eBay
Annual Report 2004

Plain-text annual report

To our Stockholders, Partners, Employees and the eBay Community A Global Community Ì 10 Years Old eBay is an extraordinary company. During the past 10 years Ì the company's Ñrst decade Ì eBay has revolutionized the way people shop and trade. Before eBay came along very few people had ever experienced an auction. eBay has introduced millions of people to a whole new trading format Ì a format based on the fairness inherent in natural market dynamics and the good we Ñnd in our friends and neighbors. Perhaps more importantly, eBay has empowered millions of people to pursue their dreams of economic and entrepreneurial success. And that success has had an even deeper social impact. After all, the eBay platform is built on trust. The millions of successful transactions that take place on the site each day are a testament to the fact that people, when left to their own devices, almost always do the right thing. Every successful eBay transaction validates two people's beliefs in the good of others. In our world, that is a very powerful achievement. eBay thrived in 2004 because our global community of buyers and sellers unleashed their passion for trading. Our community grew to 135 million registered users worldwide, with more and more people recognizing the many opportunities available to them through eBay. Small business on eBay really came into its own in 2004. Early in the year, we discovered through our research that more than 430,000 users in the United States make all or some of their livelihoods through selling on the site. The ingenuity and creativity of our users, no matter where they are, is inspiring. A mother of six in Germany started a business selling kitchen products on eBay, and now teaches others in her isolated community how to use the site to make extra money. A man in China who always dreamed of starting his own business now sells coins and stamps from his home in Shanghai to buyers around the world. A radio collector in Colorado has purchased more than 1,300 radios on eBay, fulÑlling his passion to own one of the world's most comprehensive radio collections. And a Utah restaurateur purchased the majority of the equipment for his family-owned restaurant on eBay at a savings that allowed him to start his business much sooner than expected. These stories, and millions more just like them, convince us that eBay is the best place to buy and sell online. A Fast Growing Company Thanks to our community's success, eBay experienced exceptional growth across every part of the business in 2004. The eBay community listed more than 1.4 billion items last year, a 45% increase from 2003. This increase in listings led to gross merchandise volume or GMV, which is the value of all successfully closed listings on eBay, of $34.2 billion in 2004, up from $23.8 billion in 2003. As a result, 2004 net revenues reached nearly $3.3 billion, a jump of 51% over the prior year. eBay achieved new milestones in 2004. Operating proÑt grew more than 68%, reaching well over one billion dollars for the Ñrst time in eBay's history. This proÑt growth translated directly into cash Öows, with operating cash Öows also breaking the one billion dollar mark for the Ñrst time ever and free cash Öows1 growing by more than 95% to $992 million. eBay ended 2004 with more than $7.9 billion in total assets, including nearly $3.4 billion in cash and investments, which gives us the Ñnancial Öexibility to reinvest in the business. Few ten year old companies can deliver these types of results. 2004 was also a year of expansion for eBay. In India, we acquired Baazee.com, which allowed us to enter a very young but promising Internet market. We launched two new sites of our own in the Philippines and Malaysia, and consolidated our ownership of Internet Auction Company in Korea, our third largest market outside the U.S. In the U.S., we announced the acquisition of Rent.com, the leading transaction-based website for apartment rentals, which closed in early 2005. We believe Rent.com will complement our own real estate category and provide for additional growth in this area. With the acquisition of mobile.de in Germany and Marktplaats.nl in the Netherlands, as well as our equity investment in craigslist.org, we took important Ñrst 1 eBay deÑnes free cash Öows as operating cash Öows less purchase of property and equipment, which in 2004 were $1.3 billion and $293 million, respectively. steps into classiÑeds, which set the stage for the launch of our own local classiÑeds websites in select international markets, under the brand name Kijiji, in February 2005. PayPal also had a strong year, adding 23 million new accounts in 2004 for a total of 64 million user accounts. PayPal now has more accounts than the total cardholder base of Discover and the account base of Bank of America. Total payment volume, the dollar volume of payments through the PayPal system, totaled $18.9 billion, an increase of 55% over the prior year. In just Ñve years, PayPal is already the most visited Ñnancial services website in the U.S. and the United Kingdom. eBay communities around the world have enthusiastically welcomed PayPal. In the last two years, we have localized in 10 countries. Today, users from 45 countries can use their PayPal account as buyers. In 23 of those countries, we also enable sellers to do cross-border trade. We believe PayPal's Merchant Services, or oÅ- eBay opportunity, has great potential. By oÅering an extremely compelling value proposition for online payments to merchants of all sizes, we have signed up more merchant accounts in Ñve years than the industry has in 30. By meeting the needs of buyers and sellers both on and oÅ eBay, PayPal is fast becoming the wallet of a generation of online shoppers. Our conÑdence in the vibrancy of the eBay marketplace, the continued growth of PayPal, the opportunities ahead for both, and our ability to manage these businesses has never been stronger. Helping our community members thrive remains our highest priority. Their success is critical to our own, and we remain focused on providing our users with the best tools for trading online. Investments and ProÑtability In addition to the strength of our core business, new opportunities are emerging rapidly. As a result, we plan to invest signiÑcantly in strategic investment opportunities in 2005, most notably in China and PayPal. In the past year eBay EachNet more than doubled its user base, strengthening its position as China's number one e-commerce site. We see great opportunity to consolidate our position in China and set the stage for long-term growth. PayPal is still in an early stage of development, and we see a great deal of untapped potential in the U.S., both on eBay and among merchants oÅ eBay, and throughout eBay's global platform. With greater investment in PayPal in 2005 we can lay the foundation for future growth and come closer to making PayPal the online payment standard around the world. It has always been a part of eBay's management philosophy that investments in future growth must be balanced against generating real gains on the bottom line. As a result, we are focused on realizing the full margin potential of the business, so that we can deliver increasing proÑts while also generating the capacity to fund these investments. We believe this strategy of prioritizing top-line growth with eBay's cost leverage will translate into higher cash Öows and value for our stockholders. eBay's accomplishments in 2004 could not have been achieved alone. We would like to acknowledge our partners, employees, and stockholders for their ongoing support and conÑdence. And, we would also like to extend our appreciation and gratitude to eBay's community of users worldwide. These passionate and inventive men and women have built our marketplace. Their support, guidance and dedication are at the heart of all we achieve. Pierre Omidyar Founder and Chairman of the Board Meg Whitman President and CEO UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K ¥ n ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Ñscal year ended December 31, 2004. OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period from to . Commission Ñle number 000-24821 eBay Inc. (Exact name of registrant as speciÑed in its charter) Delaware (State or other jurisdiction of incorporation or organization) 2145 Hamilton Avenue San Jose, California (Address of principal executive oÇces) 77-0430924 (I.R.S. Employer IdentiÑcation Number) 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 whether the registrant (1) has Ñled all reports required to be Ñled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to Ñle such reports), and (2) has been subject to such Ñling requirements for the past 90 days. Yes ¥ No n Indicate by check mark if disclosure of delinquent Ñlers 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 deÑnitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. n Indicate by check mark whether the registrant is an accelerated Ñler (as deÑned in Exchange Act Rule 12b-2). Yes ¥ No n As of June 30, 2004, the last business day of the registrant's most recently completed second Ñscal quarter, there were 1,321,484,422 shares (after giving retroactive eÅect to the registrant's two-for-one stock split eÅective February 16, 2005) of the registrant's common stock, $0.001 par value, outstanding, which is the only class of common or voting stock of the registrant issued as of that date. The aggregate market value of the voting stock held by non-aÇliates, computed by reference to the closing price for the common stock as quoted by the Nasdaq National Stock Market as of that date and based upon information provided by stockholders on Schedules 13D and 13G Ñled with the Securities and Exchange Commission, was approximately $44,167,700,000. Shares of common stock held by each executive oÇcer and director and by each person who owns 5% or more of the registrant's outstanding common stock have been excluded in that such persons may be deemed to be aÇliates. This determination of aÇliate status is not necessarily a conclusive determination for other purposes. As of February 18, 2005, there were 1,344,806,283 shares of the registrant's common stock outstanding. FORWARD LOOKING STATEMENTS PART I This report contains statements that involve expectations, plans or intentions (such as those relating to future business or Ñnancial 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 That May AÅect Results of Operations and Financial Condition'' in Item 7, as well as our consolidated Ñnancial statements, related notes, and the other Ñnancial information appearing elsewhere in this report and our other Ñlings with the Securities and Exchange Commission. We assume no obligation to update any forward-looking statements. ITEM 1: BUSINESS 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 oÅering of our common stock. Our principal executive oÇces 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. When we refer to ""PayPal.com,'' we mean the online payments platform located at www.paypal.com. Our Purpose and Our Mission Our purpose is to pioneer new communities around the world built on commerce, sustained by trust, and inspired by opportunity. We currently have two major businesses: the eBay Marketplace and PayPal. Our eBay Marketplace Mission is to create the world's online marketplace. Our PayPal Mission is to create the new global standard for online payments. eBay Marketplace Our marketplace exists as an online trading platform that enables 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 trading platform while, at the same time, supporting the growth and success of our community of users. Trading Platform Our trading platform is a fully automated, topically arranged, intuitive and easy-to-use online service that seeks to provide availability 24 hours a day, seven days a week, enabling sellers to list items for sale in either auction or Ñxed-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 platform includes 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. Our software tools and services are designed to make our trading process easier and more eÇcient. These tools and services include: Turbo Lister, Seller's Assistant, 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; and PayPal, which facilitates the online exchange of funds. 2 Whether provided by us or our commercial partners, services such as our global payments platform, trust and safety programs, user veriÑcation, 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 trading environment. Community Our community of users is the largest and one of the most loyal online trading communities on the Internet. We have aggregated a signiÑcant number of buyers, sellers, and items listed for sale, which, in turn, has resulted in an extremely vibrant trading environment. Our sellers enjoy generally high conversion rates and buyers enjoy an extensive selection of broadly priced goods and services. Key components of our community philosophy are maintaining an honest and open marketplace and treating individual users with respect. We seek to maintain the satisfaction and loyalty of our frequent buyers and sellers by oÅering 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-speciÑc information exchanges. By applying a consistent set of policies and fees to our community, we have created a level playing Ñeld 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 conÑrmed registered users, which has grown from approximately two million at the end of 1998 to more than 94 million at the end of 2003 and to more than 135 million at December 31, 2004. In addition, at December 31, 2004, we had approximately 56 million active users, compared to approximately 41 million at the end of 2003. We deÑne an active user as any user who bid on, bought, or listed an item during the prior 12-month period. We attract buyers and sellers to our community by oÅering: Buyers ‚ Selection ‚ Value ‚ Convenience ‚ Entertainment Sellers ‚ Access to broad markets ‚ EÇcient marketing and distribution costs ‚ Ability to maximize prices ‚ Opportunity to increase sales We focus on three fundamental building blocks to grow the gross merchandise volume and net revenues derived from the eBay Marketplace. These building blocks are: ‚ Acquisition Ì increasing the number of new registered users on our eBay Marketplace ‚ Activation Ì increasing the number of registered users that become active bidders, buyers or sellers on our eBay Marketplace ‚ Activity Ì increasing the volume and value of transactions that are conducted by each active user on our eBay Marketplace The speciÑc areas of focus in each of our online trading marketplaces depend on the stage of local market development and other considerations. eBay Marketplace Value Proposition We believe our online marketplace makes ineÇcient markets more eÇcient. Traditional oÉine marketplaces can be ineÇcient because: ‚ They are fragmented and regional, making it diÇcult and expensive for buyers and sellers to meet, exchange information and complete transactions; ‚ They oÅer a limited variety and breadth of goods; ‚ They often have high transaction costs due to intermediaries; and 3 ‚ They are information ineÇcient, as buyers and sellers lack a reliable and convenient means of setting prices. We make these ineÇcient marketplaces more eÇcient because: ‚ Our global community of users can easily and inexpensively communicate, exchange information and complete transactions; ‚ Our marketplace includes tens of millions of items creating a wide variety and selection of goods; ‚ We bring buyers and sellers together for much lower fees than traditional intermediaries; and ‚ Our marketplace provides for eÇcient 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 Marketplace. Our marketplace is most eÅective, relative to available alternatives, at addressing markets of new and scarce goods, end-of-life products and used and vintage items. eBay Marketplace 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. Categories Category growth both in number and size within the eBay Marketplace is a key element in creating a faster, easier and safer online trading experience. As of December 31, 2004, listings on eBay.com were organized under the following major categories: ‚ Antiques ‚ Art ‚ Books ‚ Business & Industrial ‚ Camera & Photo ‚ Cell Phones ‚ Clothing, Shoes & Accessories ‚ Coins ‚ Collectibles ‚ Computers & Networking ‚ Consumer Electronics ‚ Crafts ‚ Dolls & Bears ‚ DVDs & Movies ‚ Entertainment Memorabilia ‚ Everything Else ‚ Gift CertiÑcates ‚ Health & Beauty ‚ Home & Garden ‚ Jewelry & Watches ‚ Music ‚ Musical Instruments ‚ Pottery & Glass ‚ Real Estate ‚ Specialty Services ‚ Sporting Goods ‚ Sports Memorabilia, Cards and FanShop ‚ Stamps ‚ Tickets ‚ Toys & Hobbies ‚ Travel ‚ Video Games ‚ eBay Motors ‚ Boats ‚ Motorcycles ‚ Parts & Accessories ‚ Passenger Vehicles ‚ Powersports ‚ Other Vehicles 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 marketplace 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 represents another format through which sellers can oÅer their goods and 4 services. eBay Stores enables sellers to show all of their listings and to describe their respective businesses through customized pages. In addition to our more established eBay Marketplace formats, we are continually looking for ways to better enable members of our community to interact and transact with one another online. One new format that we are exploring with our acquisitions in 2004 of mobile.de in Germany and Marktplaats.nl in the Netherlands, as well as our investment in craigslist, is the classiÑeds format. These transactions will allow us to increase our knowledge of classiÑeds-style trading. In addition, we recently acquired Rent.com, which will allow us to expand into the online housing and apartment rental market. Geographies A key element of our growth strategy is to continually expand the eBay Marketplace 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 marketplace. As of December 31, 2004, eBay and its consolidated subsidiaries had marketplace websites directed toward the following markets: ‚ Australia ‚ Austria ‚ Belgium ‚ Canada ‚ China ‚ France ‚ Germany ‚ Hong Kong ‚ India ‚ Ireland ‚ Italy ‚ Malaysia ‚ the Netherlands ‚ New Zealand ‚ the Philippines ‚ Singapore ‚ South Korea ‚ Spain ‚ Sweden ‚ Switzerland ‚ Taiwan ‚ United Kingdom ‚ United States In addition, through our equity investment in MercadoLibre, our geographic reach as of December 31, 2004, included the following markets: ‚ Argentina ‚ Brazil ‚ Chile ‚ Columbia ‚ Ecuador ‚ Mexico Marketplace Services Trust and Safety Programs ‚ Peru ‚ Uruguay ‚ Venezuela We have developed a number of programs on our eBay Marketplace, 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' proÑles, which include feedback ratings and comments by other users. Every registered eBay user has a feedback proÑle 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 speciÑc transactions and provides an easy tool for users to match speciÑc transactions with the user names of their trading partners. This information is recorded in a proÑle 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 proÑle 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 5 features designed to detect and prevent some forms of abuse. Users who receive a suÇciently 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 extremely 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 oÅer 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 staÅ 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 staÅ 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 oÇcially Ñled, written claim of fraud from a user, we will generally suspend the oÅending 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 Marketplace 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 oÅending 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 veriÑcation, buyer protection, integrated escrow, authentication, and other proactive anti-fraud eÅorts are key elements of our eÅort to make the eBay Marketplace a safer place to trade. eBay Standard Purchase Protection Program: Disputes over items not received, or items received but where signiÑcantly 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 oÅers 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 Ñle 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 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 Marketplace trust and safety programs, PayPal also oÅers a Buyer Protection Program that makes buying on the eBay Marketplace more secure. With PayPal Buyer Protection, qualiÑed purchases are eligible for up to $1,000 coverage. Customer Support We devote signiÑcant 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-speciÑc support, extending our online self-help features, and improving our systems and processes to allow us to provide the most eÇcient and eÅective support possible. 6 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 We oÅer 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 oÅer 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. Our global payments platform also makes online trading more eÇcient 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 trading 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-eÅectively. The PayPal network builds on the existing Ñnancial 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 45 countries, including the United States. As of December 31, 2004, PayPal had approximately 64 million total accounts, comprising approximately 13 million business accounts and 51 million personal accounts. PayPal Services Joining the Network PayPal oÅers 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 identiÑer. PayPal also oÅers 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, conÑrms 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 instantly 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 Ñve business days. In turn, the recipient can make 7 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, with credit card and debit card funding costs being signiÑcantly 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 2.03% as of December 31, 2004. VeriÑcation of PayPal's Account Holders To fund payments from their bank accounts in the United States, the United Kingdom and Canada, senders must Ñrst become veriÑed PayPal users. The primary method for veriÑcation 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, veriÑcation 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, 2004, in 23 other countries, 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 Ñve business days to arrive in the account holder's bank account, depending on the bank. 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 Value Proposition Providing more eÇcient and eÅective payment methods is essential to creating a faster, easier and safer online trading experience. Traditional payment methods such as checks, money orders and credit cards processed through merchant accounts, all present various obstacles to the online trading 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 Ñnancial 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 Ñnancial information online Ñnd this high level of personal privacy attractive. PayPal oÅers online merchants an all-in-one payment processing solution that is cheaper than most merchant accounts, oÅers industry-leading fraud prevention, and enables merchants to access approximately 64 million customers in 45 countries. 8 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 Marketplace and expansion of PayPal's merchant services, which are services for merchants who sell through their own websites. Increase PayPal's adoption on the eBay Marketplace eBay.com: In 2004, the U.S. Marketplace segment of eBay generated more than $18 billion in gross merchandise volume, which is a measure of the total value of all successfully closed listings between users on our marketplace. We intend to strengthen PayPal's penetration into the payments area on the eBay Marketplace in the United States by continuing to integrate with eBay listings and seeking to add product features important to the eBay community. During 2004, we added features such as PayPal Buyer Credit and payment for postage and shipment insurance through PayPal, we expanded the free coverage aÅorded to buyers under the PayPal Buyer Protection Program from $500 to $1,000 per transaction (from 250 to 500 for British pound-denominated transactions), and we added PayPal Buyer Protection coverage for buyers from qualiÑed U.K., Canadian and German sellers. International sites: Prior to 2004, PayPal was oÅered in a local language and currency in only three countries Ì the United States, Canada and the United Kingdom. As of December 31, 2004, PayPal was available in a local language and currency in Ñve additional countries. PayPal plans to continue its expansion into new countries, while innovating on the product and adding new features to increase adoption by the eBay international community. As of December 31, 2004, PayPal was oÅered in a local language and currency in eight markets: ‚ Austria ‚ Belgium ‚ Canada ‚ France ‚ Germany ‚ Switzerland ‚ United States ‚ United Kingdom As of December 31, 2004, PayPal allowed its customers with credit cards to send payments from an additional 36 markets outside of the U.S., and to receive payments in 35 of those markets. In 15 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 eÇcient, which beneÑts both the eBay Marketplace 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 and medium-sized businesses. During the past year, we added features that allow merchants to customize PayPal's payment Öows to their own websites, and to integrate PayPal more seamlessly into their checkouts. We also completely redesigned the PayPal home page to make it more user friendly for businesses, and rolled out a ""PayPal For Business'' campaign. 9 We intend to continue to market the PayPal product to small and medium-sized businesses and large merchants, and enable them to add PayPal as a ""payment mark'' on their websites. These merchants will oÅer 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. For example, during the past year, we integrated PayPal with Apple iTunes and Napster. 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 certain additional protection to eBay 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 on certain fraudulent transactions. In order to be eligible for 100% protection, PayPal sellers must adhere to certain steps which include: having a veriÑed Business or Premier account; shipping goods, in a timely manner, to an eligible address; retaining proof of shipping which is trackable online and, for items with a value of over $250, requiring a signature receipt; accepting entire payment in a single transaction; and, responding to all PayPal inquiries in a timely manner. Buyer Protection Policy: With PayPal Buyer Protection, qualiÑed purchases are eligible for up to $1,000 (or for up to 500 for British pound-denominated transactions) coverage at no cost. This program covers qualiÑed purchases that the buyer has paid for, and either has never received, or has received but where signiÑcantly diÅerent than described in the listing. When a buyer Ñles 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 eÅort to come to a fair conclusion. For a purchase to be eligible for this coverage, the PayPal Buyer Protection icon must be displayed in the Seller Information box on the eBay listing, 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 Ñled within 45 days of PayPal payment, and buyers are limited to three PayPal Buyer Protection refunds per year. Money Back Guarantee: When a payment is made on the PayPal website, users are often given the option to buy a Money Back Guarantee to protect the purchase of physical goods. If a Money Back Guarantee is purchased, buyers will have the option to return the merchandise to us in exchange for a reimbursement (not including the guarantee fee), provided that they Ñle a complete reimbursement request within 45 days of payment. This program is only oÅered for transactions involving tangible goods of less than $1,000 with pre- qualiÑed sellers. In addition, we may take additional criteria into account in deciding whether to oÅer the Money Back Guarantee on a particular transaction. 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 auction close. The eBay platform also manages various notiÑcations for sellers and buyers, including daily status updates, bid and outbid notices, registration conÑrmations, 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 10 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-speciÑed 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. Overall system volume on the eBay platform is signiÑcant, with peak usage in 2004 of approximately 890 million page views per day and 7.7 gigabits of outbound data traÇc per second. Our eBay platform is designed around industry standard architectures to reduce downtime in the event of outages or catastrophic occurrences. eBay seeks to provide availability 24 hours a day, seven days a week. Substantially all of our system hardware is hosted at Cable & Wireless and Qwest facilities in San Jose, California, an eBay-owned data center in Denver, Colorado, and a Sprint Communications facility in Sacramento, California. Each of these facilities provides redundant communications lines and emergency power backup. Although our systems have been designed around industry-standard architecture to reduce downtime in the event of outages or catastrophic occurrences, they remain vulnerable to damage or interruption, and we do not maintain fully redundant systems. For more information regarding these risks, see the information in Item 7 under ""Risk Factors That May AÅect Results of Operations and Financial Condition Ì System failures could harm our business.'' 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 Veritas to provide for fault tolerance, and we use IBM's WebSphere application server for certain platform functions. In 2004 we completed the implementation of a new billing and collections system from CSG Systems. 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 eÅectively integrate our technology, transaction processing systems, security infrastructure, or network infrastructure to accommodate increased traÇc or transaction volume our business could be harmed. For more information regarding these risks, see the information in Item 7 under ""Risk Factors That May AÅect Results of Operations and Financial Condition Ì 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, to adapt our services to evolving industry standards and to improve the performance, features and reliability of our services in response to competitive services and product oÅerings 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. In 2004, we completed our migration to a new software architecture intended to facilitate continued stability, improved scalability, and enhanced eÇciency on the eBay Marketplace. The new architecture now serves nearly 100% of the site traÇc of the eBay Marketplace. PayPal Platform Our PayPal technology is designed to assure user access to the PayPal website. We focus much of PayPal's development eÅorts on creating specialized software that enhances its Internet-based customer functionality. One of PayPal's key challenges remains building and maintaining a scalable and reliable system, capable of handling traÇc and transactions for a growing customer base. Most major components of our PayPal network reside at our facilities in San Jose, California, at an eBay-owned data center in Denver, Colorado, at an Equinix data center in San Jose, California, and at our PayPal operations and customer support facility in Omaha, Nebraska. 11 Due to the Ñnancial nature of the PayPal product, we seek to oÅer a high level of data security in order to build customer conÑdence 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 Ñre 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, Öoods, Ñres, 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 Ñnancial diÇculties. For more information regarding these risks, see the information in Item 7 under ""Risk Factors That May AÅect Results of Operations and Financial Condition Ì 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 fulÑlling a decryption request. Competition We encounter vigorous competition in our business from numerous sources. Our users can Ñnd, buy, sell, and pay for similar items through a variety of competing channels. These include but are not limited to, online and oÉine retailers, distributors, liquidators, import and export companies, auctioneers, catalog and mail-order companies, classiÑeds, directories, search engines, products of search engines, virtually all online and oÉine commerce participants (consumer-to-consumer, business-to-consumer and business-to-business) and online and oÉine shopping channels and networks. As our product oÅerings continue to broaden into new categories of items and new trading formats, we expect our competition to continue to broaden to include other online and oÉine channels for those new oÅerings. 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, oÉine payment methods such as cash, check or money order, and traditional online or oÉine credit card merchant accounts. To compete eÅectively, we may need to expend signiÑcant resources in technology and marketing. These eÅorts may be expensive and could reduce our margins and have a material adverse eÅect on our business, Ñnancial position, operating results, cash Öows and reduce the value of our stock. We believe that we will be able to maintain proÑtability 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 7 under ""Risk Factors That May AÅect Results of Operations and Financial Condition Ì 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 Ñrst and fourth Ñscal quarters. PayPal has shown similar seasonality, especially in the fourth Ñscal quarter. We expect these patterns of seasonality to continue as our websites gain acceptance by a broader base of mainstream users. In addition, as our business matures, transaction activity patterns on our websites increasingly mirror general consumer buying patterns, both online and oÉine. 