the most
efficient and effective support possible.
Value-Added Tools and Services
eBay users have access to a variety of “pre-trade” and
“post-trade” tools and services to enhance their user
experience and to make trading faster, easier and safer for
them. “Pre-trade” tools and services are intended to
simplify the listing process and include photo hosting,
authentication services and seller productivity software.
“Post-trade” tools and services, which make
transactions easier and more convenient to complete, include
payment processing, insurance, vehicle inspections, escrow,
shipping and postage. We currently provide these services
directly or through contractual arrangements with third parties.
My eBay and About Me
We offer My eBay, which permits users to receive a report of
their recent eBay activity, including bidding, selling, account
balances, favorite categories and recent feedback. Users with
their own web pages also may post links from their pages to eBay
and list the items they are selling on eBay. We also offer About
Me, which provides users the opportunity to create their own
personal home page free of charge on eBay using step-by-step
instructions. The About Me home page can include personal
information, items listed for sale, eBay feedback ratings,
images and links to other favorite sites.
PayPal
Global Payments Platform
Our global payments platform, PayPal, enables any individual or
business with an email address to securely, easily and quickly
send and receive payments online. We believe our global payments
platform makes online commerce more efficient compared to
traditional payment methods such as checks, money orders, and
credit cards via merchant accounts. These traditional payment
methods present various obstacles to the online commerce
experience, including lengthy processing time, inconvenience,
and high costs. PayPal delivers a product well-suited for small
businesses, online merchants and individuals by allowing them to
send and receive online payments securely, conveniently and
cost-effectively. The PayPal network builds on the existing
financial infrastructure of bank accounts and credit cards to
create a global, real-time payment solution.
PayPal’s account-based system is available to users in 55
markets, including the United States. As of December 31,2005, PayPal had approximately 96 million total accounts,
comprising approximately 19 million business accounts and
77 million personal accounts.
PayPal Value Proposition
Providing more efficient and effective payment methods is
essential to creating a faster, easier and safer online commerce
experience. Traditional payment methods such as checks, money
orders and credit cards processed through merchant accounts, all
present various obstacles to the online commerce experience,
including lengthy processing time, inconvenience and high costs.
Our PayPal online payments solution allows our community of eBay
users, as well as users of other online businesses, to pay for
their transactions securely, easily and quickly.
PayPal enables buyers to store their sensitive financial
information online, and to pay merchants without sharing this
information with them, or entering their information onto a
website each time they make a purchase. To make payments,
senders need to disclose only their email addresses to
recipients. Similarly, to receive payments, recipients need to
disclose only their email addresses to senders. Many buyers and
sellers wary of disclosing financial information online find
this high level of personal privacy attractive.
PayPal offers online merchants an
all-in-one payment
processing solution that is cheaper than most merchant accounts,
offers industry-leading fraud prevention, and enables merchants
to access approximately 96 million customers in 55 markets.
A merchant can open a PayPal account and begin accepting credit
card payments within a few minutes. Merchants are approved
instantly for a PayPal account, and do not need to provide a
personal guaranty, acquire any specialized hardware, prepare an
application, contact a payment gateway or encrypt customer data.
Furthermore, PayPal charges lower transaction fees than most
merchant accounts, and charges no setup fees and no recurring
monthly fees.
The account-based nature of PayPal’s network helps us to
detect and prevent fraud when funds enter the PayPal network, as
funds move within the network, and when they leave. Sellers can
also reduce the risk of transaction losses due to unauthorized
credit card use and fraudulent chargebacks entirely, if they
comply with PayPal’s Seller Protection Policy.
PayPal Strategy
We seek to extend our leading position and become the online
payment network of choice around the world. To establish PayPal
as the global payment standard in online payments, we will focus
on, among other things, increased adoption of PayPal on the eBay
Marketplaces and expansion of PayPal’s merchant services,
which are services for merchants who sell through their own
websites.
Increase PayPal’s adoption on eBay Marketplaces
eBay.com: In 2005, the U.S. Marketplaces segment of
eBay generated more than $21.9 billion in gross merchandise
volume, which is a measure of the total value of all
successfully closed listings between users on our marketplaces.
We intend to strengthen PayPal’s penetration into the
payments area on the eBay Marketplaces in the United States by
continuing to integrate with eBay listings and new formats,
focusing on buyer protection programs and seeking to add product
features important to the eBay community.
International sites: As of December 31, 2005, PayPal
was available in a local language and currency in 13
international markets. PayPal plans to continue its expansion
into new markets, while improving its product and adding new
features to increase adoption by the eBay international
community.
As of December 31, 2005, PayPal allowed its customers with
credit cards to send payments from an additional 54 markets
outside of the U.S., and to receive payments in 42 of those
markets. In 27 of these markets, customers can withdraw funds to
local bank accounts.
Our international expansion into an increased number of markets
and currencies makes cross-border transactions easier and more
efficient, which benefits both eBay Marketplaces and PayPal.
Expand PayPal’s merchant services business in the
U.S.
We intend to continue to develop features and to market our
global payments solution to spur our growth as a payment
solution for sole proprietors and small, medium, and large
businesses. During 2005, we added offerings such as PayPal
micropayments processing pricing for digital goods and a payment
gateway business. The new micropayments processing pricing
provides merchants with a way to process payments for low-cost
digital content such as video games, online greeting cards, news
articles, mobile phone content and digital music. With the
addition of the payment gateway business we acquired from
VeriSign in November 2005 and new merchant services features, we
are increasing the types of services offered to merchants,
including the ability for merchants to control checkout on their
websites, automating order acceptance, splitting authorization
and settlement, and advanced transaction management.
We intend to continue to market the PayPal product to sole
proprietors, small and medium-sized businesses and large
merchants, and enable them to add PayPal as a “payment
mark” on their websites. These merchants will offer PayPal,
alongside other payment methods, such as credit cards, checks
and money orders.
Finally, we will continue to identify transactions and markets
not served adequately by existing payment systems and seek to
develop product features that improve upon those legacy systems.
PayPal Services
Joining the Network
PayPal offers three types of accounts: Personal, Business, and
Premier. A new user typically opens an account to send money for
an eBay purchase or a purchase on another website, a payment for
services rendered, or for a payment to an individual in lieu of
cash. Allowing new users to join the network when they make or
receive payments encourages PayPal’s natural, user-driven
growth. PayPal’s account
sign-up process asks
each new user to provide PayPal his or her name, street address,
phone number, and email address. The user’s email address
serves as the unique account identifier. PayPal also offers
customers who sell on their own websites the ability to accept
credit card payments from buyers without requiring the buyer to
open a PayPal account.
Senders make payments at the PayPal website, at an item listing
on eBay or another online business or platform where the seller
has integrated PayPal’s Instant Purchase Feature, or at the
sites of merchants that have integrated PayPal’s Website
Payments feature. To make a payment at PayPal’s website, a
sender logs in to his or her account and enters the
recipient’s email address and the amount of the payment. To
make a payment through Instant Purchase or Website Payments, a
sender selects an item for purchase, confirms the payment
information and enters his or her email address and password to
authorize the payment. PayPal debits the money from the
sender’s PayPal balance, credit card, or bank account and
credits it to the recipient’s PayPal balance. In the case
of an eCheck payment, the transaction is held until the funds
have cleared the sender’s bank, which typically takes three
to five business days. In turn, the recipient can make payments
to others or withdraw his or her funds at any time via check (in
the U.S.), electronic funds transfer, or via a PayPal-branded
debit card (which is only available to U.S. users).
PayPal earns revenue in five ways. First, PayPal earns
transaction fees when a Business or Premier account receives a
payment. Second, PayPal earns a foreign exchange fee when a user
converts a balance from one currency to another. Third, PayPal
may earn fees when a user withdraws money to a
non-U.S. bank
account, depending on the amount of the withdrawal. Fourth,
PayPal earns a return on certain customer balances. Finally,
PayPal may earn ancillary revenues from a suite of financial
products, including the PayPal-branded debit card, the
PayPal-branded credit card and the PayPal Buyer Credit offering.
We incur funding costs on payments at varying levels based on
the source of the payment due to credit card and debit card
funding costs being significantly higher than bank account or
balance-funded payments. U.S. users who choose to maintain
PayPal balances in U.S. dollars have the ability to sweep
balances into the
PayPal Money Market Fund. This Money Market Fund, which is
invested in a portfolio managed by Barclays Global
Fund Advisors, bore a current compound annual yield of
4.22% as of December 31, 2005.
Verification of PayPal’s Account Holders
To fund payments from their bank accounts in the United States,
senders must first become verified PayPal users. The primary
method for verification is our Random Deposit technique. Under
this technique, PayPal makes two deposits ranging from 1 to 99
cents to the user’s bank account. To verify ownership of
the account, the user then enters the two amounts as a
four-digit code at the PayPal website. In addition to allowing
funding through bank accounts, verification also removes some
spending limits on users’ accounts and gives them
reputational advantages when transacting with other members of
the PayPal community.
Withdrawing Money
Each account holder in the U.S. and, as of December 31,2005, in 26 other markets, may withdraw money from their PayPal
account through an electronic fund transfer to his or her bank
account or, in the U.S., by a mailed check from PayPal.
Automated Clearing House, or ACH, withdrawals may take three to
five business days to arrive in the account holder’s bank
account, depending on the bank. However, everyone who can
receive funds can withdraw to a U.S. bank account. Mailed checks
may take one to two weeks to arrive, and PayPal charges
$1.50 per check. Qualifying PayPal business users in the
U.S. can receive a PayPal ATM/debit card, which provides
instant liquidity to their PayPal account balances. ATM/debit
cardholders can withdraw cash, for a $1.00 fee per transaction,
from any ATM connected to the Cirrus or Maestro networks and can
make purchases at any merchant accepting MasterCard.
PayPal’s Trust and Safety Programs
We have developed a number of PayPal trust and safety programs,
including PayPal’s Seller Protection Policy, Buyer
Protection Policy and PayPal’s Money Back Guarantee. These
programs provide additional protection to certain users who pay,
or receive payment, for their transactions through PayPal. In
addition, our Fraud Investigation Team focuses on identifying
and preventing fraud before it occurs, detecting fraud in
process, mitigating loss if fraud does occur and delivering
information to law enforcement around the world to better combat
online fraud.
Seller Protection Policy: PayPal’s Seller Protection
Policy covers sellers for up to $5,000 per year on certain
reversed transactions. In order to be eligible for 100%
protection, PayPal sellers must adhere to certain steps which
include: having a verified Business or Premier account; shipping
goods, in a timely manner, to an eligible address; retaining
proof of shipping that is traceable online and, for items with a
value of over $250, requiring a signature receipt; accepting the
entire payment in a single transaction; and responding to all
PayPal inquiries in a timely manner.
Buyer Protection Policy: With PayPal Buyer Protection,
qualified purchases on eBay are eligible for up to $1,000
coverage at no cost (with different terms for transactions
denominated in other currencies). This program covers qualified
purchases that the buyer has paid for, and either has never
received, or has received but were significantly different than
described in the listing. When a buyer files a claim through
PayPal Buyer Protection, we work with both the buyer and seller
to gather the details of the transaction. We investigate the
facts of the case and make an effort to come to a fair
conclusion. For a purchase to be eligible for this coverage, the
item purchased must be a physical item, PayPal must be used to
pay for the item, and the buyer must use the seller’s
e-mail address
associated with the listing. Claims must be filed within
45 days of PayPal payment, and buyers are limited to three
PayPal Buyer Protection refunds per year.
Communications
We added the Communications business upon our acquisition of
Skype in October 2005. Skype is a Luxembourg-based company that
was established in 2003. Skype provides software that, among
other things, enables free VoIP calls between Skype users
online. Skype’s premium offerings, which are currently
Skype’s
primary source of revenue, provide Skype’s users with
low-cost connectivity to traditional fixed-line and mobile
telephones. Skype currently offers its software in 23 different
languages.
Communications Strategy and Offerings
Skype offers high-quality voice communications to anyone with an
Internet connection anywhere in the world. The Skype software is
easy to download and install, and enables free VoIP calls
between Skype users online. Skype’s software also offers a
robust set of features, including voicemail, instant messaging,
call forwarding, conference calling and Skype video.
At the core of our Communications business is the ability to
communicate with buyers and sellers over the Internet.
Communication via
e-mail, the traditional
way for buyers and sellers to communicate, can cause friction in
the online shopping experience, caused primarily by delays in
response time. We believe that Skype will enable eBay to create
new potential channels to monetize
e-commerce activity and
that it can reduce friction in the online shopping experience.
Communication via Skype allows buyers and sellers in highly
involved, expensive or complex categories of goods or services,
to benefit from being able to communicate directly with each
other in an instantaneous and private environment. For
Skype’s fee-based offerings, users can utilize PayPal,
which allows for efficient online payments and increased growth
in users for PayPal as well.
As of December 31, 2005, Skype had 75 million members
in 225 countries and territories. Skype is considered a market
leader in VoIP offerings in virtually all countries in which it
does business.
Technology
eBay Platform
The eBay platform is composed of a scalable transaction
processing system, consumer user interface, and externally
accessible Application Programming Interface, or API, for
third-party integrations. The scalable system is primarily based
on internally developed proprietary software, but also includes
selected vendor components. The eBay platform supports the full
selling and buying processes, including initial registration for
the service, placing bids and managing outbids, listing items
for sale, and transaction close. The eBay platform also manages
various notifications for sellers and buyers, including daily
status updates, bid and outbid notices, registration
confirmations, account change notices, billing notices, and
end-of-auction notices.
The platform maintains user registration information, billing
accounts, current item listings and historical listings. All
information is regularly archived for record-keeping and
analysis purposes. The platform regularly updates a
comprehensive search engine with the titles and descriptions of
items, as well as pricing and bidding updates for active items.
The platform also updates the seller’s billing account
every time an item is listed, a feature is selected, or an
auction closes with a bid in excess of the seller-specified
minimum bid. The platform sends electronic invoices to all
sellers at least monthly. In addition to these features, the
eBay service supports a community bulletin board and chat areas
where users and eBay customer support personnel can interact.
Our eBay platform consists of Sun database servers running
Oracle relational database management applications with a mix of
Sun and Hitachi storage devices, along with a suite of
Pentium-based Internet servers running the Windows NT and
Linux operating systems. We use F5 Networks’ load
balancing systems and our own redundant servers along with
select software from Symantec to provide for fault tolerance,
and we use IBM’s WebSphere application server for certain
platform functions. We must continually improve our systems to
accommodate the increasing levels of use of our websites. In
addition, we may need to develop or license additional
technology in order to add new features and functionality to our
services. If we are unable to upgrade or effectively integrate
our technology, transaction processing systems, security
infrastructure, or network infrastructure to accommodate
increased traffic or transaction volume our business could be
harmed. For more information regarding these risks, see the
information in Item 1A under “Risk Factors —
Our failure to manage growth could harm our business.”
Our competitive space is characterized by rapidly changing
technology, evolving industry standards, frequent new service
and product announcements, introductions and enhancements and
changing customer demands. Accordingly, our future success will
depend on our ability to adapt to rapidly changing technologies
and evolving industry standards and to improve the performance,
features and reliability of our services in response to
competitive services and product offerings and evolving demands
of the Internet. Also, due to the potential growth in our
customer base and number of listings, we anticipate that
expansion will be required. If we fail to adapt to any of these
changes and to our anticipated growth, our business would be
harmed. In addition, the widespread adoption of new Internet,
networking or telecommunications technologies or other
technological changes could require substantial expenditures to
modify or adapt our services or infrastructure. Our current
architecture now serves nearly 100% of the site traffic of the
eBay platform.
PayPal Platform
Our PayPal technology is designed to assure user access to the
PayPal website. We focus much of PayPal’s development
efforts on creating specialized software that enhances our
Internet-based customer functionality. One of PayPal’s key
challenges remains building and maintaining a scalable and
reliable system, capable of handling traffic and transactions
for a growing customer base.
Due to the financial nature of the PayPal product, we seek to
offer a high level of data security in order to build customer
confidence and to protect our customers’ private
information. We have designed our PayPal security infrastructure
to protect data from unauthorized access, both physically and
over the Internet. PayPal’s most sensitive data and
hardware reside at the Denver and Equinix data centers. These
data centers have redundant connections to the Internet, as well
as fault-tolerant power and fire suppression systems. Due to
PayPal’s special security needs, we house our PayPal
equipment in physically secure areas and we tightly control
physical access to our systems. PayPal’s systems and
operations are vulnerable to damage or interruption from
earthquakes, floods, fires, power loss, telecommunication
failures and similar events. They are also subject to break-ins,
sabotage and intentional acts of vandalism, and to potential
disruption if the operators of these facilities have financial
difficulties. For more information regarding these risks, see
the information in Item 1A under “Risk
Factors — System failures could harm our
business.”
Multiple layers of network security and network intrusion
detection devices further enhance the security of our PayPal
systems. We segment various components of the system logically
and physically from each other on our PayPal networks.
Components of the system communicate with each other via Secure
Sockets Layer, or SSL, an industry-standard communications
security protocol, and require mutual authentication. Finally,
we store all customer data we deem private or sensitive only in
encrypted form in our PayPal database. PayPal decrypts data only
on an as-needed basis, using a specially designated component of
our PayPal system that requires authentication before fulfilling
a decryption request.
Skype’s Peer-to-Peer Software
Skype provides downloadable peer-to-peer Internet software. As
of December 31, 2005, there were approximately
75 million registered users of Skype. To use Skype
offerings, users need only a broadband Internet-connected
computer with microphone and speakers, a headset, or a USB
phone. Once the software is downloaded, users register with
Skype, contact their peers and begin the online communication
process. Skype is cross-compatible for a wide range of different
computer platforms and devices including Windows,
Mac OS X, Linux and Pocket PC. Skype provides its
software by using its users’ existing broadband Internet
connections. In addition, Skype works behind the majority of
firewalls and gateways with no special user configuration. Skype
encrypts all calls and instant messages,
end-to-end, for
privacy. Encryption is necessary since all calls are routed
through the public Internet. Skype licenses from third parties
certain key technology underlying particular components of its
offerings, including the technology underlying its
peer-to-peer
architecture and firewall traversal technology, and the audio
compression/decompression used to provide high sound quality.
Competition
We encounter vigorous competition in our businesses from
numerous sources. Our users can find, buy, sell, and pay for
similar items through a variety of competing channels. These
include but are not limited to, online and offline retailers,
distributors, liquidators, import and export companies,
auctioneers, catalog and
mail-order companies, classifieds, directories, search engines,
products of search engines, virtually all online and offline
commerce participants
(consumer-to-consumer,
business-to-consumer
and
business-to-business),
online and offline shopping channels and networks. As our
product offerings continue to broaden into new categories of
items and new commerce formats, we expect our competition to
continue to broaden to include other online and offline channels
for those new offerings. We also compete on the basis of price,
product selection, and services. For our PayPal service, our
users may choose to pay through a variety of alternative means,
including other online payment services, offline payment methods
such as cash, check or money order, and traditional online or
offline credit card merchant accounts. For our Communications
business, our users may choose to use their local telephone
companies, cable providers, and other VoIP providers. To compete
effectively, we may need to expend significant resources in
technology and marketing. These efforts may be expensive and
could reduce our margins and have a material adverse effect on
our business, financial position, operating results, and cash
flows and reduce the value of our stock. We believe that we will
be able to maintain profitability by preserving and expanding
the abundance and diversity of our users’ online community
and enhancing our user experience, but there can be no assurance
that we will be able to continue to manage our operating
expenses to mitigate a decline in consolidated net income. For
more information regarding these risks, see the information in
Item 1A under “Risk Factors — Our industry
is intensely competitive.”
Seasonality
Our results of operations historically have been seasonal
because many of our users reduce their activities on our
websites with the onset of good weather during the summer
months, and on and around national holidays. We have
historically experienced our strongest quarters of online
sequential growth in our first and fourth fiscal quarters due to
the holiday season. PayPal has shown similar seasonality,
especially in the fourth fiscal quarter. We expect transaction
activity patterns on our websites to increasingly mirror general
consumer buying patterns, both online and offline, as our
business matures. Our expectation is that Skype’s business
will experience seasonally slower growth during holiday periods.
Intellectual Property
We regard the protection of our trademarks, copyrights, patents,
domain names, trade dress and trade secrets as critical to our
success. We have entered into confidentiality and invention
assignment agreements with our employees and contractors, and
nondisclosure agreements with parties with whom we conduct
business in order to limit access to and disclosure of our
proprietary information.
We aggressively protect our intellectual property rights by
relying on a combination of trademark, copyright, patent, trade
dress and trade secret laws and by using the domain name dispute
resolution system. As a result, we actively pursue the
registration of our trademarks, copyrights, patents and domain
names in the U.S. and other major countries. We must also
protect our trademarks, patents and domain names in an
increasing number of jurisdictions, a process that is expensive,
may require litigation, and may not be successful in every
location. We have registered or applied for our “eBay”
trademark in the U.S. and over 50
non-U.S. jurisdictions
and have in place an active program to continue securing the
“eBay,”“PayPal,” and “Skype”
domain names in major
non-U.S. jurisdictions.
Our inability to secure our trademarks or domain names could
adversely affect us in any jurisdiction in which we are not able
to register.
Third parties have from time to time claimed, and others may
claim in the future, that we have infringed their intellectual
property rights. We currently are involved in several such legal
proceedings. Please see the information in “Item 3:
Legal Proceedings” and in Item 1A under “Risk
Factors — We are subject to intellectual property and
other litigation” and “— We may be unable to
protect or enforce our own intellectual property rights
adequately.”
Employees
As of December 31, 2005, eBay Inc. and its subsidiaries
employed approximately 11,600 people (excluding approximately
1,000 temporary employees), of whom approximately 6,500 were
located in the United States (excluding approximately 400
temporary employees). Our future success is substantially
dependent on the performance of our executive and senior
management and key technical personnel, and on our continuing
ability to find and retain highly qualified technical and
managerial personnel.
Segments
Reporting segments are based upon our internal organizational
structure, the manner in which our operations are managed, the
criteria used by our chief operating decision-maker to evaluate
segment performance, the availability of separate financial
information and overall materiality considerations.
The U.S. Marketplaces segment includes U.S. online
marketplaces commerce platforms. The International Marketplaces
segment includes our international online marketplaces commerce
platforms. The Payments segment consists of our global payments
platform operated by our PayPal subsidiary. The Communications
segment consists of the VoIP offerings provided by our Skype
subsidiary. The results of our Communications segment reflect
Skype’s operations for the post-acquisition period from
October 15, 2005 through December 31, 2005.
The financial information used by our chief operating
decision-maker is focused on revenues and direct costs of the
particular segment. Direct contribution consists of net revenues
less direct costs. Direct costs include specific costs of net
revenues, sales and marketing expenses, and general and
administrative expenses over which segment managers have direct
discretionary control, such as advertising and marketing
programs, customer support expenses, bank charges, provisions
for doubtful accounts, authorized credits and transaction
losses. Expenses over which segment managers do not currently
have discretionary control, such as certain general and
administrative costs, are monitored by management through shared
cost centers and are not evaluated in the measurement of segment
performance.
For an analysis of financial information about geographic areas
as well as our segments, see “Note 4 —
Segments” to our consolidated financial statements included
elsewhere in this Annual Report on
Form 10-K.
Available Information
Our Internet address is www.ebay.com. Our investor
relations website is located at http://investor.ebay.com.
We make available free of charge on our investor relations
website under “SEC Filings” our Annual Reports on
Form 10-K,
Quarterly Reports on
Form 10-Q, Current
Reports on
Form 8-K and
amendments to those reports as soon as reasonably practicable
after we electronically file or furnish such materials to the
SEC.
ITEM 1A: RISK
FACTORS
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 affect our results
of operations and financial condition.
Our operating results may fluctuate.
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:
•
our ability to retain an active user base, to attract new users,
and to encourage existing users to list items for sale, purchase
items through our websites, or use our payment service or
communication software and products;
•
the volume, size, timing, and completion rate of transactions
using our websites or technology;
•
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 integrate, manage, and profitably expand our
newly-acquired Skype business;
our ability to successfully integrate and manage other recent
and prospective acquisitions, including the recent acquisitions
of Shopping.com, Skype and VeriSign, Inc.’s payment gateway
business;
•
regulatory actions imposing obligations on our businesses
(including Skype) or our users;
•
the actions of our competitors, including the introduction of
new sites, services, and products;
•
consumer confidence in the safety and security of transactions
using our websites or technology;
•
the cost and availability of online and traditional advertising,
and the success of our brand building and marketing campaigns;
•
new laws or regulations, or interpretations of existing laws or
regulations, that harm the Internet, electronic commerce, online
payments or communications, or our business models;
•
our ability to comply with the requirements of entities whose
services are required for our operations, such as credit card
associations;
•
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;
•
the costs and results of litigation that involves us;
•
our ability to expand PayPal’s product offerings outside of
the U.S. (including our ability to obtain any necessary
regulatory approvals);
•
our ability to increase the acceptance of PayPal by online
merchants outside of the eBay marketplaces;
•
our ability to develop product enhancements at a reasonable cost
and to develop programs and features in a timely manner;
•
our ability to manage PayPal’s transaction loss and credit
card chargeback rates and payment funding mix;
•
the success of our geographic and product expansions;
•
our ability to attract new personnel in a timely and effective
manner and to retain key employees;
•
the continued financial strength of our technology suppliers and
other parties with whom we have commercial relations;
•
continued consumer acceptance of the Internet as a medium for
commerce and communication in the face of increasing publicity
about fraud, spoofing, viruses, and other dangers of the
Internet;
•
general economic conditions and those economic conditions
specific to the Internet and
e-commerce
industries; and
•
geopolitical events such as war, threat of war, or terrorist
actions.
The increased variety of services offered on our websites makes
it 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 and our limited operating history, 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 may not maintain our level of profitability or rates of
growth.
We believe that our continued profitability and growth will
depend in large part on our ability to do the following:
•
attract new users, keep existing users active on our websites,
and increase the activity levels of our active users;
•
react to changes in consumer use of the Internet and develop new
sources of monetization for some of our services;
•
manage the costs of our business, including the costs associated
with maintaining and developing our websites, customer support,
transaction and chargeback rates, and international and product
expansion;
•
maintain sufficient transaction volume to attract buyers and
sellers;
•
increase the awareness of our brands; and
•
provide our customers with superior community, customer support,
and trading and payment experiences.
We invest heavily in marketing and promotion, customer support,
and further development of the operating infrastructure for our
core and recently acquired 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. In addition, we are spending in advance of
anticipated growth, which may also harm our profitability.
Growth rates in our most established markets, such as Germany
and the U.S., have declined over time and may continue to do so
as the existing base of users and transactions becomes larger.
The expected future growth of our PayPal, Skype and Shopping.com
businesses may also cause downward pressure on our profit margin
because those businesses have lower gross margins than our eBay
trading platforms.
There are many risks associated with our international
operations.
Our international expansion has been rapid and we have only
limited experience in many of the countries in which we now do
business. Our international business, especially in Germany, the
U.K., and South Korea, has also become critical to our revenues
and profits. Net revenues outside the United States accounted
for approximately 46% of our net revenues in 2005. Expansion
into international markets requires management attention and
resources and requires us to localize our service to conform to
local cultures, standards, and policies. The commercial,
Internet, and transportation infrastructure in lesser-developed
countries may make it difficult for us to replicate our business
model. In many countries, we compete with local companies who
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. Even if we are
successful, we expect the costs of operating new sites to exceed
our net revenues for at least 12 months in most countries.
As we continue to expand internationally, including through the
expansion of PayPal, Skype, and Shopping.com, we are subject to
risks of doing business internationally, including the following:
•
regulatory requirements, including regulation of Internet
services, auctioneering, professional selling, distance selling,
communications, 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
special taxes, or limit the transfer of information between eBay
and our affiliates;
•
legal uncertainty regarding our liability for the listings and
other content provided by our users, including uncertainty as a
result of less Internet-friendly legal systems, unique local
laws, and lack of clear precedent or applicable law;
volatility in a specific country’s or region’s
political or economic conditions; 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 risks relating to foreign
currency exchange rate fluctuations. The impact of currency
exchange rate fluctuations is discussed in more detail under
“We are exposed to fluctuations in currency exchange
rates,” below.
We are continuing to expand PayPal’s services
internationally. We have limited experience with the payments
business outside of the U.S. In some countries, expansion of
PayPal’s business may require a close commercial
relationship with one or more local banks or a shared ownership
interest with a local entity. We do not know if these or other
factors may prevent, delay, or limit PayPal’s expansion or
reduce its profitability. Any limitation on our ability to
expand PayPal internationally could harm our business.
We maintain a portion of Shopping.com’s research and
development facilities and personnel in Israel, and as a result,
political, economic and military conditions in Israel affect
those operations. Increased hostilities or terrorism within
Israel or armed hostilities between Israel and neighboring
states could make it more difficult for us to continue our
operations in Israel, which could increase our costs. In
addition, many of Shopping.com’s employees in Israel could
be required to serve in the military for extended periods of
time under emergency circumstances. Shopping.com’s Israeli
operations could be disrupted by the absence of employees due to
military service, which could adversely affect its business.
Our operations in China are subject to risks and
uncertainties relating to the laws and regulations of the
People’s Republic of China.
Our operations in the People’s Republic of China, or PRC,
are conducted through our EachNet subsidiary and through a
PayPal subsidiary. EachNet and PayPal are Delaware corporations
and foreign persons under the laws of the PRC and are subject to
many of the risks of doing business internationally described
above in “There are many risks associated with our
international operations.” The PRC currently regulates its
Internet sector through regulations restricting the scope of
foreign investment and through the enforcement of content
restrictions on the Internet. While many aspects of these
regulations remain unclear, they purport to limit and require
licensing of various aspects of the provision of Internet
information services. These regulations have created substantial
uncertainties regarding the legality of foreign investments in
PRC Internet companies, including EachNet and PayPal, and the
business operations of such companies. In order to meet local
ownership and regulatory licensing requirements, the eBay
EachNet website is operated through a foreign-owned enterprise
indirectly owned by eBay’s European operating entity, which
acts in cooperation with a local PRC company owned by certain
local employees. The PayPal China website is operated through a
foreign-owned enterprise owned by PayPal’s International
headquarters entity, which acts in cooperation with a local PRC
company owned by certain local employees. We believe
EachNet’s and PayPal’s current ownership structures
comply with all existing PRC laws, rules, and regulations. There
are, however, substantial uncertainties regarding the
interpretation of current PRC laws and regulations, and it is
possible that the PRC government will ultimately take a view
contrary to ours. The People’s Bank of China, or PBOC, has
recently proposed guidelines for payment settlement
organizations which, if enacted and applied to PayPal’s
operations in China, could have a material adverse effect on
those operations, including, but not limited to, requiring
PayPal to act in cooperation with a different local PRC entity
and obtain approval from the PBOC. There are also uncertainties
regarding EachNet’s and PayPal’s ability to enforce
contractual relationships they have entered into with respect to
management and control of the company’s business. If
EachNet or PayPal were found to be in violation of any existing
or future PRC laws or regulations, it could be subject to fines
and other financial penalties, have its business and Internet
content provider licenses revoked, or be forced to discontinue
its business entirely. In addition, any finding of a violation
by EachNet or PayPal of PRC laws or regulations could make it
more difficult for us to launch new or expanded services in the
PRC.
Although Skype does not conduct operations in the PRC directly,
it makes its product available through a joint venture and its
product is used by residents of the PRC. PRC regulations
surrounding VoIP telephony are unclear or non-existent, and the
PRC or one of more of its provinces may adopt regulations that
restrict or prohibit the use of Skype’s product.
We are exposed to fluctuations in currency exchange
rates.
Because we conduct a significant and growing portion of our
business outside the United States but report our 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 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 net revenues, operating expenses, and
net income will decrease if the U.S. dollar strengthens
against foreign currencies. The change in weighted average
foreign currency exchange rates in 2005 relative to 2004
resulted in higher net revenues of approximately
$12.0 million and an increase in aggregate cost of revenues
and operating expenses of approximately $5.6 million. As
exchange rates vary, net sales and other operating results, when
translated, may differ materially from expectations. In
particular, to the extent the U.S. dollar strengthens
against the Euro and British Pound, our European revenues and
profits will be reduced as a result of these translation
adjustments. In addition, to the extent the U.S. dollar
strengthens against the Euro and the British Pound, cross-border
trade related to purchases of dollar-denominated goods by
non-U.S. purchasers
may decrease, and that
decrease may not be offset by a corresponding increase in
cross-border trade involving purchases by U.S. buyers of
goods denominated in other currencies. While we from time to
time 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.
Skype depends on key technology that is licensed from
third parties.
Skype licenses technology underlying certain components of its
software from third parties it does not control, including the
technology underlying its
peer-to-peer
architecture and firewall traversal technology, and the audio
and video compression/decompression used to provide high sound
and video quality. Both of these technologies are key to the
software Skype provides. In addition, various other technologies
used by Skype are licensed from third parties. Although Skype
has contracts in place with its third party technology
providers, there can be no assurance that the licensed
technology or other technology that we may seek to license in
the future will continue to be available on commercially
reasonable terms, or at all. The loss of, or inability to
maintain, existing licenses could result in delays, a decrease
in service quality, or a complete failure of Skype’s
product until equivalent technology or suitable alternatives can
be developed, identified, licensed and integrated. While we
believe Skype has the ability to either extend these licenses on
commercially reasonable terms or identify and obtain or develop
suitable alternative products, the costs associated with
licensing or developing such products could be high. Any failure
to maintain these licenses on commercially reasonable terms or
to license or develop alternative technologies would harm
Skype’s business.