12 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 conÑdentiality 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'' and ""PayPal'' domain names in major non-U.S. jurisdictions. We have Ñled to protect our rights to the ""eBay'' and ""PayPal'' names in certain new top-level domains such as "".biz'', "".info'' and "".us'' that have become operational more recently. Our inability to secure our trademarks or domain names could adversely aÅect 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 7 under ""Risk Factors That May AÅect Results of Operations and Financial Condition Ì We are subject to intellectual property and other litigation'' and ""Ì We may be unable to protect or enforce our own intellectual property rights adequately.'' Employees As of December 31, 2004, eBay Inc. and its consolidated subsidiaries employed approximately 8,100 people (excluding approximately 600 temporary employees), of whom approximately 5,900 were located in the United States (excluding approximately 500 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 Ñnd and retain highly qualiÑed 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 Ñnancial information and overall materiality considerations. The U.S. Marketplace segment includes U.S. online marketplace trading platforms other than our PayPal subsidiary. The International Marketplace segment includes our international online marketplace trading platforms other than our PayPal subsidiary. The Payments segment includes our global payments platform consisting of our PayPal subsidiary. The Payments amounts reÖect the historical operations of our former Billpoint subsidiary and PayPal's operations for the post-acquisition period from October 4, 2002 through December 31, 2004. We completed our planned wind-down of Billpoint in the Ñrst half of 2003. The Ñnancial 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 speciÑc 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 site operations costs, product development expenses, and certain other general and administrative costs, are monitored by management through shared cost centers and are not evaluated in the measurement of segment performance. 13 For an analysis of Ñnancial information about geographic areas as well as our segments, see ""Note 4 Ì Segments'' of the notes to our consolidated Ñnancial statements incorporated herein. 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 Ñle or furnish such materials to the U.S. Securities and Exchange Commission. Further, a copy of this annual report on Form 10-K is located at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, D.C. 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1- 800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding our Ñlings at www.sec.gov. ITEM 2: PROPERTIES We own and lease various properties in the United States and in 17 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, 2004, our owned and leased properties provided us with aggregate square footage of approximately 730,000 and 1.4 million, respectively, and the total square footage occupied by our U.S. Marketplace, International Marketplace and Payments segments totaled approximately 800,000, 650,000 and 450,000, respectively. As of December 31, 2004, the remaining total square footage of our owned and leased properties were either sublet or were 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. For a discussion of the accounting treatment of our leased corporate headquarters that we will purchase on March 1, 2005, see ""Note 8 Ì Long-Term Obligations'' of the notes to our consolidated Ñnancial statements, included elsewhere in this Annual Report on Form 10-K. 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 aÇliates in the regional court of Cologne, Germany. The suit subsequently was transferred to the regional court in D usseldorf, 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 D usseldorf, 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. In March 2004, the German Federal Supreme Court ruled in favor of Rolex in a case involving an unrelated company, ricardo.de AG, but somewhat comparable legal theories. The court issued its written decision in that case in September 2004. Although it is not yet clear what eÅect the reasoning of the German Federal Supreme Court's ricardo.de decision would have when applied to eBay, we believe the Court's decision will likely not require any signiÑcant change in our business practices. In September 2001, a complaint was Ñled by MercExchange LLC 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 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 14 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 $35.0 million in compensatory damages. Both parties filed post-trial motions, and in August 2003, the court entered judgment for MercExchange in the amount of $29.5 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. Oral arguments for the appeals were heard on October 5, 2004. The U.S. Patent and Trademark Office recently granted our request that it reexamine the three patents at suit, and on January 26, 2005, the Patent and Trademark Office issued a ruling rejecting all of MercExchange's claims under the patent that related to online auctions. We continue to believe that the verdict against us in the trial was incorrect and intend to continue to pursue our appeal and defend ourselves vigorously. However, even if successful, our appeal of and defense against this action 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 makes them not infringe the two patents that we were found to have infringed. Nonetheless, if we are not successful in appealing the court's ruling, we might be forced to pay significant additional damages and licensing fees or modify our business practices in an adverse manner. We recorded an operating charge in the amount of $30.0 million, reflecting the $29.5 million judgment, together with our estimate for pre-judgment interest of $0.5 million. The charge and the related estimated tax benefit of $12.1 million were reflected in our consolidated statement of income as patent litigation expense in the year ended December 31, 2003. In August 2002, Charles E. Hill & Associates, Inc. Ñled 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, unspeciÑed damages, including treble damages for willful infringement, and interest, costs, expenses, and fees. In January 2003, the case was transferred to the U.S. District Court for the Southern District of Indiana. After pending in Indiana for almost a year, the case was transferred back to the U.S. District Court for the Eastern District of Texas in December 2003. A scheduling conference was held in November 2004 and a preliminary trial date has been set for February 2006. The case is currently in fact discovery and claim construction discovery. We believe that we have meritorious defenses and intend to defend ourselves vigorously. In February 2002, PayPal was sued in California state court (No. CV-805433) in a purported class action alleging that its restriction of customer accounts and failure to promptly unrestrict 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 restrictions of customer accounts and failure to promptly unrestrict 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, but the court's approval could be appealed. 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 will be 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 will be distributed to class members who have submitted timely claims in accordance with the settlement's plan of allocation, which still must be approved by the court. The parties expect that a plan of allocation will be submitted to the court in the first quarter of 2005. The amount of the settlement was fully accrued in our consolidated statement of income for the year ended December 31, 2003. 15 In July 2004, a purported class action lawsuit was Ñled 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 Ñled in January 2005, dropping one plaintiÅ, changing the capacity of the other plaintiÅ to that of representative plaintiÅ, and adding seven additional eBay users as plaintiÅs. The amended complaint expanded its claim to include numerous alleged improper billing practices from September 2003 until the present. In February 2005, eBay Ñled a motion to strike and a demurrer seeking to dismiss the complaint. We believe that we have meritorious defenses and intend to defend ourselves vigorously. 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 artiÑcially inÖating 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. The plaintiÅs have not yet served eBay with the complaint. We believe that we have meritorious defenses and intend to defend ourselves vigorously. 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 notiÑed 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 business. 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 that arise in the ordinary course of business. The number and signiÑcance of these disputes is increasing as our business expands and our company grows larger. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require signiÑcant amounts of management time, and result in the diversion of signiÑcant 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, 2004. 16 PART II ITEM 5: 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 eÅect to all previous stock splits, including the recent two-for-one stock split eÅective February 16, 2005) for the periods indicated, as reported by The Nasdaq Stock Market. High Low Year Ended December 31, 2003 First QuarterÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Second Quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Third Quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fourth Quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $22.61 26.44 29.47 32.40 Year Ended December 31, 2004 First QuarterÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Second Quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Third Quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fourth Quarter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 36.02 47.07 47.95 59.21 $16.88 21.38 24.94 25.32 31.30 34.53 35.73 45.22 As of February 18, 2005, there were approximately 2,800 holders of record of our common stock, although we believe that there is a signiÑcantly larger number of beneÑcial 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 Ñnance the growth of our business. Equity Compensation Plans For information on securities authorized for issuance under our equity compensation plans, refer to ""Equity Compensation Plan Information'' under Item 12, which is included elsewhere in this Annual Report on Form 10-K. Issuer Purchases of Equity Securities We did not repurchase any of our equity securities during the quarter ended December 31, 2004. 17 ITEM 6: SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated Ñnancial and supplemental operating data should be read in conjunction with the consolidated Ñnancial 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 ended, and as of, December 31, 2000, 2001, 2002, 2003 and 2004 are derived from our audited consolidated Ñnancial statements. All share and per share amounts included in the following consolidated Ñnancial data have been retroactively adjusted to reÖect all previous stock splits, including our recent two-for-one stock split, eÅective February 16, 2005. 2000 Year Ended December 31, 2002(1) (In thousands, except per share amounts) 2003 2001 2004 Consolidated Statement of Income Data: Net revenuesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cost of net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 431,424 $ 748,821 $1,214,100 213,876 134,816 95,453 $2,165,096 416,058 $3,271,309 614,415 Gross proÑt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 335,971 614,005 1,000,224 1,749,038 2,656,894 Operating expenses: Sales and marketingÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Product development ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ General and administrative ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Patent litigation expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Payroll tax on employee stock options ÏÏÏÏÏÏÏÏÏÏÏÏ Amortization of acquired intangible assets ÏÏÏÏÏÏÏÏ Merger related costsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total operating expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income from operationsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impairment of certain equity investments ÏÏÏÏÏÏÏÏÏÏÏ Income before cumulative eÅect of accounting change, income taxes and minority interests ÏÏÏÏÏÏÏ Provision for income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minority interests ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before cumulative eÅect of accounting change Cumulative eÅect of accounting change, net of tax ÏÏÏ 166,767 55,863 73,027 Ì 2,337 1,433 1,550 300,977 34,994 46,337 (3,374) Ì 77,957 (32,725) 3,062 48,294 Ì 253,474 75,288 105,784 Ì 2,442 36,591 Ì 473,579 140,426 41,613 (2,851) (16,245) 162,943 (80,009) 7,514 90,448 Ì 349,650 104,636 171,785 Ì 4,015 15,941 Ì 567,565 159,315 302,703 29,965 9,590 50,659 Ì 857,874 240,647 415,725 Ì 17,479 65,927 Ì 646,027 1,119,797 1,597,652 354,197 49,209 (1,492) (3,781) 629,241 37,803 (4,314) (1,230) 1,059,242 77,867 (8,879) Ì 398,133 (145,946) (2,296) 661,500 (206,738) (7,578) 1,128,230 (343,885) (6,122) 249,891 Ì 447,184 (5,413) 778,223 Ì Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 48,294 $ 90,448 $ 249,891 $ 441,771 $ 778,223 Net income per basic share: Income before cumulative eÅect of accounting change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of accounting change ÏÏÏÏÏÏÏÏÏÏ Net income per basic share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income per diluted share: Income before cumulative eÅect of accounting change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of accounting change ÏÏÏÏÏÏÏÏÏÏ Net income per diluted share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ $ $ $ Weighted average shares: 0.05 $ Ì 0.05 $ 0.08 $ Ì 0.08 $ 0.22 $ Ì 0.22 $ 0.35 $ (0.00) 0.35 $ 0.04 $ Ì 0.04 $ 0.08 $ Ì 0.08 $ 0.21 $ Ì 0.21 $ 0.34 $ (0.00) 0.34 $ 0.59 Ì 0.59 0.57 Ì 0.57 Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,007,104 1,075,884 1,149,984 1,276,576 1,319,458 DilutedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,121,384 1,122,380 1,171,280 1,313,314 1,367,720 18 2000 2001 December 31, 2002 (In thousands) 2003 2004 Consolidated Balance Sheet Data: Cash and cash equivalents ÏÏÏÏÏÏÏÏÏ Short-term investments ÏÏÏÏÏÏÏÏÏÏÏÏ Long-term investments ÏÏÏÏÏÏÏÏÏÏÏÏ Working capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Short-term obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏ Total stockholders' equity ÏÏÏÏÏÏÏÏÏÏ $ 201,873 354,166 218,197 538,022 1,182,403 15,272 11,404 1,013,760 $ 523,969 199,450 286,998 703,666 1,678,529 16,111 12,008 1,429,138 $1,109,313 89,690 470,227 1,082,234 4,040,226 2,970 13,798 3,556,473 $1,381,513 340,576 934,171 1,498,606 5,820,134 2,840 124,476(2) 4,896,242 $1,330,045 682,004 1,266,289 1,826,279 7,991,051 124,272(2) 75 6,728,341 (1) Includes the results of PayPal subsequent to our acquisition on October 3, 2002. (2) Includes a lease obligation totaling $122.5 million that was reclassiÑed as short-term in 2004 as the lease will expire on March 1, 2005, at which time we will purchase the facility. See ""Note 8 Ì Long-Term Obligations'' in the notes to the consolidated Ñnancial statements, included elsewhere in this Annual Report on Form 10-K. 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 Ñnancial 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 That May AÅect Results of Operations and Financial Condition'' below, as well as our consolidated Ñnancial statements, related notes, and the other Ñnancial information appearing elsewhere in this report and our other Ñlings 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 Ñnancial statements and the related notes that appear elsewhere in this document. Overview About eBay We pioneered online trading by developing an Internet-based marketplace in which a community of buyers and sellers are brought together in an entertaining, intuitive, easy-to-use environment to browse, buy and sell an enormous variety of items. Through our PayPal service, we enable any business or consumer with email to send and receive electronic payments securely, conveniently and cost-eÅectively. Executive Operating and Financial Summary Our focus is on understanding our key operating and Ñnancial metrics Members of our senior management team regularly review key operating metrics such as new users, active users, listings and gross merchandise volume as well as new user accounts and total payment volume processed by our wholly owned PayPal subsidiary. Members of our senior management also regularly review key Ñnancial information including net revenues, operating income margins, earnings per share, cash Öows from operations and free cash Öows, which we deÑne as operating cash Öows less purchases of property and equipment, net. These operating and Ñnancial measures allow us to monitor the health and vibrancy of our 19 marketplace and our global payments platform, and the proÑtability of our business and to evaluate the eÅectiveness 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 Ñnancial 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 2005 will result primarily from increased net transaction revenues across our U.S. Marketplace, International Marketplace and Payments 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 both our eBay Marketplace and our PayPal 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 and the British pound, 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 detailed discussion of our consolidated Ñnancial results contained herein is intended to provide information to assist investors, analysts and other parties reading this report in understanding the key operating and Ñnancial 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) 2002 Net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Current quarter vs prior quarterÏÏÏÏÏÏÏÏÏÏ $245,106 $266,287 $288,779 12% 9% 8% $ 413,928* 43% 2003 Net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Current quarter vs prior quarterÏÏÏÏÏÏÏÏÏÏ $476,492 $509,269 $530,942 $ 648,393 15% 7% 4% 22% 2004 Net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Current quarter vs prior quarterÏÏÏÏÏÏÏÏÏÏ $756,239 $773,412 $805,876 $ 935,782 17% 2% 4% 16% * Includes net revenues from PayPal subsequent to our acquisition on October 3, 2002. As our business matures, transaction activity patterns on our websites increasingly mirror general consumer buying patterns, both online and oÉine. We have historically experienced our strongest quarters of sequential growth in the Ñrst and fourth Ñscal quarters. We expect this pattern of seasonality to continue. Business Combinations Through both domestic and international acquisitions, we have continued to expand eBay's global online marketplace. The Ñnancial results of entities acquired in purchase transactions are reÖected in our consoli- dated results from the eÅective dates of each acquisition. The aggregate purchase price for completed acquisitions totaled $1.0 billion in 2004, $246 million in 2003, and $1.6 billion in 2002. We accounted for each acquisition as a purchase transaction and, accordingly, each 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 20 the acquisition date. Acquired intangible assets related to these purchases totaled $131 million in 2004, $29 million in 2003, and $286 million in 2002. See ""Note 1 Ì The Company and Summary of SigniÑcant Accounting Policies'' and ""Note 3 Ì Business Combinations, Goodwill and Intangible Assets'' to our consolidated Ñnancial 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 Ñnancial statements and notes thereto included elsewhere in this Annual Report on Form 10-K. Year Ended December 31, 2004 2003 2002 Net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cost of net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 100.0% 100.0% 100.0% 19.2 17.6 18.8 Gross proÑt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 82.4 80.8 81.2 Operating expenses: Sales and marketing ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Product development ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ General and administrative ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Patent litigation expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Payroll tax on employee stock options ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amortization of acquired intangible assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total operating expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income from operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impairment of certain equity investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 28.8 8.6 14.1 Ì 0.3 1.3 53.1 29.3 4.1 (0.1) (0.3) Income before cumulative eÅect of accounting change, income taxes and minority interests ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minority interests ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 32.8 (12.0) (0.2) Income before cumulative eÅect of accounting change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of accounting change, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 20.6 Ì 26.2 7.4 14.0 1.4 0.4 2.3 51.7 29.1 1.7 (0.2) (0.1) 30.6 (9.5) (0.4) 20.7 (0.3) 26.2 7.4 12.7 Ì 0.5 2.0 48.8 32.4 2.4 (0.3) Ì 34.5 (10.5) (0.2) 23.8 Ì Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 20.6% 20.4% 23.8% Our net revenues are derived primarily from listing, feature and Ñnal value fees paid by sellers on our eBay Marketplace 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 Ñxed-price transaction activity, reÖected in the growth in the number of our conÑrmed registered users, user activity, listings, user gross merchandise volume on our eBay Marketplace platforms and payment transactions processed by PayPal. We believe these increases are largely the result of our promotional eÅorts and our emphasis on enhancing the online trading experience of our user community, both domestically and internationally, through the introduction of new site features and functionality and expanded trust and safety programs. 21 Net Revenues Summary Net Revenues by Type: Net transaction revenues Year Ended December 31, 2002 Year Ended Percent December 31, Percent Change Change 2003 (In thousands, except percent changes) Year Ended December 31, 2004 U.S. Marketplace ÏÏÏÏÏÏÏÏÏÏÏÏÏ International Marketplace ÏÏÏÏÏÏ Payments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 718,239 297,485 93,303 43% $1,024,915 657,874 121% 429,453 360% Total net transaction revenues 1,109,027 90% 2,112,242 Advertising and other non- transaction net revenues ÏÏÏÏÏÏÏÏ 105,073 (50)% 52,854 Total net revenuesÏÏÏÏÏÏÏÏÏÏÏ $1,214,100 78% $2,165,096 Net Revenues by Segment: U.S. Marketplace ÏÏÏÏÏÏÏÏÏÏÏÏÏ International Marketplace ÏÏÏÏÏÏ Payments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 816,596 302,136 95,368 30% $1,062,834 664,640 120% 437,622 359% Total net revenuesÏÏÏÏÏÏÏÏÏÏÏ $1,214,100 78% $2,165,096 Net Revenues by Geography: U.S. ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ InternationalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 897,701 316,399 57% $1,406,512 758,584 140% Total net revenuesÏÏÏÏÏÏÏÏÏÏÏ $1,214,100 78% $2,165,096 31% 76% 59% 50% 78% 51% 32% 77% 59% 51% 34% 82% 51% $1,338,715 1,157,472 680,813 3,177,000 94,309 $3,271,309 $1,399,848 1,173,759 697,702 $3,271,309 $1,889,936 1,381,373 $3,271,309 Net 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 segment net revenues include amounts earned internationally. Year Ended December 31, 2000 2001 2002 2003 2004 (In millions) Supplemental Operating Data: U.S. and International Marketplace Segments:(1) ConÑrmed registered users(2) ÏÏÏÏÏÏÏÏÏÏÏ Active users(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Number of non-stores listings(4) ÏÏÏÏÏÏÏÏ Number of stores listings(4) ÏÏÏÏÏÏÏÏÏÏÏÏ Gross merchandise volume(5)ÏÏÏÏÏÏÏÏÏÏÏ Payments Segment: 22.5 Ì 264.7 Ì $5,422 42.4 17.8 419.1 4.0 $9,319 61.7 27.7 629.7 8.6 $14,868 Total accounts(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Active accounts(7) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total number of payments(8) ÏÏÏÏÏÏÏÏÏÏÏ Total payment volume(9) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Ì Ì 23.3 Ì 7.9 Ì Ì 39.2 Ì $ 2,138 94.9 41.2 955.0 16.0 $23,779 40.3 13.2 229.8 $12,226 135.5 56.1 1,339.9 72.7 $ 34,168 63.8 20.2 339.9 $ 18,915 (1) Marktplaats.nl in the Netherlands and mobile.de in Germany 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. 22 (3) All users, excluding users of Baazee.com, Half.com, Internet Auction, Marktplaats.nl and mobile.de, who bid on, bought, or listed an item within the previous 12-month period. Includes users of eBay EachNet in China since the migration to the eBay platform in September 2004. Active user information not available for periods prior to 2001. (4) All listings on eBay's trading platforms during the year, regardless of whether the listing subsequently closed successfully. (5) Total value of all successfully closed listings between users on eBay's trading platforms during the year, 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. (7) All accounts that sent or received at least one payment through the PayPal system within the previous three-month period. (8) Total number of payments initiated through the PayPal system during the year, regardless of whether the payment was actually sent successfully, or was reversed, rejected, or pending at the end of the year. (9) Total dollar volume of payments initiated through the PayPal system during the year, regardless of whether the payment was actually sent successfully, or was reversed, rejected, or was pending at the end of the year. The U.S. Marketplace segment includes our U.S. marketplace trading platforms, other than our PayPal subsidiary. The International Marketplace segment includes our international marketplace trading platforms excluding our PayPal subsidiary. The Payments segment includes our global payments platform consisting of our PayPal subsidiary. The Payments segment reÖects the historical operations of our former Billpoint subsidiary and of PayPal's operations for the periods subsequent to our acquisition of PayPal on October 3, 2002. We completed our planned wind-down of Billpoint in the Ñrst half of 2003. Our net revenues result from fees associated with our transaction, advertising and other services in our U.S. Marketplace, International Marketplace and Payments segments. Net transaction revenues are derived primarily from listing, feature and Ñnal 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 and also from oÉine services provided by our former ButterÑelds and Kruse subsidiaries, which were divested in the second half of 2002. The successive year-over-year growth in net revenues from 2002 through 2004 was primarily the result of increased auction and Ñxed-price transaction activity, reÖected in the growth in the number of our conÑrmed registered users, user activity, listings, gross merchandise volume and payment transactions processed by PayPal. Our net revenue growth during the year ended December 31, 2003 also reÖects a full year of payment transactions processed by PayPal, which we acquired in October 2002. eBay Marketplace Net Transaction Revenues Total net transaction revenues from the U.S. and International Marketplace segments in aggregate increased 48% in 2004, 66% in 2003, and 73% in 2002, compared to the respective prior year. The growth in both U.S. Marketplace and International Marketplace segment net transaction revenues was primarily the result of increased auction transaction activity, reÖected 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 Marketplace segments together increased 44% in 2004 and 60% in both 2003 and 2002, compared to the respective prior year. U.S. and International Marketplace segment net transaction revenues as a percentage of user gross merchandise volume was 7.3% for 2004, 7.1% for 2003, and 6.8% for 2002. The increases in 2004 and 2003 reÖected 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 signiÑcant dollar impact. The number of active users on the eBay platform increased 36% during 2004 to 56.1 million at December 31, 2004. Active users increased 49% during 2003 to 41.2 million at December 31, 2003, from 27.7 million at December 31, 2002. We believe that increases in user activity are largely the result of our promotional eÅorts 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. 23 The number of items listed on eBay's trading platforms increased 45% to 1.4 billion in 2004, from 971.0 million in 2003, and increased 52% in 2003 from 638.3 million in 2002. This percentage growth in listings was experienced across our U.S. and, more signiÑcantly, our international platforms. U.S. Marketplace Segment U.S. Marketplace segment net transaction revenues increased 31% in 2004, 43% in 2003, and 51% in 2002, compared to the respective prior year. Gross merchandise volume from the U.S. Marketplace segment increased 27% in 2004, and 41% in 2003 and 2002, respectively. The U.S. Marketplace is our largest and most developed business. Net transaction revenues derived from the U.S. Marketplace segment represented 42% of the total net transaction revenues in 2004. We expect net transaction revenues from our U.S. Marketplace segment to increase in 2005, but to decrease as a percentage of total eBay Marketplace net transaction revenues as the International Marketplace segment grows in signiÑcance. In addition, even as the U.S. Marketplace segment continues to grow in absolute terms, we expect its growth rate in 2005 to be lower than that of 2004. International Marketplace Segment International Marketplace segment net transaction revenues increased 76% in 2004, 121% in 2003, and 168% in 2002, compared to the respective prior year. International Marketplace segment net transaction revenues as a percentage of total net transaction revenues was 36% in 2004, 31% in 2003 and 27% in 2002. Gross merchandise volume from the International Marketplace segment increased 70% in 2004, 102% in 2003, and 126% in 2002, compared to the respective prior year. For 2004, the growth in our International Marketplace 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 South Korea and a solid performance in Germany. The relative strength of foreign currencies against the U.S. dollar resulted in increased net revenues of approximately $117.0 million during 2004, when compared to the results if the weighted-average foreign currency exchange rates used in the preparation of our 2003 consolidated Ñnancial 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 Marketplace segment transaction net revenues will continue to decline in 2005, although we expect such revenues to grow in signiÑcance relative to our total eBay Marketplace as we continue to develop and deploy our global online trading platform during 2005. Payments Segment Net Transaction Revenues Payments segment net transaction revenues increased 59% in 2004, 360% in 2003 and 452% in 2002, compared to the respective prior year. Payments segment net transaction revenues as a percentage of total net transaction revenues was 21% in 2004, 20% in 2003, and 8% in 2002. 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 primarily by the growth in the eBay Marketplace and, for 2003 and 2002, our acquisition of PayPal in October 2002. During 2004, over $18.9 billion in total payment volume was transacted on the PayPal platform as compared to $12.2 billion during 2003. As of December 31, 2004, PayPal had 63.8 million accounts, compared to 40.3 million accounts at December 31, 2003. Our Payments segment net transaction revenues as a percentage of total payment volume was 3.6% in 2004 and 3.5% in 2003. The growth in Payments net transaction revenues was positively aÅected by PayPal's continued penetration of eBay Marketplace transac- tions 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 Marketplace gross merchandise volume during 2003 and 2004. The relative strength of foreign currencies, primarily the Euro, against the U.S. dollar and the British pound, resulted in increased net revenues of approximately $12.9 million during 2004 when compared to the results if the weighted-average foreign currency exchange rates used in the preparation of our 2003 consolidated Ñnancial statements were used. 24 Net transaction revenues from the Payments segment earned internationally totaled $207.6 million in 2004 and $93.9 million in 2003, representing 30.5% and 21.9% 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 2005 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 2005. Advertising and Other Non-Transaction Net Revenues Advertising and other non-transaction net revenues increased in total and as a percentage of total net revenues in 2004 as compared to 2003. Advertising and other net revenues totaled $94.3 million in 2004, $52.9 million in 2003 and $105.1 million in 2002. These amounts as a percentage of total net revenues represented 3% in 2004, 2% in 2003 and 9% in 2002. 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 2005. Cost of Net Revenues Cost of net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ As a percentage of net revenues ÏÏÏÏÏÏÏÏÏ $213,876 17.6% 2002 Percent Percent Change Change 2003 (In thousands, except percentages) 48% $416,058 95% 19.2% 2004 $614,415 18.8% Cost of net revenues consists primarily of costs associated with payment processing, site operations, and certain types of customer support. SigniÑcant 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 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 Marketplace 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. Costs of net revenues are expected to increase in total and to decrease slightly as a percentage of net revenues during 2005. Cost of net revenues increased in total and slightly as a percentage of net revenues in 2003 as compared to 2002. The increase in absolute dollars was due to a full year of payment processing costs resulting from our acquisition of PayPal in October 2002, an increase in the volume of transactions on the eBay websites, and continued development and expansion of our customer support and site operations infrastructure. The increase in cost of net revenues as a percentage of net revenues was primarily due to the impact of PayPal's higher structural costs relating to payment processing oÅset, in part, by eBay's site operations costs growing at a slower rate than net revenues. Payment processing costs, which consist of credit card interchange fees, bank charges and other processing charges increased by approximately $94.9 million in 2003, reÖecting the full year of PayPal activity in 2003, the substantial increase in PayPal's total payment volume and increased payment processing costs related to our eBay fees. Aggregate customer support and site operations costs increased 25 $80.0 million during 2003, compared to the prior year, and resulted primarily from an increase in headcount and related employee costs of approximately $26.5 million. In addition, aggregate depreciation of site equipment and amortization of capitalized software development costs increased $21.5 million as compared to 2002. Operating Expenses Sales and Marketing Sales and marketingÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ As a percentage of net revenues ÏÏÏÏÏÏÏÏÏ $349,650 28.8% 2002 Percent Percent Change 2003 Change (In thousands, except percentages) 51% $567,565 62% 26.2% 2004 $857,874 26.2% Sales and marketing expenses consist primarily of advertising, tradeshow and other promotional costs, employee compensation for our category development and marketing staÅ and certain trust and safety programs. 