Acquisitions could result in operating difficulties,
dilution, and other harmful consequences.
We have acquired a number of businesses in the past, and
completed eight acquisitions in 2005. These include, most
recently, the acquisition of Skype, the acquisition of
Shopping.com, and the acquisition through PayPal of VeriSign,
Inc.’s payment gateway business.
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, including
interests in our existing subsidiaries. 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 the businesses to issues related to integration and
administration, particularly given the large number and size and
varying scope of our recent acquisitions, and, in the case of
Skype, the complex earn-out structure associated with the
transaction;
•
declining employee morale and retention issues resulting from
changes in, or acceleration of, compensation, or changes in
reporting relationships, future prospects, or the direction of
the business;
•
the need to integrate each company’s accounting,
management, information, human resource and other administrative
systems to permit effective management, and the lack of control
if such integration is delayed or not implemented;
•
the need to implement controls, procedures and policies
appropriate for a larger public company at companies that prior
to acquisition had lacked such controls, procedures and
policies; and
•
in some cases, including in connection with PayPal’s recent
acquisition of VeriSign’s payment gateway business, the
need to transition operations, users, and/or customers onto our
existing platforms.
Foreign acquisitions involve special risks, including those
related to integration of operations across different cultures
and languages, currency risks, and the particular economic,
political, and regulatory risks associated with specific
countries. Moreover, we may not realize the anticipated benefits
of any or all of our acquisitions. Future acquisitions or
mergers may result in a need to issue additional equity
securities, spend
our cash, or incur debt, liabilities, or amortization expenses
related to intangible assets, any of which could reduce our
profitability and harm our business.
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.
eBay’s primary website has been interrupted for periods of
up to 22 hours, and our PayPal site suffered intermittent
unavailability over a five-day period in October 2004. 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. These
interruptions increase the burden on our engineering staff,
which, in turn, could delay our introduction of new features and
services on our sites. Because PayPal is a regulated financial
entity, frequent or persistent site interruptions could lead to
regulatory inquiries. These inquiries could result in 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 outages or
catastrophic occurrences, they remain vulnerable to damage or
interruption from earthquakes, floods, fires, power loss,
telecommunication failures, terrorist attacks, computer viruses,
computer
denial-of-service
attacks, and similar events. Some of our systems, including our
Shopping.com and Skype websites, 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 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.
Our growth will depend on our ability to develop our
brands, and these efforts may be costly.
Our historical growth has been largely attributable to word of
mouth, and to frequent and high visibility national and local
media coverage. We believe that continuing to strengthen our
brands will be critical to achieving widespread acceptance of
our services, and will require an increased focus on active
marketing efforts. The demand for and cost of online and
traditional advertising have been increasing, and may continue
to increase. Accordingly, we will need to spend increasing
amounts of money on, and devote greater resources to,
advertising, marketing, and other efforts to create and maintain
brand loyalty among users. During 2004 and 2005, we
significantly increased the number of brands we are supporting,
adding Rent.com, Shopping.com, Kijiji, and Skype, 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. If we do attract new users to our services, they may not
conduct transactions using our services on a regular basis. 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.
Our business and users may be subject to sales tax and
other taxes.
The application of indirect taxes (such as sales and use tax,
value added tax, or VAT, goods and services tax, business tax,
and gross receipt tax) to
e-commerce businesses
such as eBay and our users is a complex and evolving issue. Many
of the fundamental statutes and regulations that impose these
taxes were established
before the growth of the Internet and
e-commerce. In many
cases, it is not clear how existing statutes apply to the
Internet or e-commerce.
In addition, some jurisdictions have implemented or may
implement laws specifically addressing the Internet or some
aspect of e-commerce.
The application of existing, new, or future laws could have
adverse effects on our business.
Several proposals have been made at the U.S. state and
local level that would impose additional taxes on the sale of
goods and services through the Internet. These proposals, if
adopted, could substantially impair the growth of
e-commerce, and could
diminish our opportunity to derive financial benefit from our
activities. The U.S. federal government’s moratorium
on states and other local authorities imposing access or
discriminatory taxes on the Internet is scheduled to expire in
November 2007. This moratorium does not prohibit federal, state,
or local authorities from collecting taxes on our income or from
collecting taxes that are due under existing tax rules.
In conjunction with the Streamlined Sales Tax
Project — an ongoing, multi-year effort by U.S.,
state, and local governments to require collection and
remittance of distant sales tax by
out-of-state
sellers — bills have been introduced in the
U.S. Congress to overturn the Supreme Court’s Quill
decision, which limits the ability of state governments to
require sellers outside of their own state to collect and remit
sales taxes on goods purchased by in-state residents. An
overturning of the Quill decision would harm our users
and our business.
We do not collect taxes on the goods or services sold by users
of our services. One or more states or foreign countries may
seek to impose a tax collection or reporting or record-keeping
obligation on companies such as eBay that engage in or
facilitate e-commerce.
Such an obligation could be imposed if eBay were ever deemed to
be the legal agent of eBay sellers by a jurisdiction in which
eBay operates. A successful assertion by one or more states or
foreign countries that we should collect taxes on the exchange
of merchandise or services on our websites would harm our
business.
In July 2003, in compliance with the changes brought about by
the European Union (EU) VAT directive on
“electronically supplied services,” eBay began
collecting VAT on the fees charged to EU sellers on eBay sites
catering to EU residents. eBay also pays input VAT to suppliers
within the various countries the company operates. In most
cases, eBay is entitled to reclaim input VAT from the various
countries with regard to our own payments to suppliers or
vendors. However, because of our unique business model, the
application of the laws and rules that allow such reclamation is
sometimes uncertain. A successful assertion by one or more
countries that eBay is not entitled to reclaim VAT would harm
our business.
We continue to work with the relevant tax authorities and
legislators to clarify eBay’s obligations under new and
emerging laws and regulations. Passage of new legislation and
the imposition of additional tax requirements could harm eBay
sellers and our business. There have been, and will continue to
be, substantial ongoing costs associated with complying with the
various indirect tax requirements in the numerous markets in
which eBay conducts or will conduct business.
Fraudulent activities on our websites and disputes between
users of our services may harm our business.
PayPal faces significant risks of loss due to fraud and disputes
between senders and recipients, including:
•
non-delivery of, or disputes over the quality of, goods and
services due to merchant fraud or inadequate merchant business
practices;
•
reversal of payment by buyers both for legitimate reasons and in
cases of buyer fraud;
•
unauthorized use of credit card and bank account information and
identity theft;
•
the need to provide effective customer support to process
disputes between senders and recipients;
•
potential breaches of system security;
•
potential employee fraud; and
•
use of PayPal’s system by customers to make or accept
payment for illegal or improper purposes.
For the year ended December 31, 2005 PayPal’s
transaction loss totaled $73.8 million, representing 0.27%
of PayPal’s total payment volume. Failure to deal
effectively with fraudulent transactions and customer disputes
would increase PayPal’s loss rate and harm its business.
PayPal’s highly automated and liquid payment service makes
PayPal an attractive target for fraud. In configuring its
service, PayPal faces an inherent trade-off between customer
convenience and security. 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. In addition, PayPal’s service could be subject to
employee fraud or other internal security breaches, and PayPal
would 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.
PayPal incurs substantial losses from merchant fraud, including
claims from customers that merchants have not performed or that
their goods or services do not match the merchant’s
description. 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 result in PayPal losing the right to accept credit cards
for payment. If PayPal were unable to accept credit cards, the
velocity of trade on eBay could decrease, in which case our
business would further suffer. PayPal has been assessed
substantial fines for excess chargebacks in the past, and
excessive chargebacks may arise in the future. PayPal has taken
measures to detect and reduce the risk of fraud, but these
measures may not be effective against new forms of fraud. If
these measures do not succeed, our business will suffer.
PayPal offers a buyer protection program that refunds to buyers
up to $1,000 in certain eBay transactions if they do not receive
the goods they purchased or if the goods differ significantly
from what was described by the seller. If PayPal makes such a
refund, it seeks to collect reimbursement from the seller, but
may not be able to receive any funds from the seller. The PayPal
buyer protection program has increased PayPal’s loss rate
and could cause future fluctuations in PayPal’s loss rate.
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 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 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. Other than through these
programs, eBay does not compensate users who believe they have
been defrauded by other users, although 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 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 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 eBay and PayPal
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.
Changes to credit card association fees, rules, or
practices could harm PayPal’s business.
Because PayPal is not a bank, it cannot belong to or directly
access credit card associations, such as Visa and MasterCard. As
a result, PayPal must rely on banks or payment processors to
process transactions, and must pay a fee for this service. From
time to time, credit card associations may increase the
interchange fees that they charge for each transaction using one
of their cards. MasterCard and Visa each implemented increases
in their interchange fees for credit cards in April 2005.
PayPal’s credit card processors have the right to pass any
increases in interchange fees on to PayPal as well as increase
their own fees for processing. These increased fees increase
PayPal’s operating costs and reduce its profit margins.
PayPal is also required by its processors to comply with credit
card association operating rules, and PayPal has agreed to
reimburse its processors for any fines they are assessed by
credit card associations as a result of any rule violations by
PayPal. The credit card associations and their member banks set
and interpret the credit card rules. Some of those member banks
compete with PayPal. Visa, MasterCard, American Express, or
Discover could adopt new operating rules or re-interpret
existing rules that PayPal or its processors might find
difficult or even impossible to follow. As a result, PayPal
could lose its ability to give customers the option of using
credit cards to fund their payments. If PayPal were unable to
accept credit 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 credit card associations’
special operating rules for Internet payment services. PayPal
and its credit 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 Visa’s and
MasterCard’s discretion. PayPal also could be subject to
fines from MasterCard and Visa if it fails to detect that
merchants are engaging in activities that are illegal or
activities that are considered “high risk,” primarily
the sale of certain types of digital content. For “high
risk” merchants, PayPal must either prevent such merchants
from using PayPal or register such merchants with MasterCard and
Visa and conduct additional monitoring with respect to such
merchants. PayPal has incurred fines from its credit card
processor 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 credit cards or changes in PayPal’s
process for registering new customers, which would seriously
damage PayPal’s business.
Changes in PayPal’s funding mix could adversely
affect PayPal’s results.
PayPal pays significant transaction fees when senders fund
payment transactions using credit 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.
Senders funded 53% of PayPal’s payment volume using credit
cards during both 2004 and 2005, 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 if merchandise is not delivered or
is not as described, the ability to earn frequent flier miles or
other incentives offered by credit cards, the ability to defer
payment, or a reluctance to provide bank account information to
PayPal. PayPal has received inquiries regarding its disclosure
practices with regard to funding mechanisms from the attorneys
general of a number of states, and in March 2005, a complaint
seeking class action status was filed alleging, among other
things, that PayPal’s disclosure regarding the effects of
users’ choice of funding mechanism is deceptive. While we
believe PayPal’s disclosure is legal and accurate, any
required change to our disclosure practices could result in
increased use of credit card funding, damaging PayPal’s
business.
If PayPal were found to be subject to or in violation of
any U.S. laws or regulations governing banking, money
transmission, or electronic funds transfers, it could be subject
to liability and forced to change its business practices.
A number of U.S. states have enacted legislation regulating
money transmitters. To date, PayPal has obtained licenses in 33
of these jurisdictions and interpretations in nine states that
licensing is not required under their existing statutes. As a
licensed money transmitter, PayPal is subject to bonding
requirements, restrictions on its investment of customer funds,
reporting requirements, and inspection by state regulatory
agencies. In July 2005, PayPal entered into a settlement
agreement and agreed to pay $225,000 to the California
Department of Financial Institutions in connection with alleged
violations of the California Financial Code relating to the use
of a receipt form for international payments that had not been
pre-approved by the Department, and incomplete reporting to the
Department. If PayPal were found to be in violation of other
money services laws or regulations, PayPal could be subject to
liability, forced to cease doing business with residents of
certain states, or forced to change its business practices. 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. Even if PayPal is not forced to change its business
practices, it could be required to obtain additional licenses or
regulatory approvals that could impose a substantial cost on
PayPal.
We believe that the licensing or approval requirements of the
U.S. Office of the Comptroller of the Currency, the Federal
Reserve Board, and other federal or state agencies that regulate
banks, bank holding companies, or other types of providers of
e-commerce services do
not apply to PayPal, except for certain money transmitter
licenses mentioned above. However, PayPal has received written
communications in the past from state regulatory authorities
expressing the view that its service might constitute an
unauthorized banking business. PayPal has taken steps to address
these states’ concerns. However, we cannot guarantee that
the steps PayPal has taken to address these regulatory concerns
will be effective in all states, and one or more states may
conclude that PayPal is engaged in an unauthorized banking
business. If PayPal is found to be engaged in an unauthorized
banking business in one or more states, it might be subject to
monetary penalties and adverse publicity and might be required
to cease doing business with residents of those states. Even if
the steps it has taken to resolve these states’ concerns
are deemed sufficient by the state regulatory authorities,
PayPal could be subject to fines and penalties for its prior
activities. The need to comply with state laws prohibiting
unauthorized banking activities could also limit PayPal’s
ability to enhance its services in the future. 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.
Although there have been no definitive interpretations to date,
PayPal has assumed that its service is subject to the Electronic
Fund Transfer Act and Regulation E of the Federal
Reserve Board. As a result, among other things, PayPal must
provide advance disclosure of changes to its service, follow
specified error resolution procedures and absorb losses above
$50 from transactions not authorized by the consumer. In
addition, PayPal is subject to the financial privacy provisions
of the Gramm-Leach-Bliley Act, state financial privacy laws, and
related regulations. As a result, some customer financial
information that PayPal receives is subject to limitations on
reuse and disclosure. Existing and potential future privacy laws
may limit PayPal’s ability to develop new products and
services that make use of data gathered through its service. The
provisions of these laws and related regulations are
complicated, and PayPal does not have extensive experience in
complying with them. Even technical violations of these laws can
result in penalties of up to $1,000 for each non-compliant
transaction. PayPal processed an average of approximately
1.32 million transactions per day during 2005, and any
violations could expose PayPal to significant liability.
PayPal’s status under banking or financial services
laws or other laws in markets outside the U.S. is
unclear.
PayPal currently allows its customers with credit cards to send
payments from 55 markets, and to receive payments in 42 of those
markets. In 25 of these 42 markets, customers can withdraw funds
to local bank accounts, and in eight of these markets customers
can withdraw funds by receiving a bank draft in the mail.
PayPal offers customers the ability to send or receive payments
denominated in U.S. dollars, British pounds, Euros,
Canadian dollars, Japanese yen, and Australian dollars. We act
in cooperation with a local company in the People’s
Republic of China, or PRC, which offers PRC residents the
ability to send or receive payments denominated in renminbi. 25
of the 55 markets whose residents can use the PayPal service are
members of the European Union, and PayPal provides localized
versions of its service to customers in the EU through PayPal
(Europe) Ltd., a wholly-owned subsidiary of PayPal that is
licensed in the United Kingdom to operate as an Electronic Money
Institution. PayPal (Europe) implements its localized services
in EU countries through an expedited “passport”
notification process through the UK regulator to regulators in
other EU member states, pursuant to EU Directives. PayPal
(Europe) 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 UK consumer
protection law. Any such responses from these regulators could
increase the cost of, or delay, PayPal’s plans for
expanding its business. PayPal (Europe) is subject to
significant fines or other enforcement action if it violates the
disclosure, reporting, anti-money laundering, capitalization,
funds management or other requirements imposed on electronic
money institutions.
In many markets outside of the U.S. and the European Union, it
is not clear whether PayPal’s
U.S.-based service is
subject to local law or, if it is subject to local law, whether
such local law requires a payment processor like PayPal to be
licensed as a bank or financial institution or otherwise. Even
if PayPal is not currently required to obtain a license in those
countries, future localization or targeted marketing of
PayPal’s service in those countries could require licensure
and other laws of those countries (such as data protection and
anti-money laundering laws) may apply. If PayPal were found to
be subject to and in violation of any foreign laws or
regulations, it could be subject to liability, forced to change
its business practices or forced to suspend providing services
to customers in one or more countries. Alternatively, PayPal
could be required to obtain licenses or regulatory approvals
that could impose a substantial cost on it and involve
considerable delay to the provision or development of its
product. Delay or failure to receive such a license would
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
services to customers in one or more countries.
The current regulatory environment for Voice over Internet
Protocol (VoIP) is unclear, and Skype’s business could be
harmed by new regulations or the application of existing
regulations to its products.
The current regulatory environment for VoIP is unclear.
Skype’s VoIP communications products are not currently
subject to all of the same regulations that apply to traditional
telephony. VoIP companies are generally subject to different
regulatory regimes in different countries, and in some cases are
subject to lower regulatory fees and lesser regulatory
requirements. Governments may impose increased fees, taxes, and
administrative burdens on VoIP companies. Increased fees could
include interconnection fees and access charges payable to local
exchange carriers to carry and terminate traffic, contributions
to the Universal Service Fund in the United States and
elsewhere, and other charges. New laws and regulations may
require Skype to meet various emergency service requirements,
disability access requirements, consumer protection
requirements, number assignment and portability requirements,
and interception or wiretapping requirements, such as the
Communications Assistance for Law Enforcement Act. Such
regulations could result in substantial costs depending on the
technical changes required to accommodate the requirements, and
any increased costs could erode Skype’s pricing advantage
over competing forms of communication. Regulations that decrease
the degree of privacy for users of Skype’s products could
also slow its adoption. The increasing growth of the VoIP
telephony market and popularity of VoIP telephony products
heighten the risk that governments will seek to regulate VoIP
telephony and the Internet. Competitors, including the incumbent
telephone companies, may devote substantial lobbying efforts to
seek greater protection for their existing businesses and
increased regulation of VoIP. In the United States, various
state legislatures are considering legislation to impose their
own requirements and taxes on VoIP. Increased regulatory
requirements on VoIP would increase Skype’s costs, and, as
a result, our business would suffer.
Regulatory agencies may require Skype to conform to rules that
are unsuitable for VoIP communications technologies, that are
difficult or impossible to comply with due to the nature of IP
routing, or that are unnecessary or unreasonable in light of the
manner in which Skype’s products are offered to customers.
For
example, while suitable alternatives may be developed in the
future, the current IP network does not enable Skype to identify
the geographic origin of the traffic traversing the Internet or
to provide detailed calling information about
computer-to-computer
communications, either of which may make complying with future
regulatory requirements, such as emergency service requirements,
difficult or impossible. If Skype were subject to regulations
that are costly or impossible for it to comply with given its
technology, its business would be adversely affected.
In many countries in which Skype operates or provides VoIP
products, the laws that may relate to its offerings are unclear.
We cannot be certain that Skype or its customers are currently
in full compliance with regulatory or other legal requirements
in all countries in which Skype is used, that Skype or its
customers will be able to comply with existing or future
requirements, or that Skype or its customers will continue in
full compliance with any requirements. Skype’s failure or
the failure of those with whom Skype transacts business to
comply with these requirements could materially adversely affect
our business, financial condition and results of operations.
New rules and regulations with respect to VoIP are being
considered in various countries around the world. Such new rules
and regulations could increase our costs of doing business or
prevent us from delivering our products and offerings over the
Internet, which could adversely affect Skype’s customer
base, and thus its revenue.
Our businesses depend on continued and unimpeded access to
the Internet. Internet service providers may be able to block,
degrade, or charge us or our users additional fees for our
offerings.
Our customers rely on access to the Internet to use our products
and services. In many cases that access is provided by companies
that compete with at least some of our offerings, including
incumbent telephone companies, cable companies, mobile
communications companies, and large Internet service providers.
Some of these providers have stated that they may take measures
that could degrade, disrupt, or increase the cost of
customers’ use of Skype — and possibly our other
offerings — by restricting or prohibiting the use of
their lines for our offerings, by filtering, blocking or
delaying the packets containing the data associated with our
products, or by charging increased fees to us or our users for
use of their lines to provide our offerings. These activities
are technically feasible and may be permitted in the U.S. after
recent regulatory changes, including recent decisions by the
U.S. Supreme Court and Federal Communications Commission.
In addition, Internet service providers could attempt to charge
us each time our customers use our offerings, or could charge us
for delivery of email to our customers. Worldwide, a number of
companies have announced plans to take such actions or are
selling products designed to facilitate such actions.
Interference with our offerings or higher charges for access to
our offerings, whether paid by us or by our customers, could
cause us to lose existing customers, impair our ability to
attract new customers, and harm our revenue and growth.
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. Today,
there are still relatively few laws specifically directed
towards online services. However, due to the increasing
popularity and use of the Internet and online services, many
laws relating to the Internet are being debated at all levels of
government around the world and it is possible that such laws
and regulations will be adopted. These laws and regulations
could cover issues such as user privacy, freedom of expression,
pricing, fraud, content and quality of products and services,
taxation, advertising, intellectual property rights, and
information security. It is not clear how existing laws
governing issues such as property ownership, copyrights and
other intellectual property issues, taxation, libel and
defamation, obscenity, and personal privacy apply to online
businesses. The vast 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 Directive on Distance Selling
and Electronic Commerce have begun to be interpreted by the
courts and implemented by the EU Member States, but their
applicability and scope remain somewhat uncertain. As our
activities and the types of goods listed on our website expand,
regulatory agencies or courts may claim or hold that we or our
users are either subject to
licensure or prohibited from conducting our business in their
jurisdiction, either with respect to our services in general, or
in order to allow the sale of certain items, such as real
estate, event tickets, cultural goods, boats, and automobiles.
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.” No final legal determination has been
made as to whether the California regulations apply to our
business (or that of our users) and little precedent exists in
this area. Several states and some foreign jurisdictions 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 2002,
Illinois amended its auction law to provide for a special
regulatory regime for “Internet auction listing
services,” and we have registered as an Internet auction
listing service in Illinois. Although this registration has not
had a negative impact on our business to date, other regulatory
and licensure claims could result in costly litigation or could
require us to change the way we or our users do business in ways
that increase costs or reduce revenues or force 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.
In addition, because our services are accessible worldwide, and
we facilitate sales of goods to users worldwide, foreign
jurisdictions may claim that we are required to comply with
their laws. For example, the Australian high court has ruled
that a U.S. website in certain circumstances must comply
with Australian laws regarding libel. As we expand and localize
our international activities, we become obligated to comply with
the laws of the countries in which we operate. Laws regulating
Internet companies outside of the U.S. may be less
favorable than those in the U.S., giving greater rights to
consumers, content owners, and users. Compliance may be more
costly or may require us to change our business practices or
restrict our service offerings relative to those in the
U.S. Our failure to comply with foreign laws could subject
us to penalties ranging from criminal prosecution to bans on our
services.
Our business is subject to online security risks,
including security breaches and identity theft.
To succeed, online commerce and communications must provide a
secure transmission of confidential information over public
networks. Our security measures may not prevent security
breaches that 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 effect 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 a compromise or
breach of the technology used by us to protect transaction data.
In addition, any party who is able to illicitly obtain a
user’s password could access the user’s transaction
data. An increasing number of websites have reported breaches of
their security. Any compromise of our security could harm our
reputation and, therefore, our business. In addition, a party
who is able to circumvent our security measures could
misappropriate proprietary information, or cause interruptions
in our operations, damage our computers or those of our users,
or otherwise damage our reputation and business.
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 made all or portions of our
websites unavailable for periods of time. 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 could damage our reputation and
expose us to a risk of loss or 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 emails to misappropriate passwords, credit card
numbers, or other personal information or to introduce viruses
through “trojan horse” programs to our users’
computers. These
emails appear to be legitimate emails sent by eBay, PayPal,
Skype, or a user of one of those 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. We
actively pursue the parties responsible for these attempts at
misappropriation, and we have developed tools to detect, and
help users detect, fake websites and unauthorized access to
customer accounts and we encourage our users to divulge
sensitive information only after they have verified that they
are on our legitimate websites, but we cannot entirely eliminate
these types of activities.
Some businesses and security consultants have expressed concern
over the potential for Skype’s software to create security
vulnerabilities on its users’ computers. While we believe
Skype’s software is safe and does not pose a security risk
to its users, the perception that Skype’s software is
unsafe could hamper its adoption, and any actual security breach
could damage Skype’s reputation and expose us to a risk of
loss or litigation and possible liability.
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.
PayPal has neither an established operating history nor proven
management experience in maintaining, over a long term, 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 accurately customer funds could diminish
customer use of PayPal’s product severely.
Our failure to manage growth could harm our
business.
We are currently expanding our headcount, facilities, and
infrastructure in the U.S. and internationally. We anticipate
that further expansion will be required as we continue to expand
into new lines of business and geographic areas. This expansion
has placed, and we expect it will continue to place, a
significant strain on our management, operational, and financial
resources. The areas that are put under strain by our growth
include the following:
•
Our Websites. We must constantly add new hardware, update
software and add new engineering personnel to accommodate the
increased use of our and our subsidiaries’ websites and the
new products and features we regularly introduce. This upgrade
process is expensive, and the increased complexity of our
websites and the need to support multiple platforms as our
portfolio of brands grows increases the cost of additional
enhancements. Failure to upgrade our technology, features,
transaction processing systems, security infrastructure, or
network infrastructure to accommodate increased traffic or
transaction volume could harm our business. Adverse consequences
could include unanticipated system disruptions, slower response
times, degradation in levels of customer support, impaired
quality of users’ experiences of our services, impaired
quality of services for third-party application developers using
our externally accessible Application Programming Interface, or
API, and delays in reporting accurate financial information. We
may be unable to effectively upgrade and expand our systems in a
timely manner or smoothly integrate any newly developed or
purchased technologies or businesses with our existing systems,
and any failure to do so could result in problems on our sites.
For example, in October 2004, we experienced unscheduled
downtime on the PayPal website over a period of five days
related to system upgrades. Despite our efforts to increase site
scalability and reliability, our infrastructure could prove
unable to handle a larger volume of customer transactions. Some
of our more recently acquired businesses may be particularly
subject to this risk given their shorter histories and, in some
cases, higher growth rates. Any failure to accommodate
transaction growth could impair customer satisfaction, lead to a
loss of customers, impair our ability to add customers, or
increase our costs, all of which would harm our business.
Further, steps to increase the reliability and redundancy of our
systems are expensive, reduce our margins, and may not be
successful in reducing the frequency or duration of unscheduled
downtime.
Customer Account Billing. Our revenues depend on
prompt and accurate billing processes. In 2004, we completed a
significant project to enhance our billing software. Problems
with the conversion to the new billing system during the second
and third quarters of 2004 caused incorrect account balance
totals to be displayed for some users. While these problems have
been corrected and we believe that no users were overcharged,
our failure to grow our transaction-processing capabilities to
accommodate the increasing number of transactions that must be
billed on any of our websites would harm our business and our
ability to collect revenue.
•
Customer Support. We are expanding our customer support
operations to accommodate the increased number of users and
transactions on our websites and the increased level of trust
and safety activity we provide worldwide. If we are unable to
provide these operations in a cost-effective manner, users of
our websites may have negative experiences, current and future
revenues could suffer, and our operating margins may decrease.
We must continue to hire, train, and manage new employees at a
rapid rate. If our new hires perform poorly, if we are
unsuccessful in hiring, training, managing, and integrating
these new employees, or if we are not successful in retaining
our existing employees, our business may be harmed. To manage
the expected growth of our operations and personnel, we will
need to improve our transaction processing, operational and
financial systems, procedures, and controls. This is a special
challenge as we acquire new operations with different systems.
Our current and planned personnel, systems, procedures, and
controls may not be adequate to support our future operations.
The additional headcount and capital investments we are adding
increase our cost base, which will make it more difficult for us
to offset any future revenue shortfalls by expense reductions in
the short term.
Our business is adversely affected by anything that causes
our users to spend less time on their computers, including
seasonal factors and national events.
Anything that diverts our users from their customary level of
usage of our websites could adversely affect our business. We
would therefore be adversely affected by geopolitical events
such as war, the threat of war, or terrorist activity, and
natural disasters, such as hurricanes or earthquakes. Similarly,
our results of operations historically have been seasonal
because many of our users reduce their activities on our
websites with the onset of good weather during the summer
months, and on and around national holidays.
We depend on the continued growth of online commerce and
communications.
The business of selling goods over the Internet, particularly
through online trading, is dynamic and relatively new. Concerns
about fraud, privacy, and other problems may discourage
additional consumers from adopting the Internet as a medium of
commerce. In countries such as the U.S. and Germany, where our
services and online commerce generally have been available for
some time and the level of market penetration of our services is
high, acquiring new users for our services may be more difficult
and costly than it has been in the past. In order to expand our
user base, we must appeal to and acquire consumers who
historically have used traditional means of commerce to purchase
goods. If these consumers prove to be less active than our
earlier users, and we are unable to gain efficiencies in our
operating costs, including our cost of acquiring new customers,
our business could be adversely impacted.
The success of Skype depends on continued growth in its number
of users, which in turn depends on wider public acceptance of
VoIP. The VoIP communications medium is in its early stages, and
it may not develop a broad audience. Potential new users may
view VoIP as unattractive relative to traditional telephone
services for a number of reasons, including the need to purchase
computer headsets, the need to leave a personal computer on in
order to communicate with Skype, or the perception that the
price advantage for VoIP is insufficient to justify the
perceived inconvenience. Potential users may also view more
familiar online communication methods, such as
e-mail or instant
messaging, as sufficient for their communications needs.
Managers of some large private branch exchange, or PBX, systems
in businesses, universities, government agencies, and other
institutions may refuse to allow the use of Skype due to
concerns over security, server
usage, or for other reasons. If VoIP does not achieve wide
public acceptance, our Skype business will be adversely affected.
Use of our services for illegal purposes could harm our
business.
The law relating to the liability of providers of online
services for the activities of their users on their service is
currently unsettled in the United States and internationally. We
are aware that certain goods, such as weapons, adult material,
tobacco products, alcohol, and other goods that may be subject
to regulation, have been listed and traded on our service. We
may be unable to prevent our users from selling unlawful goods
or selling goods 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 service. 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 site. Similarly,
our Korean subsidiary and one of its employees were found
criminally liable for listings on the Korean subsidiary’s
website. In order to reduce our exposure to this liability, we
have prohibited the listing of certain items and increased the
number of personnel reviewing questionable items. In the future,
we may implement other protective measures that could require us
to spend substantial resources or discontinue certain service
offerings. Any costs incurred as a result of potential liability
relating to the sale of unlawful goods or the unlawful sale of
goods could harm our business. In addition, we have received
significant and continuing media attention relating to the
listing or sale of unlawful goods using our services. This
negative publicity could damage our reputation and diminish the
value of our brand names. It also could make users reluctant to
continue 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 intellectual property, money laundering, bank
fraud, child pornography trafficking, prohibited sales of
alcoholic beverages or tobacco products, and online securities
fraud. PayPal’s acceptable use policy enables PayPal to
fine users in certain jurisdictions up to $500 or take legal
action to recover its losses for certain violations of that
policy, including online gambling and illegal sales of
prescription medications. Despite measures PayPal has taken to
detect and lessen the risk of this kind of conduct, illegal
activities could still be funded using PayPal.
PayPal is subject to anti-money laundering laws and regulations
that prohibit, among other things, its involvement in
transferring the proceeds of criminal activities. Although
PayPal has adopted a program to comply with these laws and
regulations, any errors or failure to implement the program
properly could lead to lawsuits, administrative action, and
prosecution by the government. In July 2003, PayPal agreed with
the U.S. Attorney for the Eastern District of Missouri that
it would pay $10 million as a civil forfeiture to settle
allegations that its provision of services to online gambling
merchants violated provisions of the USA PATRIOT Act and further
agreed to have its compliance program reviewed by an independent
audit firm. PayPal is also 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. Future regulations
under the USA PATRIOT Act may require PayPal to revise the
procedures it uses to verify the identity of its customers and
to monitor international transactions more closely. As PayPal
localizes its service in other countries, additional
verification and reporting requirements could apply. These
regulations could impose significant costs on PayPal and make it
more difficult for new customers to join its network. PayPal
could be required to learn more about its customers before
opening an account, to obtain additional verification of
customers and to monitor its customers’ activities more
closely. These requirements, as well as any additional
restrictions imposed by credit card associations, could raise
PayPal’s costs significantly and reduce the attractiveness
of its product. Failure to comply with federal, state or foreign
country money laundering laws could result in significant
criminal and civil lawsuits, penalties, and forfeiture of
significant assets.
We are subject to intellectual property and other
litigation.
In April 2001, two of our European subsidiaries, eBay GmbH and
eBay International AG, were sued by Montres Rolex S.A. and
certain of its affiliates in the regional court of Cologne,
Germany. The suit subsequently was transferred to the regional
court in Düsseldorf, Germany. Rolex alleged that our
subsidiaries were infringing Rolex’s trademarks as a result
of users selling counterfeit Rolex watches through our German
website. The suit also alleged unfair competition. Rolex sought
an order enjoining the sale of Rolex-branded watches on the
website as well as damages. In December 2002, a trial was held
in the matter and the court ruled in favor of eBay on all causes
of action. Rolex appealed the ruling to the Higher Regional
Court of Düsseldorf, and the appeal was heard in October
2003. In February 2004, the court rejected Rolex’s appeal
and ruled in our favor. Rolex has appealed the ruling to the
German Federal Supreme Court, and a hearing is expected in
December 2006. In September 2004, the German Federal Supreme
Court issued its written opinion in favor of Rolex in a case
involving an unrelated company, ricardo.de AG, but somewhat
comparable legal theories. Although it is not yet clear what the
ultimate effect of the reasoning of the German Federal Supreme
Court’s ricardo.de decision will have when applied to eBay,
we believe the Court’s decision has resulted in an increase
in similar litigation against us in Germany, although we do not
currently believe that it will require a significant change in
our business practices.
In September 2001, MercExchange LLC filed a complaint against
us, our Half.com subsidiary and ReturnBuy, Inc. in the U.S.
District Court for the Eastern District of Virginia
(No. 2:01-CV-736) alleging infringement of three patents
(relating to online consignment auction technology, multiple
database searching and electronic consignment systems) and
seeking a permanent injunction and damages (including treble
damages for willful infringement). In October 2002, the court
granted in part our summary judgment motion, effectively
invalidating the patent related to online auction technology and
rendering it unenforceable. This ruling left only two patents in
the case. Trial of the matter began in April 2003. In May 2003,
the jury returned a verdict finding that eBay had willfully
infringed one and Half.com had willfully infringed both of the
patents in the suit, awarding $35 million in compensatory
damages. Both parties filed post-trial motions, and in August
2003, the court entered judgment for MercExchange in the amount
of approximately $30 million plus pre-judgment interest and
post-judgment interest in an amount to be determined, while
denying MercExchange’s request for an injunction and
attorneys’ fees. We appealed the verdict and judgment in
favor of MercExchange and MercExchange filed a cross-appeal of
the granting in part of our summary judgment motion and the
denial of its request for an injunction and attorneys’ fees.
In March 2005, the U.S. Court of Appeals for the Federal Circuit
issued a ruling in the appeal of the MercExchange patent
litigation suit which, among other things (1) invalidated
all claims asserted against eBay and Half.com arising out of the
multiple database search patent and reduced the verdict amount
by $4.5 million; (2) upheld the electronic consignment
system patent; (3) affirmed the district court’s
refusal to award attorneys’ fees or enhanced damages
against us; (4) reversed the district court’s order
granting summary judgment in our favor regarding the auction
patent; and (5) reversed the district court’s refusal
to grant an injunction and remanded that issue to the district
court for further proceedings. In May 2005, the Court of Appeals
for the Federal Circuit granted our petition to stay the mandate
in the case in order to allow us to petition the U.S. Supreme
Court for review on certain issues. We filed our petition for
review with the U.S. Supreme Court in July 2005, and on
November 28, 2005, the Court granted our petition for
review. Oral arguments in the case are scheduled for
March 29, 2006. In parallel with the federal court
proceedings, at our request, the U.S. Patent and Trademark
Office is actively reexamining each of the patents in suit,
having found that substantial questions exist regarding the
validity of the claims contained in them. In January 2005, the
Patent and Trademark Office issued an initial ruling rejecting
all of the claims contained in the patent that related to online
auctions; in March 2005, the Patent and Trademark Office issued
an initial ruling rejecting all of the claims contained in the
patent that related to electronic consignment systems; and in
May 2005, the Patent and Trademark Office issued an initial
ruling rejecting all of the claims contained in the patent that
related to multiple database searching. Even if successful, our
litigation of these matters will continue to be costly. In
addition, as a precautionary measure, we have modified certain
functionality of our websites and business practices in a manner
which we believe would avoid any further infringement. For this
reason, we
believe that any injunction that might be issued by the district
court will not have any impact on our business. We also believe
we have appropriate reserves for this litigation. Nonetheless,
if we are not successful in appealing or modifying the
court’s ruling, and if the modifications to the
functionality of our websites and business practices are not
sufficient to make them non-infringing, we would likely be
forced to pay significant additional damages and licensing fees
and/or modify our business practices in an adverse manner.
In August 2002, Charles E. Hill & Associates, Inc. filed a
lawsuit in the U.S. District Court for the Eastern District of
Texas (No. 2:02-CV-186) alleging that we and 17 other
companies, primarily large retailers, infringed three patents
owned by Hill generally relating to electronic catalog systems
and methods for transmitting and updating data at a remote
computer. The suit seeks an injunction against continuing
infringement, unspecified damages, including treble damages for
willful infringement, and interest, costs, expenses, and fees.
The case was transferred to the U.S. District Court for the
Southern District of Indiana in January 2003, but was
transferred back to the U.S. District Court for the Eastern
District of Texas in December 2003. A claim construction hearing
was held in August 2005. In February 2006, we entered into a
settlement agreement with the plaintiffs in the case under which
we will be licensed under all of the patents at issue.
In February 2002, PayPal was sued in California state court
(No. CV-805433) in a purported class action alleging that
its limiting access to customer accounts and failure to promptly
restore access to legitimate accounts violates California state
consumer protection laws and is an unfair business practice and
a breach of PayPal’s User Agreement. This action was
re-filed with a different named plaintiff in June 2002
(No. CV-808441), and a similar action was also filed in the
U.S. District Court for the Northern District of California in
June 2002 (No. C-02-2777). In March 2002, PayPal was sued
in the U.S. District Court for the Northern District of
California (No. C-02-1227) in a purported class action
alleging that its limiting access to customer accounts and
failure to promptly restore access to legitimate accounts
violates federal and state consumer protection and unfair
business practice laws. The two federal court actions were
consolidated into a single case, and the state court action was
stayed pending developments in the federal case. In June 2004,
the parties announced that they had reached a proposed
settlement. The settlement received approval from the federal
court on November 2, 2004, and the state court action was
dismissed with prejudice in March 2005. In the settlement,
PayPal does not acknowledge that any of the allegations in the
case are true. Under the terms of the settlement, certain PayPal
account holders are eligible to receive payment from a
settlement fund of $9.25 million, less administrative costs
and the amount awarded to plaintiffs’ counsel by the court.
That sum is being distributed to class members who have
submitted timely claims in accordance with the settlement’s
plan of allocation. The plan of allocation for a portion of the
settlement fund that remains undistributed must still be
approved by the court. That plan was recently approved by the
Special Master, who has recommended that the District Court
issue its approval. Substantially all of the cost associated
with the settlement was reserved in 2003.
In July 2004, a purported class action lawsuit was filed by two
eBay users in Superior Court of the State of California, County
of Santa Clara (No. 104CV022708) alleging that eBay engaged
in improper billing practices as the result of problems with the
rollout of a new billing software system in the second and third
quarters of 2004. The lawsuit sought damages and injunctive
relief. An amended complaint was filed in January 2005, dropping
one plaintiff, changing the capacity of the other plaintiff to
that of representative plaintiff, and adding seven additional
eBay users as plaintiffs. The amended complaint expanded its
claim to include numerous alleged improper billing practices
from September 2003 until the present. In February 2005, eBay
filed a motion to strike and a demurrer seeking to dismiss the
complaint. In April 2005, the court sustained portions of the
demurrer, but granted the plaintiffs leave to amend their
complaint. The plaintiffs filed a second amended complaint,
dropping the last original plaintiff and again adding new
plaintiffs. We filed a motion to strike and a demurrer regarding
the plaintiffs’ second amended complaint. In July 2005, the
court again sustained a portion of the demurrer and again
granted the plaintiffs leave to amend their complaint, and the
plaintiffs filed a third amended complaint. In December 2005,
the plaintiffs filed a fourth amended complaint, dropping
several plaintiffs. In January 2006, the parties reached
tentative agreement on the terms of a settlement, though the
settlement has not been finalized.
In February 2005, eBay was sued in Superior Court of the State
of California, County of Santa Clara (No. 105CV035930) in a
purported class action alleging that certain bidding features of
our site constitute “shill bidding” for the purpose of
artificially inflating bids placed by buyers on the site. The
complaint alleges violations of California’s Auction Act,
California’s Consumer Remedies Act, and unfair competition.
The complaint seeks injunctive relief, damages, and a
constructive trust. In April 2005, we filed a demurrer seeking
to dismiss the complaint, and a hearing on the demurrer was held
in February 2006. We believe that we have meritorious defenses
and intend to defend ourselves vigorously.
In March 2005, eBay, PayPal, and an eBay seller were sued in
Supreme Court of the State of New York, County of Kings
(No. 6125/05) in a purported class action alleging that
certain disclosures regarding PayPal’s Buyer Protection
Policy, users’ chargeback rights, and the effects of
users’ choice of funding mechanism are deceptive and/or
misleading. The complaint alleged misrepresentation on the part
of eBay and PayPal, breach of contract and deceptive trade
practices by PayPal, and that PayPal and eBay have jointly
violated the civil RICO statute (18 U.S.C.
Section 1961(4)). In April 2005, eBay and PayPal removed
the case to the U.S. District Court for the Eastern District of
New York and the plaintiffs filed an amended complaint in the
U.S. District Court (No. 05-CV-01720) repeating the
allegations of the initial complaint but dropping the civil RICO
allegations. The complaint seeks injunctive relief, compensatory
damages, and punitive damages. Following several mediation
sessions, the parties reached a tentative settlement in December
2005. The parties are still engaged in the process of
documenting this settlement. In order for the settlement to
become final, the court must preliminarily approve its terms,
and the settlement must then receive final approval from the
court after a public hearing. The full amount of the proposed
settlement was accrued in our consolidated income statement for
the year ended December 31, 2005.
In January 2005, 51 former shareholders of Epinions, Inc. common
stock including founders and former employees of that company
filed a lawsuit in Superior Court of the State of California
County of San Francisco (No. CGC 05-437906) related to the
April 2003 merger of Epinions and DealTime, Ltd. The lawsuit was
filed against certain of Epinions’ former officers and
directors and preferred shareholders and the company that
resulted from the merger, Shopping.com Ltd. eBay completed its
acquisition of Shopping.com Ltd. on August 30, 2005. The
lawsuit contended that the defendants were responsible for
breaches of fiduciary duty and material misstatements and
omissions, that defendants undervalued the DealTime stock that
Epinions’ shareholders received in connection with the
merger, and that plaintiffs’ common stock of Epinions was
wrongfully cancelled without compensation. Defendants disputed
the contentions of the case and denied any allegations of
wrongdoing. The parties tentatively reached agreement as to the
monetary terms for settlement of the dispute in September 2005,
and in December 2005, the settlement was finalized and the
lawsuit was dismissed. The settlement amount has been accounted
for as an assumed liability in connection with our acquisition
of Shopping.com.
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 have been notified of several
potential 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 to face
additional patent infringement claims involving services we
provide, including various aspects of our Payments and
Communications 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 expand geographically
into jurisdictions where the underlying laws with respect to the
potential liability of online intermediaries like ourselves are
either unclear or less favorable. These claims, whether
meritorious or not, could be time consuming and costly to
resolve, cause service upgrade delays, 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. The number and significance of these disputes and
inquiries are increasing as our business expands and our company
grows larger. Any claims or regulatory actions against us,
whether meritorious or not, could be time consuming, result in
costly litigation, require significant amounts of management
time, and result in the diversion of significant operational
resources.
Government inquiries may lead to charges or
penalties.
A large number of transactions occur on our websites. We believe
that government regulators have received a substantial 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, we have from time to time 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 these and other
business practices from the attorneys general of a number of
states. If PayPal’s processes are found to violate federal
or state law on consumer protection and unfair business
practices, it could be subject to an enforcement action or
fines. If PayPal becomes subject to an enforcement action, it
could be required to restructure its business processes in ways
that would harm its business, and to pay substantial fines. Even
if PayPal is able to defend itself successfully, an enforcement
action could cause damage to its reputation, could consume
substantial amounts of its management’s time and attention,
and could require PayPal to change its customer service and
operations in ways that could increase its costs and decrease
the effectiveness of its anti-fraud program. Both eBay and
PayPal are likely to receive additional inquiries from
regulatory agencies in the future, which may lead to action
against either company. 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 fines or other penalties, or forced to
change our operating practices in ways that could harm our
business.
We are subject to laws relating to the use and transfer of
personally identifiable information about our users, especially
for financial information and for users located outside of the
U.S. New laws in this area have been passed by several
jurisdictions, and other jurisdictions are considering imposing
additional restrictions. Violation of these laws, which in many
cases 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, could subject us to
significant penalties and negative publicity and could adversely
affect us.
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. 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 defending their rights against online
companies, including eBay. Allegations of infringement of
intellectual property rights have resulted in litigation against
us from time to time, including litigation brought by
Tiffany & Co. and Robespierre, Inc. (doing business as
Nanette Lepore) in the U.S., Rolex S.A. in Germany, and a number
of other owners of intellectual property rights. While we have
been largely successful to date 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
our defense. In addition, a public perception that counterfeit
or pirated items are commonplace on our site could damage our
reputation and our business. Litigation and negative publicity
may increase as our sites gain prominence in markets outside of
the U.S., where the laws may be unsettled or less favorable to
us. Such litigation is costly for us, could result in damage
awards or increased costs of doing business through adverse
judgment or settlement, could require us to change our business
practices in expensive ways, or could otherwise harm our
business. Litigation against other online companies could result
in interpretations of the law that could also require us to
change our business practices or otherwise increase our costs.
We are subject to risks associated with information
disseminated through our service.
The law relating to the liability of online services companies
for information carried on or disseminated through their
services is currently 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 upon us under a number of these
theories have been brought against us. 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 content
posted in the Feedback Forum. Several recent court decisions
have narrowed the scope of the immunity provided to Internet
service providers like us under the Communications Decency Act.
This trend, if continued, may increase our potential liability
to third parties for the user-provided content on our site. Our
liability for such claims may be higher 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.
This may require us to expend substantial resources or to
discontinue 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 harm our reputation or
otherwise impact the growth of our business. Any costs incurred
as a result of this potential liability could harm our business.
Customer complaints or negative publicity about our
customer service could diminish use of our services.
Customer complaints or negative publicity about our customer
service could severely diminish consumer confidence in and use
of our services. Measures we sometimes take to combat risks of
fraud and breaches of privacy and security can damage relations
with our customers. These measures heighten the need for prompt
and accurate customer service to resolve irregularities and
disputes. Effective customer service requires significant
personnel expense, and this expense, if not managed properly,
could significantly impact our profitability. Failure to manage
or train our customer service representatives properly could
compromise our ability to handle customer complaints
effectively. If we do not handle customer complaints
effectively, our reputation may suffer and we may lose our
customers’ confidence.
Because it is providing a financial service and operating in a
more regulated environment, PayPal, unlike eBay, must provide
telephone as well as email customer service and must resolve
certain customer contacts within shorter time frames. As part of
PayPal’s program to reduce fraud losses, it may temporarily
restrict the ability of customers to withdraw their funds if
those funds or the customer’s account activity are
identified by PayPal’s anti-fraud models as suspicious.
PayPal has in the past received negative publicity with respect
to its customer service and account restrictions, and has been
the subject of purported class action lawsuits and state
attorney general inquiries alleging, among other things, failure
to resolve account restrictions promptly. If PayPal is unable to
provide quality customer support operations in a cost-effective
manner, PayPal’s users may have negative experiences,
PayPal may receive additional negative publicity, its ability to
attract new customers may be damaged, and it could become
subject to additional litigation. Current and future revenues
could suffer, or its operating margins may decrease. In
addition, negative publicity about or experiences with
PayPal’s customer support could cause eBay’s
reputation to suffer or affect consumer confidence in the eBay
brands as a whole.
Problems with third parties who provide services to us or
to our users could harm our business.
A number of parties provide services to us or to our users that
benefit us. Such services include seller tools that automate and
manage listings, merchant tools that manage listings and
interface with inventory management software, storefronts that
help our users list items, and caching services that make our
sites load faster, among others. In some cases we have
contractual agreements with these companies that give us a
direct financial interest in their success, while in other cases
we have none. In either circumstance, financial, regulatory, or
other problems that prevent these companies from providing
services to us or our users could reduce the number of listings
on our websites or make completing transactions on our websites
more difficult, and thereby harm our business. Any security
breach at one of these companies could also affect our customers
and harm our business. Although we generally have been able to
renew or extend the terms of contractual
arrangements with these third party service providers on
acceptable terms, there can be no assurance that we will
continue to be able to do so in the future.
We depend on key personnel.
Our future performance depends substantially on the continued
services of our senior management and other key personnel and
our ability to retain and motivate them. The loss of the
services of any of our executive officers or other key employees
could harm our business. We do not have long-term employment
agreements with any of our key personnel, we do not maintain any
“key person” life insurance policies, and our Chief
Executive Officer and many other members of our senior
management team have fully vested the vast majority of their
equity incentives. Our new businesses all depend on attracting
and retaining key personnel. Our future success also will depend
on our ability to attract, train, retain and motivate highly
skilled technical, managerial, marketing, and customer support
personnel. Competition for these personnel is intense, and we
may be unable to successfully attract, integrate, or retain
sufficiently qualified personnel. In making employment
decisions, particularly in the Internet and high-technology
industries, job candidates often consider the value of the stock
options they are to receive in connection with their employment.
Fluctuations in our stock price may make it more difficult to
retain and motivate employees whose stock option strike prices
are substantially above current market prices. Similarly,
decreases in the number of unvested stock options held by
existing employees, either because their options have vested or
because the size of follow-on option grants has declined, may
make it more difficult to retain and motivate employees.
Skype’s future success depends substantially upon the
continued services of its senior management and key personnel,
and the loss of their services could harm our business. Several
key members of Skype’s engineering team are consultants,
not full time employees, who provide services to us and third
parties. Many of Skype’s employees had equity in Skype
prior to its acquisition by eBay. Skype equity holders were
given the option of receiving their portion of the acquisition
consideration in the form of a lump-sum up-front payment or
receiving a lower up-front payment in exchange for the
possibility of receiving additional consideration in the form of
potential earn-out payments tied to the achievement of certain
performance targets prior to June 30, 2009. Several key
members of Skype’s senior management and key employees
chose to receive less up-front consideration in exchange for the
possibility of receiving the performance-based earn-out
payments. Although eligible Skype employees have also been
granted eBay stock options, the earn-out payments are not tied
to continued employment with Skype or eBay, and key Skype
employees may choose to depart because of differences in
corporate culture, because they believe the earn-out targets
will be achieved without their contributions, or because they
believe the earn-out targets are not achievable. The loss of the
services of any of Skype’s senior management or key
personnel could delay the development and introduction of new
features and products, and could harm our ability to grow
Skype’s business.
Our industry is intensely competitive, and other companies
or governmental agencies may allege that our behavior is
anti-competitive.
Marketplaces
eBay’s Marketplaces businesses currently or potentially
compete with a number of companies providing both particular
categories of goods and broader ranges of goods. The Internet
provides new, rapidly evolving and intensely competitive
channels for the sale of all types of goods. We expect
competition to intensify in the future. The barriers to entry
into these channels are relatively low, and current offline and
new competitors can easily launch online sites at a nominal cost
using commercially available software or partnering with any one
of a number of successful
e-commerce companies.
Our broad-based competitors include the vast majority of
traditional department, warehouse, discount, and general
merchandise stores (as well as the online operations of these
traditional retailers), emerging online retailers, online
classified services, and other shopping channels such as offline
and online home shopping networks. These include most
prominently: Wal-Mart, Target, Sears, Macy’s,
JC Penney, Costco, Office Depot, Staples, OfficeMax,
Sam’s Club, Amazon.com, Buy.com, AOL.com, Yahoo! Shopping,
MSN, QVC, and Home Shopping Network.
A number of companies have launched a variety of services that
provide new channels for buyers to find and buy items from
sellers of all sizes. We recently acquired Shopping.com Ltd., an
online shopping comparison site. Shopping.com competes with
sites such as Buy.com, Google’s Froogle,
In-Store.com,
MySimon.com, Nextag.com, Pricegrabber.com, Shopzilla, and Yahoo!
Product Search, which offer shopping search engines that allow
consumers to search the Internet for specified products.
Similarly, sellers are increasingly acquiring new customers by
paying for search-related advertisements on search engine sites
such as Google and Yahoo!. We use product search engines and
paid search advertising to channel users to our sites, but these
services also have the potential to divert users to other online
shopping destinations.
We also compete with many local, regional, and national
specialty retailers and exchanges in each of the major
categories of products offered on our site. For example,
category-specific competitors to offerings in our
‘Books/Movies/Music’ category include Abebooks.com,
Amazon.com, Barnes & Noble, Alibris.com, Blockbuster,
BMG, Columbia House, Best Buy, CDNow, Express.com, Emusic.com,
Tower Records, and a host of local bookstores, music stores and
video stores. In addition, many competitors have been successful
at establishing online marketplaces that cater to a particular
retail category, such as vehicles, tickets, or sporting goods.
Our international Marketplaces websites compete with similar
online and offline channels in each of their vertical categories
in most countries. In addition, they compete with general online
e-commerce sites, such
as Quelle and Otto in Germany, Yahoo-Kimo in Taiwan, Daum and
Gmarket in South Korea, TaoBao and 1pai, a partnership between
Sina.com and Yahoo! in China, and Amazon in the U.K. and other
countries. In some of these countries, there are online sites
that have much larger customer bases and greater brand
recognition than we do, and in certain of these jurisdictions
there are competitors that may have a better understanding of
local culture and commerce than we do.
The principal competitive factors for eBay Marketplaces include
the following:
•
ability to attract buyers and sellers;
•
volume of transactions and price and selection of goods;
•
customer service; and
•
brand recognition.
With respect to our online competition, additional competitive
factors include:
Some current and potential competitors have longer operating
histories, larger customer bases and greater brand recognition
in other business and Internet sectors than we do. Other online
trading services may be acquired by, receive investments from,
or enter into other commercial relationships with larger,
well-established and well-financed companies. As a result, some
of our competitors with other revenue sources may be able to
devote more resources to marketing and promotional campaigns,
adopt more aggressive pricing policies and devote substantially
more resources to website and systems development than we can.
Some of our competitors have offered services for free and
others may do this as well. We may be unable to compete
successfully against current and future competitors. In
addition, certain offline competitors may encourage
manufacturers to limit or cease distribution of their products
to dealers who sell through online channels such as eBay, or may
attempt to use existing or future government regulation to
prohibit or limit online commerce in certain categories of goods
or services. The adoption by manufacturers or government
authorities of policies or regulations discouraging the sales of
goods or services over the Internet could force eBay users to
stop selling certain products on our websites. Increased
competition or anti-Internet distribution policies or
regulations may result in reduced operating margins, loss of
market share and diminished value of our brand.
Conversely, other companies and government agencies have in the
past and may in the future allege that our actions violate the
antitrust or competition laws of the U.S. or other
countries, or otherwise constitute unfair competition. Such
claims, even if without foundation, typically are very expensive
to defend, involve negative publicity and diversion of
management time and effort, and could result in significant
judgments against us.
In order to respond to changes in the competitive environment,
we may, from time to time, make pricing, service or marketing
decisions or acquisitions that could harm our profitability. For
example, we have implemented a buyer protection program that
generally insures items up to a value of $200, with a $25
deductible, for users with a non-negative feedback rating at no
cost to the user. PayPal has implemented a similar buyer
protection program covering losses from selected eBay sellers up
to $1,000, with no deductible. Depending on the amount and size
of claims we receive under these programs, these product
offerings could harm our profitability. In addition, certain
competitors may offer or continue to offer free shipping or
other transaction related services, which could be impractical
or inefficient for eBay users to match. New technologies may
increase the competitive pressures by enabling our competitors
to offer a lower cost service.
Although we have established Internet traffic arrangements with
several large online services and search engine companies, these
arrangements may not be renewed on commercially reasonable terms
or these companies may decide to promote competitive services.
Even if these arrangements are renewed, they may not result in
increased usage of our services. In addition, companies that
control user access to transactions through network access,
Internet browsers, or search engines, could promote our
competitors, channel current or potential users to their
vertically integrated electronic commerce sites or their
advertisers’ sites, attempt to restrict our access, or
charge us substantial fees for inclusion.
PayPal
The market for PayPal’s product is emerging, intensely
competitive, and characterized by rapid technological change.
PayPal competes with existing online and off-line payment
methods, including, among others:
•
credit card merchant processors that offer their services to
online merchants, including Cardservice International, Chase
Paymentech, First Data, iPayment and Wells Fargo; and payment
gateways, including CyberSource and Authorize.net;
•
Money remitters such as MoneyGram and Western Union, a
subsidiary of First Data;
•
Bill payment services, including CheckFree;
•
processors that provide online merchants the ability to offer
their customers the option of paying for purchases from their
bank account, including Certegy, PayByTouch and TeleCheck, a
subsidiary of First Data, or to pay on credit, including Bill Me
Later;
•
providers of traditional payment methods, particularly credit
cards, checks, money orders, and Automated Clearing House
transactions; and
•
issuers of stored value targeted at online payments, including
VisaBuxx, NetSpend and Next Estate.
In addition, Google has stated it is developing a new payment
service.
Some of these competitors have longer operating histories,
significantly greater financial, technical, marketing, customer
service and other resources, greater name recognition, or a
larger base of customers in affiliated businesses than PayPal.
PayPal’s competitors may respond to new or emerging
technologies and changes in customer requirements faster and
more effectively than PayPal. They may devote greater resources
to the development, promotion, and sale of products and services
than PayPal, and they may offer lower prices. PayPal may be
forced to lower its prices in response. Competing services tied
to established banks and other financial institutions may offer
greater liquidity and engender greater consumer confidence in
the safety and efficacy of their services than PayPal.
Overseas, PayPal faces competition from similar channels and
payment methods. In each country, numerous banks provide
standard online credit card acquiring and processing services,
and these banks
typically have leading market share. In addition, PayPal faces
competition from Visa’s Visa Direct, MasterCard’s
MoneySend, and Royal Bank of Scotland’s World Pay and
Webpay International’s Click & Buy in the European
Community, NOCHEX, Moneybookers, NETeller and FirePay in the
U.K., CertaPay and HyperWallet in Canada, Paymate in Australia,
Alipay and 99Bill in China and Inicis in South Korea. In
addition, in certain countries, such as Germany and Australia,
electronic funds transfer is a leading method of payment for
both online and offline transactions. As in the U.S.,
established banks and other financial institutions that do not
currently offer online payments could quickly and easily develop
such a service.
Skype
The market for Skype’s products is also emerging, intensely
competitive, and characterized by rapid technological change.
Many traditional telecommunications carriers and cable providers
offer, or have indicated that they plan to offer, VoIP products
or services that compete with the software Skype provides. In
addition, many Internet companies, including AOL, Google,
Microsoft, and Yahoo! offer, or have indicated that they plan to
offer in the near future, VoIP products that are similar to
Skype’s. We expect VoIP competitors to continue to improve
the performance of their current products and introduce new
products, software, services, and technologies. If Skype’s
competitors successfully introduce new products or enhance their
existing products, this could reduce the market for Skype’s
products, increase price competition, or make Skype’s
products obsolete. For example, Skype’s competitors may
integrate more traditional methods of online communication that
do not involve VoIP technology, such as instant messaging, with
content and functionality that Skype does not have, or that is
superior to Skype’s, which could lower Skype’s
adoption rates, decrease its ability to attract new users or
cause its current users to migrate to a competing company. In
addition, some of Skype’s competitors, such as
telecommunications carriers and cable television providers, may
be able to bundle services and products that Skype does not
offer. These could include various forms of wireless
communications, voice and data services, Internet access, and
cable television. This form of bundling would put Skype at a
competitive disadvantage if these providers can combine a
variety of service offerings at a single attractive price.
Furthermore, competitors may choose to make their services
interoperable with one another, rather than proprietary, which
could increase the attractiveness of their services relative to
Skype and decrease the value of Skype’s network of users.
Many of Skype’s current and potential competitors have
longer operating histories, are substantially larger, and have
greater financial, marketing, technical, and other resources.
Some also have greater name recognition and a larger installed
base of customers than Skype has. As a result of their greater
resources, many current and potential competitors may be able to
lower their prices substantially, thereby eroding some or all of
Skype’s cost advantage.
Our business depends on the development and maintenance of
the Internet infrastructure.
The success of our services will depend largely on the
development and maintenance of the Internet infrastructure. This
includes maintenance of a reliable network backbone with the
necessary speed, data capacity, and security, as well as timely
development of complementary products, for providing reliable
Internet access and services. The Internet has experienced, and
is likely to continue to experience, significant growth in the
numbers of users and amount of traffic. The Internet
infrastructure may be unable to support such demands. In
addition, increasing numbers of users, increasing bandwidth
requirements, or problems caused by “viruses,”“worms,” and similar programs may harm the performance
of the Internet. The backbone computers of the Internet have
been the targets of such programs. The Internet has experienced
a variety of outages and other delays as a result of damage to
portions of its infrastructure, and it could face outages and
delays in the future. These outages and delays could reduce the
level of Internet usage generally as well as the level of usage
of our services.
We may be unable to protect or enforce our own
intellectual property rights adequately.
We regard the protection of our trademarks, copyrights, patents,
domain names, trade dress, and trade secrets as critical to our
success. We aggressively protect our intellectual property
rights by relying on a combination of trademark, copyright,
patent, trade dress and trade secret laws, and through the
domain name
dispute resolution system. We also rely on contractual
restrictions to protect our proprietary rights in products and
services. We have entered into confidentiality and invention
assignment agreements with our employees and contractors, and
confidentiality agreements with parties with whom we conduct
business in order to limit access to and disclosure of our
proprietary information. These contractual arrangements and the
other steps we have taken to protect our intellectual property
may not prevent misappropriation of our technology or deter
independent development of similar technologies by others. We
pursue the registration of our domain names, trademarks, and
service marks in the U.S. and internationally. Effective
trademark, copyright, patent, domain name, trade dress, and
trade secret protection is very expensive to maintain and may
require litigation. We must protect our trademarks, patents, and
domain names in an increasing number of jurisdictions, a process
that is expensive and may not be successful in every location.
For example, Skype is in the process of applying to register the
Skype name as a trademark worldwide. In the EU, Skype’s
application is being opposed. If this opposition to Skype’s
application were to be successful, Skype might be forced to
apply for trademark registration in each individual EU country,
resulting in increased expenditures and damage to its business
if its application were rejected in individual countries. We
have licensed in the past, and expect to license in the future,
certain of our proprietary rights, such as trademarks or
copyrighted material, to others. These licensees may take
actions that diminish the value of our proprietary rights or
harm our reputation.
We are subject to the risks of owning real
property.
We own real property including land and buildings related to our
operations. We have little experience in managing real property.
Ownership of this property subjects us to risks, including:
•
the possibility of environmental contamination and the costs
associated with fixing any environmental problems;
•
adverse changes in the value of these properties, due to
interest rate changes, changes in the neighborhoods in which the
properties are located, or other factors;
•
the possible need for structural improvements in order to comply
with zoning, seismic, disability act, or other
requirements; and
•
possible disputes with tenants, neighboring owners, or others.
Some anti-takeover provisions may affect the price of our
common stock.
Our Board of Directors has the authority to issue up to
10,000,000 shares of preferred stock and to determine the
preferences, rights and privileges of those shares without any
further vote or action by the stockholders. The rights of the
holders of common stock may be harmed by rights granted to the
holders of any preferred stock that may be issued in the future.
Some provisions of our certificate of incorporation and bylaws
could have the effect of making it more difficult for a
potential acquirer to acquire a majority of our outstanding
voting stock. These include provisions that provide for a
classified board of directors, prohibit stockholders from taking
action by written consent and restrict the ability of
stockholders to call special meetings. We are also subject to
provisions of Delaware law that prohibit us from engaging in any
business combination with any interested stockholder for a
period of three years from the date the person became an
interested stockholder, unless certain conditions are met. This
restriction could have the effect of delaying or preventing a
change of control.
ITEM 1B: UNRESOLVED STAFF
COMMENTS
Not applicable.
ITEM 2: PROPERTIES
We own and lease various properties in the United States and in
24 other countries around the world. We use the properties for
corporate, administrative, customer support and other general
business needs. Our corporate headquarters are located in
San Jose, California. As of December 31, 2005, our
owned and leased properties provided us with aggregate square
footage of approximately 1.3 million and 1.4 million,
respectively,
and the total square footage occupied by our
U.S. Marketplaces, International Marketplaces, Payments and
Communications segments totaled approximately 800,000,
1,000,000, 900,000, and 15,000 square feet respectively. As of
December 31, 2005, the remaining total square footage of
our owned and leased properties was either sublet or was being
marketed for sublet.
From time to time we consider various alternatives related to
our long-term facilities needs. While we believe our existing
facilities are adequate to meet our immediate needs, it may
become necessary to lease or acquire additional or alternative
space to accommodate any future growth.