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 and 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. Sales and marketing expenses are expected to increase in total and as a percentage of net revenues during 2005. In addition, our 2005 online marketing expenses will likely increase both in total and slightly as a percentage of revenues because of increases in the volume of online advertising that we expect to purchase in order to attract new customers and increase the activity on our websites including growth initiatives in sales and marketing activities in our U.S. and International Marketplaces, including China. Sales and marketing expenses increased in 2003, but decreased as a percentage of total net revenues due to cost eÇciencies in our business and the acquisition of PayPal, which has a signiÑcantly lower sales and marketing requirement as PayPal beneÑts from eBay customer acquisitions. Growth in advertising and marketing costs as well as employee-related costs comprised the majority of the dollar increases. Combined advertising and marketing costs increased $155.2 million in 2003, as compared to the prior year. This increase was primarily the result of our marketing programs directed towards our internet marketing and national television advertising campaigns as well as several category-focused print campaigns. Employee-related costs increased by $34.0 million in 2003 as we continued to expand our international operations. Product Development Product development ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ As a percentage of net revenues ÏÏÏÏÏÏÏÏÏ $104,636 8.6% 2002 Percent Percent Change Change 2003 (In thousands, except percentages) 51% $159,315 52% 7.4% 2004 $240,647 7.4% Product development expenses consist primarily of employee compensation, consultant costs, facilities costs and depreciation on equipment used for development. Product development expenses are net of required capitalization of major site and other product development eÅorts, including the development of our ""V3'' platform architecture, migration of certain platforms, global billing, seller tools and payment gateway projects. These capitalized costs totaled $41.3 million in 2004, $38.5 million in 2003 and $15.5 million in 2002, and are reÖected as a cost of net revenues when amortized in future periods. We anticipate that we will continue to devote signiÑcant resources to product development in the future as we add new features and functionality to the eBay and PayPal platforms. 26 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 staÅ 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. Product development expenses are expected to increase in total and may increase slightly as a percentage of net revenues in 2005, as we develop new site features and functionality and continue to improve and expand operations across all our segments including the U.S. Marketplace, China, and PayPal Merchant Services. The increase in product development expenses in 2003, as compared to the prior year, was primarily the result of increased headcount and computer equipment depreciation. These increases were partially oÅset by the amounts capitalized in connection with major site and other product development eÅorts in 2003. The headcount growth was focused on hiring new employees for various platform development initiatives at eBay and PayPal. Our product development employees increased approximately 59% from approximately 600 at December 31, 2002 to approximately 1,000 at December 31, 2003. General and Administrative General and administrative ÏÏÏÏÏÏÏÏÏÏÏÏÏ As a percentage of net revenues ÏÏÏÏÏÏÏÏÏ $171,785 14.1% 2002 Percent Percent Change Change 2003 (In thousands, except percentages) 37% $302,703 76% 14.0% 2004 $415,725 12.7% General and administrative expenses consist primarily of employee compensation, provisions for transac- tion losses associated with our Payments segment, depreciation of equipment, provision for doubtful accounts, insurance and professional fees. 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 Ñnance, 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 eBay 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 payment transaction loss increased by approximately $14.1 million, to $50.5 million at December 31, 2004, reÖecting the increase in activity in the Payments segment in addition to the expansion of our PayPal Buyer Protection Program. PayPal's payment transaction loss 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 oÅset in part by the increase in coverage for our PayPal Buyer Protection Program. With our continued investment, primarily in the expansion in our Marketplace and Payments segments, and related corporate functions, we expect general and administrative expenses to increase during 2005. The increase in general and administrative expenses in 2003 was due primarily to employee and facilities related costs, fees for external professional advisors, payment transaction loss expenses resulting from our acquisition of PayPal and charges associated with various legal matters. The increases in employee and facilities related costs resulted from the addition of PayPal employees in various trust and safety functions as well as continued headcount growth in the Ñnance, human resource and legal departments to meet the demands of our expanding business, including growing international operations and the integration of acquired businesses. We increased our general and administrative staff from approximately 1,300 at December 31, 2002 to approximately 1,900 at December 31, 2003. Fees for external professional advisors increased by $10.4 million. 27 Charges associated with various legal matters recorded in general and administrative expense totaled $8.6 million. PayPal's payment transaction loss increased $28.6 million in 2003, reÖecting a full year of consolidated operations. In February 2004, we began migrating eBay users from our legacy billing system to a newly implemented billing system. As we managed this migration, we delayed billing cycles to facilitate the migration process and to allow additional time for quality assurance reviews. The delay in billing cycles continued for the remainder of the year and resulted in an increase in the average days our customer account balances were outstanding. Although we believe this change in account balance aging is a temporary condition, our historical experience indicates an increased risk of collection for aged accounts receivable balances. Accordingly, our provision for doubtful accounts during the year ended December 31, 2004 increased to a total of $85.4 million, or 2.6% of net revenues, compared to $44.3 million, or 2.0% of net revenues, during the year ended December 31, 2003. The allowance for doubtful accounts receivable at December 31, 2004 was $67.9 million. Patent Litigation Expense 2002 Patent litigation expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ As a percentage of net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ N/A $ Ì N/A 1.4% Percent Percent Change Change 2003 (In thousands, except percentages) $29,965 N/A 2004 $ Ì N/A Patent litigation expense during 2003 relates to the accrual of an August 6, 2003 court judgment resulting from the MercExchange patent infringement lawsuit. See ""Note 10 Ì Commitments and Contin- gencies'' to our consolidated Ñnancial statements included elsewhere in this Annual Report on Form 10-K. Payroll Tax on Employee Stock Options 2002 Percent Change 2003 (In thousands, except percentages) Percent Change 2004 Payroll tax on employee stock options ÏÏÏÏÏÏÏÏÏ As a percentage of net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $4,015 139% $9,590 82% $17,479 0.3% 0.4% 0.5% We are subject to employer payroll taxes on employee gains from the exercise of non-qualiÑed 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 increases in 2004 and 2003 as compared to the respective prior years were primarily a result of larger individual gains recognized on stock option exercises by our employees during periods in which our stock price was high relative to historic levels. Our results of operations and cash Öows could vary signiÑcantly 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 2002 Amortization of acquired intangible assets ÏÏÏ As a percentage of net revenues ÏÏÏÏÏÏÏÏÏÏÏÏ $15,941 1.3% Percent Percent Change 2003 Change (In thousands, except percentages) 30% 218% $50,659 2.3% 2004 $65,927 2.0% 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 trading. 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. 28 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, using the straight-line method over 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 identiÑable intangible assets acquired in a business combination. Goodwill is subject to at least an annual assessment for impairment, applying a fair-value based test. 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 Öows, 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, 2004 and we determined that there was no impairment. There were no events or circumstances from that date through December 31, 2004 that would impact this assessment. We expect amortization of acquired intangible assets will increase in 2005 as a result of the intangible assets associated with our acquisitions of mobile.de and Marktplaats.nl, as well as our additional investment in Internet Auction during 2004 and our recent acquisition of Rent.com. Amortization of acquired intangible assets will also increase should we make additional acquisitions in the future. Non-Operating Items Interest and Other Income, Net 2002 Percent Percent Change 2003 Change (In thousands, except percentages) 2004 Interest and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏ As a percentage of net revenues ÏÏÏÏÏÏÏÏÏÏÏÏ $49,209 (23)% $37,803 106% $77,867 4.1% 1.7% 2.4% 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 as a percentage of net revenues during 2004 as compared to the prior year, 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. We expect that interest and other income, net, will remain generally comparable in total to 2004 during 2005. Our interest and other income, net decreased in total and as a percentage of net revenues during 2003, primarily as a result of one-time gains recognized in 2002 from the sale of certain subsidiaries, real estate properties and an equity investment that totaled $20.3 million. This decrease was oÅset, in part, by increased investment income on a larger aggregate balance of cash, cash equivalents and investments even though the weighted-average interest rate of our portfolio declined to 1.6% in 2003 from 2.8% in 2002. Interest Expense 2002 Percent Change 2003 (In thousands, except percentages) Percent Change 2004 Interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ As a percentage of net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,492 189% $4,314 106% $8,879 0.1% 0.2% 0.3% Interest expense consists of interest charges on our consolidated lease arrangement related to our San Jose headquarters oÇce facilities, capital leases, and mortgage notes. 29 In January 2003, the FASB issued FIN 46, ""Consolidation of Variable Interest Entities.'' In accordance with the provisions of this standard, we have included our San Jose headquarters lease arrangement in our consolidated Ñnancial statements eÅective July 1, 2003. Beginning July 1, 2003, our consolidated statement of income reÖects the reclassiÑcation of lease payments on our San Jose headquarters oÇce facilities from operating expense to interest expense. The increase in interest expense during 2003, compared to the prior year, was primarily the result of the inclusion of interest payments on our San Jose headquarters oÇce facilities. The increase in interest expense during 2004 is primarily the result of the inclusion of these interest payments for a full year in 2004. We expect our interest expense will decrease both in total and as a percentage of net revenue during 2005 due to the acquisition of the San Jose headquarters oÇce facilities at the expiration of the lease arrangement on March 1, 2005. Impairment of Certain Equity Investments 2002 Percent Change 2003 (In thousands, except percentages) Percent Change Impairment of certain equity investments ÏÏÏÏÏÏÏ As a percentage of net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $3,781 (67)% $1,230 N/A 0.3% 0.1% 2004 $ Ì N/A During 2003 and 2002, we recorded impairment charges totaling $1.2 million and $3.8 million, respectively, as a result of the deterioration of the Ñnancial condition of certain of our private and public equity investees. We identiÑed these impairment losses as part of our normal process of assessing the quality of our investment portfolio. The impairment loss reÖects a decline in fair value and other market conditions that we believe are other than temporary. We expect that the fair value of our equity investments will Öuctuate from time to time and future impairment assessments may result in additional charges to our operating results. We did not record any impairment of our equity investments during 2004. Provision for Income Taxes 2002 Provision for income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏ As a percentage of net revenues ÏÏÏÏÏÏÏÏÏ EÅective tax rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $145,946 12.0% 37% Percent Percent Change 2003 Change (In thousands, except percentages) 66% $206,738 42% 9.5% 32% 2004 $343,885 10.5% 30% The provision for income taxes diÅers from the amount computed by applying the statutory U.S. federal rate principally due to non-deductible expenses related to acquisitions, state taxes, subsidiary losses for which we have not provided a beneÑt and other factors that increase the eÅective tax rate. These expenses are partially oÅset by decreases resulting from foreign income with lower eÅective tax rates, tax credits, and tax- exempt interest income. The lower eÅective tax rates in 2004 and 2003 as compared to the respective prior years reÖect the increasing proÑt contribution from our international operations that are subject to lower tax rates. We receive tax deductions from the gains realized by employees on the exercise of certain non-qualiÑed stock options for which the beneÑt is recognized as a component of stockholders' equity. We have evaluated our deferred tax assets relating to these stock option deductions along with our other deferred tax assets and concluded that a valuation allowance is required for that portion of the total deferred tax assets that is not considered more likely than not to be realized in future periods. To the extent that the deferred tax assets with a full valuation allowance become realizable in future periods, we will have the ability, subject to carryforward limitations, to use up to $158.6 million of deferred tax assets to reduce future income tax liabilities. Should a valuation allowance no longer be required, the reversal of the valuation allowance will be reÖected as an increase in additional paid-in capital rather than a reduction of the income tax provision. 30 Minority Interests Minority interests ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ As a percentage of net revenues ÏÏÏÏÏÏÏÏÏÏÏÏ $(2,296) 0.2% 2002 Percent Percent Change 2003 Change (In thousands, except percentages) 19% (230)% $(7,578) 0.4% 2004 $(6,122) 0.2% Minority interests represents the minority investors' percentage share of income or losses from subsidiar- ies in which we hold a majority ownership interest and consolidate the subsidiaries' results in our Ñnancial statements. Third parties held minority interests in various of our subsidiaries during 2004, 2003 and 2002. The change in minority interests in 2004 is due primarily to our acquisition of an additional 37.9% ownership interest in Internet Auction. The change in minority interests in 2003 primarily resulted from the minority interests' portion of the net income generated by Internet Auction. Cumulative EÅect of Change in Accounting Principle In accordance with the provisions of FIN 46, ""Consolidation of Variable Interest Entities,'' we have included our San Jose headquarters lease arrangement in our consolidated Ñnancial statements eÅective July 1, 2003. Our consolidated statement of income for the year ended December 31, 2003 reÖects the reclassiÑcation 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 have adopted the provisions of FIN 46 prospectively from July 1, 2003, and as a result, have not restated prior periods. The cumulative eÅect of the change in accounting principle arising from the adoption of FIN 46 has been reÖected in net income in 2003. Impact of Foreign Currency Translation During 2004, our international net revenues, based upon the country in which the seller, payment recipient, advertiser or other service provider is located, accounted for approximately 42% of our consolidated net revenues, as compared to 35% of our net revenues in 2003 and 26% of our net revenues in 2002. The growth in our international operations has increased our exposure to foreign currency Öuctuations. 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, and Australian dollars. The results of operations and certain of our inter-company balances associated with our international locations are exposed to foreign exchange rate Öuctuations. 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. Similarly, our consolidated net revenues, operating expenses and net income will decrease when the U.S. dollar strengthens against foreign currencies. During 2004, the U.S. dollar weakened against the foreign currencies listed above. Using the weighted- average foreign currency exchange rates from 2003, our net revenues for 2004 would have been lower than we reported using the actual exchange rates for 2004 by approximately $129.9 million, of which $117.0 million and $12.9 million relate to our International Marketplace and Payments segments, respectively. In addition, if the weighted-average foreign currency exchange rates from 2003 were applied to our cost of revenues and operating expenses for 2004, these costs of revenues and operating expenses would have been lower in total than we reported using the actual exchange rates for 2004 by approximately $58.4 million. The majority of this impact relates to the relative strength of the Euro against the U.S. dollar. 31 We expect our international operations will continue to grow in signiÑcance as we develop and deploy our global marketplace and global payments platform. As a result, the impact of foreign currency Öuctuations in future periods could become more signiÑcant and may have a negative impact on our consolidated net revenues and net income. 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 eÅects of currency Öuctuations on our reported consolidated cash Öows, 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 Öuctuations in our reported consolidated Ñnancial position, results of operations and cash Öows. We may enter into foreign exchange forward contracts or other instruments to minimize the short-term foreign currency Öuctuations on such assets and liabilities. The gains and losses on the foreign exchange forward contracts oÅset 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 Öows, 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 Öuctuations in the cash Öows we expect to receive when these cash Öows 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 Öows. We account for these foreign exchange contracts as cash Öow hedges. The eÅective portion of the derivative's gain or loss is initially reported as a component of accumulated other comprehensive income (loss) and subsequently reclassiÑed into earnings when the transaction is settled. Earnings Translation Exposure: As our international operations grow, Öuctuations 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 oÅset the earnings impact of currency Öuctuations. Such contracts will be marked-to-market on a monthly basis and any unrealized gain or loss 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 beneÑt of our stockholders. Stock options granted during the year ended December 31, 2004 and 2003, net of cancellations, represented approximately 3% of our total outstanding common stock at December 31, 2004 and 2003, a substantial portion of which was granted to new employees. We expect that our stock option grants, net of cancellations, for 2005 will represent approximately 2% of our total outstanding common stock at December 31, 2005. 32 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 using the intrinsic value method as 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 statement and may deem an alternative model to be the most appropriate. The use of a diÅerent model to value options may result in a diÅerent 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 will result in diÅering accounting treatment than currently required. These diÅerences include, but are not limited to, the accounting for the tax beneÑt on employee stock options and for stock issued under our employee stock purchase plan. 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 include prospective and retroactive adoption options. Under the retroactive options, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the Ñrst quarter of adoption of FAS 123R, while the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the Ñrst period restated. The eÅective date of the new standard for our consolidated Ñnancial statements is our third Ñscal quarter in 2005. Upon adoption, this statement will have a signiÑcant impact on our consolidated Ñnancial 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 of the notes of the consolidated Ñnancial 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. Compensation expense calculated under FAS 123R may diÅer from amounts currently disclosed within our footnotes 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 beneÑts and changes in interest rates or other factors. In addition, upon adoption of FAS 123R we may choose to use a diÅerent valuation model to value the compensation expense associated with employee stock options. In December 2004, the FASB issued SFAS No. 153, ""Exchanges of Nonmonetary Assets Ì An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions'' (SFAS 153). SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, ""Accounting for Nonmonetary Transactions,'' and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 speciÑes that a nonmonetary exchange has commercial substance if the future cash Öows of the entity are expected to change signiÑcantly as a result of the exchange. This standard is eÅective for Ñscal periods beginning after June 15, 2005. We are currently evaluating the eÅect that the adoption of SFAS 153 will have on our consolidated statement of income and Ñnancial condition. 33 Liquidity and Capital Resources Cash Flows Consolidated Cash Flow Data: Net cash provided by (used in): 2002 Year Ended December 31, 2003 (In thousands) 2004 Operating activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investing activitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Financing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EÅect of exchange rates on cash and cash $ 479,903 (157,759) 252,067 $ 874,119 (1,319,542) 688,866 $ 1,285,315 (2,013,220) 647,669 equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 11,133 28,757 28,768 Net increase (decrease) in cash and cash equivalents ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 585,344 $ 272,200 $ (51,468) We have generated annual cash provided by operating activities in amounts greater than net income in 2004, 2003 and 2002. This result was driven mainly by non-cash charges to earnings. Non-cash charges to earnings included depreciation and amortization on our long-term assets, tax beneÑts on the exercise of employee stock options resulting from our increasing stock price and the related increases in the personal gains recognized by our employees, 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 2003 and 2002, operating cash Öows 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 2004, 2003 and 2002 reÖected 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 $292.8 million in 2004, $365.4 million in 2003, and $138.7 million in 2002. Purchases of property and equipment in 2004 and 2002 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 mil- lion purchase of additional oÇce 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 $1.0 billion in 2004, $216.4 million in 2003 and $59.4 million in 2002. 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. Our cash acquisitions in 2002 included acquiring the remaining ownership interest in our Billpoint subsidiary and a 38% interest in EachNet, located in China. We completed our acquisition of PayPal during 2002 through the exchange of our common stock for PayPal's then outstanding common stock. The net cash Öows provided by Ñnancing activities in 2004, 2003 and 2002 were due primarily to proceeds from stock option exercises. Proceeds from stock option exercises totaled $650.6 million in 2004, $700.8 mil- lion in 2003, and $252.2 million in 2002. Our future cash Öows from stock options are diÇcult 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 positive eÅect of exchange rates on cash and cash equivalents during 2004, 2003, and 2002 was due to the weakening 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 suÇcient to fund our operating activities, capital expenditures and other obligations for the 34 foreseeable future. However, if during that period or thereafter we are not successful in generating suÇcient cash Öows from operations or in raising additional capital when required in suÇcient amounts and on terms acceptable to us, our business could suÅer. We expect capital expenditures to amount to between $340 million and $400 million during 2005, without taking into account any acquisitions or the $126 million associated with the purchase of our San Jose headquarters facility. On February 23, 2005, we paid $415 million, net of Rent.com's cash on hand, to acquire all of the outstanding securities of Rent.com. See ""Subsequent Events'' within this section for further details. Commitments and Contingencies We have certain Ñxed 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 diÅering from the estimates. We cannot provide certainty regarding the timing and amounts of payments. We have presented below a summary of the most signiÑcant 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 Ñnancial position, results of operations, and cash Öows. The following table summarizes our Ñxed contractual obligations and commitments (in thousands): Payment Due By Year Ending December 31, Capital Leases Operating Leases 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2008 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2009 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Thereafter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $128,164 75 Ì Ì Ì Ì $19,987 15,522 11,238 9,371 7,435 26,634 Other Purchase Obligations $397,176 64,505 12,353 2,958 Ì Ì Total $545,327 80,102 23,591 12,329 7,435 26,634 $128,239 $90,187 $476,992 $695,418 Capital lease amounts primarily comprises the assumed purchase of the corporate headquarters in San Jose, California, in March 2005, when the lease is scheduled to expire, and includes the $3.9 million in relation to the non-controlling minority interest. See ""Note 8 Ì Long-Term Obligations'' in the notes to the consolidated Ñnancial statements, included elsewhere in this Annual Report on Form 10-K. Operating lease amounts include minimum rental payments under our non-cancelable operating leases for oÇce facilities, as well as limited computer and oÇce equipment that we utilize under lease arrangements. The amounts presented are consistent with contractual terms and are not expected to diÅer signiÑcantly, unless a substantial change in our headcount needs requires us to exit an oÇce facility early or expand our occupied space. Other purchase obligation amounts include minimum purchase commitments for advertising, computer equipment, software applications, a corporate airplane, 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 signiÑcant 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 signiÑcance of such performance requirements within our advertising and other arrangements, actual payments could diÅer signiÑcantly from these estimates. Other Financial Arrangements As of December 31, 2004, we had no oÅ-balance sheet arrangements that are reasonably likely to have, a future material eÅect on our consolidated Ñnancial condition, results of operations, liquidity, capital expenditures or capital resources. 35 IndemniÑcation Provisions In the ordinary course of business we have included limited indemniÑcation 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 indemniÑed party for losses suÅered or incurred by the indemniÑed 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. To date, no signiÑcant costs have been incurred, either individually or collectively, in connection with our indemniÑca- tion provisions. Subsequent Events On February 23, 2005, we acquired all outstanding securities of Rent.com for approximately $415 million plus our acquisition costs, net of Rent.com's cash on hand. Rent.com is a leading Internet listing website in the apartment and rental housing industry. In January 2005, our Board of Directors approved a two-for-one split of our shares of common stock to be issued in the form of a stock dividend. As a result of the stock split, our stockholders received one additional share of our common stock for each share of common stock held of record on January 31, 2005. The additional shares of our common stock were distributed on February 16, 2005. All share and per share amounts in this Management's Discussion and Analysis of Financial Condition and Results of Operations have been retroactively adjusted to reÖect the stock split for all periods presented. Critical Accounting Policies, Judgments and Estimates General The preparation of our consolidated Ñnancial statements and related notes requires us to make judgments, estimates and assumptions that aÅect 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 diÅer from these estimates under diÅerent 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 diÅerent 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 Ñnancial statements. We believe the following critical accounting policies reÖect the more signiÑcant estimates and assumptions used in the preparation of the consolidated Ñnancial statements. The following descriptions of critical accounting policies, judgments and estimates should be read in conjunction with our consolidated Ñnancial statements and other disclosures included in this report. 36 Provisions for Doubtful Accounts and Authorized Credits Our U.S. Marketplace and International Marketplace 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 2002, 2003, and 2004 (in thousands, except percentages). Net revenues from the U.S. and International Marketplace segments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for doubtful accounts and authorized credits ÏÏ Provision for doubtful accounts and authorized credits as a % of net revenues from the U.S. and International Marketplace segments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Years Ended December 31, 2003 2002 2004 $1,118,732 25,455 $ $1,727,474 46,049 $ $2,573,607 90,942 $ 2.28% 2.67% 3.53% 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 Öows. Based on our results for the year ended December 31, 2004, a 25 basis point deviation from our estimates would have resulted in an increase or decrease in operating income of approximately $6.4 million. The following analysis demonstrates, for illustrative purposes only, the potential eÅect a 25 basis point deviation from our estimates would have upon our consolidated Ñnancial statements and is not intended to provide a range of exposure or expected deviation (in thousands, except per share data): Ó25 Basis Points 2004 °25 Basis Points Income from operating impact related to doubtful accounts and authorized credits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income from operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings per share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ $ 84,508 1,065,676 784,657 0.57 $ $ 90,942 1,059,242 778,223 0.57 $ $ 97,376 1,052,808 771,789 0.56 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, ACH returns, and debit card overdrafts. These allowances represent an accumulation of the estimated amounts, using an actuarial technique, necessary to provide for transaction losses incurred as of the reporting date, including those of which we have not yet been notiÑed. The allowances 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 loss expense is reÖected as a general and administrative expense in our consolidated statement of income. As of December 31, 2004, the transaction loss reserve totaled $11.0 million and was included in accrued expenses and other current liabilities in our consolidated balance sheet. 37 The following table illustrates the provision for transaction loss expense as a percentage of total payment volume from PayPal operations for the period from October 3, 2002 (date of acquisition of PayPal) through December 31, 2002 and for the years ended December 31, 2003 and 2004 (in thousands, except percentages). Period from October 3, 2002 through December 31, 2002 Year Ended December 31, 2003 Year Ended December 31, 2004 Total payment volume ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Transaction loss expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ As a % of total payment volume ÏÏÏÏÏÏÏÏ $2,138,000 7,832 $ 0.37% $12,226,000 36,401 $ $18,915,000 50,459 $ 0.30% 0.27% 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, 2004, a Ñve basis point deviation from our estimates would have resulted in an increase or decrease in our operating expenses of approximately $9.5 million. The following analysis demonstrates, for illustrative purposes only, the potential eÅect a Ñve basis point deviation from our estimates would have upon our consolidated Ñnancial statements for the year ended December 31, 2004, and is not intended to provide a range of exposure or expected deviation (in thousands, except per share data): Transaction loss expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income from operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings per share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ $ 41,003 1,068,698 787,679 0.58 ¿5 Basis Points 2004 $ $ 50,459 1,059,242 778,223 0.57 °5 Basis Points $ $ 59,915 1,049,786 768,767 0.56 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 10 Ì Commitments and Contingencies Ì Litigation and Other Legal Matters'' to our consolidated Ñnancial statements, which we incorporate herein. 