ITEM 3: LEGAL
PROCEEDINGS
In April 2001, two of our European subsidiaries, eBay GmbH and
eBay International AG, were sued by Montres Rolex S.A. and
certain of its affiliates in the regional court of Cologne,
Germany. The suit subsequently was transferred to the regional
court in Düsseldorf, Germany. Rolex alleged that our
subsidiaries were infringing Rolex’s trademarks as a result
of users selling counterfeit Rolex watches through our German
website. The suit also alleged unfair competition. Rolex sought
an order enjoining the sale of Rolex-branded watches on the
website as well as damages. In December 2002, a trial was held
in the matter and the court ruled in favor of eBay on all causes
of action. Rolex appealed the ruling to the Higher Regional
Court of Düsseldorf, and the appeal was heard in October
2003. In February 2004, the court rejected Rolex’s appeal
and ruled in our favor. Rolex has appealed the ruling to the
German Federal Supreme Court, and a hearing is expected in
December 2006. In September 2004, the German Federal Supreme
Court issued its written opinion in favor of Rolex in a case
involving an unrelated company, ricardo.de AG, but somewhat
comparable legal theories. Although it is not yet clear what the
ultimate effect of the reasoning of the German Federal Supreme
Court’s ricardo.de decision will have when applied to eBay,
we believe the Court’s decision has resulted in an increase
in similar litigation against us in Germany, although we do not
currently believe that it will require a significant change in
our business practices.
In September 2001, MercExchange LLC filed a complaint against
us, our Half.com subsidiary and ReturnBuy, Inc. in the
U.S. District Court for the Eastern District of Virginia
(No. 2:01-CV-736) alleging infringement of three patents
(relating to online consignment auction technology, multiple
database searching and electronic consignment systems) and
seeking a permanent injunction and damages (including treble
damages for willful infringement). In October 2002, the court
granted in part our summary judgment motion, effectively
invalidating the patent related to online auction technology and
rendering it unenforceable. This ruling left only two patents in
the case. Trial of the matter began in April 2003. In May 2003,
the jury returned a verdict finding that eBay had willfully
infringed one and Half.com had willfully infringed both of the
patents in the suit, awarding $35 million in compensatory
damages. Both parties filed post-trial motions, and in August
2003, the court entered judgment for MercExchange in the amount
of approximately $30 million plus pre-judgment interest and
post-judgment interest in an amount to be determined, while
denying MercExchange’s request for an injunction and
attorneys’ fees. We appealed the verdict and judgment in
favor of MercExchange and MercExchange filed a cross-appeal of
the granting in part of our summary judgment motion and the
denial of its request for an injunction and attorneys’ fees.
In March 2005, the U.S. Court of Appeals for the Federal
Circuit issued a ruling in the appeal of the MercExchange patent
litigation suit which, among other things (1) invalidated
all claims asserted against eBay and Half.com arising out of the
multiple database search patent and reduced the verdict amount
by $4.5 million; (2) upheld the electronic consignment
system patent; (3) affirmed the district court’s
refusal to award attorneys’ fees or enhanced damages
against us; (4) reversed the district court’s order
granting summary judgment in our favor regarding the auction
patent; and (5) reversed the district court’s refusal
to grant an injunction and remanded that issue to the district
court for further proceedings. In May 2005, the Court of Appeals
for the Federal Circuit granted our petition to stay the mandate
in the case in order to allow us to petition the
U.S. Supreme Court for review on certain issues. We filed
our petition for review with the U.S. Supreme Court in July
2005, and on November 28, 2005, the Court granted our
petition for review. Oral arguments in the case are scheduled
for March 29, 2006. In parallel with the federal court
proceedings, at our request, the U.S. Patent and Trademark
Office is actively reexamining each of the patents in suit,
having found that substantial questions exist regarding the
validity of the claims contained in them. In January 2005, the
Patent and Trademark Office issued an initial ruling
rejecting all of the claims contained in the patent that related
to online auctions; in March 2005, the Patent and Trademark
Office issued an initial ruling rejecting all of the claims
contained in the patent that related to electronic consignment
systems; and in May 2005, the Patent and Trademark Office issued
an initial ruling rejecting all of the claims contained in the
patent that related to multiple database searching. Even if
successful, our litigation of these matters will continue to be
costly. In addition, as a precautionary measure, we have
modified certain functionality of our websites and business
practices in a manner which we believe would avoid any further
infringement. For this reason, we believe that any injunction
that might be issued by the district court will not have any
impact on our business. We also believe we have appropriate
reserves for this litigation. Nonetheless, if we are not
successful in appealing or modifying the court’s ruling,
and if the modifications to the functionality of our websites
and business practices are not sufficient to make them
non-infringing, we would likely be forced to pay significant
additional damages and licensing fees and/or modify our business
practices in an adverse manner.
In August 2002, Charles E. Hill & Associates, Inc.
filed a lawsuit in the U.S. District Court for the Eastern
District of Texas
(No. 2:02-CV-186)
alleging that we and 17 other companies, primarily large
retailers, infringed three patents owned by Hill generally
relating to electronic catalog systems and methods for
transmitting and updating data at a remote computer. The suit
seeks an injunction against continuing infringement, unspecified
damages, including treble damages for willful infringement, and
interest, costs, expenses, and fees. The case was transferred to
the U.S. District Court for the Southern District of
Indiana in January 2003, but was transferred back to the
U.S. District Court for the Eastern District of Texas in
December 2003. A claim construction hearing was held in August
2005. In February 2006, we entered into a settlement agreement
with the plaintiffs in the case under which we will be licensed
under all of the patents at issue.
In February 2002, PayPal was sued in California state court (No.
CV-805433) in a purported class action alleging that its
limiting access to customer accounts and failure to promptly
restore access to legitimate accounts violates California state
consumer protection laws and is an unfair business practice and
a breach of PayPal’s User Agreement. This action was
re-filed with a different named plaintiff in June 2002
(No. CV-808441),
and a similar action was also filed in the U.S. District
Court for the Northern District of California in June 2002
(No. C-02-2777). In March 2002, PayPal was sued in the
U.S. District Court for the Northern District of California
(No. C-02-1227) in a purported class action alleging that
its limiting access to customer accounts and failure to promptly
restore access to legitimate accounts violates federal and state
consumer protection and unfair business practice laws. The two
federal court actions were consolidated into a single case, and
the state court action was stayed pending developments in the
federal case. In June 2004, the parties announced that they had
reached a proposed settlement. The settlement received approval
from the federal court on November 2, 2004, and the state
court action was dismissed with prejudice in March 2005. In the
settlement, PayPal does not acknowledge that any of the
allegations in the case are true. Under the terms of the
settlement, certain PayPal account holders are eligible to
receive payment from a settlement fund of $9.25 million,
less administrative costs and the amount awarded to
plaintiffs’ counsel by the court. That sum is being
distributed to class members who have submitted timely claims in
accordance with the settlement’s plan of allocation. The
plan of allocation for a portion of the settlement fund that
remains undistributed must still be approved by the court. That
plan was recently approved by the Special Master, who has
recommended that the District Court issue its approval.
Substantially all of the cost associated with the settlement was
reserved in 2003.
In July 2004, a purported class action lawsuit was filed by two
eBay users in Superior Court of the State of California, County
of Santa Clara (No. 104CV022708) alleging that eBay engaged
in improper billing practices as the result of problems with the
rollout of a new billing software system in the second and third
quarters of 2004. The lawsuit sought damages and injunctive
relief. An amended complaint was filed in January 2005, dropping
one plaintiff, changing the capacity of the other plaintiff to
that of representative plaintiff, and adding seven additional
eBay users as plaintiffs. The amended complaint expanded its
claim to include numerous alleged improper billing practices
from September 2003 until the present. In February 2005, eBay
filed a motion to strike and a demurrer seeking to dismiss the
complaint. In April 2005, the court sustained portions of the
demurrer, but granted the plaintiffs leave to amend their
complaint. The plaintiffs filed a second amended complaint,
dropping the last original plaintiff and again adding new
plaintiffs. We filed a motion to strike and a demurrer regarding
the plaintiffs’ second amended complaint. In July 2005, the
court again sustained a portion of the demurrer and again
granted the plaintiffs leave to amend their complaint, and the
plaintiffs filed a third amended complaint. In December 2005,
the plaintiffs filed a fourth amended complaint, dropping
several plaintiffs. In January 2006, the parties reached
tentative agreement on the terms of a settlement, though the
settlement has not been finalized.
In February 2005, eBay was sued in Superior Court of the State
of California, County of Santa Clara (No. 105CV035930)
in a purported class action alleging that certain bidding
features of our site constitute “shill bidding” for
the purpose of artificially inflating bids placed by buyers on
the site. The complaint alleges violations of California’s
Auction Act, California’s Consumer Remedies Act, and unfair
competition. The complaint seeks injunctive relief, damages, and
a constructive trust. In April 2005, we filed a demurrer seeking
to dismiss the complaint, and a hearing on the demurrer was held
in February 2006. We believe that we have meritorious defenses
and intend to defend ourselves vigorously.
In March 2005, eBay, PayPal, and an eBay seller were sued in
Supreme Court of the State of New York, County of Kings
(No. 6125/05) in a purported class action alleging that
certain disclosures regarding PayPal’s Buyer Protection
Policy, users’ chargeback rights, and the effects of
users’ choice of funding mechanism are deceptive and/or
misleading. The complaint alleged misrepresentation on the part
of eBay and PayPal, breach of contract and deceptive trade
practices by PayPal, and that PayPal and eBay have jointly
violated the civil RICO statute (18 U.S.C.
Section 1961(4)). In April 2005, eBay and PayPal removed
the case to the U.S. District Court for the Eastern
District of New York and the plaintiffs filed an amended
complaint in the U.S. District Court (No. 05-CV-01720)
repeating the allegations of the initial complaint but dropping
the civil RICO allegations. The complaint seeks injunctive
relief, compensatory damages, and punitive damages. Following
several mediation sessions, the parties reached a tentative
settlement in December 2005. The parties are still engaged in
the process of documenting this settlement. In order for the
settlement to become final, the court must preliminarily approve
its terms and the settlement must then receive final approval
from the court after a public hearing. The full amount of the
proposed settlement was accrued in our consolidated income
statement for the year ended December 31, 2005.
In January 2005, 51 former shareholders of Epinions, Inc. common
stock including founders and former employees of that company
filed a lawsuit in Superior Court of the State of California
County of San Francisco (No. CGC 05-437906) related to
the April 2003 merger of Epinions and DealTime, Ltd. The lawsuit
was filed against certain of Epinions’ former officers and
directors and preferred shareholders and the company that
resulted from the merger, Shopping.com Ltd. eBay completed its
acquisition of Shopping.com Ltd. on August 30, 2005. The
lawsuit contended that the defendants were responsible for
breaches of fiduciary duty and material misstatements and
omissions, that defendants undervalued the DealTime stock that
Epinions’ shareholders received in connection with the
merger, and that plaintiffs’ common stock of Epinions was
wrongfully cancelled without compensation. Defendants disputed
the contentions of the case and denied any allegations of
wrongdoing. The parties tentatively reached agreement as to the
monetary terms for settlement of the dispute in September 2005,
and in December 2005, the settlement was finalized and the
lawsuit was dismissed. The settlement amount has been accounted
for as an assumed liability in connection with our acquisition
of Shopping.com.
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 have been notified of several
potential 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 to face
additional patent infringement claims involving services we
provide, including various aspects of our Payments and
communications 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 expand geographically
into jurisdictions where the underlying laws with respect to the
potential liability of online intermediaries like ourselves are
either unclear or less favorable. These claims, whether
meritorious or not, could be time consuming and costly to
resolve, cause service upgrade delays, 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. The number and significance of these disputes and
inquiries are increasing as our business
expands and our company grows larger. Any claims or regulatory
actions against us, whether meritorious or not, could be time
consuming, result in costly litigation, require significant
amounts of management time, and result in the diversion of
significant operational resources.
ITEM 4: SUBMISSION OF MATTERS
TO A VOTE OF SECURITY HOLDERS
There were no submissions of matters to a vote of security
holders during the quarter ended December 31, 2005.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES
Price Range of Common Stock
Our common stock has been traded on The Nasdaq Stock
MarketSM
under the symbol “EBAY” since September 24, 1998.
The following table sets forth the intra-day high and low per
share bid prices of our common stock (after giving retroactive
effect to all previous stock splits for the periods indicated),
as reported by The Nasdaq Stock Market.
As of February 17, 2006, there were approximately 3,700
holders of record of our common stock, although we believe that
there are a significantly larger number of beneficial owners of
our common stock.
Dividend Policy
We have never paid cash dividends on our stock and currently
anticipate that we will continue to retain any future earnings
to finance the growth of our business.
Equity Compensation Plan Information
The following table gives information about our shares of common
stock that may be issued upon the exercise of options, warrants
and rights under all of our existing equity compensation plans
as of December 31, 2005, including our 1996 Stock Option
Plan, 1997 Stock Option Plan, 1998 Equity Incentive Plan, 1998
Directors Stock Option Plan, 1999 Global Equity Incentive Plan,
2001 Equity Incentive Plan, and 2003 Deferred Stock Unit Plan,
as well as shares of our common stock that may be issued under
individual
compensation arrangements that were not approved by our
stockholders, also referred to as our Non-Plan Grants. No
warrants are outstanding under any of the foregoing plans.
(c)
Number of Securities
(a)
Remaining Available for
Number of Securities
(b)
Future Issuance Under
to be Issued Upon
Weighted Average
Equity Compensation
Exercise of
Exercise Price of
Plans (Excluding
Outstanding Options,
Outstanding Options,
Securities Reflected in
Plan Category
Warrants and Rights
Warrants and Rights
Column (a))
Equity compensation plans approved by securityholders
123,622,549
(1)
$
28.97
(2)
103,280,368
(3)
Equity compensation plans not approved by securityholders
1,382,728
(4)(5)(6) (7)(8)(9)
0.39
—
Total
125,005,277
$
28.65
103,280,368
(1)
Includes 27,391 shares of our common stock issuable pursuant to
deferred stock units, or DSUs, under our 2003 Deferred Stock
Unit Plan. DSUs represent an unfunded, unsecured right to
receive shares of eBay common stock (or the equivalent value
thereof in cash or property), and the value of DSUs varies
directly with the price of eBay’s common stock.
(2)
Because DSUs do not have an exercise price, the 27,391 shares of
our common stock issuable pursuant to DSUs under our 2003
Deferred Stock Unit Plan are not included in the calculation of
weighted average exercise price.
(3)
Includes 5,788,596 shares of our common stock remaining reserved
for future issuance under our 1998 Employee Stock Purchase Plan,
as amended, or the ESPP, as of December 31, 2005. Our ESPP
contains an “evergreen” provision that automatically
increases, on each January 1, the number of securities
reserved for issuance under the ESPP by the number of shares
purchased under the ESPP in the preceding calendar year,
provided that the aggregate number of shares reserved for
issuance under the ESPP may not exceed 36,000,000 shares. As of
December 31, 2005, an aggregate amount of 8,160,996 shares
had been purchased under the ESPP since its inception. An
aggregate amount of 1,411,404 shares was purchased under the
ESPP in 2005, and the number of securities available for
issuance under the ESPP was increased by that number on
January 1, 2006, bringing the total number of shares
reserved for future issuance on January 1, 2006 to
7,200,000. None of our other plans has an “evergreen”
provision.
(4)
Does not include 12,262 shares of our common stock, with a
weighted average exercise price of $2.38 per share, to be
issued upon exercise of outstanding options assumed by us under
the Half.com, Inc. 1999 Equity Compensation Plan, or the
Half.com Plan, in connection with our acquisition of Half.com in
2000, as we cannot make subsequent grants or awards of our
equity securities under the Half.com Plan. Prior to our
acquisition of Half.com, the stockholders of Half.com approved
the Half.com Plan. Our stockholders, however, did not approve
the Half.com Plan in connection with our acquisition of Half.com.
(5)
Does not include 60,572 shares of our common stock, with a
weighted average exercise price of $0.77 per share, to be
issued upon exercise of outstanding options assumed by us under
the X.com Corporation 1999 Stock Plan, or the X.com Plan, in
connection with our acquisition of PayPal in October 2002, as we
cannot make subsequent grants or awards of our equity securities
under the X.com Plan. Prior to our acquisition of PayPal, the
stockholders of PayPal approved the X.com Plan. Our
stockholders, however, did not approve the X.com Plan in
connection with our acquisition of PayPal.
(6)
Does not include 637,142 shares of our common stock, with a
weighted average exercise price of $9.19 per share, to be
issued upon exercise of outstanding options assumed by us under
the PayPal, Inc. 2001 Equity Incentive Plan, or the PayPal Plan,
in connection with our acquisition of PayPal in October 2002, as
we cannot make subsequent grants or awards of our equity
securities under the PayPal Plan. Prior to our acquisition of
PayPal, the stockholders of PayPal approved the PayPal Plan. Our
stockholders, however, did not approve the PayPal Plan in
connection with our acquisition of PayPal.
Does not include 445,623 shares of our common stock, with a
weighted average exercise price of $8.42 per share, to be
issued upon exercise of outstanding options assumed by us under
the Shopping.com Ltd. 2003 Omnibus Stock Option and Restricted
Stock Incentive Plan, or the Shopping.com 2003 Plan, in
connection with our acquisition of Shopping.com Ltd. in August
2005, as we cannot make subsequent grants or awards of our
equity securities under the Shopping.com 2003 Plan. Prior to our
acquisition of Shopping.com, the stockholders of Shopping.com
approved the 2003 Shopping.com 2003 Plan. Our stockholders,
however, did not approve the Shopping.com 2003 Plan in
connection with our acquisition of Shopping.com.
(8)
Does not include 1,153,067 shares of our common stock, with
a weighted average exercise price of $36.19 per share, to
be issued upon exercise of outstanding options assumed by us
under the Shopping.com Ltd. 2004 Equity Incentive Plan, or the
Shopping.com 2004 Plan, in connection with our acquisition of
Shopping.com in August 2005, as we cannot make subsequent grants
or awards of our equity securities under the Shopping.com 2004
Plan. Prior to our acquisition of Shopping.com, the stockholders
of Shopping.com approved the Shopping.com 2004 Plan. Our
stockholders, however, did not approve the Shopping.com 2004
Plan in connection with our acquisition of Shopping.com.
(9)
Does not include 1,822,090 shares of our common stock, with
a weighted average exercise price of $4.02 per share, to be
issued upon exercise of outstanding options assumed by us under
the Skype Technologies S.A. Stock Option Plan Rules, or the
Skype Plan, in connection with our acquisition of Skype
Technologies S.A. in October 2005, as we cannot make subsequent
grants or awards of our equity securities under the Skype Plan.
Prior to our acquisition of Skype, the stockholders of Skype
approved the Skype Plan. Our stockholders, however, did not
approve the Skype Plan in connection with our acquisition of
Skype.
The only outstanding Non-Plan Grant as of December 31, 2005
relates to an individual compensation arrangement that was made
prior to the initial public offering of our Common Stock in
1998. At the time of this Non-Plan Grant, members of our Board
and their affiliates beneficially owned in excess of 90% of our
then outstanding equity and voting interests. This Non-Plan
Grant has been previously disclosed in our initial public
offering Prospectus filed with the SEC on September 25,1998 under the headings “Management — Director
Compensation” and “— Compensation
Arrangements.” Except as set forth below, the terms and
conditions of this Non-Plan Grant are identical to the terms of
our 1997 Stock Option Plan, a copy of which was filed as an
exhibit to our S-1
Registration Statement
(No. 33-59097)
filed in connection with our initial public offering.
The outstanding Non-Plan Grant involved the Board’s grant
of an option to purchase 3,600,000 shares of our
Common Stock at an exercise price of $0.39 to Mr. Cook upon
his joining our Board in June 1998 as an independent director.
These options granted to Mr. Cook were non-qualified
options and were immediately exercisable, with a term of
10 years. These options vested as to 25% of the underlying
shares in June 1999 and as to 2.08% of the shares each month
thereafter until they fully vested in June 2002. Mr. Cook
exercised options to purchase 480,000 shares in 2002,
exercised options to purchase 1,430,000 shares in 2003, and
exercised options to purchase 307,272 shares during 2005.
As of December 31, 2005, options to purchase
1,382,728 shares remain outstanding under the Non-Plan
Grant.
Issuer Purchases of Equity Securities
We did not repurchase any of our equity securities during the
quarter ended December 31, 2005.
ITEM 6:
SELECTED FINANCIAL DATA
The following selected consolidated financial and supplemental
operating data should be read in conjunction with the
consolidated financial statements and notes thereto and
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations” appearing elsewhere in
this Annual Report on
Form 10-K. The
consolidated statement of income and the consolidated balance
sheet data for the years
These results include acquired company results of operations
beginning on the date of acquisition. See Note 3 in the
notes to the consolidated financial statements, included
elsewhere in this Annual Report on
Form 10-K, for a
summary of recent acquisitions.
(2)
Includes a lease obligation totaling $122.5 million that
was reclassified as short-term in 2004 as the lease expired on
March 1, 2005, at which time we purchased the facility.
ITEM 7:
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This report contains statements that involve expectations,
plans or intentions (such as those relating to future business
or financial results, new features or services, or management
strategies). These statements are forward-looking and are
subject to risks and uncertainties, so actual results may vary
materially. You can identify these forward-looking statements by
words such as “may,”“will,”“should,”“expect,”“anticipate,”“believe,”“estimate,”“intend,”“plan” and other similar expressions. You should
consider our forward-looking statements in light of the risks
discussed under the heading “Risk Factors” in Item
1A above as well as our 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. We assume no obligation to
update any forward-looking statements.
You should read the following Management’s Discussion and
Analysis of Financial Condition and Results of Operations in
conjunction with the consolidated financial statements and the
related notes that appear elsewhere in this document.
Overview
About eBay Inc.
Our purpose is to pioneer new communities around the world built
on commerce, sustained by trust, and inspired by opportunity. We
bring together millions of buyers and sellers every day on a
local, national and international basis through an array of
websites. We provide online marketplaces for the sale of goods
and services, online payments services and online communication
offerings to a diverse community of individuals and businesses.
We currently have three primary businesses: the eBay
Marketplaces, Payments and Communications. Our eBay Marketplaces
provide the infrastructure to enable online commerce in a
variety of formats, including the traditional auction platform,
along with our other online platforms, such as Rent.com,
Shopping.com, Kijiji, mobile.de, and Marktplaats.nl. Our
Payments business, which consists of our PayPal business,
enables individuals or businesses to securely, easily and
quickly send and receive payments online. Our Communications
business, which consists of our Skype business, enables VoIP
calls between Skype users, as well as provides low-cost
connectivity to traditional
fixed-line and mobile
telephones.
Our focus is on understanding our key operating and financial
metrics
Members of our senior management team regularly review key
operating metrics such as new users, new user accounts, active
users, listings and gross merchandise volume, as well as total
payment volume processed by our wholly owned PayPal subsidiary
and number of users registered with our Skype subsidiary.
Members of our senior management also regularly review key
financial information including net revenues, operating income
margins, earnings per share, cash flows from operations and free
cash flows, which we define as operating cash flows less
purchases of property and equipment, net. These operating and
financial measures allow us to monitor the health and vibrancy
of our Marketplaces, Payments, and Communications platforms and
the profitability of our business and to evaluate the
effectiveness of investments that we have made and continue to
make in the areas of international expansion, customer support,
product development, marketing and site operations. We believe
that an understanding of these key operating and financial
measures and how they change over time is important to
investors, analysts and other parties analyzing our business
results and future market opportunities.
Our expectations for growth
We expect that our growth in net revenues during 2006 will
result primarily from increased net transaction revenues across
our U.S. Marketplaces, International Marketplaces, Payments
and Communications segments. We continue to make investments in
our business and infrastructure to help us achieve our long-term
growth objectives. We expect to continue our investments in the
areas of international expansion for our eBay Marketplaces, our
Payments and Communications businesses, customer support, site
operations, marketing and various corporate infrastructure
areas. We believe these investments are necessary to support the
long-term demands of our growing business as well as to build
the infrastructure necessary to support long-term growth. In
addition, to the extent that the U.S. dollar strengthens
against foreign currencies, and, in particular, the Euro,
British pound and Korean won, the remeasurement of these foreign
currency denominated transactions into U.S. dollars will
negatively impact our consolidated net revenues and, to the
extent that they are not hedged, our net income.
The discussion of our consolidated financial results contained
herein is intended to assist investors, analysts and other
parties reading this report to better understand the key
operating and financial measures summarized above as well as the
changes in our consolidated results of operations from year to
year, and the primary factors that accounted for those changes.
Seasonality
The following table sets forth, for the periods presented, our
total net revenues and the sequential quarterly growth of these
net revenues.
March 31
June 30
September 30
December 31
(In thousands, except percentages)
2003
Net revenues
$
476,492
$
509,269
$
530,942
$
648,393
Current quarter vs prior quarter
15
%
7
%
4
%
22
%
2004
Net revenues
$
756,239
$
773,412
$
805,876
$
935,782
Current quarter vs prior quarter
17
%
2
%
4
%
16
%
2005
Net revenues
$
1,031,724
$
1,086,303
$
1,105,515
$
1,328,859
Current quarter vs prior quarter
10
%
5
%
2
%
20
%
We have historically experienced our strongest quarters of
sequential growth in the first and fourth fiscal quarters. We
expect transaction activity patterns on our websites to
increasingly mirror general consumer
buying patterns, both online and offline as our business
matures. Our expectation is that Skype’s business will
experience seasonally slower growth during holiday periods.
Business Combinations
Through both domestic and international acquisitions, we have
continued to expand our global online platforms. The financial
results of entities acquired in purchase transactions are
reflected in our consolidated results from the dates that each
acquisition closed. The aggregate purchase price for completed
acquisitions, paid in the form of cash and our common stock,
totaled $4.2 billion in 2005 (not including any possible
future earn out payments associated with our acquisition of
Skype), $1.0 billion in 2004 and $246 million in 2003.
The purchase price has been allocated to the tangible and
intangible assets acquired and liabilities assumed on the basis
of their respective estimated fair values on the acquisition
date. See “Note 1 — The Company and Summary
of Significant Accounting Policies” and
“Note 3 — Business Combinations, Goodwill
and Intangible Assets” to our consolidated financial
statements, included elsewhere in this Annual Report on
Form 10-K.
Results of Operations
The following table sets forth, for the periods presented,
certain data from our consolidated statement of income as a
percentage of net revenues. This information should be read in
conjunction with “Critical Accounting Policies, Judgments
and Estimates” as well as our consolidated financial
statements and notes thereto included elsewhere in this Annual
Report on
Form 10-K.
Income before cumulative effect of accounting change, income
taxes and minority interests
30.6
34.5
34.0
Provision for income taxes
(9.5
)
(10.5
)
(10.3
)
Minority interests
(0.4
)
(0.2
)
(0.0
)
Income before cumulative effect of accounting change
20.7
23.8
23.8
Cumulative effect of accounting change, net of tax
(0.3
)
—
—
Net income
20.4
%
23.8
%
23.8
%
Our net revenues are derived primarily from listing, feature and
final value fees paid by sellers on our eBay Marketplaces and
fees from payment processing services on our PayPal platform.
Our net revenues have continued to grow each year, primarily as
a result of increased auction and fixed-price transaction
activity, reflected in the growth in the number of our confirmed
registered users, user activity, listings, user gross
merchandise volume on our eBay Marketplaces platforms and
payment transactions processed by PayPal. We believe these
increases are largely the result of our promotional efforts and
our emphasis on enhancing the
online commerce experience of our user community, both
domestically and internationally, through the introduction of
new site features and functionality and expanded trust and
safety programs.
Advertising and other non- transaction net revenues
52,854
78
%
94,309
31
%
123,376
Total net revenues
$
2,165,096
51
%
$
3,271,309
39
%
$
4,552,401
Net Revenues by Segment:
U.S. Marketplaces
$
1,062,834
32
%
$
1,399,848
29
%
$
1,804,092
International Marketplaces
664,640
77
%
1,173,759
44
%
1,695,045
Payments
437,622
59
%
697,702
47
%
1,028,455
Communications
—
—
—
—
24,809
Total net revenues
$
2,165,096
51
%
$
3,271,309
39
%
$
4,552,401
Net Revenues by Geography:
U.S.
$
1,406,512
34
%
$
1,889,936
31
%
$
2,471,273
International
758,584
82
%
1,381,373
51
%
2,081,128
Total net revenues
$
2,165,096
51
%
$
3,271,309
39
%
$
4,552,401
Net Marketplaces revenues are attributed to U.S. and
International geographies based upon the country in which the
seller, payment recipient, advertiser or service provider is
located. Our Payments and Communications segments net revenues
include amounts earned internationally.
Rent.com, Shopping.com, and our classifieds websites are not
included in these metrics.
(2)
Cumulative total of all users who have completed the
registration process on one of eBay’s trading platforms.
(3)
All users, excluding users of Half.com, Internet Auction,
Rent.com, Shopping.com, and our classifieds websites, who bid
on, bought, or listed an item within the previous
12-month period.
Includes users of eBay EachNet in China and eBay India since the
migration to the eBay platform in September 2004 and April 2005,
respectively.
(4)
All listings on eBay’s trading platforms during the
quarter, regardless of whether the listing subsequently closed
successfully.
(5)
Total value of all successfully closed items between users on
eBay’s trading platforms during the quarter, regardless of
whether the buyer and seller actually consummated the
transaction.
(6)
Cumulative total of all personal, premier, or business accounts
opened, excluding accounts that have been closed or locked and
the payment gateway business accounts, and including users who
made payments using PayPal but have not registered.
(7)
All accounts, and users whether registered or not, that sent or
received at least one payment through the PayPal system during
the quarter.
(8)
Total number of payments initiated through the PayPal system
during the quarter, excluding the payment gateway business,
regardless of whether the payment was actually sent
successfully, or was reversed, rejected, or pending at the end
of the quarter.
(9)
Total dollar volume of payments initiated through the PayPal
system during the quarter, excluding the payment gateway
business, regardless of whether the payment was actually sent
successfully, or was reversed, rejected, or was pending at the
end of the quarter.
(10)
Communications registered users represent the cumulative total
of all users who have completed the Skype registration process.
The U.S. Marketplaces segment includes our
U.S. marketplaces commerce platforms, other than our PayPal
subsidiary. The International Marketplaces segment includes our
international marketplaces commerce platforms excluding our
PayPal and Skype subsidiaries. The Payments segment consists of
our global payments platform operated by our PayPal subsidiary.
The Communications segment consists of our VoIP offerings from
our Skype subsidiary subsequent to our acquisition of Skype on
October 14, 2005.
Our net revenues result from fees associated with our
transaction, referral fees, advertising and other services in
our U.S. Marketplaces, International Marketplaces,
Payments, and Communications segments. Net transaction revenues
are derived primarily from listing, feature and final value fees
paid by sellers and fees from payment processing services. Net
revenues from advertising are derived principally from the sale
of banner and sponsorship advertisements for cash and through
barter arrangements. Other non-transaction net revenues are
derived principally from contractual arrangements with third
parties that provide transaction services to eBay and PayPal
users.
The successive year-over-year growth in net revenues from 2003
through 2005 was primarily the result of increased auction and
fixed-price transaction activity, reflected in the growth in the
number of our confirmed registered users, user activity,
listings, gross merchandise volume and payment transactions
processed by PayPal.
eBay Marketplaces Net Transaction Revenues
Total net transaction revenues from the U.S. and International
Marketplaces segments in aggregate increased 36% in 2005, 48% in
2004, and 66% in 2003, compared to the respective prior year.
The growth in both U.S. Marketplaces and International
Marketplaces segment net transaction revenues was primarily the
result of increased auction transaction activity, reflected in
the growth of the number of registered users, active users,
listings and gross merchandise volume. Gross merchandise volume
from the U.S. and International Marketplaces segments together
increased 30% in 2005, 44% in 2004 and 60% in 2003, compared to
the respective prior year. U.S. and International Marketplaces
segment net transaction revenues as a percentage of user gross
merchandise volume was 7.7% for 2005, 7.3% for 2004, and 7.1%
for 2003. The increases in 2005 reflected the growth in both
domestic and international net transaction revenues due to
increased transaction activity, reflected in the growth of the
number of registered users, active users, listings and gross
merchandise volume and revenue transactions from our acquired
entities. The increases in 2004 and 2003 reflected increased
feature adoption and the impact of our fee increases implemented
in those years. In addition, there was gross merchandise volume
growth across all major categories, with the motors,
clothing & accessories, consumer electronics,
home & garden, books/movies/music, sports, and computer
categories having the most significant dollar impact.
The number of active users on the eBay platform increased 28%
during 2005 to 71.8 million at December 31, 2005.
Active users increased 36% during 2004 to 56.1 million at
December 31, 2004, from 41.2 million at
December 31, 2003. We believe that increases in user
activity are largely the result of our promotional efforts and
our emphasis on helping our user community be successful through
the introduction of new site features and functionality and
expanded trust and safety programs, in addition to our
international expansion.
The number of items listed on eBay’s trading platforms
increased 33% to 1.9 billion in 2005, from 1.4 billion
in 2004, and increased 45% in 2004 from 971.0 million in
2003. This percentage growth in listings was experienced across
our U.S. and, more significantly, our international platforms.
U.S. Marketplaces Segment
U.S. Marketplaces segment net transaction revenues
increased 30% in 2005, 31% in 2004, and 43% in 2003, compared to
the respective prior year. Gross merchandise volume from the
U.S. Marketplaces segment increased 19% in 2005, 27% in
2004 and 41% in 2003, respectively. Net transaction revenues
derived from the U.S. Marketplaces segment represented 39%
of the total net transaction revenues in 2005. For 2005, the
growth in our U.S. Marketplaces segments net transaction
revenues was primarily the result of continued strong
transaction activity and approximately $100 million in
revenues from our recent acquisitions. We expect net transaction
revenues from our U.S. Marketplaces segment to increase in
2006, but to decrease as a percentage of total eBay Marketplaces
net transaction revenues as the International Marketplaces
segment grows in significance. In addition, even as the
U.S. Marketplaces segment continues to grow in absolute
terms, we expect its growth rate in 2006 to be lower than that
of 2005.
International Marketplaces Segment
International Marketplaces segment net transaction revenues
increased 44% in 2005, 76% in 2004, and 121% in 2003, compared
to the respective prior year. International Marketplaces segment
net transaction revenues as a percentage of total net
transaction revenues was 38% in 2005, 36% in 2004 and 31% in
2003. Gross merchandise volume from the International
Marketplaces segment increased 42% in 2005, 70% in 2004, and
102% in 2003, compared to the respective prior year. For 2005,
the growth in our International Marketplaces segment net
transaction revenues, both in absolute terms and as a percentage
of total net
transaction revenues, was primarily the result of strong
performances in the United Kingdom and Germany, as well as
significant increases in certain of our less established
markets, particularly Australia, France and Italy. For 2004, the
growth in our International Marketplaces segment net transaction
revenues, both in absolute terms and as a percentage of total
net transaction revenues, was primarily the result of strong
performances in the United Kingdom, South Korea and Germany. The
relative strength of foreign currencies against the
U.S. dollar resulted in increased net revenues of
approximately $6.7 million during 2005, when compared to
the results if the weighted-average foreign currency exchange
rates used in the preparation of our 2004 consolidated financial
statements were used. Changes in foreign currency rates will
impact our operating results and, to the extent that the
U.S. dollar strengthens, our foreign currency denominated
net revenues will be negatively impacted. We expect that the
growth rates of our International Marketplaces segment
transaction net revenues will continue to decline in 2006,
although we expect such revenues to grow in significance
relative to our total eBay Marketplaces as we continue to
develop and deploy our global online commerce platform during
2006.
Payments Segment Net Transaction Revenues
Payments segment net transaction revenues increased 47% in 2005,
59% in 2004 and 360% in 2003, compared to the respective prior
year. Payments segment net transaction revenues as a percentage
of total net transaction revenues were 23% in 2005, 21% in 2004,
and 20% in 2003. The growth in our Payments segment net
transaction revenues, both in absolute terms and as a percentage
of total net transaction revenues is primarily the result of
increases in PayPal transaction volume driven by the growth in
both eBay Marketplaces and PayPal merchant services
transactions, and the higher penetration of PayPal in the eBay
Marketplaces.
During 2005, over $27.5 billion in total payment volume was
transacted on the PayPal platform as compared to
$18.9 billion during 2004. As of December 31, 2005,
PayPal had 96.2 million accounts, compared to
63.8 million accounts at December 31, 2004. Our
Payments segment net transaction revenues as a percentage of
total payment volume was 3.6% in 2005 and 2004. The growth in
Payments net transaction revenues was positively affected by
PayPal’s continued penetration of eBay Marketplaces
transactions in all countries, particularly in the United States
and the United Kingdom. Further, Payments net transaction
revenues have grown in connection with the increase in our eBay
Marketplaces gross merchandise volume during 2004 and 2005. The
relative strength of foreign currencies, primarily the Euro,
against the U.S. dollar, resulted in higher net revenues of
approximately $5.3 million during 2005 when compared to the
results if the weighted-average foreign currency exchange rates
used in the preparation of our 2004 consolidated financial
statements were used.
Net transaction revenues from the Payments segment earned
internationally totaled $364.5 million in 2005 and
$207.6 million in 2004, representing 36.4% and 30.5% of
total Payments segment net transaction revenue, respectively.
Changes in foreign currency rates will impact our operating
results and, to the extent that the U.S. dollar
strengthens, our foreign currency denominated net revenues will
be negatively impacted. We expect the Payments segment net
transaction revenues to increase in total during 2006 and for
net transaction revenues earned internationally to increase in
total and as a percentage of Payments net transaction revenues.
We also expect that the Payments segment net transaction
revenues will increase as a percentage of total net transaction
revenues in 2006.
Communications Segment Net Transaction Revenues
Communications net transaction revenues were $24.8 million
in 2005, which represents the revenue generated from VoIP
offerings from our recent acquisition of Skype on
October 14, 2005 through December 31, 2005. We expect
the Communications segment net transaction revenues to increase
in total and as a percentage of total net transactions revenues
during 2006. For revenue generating offerings, revenue is
recognized when the related offering is provided, or over the
offering period. The majority of revenue offerings are prepaid.
We record deferred revenue for the prepaid amounts in excess of
revenue recognized.
Advertising and Other Non-Transaction Net Revenues
Advertising and other non-transaction net revenues increased in
total in 2005 as compared to 2004 and remained consistent as a
percentage of revenue in 2005 as compared to 2004. Advertising
and other net revenues totaled $123.4 million in 2005,
$94.3 million in 2004 and $52.9 million in 2003. These
amounts as a percentage of total net revenues represented 3% in
2005 and 2004 and 2% in 2003. We continue to view our business
as primarily transaction driven and we expect advertising and
other net revenues to continue to represent a relatively small
proportion of total net revenues during 2006.
Cost of Net Revenues
Percent
Percent
2003
Change
2004
Change
2005
(In thousands, except percentages)
Cost of net revenues
$
416,058
48
%
$
614,415
33
%
$
818,104
As a percentage of net revenues
19.2
%
18.8
%
18.0
%
Cost of net revenues consists primarily of costs associated with
payment processing, site operations, and customer support.
Significant cost components include bank charges, credit card
interchange, other payment processing costs, employee
compensation and facilities costs for our customer support and
site operations, depreciation of equipment and amortization of
required capitalization of major site and product development
costs.
The increase in cost of net revenues during 2005 was primarily
due to an increase in the volume of transactions on the
Marketplaces and Payments websites and continued development and
expansion of our customer support and site operations
infrastructure. Payment processing costs increased to
$403.1 million in 2005 from $305.1 million in 2004,
due to the increase in PayPal’s total payment volume and
increased payment processing costs related to the growth of our
eBay Marketplaces activity. Aggregate customer support and site
operations costs increased approximately $88.4 million
during 2005, compared to the prior year. The decrease in cost of
net revenues as a percentage of net revenues was primarily due
to lower payment processing costs as a percentage of total
payment volume in our payments segments as compared to prior
periods. Costs of net revenues are expected to increase in total
and as a percentage of net revenues during 2006 primarily due to
the Payments and Communications businesses, each of which
currently has a lower gross margin than our traditional
marketplaces businesses.
The increase in cost of net revenues during 2004 was primarily
due to an increase in the volume of transactions on the PayPal
and eBay websites and continued development and expansion of our
customer support and site operations infrastructure. The
decrease in cost of net revenues as a percentage of net revenues
was primarily due to eBay’s Marketplace’s site
operations costs growing at a slower rate than net revenues.
Payment processing costs increased to $305.1 million in
2004 from $215.7 million in 2003, due to the increase in
PayPal’s total payment volume and increased payment
processing costs related to the growth of our eBay Marketplaces
activity. Aggregate customer support and site operations costs
increased $105.3 million during 2004, compared to the prior
year, and resulted primarily from an increase in headcount and
related employee costs and consultant costs of approximately
$37.1 million and increased facilities costs of
approximately $16.2 million. In addition, aggregate
depreciation of site equipment and amortization of capitalized
software development costs increased $36.0 million as
compared to 2003.
Sales and marketing expenses consist primarily of advertising,
tradeshow and other promotional costs, employee compensation for
our category development and marketing staff and certain trust
and safety programs.
Sales and marketing expenses increased in 2005 and increased as
a percentage of total net revenues due to our continued
investment in growing our global user base. Growth in
advertising and marketing costs as well as employee-related
costs comprised the majority of the increases. Combined
advertising and marketing costs increased $228.8 million in
2005, compared to the prior year. This increase, both in dollars
and as a percentage of net revenues, was primarily the result of
international expansion and industry-wide increases in Internet
marketing rates, partially offset by marketing efficiencies.
Employee-related costs increased by $97.4 million in 2005
as we continued to expand our domestic and international
operations. Sales and marketing expenses are expected to
increase in total and as a percentage of net revenues during
2006 due to the recent acquisition of Shopping.com which has
higher sales and marketing expenses as a percentage of net
revenues than our other businesses. In addition, our online
marketing expenses are expected to increase because of increases
in the volume of online advertising that we expect to purchase
in order to attract new customers and increased user activity on
our websites, including growth initiatives in sales and
marketing activities in our Marketplaces segments.
Sales and marketing expenses increased in 2004, but remained
consistent as a percentage of total net revenues due to our
continued investment in growing our user base and our
development of new media campaigns. Growth in advertising and
marketing costs as well as employee-related costs comprised the
majority of the increases. Combined advertising and marketing
costs increased $169.8 million in 2004, compared to the
prior year. This increase was primarily the result of our
internet marketing, domestic and international television, and
radio advertising campaigns as well as several category-focused
print campaigns. Employee-related costs increased by
$68.4 million in 2004 as we continued to expand our
domestic and international operations.
Product Development
Percent
Percent
2003
Change
2004
Change
2005
(In thousands, except percentages)
Product development
$
159,315
51
%
$
240,647
36
%
$
328,191
As a percentage of net revenues
7.4
%
7.4
%
7.2
%
Product development expenses consist primarily of employee
compensation, consultant 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, global billing, seller tools and payment gateway
projects. These capitalized costs totaled $37.1 million in
2005, $41.3 million in 2004 and $38.5 million in 2003,
and are reflected as a cost of net revenues when amortized in
future periods. We anticipate that we will continue to devote
significant resources to product development in the future as we
add new features and functionality to the Marketplaces, Payments
and Communications businesses.
The increase in product development expenses in 2005, as
compared to the prior year, was primarily the result of
increased headcount to support various platform development
initiatives in our Marketplaces, Payments and Communications
segments, domestically and internationally. Employee related
costs increased by $63.9 million compared to the prior
year. Our product development staff increased approximately 50%
from approximately 1,500 at December 31, 2004 to
approximately 2,200 at December 31, 2005. Product
development expenses are expected to increase in total and may
increase slightly as a percentage of net revenues in 2006, as we
develop new site features and functionality and continue to
improve and expand operations across all platforms.
The increase in product development expenses in 2004, as
compared to the prior year, was primarily the result of
increased headcount and consultant costs. The headcount growth
was focused on hiring new employees for various platform
development initiatives at eBay and PayPal in addition to our
international
expansion of both platforms. Our development staff increased
approximately 48% from approximately 1,000 at December 31,2003 to approximately 1,500 at December 31, 2004. In
addition, our consultant costs increased by approximately
$13.4 million.
General and Administrative
Percent
Percent
2003
Change
2004
Change
2005
(In thousands, except percentages)
General and administrative
$
332,668
25
%
$
415,725
42
%
$
591,716
As a percentage of net revenues
15.4
%
12.7
%
13.0
%
General and administrative expenses consist primarily of
employee compensation, provisions for transaction losses
associated with our Payments segment, depreciation of equipment,
provision for doubtful accounts, insurance and professional fees.
General and administrative expenses increased in total and
remained consistent as a percentage of net revenues in 2005, as
compared to the prior year. The dollar increase was due
primarily to employee related and facilities costs. Employee
related costs increased by approximately $111.3 million
during 2005 as compared to the prior year. We increased our
general and administrative employees from approximately 2,700 at
December 31, 2004 to approximately 4,200 at
December 31, 2005. This increase related primarily to the
addition of employees in our trust and safety and corporate
functions. Facilities costs increased by approximately
$48.2 million during 2005 as compared to the prior year.
PayPal’s transaction loss expense increased by
approximately $23.3 million, to $73.8 million during
the year ended December 31, 2005, reflecting the increase
in activity in the Payments segment in addition to the expansion
of our PayPal Buyer Protection Program. PayPal’s
transaction loss expense rate, which is the transaction loss
expense as a percentage of PayPal’s total payment volume,
was consistent at 0.27% in 2005 and 2004. With our continued
investment across all areas of our business and related
corporate functions, we expect general and administrative
expenses to increase during 2006, but decrease as a percentage
of revenue as our revenue base increases at a higher rate.
General and administrative expenses increased in total, but
decreased as a percentage of net revenues in 2004, as compared
to the prior year. The dollar increase was due primarily to
employee related costs, fees for external professional advisors,
including Sarbanes-Oxley compliance costs, and payment
transaction loss expenses. The increases in employee related
costs resulted from growth in the finance, human resource and
legal departments to meet the demands of our expanding business,
including growing international operations, increased regulatory
demands, and the integration of acquired businesses. We
increased our general and administrative employees from
approximately 1,900 at December 31, 2003 to approximately
2,700 at December 31, 2004. This increase related primarily
to the addition of employees in our trust and safety functions.
Consultant and employee related costs increased by approximately
$53.8 million during 2004 as compared to the prior year.
PayPal’s transaction loss expense increased by
approximately $14.1 million, to $50.5 million during
the year ended December 31, 2004, reflecting the increase
in activity in the Payments segment in addition to the expansion
of our PayPal Buyer Protection Program. PayPal’s
transaction loss expense rate, which is the transaction loss
expense as a percentage of PayPal’s total payment volume,
was 0.27% in 2004 compared to 0.30% in 2003. The decrease in
this percentage from 2003 to 2004 was offset in part by the
increase in coverage for our PayPal Buyer Protection Program.
Patent litigation expense of approximately $30 million
during 2003 has been included in general and administrative
expense and was related to the accrual of an August 6, 2003
court judgment resulting from the MercExchange patent
infringement lawsuit.
We are subject to employer payroll taxes on employee gains from
the exercise of non-qualified stock options. These employer
payroll taxes are recorded as a charge to operations in the
period in which such options are exercised and sold based on
actual gains realized by employees. The fluctuation in each
respective year was primarily the result of the extent of
employee gains recognized on stock option exercises. Our results
of operations and cash flows could vary significantly depending
on the actual period that stock options are exercised by
employees and, consequently, the amount of employer payroll
taxes assessed. In general, we expect payroll taxes on employee
stock option gains to increase during periods in which our stock
price is high relative to historic levels.
Amortization of Acquired Intangible Assets
Percent
Percent
2003
Change
2004
Change
2005
(In thousands, except percentages)
Amortization of acquired intangible assets
$
50,659
30
%
$
65,927
96
%
$
128,941
As a percentage of net revenues
2.3
%
2.0
%
2.8
%
From time to time we have purchased, and we expect to continue
purchasing, assets or businesses to accelerate category and
geographic expansion increase the features, functions, and
formats available to our users and maintain a leading role in
online e-commerce.
These purchase transactions generally result in the creation of
acquired intangible assets and lead to a corresponding increase
in the amortization expense in future periods. The increase in
amortization of acquired intangibles during 2005 compared to
prior years is due to the business acquisitions consummated
during 2004 and 2005.
Intangible assets include purchased customer lists and user
base, trademarks and trade names, developed technologies, and
other intangible assets. We amortize intangible assets,
excluding goodwill, over the period of estimated benefit, using
the straight-line method and estimated useful lives ranging from
one to eight years.
Goodwill represents the excess of the purchase price over the
fair value of the net tangible and identifiable intangible
assets acquired in a business combination. We evaluate goodwill,
at a minimum, on an annual basis and whenever events and changes
in circumstances suggest that the carrying amount may not be
recoverable. Impairment of goodwill is tested at the reporting
unit level by comparing the reporting unit’s carrying
amount, including goodwill, to the fair value of the reporting
unit. The fair values of the reporting units are estimated using
a combination of the income, or discounted cash flows, approach
and the market approach, which utilizes comparable
companies’ data. If the carrying amount of the reporting
unit exceeds its fair value, goodwill is considered impaired and
a second step is performed to measure the amount of impairment
loss, if any. Our annual impairment test was carried out as of
August 31, 2005 and we determined that there was no
impairment. There were no events or circumstances from that date
through December 31, 2005 that would impact this assessment.
We expect amortization of acquired intangible assets to increase
in 2006 as a result of the intangible assets associated with our
2005 acquisitions. Amortization of acquired intangible assets
may increase should we make additional acquisitions in the
future.
Interest and other income, net consists primarily of interest
earned on cash, cash equivalents and investments as well as
foreign exchange transaction gains and losses and other
non-operating transactions.
Our interest and other income, net increased in total and
remained consistent as a percentage of net revenues during 2005
as compared to the prior year, primarily as a result of
increased interest income due to increased cash, cash
equivalents and investments balances and higher interest rates.
The weighted-average interest rate of our portfolio increased to
2.9% in 2005 from 1.7% in 2004. We expect that interest and
other income, net, will remain consistent during 2006 compared
to 2005, excluding the potential effects from our recent and
future acquisitions.
Our interest and other income, net increased in total and as a
percentage of net revenues during 2004 as compared to 2003,
primarily as a result of gains from the sale of an equity
investment and amendments to certain sublease agreements. In
addition, we recorded increased interest income primarily due to
higher investment balances, and increased cash and cash
equivalents balances. The weighted-average interest rate of our
portfolio increased to 1.7% in 2004 from 1.6% in 2003. During
2003 we recorded impairment charges totaling $1.2 million
within interest and other income, net.
Interest Expense
Percent
Percent
2003
Change
2004
Change
2005
(In thousands, except percentages)
Interest expense
$
4,314
106
%
$
8,879
(61
)%
$
3,478
As a percentage of net revenues
0.2
%
0.3
%
0.1
%
Interest expense consists of interest charges on our
consolidated lease arrangement related to our San Jose
headquarters office facilities, capital leases, and mortgage
notes.
In January 2003, the FASB issued FIN 46,
“Consolidation of Variable Interest Entities.” In
accordance with the provisions of this standard, we included our
San Jose headquarters lease arrangement in our consolidated
financial statements effective July 1, 2003. Beginning
July 1, 2003, our consolidated statement of income
reflected the reclassification of lease payments on our
San Jose headquarters office facilities from operating
expense to interest expense. The increase in interest expense
during 2004 was primarily the result of the inclusion of these
interest payments for the full year 2004. Interest expense
decreased during 2005 primarily due to the payment of the lease
obligation of our San Jose headquarters facility on
March 1, 2005. We expect our interest expense will decrease
both in total and as a percentage of net revenue during 2006.
Provision for Income Taxes
Percent
Percent
2003
Change
2004
Change
2005
(In thousands, except percentages)
Provision for income taxes
$
206,738
66
%
$
343,885
36
%
$
467,285
As a percentage of net revenues
9.5
%
10.5
%
10.3
%
Effective tax rate
32
%
30
%
30
%
The provision for income taxes differs from the amount computed
by applying the statutory U.S. federal rate principally due
to state taxes, subsidiary losses for which we have not provided
a benefit and other factors
that increase the effective tax rate, offset by decreases
resulting from foreign income with lower effective tax rates and
tax credits.
The lower effective tax rates in 2005 and 2004 as compared to
2003 reflect the increasing profit contribution from our
international operations that are subject to lower tax rates.
Minority Interests
Percent
Percent
2003
Change
2004
Change
2005
(In thousands, except percentages)
Minority interests
$
(7,578
)
19
%
$
(6,122
)
(99
)%
$
(49
)
As a percentage of net revenues
0.4
%
0.2
%
0.0
%
Minority interests represents the minority investors’
percentage share of income or losses from subsidiaries in which
we hold a majority ownership interest and consolidate the
subsidiaries’ results in our financial statements. Third
parties held minority interests in various of our subsidiaries
during 2003, 2004 and 2005.
The changes in minority interests in 2004 and 2005 were due
primarily to our acquisition of a 38% additional ownership
interest in Internet Auction during 2004, which brought our
ownership to over 99%.
Cumulative Effect of Change in Accounting Principle
In accordance with the provisions of FIN 46,
“Consolidation of Variable Interest Entities,” we
included our San Jose headquarters lease arrangement in our
consolidated financial statements effective July 1, 2003.
Our consolidated statement of income for the year ended
December 31, 2003 reflected the reclassification of lease
payments on our San Jose headquarters from operating
expense to interest expense, beginning with the quarters
following our adoption of FIN 46 on July 1, 2003, a
$5.4 million after-tax charge for cumulative depreciation
for periods from lease inception through June 30, 2003, and
incremental depreciation expense of approximately $400,000, net
of tax, per quarter for periods after June 30, 2003. We
adopted the provisions of FIN 46 prospectively from
July 1, 2003, and as a result, did not restate prior
periods. The cumulative effect of the change in accounting
principle arising from the adoption of FIN 46 was reflected
in net income in 2003. As of December 31, 2004, we had
$126.4 million included within current restricted cash and
investments relating to our San Jose headquarters lease
facility lease arrangement, which had effectively provided us
with full ownership rights to these facilities. In February
2004, we elected not to extend the lease period, which required
us to purchase the facility on March 1, 2005. We utilized
the $126.4 million related restricted cash and investments
to complete the purchase of the facility.
Impact of Foreign Currency Translation
During 2005, our international net revenues, based upon the
country in which the seller, payment recipient, advertiser or
other service provider is located, accounted for approximately
46% of our consolidated net revenues, as compared to 42% of our
net revenues in 2004 and 35% of our net revenues in 2003. The
growth in our international operations has increased our
exposure to foreign currency fluctuations. Net revenues and
related expenses generated from international locations are
denominated in the functional currencies of the local countries,
and include Euros, British pounds, Korean won, Canadian dollars,
Taiwanese dollars, Australian dollars, Chinese renminbi, and
Indian rupee. The results of operations and certain of our
inter-company balances associated with our international
locations are exposed to foreign exchange rate fluctuations. The
statements of income of our international operations are
translated into U.S. dollars at the average exchange rates
in each applicable period. To the extent the U.S. dollar
weakens against foreign currencies, the translation of these
foreign currency denominated transactions results in increased
consolidated net revenues, operating expenses and net income.
During 2005, the U.S. dollar weakened against most of the
foreign currencies listed above. Using the weighted-average
foreign currency exchange rates from 2004, our net revenues for
2005 would have been lower than reported using the actual
exchange rates for 2005 by approximately $12.0 million. In
addition, if
the weighted-average foreign currency exchange rates from 2004
were applied to our cost of revenues and operating expenses for
2005, these costs of revenues and operating expenses would have
been lower in total than reported using the actual exchange
rates for 2005 by approximately $5.6 million. The majority
of this impact relates to the relative strength of the Euro
against the U.S. dollar.
We expect our international operations will continue to grow in
significance as we develop and deploy our global marketplaces
and global payments platform. As a result, the impact of foreign
currency fluctuations in future periods could become more
significant and may have a negative impact on our consolidated
net revenues and net income in the event the U.S. dollar
strengthens relative to other currencies. See the information in
Item 7A under “Foreign Currency Risk” for
additional discussion of the impact of foreign currency
translation and related hedging activities.
Foreign Exchange Hedging Policy
We are a rapidly growing company, with an increasing proportion
of our operations outside the United States. Accordingly, our
foreign currency exposures have increased substantially and are
expected to continue to grow. The objective of our foreign
exchange exposure management program is 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.
Our primary foreign currency exposures are transaction, economic
and translation:
Transaction Exposure: Around the world, we have certain
assets and liabilities, primarily receivables, investments and
accounts payable (including inter-company transactions) that are
denominated in currencies other than the relevant entity’s
functional currency. In certain circumstances, changes in the
functional currency value of these assets and liabilities create
fluctuations in our reported consolidated financial position,
results of operations and cash flows. We may enter into foreign
exchange forward contracts or other instruments to minimize the
short-term foreign currency fluctuations on such assets and
liabilities. The gains and losses on the foreign exchange
forward contracts offset the transaction gains and losses on
certain foreign currency receivables, investments and payables
recognized in earnings.
Economic Exposure: We also have anticipated and
unrecognized future cash flows, including revenues and expenses,
denominated in currencies other than the relevant entity’s
functional currency. Our primary economic exposures include
future royalty receivables, customer collections, and vendor
payments. Changes in the relevant entity’s functional
currency value will cause fluctuations in the cash flows we
expect to receive when these cash flows are realized or settled.
We may enter into foreign exchange forward contracts or other
derivatives to hedge the value of a portion of these cash flows.
We account for these foreign exchange contracts as cash flow
hedges. The effective portion of the derivative’s gain or
loss is initially reported as a component of accumulated other
comprehensive income (loss) and subsequently reclassified into
earnings when the transaction is settled.
Earnings Translation Exposure: As our international
operations grow, fluctuations in the foreign currencies create
volatility in our reported results of operations because we are
required to consolidate the results of operations of our foreign
denominated subsidiaries. We may decide to purchase forward
exchange contracts or other instruments to offset the earnings
impact of currency fluctuations. Such contracts will be
marked-to-market on a
monthly basis and any unrealized gain or loss will be recorded
in interest and other income, net.
Employee Stock Options
We continue to believe that employee stock options represent an
appropriate and essential component of our overall compensation
program. We grant options to substantially all employees and
believe that this broad-based program helps us to attract,
motivate, and retain high quality employees, to the ultimate
benefit of our stockholders. Stock options granted during the
year ended December 31, 2005, net of cancellations,
represented approximately 2% of our total common stock
outstanding as of December 31, 2005. This represented a
decrease from the approximately 3% of total common stock
outstanding as of December 31,
2004 represented by stock options granted, net of cancellations,
during the year ended December 31, 2004. A substantial
portion of our stock options granted during the year were
granted to new employees.
Recent Accounting Pronouncements
Share-Based Payment
In December 2004, the FASB issued Statement of Financial
Accounting Standards No. 123 (revised 2004),
“Share-Based Payment” (FAS 123R) that addresses
the accounting for share-based payment transactions in which an
enterprise receives employee services in exchange for either
equity instruments of the enterprise or liabilities that are
based on the fair value of the enterprise’s equity
instruments or that may be settled by the issuance of such
equity instruments. The statement eliminates the ability to
account for share-based compensation transactions, as we do
currently, using the intrinsic value method prescribed by
Accounting Principles Board, or APB, Opinion No. 25,
“Accounting for Stock Issued to Employees,” and
generally requires that such transactions be accounted for using
a fair-value-based method and recognized as expenses in our
consolidated statement of income. The statement requires
companies to assess the most appropriate model to calculate the
value of the options. We currently use the Black-Scholes option
pricing model to value options and are currently assessing which
model we may use in the future under the new statement and may
deem an alternative model to be more appropriate. The use of a
different model to value options may result in a different fair
value than the use of the Black-Scholes option pricing model. In
addition, there are a number of other requirements under the new
standard that would result in differing accounting treatment
than currently required. These differences include, but are not
limited to, the accounting for the tax benefit on employee stock
options and for stock issued under our employee stock purchase
plan, and the presentation of these tax benefits within the
consolidated statement of cash flows. In addition to the
appropriate fair value model to be used for valuing share-based
payments, we will also be required to determine the transition
method to be used at date of adoption. The allowed transition
methods are the prospective and retroactive adoption
alternatives. The prospective method requires that compensation
expense be recorded for all unvested stock options and
restricted stock at the beginning of the first quarter of
adoption of FAS 123R, while the retroactive method requires
companies to record compensation expense for all unvested stock
options and restricted stock beginning with the first disclosed
period restated.
In April 2005, the Securities and Exchange Commission announced
the adoption of a new rule that amends the effective date of
FAS 123R. The effective date of the new standard under
these new rules for our consolidated financial statements is
January 1, 2006. Adoption of this statement will have a
significant impact on our consolidated financial statements as
we will be required to expense the fair value of our stock
option grants and stock purchases under our employee stock
purchase plan rather than disclose the impact on our
consolidated net income within our footnotes, as is our current
practice (see “Note 1 — The Company and
Summary of Significant Accounting Policies” of the notes to
the condensed consolidated financial statements contained
herein).
The amounts disclosed within our footnotes are not necessarily
indicative of the amounts that will be expensed upon the
adoption of FAS 123R. We expect the compensation charges
under FAS 123R to reduce earnings per diluted share by
approximately $0.16 to $0.17 per share for the year
ending December 31, 2006. Compensation expense calculated
under FAS 123R may differ from amounts currently disclosed
within our footnotes and may differ from our expectations based
on changes in the fair value of our common stock, changes in the
number of options granted or the terms of such options, the
treatment of tax benefits, and changes in interest rates or
other factors. In addition, upon adoption of FAS 123R, we
may choose to use a different valuation model to value the
compensation expense associated with employee stock options and
stock purchases under our employee stock purchase plan.
Effect of exchange rates on cash and cash equivalents
28,757
28,768
(45,231
)
Net increase (decrease) in cash and cash equivalents
$
272,200
$
(51,468
)
$
(16,465
)
We have generated annual cash provided by operating activities
in amounts greater than net income in 2003, 2004 and 2005 due
primarily to the tax benefit on the exercise of employee stock
options and non-cash charges to earnings. Non-cash charges to
earnings included depreciation and amortization on our long-term
assets, provision for doubtful accounts and authorized credits
resulting from increasing revenues and the provision for
transaction losses resulting from increased total payment
volumes processed by our PayPal subsidiary. In 2005 and 2003,
operating cash flows were also positively impacted by the net
cash amounts provided by year-over-year changes in working
capital assets and liabilities.
The net cash used in investing activities in 2003, 2004 and 2005
reflected primarily the movement of cash and cash equivalents
between cash and cash equivalents and investments, the purchase
of property and equipment, and acquisitions. Purchases of
property and equipment, net totaled $338.3 million in 2005,
$292.8 million in 2004, and $365.4 million in 2003.
Purchases of property and equipment in 2005 and 2004 related
mainly to purchases of computer equipment and software to
support our site operations, customer support and international
expansion. In 2003, purchases of property and equipment included
the $125.1 million purchase of additional office space in
San Jose, California. Purchases of property and equipment
in 2003 also included amounts for improvements to various
facilities in the U.S. and around the world as well as computer
equipment and software to support our site operations, customer
support and international expansion. Cash expended for
acquisitions, net of cash acquired, totaled approximately
$2.7 billion in 2005, $1.0 billion in 2004 and
$216.4 million in 2003. In 2005, net cash payments for
acquisitions consisted primarily of the cash payment, net of
cash acquired for the acquisition of Rent.com, certain
international classifieds websites, Shopping.com, Skype and the
payment gateway business acquired from VeriSign. In 2004, our
cash acquisitions included the acquisition of mobile.de,
Baazee.com, and Marktplaats.nl, as well as an additional
ownership interest in Internet Auction Co. Our cash acquisitions
in 2003 included acquiring the remaining ownership interest in
EachNet and an additional ownership interest in Internet Auction
Co.
The net cash flows provided by financing activities in 2003,
2004 and 2005 were due primarily to proceeds from stock option
exercises. Proceeds from stock option exercises totaled
$599.8 million in 2005, $650.6 million in 2004, and
$700.8 million in 2003. Our future cash flows from stock
options are difficult to project as such amounts are a function
of our stock price, the number of options outstanding and the
decisions by employees to exercise stock options. In general, we
expect proceeds from stock option exercises to increase during
periods in which our stock price has increased relative to
historical levels.
The negative effect of exchange rates on cash and cash
equivalents during 2005 was due to the weakening of the
U.S. dollar against other foreign currencies, primarily the
Euro. The positive effect of exchange rates on cash and cash
equivalents during 2004 and 2003 was due to the strengthening of
the U.S. dollar against other foreign currencies, primarily
the Euro.
We believe that existing cash, cash equivalents and investments,
together with any cash generated from operations, will be
sufficient to fund our operating activities, capital
expenditures and other obligations for the foreseeable future.
However, if during that period or thereafter we are not
successful in generating sufficient cash flows from operations
or in raising additional capital when required in sufficient
amounts and on terms acceptable to us, our business could suffer.
Commitments and Contingencies
We have certain fixed contractual obligations and commitments
that include future estimated payments. Changes in our business
needs, cancellation provisions, changing interest rates, and
other factors may result in actual payments differing from the
estimates. We cannot provide certainty regarding the timing and
amounts of payments. We have presented below a summary of the
most significant assumptions used in our determination of
amounts presented in the tables, in order to assist in the
review of this information within the context of our
consolidated financial position, results of operations, and cash
flows. The following table summarizes our fixed contractual
obligations and commitments (in thousands):
Other
Operating
Purchase
Payments Due By Year Ending December 31,
Leases
Obligations
Total
2006
$
22,988
$
324,237
$
347,225
2007
19,455
33,893
53,348
2008
17,141
15,014
32,155
2009
15,259
3,533
18,792
2010
12,035
2,374
14,409
Thereafter
53,287
—
53,287
$
140,165
$
379,051
$
519,216
Operating lease amounts include minimum rental payments under
our non-cancelable operating leases for office facilities, as
well as limited computer and office equipment that we utilize
under lease arrangements. The amounts presented are consistent
with contractual terms and are not expected to differ
significantly, unless a substantial change in our headcount
needs requires us to exit an office facility early or expand our
occupied space.