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 plaintiÅs were to prevail on certain claims, we might be forced to pay signiÑcant damages and licensing fees, modify our business practices or even be prohibited from conducting a signiÑcant part of our business. Any such results could materially harm our business and could result in a material adverse impact on the Ñnancial position, results of operations or cash Öows 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 diÅerences 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 diÅerences between the book and tax bases of our assets and liabilities, including various accruals, allowances, depreciation and amortization. The tax eÅect of these temporary diÅerences and the estimated tax beneÑt from our tax net operating losses are reported as deferred tax assets and liabilities in our consolidated balance sheet. We also 38 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. To the extent we establish a valuation allowance or change the allowance in a period, we reÖect 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 deduction for employee stock option exercises, the change is reÖected as a credit to additional paid-in capital. As employee stock option exercises are highly dependent upon our stock price, it is extremely diÇcult to predict the amount of deductions that will be generated from future option exercises and, therefore, for us to ascertain the amount of deferred tax assets related to employee stock option exercises that may be realized in future periods. At December 31, 2004, we have maintained an allowance on certain net operating losses generated from deductions for employee stock option expenses based on our assessment that it is more likely than not that the deferred tax assets related to these net operating losses will not be realized. The deferred tax asset, net of a valuation allowance of $158.6 million, totaled $58.1 million at December 31, 2004 and was oÅset by deferred tax liabilities of $183.7 million resulting in a net deferred tax liability of $125.5 million. In addition, due to our signiÑcant anticipated international expansion, we have not provided for U.S. federal income and foreign withholding taxes on non-U.S. subsidiaries' undistributed earnings as of December 31, 2004, because such earnings are intended to be reinvested indeÑnitely. In the event that our future international expansion plans change and such amounts are not reinvested indeÑnitely, we would be subject to U.S. income taxes partially oÅset by foreign tax credits. The following table illustrates the eÅective tax rates for 2002, 2003, and 2004 (in thousands, except percentages): Years Ended December 31, 2003 2004 2002 Provision for income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EÅective tax rates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $145,946 $206,738 $ 343,885 37% 32% 30% Historically, these provisions have adequately provided for our actual income tax liabilities. However, unexpected or signiÑcant future changes in trends could result in a material impact to future consolidated statements of income and cash Öows. Based on our results for the year ended December 31, 2004, 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 $11.3 million. The following analysis demonstrates, for illustrative purposes only, the potential eÅect such a one-percentage point deviation change would have upon our consolidated Ñnancial statements and is not intended to provide a range of exposure or expected deviation (in thousands, except per share data): Provision for income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income from operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted earnings per share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Advertising and Other Non-Transaction Revenues ¿100 Basis Points $ 332,603 1,070,524 789,505 0.58 $ 2004 $ 343,885 1,059,242 778,223 0.57 $ °100 Basis Points $ 355,167 1,047,960 766,941 0.56 $ A portion of our net revenues result from fees associated with advertising and other non-transaction services in our U.S. Marketplace, International Marketplace 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 oÉine 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 9%, 2% and 3% of our consolidated net revenues for the years ended December 31, 2002, 2003 and 2004, respectively, and were primarily generated by our U.S. Marketplace segment. Revenue from barter arrangements totaled $10.1 million in both 2002 and 2003, and $13.3 million in 2004. Certain judgments are involved in the determination of the appropriate 39 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 aÅected by the Ñnancial 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 In accordance with the provisions of SFAS 141, 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 Öows that an asset is expected to generate in the future and the appropriate weighted average cost of capital. At December 31, 2004 our goodwill totaled $2.7 billion and our identiÑable intangible assets totaled $362.9 million. In accordance with the provisions of SFAS 142, we assess the impairment of goodwill and identiÑable 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 Öow analysis and analysis of our market capitalization. The estimate of cash Öow 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 Öows may diÅer from actual cash Öows due to, among other things, economic conditions, changes to its business model or changes in operating performance. SigniÑcant diÅerences between these estimates and actual cash Öows could materially aÅect our future Ñnancial results. We completed our annual goodwill impairment test as of August 31, 2004 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 have occurred from that date through December 31, 2004 that would require an updated analysis. 40 Risk Factors That May AÅect Results of Operations and Financial Condition The risks and uncertainties described below are not the only ones facing us. Other events that we do not currently anticipate or that we currently deem immaterial also may impair our business operations. Our operating results may Öuctuate. Our operating results have varied on a quarterly basis during our operating history. Our operating results may Öuctuate signiÑcantly as a result of a variety of factors, many of which are outside our control. Factors that may aÅect 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 service, or use our payment services; ‚ the volume, size, timing, and completion rate of transactions on our websites; ‚ the amount and timing of operating costs and capital expenditures relating to the maintenance and expansion of our businesses, operations, and infrastructure; ‚ technical diÇculties or service interruptions involving our websites or services provided to our users by third parties; ‚ the success of our geographic and product expansions; ‚ the actions of our competitors, including the introduction of new sites, services, and products; ‚ consumer conÑdence in the safety and security of transactions on our websites; ‚ 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, or our business model; ‚ 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 at a reasonable cost; ‚ the costs and results of litigation that involves us; ‚ our ability to keep our websites operational at a reasonable cost; ‚ our ability to develop product enhancements at a reasonable cost and to develop programs and features in a timely manner, including expanding our Ñxed-price oÅerings; ‚ our ability to successfully integrate and manage our acquisitions, including, most recently, Rent.com; ‚ our ability to manage PayPal's transaction loss and credit card chargeback rate and payment funding mix; ‚ our ability to expand PayPal's product oÅerings outside of the U.S. (including our ability to obtain any necessary regulatory approvals) and to increase the acceptance of PayPal by online merchants outside of the eBay marketplace; ‚ our ability to attract new personnel in a timely and eÅective manner and to retain key employees; ‚ the results of regulatory decisions that aÅect us; ‚ the continued Ñnancial strength of our technology suppliers and other parties with whom we have commercial relations; 41 ‚ increasing consumer acceptance of the Internet and other online services for commerce in the face of increasing publicity about fraud, spooÑng, viruses, and other dangers of the Internet; ‚ general economic conditions and those economic conditions speciÑc to the Internet and e-commerce industries; and ‚ geopolitical events such as war, threat of war, or terrorist actions. Our limited operating history and the increased variety of services oÅered on our websites make it diÇcult 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 diÇculty in forecasting revenues it is also diÇcult 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 signiÑcantly diÅerent 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 proÑtability or rates of growth. We believe that our continued proÑtability and growth will depend in large part on our ability to do the following: ‚ attract new users and keep existing users active on our websites; ‚ 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 suÇcient transaction volume to attract buyers and sellers; ‚ increase the awareness of our brands; and ‚ provide our customers with superior community, customer support, and trading experiences. We invest heavily in marketing and promotion, customer support, and further development of 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 proÑtability. In addition, we are spending in advance of anticipated growth, which may also harm our proÑtability. 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 business may also cause downward pressure on our proÑt margin because that business has lower gross margins than our eBay 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 proÑts, could harm our future revenues and proÑts, 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 suÅered intermittent unavailability over a Ñve-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 staÅ, which, in turn, could delay our introduction of new features and services on our sites. Because PayPal is a regulated Ñnancial entity, frequent or persistent site interruptions could lead to regulatory inquiries. These inquiries 42 could result in Ñnes, 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 signiÑcant 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, Öoods, Ñres, power loss, telecommunication failures, terrorist attacks, computer viruses, com- puter denial-of-service attacks, and similar events. Some of our systems, including PayPal's customer support operations, are not fully redundant, and our disaster recovery planning is not suÇcient 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 Ñnancial or other reasons, or other unanticipated problems at our hosting facilities could result in lengthy interruptions in our services. In addition, the failure by our hosting facilities to provide our required data communications capacity could result in interruptions in our service. We do not carry business interruption insurance suÇcient 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 eÅorts 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 eÅorts. 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 eÅorts to create and maintain brand loyalty among users. Brand promotion activities may not yield increased revenues, and even if they do, any increased revenues may not oÅset the expenses incurred in building our brands. If we do attract new users to our services, they may not conduct transactions over 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. We depend on the continued growth of online commerce. The business of selling goods over the Internet, particularly through online trading, is dynamic and relatively new. Growth in the use of the Internet as a medium for consumer commerce may not continue. Concerns about fraud, privacy, and other problems may discourage additional consumers from adopting the Internet as a medium of commerce. Market acceptance for recently introduced services and products over the Internet is highly uncertain, and there are few proven services and products. In countries such as the U.S., where our services and online commerce generally have been available for some time, acquiring new users for our services may be more diÇcult 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 eÇciencies in our operating costs, including our cost of acquiring new customers, our business could be adversely impacted. We must keep pace with rapid technological change to remain competitive. Our competitive arena is characterized by rapidly changing technology, evolving industry standards, frequent new service and product introductions and enhancements, and changing customer demands. These characteristics are caused in part by the emerging and changing nature of the Internet. Our future success therefore 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 service. Our failure to adapt to such changes 43 would harm our business. Recent changes in search functionality, including both paid and natural search, may give buyers easier access to Internet sellers who do not use our trading platforms and may provide such sellers with alternative access to buyers. These developments may reduce the attractiveness of our platform to sellers and may adversely aÅect our growth and business. New technologies, such as the development of a peer-to- peer personal trading technology, could also adversely aÅect us. In addition, the widespread adoption of new Internet, networking, or telecommunications technologies or other technological changes could require us to make substantial expenditures to modify or adapt our services or infrastructure. 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., Canada, and South Korea, has also become critical to our revenues and proÑts. In 2004, our international net transaction revenues represented 36% of our total net transaction revenues. Expansion into international markets requires management attention and resources. We have limited experience in localizing our service to conform to local cultures, standards, and policies. The commercial, Internet, and transportation infrastructure in lesser- developed countries may make it diÇcult 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 beneÑt from Ñrst-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 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, we are subject to risks of doing business internationally, including the following: ‚ regulatory requirements, including regulation of auctioneering, professional selling, distance selling, banking, and money transmitting, that may limit or prevent the oÅering of eBay's and PayPal's services in some jurisdictions, prevent enforceable agreements between sellers and buyers, prohibit the listing of certain categories of goods, require special licensure, or limit the transfer of information between eBay and our aÇliates; ‚ 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; ‚ diÇculties in integrating with local payment providers, including banks, credit and debit card associations, and electronic fund transfer systems; ‚ diÅering levels of retail distribution, shipping, and communications infrastructures; ‚ diÅerent employee/employer relationships and the existence of workers' councils and labor unions; ‚ diÇculties in staÇng and managing foreign operations; ‚ longer payment cycles, diÅerent accounting practices, and greater problems in collecting accounts receivable; ‚ potentially adverse tax consequences, including local taxation of our fees or of transactions on our websites; ‚ higher telecommunications and Internet service provider costs; ‚ strong local competitors; ‚ diÅerent and more stringent consumer protection, data protection and other laws; ‚ cultural ambivalence towards, or non-acceptance of, online trading; ‚ seasonal reductions in business activity; 44 ‚ expenses associated with localizing our products, including oÅering customers the ability to transact business in the local currency; ‚ laws and business practices that favor local competitors or prohibit foreign ownership of certain businesses; ‚ proÑt repatriation restrictions, foreign currency exchange restrictions, and exchange rate Öuctuations; ‚ volatility in a speciÑc country's or region's political or economic conditions; and ‚ diÅering 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 diÇculties in collecting accounts receivable and risks relating to foreign currency exchange rate Öuctuations. The impact of currency exchange rate Öuctuations is discussed in more detail under ""We are exposed to Öuctuations in currency exchange rates,'' below. We are in the process of expanding PayPal's services internationally. Both eBay and PayPal 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. We do not know if these or other factors may prevent, delay, or limit PayPal's expansion or reduce its proÑtability. Any limitation on our ability to expand PayPal internationally could harm our business. Our operations in China are subject to risks and uncertainties relating to the laws and regulations of the People's Republic of China. In July 2003, we completed the acquisition of the remaining outstanding capital stock and options of EachNet. EachNet is a Delaware corporation and a foreign person under the laws of the People's Republic of China, or PRC, and is 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 the business operations of such companies. In order to meet local ownership and regulatory licensing requirements, the new 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. We believe EachNet's current ownership structure complies 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. There are also uncertainties regarding EachNet's ability to enforce contractual relationships it has entered into with respect to management and control of the company's business. If EachNet were found to be in violation of any existing or future PRC laws or regulations, it could be subject to Ñnes and other Ñnancial penalties, have its business and Internet content provider licenses revoked, or be forced to discontinue its business entirely. We are exposed to Öuctuations in currency exchange rates. Net revenues outside the United States accounted for approximately 42% of our net revenues in 2004. Because we conduct a signiÑcant 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 Ñxes exchange rates twice per day, and may face Ñnancial exposure if it incorrectly Ñxes the exchange rate. PayPal also holds some corporate funds in non-U.S. currencies to facilitate customer withdrawals, and thus its Ñnancial results are aÅected 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 45 foreign exchange rate Öuctuations as the Ñnancial 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, as it did in 2004, the translation of these foreign-currency-denominated transactions will result in increased net revenues, operating expenses, and net income. The change in weighted average foreign currency exchange rates in 2004 relative to the comparable rates used in preparation of our consolidated 2003 Ñnancial statements resulted in an increase in net revenues of approximately $129.9 million and an increase in aggregate cost of revenues and operating expenses of approximately $58.4 million. Similarly, our net revenues, operating expenses, and net income will decrease if the U.S. dollar strengthens against foreign currencies. As exchange rates vary, net sales and other operating results, when translated, may diÅer materially from expectations. In particular, to the extent the U.S. dollar strengthens against the Euro and British Pound, our European revenues and proÑts 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 oÅset 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, these hedges are relatively costly and, even with them in eÅect, it is impossible to perfectly predict or completely eliminate the eÅects of this exposure. 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 speciÑcally addressing the Internet or some aspect of e-commerce. The application of existing, new, or future laws could have adverse eÅects 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 Ñnancial beneÑt from our activities. In December 2004, the U.S. federal government enacted legislation extending the moratorium on states and other local authorities imposing access or discriminatory taxes on the Internet through 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, the U.S. Congress continues to consider overriding 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. 46 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 signiÑcant risks of loss due to fraud and disputes between senders and recipients, including: ‚ merchant fraud and other disputes over the quality of goods and services; ‚ unauthorized use of credit card and bank account information and identity theft; ‚ the need to provide eÅective 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, 2004, PayPal's transaction loss expense totaled $50.5 million, representing 0.27% of PayPal's total payment volume. Failure to deal eÅectively 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 conÑguring its service, PayPal faces an inherent trade-oÅ 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 signiÑcantly restricted their businesses largely due to losses from this type of fraud. 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. 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 erroneous transmissions and from customers who have closed bank accounts or have insuÇcient 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 suÅer. PayPal has been assessed substantial Ñnes 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 eÅective. If these measures do not succeed, our business will suÅer. In October 2003, PayPal launched a buyer protection program that refunds to buyers up to $500 in certain eBay transactions if they do not receive the goods they purchased or if the goods diÅer signiÑcantly from what was described by the seller. In November 2004, PayPal increased the amount of protection available under its buyer protection program to $1,000. 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 Öuctuations. eBay faces similar risks to those of PayPal with respect to fraudulent activities, although eBay's risks may to some extent be less signiÑcant. 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 47 jurisdictions, buyers may also have the right to withdraw from a sale made by a professional seller within a speciÑed time period. While eBay can suspend the accounts of users who fail to fulÑll 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. 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 clariÑed 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, aÅected users will likely complain to regulatory agencies that could take action against us, including imposing Ñnes 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 or its users' credit card usage rates could negatively aÅect 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 has announced an increase in the standard interchange fee for credit cards in online commerce transactions eÅective 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. Such increased fees increase PayPal's operating costs and reduce its proÑt 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 Ñnes they are assessed by credit card associations as a result of processing payments for 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 Ñnd diÇcult 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 suÅer. In 2002, both Visa and MasterCard adopted new operating rules for Internet payment services like PayPal. In order to comply with the associations' new rules, PayPal and its credit card processors have implemented changes to existing business processes for merchant customers. Any problems with this implementation could result in Ñnes, the amount of which would be within Visa's and MasterCard's discretion. PayPal also could be subject to Ñnes from MasterCard and Visa if it fails to register and conduct additional monitoring with respect to the activities of merchants that are considered ""high risk,'' primarily certain merchants that sell digital content. PayPal has incurred Ñnes from its credit card processor in 2003 and 2004 relating to PayPal's failure to detect the use of its service by certain ""high risk'' merchants using the PayPal service. The amount of these Ñnes has not been material, but any additional Ñnes 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, which would seriously damage PayPal's business. PayPal pays signiÑcant 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 during 2004 using credit cards, and PayPal's Ñnancial success will 48 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 Öier miles or other incentives oÅered by credit cards, the ability to defer payment, or a reluctance to provide bank account information to PayPal. 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. We believe that the licensing or approval requirements of the U.S. OÇce 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 below. However, PayPal has in the past received written communica- tions 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 eÅective 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 suÇcient by the state regulatory authorities, PayPal could be subject to Ñnes 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. A number of U.S. states have enacted legislation regulating money transmitters. To date, PayPal has obtained licenses in 32 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. If PayPal's pending applications were denied, or if it were found to be subject to and in violation of any money services laws or regulations, PayPal also 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 licenses or regulatory approvals that could impose a substantial cost on PayPal. Although there have been no deÑnitive 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 speciÑed error resolution procedures and absorb losses above $50 from transactions not authorized by the consumer. In addition, PayPal is subject to the Ñnancial privacy provisions of the Gramm-Leach-Bliley Act, state Ñnancial privacy laws, and related regulations. As a result, some customer Ñnancial 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 929,000 transactions per day during 2004, and any violations could expose PayPal to signiÑcant liability. 49 PayPal's status under banking or Ñnancial services laws or other laws in countries outside the U.S. is unclear. PayPal currently allows its customers with credit cards to send payments from 44 countries outside the U.S., and to receive payments in 43 of those countries. In 23 of these countries, customers can withdraw funds to local bank accounts, and in eight of these countries customers can withdraw funds by receiving a bank draft in the mail. PayPal oÅers customers the ability to send or receive payments denominated in U.S. Dollars, British Pounds, Euros, Canadian Dollars, Yen, and, beginning in January 2005, Australian Dollars. PayPal has applied for an Australian Financial Services License, and has received an oÇcial exemption from the Banking Act in Australia until October 2005. In February 2004, PayPal (Europe) Ltd., a wholly-owned subsidiary of PayPal, received a license to operate as an Electronic Money Institution in the United Kingdom as a vehicle for providing localized versions of PayPal's service to customers in the EU. Fifteen of the 44 countries outside of the U.S. whose residents can use the PayPal service are members of the European Union. As PayPal (Europe) develops localized services for the domestic market in these countries, it is implementing such localized services through an expedited ""passport'' notiÑcation process through the UK regulator to regulators in other EU member states, pursuant to EU Directives. PayPal (Europe) has Ñled ""passport'' notices in Austria, Belgium, France, Germany, the Netherlands, Ireland, Italy, Sweden, Denmark, Finland, Luxem- bourg, Portugal, Greece and Spain. 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 signiÑcant Ñnes 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 countries 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 Ñnancial 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 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 aÅect PayPal's international expansion plans and could require PayPal to suspend providing services to customers in one or more countries. We are subject to regulations relating to consumer privacy. Several domestic jurisdictions have proposed, and California, Minnesota, Utah, and Vermont have recently passed, legislation that limits the uses of personal information gathered online or oÉine. In addition to these four states, many other jurisdictions already have such laws and continuously consider strengthening them, especially against online services. eBay and PayPal in certain instances are subject to some of these current laws. PayPal may also be subject to recently enacted legislation in several states and countries imposing greater restrictions on the ability of Ñnancial services companies to share user information with third parties without aÇrmative user consent. However, the Fair and Accurate Credit Transactions Act of 2003, or FACT, included a provision preempting conÖicting state laws on the sharing of information between corporate aÇliates, and as a result we believe that PayPal and eBay will not be subject to the laws of each individual state with respect to matters within the scope of FACT, but will remain subject to the provisions of FACT and the Fair Credit Reporting Act. Courts are currently determining the scope of these preemptive provisions. SpeciÑc statutes intended to protect user privacy have been passed in many non-U.S. jurisdictions, including virtually every non-U.S. jurisdiction in which we currently have a localized website. Compliance with these laws, given the tight integration of our systems across diÅerent countries and the need to move data to facilitate transactions amongst our users (e.g., to payment companies, shipping companies, etc.), is both 50 necessary and diÇcult. Failure to comply could subject us to lawsuits, Ñnes, criminal penalties, statutory damages, adverse publicity, and other losses that could harm our business. Changes to existing laws or the passage of new laws intended to address these privacy and data protection and retention issues could directly aÅect the way we do business or could create uncertainty on the Internet. This could reduce demand for our services, increase the cost of doing business as a result of litigation costs or increased service or delivery costs, or otherwise harm our business. 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 oÅ the Internet. Today, there are still relatively few laws speciÑcally 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 (e.g., real estate, event tickets, cultural goods, boats, 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 ""pawnbrokers.'' No Ñnal legal determination has been made as to whether the California regulations apply to our business 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, which could harm our business. In August 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 we do not expect this registration to have a negative impact on our business, 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 Ñnes 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 oÅerings 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. PayPal has limited experience in managing and accounting accurately for large amounts of customer funds. PayPal's failure to manage these 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, 51 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 signiÑcant public conÑdence 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 business is subject to online commerce security risks, including security breaches and identity theft. To succeed, online commerce and communications must provide a secure transmission of conÑdential information over public networks. Our security measures may not prevent security breaches that could harm our business. Currently, a signiÑcant 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 Ñnancial information. We rely on encryption and authentication technology licensed from third parties to provide the security and authentication technology to eÅect secure transmission of conÑdential information, including customer credit card numbers. Advances in computer capabilities, new discoveries in the Ñeld 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. A 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 signiÑcant resources to protect against security breaches or to address problems caused by breaches. These issues are likely to become more diÇcult 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. These emails appear to be legitimate emails sent by eBay or PayPal, but direct recipients to fake websites operated by the sender of the email or request that the recipient send a password or other conÑdential information via email. We actively pursue the parties responsible for these attempts at misappropriation and encourage our users to divulge sensitive information only after they have veriÑed that they are on our legitimate websites, but we cannot entirely eliminate these types of activities. 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 to address potential growth in our customer base and number of listings and payment transactions, as well as our expansion into new geographic areas, types of goods, and alternative methods of sale. This expansion has placed, and we expect it will continue to place, a signiÑcant strain on our management, operational, and Ñnancial 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 increases the cost of additional enhancements. Failure to upgrade our technology, features, transaction processing systems, security infrastructure, or network infrastructure to accommo- date increased traÇc 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 52 API, and delays in reporting accurate Ñnancial information. We may be unable to eÅectively 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 related to system upgrades. Despite our eÅorts to increase site scalability and reliability, our infrastructure could prove unable to handle a larger volume of customer transactions. 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. We recently completed a signiÑcant 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. In July 2004, a complaint seeking class action status was Ñled alleging that eBay improperly billed its users and improperly debited some user accounts. The complaint was recently amended to include a larger variety of billing related problems and a longer time frame. 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 would harm our business and our ability to collect revenue. ‚ Customer Support. We are expanding our customer support operations to accommodate the in- creased 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-eÅective manner, users of our websites may have negative experiences, current and future revenues could suÅer, 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 Ñnancial systems, procedures, and controls. This is a special challenge as we acquire new operations with diÅerent 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 diÇcult for us to oÅset any future revenue shortfalls by expense reductions in the short term. Our business is adversely aÅected 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 aÅect our business. We would therefore be adversely aÅected 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 have historically experienced our strongest quarters of online growth in our Ñrst and fourth Ñscal quarters. PayPal has shown similar seasonality, especially in the fourth Ñscal quarter. We expect these patterns of seasonality to become more pronounced as our websites gain acceptance by a broader base of mainstream users and as the size of our European operations, which experience greater seasonality, grows relative to our other operations. 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 53 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 the listing of a pornographic video clip on that site. Similarly, our Korean subsidiary and one of its employees was found criminally liable for a listing 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 oÅerings. 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 signiÑcant 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 traÇcking, prohibited sales of alcoholic beverages or tobacco products, and online securities fraud. PayPal recently announced a change in its acceptable use policy that would enable PayPal to Ñne 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 may be funded using PayPal. PayPal is subject to 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 Ñrm. 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 more closely international transactions. These regulations could impose signiÑcant costs on PayPal and make it more diÇcult for new customers to join its network. PayPal could be required to learn more about its customers before opening an account, to obtain additional veriÑcation of international customers and to monitor its customers' activities more closely. These require- ments, as well as any additional restrictions imposed by Visa, MasterCard, American Express, and Discover, could raise PayPal's costs signiÑcantly and reduce the attractiveness of its product. Failure to comply with federal and state money laundering laws could result in signiÑcant criminal and civil lawsuits, penalties, and forfeiture of signiÑcant 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 aÇliates in the regional court of Cologne, Germany. The suit subsequently was transferred to the regional court in D usseldorf, 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 D usseldorf, 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. In March 2004, 54 the German Federal Supreme Court ruled in favor of Rolex in a case involving an unrelated company, ricardo.de AG, but somewhat comparable legal theories. The court issued its written decision in that case in September 2004. Although it is not yet clear what eÅect the reasoning of the German Federal Supreme Court's ricardo.de decision would have when applied to eBay, we believe the Court's decision will likely not require any signiÑcant change in our business practices. In September 2001, a complaint was Ñled by MercExchange LLC 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 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, eÅectively 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 Ñnding 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 Ñled post-trial motions, and in August 2003, the court entered judgment for MercExchange in the amount of $29.5 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 Ñled 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. Oral arguments for the appeals were heard on October 5, 2004. The U.S. Patent and Trademark OÇce recently granted our request that it reexamine the three patents at suit, and on January 26, 2005, the Patent and Trademark OÇce issued a ruling rejecting all of MercExchange's claims under the patent that related to online auctions. We continue to believe that the verdict against us in the trial was incorrect and intend to continue to pursue our appeal and defend ourselves vigorously. However, even if successful, our appeal of and defense against this action will continue to be costly. In addition, as a precautionary measure, we have modiÑed certain functionality of our websites and business practices in a manner which we believe makes them not infringe the two patents that we were found to have infringed. Nonetheless, if we are not successful in appealing the court's ruling, we might be forced to pay signiÑcant additional damages and licensing fees or modify our business practices in an adverse manner. In August 2002, Charles E. Hill & Associates, Inc. Ñled 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, unspeciÑed damages, including treble damages for willful infringement, and interest, costs, expenses, and fees. In January 2003, the case was transferred to the U.S. District Court for the Southern District of Indiana. After pending in Indiana for almost a year, the case was transferred back to the U.S. District Court for the Eastern District of Texas in December 2003. A scheduling conference was held in November 2004, and a preliminary trial date has been set for February 2006. The case is currently in fact discovery and claim construction discovery. We believe that we have meritorious defenses and intend to defend ourselves vigorously. In February 2002, PayPal was sued in California state court (No. CV-805433) in a purported class action alleging that its restriction of customer accounts and failure to promptly unrestrict 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-Ñled with a diÅerent named plaintiÅ in June 2002 (No. CV-808441), and a similar action was also Ñled 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 restrictions of customer accounts and failure to promptly unrestrict 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, but the court's approval could be appealed. In the settlement, PayPal does not acknowledge that any of the 55 allegations in the case are true. Under the terms of the settlement, certain PayPal account holders will be eligible to receive payment from a settlement fund of $9.25 million, less administrative costs and the amount awarded to plaintiÅs' counsel by the court. That sum will be distributed to class members who have submitted timely claims in accordance with the settlement's plan of allocation, which still must be approved by the court. The parties expect that a plan of allocation will be submitted to the court in the Ñrst quarter of 2005. The amount of the settlement was fully accrued in our consolidated statement of income for the year ended December 31, 2003. In July 2004, a purported class action lawsuit was Ñled 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 Ñled in January 2005, dropping one plaintiÅ, changing the capacity of the other plaintiÅ to that of representative plaintiÅ, and adding seven additional eBay users as plaintiÅs. The amended complaint expanded its claim to include numerous alleged improper billing practices from September 2003 until the present. In February 2005, eBay Ñled a motion to strike and a demurrer seeking to dismiss the complaint. We believe that we have meritorious defenses and intend to defend ourselves vigorously. 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 artiÑcially inÖating 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. The plaintiÅs have not yet served eBay with the complaint. We believe that we have meritorious defenses and intend to defend ourselves vigorously. 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 notiÑed 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 business. 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 that arise in the ordinary course of business. The number and signiÑcance of these disputes is increasing as our business expands and our company grows larger. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require signiÑcant amounts of management time, and result in the diversion of signiÑcant operational resources. Government inquiries may lead to charges or penalties. In January 1999, we received initial requests to produce certain records and information to the federal government relating to an investigation of possible illegal transactions in connection with our websites. We were informed that the inquiry includes an examination of our practices with respect to these transactions. In order to protect the investigation, the court has ordered that no further public disclosures be made with respect to the matter. Any civil or criminal charges against us would likely harm our business due to negative publicity, the cost of litigation, the diversion of management time, and any Ñnes or penalties assessed. 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 56 its restriction and disclosure practices from the Federal Trade Commission and 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 Ñnes. If PayPal becomes subject to an enforcement action, it could be required to restructure its anti-fraud processes in ways that would harm its business, and to pay substantial Ñnes. 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 eÅectiveness 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 eÅorts, customer support procedures and operating procedures. If one or more of these agencies is not satisÑed with our response to current or future inquiries, we could be subject to Ñnes 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 identiÑable information about our users, especially users located outside of the U.S. 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 signiÑcant penalties and negative publicity and could adversely aÅect 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 oÅering infringing items on our websites, some rights owners have expressed the view that our eÅorts are insuÇcient. 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 TiÅany & Co. 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 diÅerent legal theories than those of earlier cases, and there is no guarantee that we will continue to be successful in our defense. In addition, we expect that this type of litigation 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 57 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 oÅerings, which would negatively aÅect our Ñnancial 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 conÑdence in and use of our services. Breaches of our customers' privacy and our security measures could have the same eÅect. 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. EÅective customer service requires signiÑcant personnel expense, and this expense, if not managed properly, could impact our proÑtability signiÑcantly. Failure to manage or train our customer service representatives properly could compromise our ability to handle customer complaints eÅectively. If we do not handle customer complaints eÅectively, our reputation may suÅer and we may lose our customers' conÑdence. Because it is providing a Ñnancial 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 identiÑed 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 is 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-eÅective manner, PayPal's users may have negative experiences, PayPal may receive additional negative publicity and its ability to attract new customers may be damaged. Current and future revenues could suÅer, or its operating margins may decrease. In addition, negative publicity about or experiences with PayPal's customer support could cause eBay's reputation to suÅer or aÅect consumer conÑdence in eBay as a whole. Acquisitions could result in operating diÇculties, dilution and other harmful consequences. We have acquired a number of businesses in the past, and have recently completed or announced the acquisitions of Marktplaats.nl, a classiÑed listing site in the Netherlands, and Rent.com, an Internet classiÑed site focused on the apartment and rental housing industry. 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 and joint ventures. At any given time we may be engaged in discussions or negotiations with respect to one or more of such transactions. Any of such transactions could be material to our Ñnancial condition and results of operations. There is no assurance that any such discussions or negotiations will result in the consummation of any transaction. The process of integrating any acquired business may create unforeseen operating diÇculties and expenditures and is itself risky. The areas where we may face diÇculties include: ‚ diversion of management time, as well as a shift of focus from operating the businesses to issues of integration and future products; ‚ declining employee morale and retention issues resulting from changes in compensation, 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 eÅective management, and the lack of control if such integration is delayed or not implemented; 58 ‚ 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, the need to transition operations onto the existing eBay platform. Foreign acquisitions involve special risks, including those related to integration of operations across diÅerent cultures and languages, currency risks, and the particular economic, political, and regulatory risks associated with speciÑc countries. Moreover, we may not realize the anticipated beneÑts of any or all of our acquisitions. As a result of future acquisitions or mergers, we might need to issue additional equity securities, spend our cash, or incur debt, contingent liabilities, or amortization expenses related to intangible assets, any of which could reduce our proÑtability and harm our business. Our stock price has been and may continue to be extremely volatile. The trading price of our common stock has been and is likely to be extremely volatile and could Öuctuate in response to a variety of factors, including the following: ‚ actual or anticipated variations in our quarterly operating results and expected future results; ‚ changes in, or failure to meet, Ñnancial estimates by securities analysts; ‚ unscheduled system downtime; ‚ additions or departures of key personnel; ‚ announcements of technological innovations or new services by us or our competitors; ‚ initiation of or developments in litigation aÅecting us; ‚ conditions or trends in the Internet and online commerce industries; ‚ changes in the market valuations of other Internet, online commerce, or technology companies; ‚ developments in regulation; ‚ announcements by us or our competitors of signiÑcant acquisitions, strategic partnerships, joint ventures, new products or capital commitments; ‚ unanticipated economic or political events; ‚ sales of our common stock or other securities in the open market; and ‚ other events or factors, including those described in this ""Risk Factors That May AÅect Results of Operations and Financial Condition'' section and others that may be beyond our control. The trading prices of Internet stocks in general, and ours in particular, have experienced extreme price and volume Öuctuations in recent periods. These Öuctuations often have been unrelated or disproportionate to the operating performance of these companies. Even considering recent changes, the valuation of our stock remains high based on conventional valuation standards such as price-to-earnings and price-to-sales ratios. The trading price of our common stock has decreased sharply from its level in the fourth quarter in 2004, but remains much higher than our stock price during 2002 and early 2003. This trading price and valuation may not be sustained. Negative changes in the public's perception of the prospects of Internet or e-commerce or technology companies have in the past and may in the future depress our stock price regardless of our results. Other broad market and industry factors may decrease the market price of our common stock, regardless of our operating performance. Market Öuctuations, as well as general political and economic conditions, such as recession or interest rate or currency rate Öuctuations, also may decrease the market price of our common stock. Securities class-action litigation is often instituted following declines in the market price of a company's securities. Litigation of this type could result in substantial costs and a diversion of management's attention and resources. 59 Problems with third parties who provide services to our users could harm our business. A number of parties provide services to our users that indirectly beneÑt 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 other services. In some cases we have contractual agreements with these companies that give us a direct Ñnancial interest in their success, while in other cases we have none. In either circumstance, Ñnancial, regulatory, or other problems that prevent these companies from providing services to our users could reduce the number of listings on our websites or make completing transactions on our websites more diÇcult, and thereby harm our business. Any security breach at one of these companies could also aÅect 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. Other companies or governmental agencies may view our behavior as anti-competitive. Other companies 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 typically are very expensive to defend, involve negative publicity and diversion of management time and eÅort, and could result in signiÑcant judgments against us. We provided information to the Antitrust Division of the U.S. Department of Justice in connection with an inquiry into our conduct with respect to ""auction aggregators,'' including our licensing program and a previously settled lawsuit against Bidder's Edge. Although the Antitrust Division has closed this inquiry, any future antitrust investigation would likely harm our business due to negative publicity, the costs of the investigation, possible private antitrust lawsuits, the diversion of management time and eÅort, and penalties we might suÅer if we ultimately were not to prevail. 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 oÇcers 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 OÇcer has fully vested the vast majority of her 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 suÇciently qualiÑed 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 diÇcult 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 diÇcult to retain and motivate employees. Our industry is intensely competitive. We 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 oÉine 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, emerging online retailers, online classiÑed services, and other shopping 60 channels such as oÉine and online home shopping networks. These include most prominently: Wal-Mart, Kmart, Target, Sears, Macy's, JC Penney, Costco, OÇce Depot, Staples, OÇceMax, 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 Ñnd and buy items from sellers of all sizes. For example, sites such as Buy.com, DealTime, Google's Froogle, In- Store.com, MySimon.com, Nextag.com, Pricegrabber.com, Shopping.com, and Yahoo! Product Search oÅer shopping search engines that allow consumers to search the Internet for speciÑed 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 face competition from local, regional, and national specialty retailers and exchanges in each of our categories of products. Many competitors have been successful at establishing marketplaces that cater to a particular retail category, such as vehicles, tickets, or sporting goods. Examples of category-speciÑc competi- tors include: Books/Movies/Music: Abebooks.com, Amazon.com, Barnes & Noble, Alibris.com, Blockbuster, BMG, Columbia House, Best Buy, CDNow, Express.com, Emusic.com, and Tower Records; Business & Industrial: Ariba, BidFreight.com, Bid4Assets, BizBuyer.com, bLiquid.com, Buyer Zone, CloseOutNow.com, Commerce One, Concur Technologies, DoveBid, FreeMarkets, Iron Planet, labx.com, Oracle, PurchasePro.com, RicardoBiz.com, Sabre, SurplusBin.com, Ventro, and VerticalNet; Clothing & Accessories: Abercrombie & Fitch, AE.com, Bloomingdales, BlueÖy.com, Coldwater- Creek.com, Delias.com, Dockers.com, Eddie Bauer, The Gap, J. Crew, Land's End, The Limited, LLBean, Macy's, The Men's Wearhouse, Nieman-Marcus, Nordstrom, Overstock.com, Payless, Ross, Saks Fifth Avenue, Shoes.com, Urban OutÑtters, Victoria's Secret, Yoox.com, and Zappos.com; Collectibles: Bonhams & ButterÑelds, Bowers and Morena, Christie's, Collectiblestoday.com, Collec- tors Universe, Franklin Mint, Go Collect, Heritage, Just Glass, Mastronet, Pottery Auction, Replace- ments.com, Ruby Lane, Shop At Home, Sotheby's, Tias, US Mint, US Postal Service, antique and collectible dealers, antique and collectible fairs, auction houses, Öea markets and swap meets, independent coin and stamp dealers, and specialty retailers; Computers, Consumer Electronics, and Cameras & Photo: Best Buy, Buy.com, Circuit City, CNET, CompUSA, Computer Discount Warehouse, Dell, Electronics Boutique, Fry's Electronics, Gamestop, Gateway, The Good Guys, Hewlett Packard, IBM, MicroWarehouse, Overstock.com, PC Connection, PCMall.com, Radio Shack, Ritz Camera, Tech Depot, Tiger Direct, Tweeter Home Entertainment, uBid, major wireless carriers, and computer, consumer electronics, and photography retailers; Home & Garden: Ace Hardware, Bed, Bath & Beyond, Burpee.com, Crate & Barrel, Do-It-Best Hardware, Ethan Allen, Frontgate, IKEA, HomeBase, Home Depot, Kohl's, Lowes, Linens "n Things, OSH, Pier One, Pottery Barn, Spiegel, TJ Max, Tuesday Morning, True Value Hardware, and Williams-Sonoma; Jewelry & Watches: Bluenile.com, Diamond.com, Ice.com, Macy's, Mondera.com, HSN.com, QVC.com, TiÅany.com, and Zales; Motors (used vehicles and parts): Advance Auto Parts, AutoByTel.com, Autonation.com, AutoPartsPlace, AutoTrader.com, Autozone, Barons Ltd., Barrett-Jackson, California Classics, Car Parts Wholesale, Car-Part.com, CarMax, Cars.com, CarsDirect.com, Collectorcartraderonline.com, CSK Auto, Dealix, Discount Auto Parts, Dupont Registry, eClassics.com, ExpressAutoparts.com, General Parts (Car- quest), Genuine/NAPA, Hemmings, iMotors.com, JC Whitney, Kragen, Kruse International, OpenAuto.com, PartsAmerica.com, Pep Boys, RM Auctions, Inc., The Tire Rack, TraderOnline, Trader Publishing, newspaper classiÑeds, used car dealers, swap meets, car clubs, and vehicle recyclers; 61 Sports: Academy Sports, Bass Pro Shops, Big 5, Cabela's, Dick's Sporting Goods, Golf- ClubExchange.com, Golfsmith, GSI Commerce, Performance Bike, Play It Again Sports, REI, The Sports Authority, SportsLine.com, and TGW.com; and Toys: FAO Schwarz, KB Toys, Toys R Us, and Zany Brainy. Our international websites compete with similar online and oÉine 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 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 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: ‚ community cohesion, interaction and size; ‚ system reliability; ‚ reliability of delivery and payment; ‚ website convenience and accessibility; ‚ level of service fees; and ‚ quality of search tools. Some current and potential competitors have longer company operating histories, larger customer bases and greater brand recognition in other business and Internet sectors than we do. Some of these competitors also have signiÑcantly greater Ñnancial, marketing, technical and other resources. Other online trading services may be acquired by, receive investments from, or enter into other commercial relationships with larger, well- established and well-Ñnanced 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 oÅered 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 oÉine 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. 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 proÑtability. 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 oÅerings could harm our proÑtability. In addition, certain competitors may oÅer or continue to oÅer free shipping or other 62 transaction related services, which could be impractical or ineÇcient for eBay users to match. New technologies may increase the competitive pressures by enabling our competitors to oÅer a lower cost service. Although we have established Internet traÇc 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. The market for PayPal's product is emerging, intensely competitive, and characterized by rapid technological change. PayPal competes with existing online and oÅ-line payment methods, including, among others: ‚ credit card merchant processors that oÅer their services to online merchants, including Card Services International, Chase, First Data, iPayment, Paymentech, and Wells Fargo; and payment gateways, including CyberSource, VeriSign, and Authorize.net; ‚ BidPay.com and Western Union MoneyZap, each operated by subsidiaries of First Data; ‚ payment services oÅered by Amazon.com; ‚ CheckFree; ‚ processors that provide online merchants the ability to oÅer their customers the option of paying for purchases from their bank account, including Certegy and TeleCheck, a subsidiary of First Data, or to pay on credit, including Bill Me Later from I4 Commerce and CIT Bank; ‚ 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. Some of these competitors have longer operating histories, signiÑcantly greater Ñnancial, technical, marketing, customer service and other resources, greater name recognition, or a larger base of customers in aÇliated businesses than PayPal. PayPal's competitors may respond to new or emerging technologies and changes in customer requirements faster and more eÅectively than PayPal. They may devote greater resources to the development, promotion, and sale of products and services than PayPal, and they may oÅer lower prices. Some of these competitors have oÅered, and may continue to oÅer, their services for free in order to gain market share, and PayPal may be forced to lower its prices in response. Competing services tied to established banks and other Ñnancial institutions may oÅer greater liquidity and engender greater consumer conÑdence in the safety and eÇcacy of their services than PayPal. If these competitors acquired signiÑcant market share, this could result in PayPal losing market share. Overseas, PayPal faces competition from similar channels and payment methods in most countries and from regional and national online and oÉine competitors in each country including Visa's Visa Direct, MasterCard's MoneySend, ING's Way2Pay and Royal Bank of Scotland's World Pay in the European Community, NOCHEX, Moneybookers, and Royal Bank of Scotland's FastPay in the U.K., CertaPay and HyperWallet in Canada, Paymate in Australia, Alipay 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 oÉine transactions. As in the U.S., established banks and other Ñnancial institutions that do not currently oÅer online payments could quickly and easily develop such a service. Our business depends on the development and maintenance of the Internet infrastructure. The success of our service 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 63 Internet access and services. The Internet has experienced, and is likely to continue to experience, signiÑcant growth in the numbers of users and amount of traÇc. 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 as well as the level of traÇc and the processing transactions on our service. We need to develop new services, features, and functions in order to expand. We plan to expand our operations by developing new or complementary services, products, or transaction formats and expanding the breadth and depth of our pre-trade and post-trade services. We may be unable to expand our operations in a cost-eÅective or timely manner. We are pursuing strategic relationships with other companies to provide many of these services. As a result, we may be unable to control the quality of these services or adequately address problems that arise. Expanding our operations in this manner also will require signiÑcant additional expenses and development, operations and other resources and will strain our manage- ment, Ñnancial and operational resources. The lack of acceptance of any new businesses or services could harm our business, damage our reputation, and diminish the value of our brand. 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 conÑdentiality 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. 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. EÅective trademark, copyright, patent, trade dress, trade secret, and domain name 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. 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 Ñxing 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. 64 Some anti-takeover provisions may aÅect 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 certiÑcate of incorporation and bylaws could have the eÅect of making it more diÇcult for a potential acquirer to acquire a majority of our outstanding voting stock. These include provisions that provide for a classiÑed 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 eÅect of delaying or preventing a change of control. 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 signiÑcantly 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 classiÑed 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 Ñxed-rate and Öoating-rate interest-earning instruments carry varying degrees of interest rate risk. The fair market value of our Ñxed-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 Öoating rate securities generally are subject to less interest-rate risk than Ñxed- rate securities, Öoating-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 suÅer losses in principal if securities are sold that have declined in market value due to changes in interest rates. As of December 31, 2004, our Ñxed-income investments earned a pretax yield of approximately 1.7%, with a weighted average maturity of six months. If interest rates were to instantaneously increase (decrease) by 100 basis points, the fair market value of the total investment portfolio could decrease (increase) by approximately $16.8 million. We entered into two interest rate swaps on June 19 and July 20, 2000, with notional amounts totaling $95 million to reduce the impact of changes in interest rates on a portion of the Öoating rate operating lease for our San Jose headquarters oÇce facilities. The interest rate swaps allow us to receive Öoating rate receipts based on the London Interbank OÅered Rate, or LIBOR, in exchange for making Ñxed rate payments which eÅectively changes our interest rate exposure on our operating lease from a Öoating rate to a Ñxed rate on $95 million of the total $126.4 million notional amount of our San Jose headquarters facility lease commitment. The balance of $31.4 million remains at a Öoating rate of interest based on the spread over 3-month LIBOR. If the 3-month LIBOR rates were to increase (decrease) by 100 basis points, then our payments would increase (decrease) by $78,000 per quarter. The fair value of the interest rate swaps as of December 31, 2004 was an unrealized loss of approximately $662,000, net of tax beneÑt, and is recorded in accumulated other comprehensive loss on the balance sheet. The interest rate swap will mature in March 2005, at which time the lease will expire and we will purchase our San Jose headquarters facility. Equity Price Risk We are exposed to equity price risk on the marketable portion of equity 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. In accordance with our policy to assess whether an impairment loss on our investments has occurred due to declines in fair value and other market conditions, we determined that declines in fair value of certain of our 65 marketable and non-marketable equity investments were other than temporary. Accordingly, we recorded impairment charges totaling $3.8 million and $1.2 million during the years ended December 31, 2002 and 2003, respectively, relating to the other-than-temporary impairment in the fair value of certain equity investments. We did not record an impairment charge related to the other-than-temporary impairment in the fair value of equity investments during the year ended December 31, 2004. At December 31, 2004, the total carrying value of our equity instruments and equity method investment was $48.3 million, including $1.1 million in marketable investments. At December 31, 2003, the total carrying value of our equity investments was $14.3 million, including $1.1 million in marketable investments. Foreign Currency Risk International net revenues result from transactions by our foreign operations and are typically denomi- nated 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, diÅering economic conditions, changes in political climate, diÅering 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, 2004, we held balances in cash, cash equivalents and investments outside the U.S. totaling approximately $467 million. Transaction Exposure: As of December 31, 2004, we had outstanding forward foreign exchange hedge contracts with notional values equivalent to approximately $316 million with maturity dates within 11 days. The hedge contracts are used to oÅset changes in the functional currency value of assets and liabilities denominated in foreign currencies as a result of currency Öuctuations. 