Other purchase obligation amounts include minimum purchase
commitments for advertising, computer equipment, software
applications, engineering development services and other goods
and services that were entered into through our ordinary course
of business. For those contractual arrangements in which there
are significant performance requirements, we have developed
estimates to project expected payment obligations. These
estimates have been developed based upon historical trends, when
available, and our anticipated future obligations. Given the
significance of such performance requirements within our
advertising and other arrangements, actual payments could differ
significantly from these estimates.
In conjunction with our Skype acquisition, in addition to the
initial consideration that has already been paid to former Skype
shareholders, we have certain earn-out payments that are
contingent upon Skype achieving certain net revenue, gross
profit margin-based targets and active user targets. See
“Note 3 — Business Combinations, Goodwill
and Intangible Assets” of the consolidated financial
statements included elsewhere in this Annual Report on Form
10-K.
Off-Balance Sheet Arrangements
As of December 31, 2005, 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 changes, results of operations, liquidity, capital
expenditures or capital resources.
In the ordinary course of business we have included limited
indemnification provisions in certain of our agreements with
parties with whom we have commercial relations, including our
standard marketing, promotions and
application-programming-interface license agreements. Under
these contracts, we generally indemnify, hold harmless, and
agree to reimburse the indemnified party for losses suffered or
incurred by the indemnified party in connection with claims by
any third party with respect to 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, including agreements under which
we have developed technology for certain commercial parties, we
have provided an indemnity for other types of third-party
claims, substantially all of which are indemnities related to
our copyrights, trademarks, and patents. To date, no significant
costs have been incurred, either individually or collectively,
in connection with our indemnification provisions.
Critical Accounting Policies, Judgments and Estimates
General
The preparation of our consolidated financial statements and
related notes requires us to make judgments, estimates and
assumptions that affect the reported amounts of assets,
liabilities, revenue and expenses, and related disclosure of
contingent assets and liabilities. We have based our estimates
on historical experience and on various other assumptions that
are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the
carrying values of assets and liabilities that are not readily
apparent from other sources. Our senior management has discussed
the development, selection and disclosure of these estimates
with the Audit Committee of our Board of Directors. Actual
results may differ from these estimates under different
assumptions or conditions.
An accounting policy is considered to be critical if it requires
an accounting estimate to be made based on assumptions about
matters that are highly uncertain at the time the estimate is
made, and if different estimates that reasonably could have been
used, or changes in the accounting estimates that are reasonably
likely to occur periodically, could materially impact the
consolidated financial statements. We believe the following
critical accounting policies reflect the more significant
estimates and assumptions used in the preparation of the
consolidated financial statements. The following descriptions of
critical accounting policies, judgments and estimates should be
read in conjunction with our consolidated financial statements
and other disclosures included in this report.
Provisions for Doubtful Accounts and Authorized
Credits
Our U.S. Marketplaces and International Marketplaces
segments are exposed to losses due to uncollectible accounts and
credits to sellers. Provisions for these items represent our
estimate of actual losses and credits based on our historical
experience, are monitored monthly, and are made at the time the
related revenue is recognized. The provision for doubtful
accounts is recorded as a charge to operating expense, while the
authorized credits are recorded as a reduction of revenues. The
following table illustrates the provision related to doubtful
accounts and authorized credits as a percentage of net revenues
for 2003, 2004, and 2005 (in thousands, except percentages).
Net revenues from the U.S. and International segments
$
1,727,474
$
2,573,607
$
3,499,137
Doubtful accounts and authorized credits
$
46,049
$
90,942
$
89,499
Provision for doubtful accounts and authorized credits as a % of
net revenues from the U.S. and International segments
2.67
%
3.53
%
2.56
%
Historically, our actual losses and credits have been consistent
with these provisions. However, future changes in trends could
result in a material impact to future consolidated statements of
income and cash flows.
Based on our results for the year ended December 31, 2005,
a 25 basis point deviation from our estimates would have
resulted in an increase or decrease in operating income of
approximately $8.7 million. The following analysis
demonstrates, for illustrative purposes only, the potential
effect a 25 basis point deviation from our estimates would
have upon our consolidated financial statements and is not
intended to provide a range of exposure or expected deviation
(in thousands, except per share data):
-25 Basis
+25 Basis
Points
2005
Points
Expense related to doubtful accounts and revenue reduction
related to authorized credits
$
80,751
$
89,499
$
98,247
Income from operations
1,450,455
1,441,707
1,432,959
Net income
1,090,791
1,082,043
1,073,295
Diluted earnings per share
$
0.78
$
0.78
$
0.77
Provision for Transaction Losses
Our Payments segment is exposed to transaction losses due to
credit card and other payment misuse, as well as non-performance
of sellers who accept payment through PayPal. We establish
allowances for estimated losses arising from processing customer
transactions, such as charge-backs for unauthorized credit card
use and merchant-related charge-backs due to non-delivery of
goods or services, Automated Clearing House, or ACH, returns,
buyer protection program claims and debit card overdrafts. These
allowances represent an accumulation of the estimated amounts,
necessary to provide for transaction losses incurred as of the
reporting date, including those of which we have not yet been
notified. The allowances, which involve the use of actuarial
techniques, are monitored monthly and are updated based on
actual claims data reported by our claims processors. The
allowances are based on known facts and circumstances, internal
factors including our experience with similar cases, historical
trends involving loss payment patterns and the mix of
transaction and loss types. The provision for transaction losses
is reflected as a general and administrative expense in our
consolidated statement of income. At December 31, 2005, the
allowance for transaction losses totaled $20.2 million and
was included in accrued expenses and other current liabilities
in our consolidated balance sheet.
The following table illustrates the provision for transaction
losses as a percentage of total payment volume from PayPal
operations for the years ended December 31, 2003, 2004 and
2005 (in thousands, except percentages).
The establishment of appropriate allowances for transaction
losses is an inherently uncertain process, and ultimate losses
may vary from the current estimates. We regularly update our
allowance estimates as new facts become known and events occur
that may impact the settlement or recovery of losses. The
allowances are maintained at a level we deem appropriate to
adequately provide for losses incurred at the balance sheet
date. Based on our results for the year ended December 31,2005, a five basis point deviation from our estimates would have
resulted in an increase or decrease in our operating expenses of
approximately $13.7 million. The following analysis
demonstrates, for illustrative purposes only, the potential
effect a five basis point deviation from our estimates would
have upon our consolidated financial statements for the year
ended December 31,
2005, and is not intended to provide a range of exposure or
expected deviation (in thousands, except per share data):
-5 Basis
+5 Basis
Points
2005
Points
Transaction loss expense
$
60,030
$
73,773
$
87,516
Income from operations
1,455,450
1,441,707
1,427,964
Net income
1,095,786
1,082,043
1,068,300
Diluted earnings per share
$
0.79
$
0.78
$
0.77
Legal Contingencies
In connection with certain pending litigation and other claims,
we have estimated the range of probable loss and provided for
such losses through charges to our consolidated statement of
income. These estimates have been based on our assessment of the
facts and circumstances at each balance sheet date and are
subject to change based upon new information and future events.
From time to time, we are involved in disputes that arise in the
ordinary course of business, and we do not expect this trend to
change in the future. We are currently involved in certain legal
proceedings as discussed in “Item 3: Legal
Proceedings” and “Note 8 — Commitments
and Contingencies — Litigation and Other Legal
Matters” to our consolidated financial statements included
elsewhere in this Annual Report on
Form 10-K. We
believe that we have meritorious defenses to the claims against
us, and we will defend ourselves vigorously. However, even if
successful, our defense against certain actions will be costly
and could divert our management’s time. If the plaintiffs
were to prevail on certain claims, we might be forced to pay
significant damages and licensing fees, modify our business
practices or even be prohibited from conducting a significant
part of our business. Any such results could materially harm our
business and could result in a material adverse impact on the
financial position, results of operations or cash flows of all
or any of our three segments.
Accounting for Income Taxes
We are required to recognize a provision for income taxes based
upon the taxable income and temporary differences for each of
the tax jurisdictions in which we operate. This process requires
a calculation of taxes payable under currently enacted tax laws
around the world and an analysis of temporary differences
between the book and tax bases of our assets and liabilities,
including various accruals, allowances, depreciation and
amortization. The tax effect of these temporary differences and
the estimated tax benefit from our tax net operating losses are
reported as deferred tax assets and liabilities in our
consolidated balance sheet. We also assess the likelihood that
our net deferred tax assets will be realized from future taxable
income. To the extent we believe that it is more likely than not
that some portion, or all of, the deferred tax asset will not be
realized, we establish a valuation allowance. At
December 31, 2005, we have a valuation allowance on certain
foreign net operating losses based on our assessment that it is
more likely than not that the deferred tax asset will not be
realized. To the extent we establish a valuation allowance or
change the allowance in a period, we reflect the change with a
corresponding increase or decrease in our tax provision in our
consolidated statement of income. Where the change in the
valuation allowance relates to the tax deduction for employee
stock option exercises, the change is reflected in additional
paid-in capital. Beginning in 2006, any remaining deferred tax
asset related to stock option deductions will be recognized in
the periods when the benefit is received and, as such, a
valuation allowance will not be required.
Our U.S. businesses generate sufficient cash flow to fully fund
their operating requirements, and we expect that profits earned
outside the U.S. will be fully utilized to fund our continued
international expansion. Accordingly, we have not provided for
U.S. federal income and foreign withholding taxes on
non-U.S. subsidiaries’
undistributed earnings as of December 31, 2005, because
such earnings are intended to be reinvested indefinitely. In the
event that our future international expansion plans change and
such amounts are not reinvested indefinitely, we would be
subject to U.S. income taxes partially offset by foreign
tax credits.
Historically, these provisions have adequately provided for our
actual income tax liabilities. Our future effective tax rates
could be adversely affected by earnings being lower than
anticipated in countries where we have lower statutory rates and
higher than anticipated in countries where we have higher
statutory rates, by changes in the valuations of our deferred
tax assets or liabilities, or by changes or interpretations in
tax laws, regulations or accounting principles.
Based on our results for the year ended December 31, 2005,
a one-percentage point change in our provision for income taxes
as a percentage of income before taxes would have resulted in an
increase or decrease in the provision of approximately
$15.5 million. The following analysis demonstrates, for
illustrative purposes only, the potential effect such a
one-percentage point deviation change would have upon our
consolidated financial statements and is not intended to provide
a range of exposure or expected deviation (in thousands, except
per share data):
-100 Basis
+100 Basis
Points
2005
Points
Provision for income taxes
$
451,791
$
467,285
$
482,779
Income from operations
1,441,707
1,441,707
1,441.707
Net income
1,097,537
1,082,043
1,066,549
Diluted earnings per share
$
0.79
$
0.78
$
0.77
Advertising and Other Non-Transaction Revenues
A portion of our net revenues result from fees associated with
advertising and other non-transaction services in our
U.S. Marketplaces, International Marketplaces and Payments
segments. Net revenues from advertising are derived principally
from the sale of online banner and sponsorship advertisements
for cash and through barter arrangements. Other non-transaction
net revenues are derived principally from contractual
arrangements with third parties that provide transaction
services to eBay users and from offline services provided by
wholly-owned subsidiaries that were divested in the second half
of 2002. Advertising and other non-transaction net revenues,
including barter transactions, totaled 2%, 3% and 3% of our
consolidated net revenues for the years ended December 31,2003, 2004 and 2005, respectively, and were primarily generated
by our U.S. Marketplaces segment. Revenue from barter
arrangements totaled $10.1 million in 2003,
$13.3 million in 2004 and $6.7 million in 2005.
Certain judgments are involved in the determination of the
appropriate revenue recognition, including, but not limited to,
the assessment and allocation of fair values in multiple element
arrangements, the appropriateness of gross or net revenue
recognition and, for barter transactions, the existence of
comparable cash transactions to establish fair values. Our
advertising and other non-transaction net revenues may be
affected by the financial condition of the parties with whom we
have these relationships and by the success of online services
and promotions in general. Unlike our transaction revenues,
advertising and other non-transaction net revenues are derived
from a relatively concentrated customer base.
Business Combinations
The purchase price of an acquired company is allocated between
intangible assets and the net tangible assets of the acquired
business with the residual of the purchase price recorded as
goodwill. The determination of the value of the intangible
assets acquired involves certain judgments and estimates. These
judgments can include, but are not limited to, the cash flows
that an asset is expected to generate in the future and the
appropriate weighted average cost of capital.
At December 31, 2005 our goodwill totaled $6.1 billion
and our identifiable intangible assets totaled
$823.3 million. We assess the impairment of goodwill and
identifiable intangible assets of our reportable units annually,
or more often if events or changes in circumstances indicate
that the carrying value may not be recoverable. This assessment
is based upon a discounted cash flow analysis and analysis of
our market capitalization. The estimate of cash flow is based
upon, among other things, certain assumptions about expected
future operating performance and an appropriate discount rate
determined by our management. Our estimates of discounted cash
flows may differ from actual cash flows due to, among other
things, economic conditions, changes to its business model or
changes in operating performance. Significant differences
between these estimates and actual cash flows could materially
affect our future financial results. We completed our annual
goodwill impairment test as of August 31, 2005 and
determined that no adjustment to the carrying value of goodwill
for any of our reportable units was required. We have determined
that no events or circumstances from that date through
December 31, 2005 indicate that a further assessment was
necessary.
ITEM 7A: QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 securities,
including government and corporate securities and money market
funds. These securities are generally classified as available
for sale and consequently are recorded on the balance sheet at
fair value with unrealized gains or losses reported as a
separate component of accumulated other comprehensive income
(loss), net of estimated tax.
Investments in both fixed-rate and floating-rate
interest-earning instruments carry varying degrees of interest
rate risk. The fair market value of our fixed-rate securities
may be adversely impacted due to a rise in interest rates. In
general, securities with longer maturities are subject to
greater interest-rate risk than those with shorter maturities.
While floating rate securities generally are subject to less
interest-rate risk than fixed-rate securities, floating-rate
securities may produce less income than expected if interest
rates decrease. Due in part to these factors, our investment
income may fall short of expectations or we may suffer losses in
principal if securities are sold that have declined in market
value due to changes in interest rates. As of December 31,2005, our fixed-income investments earned a pretax yield of
approximately 3.3%, with a weighted average maturity of three
months. If interest rates were to instantaneously increase
(decrease) by 100 basis points, the fair market value of
our total investment portfolio could decrease (increase) by
approximately $6.3 million.
Equity Price Risk
We are exposed to equity price risk on the marketable portion of
equity instruments and equity method investments we hold,
typically as the result of strategic investments in third
parties that are subject to considerable market risk due to
their volatility. We typically do not attempt to reduce or
eliminate our market exposure in these equity investments. We
did not record an impairment charge during either of the years
ended December 31, 2005 or 2004 relating to the
other-than-temporary impairment in the fair value of equity
investments. At December 31, 2005, the total carrying value
of our equity instruments and equity method investments was
$51.9 million.
Foreign Currency Risk
International net revenues result from transactions by our
foreign operations and are typically denominated in the local
currency of each country. These operations also incur most of
their expenses in the local currency. Accordingly, our foreign
operations use the local currency, which is primarily the Euro,
and to a lesser extent, the British pound, as their functional
currency. Our international operations are subject to risks
typical of international operations, including, but not limited
to, differing economic conditions, changes in political climate,
differing tax structures, other regulations and restrictions,
and foreign exchange rate volatility. Accordingly, our future
results could be materially adversely impacted by changes in
these or other
factors. In addition, at December 31, 2005, we held
balances in cash, cash equivalents and investments outside the
U.S. totaling approximately $0.8 billion.
During 2005, the U.S. dollar weakened against most of the
foreign currencies listed above. Using the weighted-average
foreign currency exchange rates from 2004, our net revenues for
2005 would have been lower than reported using the actual
exchange rates for 2005 by approximately $12.0 million, of
which $6.7 million and $5.3 million relate to our
International Marketplaces and Payments segments, respectively.
In addition, if the weighted-average foreign currency exchange
rates from 2004 were applied to our cost of revenues and
operating expenses for 2005, these costs of revenues and
operating expenses would have been lower in total than reported
using the actual exchange rates for 2005 by approximately
$5.6 million. The majority of this impact relates to the
relative strength of the Euro against the U.S. dollar.
Transaction Exposure:
As of December 31, 2005, we had outstanding forward foreign
exchange hedge contracts with notional values equivalent to
approximately $151.5 million with maturity dates within
31 days. The hedge contracts are used to offset changes in
the functional currency value of assets and liabilities
denominated in foreign currencies as a result of currency
fluctuations. Transaction gains and losses on the contracts and
the assets and liabilities are recognized each period in our
consolidated statement of income.
Translation Exposure:
Foreign exchange rate fluctuations may adversely impact our
consolidated financial position as well as our consolidated
results of operations. Foreign exchange rate fluctuations may
adversely impact our financial position as the assets and
liabilities of our foreign operations are translated into
U.S. dollars in preparing our consolidated balance sheet.
The effect of foreign exchange rate fluctuations on our
consolidated financial position for the year ended
December 31, 2005, was a net translation loss of
approximately $140.5 million. This loss is recognized as an
adjustment to stockholders’ equity through accumulated
other comprehensive income. Additionally, foreign exchange rate
fluctuations may adversely impact our consolidated results of
operations as exchange rate fluctuations on transactions
denominated in currencies other than our functional currencies
result in gains and losses that are reflected in our
consolidated statement of income.
We consolidate the earnings of our international subsidiaries by
converting them into U.S. dollars in accordance with
Statement of Financial Accounting Standards No. 52
“Foreign Currency Translation” (FAS 52). Such
earnings will fluctuate when there is a change in foreign
currency exchange rates. From time to time, we enter into
transactions to hedge portions of our foreign currency
denominated earnings translation exposure using both foreign
currency options and forward contracts. All contracts that hedge
translation exposure mature ratably over the quarter in which
they are executed. During the year ended December 31, 2005,
the realized gains and losses related to these hedges were not
significant.
Economic Exposure:
We currently charge our international subsidiaries on a monthly
basis for their use of intellectual property and technology and
for certain corporate services provided by eBay and PayPal.
These charges are denominated in Euros and these forecasted
inter-company transactions represent a foreign currency cash
flow exposure. To reduce foreign exchange risk relating to these
forecasted inter-company transactions, we entered into forward
foreign exchange contracts during the year ended
December 31, 2005. The objective of the forward contracts
is to ensure that the U.S. dollar-equivalent cash flows are
not adversely affected by changes in the U.S. dollar/ Euro
exchange rate. Pursuant to Statement of Financial Accounting
Standards No. 133 “Accounting for Derivative
Instruments and Hedging Activities” (FAS 133), we
expect the hedge of certain of these forecasted transactions
using the forward contracts to be highly effective in offsetting
potential changes in cash flows attributed to a change in the
U.S. dollar/ Euro exchange rate. Accordingly, we record as
a component of other comprehensive income all unrealized gains
and losses related to the forward contracts that receive hedge
accounting treatment. We record all unrealized gains and losses
in interest and accumulated other income, net, related to the
forward contracts that do not receive hedge accounting
treatment pursuant to FAS 133. During the year ended
December 31, 2004 and 2005, the realized gains and losses
related to these hedges were not significant. The notional
amount of our economic hedges receiving hedge accounting
treatment and the losses, net of gains, recorded to accumulated
other comprehensive income as of December 31, 2004 was
$140.2 million and $3.4 million, respectively. The
notional amount of our economic hedges receiving hedge
accounting treatment and the loss, net of gains, recorded to
accumulated other comprehensive income as of December 31,2005 was $203.0 million and $200,000 respectively.
ITEM 8: FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA
Annual Financial Statements and Selected Quarterly Financial
Data: The consolidated financial statements and accompanying
notes listed in Part IV, Item 15(a)(1) of this Annual
Report on
Form 10-K are
included elsewhere in this Annual Report.
ITEM 9:
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A:
CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and
procedures. Based on the evaluation of our disclosure
controls and procedures (as defined in the
Rules 13a-15(e)
and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the “Exchange
Act”)) required by 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 controls over financial reporting that
occurred during our most recent fiscal quarter that have
materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
(c) Management’s Report on Internal Control Over
Financial Reporting. Our management is responsible for
establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Exchange Act
Rules 13a-15(f).
Our management, including our principal executive officer and
principal financial officer, conducted an evaluation of the
effectiveness of our internal control over financial reporting
based on the framework in Internal Control —
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on its
evaluation under the framework in Internal
Control — Integrated Framework, our management
concluded that our internal control over financial reporting was
effective as of December 31, 2005. Our management’s
assessment of the effectiveness of our internal control over
financial reporting as of December 31, 2005 has been
audited by PricewaterhouseCoopers LLP, an independent registered
public accounting firm, as stated in their report which is
included elsewhere in this Annual Report on
Form 10-K.
ITEM 9B: OTHER
INFORMATION
None.
PART III
ITEM 10: DIRECTORS AND
EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference from eBay’s Proxy Statement for
its 2006 Annual Meeting of Stockholders to be filed with the SEC
within 120 days after the end of the year ended
December 31, 2005.
Code of Ethics, Governance Guidelines and Committee
Charters
We have adopted a Code of Business Conduct and Ethics
that applies to all eBay employees. We have also adopted a
Code of Ethics for Senior Financial Officers that applies
to our senior financial officers, including our principal
executive officer, principal financial officer and principal
accounting officer. The Code of Ethics for Senior Financial
Officers is posted on our website at
http://investor.ebay.com/governance/ ethics.cfm. We will
post any amendments to or waivers from the Code of Ethics for
Senior Financial Officers at that location.
We have also adopted Governance Guidelines for the Board of
Directors and a written committee charter for each of our
Audit Committee, Compensation Committee, and Corporate
Governance and Nominating Committee. Each of these documents is
available on our website at
http://investor.ebay.com/governance/ home.cfm.
ITEM 11: EXECUTIVE
COMPENSATION
Incorporated by reference from eBay’s Proxy Statement for
its 2006 Annual Meeting of Stockholders to be filed with the SEC
within 120 days after the end of the year ended
December 31, 2005.
ITEM 12:
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Incorporated by reference from eBay’s Proxy Statement for
its 2006 Annual Meeting of Stockholders to be filed with the SEC
within 120 days after the end of the year ended
December 31, 2005.
ITEM 13: CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from eBay’s Proxy Statement for
its 2006 Annual Meeting of Stockholders to be filed with the SEC
within 120 days after the end of the year ended
December 31, 2005.
ITEM 14:
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Incorporated by reference from eBay’s Proxy Statement for
its 2006 Annual Meeting of Stockholders to be filed with the SEC
within 120 days after the end of the year ended
December 31, 2005.
PART IV
ITEM 15: EXHIBITS AND
FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this
report:
All other schedules have been omitted because the information
required to be set forth therein is not applicable or is shown
in the financial statements or notes thereto.
Sale and Purchase Agreement dated as of September 11, 2005,
by and among eBay Inc., Skype Technologies S.A. and the parties
identified on Schedule 1 thereto.
Amendment No. 1 to Earn Out Agreement dated as of
December 29, 2005, by and among eBay Inc., Skype
Technologies S.A. and the parties identified on Schedule I
thereto.
X
3
.01
Registrant’s Amended and Restated Certificate of
Incorporation.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of eBay Inc:
We have completed integrated audits of eBay Inc.’s 2005 and
2004 consolidated financial statements and of its internal
control over financial reporting as of December 31, 2005,
and an audit of its 2003 consolidated financial statements in
accordance with the standards of the Public Company Accounting
Oversight Board (United States). Our opinions, based on our
audits, are presented below.
Consolidated financial statements and financial statement
schedule
In our opinion, the consolidated financial statements listed in
the index appearing under Item 15(a)(1) present fairly, in
all material respects, the financial position of eBay Inc and
its subsidiaries at December 31, 2005 and December 31,2004, and the results of their operations and their cash flows
for each of the three years in the period ended
December 31, 2005 in conformity with accounting principles
generally accepted in the United States of America. In addition,
in our opinion, the financial statement schedule listed in the
index appearing under Item 15(a)(2) presents fairly, in all
material respects, the information set forth therein when read
in conjunction with the related consolidated financial
statements. These financial statements and financial statement
schedule are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule based on
our audits. We conducted our audits of these statements in
accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we
plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material
misstatement. An audit of financial statements includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by
management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable
basis for our opinion.
As discussed in Note 1 to the Consolidated Financial
Statements, effective July 1, 2003the Company adopted the
provisions of Financial Accounting Standards Board
Interpretation No. 46, “Consolidation of Variable
Interest Entities — an interpretation of ARB 51”.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in
Management’s Report on Internal Control Over Financial
Reporting appearing under Item 9A, that the Company
maintained effective internal control over financial reporting
as of December 31, 2005 based on criteria established in
Internal Control — Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), is fairly stated, in all material respects,
based on those criteria. Furthermore, in our opinion, the
Company maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2005,
based on criteria established in Internal Control —
Integrated Framework issued by the COSO. The Company’s
management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on management’s
assessment and on the effectiveness of the Company’s
internal control over financial reporting based on our audit. We
conducted our audit of internal control over financial reporting
in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable
assurance about whether effective internal control over
financial reporting was maintained in all material respects. An
audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial
reporting, evaluating management’s assessment, testing and
evaluating the design and operating effectiveness of internal
control, and performing such other procedures as we consider
necessary in the circumstances. We believe that our audit
provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of
financial statements for
external purposes in accordance with generally accepted
accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that
(i) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company;
(ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company
are being made only in accordance with authorizations of
management and directors of the company; and (iii) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the
financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
eBay Inc. (“eBay”) was incorporated in California in
May 1996, and reincorporated in Delaware in April 1998. eBay,
together with its subsidiaries, pioneers 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, online payment services and
online communication offerings to a diverse community of
individuals and businesses.
eBay currently has three primary businesses: the eBay
Marketplace, Payments and Communications. The eBay Marketplaces
segments provide the infrastructure to enable online commerce in
a variety of formats, including the traditional auction
platform, along with our other online platforms, such as
Rent.com, Shopping.com, Kijiji, mobile.de, and Marktplaats.nl.
The Payments segment, which consists of our PayPal, Inc.
(“PayPal”) business, enables individuals or businesses
to securely, easily and quickly send and receive payments
online. The Communications segment, which consists of our Skype
Technologies SA (“Skype”) business, enables VoIP calls
between Skype users, as well as provides low-cost connectivity
to traditional fixed-line and mobile telephones.
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 consolidated financial statements in
conformity with generally accepted accounting principles
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 doubtful accounts and authorized
credits, the provision for transaction losses, legal
contingencies, income taxes, advertising and other
non-transaction revenues, and goodwill and intangible assets. We
base our estimates on historical experience and on various other
assumptions that are believed to be reasonable under the
circumstances. Actual results could differ from those estimates.
Principles of consolidation and basis of presentation
The accompanying financial statements are consolidated and
include the financial statements of eBay and our majority-owned
subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
The consolidated financial statements include 100% of the assets
and liabilities of these majority-owned subsidiaries and the
ownership interests of minority investors are recorded as
minority interests. Investments in entities where we hold more
than a 20% but less than a 50% ownership interest and have the
ability to significantly influence the operations of the
investee are accounted for using the equity method of accounting
and the investment balance is included in long-term investments,
while our share of the investees’ results of operations is
included in interest and other income, net. Investments in
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 and are included in long-term investments.
Certain prior period balances have been reclassified to conform
to the current period presentation.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Fair value of financial instruments
Cash and cash equivalents are short-term, highly liquid
investments with original or remaining maturities of three
months or less when purchased. Our financial instruments,
including cash, cash equivalents, accounts receivable, funds
receivable, accounts payable, and funds payable are carried at
cost, which approximates their fair value because of the
short-term maturity of these instruments.
Short and long-term investments, which include marketable equity
securities and government and corporate bonds, are classified as
available-for-sale and reported at fair value using the specific
identification method. Unrealized gains and losses are excluded
from earnings and reported as a component of other comprehensive
income (loss), net of related estimated tax provisions or
benefits. Additionally, we assess whether an
other-than-temporary impairment loss on our investments has
occurred due to declines in fair value or other market
conditions. Declines in fair value that are considered other
than temporary are recorded as an impairment of certain equity
investments in the consolidated statement of income.
Derivative instruments
We recognize all derivative instruments on the balance sheet at
fair value. Changes in the fair value (i.e., gains or losses) of
the derivatives are recorded each period in the consolidated
statement of income or accumulated other comprehensive income
(loss). For a derivative designated as a cash flow hedge, the
gain or loss on the derivative is initially reported as a
component of accumulated other comprehensive income (loss) and
subsequently reclassified into the consolidated statement of
income when the hedged transaction affects earnings. For
derivatives recognized as a fair value hedge, the gain or loss
on the derivative in the period of change and the offsetting
loss or gain of the hedged item attributed to the hedged risk,
are recognized in accumulated other comprehensive income until
the hedge matures, at which time the gain or loss is recognized
as interest and other income, net. For derivatives not
recognized as hedges, the gain or loss on the derivative in the
period of changes is recognized as interest and other income,
net.
Concentrations of credit risk
Our cash, cash equivalents, accounts receivable and funds
receivable are potentially subject to concentration of credit
risk. Cash and cash equivalents are placed with financial
institutions that management believes are of high credit
quality. Our accounts receivable are derived from revenue earned
from customers located in the U.S. and internationally. Accounts
receivable balances are settled through customer credit cards,
debit cards, and PayPal accounts, with the majority of accounts
receivable collected upon processing of credit card
transactions. We maintain an allowance for doubtful accounts
receivable and authorized credits based upon our historical
experience. Historically, such losses have been within our
expectations. However, unexpected or significant future changes
in trends could result in a material impact to future statements
of income or cash flows. Due to the relatively small dollar
amount of individual accounts receivable, we generally do not
require collateral on these balances. The provision for doubtful
accounts is recorded as a charge to operating expense, while the
provision for authorized credits is recognized as a reduction of
net revenues.
During the years ended December 31, 2003, 2004, and 2005,
no customers accounted for more than 10% of net revenues. As of
December 31, 2004 and 2005, no customers accounted for more
than 10% of net accounts receivable.
Allowances for transaction losses
Our Payments segment is exposed to transaction losses due to
fraud, as well as non-performance of customers. We establish
allowances for estimated losses arising from processing customer
transactions, such as charge-backs for unauthorized credit card
use and merchant related charge-backs due to non-delivery of
goods or services, Automated Clearing House, or ACH, returns,
and debit card overdrafts. These allowances
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
represent an accumulation of the estimated amounts necessary to
provide for transaction losses incurred as of the reporting
date, including those to which we have not yet been notified.
The allowances, which involve the use of actuarial techniques,
are monitored monthly and are updated based on actual claims
data reported by our claims processors. The allowances are based
on known facts and circumstances, internal factors including our
experience with similar cases, historical trends involving loss
payment patterns and the mix of transaction and loss types.
Additions to the allowance, in the form of provisions, are
reflected as a general and administrative expense in our
consolidated statement of income. At December 31, 2004 and
2005, the allowance for transaction losses totaled
$11.0 million and $20.2 million, respectively, and was
included in accrued expenses and other current liabilities in
our consolidated balance sheet.
Foreign currency
Substantially all of our foreign subsidiaries use the local
currency of their respective countries as their functional
currency. Assets and liabilities are translated at exchange
rates prevailing at the balance sheet dates. Revenues, costs and
expenses are translated into United States dollars at average
exchange rates for the period. Gains and losses resulting from
translation are recorded as a component of accumulated other
comprehensive income (loss).
Realized gains and losses from foreign currency transactions are
recognized as interest and other income, net.
Funds receivable and funds payable to customers
Funds receivable and payable relate to our Payments segment and
arise due to the time taken to clear transactions through
external payment networks. When customers fund their account
using their bank account or credit card, or withdraw money from
their bank account or through a debit card transaction, there is
a clearing period before the cash is received or sent by PayPal,
usually two or three business days for U.S. transactions,
and up to five to eight business days for international
transactions. Hence, these funds are treated as a receivable or
payable until the cash is settled.
Customer accounts
As an agent on behalf of our customers we deposit all U.S.-based
customer funds held in U.S. dollars into Federal Deposit
Insurance Corporation (FDIC) insured bank accounts or
PayPal’s Money Market Fund. FDIC insurance is available to
U.S.-based PayPal customers if we (1) place pooled customer
funds in bank accounts denominated ‘PayPal as Agent for the
Benefit of its Customers’ or similar caption, (2) maintain
records sufficient to identify the claim of each customer in the
FDIC-insured account, (3) comply with applicable FDIC
recordkeeping requirements, and (4) truly operate as an agent of
our customers. These customer funds held by us as an agent on
behalf of customers are not reflected on our consolidated
balance sheet. Additionally, we receive a custodial credit from
our service provider in the form of a reduction in transaction
processing fees based upon balances held with each institution.
This credit is recognized as a reduction in processing costs in
cost of revenues.