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 Öuctuations may adversely impact our consolidated Ñnancial position as well as our consolidated results of operations. Foreign exchange rate Öuctuations may adversely impact our Ñnancial position as the assets and liabilities of our foreign operations are translated into U.S. dollars in preparing our consolidated balance sheet. The eÅect of foreign exchange rate Öuctuations on our consolidated Ñnancial position for the year ended December 31, 2004, was a net translation gain of approximately $140 million. This gain is recognized as an adjustment to stockholders' equity through accumulated other comprehensive income. Additionally, foreign exchange rate Öuctuations may adversely impact our consolidated results of operations as exchange rate Öuctuations on transactions denominated in currencies other than our functional currencies result in gains and losses that are reÖected in our consolidated statement of income. We consolidate the earnings of our foreign 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 Öuctuate 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. The aggregate notional amount of these hedges entered into in 2004 was 109 million Euro and 43 million British pounds. The loss on these hedges for 2004 totaled approximately $2.0 million, which were recorded in interest and other income, net. All contracts that hedge translation exposure mature ratably over the quarter in which they are executed. Economic Exposure: We currently charge our foreign subsidiaries on a monthly basis for their use of eBay's intellectual property and technology and for corporate services provided by eBay Inc. such as insurance, tax and legal. This charge is denominated in Euros and these forecasted inter-company transaction at eBay Inc. represent a 66 foreign currency cash Öow exposure. To reduce foreign exchange risk relating to these forecasted inter- company transactions, we entered into forward foreign exchange contacts during the year ended December 31, 2004. The objective of the forward contracts is to ensure that the U.S. dollar-equivalent cash Öows are not adversely aÅected 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 these forecasted transactions to be highly eÅective in oÅsetting potential changes in cash Öows 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 other income, net, related to the forward contracts that do not receive hedge accounting treatment pursuant to FAS 133. There were no outstanding forward contracts that receive hedge accounting treatment at December 31, 2004. The following table shows the notional amount of our economic hedges entered into in 2004, together with the associated losses, net of gains, recorded in our consolidated statement of income for the year ended December 31, 2004, and the amounts included in accumulated other comprehensive income at December 31, 2004: Notional Amount Net Loss Recorded to Interest and Other Income, Net (In thousands) Accumulated Other Comprehensive Income Amount receiving hedge accounting treatment under FAS 133 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $140,196 $(3,357) Amount not receiving hedge accounting treatment under FAS 133 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 30,772 (333) Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $170,968 $(3,690) $Ì Ì $Ì No economic hedges were entered into during the year ended December 31, 2003. 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 deÑned 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 OÇcer and our Chief Financial OÇcer have concluded that as of the end of the period covered by this report, our disclosure controls and procedures were eÅective. (b) Changes in internal controls. There were no changes in our internal controls over Ñnancial reporting that occurred during our most recent Ñscal quarter that have materially aÅected, or are reasonably likely to materially aÅect, our internal control over Ñnancial reporting. (c) Management's Report on Internal Control Over Financial Reporting. Our management is responsi- ble for establishing and maintaining adequate internal control over Ñnancial reporting, as such term is deÑned in Exchange Act Rules 13a-15(f). Our management, including our principal executive oÇcer and principal Ñnancial oÇcer, conducted an evaluation of the eÅectiveness of our internal control over Ñnancial reporting 67 based on the framework in Internal Control Ì Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation under the framework in Internal Control Ì Integrated Framework, our management concluded that our internal control over Ñnancial reporting was eÅective as of December 31, 2004. Our management's assessment of the eÅectiveness of our internal control over Ñnancial reporting as of December 31, 2004 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting Ñrm, 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 Executive oÇcers are elected annually by the Board and serve at the discretion of the Board. The following table sets forth certain information regarding our directors and executive oÇcers as of February 18, 2005. Name Pierre M. Omidyar(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Margaret C. Whitman(6) ÏÏÏÏÏÏÏÏÏÏÏ Matthew J. Bannick ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ William C. Cobb ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Christopher F. Corrado ÏÏÏÏÏÏÏÏÏÏÏÏÏ Age 37 48 40 48 45 Rajiv Dutta ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 43 Michael R. Jacobson ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 50 JeÅrey D. Jordan ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Eskander E. Kazim ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Lynn M. ReedyÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 46 39 49 Scott Thompson ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 47 Maynard G. Webb, Jr ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fred D. Anderson(1)(4) ÏÏÏÏÏÏÏÏÏÏÏÏ Philippe Bourguignon(2)(6) ÏÏÏÏÏÏÏÏÏ Scott D. Cook(3)(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Robert C. Kagle(2)(4) ÏÏÏÏÏÏÏÏÏÏÏÏÏ Dawn G. Lepore(1)(3)(5) ÏÏÏÏÏÏÏÏÏÏ Richard T. Schlosberg, III(1)(3)(5) Thomas J. Tierney(2)(3)(6) ÏÏÏÏÏÏÏÏ 49 60 57 52 49 50 60 50 Position Founder and Chairman of the Board President and Chief Executive OÇcer President, eBay International President, eBay North America Senior Vice President and Corporate Chief Technology OÇcer Senior Vice President and Chief Financial OÇcer Senior Vice President Legal AÅairs, General Counsel and Secretary President, PayPal Senior Vice President, New Ventures Senior Vice President, Product, Development and Architecture Senior Vice President, Chief Technology OÇcer, PayPal Chief Operating OÇcer Director Director Director Director Director Director Director (1) Member of our Audit Committee (2) Member of our Compensation Committee (3) Member of our Corporate Governance and Nominating Committee (4) Director continuing in oÇce until our 2005 Annual Meeting (5) Director continuing in oÇce until our 2006 Annual Meeting (6) Director continuing in oÇce until our 2007 Annual Meeting 68 Pierre M. Omidyar founded eBay as a sole proprietorship in September 1995. He has been a director and Chairman of the Board since eBay's incorporation in May 1996 and also served as its Chief Executive OÇcer, Chief Financial OÇcer and President from inception to February 1998, November 1997 and August 1996, respectively. Prior to founding eBay, Mr. Omidyar was a developer services engineer at General Magic, a mobile communication platform company from December 1994 to July 1996. Mr. Omidyar co-founded Ink Development Corp. (later renamed eShop) in May 1991 and served as a software engineer there from May 1991 to September 1994. Prior to co-founding Ink, Mr. Omidyar was a developer for Claris, a subsidiary of Apple Computer, and for other Macintosh-oriented software development companies. Mr. Omidyar is currently Chairman and CEO of Omidyar Network. He also serves on Board of Trustees of Tufts University, The Santa Fe Institute, and as a director of several private companies. Mr. Omidyar holds a B.S. degree in Computer Science from Tufts University. Margaret C. Whitman serves eBay as President and Chief Executive OÇcer. She has served in that capacity since February 1998 and as a director since March 1998. From January 1997 to February 1998, she was General Manager of the Preschool Division of Hasbro Inc., a toy company. From February 1995 to December 1996, Ms. Whitman was employed by FTD, Inc., a Öoral products company, most recently as President, Chief Executive OÇcer and a director. From October 1992 to February 1995, Ms. Whitman was employed by The Stride Rite Corporation, a footwear company, in various capacities, including President, Stride Rite Children's Group and Executive Vice President, Product Development, Marketing & Merchandis- ing, Keds Division. From May 1989 to October 1992, Ms. Whitman was employed by The Walt Disney Company, an entertainment company, most recently as Senior Vice President, Marketing, Disney Consumer Products. Before joining Disney, Ms. Whitman was at Bain & Co., a consulting Ñrm, most recently as a Vice President. Ms. Whitman also serves on the board of directors of The Procter & Gamble Company and Gap Inc. Ms. Whitman holds an A.B. degree in Economics from Princeton University and an M.B.A. degree from the Harvard Business School. Matthew J. Bannick serves eBay as President, eBay International. He has served in that capacity since December 2004. From October 2002 to December 2004, Mr. Bannick served as Senior Vice President and General Manager, Global Online Payments and Chief Executive OÇcer of PayPal. From November 2000 to October 2002, Mr. Bannick served as eBay's Senior Vice President and General Manager, eBay International. From February 1999 to November 2000, Mr. Bannick served in a variety of other executive positions at eBay. From April 1995 to January 1999, Mr. Bannick was an executive for Navigation Technologies (NavTech), a leading provider of digital map databases for the vehicle navigation and internet mapping industries. Mr. Bannick was President of NavTech North America for three years and also served as Senior Vice President of Marketing and Vice President of Operations. From June 1992 to August 1992, Mr. Bannick served as a consultant for McKinsey & Company, a consulting Ñrm, in Europe and from June 1993 to April 1995 in the U.S. Mr. Bannick also served as a U.S. diplomat in Germany during the period of German uniÑcation. Mr. Bannick holds a B.A. in Economics and International Studies from University of Washington and an M.B.A degree from the Harvard Business School. William C. Cobb serves eBay as President, eBay North America. He has served in that capacity since December 2004. From September 2002 to December 2004, Mr. Cobb served as Senior Vice President and General Manager, eBay International. From November 2000 to September 2002, Mr. Cobb served as eBay's Senior Vice President, Global Marketing. From February 2000 to June 2000, Mr. Cobb served as the General Manager of Consumer Sales for Netpliance, Inc., an Internet-based content company. From July 1997 to February 2000, Mr. Cobb served as the Senior Vice President of International Marketing for Tricon Global Restaurants, Inc. (now known as Yum! Brands, Inc.), a restaurant operator and franchiser. From August 1995 to July 1997, Mr. Cobb served as the Senior Vice President and Chief Marketing OÇcer for Pizza Hut, Inc., a division of Tricon Global Restaurants, Inc. From May 1994 to August 1995, Mr. Cobb served as Vice President of Colas for the Pepsi-Cola Company, a division of PepsiCo., Inc. Mr. Cobb holds a B.S. degree in Economics from the University of Pennsylvania and an M.B.A. degree from Northwestern University. Christopher F. Corrado serves eBay as Senior Vice President and Corporate Chief Technology OÇcer. He has served in that capacity since December 2004. From April 2003 to December 2004, Mr. Corrado served as Executive Vice President & Chief Information OÇcer of AT&T Wireless, a leading provider of advanced 69 wireless voice and data services for consumers and business. From December 2002 to April 2003, Mr. Corrado served as the head of the Security Solutions Practice at Wipro Technologies., an IT service provider. From March 1999 to June 2002, Mr. Corrado served as Chief Technology OÇcer, Infrastructure of Merrill Lynch & Co., Inc., a Ñnancial holding company. Mr. Corrado has also held executive level positions at Deutsche Bank and Morgan Stanley & Co. Mr. Corrado holds a B.S. degree in Management Information Systems and Business Administration from State University of New York. Rajiv Dutta serves eBay as Senior Vice President and Chief Financial OÇcer. He has served in that capacity since January 2001. From August 1999 to January 2001, Mr. Dutta served as eBay's Vice President of Finance and Investor Relations. From July 1998 to August 1999, Mr. Dutta served as eBay's Finance director. From February 1998 to July 1998, Mr. Dutta served as the World Wide Sales Controller of KLA- Tencor, a manufacturer of semiconductor equipment. Prior to KLA-Tencor, Mr. Dutta spent ten years, from January 1988 to February 1998, at Bio-Rad Laboratories, Inc., a manufacturer and distributor of life science and diagnostic products with operations in over 24 countries. Mr. Dutta held a variety of positions with Bio- Rad, including the group controller of the Life Science Group. Mr. Dutta also serves on the board of directors of Jamadat Mobile Inc., a global publisher of wireless entertainment applications. Mr. Dutta holds a B.A. degree in Economics from St. Stephen's College, Delhi University in India and an M.B.A. degree from Drucker School of Management. Michael R. Jacobson serves eBay as Senior Vice President, Legal AÅairs, General Counsel and Secretary. He has served in that capacity or as Vice President, Legal AÅairs, General Counsel since August 1998. From 1986 to August 1998, Mr. Jacobson was a partner with the law Ñrm of Cooley Godward LLP, specializing in securities law, mergers and acquisitions, and other transactions. Mr. Jacobson holds an A.B. degree in Economics from Harvard College and a J.D. degree from Stanford Law School. JeÅrey D. Jordan serves eBay as President, PayPal. He has served in that capacity since December 2004. From April 2000 to December 2004, Mr. Jordan served as eBay's Senior Vice President, eBay North America. From September 1999 to April 2000, Mr. Jordan served as eBay's Vice President, Regionals and Services. From September 1998 to September 1999, Mr. Jordan served as Chief Financial OÇcer for Hollywood Entertainment Corporation, a video rental company, and President of their subsidiary, Reel.com. From September 1990 to September 1998, Mr. Jordan served in various capacities including most recently Senior Vice President and Chief Financial OÇcer of The Disney Store Worldwide, a subsidiary of The Walt Disney Company. Mr. Jordan holds a B.A. degree in Political Science and Psychology from Amherst College and an M.B.A. degree from the Stanford Graduate School of Business. Eskander E. Kazim serves eBay as Senior Vice President, New Ventures. He has served in that capacity since December 2004. From October 2002 to December 2004, Mr. Kazim served as PayPal's Vice President of Marketing and Business Operations. From March 2002 to October 2002, Mr. Kazim served as eBay's Vice President, eBay Payments. From November 2000 to March 2002, Mr. Kazim served as eBay's Vice President of eBay's Platform Solutions Group. From August 1998 to November 2000, Mr. Kazim served as eBay's Director of Engineering. Mr. Kazim holds a B.S. degree in Mechanical Engineering from Rice University. Lynn M. Reedy serves eBay as Senior Vice President, Product, Development and Architecture. She has served in that capacity since June 2003. From February 2003 to May 2003, Ms. Reedy served as eBay's Vice President, Product, Development and Architecture. From March 2002 to January 2003, Ms. Reedy served as eBay's Vice President, Product. From November 1999 to February 2002, Ms. Reedy served as eBay's Vice President, Product Development. From March 1993 to October 1999, Ms. Reedy was Senior Vice President and Chief Information OÇcer at Miller Freeman, Inc. Ms. Reedy holds a B.S. degree from the University of Illinois and an M.B.A. from Santa Clara University. Scott Thompson serves eBay as Senior Vice President, Chief Technology OÇcer, PayPal. He has served in that capacity since February 2005. From September 2001 to February 2005, Mr. Thompson served as Executive Vice President of Technology Solutions at Inovant, LLC, a subsidiary of Visa USA. From 1998 to September 2001, Mr. Thompson was Chief Information OÇcer and Executive Vice President of Technol- ogy & Support Services for Visa USA. Mr. Thompson holds a B.S. degree in Accounting from Stonehill College. 70 Maynard G. Webb, Jr. serves eBay as Chief Operating OÇcer. He has served in that capacity since June 2002. From August 1999 to June 2002, Mr. Webb served as President, eBay Technologies. From July 1998 to August 1999, Mr. Webb was Senior Vice President and Chief Information OÇcer at Gateway, Inc., a computer manufacturer. From February 1995 to July 1998, Mr. Webb was Vice President and Chief Information OÇcer at Bay Networks, Inc., a manufacturer of computer networking products. From June 1991 to January 1995, Mr. Webb was Director, IT at Quantum Corporation. Mr. Webb also serves on the board of directors of Gartner, Inc., a high technology research and consulting Ñrm and Peribit Networks, a networking company. Mr. Webb holds a B.A.A. degree from Florida Atlantic University. John Donahoe was announced as President of the eBay Business Unit on February 24, 2005. Information about Mr. Donahoe, including the oÅer letter between Mr. Donahoe and eBay, is included in a current report on Form 8-K Ñled by eBay on that date. Fred D. Anderson has served as a director of eBay since July 2003. Mr. Anderson has been a Managing Director of Elevation Partners, a private equity Ñrm focused on the media and entertainment industry since July 2004. From March 1996 to June 2004, Mr. Anderson served as Executive Vice President and Chief Financial OÇcer of Apple Computer, Inc., a manufacturer of personal computers and related software. Prior to joining Apple, Mr. Anderson was Corporate Vice President and Chief Financial OÇcer of Automatic Data Processing, Inc., an electronic transaction processing Ñrm, from August 1992 to March 1996. Mr. Anderson also serves on the board of directors of Apple Computer, Inc. and E.piphany, Inc. Mr. Anderson holds a B.A. degree from Whittier College and an M.B.A. from the University of California, Los Angeles. Philippe Bourguignon has served as a director of eBay since December 1999. Mr. Bourguignon has been the Chairman of Aegis Media France, a media communications and market research company since April 2004. From September 2003 to March 2004, Mr. Bourguignon was Co-Chief Executive OÇcer of The World Economic Forum (The DAVOS Forum). From August 2003 to October 2003, Mr. Bourguignon served as Managing Director of The World Economic Forum. From April 1997 to January 2003, Mr. Bourguignon served as Chairman of the Board of Club Mediterranee S.A., a resort operator. Prior to his appointment at Club Mediterranee S.A., Mr. Bourguignon was Chief Executive OÇcer of Euro Disney S.A., the parent company of Disneyland Paris, since 1993, and Executive Vice President of The Walt Disney Company (Europe) S.A., since October 1996. Mr. Bourguignon was named President of Euro Disney in 1992, a post he held through April 1993. He joined The Walt Disney Company in 1988 as head of Real Estate development. Mr. Bourguignon holds a Masters Degree in Economics at the University of Aix-en-Provence and holds a post-graduate diploma from the Institut d'Administration des Enterprises (IAE) in Paris. Scott D. Cook has served as a director of eBay since June 1998. Mr. Cook is the founder of Intuit Inc., a Ñnancial software developer. Mr. Cook has been a director of Intuit since March 1984 and is currently Chairman of the Executive Committee of the Board of Intuit. From March 1993 to July 1998, Mr. Cook served as Chairman of the Board of Intuit. From March 1984 to April 1994, Mr. Cook served as President and Chief Executive OÇcer of Intuit. Mr. Cook also serves on the board of directors of The Procter & Gamble Company. Mr. Cook holds a B.A. degree in Economics and Mathematics from the University of Southern California and an M.B.A. degree from the Harvard Business School. Robert C. Kagle has served as a director of eBay since June 1997. Mr. Kagle has been a Member of Benchmark Capital, the General Partner of Benchmark Capital Partners, L.P. and Benchmark Founders' Fund, L.P., since its founding in May 1995. Mr. Kagle also has been a General Partner of Technology Venture Investors since January 1984. Mr. Kagle also serves on the board of directors of E-LOAN, Inc. and ZipRealty, Inc. Mr. Kagle holds a B.S. degree in Electrical and Mechanical Engineering from the General Motors Institute (renamed Kettering University in January 1998) and an M.B.A. degree from the Stanford Graduate School of Business. Dawn G. Lepore has served as a director of eBay since December 1999. Ms. Lepore has served as Chief Executive OÇcer and Chairman of the Board of drugstore.com, inc., a leading online provider of health, beauty, vision, and pharmacy solutions, since October 2004. From August 2003 to October 2004, Ms. Lepore served as Vice Chairman of Technology, Active Trader, Operations, Business Strategy, and Administration for the Charles Schwab Corporation and Charles Schwab & Co, Inc., a Ñnancial holding company. Prior to this 71 appointment, she held various positions with the Charles Schwab Corporation including: Vice Chairman of Technology, Operations, Business Strategy, and Administration from May 2003 to August 2003; Vice Chairman of Technology, Operations, and Administration from March 2002 to May 2003; Vice Chairman of Technology and Administration from November 2001 to March 2002; and Vice Chairman and Chief Information OÇcer from July 1999 to November 2001. She also serves on the board of directors of Catalyst, a research and advisory organization working to expand opportunities for women in business, and as a trustee of Smith College. Ms. Lepore holds a B.A. degree from Smith College. Richard T. Schlosberg, III has served as a director of eBay since March 2004. From May 1999 to January 2004, Mr. Schlosberg served as President and Chief Executive OÇcer of the David & Lucile Packard Foundation, a private family foundation. Prior to joining the foundation, Mr. Schlosberg was Executive Vice President of The Times Mirror Company and publisher and Chief Executive OÇcer of the Los Angeles Times. Prior to that, he served in the same role at the Denver Post. Mr. Schlosberg serves on the board of directors of Edison International, and is also a national board member of the Smithsonian Institution and the National Air and Space museum, a member of the USO World Board of Govenors, and a trustee of Pomona College. Mr. Schlosberg is a graduate of the United States Air Force Academy, and holds an M.B.A. degree from the Harvard Business School. Thomas J. Tierney has served as a director of eBay since March 2003. Mr. Tierney is the founder of The Bridgespan Group, a non-proÑt consulting Ñrm serving the non-proÑt sector, and has been its Chairman of the Board since late 1999. Prior to founding Bridgespan, Mr. Tierney served as Chief Executive OÇcer of Bain & Company, a consulting Ñrm, from June 1992 to January 2000. Mr. Tierney holds a B.A. degree in Economics from the University of California at Davis and an M.B.A. degree with distinction from the Harvard Business School. Mr. Tierney is the co-author of a book about organization and strategy called Aligning the Stars. Audit Committee and Audit Committee Financial Expert Our Board has a separately-designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. The members of the Audit Committee are Fred D. Anderson, Dawn G. Lepore, and Richard T. Schlosberg, III. Our Board has determined that Fred D. Anderson, Chairman of the Audit Committee, is an audit committee Ñnancial expert as deÑned by Item 401(h) of Regulation S-K of the Exchange Act and that each member of the Audit Committee is independent within the meaning of Rule 4200(a)(15) of the National Association of Securities Dealers' listing standards. 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 OÇcers that applies to our senior Ñnancial oÇcers, including our principal executive oÇcer, principal Ñnancial oÇcer and principal accounting oÇcer. The Code of Ethics for Senior Financial OÇcers 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 OÇcers 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. Section 16(a) BeneÑcial Ownership Reporting Compliance Section 16(a) of the Exchange Act requires our directors, executive oÇcers, and holders of more than 10% of our common stock to Ñle reports regarding their ownership and changes in ownership of our securities with the SEC, and to furnish us with copies of all Section 16(a) reports that they Ñle. 72 We believe that during the Ñscal year ended December 31, 2004, our directors, executive oÇcers, and greater than 10% stockholders complied with all applicable Section 16(a) Ñling requirements, except that: ‚ one late Form 3 was Ñled by Douglas JeÅries, our Principal Accounting OÇcer, on August 27, 2004 to report Mr. JeÅries becoming a Section 16 reporting individual as of August 5, 2004, and two late Form 4 reports were Ñled on August 27, 2004 to show purchases of eBay stock made by Mr. JeÅries on August 10, 2004 and August 12, 2004; and ‚ one late Form 3 was Ñled by Eskander E. Kazim, our Senior Vice President, New Ventures, on December 20, 2004 to report Mr. Kazim becoming a Section 16 reporting individual as of December 7, 2004 and one late Form 4 report was Ñled on December 20, 2004 to report a stock option granted to Mr. Kazim on December 10, 2004. In making this statement, we have relied upon a review of the copies of Section 16(a) reports furnished to us and the written representations of our directors, executive oÇcers, and greater than 10% stockholders. ITEM 11: EXECUTIVE COMPENSATION Summary of Compensation The following table shows certain compensation earned during the Ñscal years ended December 31, 2002, 2003 and 2004, by our Chief Executive OÇcer and four most highly-compensated other executive oÇcers (based on their total annual salary and bonus compensation), also referred to as the Named Executive OÇcers, at December 31, 2004. SUMMARY COMPENSATION TABLE Long-Term and Other Compensation Annual Compensation Number of Securities Underlying Compensation(3) Options(4) Compensation(5) Other Annual All Other Name and 2004 Principal Positions Margaret C. Whitman ÏÏÏ President and Chief Executive OÇcer Maynard G. Webb, Jr. ÏÏ Chief Operating OÇcer JeÅrey D. Jordan ÏÏÏÏÏÏÏ President, PayPal Matthew J. Bannick ÏÏÏÏÏ President, eBay International William C. Cobb ÏÏÏÏÏÏÏ President, eBay North America Fiscal Year 2004 2003 2002 2004 2003 2002 2004 2003 2002 2004 2003 2002 2004 2003 2002 Salary(1) Bonus(2) $994,052 843,823 250,008 620,203 582,007 531,250 494,284 439,345 345,102 474,258 423,084 334,086 419,674 382,519 312,185 $1,553,480(6) 1,159,132(6) 329,698(6) 1,880,279(7) 1,266,601(7) 837,154(7) 937,038(8) 858,793(8) 739,762(8) 944,950(9) 596,264(9) 472,540(9) 1,026,146(10) 368,899(10) 240,390(10) $357,535 377,496 336,654 35,335 Ì Ì Ì Ì Ì Ì Ì 15,987 10,796 Ì Ì 1,200,000 2,200,000 1,200,000 650,000 1,100,000 600,000 440,000 600,000 540,000 440,000 600,000 560,000 300,000 500,000 500,000 $3,164 3,164 1,980 1,009 1,009 1,104 2,290 790 672 2,257 2,257 2,173 2,173 2,173 2,173 (1) EÅective March 1, 2004, all eligible employees of eBay, including certain of the Named Executive OÇcers, received an annual salary increase representing: (i) in the case of Ms. Whitman, a salary of $995,016 per annum; (ii) in the case of Mr. Webb, a salary of $625,008 per annum; (iii) in the case of Mr. Jordan, a salary of $500,016 per annum; (iv) in the case of Mr. Bannick, a salary of $480,000 per annum; and (v) in the case of Mr. Cobb, a salary of $415,008 per annum. In addition, Mr. Cobb received a salary increase to $450,000 per annum eÅective October 1, 2004. Total salary amounts reported are lower than these annual salaries because lower salaries were in eÅect for portions of 2004. 73 (2) All 2004 bonuses represent amounts paid in 2004 and 2005 for services rendered in 2004, all 2003 bonuses represent amounts paid in 2003 and 2004 for services rendered in 2003, and all 2002 bonuses represent amounts paid in 2002 and 2003 for services rendered in 2002. (3) Represents: (i) in the case of Ms. Whitman for 2004, personal use of eBay's corporate aircraft, valued at the incremental cost of such use to the company ($229,145), and an additional $128,390 bonus granted by the Compensation Committee in 2005 to cover any income taxes relating to such aircraft use; (ii) in the case of Ms. Whitman for 2003, personal use of eBay's corporate aircraft, valued at the incremental cost of such use to the company ($307,496), and an additional $70,000 bonus granted by the Compensation Committee in 2004 to cover any income taxes relating to such aircraft use; (iii) in the case of Ms. Whitman for 2002, her personal use of eBay's corporate aircraft ($171,693), valued at the incremental cost of such use to the company, and of a corporate aircraft from an unaÇliated third-party vendor, which is valued at actual invoiced amounts ($74,961); and an additional $90,000 bonus granted by the Compensation Committee in 2003 to cover any income taxes relating to such aircraft use; (iv) in the case of Mr. Webb for 2004, personal use of eBay's corporate aircraft, valued at the incremental cost of such use to the company ($28,070), and an additional $7,265 bonus granted by the Compensation Committee in 2005 to cover any income taxes relating to such aircraft use; (v) in the case of Mr. Bannick for 2002, costs associated with family transportation while Mr. Bannick worked out of our European oÇces during the summer of 2002; and (vi) in the case of Mr. Cobb for 2004, personal use of eBay's corporate aircraft, valued at the incremental cost of such use to the company. Prior to 2004, eBay calculated the cost of the personal use of its corporate aircraft using the Standard Industrial Fare Level (SIFL) tables prescribed under applicable IRS regulations. Beginning in 2004, eBay calculated the value of the personal use of its corporate aircraft by estimating the incremental cost to the company of such use. The calculation of incremental cost is based on the weighted average cost of fuel, maintenance expenses, parts and supplies, landing fees, ground services, catering and crew expenses associated with such use. Had eBay used the IRS's SIFL tables to calculate the value of the personal use of its corporate aircraft by Ms. Whitman, Mr. Webb, and Mr. Cobb in 2004, such use would have been valued at $154,267, $13,050, and $7,070, respectively. Because eBay has determined that this incremental cost methodology produces generally higher amounts than use of the SIFL calculation method, the incremental cost methodology has also been used to calculate the value of personal use of corporate aircraft by Ms. Whitman for 2003 and 2002. Prior annual reports and proxy statements reÖected the value of Ms. Whitman's personal use of corporate aircraft in 2003 and 2002 using the SIFL calculation method, and valued such use at $115,857 and $58,101, respectively. (4) Amounts have been adjusted to reÖect all prior stock splits, including eBay's two-for-one stock split that occurred on February 16, 2005. (5) Represents, in the case of each of the Named Executive OÇcers, insurance premiums we paid with respect to group life insurance for their beneÑt and matching contributions under our 401(k) Plan (subject to the maximum of $1,500 per annum). (6) Represents amounts paid to Ms. Whitman under eBay's Management Incentive Plan. (7) Represents (i) for 2004, $726,279 paid under eBay's Management Incentive Plan and $1,154,000 paid under Mr. Webb's special retention plan; (ii) for 2003, $620,501 paid under eBay's Management Incentive Plan and $646,100 paid under Mr. Webb's special retention plan; and (iii) for 2002, $387,254 paid under eBay's Management Incentive Plan and $449,900 paid under Mr. Webb's special retention plan. See ""Item 13: Certain Relationships and Related Transactions.'' (8) Represents (i) for 2004, $462,948 for 2004 paid under eBay's Management Incentive Plan, $472,025 under Mr. Jordan's special retention plans and an additional $2,065 bonus granted by the Compensation Committee in 2005; (ii) for 2003, $361,505 for 2003 paid under eBay's Management Incentive Plan and $497,288 under Mr. Jordan's special retention plans; and (iii) for 2002, $202,212 paid under eBay's Management Incentive Plan, $522,550 paid under Mr. Jordan's special retention plans and $15,000 paid pursuant to our discretionary reward program. See ""Item 13: Certain Relationships and Related Transactions.'' 74 (9) Represents (i) for 2004, $444,950 paid under eBay's Management Incentive Plan, and $500,000 paid under Mr. Bannick's special retention plan; (ii) for 2003, $346,264 paid under eBay's Management Incentive Plan, and $250,000 paid under Mr. Bannick's special retention plan; and (iii) for 2002, $207,540 paid under eBay's Management Incentive Plan, $250,000 paid under Mr. Bannick's special retention plan and $15,000 paid pursuant to our discretionary reward program. See ""Item 13: Certain Relationships and Related Transactions.'' (10) Represents (i) for 2004, $392,211 paid under eBay's Management Incentive Plan, $350,000 paid under Mr. Cobb's special retention plans, a performance bonus of $280,000 granted by the Compensation Committee in 2004, and an additional $3,935 bonus granted by the Compensation Committee in 2005; (ii) for 2003, $298,899 paid under eBay's Management Incentive Plan, and $70,000 paid under Mr. Cobb's special retention plan; and (iii) for 2002, $170,390 paid under eBay's Management Incentive Plan and $70,000 paid under Mr. Cobb's special retention plan. See ""Item 13: Certain Relationships and Related Transactions.'' The following executive oÇcers received grants of options in 2004 under eBay's 2001's Equity Incentive Plan, which we also refer to as the 2001 Plan. Option Grants During 2004 Number of Securities Underlying Options Percentage of Total Options Granted to Employees Granted(1) During 2004(2) Exercise Price per Share(3) Expiration Date Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Option Term(4) 5% 10% Name Margaret C. Whitman ÏÏÏÏ Maynard G. Webb, Jr. ÏÏÏÏ JeÅrey D. Jordan ÏÏÏÏÏÏÏÏÏ Matthew J. Bannick ÏÏÏÏÏÏ William C. Cobb ÏÏÏÏÏÏÏÏÏ 1,200,000 650,000 440,000 440,000 300,000 2.8% 1.5 1.0 1.0 0.7 $34.62 34.62 34.62 34.62 34.62 3/1/14 3/1/14 3/1/14 3/1/14 3/1/14 $26,123,025 14,149,972 9,578,443 9,578,443 6,530,756 $66,200,874 35,858,807 24,273,654 24,273,654 16,550,219 (1) Options granted in 2004 were granted under the 2001 Plan. All options granted in 2004 to the Named Executive OÇcers were granted by our Board, are nonqualiÑed stock options and are subject to a four- year vesting schedule, vesting 12.5% after six months and 1/48 per month thereafter. Amounts have been adjusted to reÖect the two-for-one stock split eÅective on February 16, 2005. (2) Based on options to purchase 42,964,094 shares of our common stock granted to employees in 2004. (3) Options were granted at an exercise price equal to the fair market value of our common stock, as determined by the Board of Directors on the date of grant. The exercise prices per share listed in the table above are rounded to the nearest cent. The exercise per share has been adjusted to reÖect the two-for-one stock split eÅective on February 16, 2005. (4) ReÖects the value of the stock option on the date of grant assuming (i) for the 5% column, a 5% annual rate of appreciation in our common stock over the ten-year term of the option and (ii) for the 10% column, a 10% annual rate of appreciation in our common stock over the ten-year term of the option, in each case without discounting to net present value and before income taxes associated with the exercise. The 5% and 10% assumed rates of appreciation are based on the rules of the SEC and do not represent our estimate or projection of the future common stock price. The amounts in this table may not necessarily be achieved. 75 The following table sets forth the number of shares acquired and the value realized upon exercise of stock options during 2004 and the number of shares of our common stock subject to exercisable and unexercisable stock options held as of December 31, 2004, by each of the Named Executive OÇcers. The value at Ñscal year end is measured as the diÅerence between the exercise price and the fair market value at close of market on December 31, 2004, which was $58.17. Aggregate Option Exercises in 2004 and Values at December 31, 2004 Number of Securities Underlying Unexercised Options Value of Unexercised In-The-Money Options Name Shares Acquired on Exercise(1) Value Realized(2) Exercisable Unexercisable (#) (#) Exercisable ($) Unexercisable ($) Margaret C. Whitman ÏÏ Maynard G. Webb, Jr. JeÅrey D. Jordan ÏÏÏÏÏÏ Matthew J. BannickÏÏÏÏ William C. Cobb ÏÏÏÏÏÏ Ì $ 1,400,000 800,000 791,660 466,000 Ì 4,162,500 1,188,124 1,268,368 298,334 633,166 43,896,366 22,358,985 17,813,071 14,259,643 3,437,500 1,321,876 852,500 858,334 670,834 $179,531,119 47,708,954 51,442,810 10,427,623 25,564,447 $125,116,931 44,076,742 28,386,063 28,640,760 23,015,857 (1) Amounts have been adjusted to reÖect the two-for-one stock split eÅective on February 16, 2005. (2) Value realized is based on the fair market value of our common stock on date of exercise minus the exercise price and does not necessarily reÖect proceeds actually received by the oÇcer. (3) Calculated using the fair market value of our common stock on December 31, 2004 ($58.17), as adjusted to reÖect the two-for-one stock split eÅective February 16, 2005, less the exercise price of the option. Employment Agreements, Change-in-Control Arrangements, and Retention Bonus Plans We do not have long-term employment agreements or change-in-control arrangements with any of our executive oÇcers, nor are any of our executive oÇcers covered by any pension plan or deferred compensation plan. We do not have any severance payment arrangements with any of our executive oÇcers, except that under his July 17, 1999 oÅer letter, if Mr. Webb is terminated other than for cause, he is entitled to receive salary compensation for six months, and if he remains unemployed at the end of such six-month period, he is eligible to received additional salary compensation for the lesser of six months or commencement of other employment. ""Item 13: Certain Relationships and Related Transactions'' contains descriptions of the special retention bonus plans that we have entered into with certain of our executive oÇcers. Compensation of Directors New directors who are not employees of eBay, or any parent, subsidiary or aÇliate of eBay, receive deferred stock units, or DSUs, with an initial value of $150,000 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. Each DSU award granted to a non-employee director upon election to the Board will vest as to 25% of the DSUs on the Ñrst anniversary of the date of grant and as to 1/48 of the DSUs each month thereafter, provided the director continues as a director or consultant of eBay. DSUs are payable in stock or cash (at eBay's election) following the termination of a non-employee director's tenure in such capacity Non-employee directors are also eligible to participate in the 1998 Directors Stock Option Plan, also referred to as the Directors Plan. Option grants under the Directors Plan are automatic and non-discretionary, and the exercise price of the options must be 100% of the fair market value of the common stock on the date of grant. Each eligible director is granted an option to purchase 15,000 shares, of eBay common stock at the time of each annual meeting if he or she has served continuously as a member of the Board since the date elected. The Compensation Committee of the Board elected to maintain the annual option grant under the Directors Plan at 15,000 shares following the two-for-one split of eBay common stock in February 2005. All options 76 granted under the Directors Plan vest as to 25% of the shares on the Ñrst anniversary of the date of grant and as to 1/48 of the shares each month thereafter, provided the optionee continues as a director or consultant of eBay. Non-employee directors are paid a retainer of $50,000 per year, the chairman of the Audit Committee receives an additional $10,000 per year, and all other committee chairs receive an additional $5,000 per year. Each non-employee director also receives meeting fees of $2,000 for each Board meeting and $1,000 for each committee meeting. During 2004, in connection with travel to Board meetings, the company purchased commercial airfare for the spouses of Mr. Anderson and Mr. Schlosberg valued at approximately $8,800 and $7,300, respectively. Compensation Committee Interlocks and Insider Participation The members of the Compensation Committee of our Board are Philippe Bourguinon, Robert C. Kagle, and Thomas J. Tierney. No member of our Board's Compensation Committee is or was formerly an oÇcer or an employee of eBay. No interlocking relationship exists between our Board and its Compensation Committee and the board of directors or compensation committee of any other company, nor has such interlocking relationship existed in the past. Mr. Kagle, a member of our Compensation Committee, is a member of the general partner of certain venture capital funds that beneÑcially hold greater than a 10% equity interest in Business.com, Inc. In late 2003, we entered into an advertising and related services agreement with Business.com, Inc., under which we incurred fees of approximately $80,000 in 2004 and under which we currently expect to incur a similar amount of fees in 2005. We believe this transaction was made on terms no less favorable to us than we could have obtained from unaÇliated third parties. 77 ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The following table sets forth certain information known to us with respect to beneÑcial ownership of the Common Stock as of February 18, 2005, by (i) each stockholder known to us to be the beneÑcial owner of more than 5% of our common stock, (ii) each director and nominee for director, (iii) each of the executive oÇcers named in the Summary Compensation Table set forth under ""Item 11: Executive Compensation Ì Summary of Compensation'' and (iv) all executive oÇcers and directors as a group. Name of BeneÑcial Owner Shares BeneÑcially Owned(1) Number Percent Pierre M. Omidyar(2) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ JeÅrey S. Skoll(3) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Margaret C. Whitman(4)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Maynard G. Webb, Jr.(5) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ JeÅrey D. Jordan(6) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Matthew J. Bannick(7) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ William C. Cobb(8) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Fred D. Anderson(9) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Philippe Bourguignon(10) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Scott D. Cook(11) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Robert C. Kagle(12)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Dawn G. Lepore(13) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Richard T. Schlosberg, III(14) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Thomas J. Tierney(15)ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ All directors and executive oÇcers as a group (19 persons)(16) ÏÏÏÏÏÏÏÏ 215,336,568 90,578,494 31,072,351 1,483,957 1,440,234 452,815 775,499 6,000 506,250 2,199,256 3,718,336 341,250 3,200 20,250 262,748,726 16.0% 6.7 2.3 * * * * * * * * * * 19.3 * Less than one percent. (1) This table is based upon information supplied by oÇcers, directors and principal stockholders and Schedules 13D and 13G Ñled with the Securities and Exchange Commission. BeneÑcial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Unless otherwise indicated below, the persons and entities named in the table have sole voting and sole investment power with respect to all shares beneÑcially owned, subject to community property laws where applicable. Shares of our common stock subject to options that are currently exercisable or exercisable within 60 days of February 18, 2005 are deemed to be outstanding for the purpose of computing the percentage ownership of the person holding those options, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person. The percentage of beneÑcial ownership is based on 1,344,806,283 shares of our common stock outstanding as of February 18, 2005. Amounts have been adjusted to reÖect the two-for-one stock split eÅective on February 16, 2005. (2) Mr. Omidyar is our Founder and Chairman of the Board. Includes 490,000 shares held by his spouse as to which he disclaims beneÑcial ownership. The address for Mr. Omidyar is 2145 Hamilton Avenue, San Jose, California 95125. (3) Mr. Skoll is a former oÇcer and director of the company. The address for Mr. Skoll is c/o Seiler & Company, LLP, 1100 Marshall Street, Redwood City, CA 94063, Attn: James G.B. DeMartini, III. (4) Ms. Whitman is our President and Chief Executive OÇcer. Includes 7,646,842 shares held by the GriÇth R. Harsh, IV & Margaret C. Whitman TTEES of Sweetwater Trust U/A/D 10/15/99, 1,330,046 shares held by the GriÇth R. Harsh, IV, TTEE, GRH 2003 GRAT, and 1,330,046 shares held by the Margaret C. Whitman TTEE, MCW 2003 GRAT, 4,000,000 shares held by the GriÇth R. Harsh, IV, TTEE, GRH 2004 GRAT and 4,000,000 shares held by the Margaret C. Whitman TTEE, 78 MCW 2004 GRAT and 2,000,000 shares held by the GriÇth R. Harsh, IV, TTEE GRH 2005 GRAT and 2,000,000 shares held by the Margaret C. Whitman TTEE, MCW 2005 GRAT. In addition, it includes (a) 4,792 shares held by GriÇth Rutherford Harsh IV Custodian GriÇth Rutherford Harsh V UTMA California as to which Ms. Whitman's spouse is custodian for the trust and as to which Ms. Whitman disclaims beneÑcial ownership and (b) 4,792 shares held by GriÇth Rutherford Harsh IV Custodian William Whitman Harsh UTMA California as to which Ms. Whitman's spouse is custodian for the trust and as to which Ms. Whitman disclaims beneÑcial ownership. Includes 4,795,833 shares Ms. Whitman has the right to acquire pursuant to outstanding options exercisable within 60 days. The address for Ms. Whitman is c/o eBay Inc., 2145 Hamilton Avenue, San Jose, California 95125. (5) Mr. Webb is our Chief Operating OÇcer. Includes 1,383,957 shares Mr. Webb has the right to acquire pursuant to outstanding options exercisable within 60 days. The address for Mr. Webb is c/o eBay Inc., 2145 Hamilton Avenue, San Jose, California 95125. (6) Mr. Jordan is our President, PayPal. Includes 1,400,034 shares Mr. Jordan has the right to acquire pursuant to outstanding options exercisable within 60 days. The address for Mr. Jordan is c/o eBay Inc., 2145 Hamilton Avenue, San Jose, California 95125. (7) Mr. Bannick is our President, eBay International. Includes 431,667 shares Mr. Bannick has the right to acquire pursuant to outstanding options exercisable within 60 days. The address for Mr. Bannick is c/o eBay Inc., 2145 Hamilton Avenue, San Jose, California 95125. (8) Mr. Cobb is our President, eBay North America. Includes 741,499 shares Mr. Cobb has the right to acquire pursuant to outstanding options exercisable within 60 days. The address for Mr. Cobb is c/o eBay Inc., 2145 Hamilton Avenue, San Jose, California 95125. (9) The address for Mr. Anderson is c/o eBay Inc., 2145 Hamilton Avenue, San Jose, California 95125. (10) Includes 506,250 shares Mr. Bourguignon has the right to acquire pursuant to outstanding options exercisable within 60 days. The address for Mr. Bourguignon is c/o eBay Inc., 2145 Hamilton Avenue, San Jose, California 95125. (11) Includes 2,036,250 shares Mr. Cook has the right to acquire pursuant to outstanding options exercisable within 60 days. The address for Mr. Cook is c/o Intuit, Inc., 2535 Garcia Avenue, Mountain View, California 94043. (12) Includes 346,250 shares Mr. Kagle has the right to acquire pursuant to outstanding options exercisable within 60 days. The address for Mr. Kagle is c/o Benchmark Capital, 2480 Sand Hill Road, Suite 200, Menlo Park, California 94025. (13) Includes 301,250 shares Ms. Lepore has the right to acquire pursuant to outstanding options exercisable within 60 days. The address for Ms. Lepore is c/o drugstore.com, inc., 13920 S.E. Eastgate Way #300, Bellevue, WA 98005. (14) The address for Mr. Schlosberg is 9901 IT-10 West, Suite 800, San Antonio, TX 78230. (15) Includes 16,250 shares Mr. Tierney has the right to acquire pursuant to outstanding options exercisable within 60 days. The address for Mr. Tierney is c/o The Bridgespan Group, 535 Boylston Street, 10th Floor, Boston, MA 02116 (16) Includes 16,593,900 shares subject to options exercisable within 60 days. 79 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, 2004, 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 or rights are outstanding under any of the foregoing plans. Plan Category Equity compensation plans approved by securityholders Equity compensation plans not approved by securityholders (a) Number of Securities to be Issued upon Exercise of Outstanding Options, Warrants and Rights 134,119,868 1,690,000(2)(3)(4)(5)(6) Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 135,809,868 (b) Weighted Average Exercise Price of Outstanding Options, Warrants and Rights (c) Number of Securities Remaining Available for Future Issuance under Equity Compensation Plans (Excluding Securities ReÖected in Column(a)) $24.08 0.39 $23.79 122,712,098(1) Ì 122,712,098 (1) Includes 5,987,748 shares of our common stock remaining available for future issuance under our 1998 Employee Stock Purchase Plan, as amended, or the ESPP, as of December 31, 2004. Our ESPP contains an ""evergreen'' provision that automatically increases, on each January 1, the number of securities available for issuance under the ESPP by the number of shares purchased under the ESPP in the preceding calendar year. An aggregate amount of 1,212,252 shares was purchased under the ESPP in 2004. None of our other plans has an ""evergreen'' provision. (2) Does not include 396 shares of our common stock, with a weighted average exercise price of $0.27 per share, to be issued upon exercise of outstanding options assumed by us under the Billpoint, Inc. 1999 Stock Option Plan, or the Billpoint Plan, in connection with our acquisition of Billpoint in 1999, as we cannot make subsequent grants or awards of our equity securities under the Billpoint Plan. Prior to our acquisition of Billpoint, the stockholders of Billpoint approved the Billpoint Plan. Our stockholders, however, did not approve the Billpoint Plan in connection with our acquisition of Billpoint. (3) Does not include 26,884 shares of our common stock, with a weighted average exercise price of $9.53 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. (4) Does not include 780 shares of our common stock, with a weighted average exercise price of $0.19 per share, to be issued upon exercise of outstanding options assumed by us under the ConÑnity, Inc. 1999 Stock Plan, or the ConÑnity 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 ConÑnity Plan. The ConÑnity Plan was assumed by PayPal in connection with its merger with ConÑnity in 2000. Prior to our acquisition of PayPal and PayPal's merger with ConÑnity, the stockholders of ConÑnity approved the ConÑnity Plan. Our stockholders, however, did not approve the ConÑnity Plan in connection with our acquisition of PayPal. (5) Does not include 165,994 shares of our common stock, with a weighted average exercise price of $0.76 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. 80 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 1,234,440 shares of our common stock, with a weighted average exercise price of $8.95 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. The only outstanding Non-Plan Grant as of December 31, 2004 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 Ì Director Compensation'' and ""Ì 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 and exercised options to purchase an additional 1,430,000 shares during 2003. As of December 31, 2004, options to purchase 1,690,000 shares remain outstanding under the Non-Plan Grant. ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS We have entered into indemniÑcation agreements with each of our directors and executive oÇcers. 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 aÇliation with eBay. In August 2000, Mr. Webb, our Chief Operating OÇcer, entered into a four-year term loan with us at an interest rate of 6.37% per annum, with 10%, 15%, 25% and 50% of principal on the loan due on each of the Ñrst, second, third and fourth anniversary of the loan's issue date, respectively. The principal amount on the loan was approximately $2,169,800, which amount represented the principal and accrued interest due at the end of a one-year term loan entered into in August 1999 between Mr. Webb and us shortly after his relocation to San Jose as a result of his joining eBay in 1999, and was secured by Mr. Webb's principal place of residence. In January 2001, we entered into a special retention bonus plan with Mr. Webb, under which Mr. Webb received bonus payments in August of 2001, 2002, 2003, and 2004. Payment amounts under Mr. Webb's bonus plan are $355,200 for 2001, $449,900 for 2002, $646,100 for 2003 and $1,154,000 for 2004, and the terms of the bonus plan allowed those amounts to be used to pay principal and interest owed to us under the terms of his loan. In August 2001 and August 2002, in accordance with the terms of his loan, Mr. Webb paid down $355,200 and $449,900, respectively, of principal and accrued interest on the loan. In January 2003, Mr. Webb prepaid in full the principal and accrued interest on his loan in the amount of approximately $1,670,800. In May 2000, Mr. Jordan, our President, PayPal, entered into two four-year term loans with us at an interest rate of 6.40% per annum, with principal and accrued interest payable on each loan in equal installments on each anniversary. The principal amounts on the loans were $1,000,000 and $900,000, respectively, with the loan amounts secured by Mr. Jordan's principal place of residence. In May 2000, we entered into a special retention bonus plan with Mr. Jordan under which Mr. Jordan received bonus payments in May of 2001, 2002, 2003, and 2004. Payment amounts under this Mr. Jordan's bonus plan were $314,000 for 2001, $298,000 for 2002, $282,000 for 2003, and $266,000 for 2004, and the terms of the bonus plan allowed those amounts to pay principal and interest owed to us under the loans described in this paragraph. In 81 July 2000, Mr. Jordan repaid in full the principal and accrued interest on the $900,000 term loan. In addition, in April 2001, Mr. Jordan entered into a four-year term loan with us at an interest rate of 4.94% per annum, with principal and accrued interest payable in equal installments on each anniversary of this loan. The principal amount on this loan was $750,000, with the loan amount secured by Mr. Jordan's principal place of residence. In April 2001, we entered into a second special retention bonus plan with Mr. Jordan under which Mr. Jordan received bonus payments in April of 2002, 2003, and 2004 and remains eligible to receive a bonus payment in April 2005 if he is then employed by us. Payment amounts under this bonus plan with Mr. Jordan are $224,550 for 2002, $215,288 for 2003, $206,025 for 2004, and $196,763 for 2005, and the terms of the bonus plan allowed those amounts to be used to pay principal and interest owed to us under the loans described in this paragraph. In May 2001, May 2002, and May 2003, Mr. Jordan paid down $314,000, $298,000 and $282,000, respectively, of principal and accrued interest on his May 2000 loan. In April 2002 and April 2003, Mr. Jordan paid down $224,550 and $215,288, respectively, of principal and accrued interest on his April 2001 loan. In July 2003, Mr. Jordan prepaid in full the principal and accrued interest on both the May 2000 and April 2001 loans in the amounts of $252,762 and $380,380, respectively. In March 2001, in connection with his relocation to San Jose as a result of his joining eBay in November 2000, Mr. Cobb, our President, eBay North America, entered into a four-year, non-interest bearing term loan with us in the amount of $840,000. The loan to Mr. Cobb was secured by his principal place of residence. Principal payments of $70,000 were due on the Ñrst, second and third anniversary of his start date, and a balloon payment of the remaining principal was due on the fourth anniversary of his start date. In November 2000, we entered into a special retention bonus plan with Mr. Cobb under which Mr. Cobb received a $70,000 bonus payment in November of 2001, 2002, 2003 and 2004. In April 2002, we entered into a second special retention bonus plan with Mr. Cobb under which Mr. Cobb received $280,000 bonus payment in November 2004. The terms of the bonus plans allowed these bonus payments to be used to pay principal payments due under Mr. Cobb's loan. In each of November 2001, 2002 and 2003, Mr. Cobb paid down $70,000 of principal on his loan, and in November 2004 Mr. Cobb paid the remaining $630,000 in principal on his loan. Mr. Cobb's maximum indebtedness to eBay during 2004 was $630,000. In September 2002, we entered into a special retention bonus plan with Mr. Bannick. Under the terms of this bonus plan, Mr. Bannick received a $250,000 bonus payment after the closing of our acquisition of PayPal in October 2002 and upon his acceptance of the new position as our Senior Vice President and General Manager, Global Online Payments. In addition, the terms of the bonus plan provided for three performance- based bonus payments of up to $250,000 related primarily to the integration and performance of our PayPal subsidiary, payable on each of the nine months, 18 months, and 24 months after the October 2002 closing of the PayPal acquisition. Mr. Bannick received $250,000 payments in July 2003, April 2004 and October 2004. Mr. Omidyar, our Founder and the Chairman of our Board of Directors, and Mr. Skoll, a beneÑcial owner of more than 5% of our common stock, from time to time make their personal aircraft available to our oÇcers for business purposes at no cost to us. The imputed cost of the aircraft use was not material to our consolidated Ñnancial statements. Another transaction is described under the caption ""Compensation Committee Interlocks and Insider Participation''. 82 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES During the Ñscal years ended December 31, 2003 and December 31, 2004, fees for services provided by PricewaterhouseCoopers LLP, or PwC, were as follows (in thousands): Year Ended December 31, 2003 2004 Audit Fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Audit-Related Fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Tax Fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,548 720 65 $3,757 1,617 Ì Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $2,333 $5,374 ""Audit Fees'' consisted of fees incurred for services rendered for the audit of eBay's annual Ñnancial statements, review of Ñnancial statements included in eBay's quarterly reports on Form 10-Q other services normally provided in connection with statutory and regulatory Ñlings and, in the case of 2004, for attestation services related to Sarbanes-Oxley compliance. ""Audit-Related Fees'' consisted of fees billed for due diligence procedures in connection with acquisitions and divestitures and consultation regarding Ñnancial accounting and reporting matters. ""Tax Fees'' consisted of fees billed for tax payment planning and tax preparation services. Approximately 3% of Tax Fees for 2003 were approved by eBay's Audit Committee after the provision of services pursuant to the ""de minimis'' services safe harbor exception for non-audit engagements. The Audit Committee of our Board of Directors has determined that the rendering of non-audit services by PwC was compatible with maintaining their independence. Audit Committee Pre-Approval Policy The Audit Committee of our Board of Directors has adopted a policy requiring the pre-approval of any non-audit engagement of PwC. In the event that we wish to engage PwC to perform accounting, technical, diligence or other permitted services not related to the services performed by PwC as our independent registered public accounting Ñrm, our internal Ñnance personnel will prepare a summary of the proposed engagement, detailing the nature of the engagement, the reasons why PwC is the preferred provider of such services and the estimated duration and cost of the engagement. The report will be provided to our Audit Committee or a designated committee member, who will evaluate whether the proposed engagement will interfere with the independence of PwC in the performance of its auditing services. Beginning with the Ñrst quarter of 2003, we have disclosed all approved non-audit engagements during a quarter in the appropriate quarterly report on Form 10-Q or annual report on Form 10-K. Our Audit Committee approved the non-audit engagement of PwC to provide due diligence services related to certain potential acquisitions during the quarter ended December 31, 2004. 83 PART IV ITEM 15: EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) The following documents are Ñled as part of this report: 1. Consolidated Financial Statements: Page Number Report of Independent Registered Public Accounting Firm ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Balance Sheet ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statement of IncomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statement of Comprehensive Income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statement of Stockholders' Equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Consolidated Statement of Cash Flows ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Notes to Consolidated Financial Statements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 87 89 90 91 92 93 94 2. Financial Statement Schedules. Page Number Schedule II Ì Valuation and Qualifying Accounts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 128 All other schedules have been omitted because the information required to be set forth therein is not applicable or is shown in the Ñnancial statements or notes thereto. 3. Exhibits. No. 3.01 3.02 4.01 4.02 Exhibit Description Registrant's Amended and Restated CertiÑcate of Incorporation. Registrant's Amended and Restated By-laws. Form of Specimen CertiÑcate for Registrant's Common Stock. Investor Rights Agreement, dated June 20, 1997, between the Registrant and certain stockholders named therein. Filed with this 10-K Incorporated by Reference Form File No. Date Filed 10-Q 000-24821 8/4/2004 10-Q 000-24821 333-59097 S-1 11/13/1998 8/19/1998 S-1 333-59097 7/15/1998 10.01° Form of Indemnity Agreement entered into by S-1 333-59097 7/15/1998 Registrant with each of its directors and executive oÇcers. 10.02° Registrant's 1996 Stock Option Plan. 10.03° Registrant's 1997 Stock Option Plan. 10.04° Registrant's 1998 Equity Incentive Plan, as amended. 10.05° Registrant's 2001 Equity Incentive Plan. 10.06° Registrant's 1998 Directors Stock Option Plan. 10.07° Registrant's 2003 Deferred Stock Unit Plan. 10.08° Registrant's Amended and Restated 1998 Em- ployee Stock Purchase Plan. S-1 S-1 S-1 333-59097 333-59097 333-59097 7/15/1998 7/15/1998 7/15/1998 333-117913 S-8 10-Q 000-24821 333-107832 S-8 333-117913 S-8 8/4/2004 5/15/2003 8/11/2003 8/4/2004 10.09° Registrant's 1999 Global Equity Incentive Plan, as S-8 333-117913 8/4/2004 amended. 84 No. Exhibit Description 10.10° Employment Letter Agreement dated January 16, 1998, between Margaret C. Whitman and Regis- trant. Filed with this 10-K Incorporated by Reference Form File No. Date Filed S-1 333-59097 8/19/1998 10.11° Employment Letter Agreement dated August 20, S-1 333-59097 9/1/1998 1998, between Michael R. Jacobson and Registrant. 10.12° OÅer Letter to Maynard G. Webb, Jr. dated S-3 333-88205 9/30/1999 July 17, 1999. 10.13° Retention Bonus Plan dated January 10, 2001, between Registrant and Maynard G. Webb, Jr. (Corrected). 10.14° Stock Option Agreement dated June 9, 1998 between Registrant and Scott D. Cook. 10.15° OÅer Letter to JeÅrey D. Jordan dated July 30, 1999. 10.16° Retention Bonus Plan dated May 16, 2000, be- tween Registrant and JeÅrey D. Jordan. 10.17° Retention Bonus Plan dated April 3, 2001, between Registrant and JeÅrey D. Jordan. 10-Q 000-24821 8/14/2001 10-K 000-24821 3/31/2003 S-3 333-88205 9/30/1999 10-K 000-24821 3/28/2001 10-Q 000-24821 8/14/2001 10.18° OÅer Letter to William C. Cobb dated Novem- 10-K 000-24821 3/25/2002 ber 22, 2000. 10.19° Supplemental Retention Bonus Plan dated 10-Q 000-24821 8/6/2002 April 14, 2002, between Registrant and William C. Cobb. 10.20° Special Bonus Plan between Registrant and Mat- thew J. Bannick, dated as of September 6, 2002. 10.21 10.22 Lease dated March 1, 2000, between eBay Realty Trust and Registrant. Cash Collateral Agreement between Registrant and Chase Manhattan Bank as Agent, dated March 1, 2000. 10-Q 000-24821 11/14/2002 10-K 000-24821 3/30/2000 10-K 000-24821 3/30/2000 10.23° Form of Stock Bonus Agreement under eBay Inc. 10-Q 000-24821 10/27/2004 1998 Equity Incentive Plan. 10.24° Form of Stock Option Agreement under eBay Inc. 10-Q 000-24821 10/27/2004 1998 Equity Incentive Plan. 10.25° Form of Stock Option Agreement under eBay Inc. 10-Q 000-24821 10/27/2004 1999 Global Equity Incentive Plan. 10.26° Form of Stock Option Agreement under eBay Inc. 10-Q 000-24821 10/27/2004 2001 Equity Incentive Plan. 10.27° Description of eBay Inc.'s Executive Management 10-Q 000-24821 10/27/2004 Incentive Plan. 10.28° OÅer Letter to Christopher Corrado dated Novem- 8-K 000-24821 1/3/2005 ber 19, 2004. 10.29° OÅer Letter to Scott Thompson dated January 12, 8-K 000-24821 2/7/2005 2005. 10.30° OÅer Letter to John Donahoe dated November 16, 8-K 000-24821 2/24/2005 2004. 85 No. 21.01 23.01 24.01 31.01 31.02 32.01 32.02 Exhibit Description List of Subsidiaries. PricewaterhouseCoopers LLP consent. Power of Attorney (see signature page). CertiÑcation of the Registrant's Chief Executive OÇcer, as required by Section 302 of the Sarbanes-Oxley Act of 2002. CertiÑcation of Registrant's Chief Financial OÇcer, as required by Section 302 of the Sarbanes-Oxley Act of 2002. CertiÑcation of Registrant's Chief Executive Of- Ñcer, as required by Section 906 of the Sarbanes- Oxley Act of 2002. CertiÑcation of Registrant's Chief Financial OÇcer, as required by Section 906 of the Sarbanes-Oxley Act of 2002. Filed with this 10-K Incorporated by Reference Form File No. Date Filed X X X X X X X ° Indicates a management contract or compensatory plan or arrangement (b) See the Exhibits listed under Item 15(a)(3) above. (c) The Ñnancial statement schedules required by this item are listed under Item 15(a)(2) above. 86 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of eBay Inc.: We have completed an integrated audit of eBay Inc.'s 2004 consolidated Ñnancial statements and of its internal control over Ñnancial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated Ñnancial 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 Ñnancial statements and Ñnancial statement schedule In our opinion, the consolidated Ñnancial statements listed in the index appearing under Item 15(a) (1) on page 84 present fairly, in all material respects, the Ñnancial position of eBay Inc. and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash Öows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the Ñnancial statement schedule listed in the index appearing under Item 15(a) (2) on page 84 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated Ñnancial statements. These Ñnancial statements and Ñnancial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these Ñnancial statements and Ñnancial 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 Ñnancial statements are free of material misstatement. An audit of Ñnancial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the Ñnancial statements, assessing the accounting principles used and signiÑcant estimates made by management, and evaluating the overall Ñnancial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 1 to the Consolidated Financial Statements, eÅective July 1, 2003 the Company adopted the provisions of Financial Accounting Standards Board Interpretation No. 46, ""Consolidation of Variable Interest Entities Ì an interpretation of ARB 51''. Internal control over Ñnancial 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 eÅective internal control over Ñnancial reporting as of December 31, 2004 based on criteria established in Internal Control Ì 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, eÅective internal control over Ñnancial reporting as of December 31, 2004, based on criteria established in Internal Control Ì Integrated Framework issued by the COSO. The Company's management is responsible for maintaining eÅective internal control over Ñnancial reporting and for its assessment of the eÅectiveness of internal control over Ñnancial reporting. Our responsibility is to express opinions on management's assessment and on the eÅectiveness of the Company's internal control over Ñnancial reporting based on our audit. We conducted our audit of internal control over Ñnancial 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 eÅective internal control over Ñnancial reporting was maintained in all material respects. An audit of internal control over Ñnancial reporting includes obtaining an understanding of internal control over Ñnancial reporting, evaluating management's assessment, testing and evaluating the design and operating eÅectiveness 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 Ñnancial reporting is a process designed to provide reasonable assurance regarding the reliability of Ñnancial reporting and the preparation of Ñnancial statements for external 87 purposes in accordance with generally accepted accounting principles. A company's internal control over Ñnancial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reÖect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of Ñnancial 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 eÅect on the Ñnancial statements. Because of its inherent limitations, internal control over Ñnancial reporting may not prevent or detect misstatements. Also, projections of any evaluation of eÅectiveness 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. /s/PricewaterhouseCoopers LLP San Jose, California February 25, 2005 88 eBay Inc. CONSOLIDATED BALANCE SHEET December 31, December 31, 2004 2003 (In thousands, except par value amounts) Current assets: ASSETS Cash and cash equivalentsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Short-term investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts receivable, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Funds receivable from customers ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Restricted cash and investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other current assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total current assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Restricted cash and investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Property and equipment, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Goodwill ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Intangible assets, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,381,513 340,576 225,871 79,893 14,859 103,170 2,145,882 934,171 127,432 601,785 1,719,311 274,057 17,496 $1,330,045 682,004 240,856 123,424 155,405 379,415 2,911,149 1,266,289 1,418 709,773 2,709,794 362,909 29,719 $5,820,134 $7,991,051 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Funds payable and amounts due to customers ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accrued expenses and other current liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred revenue and customer advances ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Short-term obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income taxes payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Total current liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred tax liabilities, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minority interests ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Commitments and contingencies (Notes 8, 9, and 10) Stockholders' equity: Convertible Preferred Stock, $0.001 par value; 10,000 shares authorized; no 64,633 106,568 356,491 28,874 2,840 87,870 647,276 124,476 79,238 33,494 39,408 923,892 $ 37,958 331,805 421,969 50,439 124,272 118,427 1,084,870 75 135,971 37,698 4,096 1,262,710 shares issued or outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Common Stock, $0.001 par value; 1,790,000 shares authorized; 1,298,586 and 1,338,608 shares issued and outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Additional paid-in capital ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unearned stock-based compensation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Retained earnings ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accumulated other comprehensive income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,299 3,936,510 (2,008) 856,245 104,196 1,339 4,855,717 (4,825) 1,634,468 241,642 Total stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 4,896,242 6,728,341 $5,820,134 $7,991,051 The accompanying notes are an integral part of these consolidated Ñnancial statements. 