Effective February 13, 2004, PayPal customers resident in
the European Union began to receive services through
PayPal’s U.K. subsidiary, which holds an electronic
money issuer license. Electronic Money Institution, or ELMI,
regulations require that customer balances in the U.K.
subsidiary be represented as claims on the subsidiary (held as a
principal rather than as an agent) and invested only in
specified types of liquid assets. These customer balances are
therefore included on our consolidated balance sheet as other
current assets with the corresponding amount due to customers
reflected as a liability.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Property and equipment
Property and equipment are stated at historical cost less
accumulated depreciation. Depreciation and amortization are
computed using the straight-line method over the estimated
useful lives of the assets, generally, one to three years for
computer equipment and software, up to 30 years for
buildings and building improvements, ten years for aviation
equipment, the shorter of five years or the term of the lease
for leasehold improvements, three years for furniture and
fixtures and three years for vehicles.
Goodwill and intangible assets
Goodwill represents the excess of the purchase price over the
fair value of the net tangible and identifiable intangible
assets acquired in a business combination. Intangible assets
resulting from the acquisitions of entities accounted for using
the purchase method of accounting are estimated by management
based on the fair value of assets received. Identifiable
intangible assets are comprised of purchased customer lists and
user base, trademarks and trade names, developed technologies,
and other intangible assets. Identifiable intangible assets are
being amortized over the period of estimated benefit using the
straight-line method and estimated useful lives ranging from one
to eight years. Goodwill is not subject to amortization, but is
subject to at least an annual assessment for impairment,
applying a fair-value based test.
Impairment of Long-lived assets
We evaluate long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of a
long-lived asset may not be recoverable. An asset is considered
impaired if its carrying amount exceeds the future net cash flow
the asset is expected to generate. If an asset is considered to
be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the asset exceeds its
fair market value. We assess the recoverability of our
long-lived and intangible assets by determining whether the
unamortized balances can be recovered through undiscounted
future net cash flows of the related assets. The amount of
impairment, if any, is measured based on projected discounted
future net cash flows.
We evaluate goodwill, at a minimum, on an annual basis and
whenever events and changes in circumstances suggest that the
carrying amount may not be recoverable. Impairment of goodwill
is tested at the reporting unit level by comparing the reporting
unit’s carrying amount, including goodwill, to the fair
value of the reporting unit. The fair values of the reporting
units are estimated using a combination of the income, or
discounted cash flows, approach and the market approach, which
utilizes comparable companies’ data. If the carrying amount
of the reporting unit exceeds its fair value, goodwill is
considered impaired and a second step is performed to measure
the amount of impairment loss, if any. We conducted our annual
impairment test as of August 31, 2005 and determined there
was no impairment. There were no events or circumstances from
that date through December 31, 2005 that would impact this
assessment.
Revenue recognition
Our net revenues result from fees associated with our
transaction, advertising and other non-transaction services in
our U.S. Marketplaces, International Marketplaces, Payments
and Communications segments. Transaction revenue is derived
primarily from listing, feature and final value fees paid by
sellers and fees from payment processing services. Revenue from
advertising is derived principally from the sale of online
banner and sponsorship advertisements for cash and through
barter arrangements. Other non-transaction net revenue is
primarily composed of our
end-to-end services net
revenue that is derived principally from contractual
arrangements with third parties that provide transaction
services to eBay users. Revenue is recognized when evidence of
an arrangement exists, the fee is fixed and determinable, no
significant obligation remains and collection of the receivable
is reasonably assured.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Our U.S. and International Marketplaces segments earn listing
and feature fee revenues which are recognized ratably over the
estimated period of the auction while revenues related to final
value fees are recognized at the time that the transaction is
successfully concluded. A transaction is considered successfully
concluded when at least one buyer has bid above the
seller’s specified minimum price or reserve price,
whichever is higher, at the end of the transaction term. For
services offered on Shopping.com, our comparison shopping site,
revenue is generated from lead referral fees based on the number
of times a user clicks through to a merchant’s website from
our Shopping.com website. Lead referral fees are recognized in
the period in which the user clicks through to the
merchant’s website.
Our Payments segment earns transaction fees from processing
transactions for certain customers. Revenue resulting from a
payment processing transaction is recognized once the
transaction is complete.
Our Communications segment revenue is recognized when the
related offering is provided. The majority of Communications
segment revenues are prepaid. We record deferred revenue for
prepaid amounts in excess of revenue recognized.
Our advertising revenue is derived principally from the sale of
online banner and sponsorship advertisements. To date, the
duration of our banner and sponsorship advertising contracts has
ranged from one week to five years, but is generally one week to
one year. Advertising revenues on both banner and sponsorship
contracts are recognized as “impressions” (i.e., the
number of times that an advertisement appears in pages viewed by
users of our websites) are delivered or ratably over the term of
the agreement where such agreements provide for minimum monthly
or quarterly advertising commitments or where such commitments
are fixed throughout the term. Barter transactions are valued on
amounts realized in similar cash transactions occurring within
six months prior to the date of the barter transaction. To the
extent that significant delivery obligations remain at the end
of a period or collection of the resulting account receivable is
not considered probable, revenues are deferred until the
obligation is satisfied or the uncertainty is resolved. These
amounts are included in deferred revenue in our consolidated
balance sheet. Revenue from barter arrangements totaled
$10.1 million, $13.3 million and $6.7 million for
the years ended December 31, 2003, 2004 and 2005,
respectively, with the reciprocal arrangements being recognized
as an operating expense. In general, the services are received
in the same period in which the reciprocal services are
provided. In certain circumstances, we are required to record
against revenue payments to a party who is also a customer.
These payments primarily consist of certain promotional
activities which result in payments to our users.
Our end-to-end services
revenues are derived principally from contractual arrangements
with third parties that provide transaction services to eBay and
PayPal users. To date, the duration of our
end-to-end services
contracts has ranged from one to three years.
End-to-end services
revenues are recognized as the contracted services are delivered
to end users. To the extent that significant obligations remain
at the end of a period or collection of the resulting receivable
is not considered probable, revenues are deferred until the
obligation is satisfied or the uncertainty is resolved.
Provisions for doubtful accounts, transaction losses and
authorized credits are made at the time of revenue recognition
based upon our historical experience. The provision for doubtful
accounts and transaction losses are recorded as charges to
operating expense, while the provision for authorized credits is
recognized as a reduction of net revenues.
Product development costs
Costs related to the planning and post implementation phases of
our website development efforts are recorded as an operating
expense. Direct costs incurred in the development phase are
capitalized and amortized over the product’s estimated
useful life of one to three years as charges to cost of net
revenues.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Advertising expense
We expense the costs of producing advertisements at the time
production occurs and expense the cost of communicating
advertising in the period during which the advertising space or
airtime is used. Internet advertising expenses are recognized
based on the terms of the individual agreements, which is
generally over the greater of the ratio of the number of
impressions delivered over the total number of contracted
impressions,
pay-per-click, or on a
straight-line basis over the term of the contract. Advertising
expenses totaled $321.4 million, $459.5 million and
$665.1 million during the years ended December 31,2003, 2004, and 2005, respectively.
Stock-based compensation
We account for stock-based employee compensation issued under
compensatory plans using the intrinsic value method, which
calculates compensation expense based on the difference, if any,
on the date of the grant, between the fair value of our stock
and the option exercise price. Generally accepted accounting
principles require companies who choose to account for stock
option grants using the intrinsic value method to also determine
the fair value of option grants using an option pricing model,
such as the Black-Scholes model, and to disclose the impact of
fair value accounting in a note to the financial statements. In
December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, “Accounting for Stock-Based
Compensation Transition and Disclosure, an Amendment of FASB
Statement No. 123.” We did not elect to voluntarily
change to the fair value based method of accounting for stock
based employee compensation and record such amounts as charges
to operating expense. We amortize the stock-based compensation
charge in accordance with FASB Interpretation No. 28 over
the vesting period of the related options, which is generally
four years. The impact of recognizing the fair value of option
grants and stock grants under our employee stock purchase plan
as an expense under FASB Statement No. 148 would have
substantially reduced our net income, as follows (in thousands,
except per share amounts):
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
We calculated the fair value of each option award on the date of
grant using the Black-Scholes option pricing model. The
following weighted average assumptions were used for each
respective period:
We account for stock-based arrangements issued to non-employees
using the fair value based method, which calculates compensation
expense based on the fair value of the stock option granted
using the Black-Scholes option pricing model at the date of
grant, or over the period of performance, as appropriate.
Income taxes
We account for income taxes using an asset and liability
approach, which requires the recognition of taxes payable or
refundable for the current year and deferred tax liabilities and
assets for the future tax consequences of events that have been
recognized in our financial statements or tax returns. The
measurement of current and deferred tax assets and liabilities
is based on provisions of enacted tax laws; the effects of
future changes in tax laws or rates are not anticipated. If
necessary, the measurement of deferred tax assets is reduced by
the amount of any tax benefits that are not expected to be
realized based on available evidence.
Cumulative Effect of Change in Accounting Principle
In accordance with the provisions of FIN 46,
“Consolidation of Variable Interest Entities,” we have
included our San Jose corporate headquarters lease
arrangement in our consolidated financial statements since
July 1, 2003. Under this accounting standard, our balance
sheet at December 31, 2004 reflects additions for land and
buildings totaling $126.4 million, lease obligations of
$122.5 million and non-controlling minority interests of
$3.9 million. Our consolidated statement of income for the
year ended December 31, 2003, reflects the reclassification
of lease payments on our San Jose corporate headquarters
from operating expense to interest expense, beginning with
quarters following our adoption of FIN 46 on July 1,2003, a $5.4 million after-tax charge for cumulative
depreciation for periods from lease inception through
June 30, 2003, and incremental depreciation expense of
approximately $400,000, net of tax, per quarter for periods
after June 30, 2003. We have adopted the provisions of
FIN 46 prospectively from July 1, 2003, and as a
result, have not restated prior periods. The cumulative effect
of the change in accounting principle arising from the adoption
of FIN 46 has been reflected in net income in 2003. As of
December 31, 2004, we had $126.4 million included
within current restricted cash and investments relating to our
San Jose headquarters lease facility lease arrangement,
which had effectively provided us with full ownership rights to
these facilities. In February 2004, we elected not to extend the
lease period, which required us to purchase the facility on
March 1, 2005. We utilized the $126.4 million in
restricted cash and investments to complete the purchase of the
facility.
Comprehensive income
Comprehensive income includes all changes in equity (net assets)
during a period from non-owner sources. The change in
accumulated other comprehensive income for all periods presented
resulted from, net of tax foreign currency translation gains and
losses, unrealized and realized gains and losses on investments,
and unrealized gains and losses on cash flow hedges.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Recent Accounting Pronouncements
Share-Based Payments
In December 2004, the FASB issued Statement of Financial
Accounting Standards No. 123 (revised 2004),
“Share-Based Payment” (FAS 123R) that addresses
the accounting for share-based payment transactions in which an
enterprise receives employee services in exchange for either
equity instruments of the enterprise or liabilities that are
based on the fair value of the enterprise’s equity
instruments or that may be settled by the issuance of such
equity instruments. The statement eliminates the ability to
account for share-based compensation transactions, as we do
currently, using the intrinsic value method prescribed by
Accounting Principles Board, or APB, Opinion No. 25,
“Accounting for Stock Issued to Employees,” and
generally requires that such transactions be accounted for using
a fair-value-based method and recognized as expenses in our
consolidated statement of income. The statement requires
companies to assess the most appropriate model to calculate the
value of the options. We currently use the Black-Scholes option
pricing model to value options and are currently assessing which
model we may use in the future under the new statement and may
deem an alternative model to be more appropriate. The use of a
different model to value options may result in a different fair
value than the use of the Black-Scholes option pricing model. In
addition, there are a number of other requirements under the new
standard that would result in different accounting treatment
than currently required. These differences include, but are not
limited to, the accounting for the tax benefit on employee stock
options and for stock issued under our employee stock purchase
plan, and the presentation of these tax benefits within the
consolidated statement of cash flows. In addition to the
appropriate fair value model to be used for valuing share-based
payments, we will also be required to determine the transition
method to be used at date of adoption. The allowed transition
methods are the prospective and retroactive adoption
alternatives. The prospective method requires that compensation
expense be recorded for all unvested stock options and
restricted stock at the beginning of the first quarter of
adoption of FAS 123R, while the retroactive method requires
companies to record compensation expense for all unvested stock
options and restricted stock beginning with the first disclosed
period restated.
In April 2005, the Securities and Exchange Commission announced
the adoption of a new rule that amends the effective date of
FAS 123R. The effective date of the new standard under
these new rules for our consolidated financial statements is
January 1, 2006. Adoption of this statement will have a
significant impact on our consolidated financial statements as
we will be required to expense the fair value of our stock
option grants and stock purchases under our employee stock
purchase plan rather than disclose the impact on our
consolidated net income within our footnotes, as is our current
practice (see “The Company and Summary of Significant
Accounting Policies”).
The amounts disclosed within our footnotes are not necessarily
indicative of the amounts that will be expensed upon the
adoption of FAS 123R. We expect the compensation charges
under FAS 123R to reduce earnings per diluted share by
approximately $0.16 to $0.17 per share for the year ending
December 31, 2006. Compensation expense calculated under
FAS 123R may differ from amounts currently disclosed within
our footnotes and may also differ from our expectations based on
changes in the fair value of our common stock, changes in the
number of options granted or the terms of such options, the
treatment of tax benefits and changes in interest rates or other
factors. In addition, upon adoption of FAS 123R, we may
choose to use a different valuation model to value the
compensation expense associated with employee stock options and
stock purchases under our employee stock purchase plan.
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.
Potentially dilutive common stock,
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
composed of unvested restricted common stock and incremental
common shares issuable upon the exercise of stock options, are
included in diluted net income per share using the treasury
stock method to the extent such shares are dilutive. The
following table sets forth the computation of basic and diluted
net income per share for the periods indicated (in thousands,
except per share amounts):
Income before cumulative effect of accounting change
$
447,184
$
778,223
$
1,082,043
Cumulative effect of accounting, net of tax
(5,413
)
—
—
Net income
$
441,771
$
778,223
$
1,082,043
Denominator:
Weighted average common shares
1,276,674
1,319,548
1,361,748
Weighted average unvested common stock subject to repurchase
(98
)
(90
)
(40
)
Denominator for basic calculation
1,276,576
1,319,458
1,361,708
Weighted average effect of dilutive securities:
Weighted average unvested common stock subject to repurchase
98
90
40
Employee stock options
36,640
48,172
32,127
Denominator for diluted calculation
1,313,314
1,367,720
1,393,875
Per share amounts:
Income before cumulative effect of accounting change
$
0.35
$
0.59
$
0.79
Cumulative effect of accounting change
(0.00
)
—
—
Per share basic amounts
$
0.35
$
0.59
$
0.79
Per share amounts:
Income before cumulative effect of accounting change
$
0.34
$
0.57
$
0.78
Cumulative effect of accounting change
(0.00
)
—
—
Per share diluted amounts
$
0.34
$
0.57
$
0.78
The calculation of diluted income per share excludes all
anti-dilutive shares. For the years ended December 31,2003, 2004 and 2005, the number of anti-dilutive shares, as
calculated based on the weighted average closing price of our
common stock for the period, amounted to approximately
7.0 million, 3.4 million and 26.7 million shares,
respectively.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Note 3 — Business Combinations, Goodwill and
Intangible Assets:
Through both domestic and international acquisitions, we have
continued to expand our business. The following table summarizes
our purchase acquisitions in 2004 and 2005 with aggregate
purchase prices in excess of $50 million (in thousands):
Tangible net assets were valued at their respective carrying
amounts as we believe that these amounts approximated their
current fair values at the respective acquisition dates. The
valuation of identifiable intangible assets acquired reflects
management’s estimates based on, among other factors, use
of established valuation methods. Such assets consist of
customer lists and user base, trademarks and trade names,
developed technologies and other acquired intangible assets
including contractual agreements. Identifiable intangible assets
are amortized over the period of estimated benefit using the
straight-line method and the estimated useful lives of one to
eight years. We believe the straight-line method of amortization
represents our best estimate of the distribution of the economic
value of the identifiable intangible assets. Goodwill represents
the excess of the purchase price over the fair value of the net
tangible and identifiable intangible assets acquired in each
business combination. The following table summarizes our
acquired intangible assets by type related to the above purchase
acquisitions (in thousands):
The results of operations for periods prior to our acquisition
for each acquisition during 2003, 2004 and 2005, both
individually and in the aggregate, except for Skype, were not
material to our consolidated statement of income and,
accordingly, pro forma results of operations have not been
presented.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
mobile.de Acquisition
On April 1, 2004, we acquired a 100% interest in mobile.de
for a cash purchase price of approximately
€121 million.
mobile.de is a classifieds advertising website for vehicles in
Germany. The total purchase price recorded was approximately
$152 million, including approximately $3 million in
estimated acquisition-related expenses. We accounted for the
acquisition as a purchase transaction and, accordingly, the
purchase price has been allocated to the tangible and intangible
assets acquired and liabilities assumed on the basis of their
respective estimated fair values on the acquisition date.
The estimated useful economic lives of the identifiable
intangible assets acquired in the mobile.de acquisition are
eight years for the user base, two years for the developed
technology and two years for the trade name.
Baazee.com Acquisition
On August 2, 2004, we acquired a 100% interest in
Baazee.com for a cash purchase price of approximately
$50 million. Baazee.com is an online marketplace in India.
Through this acquisition, we have established eBay in India and
will open our global online marketplaces to Baazee.com’s
strong and growing community. The total purchase price recorded
was approximately $50 million, including $1 million in
estimated acquisition-related expenses. We accounted for the
acquisition as a purchase transaction and, accordingly, the
purchase price has been allocated to the tangible and intangible
assets acquired and liabilities assumed on the basis of their
respective estimated fair values on the acquisition date.
The estimated useful economic lives of the identifiable
intangible assets acquired in the Baazee.com acquisition are
three years for the noncompete agreement, three years for the
user base, one year for the trade name, and one year for the
developed technology.
Marktplaats.nl Acquisition
On November 10, 2004, we acquired a 100% interest in
Marktplaats.nl for a cash purchase price of approximately
€226 million.
The total purchase price recorded was approximately
$291 million. Marktplaats.nl is an online classifieds
website in the Netherlands. The acquisition allows us to expand
our e-commerce position
in the Netherlands while adding to our growing knowledge of
classifieds-style commerce. The total purchase price recorded
was approximately $291.4 million, including approximately
$2.0 million in estimated acquisition-related expenses. We
accounted for the acquisition as a purchase transaction and,
accordingly, the purchase price has been allocated to the
tangible and intangible assets acquired and liabilities assumed
on the basis of their respective estimated fair values on the
acquisition date.
The estimated useful economic lives of the identifiable
intangible assets acquired in the Marktplaats.nl acquisition are
five years for the trade name and eighteen months for the
developed technology.
Internet Auction Co., Ltd.
On December 17, 2003, we increased our majority interest of
Internet Auction Co., Ltd., (“IAC” or “Internet
Auction”), from approximately 51% to approximately 62% by
the settlement of our tender offer for approximately
1.6 million shares. The total cash consideration for these
additional shares was approximately $93.9 million, which
includes approximately $2.2 million in estimated
acquisition-related expenses. Internet Auction introduced online
trading in South Korea when it launched in April 1998. Shares of
Internet Auction were listed on the KOSDAQ. Prior to the fourth
quarter of 2003, we consolidated our original investment in
IAC’s common shares and recorded the minority
investor’s percentage share of income or losses in minority
interests in our consolidated statement of income.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
During September 2004, we purchased additional shares resulting
in an aggregate increase of our ownership interest to
approximately 97%. We purchased approximately 4.5 million
shares for KRW125,000 per share for a total cash amount of
approximately KRW557 billion. The total cash consideration
for these additional shares was approximately
$484.8 million, which includes approximately
$1.7 million in estimated acquisition-related expenses.
On October 5, 2004 we closed our tender offer to purchase
additional shares of IAC, resulting in an increase of our
ownership interest to approximately 99.7%. We purchased
approximately 344,000 shares for KRW125,000 per share.
The total cash consideration for these additional shares was
approximately $37.8 million, which includes approximately
$400,000 in estimated acquisition-related expenses.
On December 6, 2004, the delisting of IAC common shares
from the KOSDAQ was approved. Under Korean securities
regulations, a seven business day period is required prior to
the delisting date for
on-the-market trade of
shares. During that seven day period, from November 25,2004 through December 3, 2004, we purchased approximately
17,000 additional shares for KRW125,000 per share, to
increase our ownership interest to approximately 99.9%. The
total cash consideration for these additional shares was
approximately $2.2 million, which includes approximately
$200,000 of estimated acquisition-related expenses.
Through these purchases, we have continued to expand our
presence in South Korea, one of the largest online markets in
Asia. This is consistent with our strategy of establishing and
expanding our global online marketplaces in countries that
represent the majority of the world’s
e-commerce revenue. The
estimated useful economic lives of the identifiable intangible
assets acquired in the increase in ownership of IAC are eight
years for the user base, five years for the trade name, and two
years for the developed technology. The identifiable intangible
assets are being amortized using the straight-line method over
their useful economic lives. We accounted for this acquisition
as purchase transactions and, accordingly, the purchase price
has been allocated to the tangible and intangible assets
acquired and liabilities assumed on the basis of their
respective estimated fair values on the acquisition date.
Rent.com
On February 23, 2005, we acquired Viva Group, Inc., which
does business under the name Rent.com, for a cash purchase price
of approximately $415 million plus payments for net cash
and investments of approximately $18 million. Rent.com is
an Internet listing website in the apartment and rental housing
industry. The acquisition better enables our expansion into the
online real estate market and is consistent with our strategy of
growing our global online marketplaces. The total purchase price
recorded was approximately $435 million, including
approximately $2 million in estimated acquisition-related
expenses. We accounted for the acquisition as a non-taxable
purchase transaction and, accordingly, the purchase price has
been allocated to the tangible and intangible assets acquired
and liabilities assumed on the basis of their respective
estimated fair values on the acquisition date.
The estimated useful economic lives of the identifiable
intangible assets acquired in the Rent.com acquisition are six
years for the customer list, five years for the trade name,
three years for the developed technology and the advertising
relationships, and one year for the user base.
During the second quarter of 2005, we announced our acquisitions
of three international classifieds websites, Gumtree.com, LoQUo,
and opusforum, which operate in select international cities.
These acquisitions help us expand our global network of
classifieds websites to create a more efficient place for local
consumers to come together online. The aggregate purchase price
recorded for these acquisitions was approximately
$81.6 million, including approximately $1.3 million in
estimated acquisition-related expenses. We accounted for two of
these acquisitions as non-taxable and one as a taxable purchase
transaction and,
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
accordingly, the purchase price for each acquisition has been
allocated to the tangible and intangible assets acquired and
liabilities assumed on the basis of their respective estimated
fair values on the applicable acquisition date.
The estimated useful economic lives of the identifiable
intangible assets acquired in these acquisitions are five years
for both the trade names and for the customer lists. The final
purchase price allocation will depend primarily upon the
completion of our integration plan.
Shopping.com
On August 30, 2005, we acquired Shopping.com Ltd., or
Shopping.com, for a purchase price of approximately
$685.3 million. We acquired all outstanding shares of
Shopping.com’s common stock for $21 per share in cash
totaling approximately $634.5 million and we assumed
Shopping.com’s outstanding common stock options, valued at
approximately $43.2 million. The total purchase price also
includes approximately $7.6 million in estimated
acquisition-related expenses. Shopping.com is a provider of
online comparison shopping and consumer reviews. This
acquisition is consistent with our strategy of growing our
global online marketplaces and we believe that it will create a
premier online shopping experience for individuals and
businesses of all sizes. We accounted for the acquisition as a
taxable purchase transaction and, accordingly, the purchase
price has been allocated to the tangible and intangible assets
acquired and liabilities assumed on the basis of their
respective estimated fair values on the acquisition date.
The intrinsic value of Shopping.com’s unvested common stock
options assumed in the acquisition totaled approximately
$16.8 million and was recorded as unearned stock-based
compensation. The unearned stock-based compensation relating to
the unvested options is being amortized on an accelerated basis
over the remaining vesting period of less than one year to four
years, consistent with the graded vesting approach under FASB
Interpretation No. 28.
The estimated useful economic lives of the identifiable
intangible assets acquired in the Shopping.com acquisition are
four years for the customer base and five years for the trade
names and the developed technology. The final purchase price
allocation will depend primarily upon the completion of our
integration plan and the final valuation of certain acquired tax
attributes.
Skype
On October 14, 2005, we acquired all of the outstanding
securities of Skype Technologies S.A. (“Skype”), for a
total initial consideration of approximately $2.6 billion,
plus potential performance-based payments of up to approximately
$1.3 billion. In addition, we agreed to assume Skype’s
stock options outstanding as of the closing date and convert
them into options to acquire approximately 1.9 million
shares of our common stock. The initial consideration of
approximately $2.6 billion is comprised of approximately
$1.3 billion in cash and 32.8 million shares of our
common stock. For accounting purposes, the stock portion of the
initial consideration is valued at approximately
$1.3 billion based on the average closing price of our
common stock surrounding the acquisition announcement date of
September 12, 2005. The shares of our common stock issued
in connection with the acquisition are subject to certain
contractual restrictions on resale. Additionally, the assumed
options have been valued at $64.6 million and were included
as part of the purchase price. The purchase price will be
allocated to the tangible and intangible assets acquired and
liabilities assumed based on their respective fair values at the
acquisition date.
In addition to the initial consideration, the maximum amount
potentially payable under the performance-based earn-out is
approximately
€1.1 billion,
or approximately $1.3 billion, and would be payable in cash
or common stock, at our discretion. The earn-out payments are
contingent upon Skype achieving certain net revenue, gross
profit margin-based targets and active user targets. Base
earn-out payments of up to an aggregate of approximately
€877 million,
or approximately $1.0 billion, weighted equally among the
three
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
targets, would be payable if the targets are achieved over any
four-quarter period commencing on January 1, 2006 through
June 30, 2009. Additional bonus earn-out payments of up to
an aggregate of approximately
€292 million,
or approximately $345 million, weighted equally among the
three targets, would be payable if Skype exceeds the targets
during calendar year 2008. Any contingent earn-out payments made
will be accounted for as additional purchase price and will
increase goodwill. As any contingent earn-out payments are to be
paid in Euros, the Dollar amounts set forth above were based on
the Euro-Dollar exchange rate as of December 31, 2005.
Skype is a Luxembourg-based company that was established in
2003. Skype has developed software that, among other things,
enables free calls between Skype users online. Skype’s
premium offerings, which currently are its primary source of
revenue, provide low-cost connectivity to traditional fixed-line
and mobile telephones. We believe that Skype can increase the
velocity of trade on our websites, especially in categories that
require more involved communications, as well as enable us to
develop and provide new
e-commerce offerings.
The intrinsic value of Skype’s unvested common stock
options assumed in the acquisition totaled approximately
$55.2 million and was recorded as unearned stock-based
compensation. The unearned stock-based compensation relating to
the unvested options will be amortized on an accelerated basis
over the remaining vesting period of approximately three years,
consistent with the graded vesting approach under FASB
Interpretation No. 28.
The estimated useful economic lives of the identifiable
intangible assets acquired in the Skype acquisition are five
years for registered user technology and trade names, two years
for existing technology, and one year for network access
agreements. The final purchase price allocation will depend
primarily upon the refinement of certain estimates and analyses
and the final valuation of certain tax attributes.
Supplemental information on an unaudited pro forma basis, as if
the Skype acquisition were completed at the beginning of the
years 2004 and 2005, is as follows (in thousands, except per
share amounts):
The unaudited pro forma supplemental information is based on
estimates and assumptions, which eBay believes are reasonable.
The average foreign exchange rates during years 2004 and 2005
were used in preparing the supplemental information. The
unaudited pro forma supplemental information prepared by
management is not necessarily indicative of the condensed
consolidated financial position or results of income in future
periods or the results that actually would have been realized
had eBay and Skype been a combined company during the specified
periods.
VeriSign’s Payment Gateway Business
On November 18, 2005, we acquired VeriSign’s payment
gateway business for a purchase price of approximately
$373.8 million, consisting of $370.0 million in cash
and $3.8 million in estimated acquisition-related expenses.
The payment gateway is a real-time, scalable Internet payment
platform that allows merchants to authorize, process and manage
online payments. Additionally, we have signed a multi-year
security technology agreement with VeriSign, Inc. that calls for
us to invest in the deployment of its
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
technologies that enable and better protect online transactions,
including the purchase of up to one million two-factor
authentication tokens.
We accounted for the acquisition as a purchase transaction and,
accordingly, the purchase price has been allocated to the
tangible and intangible assets acquired and liabilities assumed
on the basis of their respective estimated fair values on the
acquisition date. The estimated useful economic lives of the
identifiable intangible assets acquired in the acquisition are
five years for registered user base and existing technology and
one year for the trade names. The final purchase price
allocation will depend primarily upon the completion of our
integration plan.
PayPal Acquisition-Related Liabilities
During the year ended December 31, 2003, we finalized our
formal plan to exit certain activities and integrate certain
facilities of PayPal. This plan included provisions to terminate
leases for redundant facilities, dispose of redundant fixed
assets and leasehold improvements, resolve certain
pre-acquisition legal contingencies, provide various
employee-related benefits and exit certain contractual
obligations.
The components of the PayPal acquisition related liabilities are
as follows (in thousands):
Excess facilities and fixed assets liabilities consist primarily
of accruals for PayPal’s remaining lease obligations, net
of estimated sublease income. A substantial portion of the
excess facilities and fixed assets liabilities recorded as of
December 31, 2005 are expected to settle in cash during
future periods.
As of December 31, 2005, other PayPal liabilities and
contingencies consist primarily of accruals for certain
employee-related tax liabilities.
Goodwill
Goodwill information for each segment is as follows (in
thousands):
The increase in goodwill acquired during the year ended
December 31, 2005, resulted primarily from our acquisition
of the outstanding shares of Rent.com, International classifieds
websites, Shopping.com, Skype, and VeriSign’s payment
gateway business, as well as certain insignificant acquisitions.
Adjustments to goodwill during the year ended December 31,2005, resulted primarily from foreign currency translation
adjustments relating to goodwill and the release of certain
acquisition liabilities associated with our current and prior
period acquisitions.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Investments accounted for under the equity method of accounting
are classified on our balance sheet as long-term investments.
Such investments include identifiable intangible assets,
deferred tax liabilities and goodwill. Goodwill related to our
equity method investments totaled approximately
$27.4 million as of December 31, 2004 and 2005.
Intangible Assets
The components of acquired identifiable intangible assets are as
follows (in thousands):
All of our acquired identifiable intangible assets are subject
to amortization. Acquired identifiable intangible assets are
comprised of customer lists and user base, trademarks and trade
names, developed technologies, and other acquired intangible
assets including patents and contractual agreements. No
significant residual value is estimated for the intangible
assets. The increase in intangible assets during the year ended
December 31, 2005 resulted primarily from certain
intangible assets acquired as part of our acquisition of the
outstanding shares of Rent.com, International classifieds
websites, Shopping.com, Skype and VeriSign’s payment
gateway business totaling approximately $61.8 million,
$13.8 million, $133.6 million, $280.3 million,
and $106.6 million, respectively. The net carrying amount
of intangible assets related to our investments totaled
approximately $4.9 million and $3.8 million, as of
December 31, 2004 and 2005, respectively. Aggregate
amortization expense for intangible assets totaled
$53.2 million, $70.2 million and $136.4 million
for the years ended December 31, 2003, 2004 and 2005,
respectively.
Expected future intangible asset amortization from acquisitions
completed as of December 31, 2005 is as follows (in
thousands):
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Note 4 — Segments:
Reporting segments are based upon our internal organization
structure, the manner in which our operations are managed, the
criteria used by our chief operating decision-maker to evaluate
segment performance, the availability of separate financial
information, and overall materiality considerations.
The U.S. Marketplaces segment includes U.S. online marketplaces
commerce platforms. The International Marketplaces segment
includes our international online marketplaces commerce
platforms. The Payments segment includes our global payments
platform consisting of our PayPal subsidiary. The Communications
segment includes the VoIP offerings provided by our Skype
subsidiary. Results from our Communications segment reflect
Skype operations for the post-acquisition period from October15, 2005 through December 31, 2005.
Direct contribution consists of revenues less direct costs.
Direct costs include specific costs of net revenues, sales and
marketing expenses, and general and administrative expenses over
which segment managers have direct discretionary control, such
as advertising and marketing programs, customer support
expenses, bank charges, provisions for doubtful accounts,
authorized credits and transaction losses. Expenses over which
segment managers do not currently have discretionary control,
such as certain general and administrative costs, are monitored
by management through shared cost centers and are not evaluated
in the measurement of segment performance. Prior period amounts
have been reclassified to reflect the current management of site
operations cost and product development expenses as direct costs.
The following table summarizes the financial performance of our
reporting segments (in thousands):
Net revenues attributed to the U.S. and International
geographies are based upon the country in which the seller,
payment recipient, advertiser or
end-to-end service
provider is located. Germany accounted for greater than 10% of
our total net revenues for the years ended December 31,2003, 2004, and 2005, respectively. The United Kingdom accounted
for greater than 10% of our total net revenues for the years
ended December 31, 2004 and 2005. Long-lived assets
attributed to the U.S. and International geographies are based
upon the country in which the asset is located or owned.
Note 5 —
Investments:
At December 31, 2004 and 2005, short and long-term
investments were classified as available-for-sale securities,
except for restricted cash and investments and equity method
investments, and are reported at fair value as follows (in
thousands):
The following table summarizes the fair value and gross
unrealized losses of our short-term and long-term investments,
aggregated by type of investment instrument and length of time
that individual securities have been in a continuous unrealized
loss position, at December 31, 2005 (in thousands):
Less than 12 Months
12 Months or Greater
Total
Gross
Gross
Gross
Unrealized
Unrealized
Unrealized
Fair Value
Losses
Fair Value
Losses
Fair Value
Losses
Corporate debt securities
$
401,789
$
(1,544
)
$
250,487
$
(3,011
)
$
652,276
$
(4,555
)
Government and agency securities
47,184
(38
)
398,486
(4,624
)
445,670
(4,662
)
$
448,973
$
(1,582
)
$
648,973
$
(7,635
)
$
1,097,946
$
(9,217
)
Our investment portfolio consists of both corporate and
government securities that have a maximum maturity of three
years. The longer the duration of these securities, the more
susceptible they are to changes in market interest rates and
bond yields. As yields increase, those securities purchased with
a lower yield-at-cost show a
mark-to-market
unrealized loss. All unrealized losses are due to changes in
interest rates and bond yields. We expect to realize the full
value of all these investments upon maturity or sale. The losses
on these securities have an average duration of approximately
11 months.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
The estimated fair value of short and long-term investments
classified by date of contractual maturity at December 31,2005 are as follows (in thousands):
One year or less (including restricted cash and investments of
$29,702)
$
804,352
One year through two years (including restricted cash and
investments of $989)
491,937
Two years through three years (including restricted cash and
investments of $76)
281,781
Equity instruments and equity method investments
51,949
$
1,630,019
During 2003, we recorded impairment charges totaling
$1.2 million as a result of the deterioration of the
financial condition of certain of our private and public equity
investees that were considered to be other than temporary. We
did not record any impairment charges during 2004 and 2005.
Equity method investments
We have certain investments accounted for using the equity
method of accounting of which the total of these investments,
including identifiable intangible assets, deferred tax
liabilities and goodwill, are classified on our balance sheet as
a long-term investments. Our consolidated results of operations
include, as a component of other income, our share of the net
income or loss of these investments together with amortization
expense relating to acquired intangible assets. Our share of the
results of investees’ results of operations are not
significant for any period presented.
Note 6 — Derivative Instruments:
Transaction Exposure
As of December 31, 2005, we had outstanding forward foreign
exchange hedge contracts with notional values equivalent to
approximately $151.5 million with maturity dates within
31 days. The hedge contracts are used to offset changes in
non-US dollar denominated functional currency value of assets
and liabilities as a result of foreign exchange rate
fluctuations. Transaction gains and losses on the contracts and
the assets and liabilities are recognized each period in
interest and other income, net.
Translation Exposure
We consolidate the earnings of our international subsidiaries by
converting them into U.S. dollars in accordance with
Statement of Financial Accounting Standards No. 52
“Foreign Currency Translation” (FAS 52). Such
earnings will fluctuate when there is a change in foreign
currency exchange rates. From time to time, we enter into
transactions to hedge portions of our foreign currency
denominated earnings translation exposure using both foreign
currency options and forward contracts. All contracts that hedge
translation exposure mature ratably over the quarter in which
they are executed. During the years ended December 31, 2004
and 2005, the realized gains and losses related to these hedges
were not significant.
Economic Exposure
We currently charge our international subsidiaries on a monthly
basis for their use of intellectual property and technology and
for certain corporate services provided by eBay and by PayPal.
These charges are denominated in Euros and these forecasted
inter-company transactions represent a foreign currency cash
flow exposure. To reduce foreign exchange risk relating to these
forecasted inter-company transactions, we entered into forward
foreign exchange contracts during the year ended
December 31, 2005. The objective of the
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
forward contracts is to better ensure that the
U.S. dollar-equivalent cash flows are not adversely
affected by changes in the U.S. dollar/ Euro exchange rate.
Pursuant to Statement of Financial Accounting Standards
No. 133 “Accounting for Derivative Instruments and
Hedging Activities” (FAS 133), we expect the hedge of
certain of these forecasted transactions to be highly effective
in offsetting potential changes in cash flows attributed to a
change in the U.S. dollar/Euro exchange rate. Accordingly,
we record as a component of accumulated other comprehensive
income all unrealized gains and losses related to the forward
contracts that receive hedge accounting treatment. We record all
unrealized gains and losses in interest and other income, net,
related to the forward contracts that do not receive hedge
accounting treatment pursuant to FAS 133. During the years
ended December 31, 2004 and 2005, the realized gains and
losses related to these hedges were not significant. The
notional amount of our economic hedges receiving hedge
accounting treatment and the losses, net of gains, recorded to
accumulated other comprehensive income as of December 31,2004 was $140.2 million and $3.4 million,
respectively. The notional amount of our economic hedges
receiving hedge accounting treatment and the losses, net of
gains, recorded to accumulated other comprehensive income as of
December 31, 2005 was $203.0 million and $200,000,
respectively.
Land and buildings, including building improvements
278,709
342,689
Leasehold improvements
99,623
121,306
Furniture and fixtures
43,689
56,854
Aviation equipment and other
30,609
40,968
1,136,346
1,456,218
Accumulated depreciation
(426,573
)
(654,616
)
$
709,773
$
801,602
During the years ended December 31, 2003, 2004 and 2005, we
capitalized $38.5 million, $41.3 million and
$37.1 million of software development costs, respectively,
the majority of which relates to major site and other product
development efforts. Total depreciation expense on our property
and equipment was $105.8 million in 2003,
$183.5 million in 2004 and $240.6 million in 2005.
During 2005, we sold a corporate aircraft at net book value for
proceeds of $28.3 million. During 2004, we sold the
remaining property related to our former Butterfields subsidiary
for approximately $12.7 million in cash and recognized a
loss of approximately $800,000.
There were no material capital leases at December 31, 2005.
Capital leases consist of various computer and other office
leases that totaled $1.8 million at December 31, 2004.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
We also have lease obligations under certain other
non-cancelable operating leases. Future minimum rental payments
under our non-cancelable operating leases, at December 31,2005, are as follows (in thousands):
Year Ending
Operating
December 31,
Leases
2006
$
22,988
2007
19,454
2008
17,142
2009
15,259
2010
12,035
Thereafter
53,287
Total minimum lease payments
$
140,165
Rent expense in the years ended December 31, 2003, 2004 and
2005, excluding payments under our consolidated facilities
lease, totaled $8.6 million, $7.7 million, and
$14.4 million, respectively.
Litigation and Other Legal Matters
In April 2001, two of our European subsidiaries, eBay GmbH and
eBay International AG, were sued by Montres Rolex S.A. and
certain of its affiliates in the regional court of Cologne,
Germany. The suit subsequently was transferred to the regional
court in Düsseldorf, Germany. Rolex alleged that our
subsidiaries were infringing Rolex’s trademarks as a result
of users selling counterfeit Rolex watches through our German
website. The suit also alleged unfair competition. Rolex sought
an order enjoining the sale of Rolex-branded watches on the
website as well as damages. In December 2002, a trial was held
in the matter and the court ruled in favor of eBay on all causes
of action. Rolex appealed the ruling to the Higher Regional
Court of Düsseldorf, and the appeal was heard in October
2003. In February 2004, the court rejected Rolex’s appeal
and ruled in our favor. Rolex has appealed the ruling to the
German Federal Supreme Court and a hearing is expected in
December 2006. In September 2004, the German Federal Supreme
Court issued its written opinion in favor of Rolex in a case
involving an unrelated company, ricardo.de AG, but somewhat
comparable legal theories. Although it is not yet clear what the
ultimate effect of the reasoning of the German Federal Supreme
Court’s ricardo.de decision will have when applied to eBay,
we believe the Court’s decision has resulted in an increase
in similar litigation against us in Germany, although we do not
currently believe that it will require a significant change in
our business practices.
In September 2001, MercExchange LLC filed a complaint against
us, our Half.com subsidiary and ReturnBuy, Inc. in the
U.S. District Court for the Eastern District of Virginia
(No. 2:01-CV-736) alleging infringement of three patents
(relating to online consignment auction technology, multiple
database searching and electronic consignment systems) and
seeking a permanent injunction and damages (including treble
damages for willful infringement). In October 2002, the court
granted in part our summary judgment motion, effectively
invalidating the patent related to online auction technology and
rendering it unenforceable. This ruling left only two patents in
the case. Trial of the matter began in April 2003. In May 2003,
the jury returned a verdict finding that eBay had willfully
infringed one and Half.com had willfully infringed both of the
patents in the suit, awarding $35 million in compensatory
damages. Both parties filed post-trial motions, and in August
2003, the court entered judgment for MercExchange in the amount
of approximately $30 million plus pre-judgment interest and
post-judgment interest in an amount to be determined, while
denying MercExchange’s request for an injunction and
attorneys’ fees. We appealed the verdict and judgment in
favor of MercExchange and MercExchange filed a cross-appeal of
the granting in part of our summary judgment motion and the
denial of its request for an injunction and attorneys’ fees.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
In March 2005, the U.S. Court of Appeals for the Federal
Circuit issued a ruling in the appeal of the MercExchange patent
litigation suit which, among other things (1) invalidated
all claims asserted against eBay and Half.com arising out of the
multiple database search patent and reduced the verdict amount
by $4.5 million; (2) upheld the electronic consignment
system patent; (3) affirmed the district court’s
refusal to award attorneys’ fees or enhanced damages
against us; (4) reversed the district court’s order
granting summary judgment in our favor regarding the auction
patent; and (5) reversed the district court’s refusal
to grant an injunction and remanded that issue to the district
court for further proceedings. In May 2005, the Court of Appeals
for the Federal Circuit granted our petition to stay the mandate
in the case in order to allow us to petition the
U.S. Supreme Court for review on certain issues. We filed
our petition for review with the U.S. Supreme Court in July
2005, and on November 28, 2005, the Court granted our
petition for review. Oral arguments in the case are scheduled
for March 29, 2006. In parallel with the federal court
proceedings, at our request, the U.S. Patent and Trademark
Office is actively reexamining each of the patents in suit,
having found that substantial questions exist regarding the
validity of the claims contained in them. In January 2005, the
Patent and Trademark Office issued an initial ruling rejecting
all of the claims contained in the patent that related to online
auctions; in March 2005, the Patent and Trademark Office issued
an initial ruling rejecting all of the claims contained in the
patent that related to electronic consignment systems; and in
May 2005, the Patent and Trademark Office issued an initial
ruling rejecting all of the claims contained in the patent that
related to multiple database searching. Even if successful, our
litigation of these matters will continue to be costly. In
addition, as a precautionary measure, we have modified certain
functionality of our websites and business practices in a manner
which we believe would avoid any further infringement. For this
reason, we believe that any injunction that might be issued by
the district court will not have any impact on our business. We
also believe we have appropriate reserves for this litigation.
Nonetheless, if we are not successful in appealing or modifying
the court’s ruling, and if the modifications to the
functionality of our websites and business practices are not
sufficient to make them non-infringing, we would likely be
forced to pay significant additional damages and licensing fees
and/or modify our business practices in an adverse manner.
In August 2002, Charles E. Hill & Associates, Inc.
filed a lawsuit in the U.S. District Court for the Eastern
District of Texas (No. 2:02-CV-186) alleging that we and 17
other companies, primarily large retailers, infringed three
patents owned by Hill generally relating to electronic catalog
systems and methods for transmitting and updating data at a
remote computer. The suit seeks an injunction against continuing
infringement, unspecified damages, including treble damages for
willful infringement, and interest, costs, expenses, and fees.
The case was transferred to the U.S. District Court for the
Southern District of Indiana in January 2003, but was
transferred back to the U.S. District Court for the Eastern
District of Texas in December 2003. A claim construction hearing
was held in August 2005. In February 2006, we entered into a
settlement agreement with the plaintiffs in the case under which
we will be licensed under all of the patents at issue.
In February 2002, PayPal was sued in California state court (No.
CV-805433) in a purported class action alleging that its
limiting access to customer accounts and failure to promptly
restore access to legitimate accounts violates California state
consumer protection laws and is an unfair business practice and
a breach of PayPal’s User Agreement. This action was
re-filed with a different named plaintiff in June 2002
(No. CV-808441), and a similar action was also filed in the
U.S. District Court for the Northern District of California
in June 2002 (No. C-02-2777). In March 2002, PayPal was
sued in the U.S. District Court for the Northern District
of California (No. C-02-1227) in a purported class action
alleging that its limiting access to customer accounts and
failure to promptly restore access to legitimate accounts
violates federal and state consumer protection and unfair
business practice laws. The two federal court actions were
consolidated into a single case, and the state court action was
stayed pending developments in the federal case. In June 2004,
the parties announced that they had reached a proposed
settlement. The settlement received approval from the federal
court on November 2, 2004, and the state court action was
dismissed with prejudice in March 2005. In the settlement,
PayPal does not acknowledge that any of the allegations in the
case are true. Under the terms of
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
the settlement, certain PayPal account holders are eligible to
receive payment from a settlement fund of $9.25 million,
less administrative costs and the amount awarded to
plaintiffs’ counsel by the court. That sum is being
distributed to class members who have submitted timely claims in
accordance with the settlement’s plan of allocation. The
plan of allocation for a portion of the settlement fund that
remains undistributed must still be approved by the court. That
plan was recently approved by the Special Master, who has
recommended that the District Court issue its approval.
Substantially all of the cost associated with the settlement was
reserved in 2003.
In July 2004, a purported class action lawsuit was filed by two
eBay users in Superior Court of the State of California, County
of Santa Clara (No. 104CV022708) alleging that eBay engaged
in improper billing practices as the result of problems with the
rollout of a new billing software system in the second and third
quarters of 2004. The lawsuit sought damages and injunctive
relief. An amended complaint was filed in January 2005, dropping
one plaintiff, changing the capacity of the other plaintiff to
that of representative plaintiff, and adding seven additional
eBay users as plaintiffs. The amended complaint expanded its
claim to include numerous alleged improper billing practices
from September 2003 until the present. In February 2005, eBay
filed a motion to strike and a demurrer seeking to dismiss the
complaint. In April 2005, the court sustained portions of the
demurrer, but granted the plaintiffs leave to amend their
complaint. The plaintiffs filed a second amended complaint,
dropping the last original plaintiff and again adding new
plaintiffs. We filed a motion to strike and a demurrer regarding
the plaintiffs’ second amended complaint. In July 2005, the
court again sustained a portion of the demurrer and again
granted the plaintiffs leave to amend their complaint, and the
plaintiffs filed a third amended complaint. In December 2005,
the plaintiffs filed a fourth amended complaint, dropping
several plaintiffs. In January 2006, the parties reached
tentative agreement on the terms of a settlement, though the
settlement has not been finalized.
In February 2005, eBay was sued in Superior Court of the State
of California, County of Santa Clara (No. 105CV035930)
in a purported class action alleging that certain bidding
features of our site constitute “shill bidding” for
the purpose of artificially inflating bids placed by buyers on
the site. The complaint alleges violations of California’s
Auction Act, California’s Consumer Remedies Act, and unfair
competition. The complaint seeks injunctive relief, damages, and
a constructive trust. In April 2005, we filed a demurrer seeking
to dismiss the complaint, and a hearing on the demurrer was held
in February 2006. We believe that we have meritorious defenses
and intend to defend ourselves vigorously.
In March 2005, eBay, PayPal, and an eBay seller were sued in
Supreme Court of the State of New York, County of Kings
(No. 6125/05) in a purported class action alleging that
certain disclosures regarding PayPal’s Buyer Protection
Policy, users’ chargeback rights, and the effects of
users’ choice of funding mechanism are deceptive and/or
misleading. The complaint alleged misrepresentation on the part
of eBay and PayPal, breach of contract and deceptive trade
practices by PayPal, and that PayPal and eBay have jointly
violated the civil RICO statute (18 U.S.C.
Section 1961(4)). In April 2005, eBay and PayPal removed
the case to the U.S. District Court for the Eastern
District of New York and the plaintiffs filed an amended
complaint in the U.S. District Court (No. 05-CV-01720)
repeating the allegations of the initial complaint but dropping
the civil RICO allegations. The complaint seeks injunctive
relief, compensatory damages, and punitive damages. Following
several mediation sessions, the parties reached a tentative
settlement in December 2005. The parties are still engaged in
the process of documenting this settlement. In order for the
settlement to become final, the court must preliminarily approve
its terms, and the settlement must then receive final approval
from the court after a public hearing. The full amount of the
proposed settlement was accrued in our consolidated income
statement for the year ended December 31, 2005.
In January 2005, 51 former shareholders of Epinions, Inc. common
stock including founders and former employees of that company
filed a lawsuit in Superior Court of the State of California
County of San Francisco (No. CGC 05-437906) related to
the April 2003 merger of Epinions and DealTime, Ltd. The lawsuit
was filed against certain of Epinions’ former officers and
directors and preferred shareholders and the
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
company that resulted from the merger, Shopping.com Ltd. eBay
completed its acquisition of Shopping.com Ltd. on
August 30, 2005. The lawsuit contended that the defendants
were responsible for breaches of fiduciary duty and material
misstatements and omissions, that defendants undervalued the
DealTime stock that Epinions’ shareholders received in
connection with the merger, and that plaintiffs’ common
stock of Epinions was wrongfully cancelled without compensation.
Defendants disputed the contentions of the case and denied any
allegations of wrongdoing. The parties tentatively reached
agreement as to the monetary terms for settlement of the dispute
in September 2005, and in December 2005, the settlement was
finalized and the lawsuit was dismissed. The settlement amount
has been accounted for as an assumed liability in connection
with our acquisition of Shopping.com.
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 have been notified of several
potential 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 to face
additional patent infringement claims involving services we
provide, including various aspects of our Payments and
communications 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 expand geographically
into jurisdictions where the underlying laws with respect to the
potential liability of online intermediaries like ourselves are
either unclear or less favorable. These claims, whether
meritorious or not, could be time consuming and costly to
resolve, cause service upgrade delays, 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. The number and significance of these disputes and
inquiries are increasing as our business expands and our company
grows larger. Any claims or regulatory actions against us,
whether meritorious or not, could be time consuming, result in
costly litigation, require significant amounts of management
time, and result in the diversion of significant operational
resources.
Indemnification Provisions
In the ordinary course of business, we have included limited
indemnification provisions in certain of our agreements with
parties with whom we have commercial relations, including our
standard marketing, promotions and
application-programming-interface license agreements. Under
these contracts, we generally indemnify, hold harmless, and
agree to reimburse the indemnified party for losses suffered or
incurred by the indemnified party in connection with claims by
any third party with respect to our domain names, trademarks,
logos and other branding elements to the extent that such marks
are applicable to our performance under the subject agreement.
In a limited number of agreements, including agreements under
which we have developed technology for certain commercial
parties, we have provided an indemnity for other types of
third-party claims, substantially all of which are indemnities
related to our copyrights, trademarks, and patents. In our
PayPal business, we have provided an indemnity to our payments
processors in the event of certain third-party claims or card
association fines against the processor arising out of conduct
by PayPal. To date, no significant costs have been incurred,
either individually or collectively, in connection with our
indemnification provisions.
Note 9 — Related Party Transactions:
We have entered into indemnification agreements with each of our
directors, executive officers and certain other officers. These
agreements require us to indemnify such individuals, to the
fullest extent permitted by Delaware law, for certain
liabilities to which they may become subject as a result of
their affiliation with us.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
A member of our Board of Directors is a general partner of
certain venture capital funds that beneficially hold in the
aggregate a greater than 10% equity interest in several public
and private companies. In 2000, we invested $3.0 million in
capital stock of one such private company that provides a real
estate solution to home buyers and sellers and received a
warrant to purchase additional shares, which if exercised, would
bring our total ownership to less than 5% of its capital stock.
The member of our Board of Directors referred to above is also a
member of such company’s Board of Directors. Such company
effected an initial public offering of its common stock in 2004
and we sold all of the shares we owned in such company in 2005.
Separately, a member of our Board of Directors is a director and
Chairman of the Executive Committee of the Board of Directors of
a company with whom PayPal, in September 2000, prior to
eBay’s acquisition of PayPal, entered into a strategic
marketing agreement. The agreement was terminated in December
2002, and PayPal paid the company an early termination fee of
$1.3 million in January 2003 in accordance with the terms
of the agreement. In addition, in July 2003, such company
purchased an entity with which eBay had a pre-existing data
licensing agreement. In June 2004, this contract was amended to
extend the term of the agreement and to update the fees. Under
the terms of eBay’s agreement, as amended, with the
purchased entity, eBay recognized $156,000 of revenue in 2003,
$323,000 of revenue in 2004, and $143,000 of revenue in 2005.
The revenues expected to be recognized by us is approximately
$35,500 per quarter for the remainder of the term, which is
through May 2006.
As of December 31, 2005, there were no significant amounts
payable or amounts receivable under these arrangements. All
contracts with related parties are at rates and terms that we
believe are comparable with those entered into with independent
third parties.
Note 10 — Preferred Stock:
We are authorized, subject to limitations prescribed by Delaware
law: to issue Preferred Stock in one or more series; to
establish the number of shares included within each series; to
fix the rights, preferences and privileges of the shares of each
wholly unissued series and any related qualifications,
limitations or restrictions; and to increase or decrease the
number of shares of any series (but not below the number of
shares of a series then outstanding) without any further vote or
action by the stockholders. At December 31, 2004 and 2005,
there were 10 million shares of $0.001 par value
Preferred Stock authorized for issuance, and no shares issued or
outstanding.
Note 11 — Common Stock:
Our Certificate of Incorporation, as amended, authorizes us to
issue 3,580 million shares of common stock. A portion of
the shares outstanding are subject to repurchase over a
four-year period from the earlier of the issuance date or
employee hire date, as applicable. At December 31, 2004 and
2005 there were 140,000 and 40,000 shares subject to
repurchase rights, respectively.
At December 31, 2005, we had reserved 222.6 million
shares of common stock available for future issuance under our
stock option plans, including 129.1 million shares related
to outstanding stock options. In addition, as of
December 31, 2005, we had reserved approximately
4.0 million shares of common stock available for future
issuance under our deferred stock unit plan, and approximately
5.8 million shares of common stock available for future
issuance under our employee stock purchase plan.
Note 12 — Employee Benefit Plans:
Employee Stock Purchase Plan
We have an employee stock purchase plan for all eligible
employees. Under the plan, shares of our common stock may be
purchased over an offering period with a maximum duration of two
years at 85% of the lower of the fair market value on the first
day of the applicable offering period or on the last day of the
six-
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
month purchase period. Employees may purchase shares having a
value not exceeding 10% of their gross compensation during an
offering period. During the years ended December 31, 2003,
2004, and 2005, employees purchased approximately
1.2 million, 1.2 million, and 1.4 million shares
at average prices of $12.79, $20.66 and $25.55 per share,
respectively. At December 31, 2005, approximately
5.8 million shares of common stock were reserved for future
issuance. Our employee stock purchase plan contains an
“evergreen” provision that automatically increases, on
each January 1, the number of shares reserved for issuance
under the employee stock purchase plan by the number of shares
purchased under this plan in the preceding calendar year.
Employee Savings Plans
We have a savings plan, which qualifies under
Section 401(k) of the Internal Revenue Code. Participating
employees may contribute up to 25% of their annual salary, but
not more than statutory limits. We contribute one dollar for
each dollar a participant contributes, with a maximum
contribution of $1,500 per employee. Our
non-U.S. employees
are covered by various other savings plans. Our expenses for
these plans were $3.9 million in 2003, $5.6 million in
2004 and $8.6 million in 2005.
Stock Unit Plan
We have a deferred stock unit plan under which deferred stock
units have been granted to new non-employee directors elected to
our Board of Directors after December 31, 2002. Under this
plan, each new director receives a one-time grant of deferred
stock units equal to the result of dividing $150,000 by the fair
market value of our common stock on the date of grant. Each
deferred stock unit constitutes an unfunded and unsecured
promise by us to deliver one share of our common stock (or the
equivalent value thereof in cash or property at our election).
Each deferred stock unit award granted to a new non-employee
director upon election to the Board vests 25% one year from the
date of grant, and at a rate of 2.08% per month thereafter.
If the services of the director are terminated at any time, all
rights to the unvested deferred stock units shall also
terminate. In addition, directors may elect to receive, in lieu
of annual retainer and committee chair fees and at the time
these fees would otherwise be payable (i.e., on a quarterly
basis in arrears for services provided), fully vested deferred
stock units with an initial value equal to the amount of these
fees. Deferred stock units are payable following the termination
of a director’s tenure as a director. All eBay officers,
directors and employees are eligible to receive awards under the
plan, although, to date, awards have been made only to new
non-employee directors. As of December 31, 2005,
27,391 units have been awarded under this plan.
Equity Incentive Plans
We have equity incentive plans for directors, officers and
employees. Stock options granted under these plans generally
vest 25% one year from the date of grant (or 12.5% six months
from the date of grant for grants to existing employees) and the
remainder vest at a rate of 2.08% per month thereafter, and
generally expire 10 years from the date of grant. Stock
options issued prior to June 1998, were exercisable immediately,
subject to repurchase rights held by us, which lapsed over the
vesting period. Shares of restricted stock issued under these
plans are subject to repurchase by us at such times as
determined by the Board of Directors, typically five years. At
December 31, 2005, 93.5 million shares were available
for future grant.
In-the-money options
are options with an exercise price lower than the $43.22 closing
price of our common stock on December 31, 2005.
Out-of-the-money
options are options with an exercise price greater than the
$43.22 closing price of our common stock on December 31,2005.
In connection with the change in status from an employee to a
non-employee, we were required, in accordance with FASB
Interpretation No. 44 “Accounting for Certain
Transactions Involving Stock Compensation — an
interpretation of APB Opinion No. 25” and
EITF 00-23
“Issues Related to the
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Accounting for Stock Compensation under APB Opinion No. 25
and FASB Interpretation No. 44”, to remeasure the
portion of an individual’s options that were unvested at
the date of the change in status. The remeasurement is required
to be at fair value and will continue to be revalued over the
period of performance. The related stock-based compensation
amortization recognized during the year ended December 31,2005 totaled approximately $6.7 million. The fair value of
these unvested options have been estimated using the
Black-Scholes option pricing model with the following weighted
average assumptions: risk-free interest rate, 4.43%; effective
contractual life, 3 years; dividend yield, 0%; and expected
volatility, 35%.
The following table summarizes additional stock option
information related to grants made to our employees and grants
made specifically to named officers, which include our chief
executive officer and the other four most highly compensated
officers during the year (in thousands, except percentages):
Total outstanding shares of common stock (at period end)
1,298,586
1,338,608
1,404,184
As a percentage of total outstanding shares of common stock:
Grants during the period
4
%
3
%
2
%
Total outstanding “in-the-money” grants
11
%
10
%
8
%
Total outstanding grants
11
%
10
%
9
%
Grants to named officers during the period
*
*
*
Total outstanding grants to named officers
1
%
1
%
1
%
Total stock option grants during the period
53,388
43,628
34,991
Grants to named officers during the period as a percent of total
grants during the period
9
%
7
%
4
%
Total outstanding stock option grants (at period end)
138,410
137,208
129,109
Total outstanding grants to named officers as a percent of total
stock option grants outstanding
11
%
11
%
11
%
*
Less than half of a percentage point
Non-stockholder approved stock option grants
Prior to our initial public offering in 1998, our Board of
Directors approved three stock option grants outside of formally
approved stockholder plans to two independent directors upon
their joining our Board of Directors and to an executive officer
upon his hiring. All of such option grants vested over 25% one
year from the date of grant, with the remainder vesting at a
rate of 2.08% per month thereafter and expire 10 years
from the date of grant. The options granted to the independent
directors were immediately exercisable, subject to repurchase
rights held by us, which lapse over the vesting period. The
terms and conditions of such grants are otherwise identical to
nonqualified option grants made under the stock option plan in
effect at that time. At the time of such grants, members of our
Board of Directors (and their affiliates) beneficially owned in
excess of 90% of our then outstanding voting interests. We have
previously disclosed such option grants in our Prospectus filed
with the Securities and Exchange Commission on
September 25, 1998 in connection with our initial public
offering under the headings “Management —
Director Compensation” and “Management —
Compensation Arrangements.” Prior to 2004, one director and
the executive officer had exercised all available options under
their respective grants. At December 31, 2005, one grant
remained outstanding to one independent director, with
1,383,000 shares to be issued upon exercise of the
outstanding options at an average
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
exercise price of $0.39. There were no shares remaining
available under these non-stockholder approved plans for future
grants as of December 31, 2005.
Note 13 —
Income Taxes:
The components of pretax income before cumulative effect of
accounting change and minority interest in consolidated
companies for the years ended December 31, 2003, 2004 and
2005 are as follows (in thousands):
The following is a reconciliation of the difference between the
actual provision for income taxes and the provision computed by
applying the federal statutory rate of 35% for 2003, 2004, and
2005 to income before income taxes (in thousands):
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Deferred tax assets and liabilities are recognized for the
future tax consequences of differences between the carrying
amounts of assets and liabilities and their respective tax bases
using enacted tax rates in effect for the year in which the
differences are expected to reverse. Significant deferred tax
assets and liabilities consist of the following (in thousands):
As of December 31, 2005, our federal net operating loss
carryforwards for income tax purposes were approximately
$123.8 million. If not utilized, the federal net operating
loss carryforwards will begin to expire in 2019. As of
December 31, 2005, our federal and state tax credit
carryforwards for income tax purposes were approximately
$70.1 million and $67.5 million, respectively. If not
utilized, the federal tax credit carryforwards will begin to
expire in 2019, and the state tax credit carryforwards will
begin to expire in 2015.
We receive tax deductions from the gains realized by employees
on the exercise of certain non-qualified stock options for which
the benefit is recognized as a component of stockholders’
equity. Historically, we have evaluated the deferred tax assets
relating to these stock option deductions along with our other
deferred tax assets and concluded that a valuation allowance is
not required for that portion of the total deferred tax assets
that are not considered more likely than not to be realized in
future periods. To the extent that the deferred tax assets with
a valuation allowance become realizable in future periods, we
will have the ability, subject to carryforward limitations, to
benefit from these amounts. When realized, the tax benefits of
tax deductions related to stock options are accounted for as an
increase to additional paid-in capital rather than a reduction
of the income tax provision. Our profitability coupled with the
level of stock option deductions generated during 2005 resulted
in the utilization of net operating losses related to deferred
tax assets for stock option deductions. Accordingly the
valuation allowance related to these deferred tax assets was
eliminated in 2005, resulting in an increase of
$166.3 million in additional paid-in capital. Beginning in
2006, deferred tax assets related to stock option deductions
will be recognized in the periods when the benefit is received.
We have not provided for U.S. federal income and foreign
withholding taxes on $974.2 million of
non-U.S. subsidiaries’
undistributed earnings as of December 31, 2005, because
such earnings are intended to be indefinitely reinvested in the
operations and potential acquisitions of our International
Marketplaces segment. Upon distribution of those earnings in the
form of dividends or otherwise, we would be subject to
U.S. income taxes (subject to an adjustment for foreign tax
credits). It is not practicable to determine the income tax
liability that might be incurred if these earnings were to be
distributed.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS — (Continued)
Supplementary Data — Quarterly Financial
Data-Unaudited:
The following tables present certain unaudited consolidated
quarterly financial information for each of the eight quarters
ended December 31, 2005. This quarterly information has
been prepared on the same basis as the Consolidated Financial
Statements and includes all adjustments necessary to state
fairly the information for the periods presented. The results of
operations for any quarter are not necessarily indicative of
results for the full year or for any future period. All share
and per share amounts included in the following consolidated
financial data have been adjusted to reflect all previous stock
splits, including our two-for-one stock split, effective
February 16, 2005.
Quarterly Financial Data
(Unaudited, in thousands, except per share amounts)
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, as amended, the Registrant has
duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of
San Jose, State of California, on the
23rd day
of February, 2006.
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose
signature appears below constitutes and appoints Margaret C.
Whitman, Rajiv Dutta, Douglas Jeffries, and Michael R. Jacobson,
and each or any one of them, each with the power of
substitution, his or her
attorney-in-fact, to
sign any amendments to this report, with exhibits thereto and
other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that
each of said
attorneys-in-fact, or
his substitute or substitutes, may do or cause to be done by
virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of
1934, as amended, this report has been signed below by the
following persons on behalf of the registrant and in the
capacities and on the dates indicated.
Sale and Purchase Agreement dated as of September 11, 2005,
by and among eBay Inc., Skype Technologies S.A. and the parties
identified on Schedule 1 thereto.
Amendment No. 1 to Earn out Agreement dated as of
December 29, 2005, by and among eBay Inc., Skype
Technologies S.A. and the parties identified on Schedule I
thereto.
X
3
.01
Registrant’s Amended and Restated Certificate of
Incorporation.