89 eBay Inc. CONSOLIDATED STATEMENT OF INCOME Net revenuesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cost of net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2002 Year Ended December 31, 2003 (In thousands, except per share amounts) $2,165,096 416,058 $1,214,100 213,876 $3,271,309 614,415 2004 Gross proÑt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,000,224 1,749,038 2,656,894 Operating expenses: Sales and marketing ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Product development ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ General and administrative ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Patent litigation expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Payroll tax on employee stock optionsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amortization of acquired intangible assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 349,650 104,636 171,785 Ì 4,015 15,941 567,565 159,315 302,703 29,965 9,590 50,659 857,874 240,647 415,725 Ì 17,479 65,927 Total operating expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 646,027 1,119,797 1,597,652 Income from operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impairment of certain equity investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before cumulative eÅect of accounting change, income taxes and minority interests ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for income taxes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minority interests ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income before cumulative eÅect of accounting changeÏÏÏÏÏÏÏÏÏÏ Cumulative eÅect of accounting change, net of taxÏÏÏÏÏÏÏÏÏÏÏÏÏ 354,197 49,209 (1,492) (3,781) 398,133 (145,946) (2,296) 249,891 Ì 629,241 37,803 (4,314) (1,230) 1,059,242 77,867 (8,879) Ì 661,500 (206,738) (7,578) 447,184 (5,413) 1,128,230 (343,885) (6,122) 778,223 Ì Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 249,891 $ 441,771 $ 778,223 Net income per basic share: Income before cumulative eÅect of accounting changeÏÏÏÏÏÏÏÏ Cumulative eÅect of accounting change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Net income per basic share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Net income per diluted share: Income before cumulative eÅect of accounting changeÏÏÏÏÏÏÏÏ Cumulative eÅect of accounting change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Net income per diluted share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 0.22 Ì 0.22 0.21 Ì 0.21 $ $ $ $ 0.35 (0.00) 0.35 0.34 (0.00) 0.34 $ $ $ $ 0.59 Ì 0.59 0.57 Ì 0.57 Weighted average shares: Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,149,984 1,276,576 1,319,458 Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,171,280 1,313,314 1,367,720 The accompanying notes are an integral part of these consolidated Ñnancial statements. 90 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME eBay Inc. Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other comprehensive income: 2002 Year Ended December 31, 2003 (In thousands) $441,771 2004 $778,223 $249,891 Foreign currency translation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unrealized gains (losses) on investments, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Investment losses included in net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unrealized gains (losses) on cash Öow hedges ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Estimated tax beneÑt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 48,000 774 558 (2,637) 448 66,326 (5,861) 364 4,249 620 139,523 (8,727) 24 5,525 1,102 Net change in other comprehensive income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 47,143 65,698 137,447 Comprehensive incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $297,034 $507,469 $915,670 The accompanying notes are an integral part of these consolidated Ñnancial statements. 91 CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY eBay Inc. 2002 Year Ended December 31, 2003 (In thousands) 2004 Convertible preferred stock: Balance, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Ì $ Ì $ Balance, end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì Common stock: Balance, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stock issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance, end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,110 136 1,246 1,246 53 1,299 Ì Ì 1,299 40 1,339 Additional paid-in-capital: Balance, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stock issued ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Common stock repurchased ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stock-based compensation, net of cancellations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Stock option income tax beneÑtÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,274,407 1,740,386 (132) 298 92,549 3,107,508 694,288 (79) 4,155 130,638 3,936,510 650,985 (1) 6,240 261,983 Balance, end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3,107,508 3,936,510 4,855,717 Unearned stock-based compensation: Balance, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unearned stock-based compensation, net of cancellations ÏÏÏÏÏ Amortization of unearned stock-based compensation ÏÏÏÏÏÏÏÏÏ Balance, end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (2,367) (8,839) 5,953 (5,253) Retained earnings: Balance, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Partnership distributions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 164,633 (50) 249,891 Balance, end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 414,474 Accumulated other comprehensive income (loss): Balance, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unrealized gain (loss) on investments, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏ Unrealized gain (loss) on cash Öow hedges, net of taxÏÏÏÏÏÏÏÏ Foreign currency translation adjustment ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Balance, end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (8,645) 724 (1,581) 48,000 38,498 (5,253) (1,079) 4,324 (2,008) 414,474 Ì 441,771 856,245 38,498 (3,178) 2,549 66,327 104,196 (2,008) (4,068) 1,251 (4,825) 856,245 Ì 778,223 1,634,468 104,196 (5,392) 3,315 139,523 241,642 Total stockholders' equity ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $3,556,473 $4,896,242 $6,728,341 Number of shares Common stock: Balance, beginning of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Issuance of common stock for cash and services ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Issuance of common stock for acquisitions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,109,036 40,112 95,960 1,245,108 53,478 Ì 1,298,586 40,022 Ì Balance, end of year ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,245,108 1,298,586 1,338,608 The accompanying notes are an integral part of these consolidated Ñnancial statements. 92 eBay Inc. CONSOLIDATED STATEMENT OF CASH FLOWS Cash Öows from operating activities: Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Adjustments: Cumulative eÅect of accounting change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Provision for doubtful accounts and authorized credits ÏÏÏÏÏÏ Provision for transaction losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Depreciation and amortization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Amortization of unearned stock-based compensation ÏÏÏÏÏÏÏ Tax beneÑt on the exercise of employee stock options ÏÏÏÏÏÏ Impairment of certain equity investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Minority interests ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Gain on sale of assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Changes in assets and liabilities, net of acquisition eÅects: Accounts receivable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Funds receivable from customers ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other current assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other non-current assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred tax liabilities, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accounts payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Funds payable and amounts due to customers ÏÏÏÏÏÏÏÏÏÏÏ Accrued expenses and other liabilitiesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred revenue and customer advances ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income taxes payable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash provided by operating activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Öows from investing activities: Purchases of property and equipment, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Purchases of investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Maturities and sales of investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Proceeds from (purchases of) intangible and other non- current assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Acquisitions, net of cash acquired ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash used in investing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash Öows from Ñnancing activities: Proceeds from issuance of common stock, net ÏÏÏÏÏÏÏÏÏÏÏÏÏ Principal payments on long-term obligations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Partnership distributions ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net cash provided by Ñnancing activities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ EÅect of exchange rate changes on cash and cash equivalents Net increase (decrease) in cash and cash equivalents ÏÏÏÏÏÏÏÏ Cash and cash equivalents at beginning of period ÏÏÏÏÏÏÏÏÏÏÏÏ Cash and cash equivalents at end of period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Supplemental cash Öow disclosures: 2002 Year Ended December 31, 2003 (In thousands) 2004 $ 249,891 $ 441,771 $ 778,223 Ì 25,455 7,832 76,576 5,953 91,237 3,781 1,324 (21,378) (54,583) (11,819) 10,716 (1,195) 8,134 14,631 (6,027) 35,481 2,780 41,114 479,903 5,413 46,049 36,401 159,003 5,492 130,638 1,230 7,784 Ì (153,373) (38,879) (13,133) (4,111) 69,770 17,348 56,172 85,704 8,864 11,976 874,119 Ì 90,942 50,459 253,690 5,832 261,983 Ì 6,122 Ì (105,540) (44,751) (312,756) (308) 28,652 (33,975) 216,967 39,618 20,061 30,096 1,285,315 (138,670) (723,307) 727,455 (365,384) (2,035,053) 1,297,262 (292,838) (1,754,808) 1,079,548 36,174 (59,411) (157,759) Ì (216,367) (1,319,542) (8,646) (1,036,476) (2,013,220) 252,181 (64) (50) 252,067 11,133 585,344 523,969 $1,109,313 700,817 (11,951) Ì 688,866 28,757 272,200 1,109,313 $ 1,381,513 650,638 (2,969) Ì 647,669 28,768 (51,468) 1,381,513 $ 1,330,045 Cash paid for interest ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cash paid for income taxesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Unearned stock-based compensation, net of cancellations ÏÏÏ $ $ $ 1,492 2,382 8,839 Non-cash investing and Ñnancing activities: Common stock issued for acquisition ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,476,504 $ $ $ $ 3,237 3,519 1,079 $ $ $ 8,234 13,875 4,068 Ì $ Ì The accompanying notes are an integral part of these consolidated Ñnancial statements. 93 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS eBay Inc. Note 1 Ì The Company and Summary of SigniÑcant Accounting Policies: The Company eBay Inc. (""eBay'') was incorporated in California in May 1996, and reincorporated in Delaware in April 1998. As of December 31, 2004, through our wholly-owned and majority-owned subsidiaries and aÇliates, we had websites directed toward the United States, Australia, Austria, Belgium, Canada, China, France, Germany, Hong Kong, India, Ireland, Italy, Malaysia, the Netherlands, New Zealand, the Philippines, Singapore, South Korea, Spain, Sweden, Switzerland, Taiwan and the United Kingdom. We pioneered online trading by developing an Internet-based community in which buyers and sellers are brought together to buy and sell almost anything. The eBay online service permits sellers to list items for sale, buyers to bid on items of interest, and all eBay users to browse through listed items in a fully-automated, topically-arranged service that is available online seven days a week. Through our PayPal service, we enable any business or consumer with email in 45 countries to send, and in 44 countries to receive online payments. As of December 31, 2004, through its wholly-owned subsidiaries, PayPal had websites directed towards the United States, Austria, Belgium, France, Germany, the Netherlands, Switzerland and the United Kingdom. On October 3, 2002, we completed our acquisition of PayPal, Inc. (""PayPal'') in a tax-free, stock-for- stock transaction. PayPal provides an online global payments platform and is headquartered in San Jose, California. The PayPal Ñnancial statements are included in our consolidated Ñnancial statements from October 4, 2002. 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. Stock split In January 2005, our Board of Directors approved a two-for-one split of our shares of common stock to be issued in the form of a stock dividend. As a result of the stock split, our stockholders received one additional share of our common stock for each share of common stock held of record on January 31, 2005. The additional shares of our common stock were distributed on February 16, 2005. All share and per share amounts in these consolidated Ñnancial statements and related notes have been retroactively adjusted to reÖect this and all prior stock splits for all periods presented. Use of estimates The preparation of consolidated Ñnancial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that aÅect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated Ñnancial 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 diÅer from those estimates. Principles of consolidation and basis of presentation The accompanying Ñnancial statements are consolidated and include the Ñnancial statements of eBay and our majority-owned subsidiaries. All signiÑcant intercompany balances and transactions have been eliminated in consolidation. 94 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. The consolidated Ñnancial 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 signiÑcantly inÖuence 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' operations is included in interest and other income, net. Investments in entities where we hold less than a 20% ownership interest or where we do not have the ability to signiÑcantly inÖuence 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 reclassiÑed to conform to the current period presentation. Fair value of Ñnancial instruments Cash and cash equivalents are short-term, highly liquid investments with original or remaining maturities of three months or less when purchased. Our Ñnancial 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, government and corporate bonds, are classiÑed as available-for-sale and reported at fair value using the speciÑc identiÑcation 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 beneÑts. 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 Öow hedge, the gain or loss on the derivative is initially reported as a component of accumulated other comprehensive income (loss) and subsequently reclassiÑed into the consolidated statement of income when the hedged transaction aÅects earnings. For derivatives recognized as a fair value hedge, the gain or loss on the derivative in the period of change and the oÅsetting 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 and accounts receivable are potentially subject to concentration of credit risk. Cash and cash equivalents are placed with Ñnancial 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 are 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 signiÑcant future changes in trends could result in a material impact to future statements of income or cash Öows. 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. 95 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. We also entered into two interest rate swaps with two separate Ñnancial institutions to reduce our interest rate exposure on our San Jose corporate headquarters lease payments. If either of these Ñnancial institutions should fail to deliver under these contracts, we may be subject to variable interest rate payments. The interest swaps will mature in March 2005. During the years ended December 31, 2002, 2003, and 2004, no customers accounted for more than 10% of net revenues. As of December 31, 2003 and 2004, 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 and others. 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 represent an accumulation of the estimated amounts, using an actuarial technique, necessary to provide for transaction losses incurred as of the reporting date, including those to which we have not yet been notiÑed. The allowances 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 reÖected as a general and administrative expense in our consolidated statement of income. At December 31, 2003 and 2004, the allowance for transaction losses totaled $12.0 million and $11.0 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 to 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 Ñve to eight business days for international transactions. Hence, these funds are treated as a receivable or payable until the cash is settled. Customer accounts We deposit all U.S.-based customer funds held in U.S. dollars not transferred to PayPal's Money Market Fund into Federal Deposit Insurance Corporation, or FDIC, insured bank accounts. 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 BeneÑt of its Customers'' or similar caption, (2) maintain records suÇcient to identify the claim of each customer in the FDIC-insured account, (3) comply with applicable 96 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. FDIC recordkeeping requirements, and (4) truly operate as an agent of our customers. The customer funds held in FDIC insured bank accounts are not reÖected 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. EÅective 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 speciÑed types of liquid assets. These customer balances are therefore included on our consolidated balance sheet as other current assets with an oÅsetting liability. 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 Ñve years or the term of the lease for leasehold improvements, three years for furniture and Ñxtures and Ñve years for vehicles. Goodwill and intangible assets Goodwill represents the excess of the purchase price over the fair value of the net tangible and identiÑable 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. IdentiÑable intangible assets are comprised of purchased customer lists and user base, trademarks and trade names, developed technologies, and other intangible assets. IdentiÑable intangible assets are being amortized using the straight-line method over estimated useful lives ranging from one to eight years. We adopted Statement of Financial Accounting Standards No. 142, or SFAS No. 142, ""Goodwill and Other Intangible Assets,'' on January 1, 2002 on a prospective basis. In accordance with SFAS No. 142, goodwill is no longer subject to amortization. Rather, goodwill is subject to at least an annual assessment for impairment, applying a fair-value based test. Long-lived assets and goodwill We evaluate long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with SFAS No. 144, ""Accounting for the Impairment or Disposal of Long-Lived Assets.'' An asset is considered impaired if its carrying amount exceeds the future net cash Öow 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 Öows of the related assets. The amount of impairment, if any, is measured based on projected discounted future net cash Öows. 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 Öows, 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 97 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. of August 31, 2004 and determined there to be no impairment. There were no events or circumstances from that date through December 31, 2004 that would impact this assessment. Due to customers Customers utilize our payment services to transfer money electronically over the Internet. Any stored value remaining from transactions in a customer's account represents a liability to the customer. Customers in the U.S. can elect to sweep their account balances into the PayPal Money Market fund to earn a rate of return; otherwise, customers earn no interest on their balances. PayPal earns interest on the customer balances receiving service through PayPal's U.K. subsidiary. Revenue recognition Our net revenues result from fees associated with our transaction, advertising and other non-transaction services in our U.S. Marketplace, International Marketplace and Payments segments. Transaction revenue is derived primarily from listing, feature and Ñnal 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. Listing and feature fee revenues are recognized ratably over the estimated period of the auction while revenues related to Ñnal 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 speciÑed minimum price or reserve price, whichever is higher, at the end of the transaction term. 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. Provisions for doubtful accounts, authorized credits and transaction losses are made at the time of revenue recognition based upon our historical experience. The provision for doubtful accounts is recorded as a charge to operating expense, while the provisions for authorized credits and transaction losses are recognized as reductions of net revenues. Our advertising revenue is derived principally from the sale of online banner and sponsorship advertise- ments. To date, the duration of our banner and sponsorship advertising contracts has ranged from one week to Ñve 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 Ñxed 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 signiÑcant 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 satisÑed 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, $10.1 million and $13.3 million for the years ended December 31, 2002, 2003 and 2004, 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 circum- stances, 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 signiÑcant obligations remain at the end of a period or 98 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. collection of the resulting receivable is not considered probable, revenues are deferred until the obligation is satisÑed or the uncertainty is resolved. Product development costs We expense costs related to the planning and post implementation phases of our website development eÅorts. 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. 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, or on a straight-line basis over the term of the contract. Advertising expenses totaled $181.8 million, $321.4 million and $459.5 million during the years ended December 31, 2002, 2003, and 2004, 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 diÅerence, 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 Ñnancial statements. In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, ""Accounting for Stock-Based Compen- sation 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): Net income, as reportedÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Add: Amortization of stock-based compensation expense Year Ended December 31, 2003 2004 2002 $ 249,891 $ 441,771 $ 778,223 determined under the intrinsic value method ÏÏÏÏÏÏÏÏÏ 5,953 5,492 1,715 Deduct: Total stock-based compensation expense determined under fair value based method, net of tax ÏÏ (192,902) (201,775) (190,935) Pro forma net incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 62,942 $ 245,488 $ 589,003 Earnings per share: Basic Ì Reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pro formaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted Ì Reported ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Pro formaÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ $ $ $ 0.22 0.05 0.21 0.05 $ $ $ $ 0.35 0.19 0.34 0.19 $ $ $ $ 0.59 0.45 0.57 0.43 99 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. The weighted average fair value of options granted in the years ended December 31, 2002, 2003 and 2004, were $5.60, $8.15 and $12.12, respectively. 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: Year Ended December 31, 2003 2002 2004 Risk-free interest ratesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Expected livesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Dividend yieldÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Expected volatility ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 3.0% 3 years 0% 68% 1.9% 3 years 0% 64% 2.5% 3 years 0% 49% 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 Ñnancial statements or tax returns. The measurement of current and deferred tax assets and liabilities is based on provisions of enacted tax laws; the eÅects 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 beneÑts that are not expected to be realized based on available evidence. Cumulative EÅect 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 Ñnancial statements eÅective July 1, 2003. Under this accounting standard, our balance sheet at December 31, 2003 and 2004 reÖects 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, reÖects the reclassiÑcation 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 eÅect of the change in accounting principle arising from the adoption of FIN 46 has been reÖected in net income in 2003. 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 Öow hedges. 100 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. 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 using the intrinsic value method as 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 the most appropriate. The use of a diÅerent model to value options may result in a diÅerent 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 will result in diÅering accounting treatment than currently required. These diÅerences include, but are not limited to, the accounting for the tax beneÑt on employee stock options and for stock issued under our employee stock purchase plan. 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 include prospective and retroactive adoption options. Under the retroactive options, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the Ñrst quarter of adoption of FAS 123R, while the retroactive methods would record compensation expense for all unvested stock options and restricted stock beginning with the Ñrst period restated. The eÅective date of the new standard for our consolidated Ñnancial statements is our third Ñscal quarter in 2005. Upon adoption, this statement will have a signiÑcant impact on our consolidated Ñnancial 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 (see above), as is our current practice. The amounts disclosed within our footnotes are not necessarily indicative of the amounts that will be expensed upon adoption of FAS 123R. Compensation expense calculated under FAS 123R may diÅer from amounts currently disclosed within our footnotes 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 beneÑts and changes in interest rates or other factors. In addition, upon adoption of FAS 123R we may choose to use a diÅerent valuation model to value the compensation expense associated with employee stock options. In December 2004, the FASB issued SFAS No. 153, ""Exchanges of Nonmonetary Assets Ì An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions'' (SFAS 153). SFAS 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, ""Accounting for Nonmonetary Transactions,'' and replaces it with an exception for exchanges that do not have commercial substance. SFAS 153 speciÑes that a nonmonetary exchange has commercial substance if the future cash Öows of the entity are expected to change signiÑcantly as a result of the exchange. This standard is eÅective for Ñscal periods beginning after June 15, 2005. We are currently evaluating the eÅect that the adoption of SFAS 153 will have on our consolidated statement of income and Ñnancial condition. 101 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. Note 2 Ì 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, composed of unvested restricted common stock and incremental common shares issuable upon the exercise of stock options and warrants, 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): Year Ended December 31, 2003 2004 2002 Numerator: Income before cumulative eÅect of accounting changeÏÏÏÏÏÏÏÏ Cumulative eÅect of accounting, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 249,891 Ì $ 447,184 (5,413) $ 778,223 Ì Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 249,891 $ 441,771 $ 778,223 Denominator: Weighted average common shares ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Weighted average unvested common stock subject to 1,150,720 1,276,674 1,319,548 repurchaseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (736) (98) (90) Denominator for basic calculation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,149,984 1,276,576 1,319,458 Weighted average eÅect of dilutive securities: Weighted average unvested common stock subject to repurchaseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Employee stock optionsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 736 20,560 98 36,640 90 48,172 Denominator for diluted calculation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,171,280 1,313,314 1,367,720 Net income per share: Income before cumulative eÅect of accounting changeÏÏÏÏÏÏÏÏ Cumulative eÅect of accounting change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Net income per basic share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Net income per diluted share: Income before cumulative eÅect of accounting changeÏÏÏÏÏÏÏÏ Cumulative eÅect of accounting change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ Net income per diluted share ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 0.22 Ì 0.22 0.21 Ì 0.21 $ $ $ $ 0.35 (0.00) 0.35 0.34 (0.00) 0.34 $ $ $ $ 0.59 Ì 0.59 0.57 Ì 0.57 The calculation of diluted net income per share excludes all anti-dilutive shares. For the years ended December 31, 2002, 2003 and 2004, 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 53.2 million, 7.0 million and 3.4 million shares, respectively. 102 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. Note 3 Ì Business Combinations, Goodwill and Intangible Assets: Through both domestic and international acquisitions, we have continued to expand eBay's global online marketplace. The following table summarizes our purchase acquisitions in 2003 and 2004 with aggregate purchase prices in excess of $30 million (in thousands): Company Name EachNet ÏÏÏÏÏÏÏÏÏ Internet Auction ÏÏ mobile.de ÏÏÏÏÏÏÏÏ Baazee.com ÏÏÏÏÏÏ Marketplaats ÏÏÏÏÏ Internet Auction ÏÏ Year Acquired Post Acquisition Ownership Net Tangible Assets/Liabilities IdentiÑable Intangible Assets Deferred Tax Liabilities Minority Interest Goodwill 2003 2003 2004 2004 2004 2004 100% 62% 100% 100% 100% 99.9% $12,345 N/A 11,183 2,747 (1,902) N/A $11,212 14,981 30,500 2,350 38,500 60,143 $ (3,599) $ Ì $124,932 71,227 12,144 Ì 123,885 Ì 46,125 Ì 266,570 438,684 (4,449) (13,115) (905) (11,778) (17,864) 43,833 Aggregate Purchase Price $144,890 93,903 152,453 50,317 291,390 524,796 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 identiÑable intangible assets acquired reÖects 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. IdentiÑable intangible assets are amortized using the straight-line method over the estimated useful lives of one to eight years. We believe the straight-line method of amortization best represents the distribution of the economic value of the identiÑable intangible assets. Goodwill represents the excess of the purchase price over the fair value of the net tangible and identiÑable intangible assets acquired in each business combination. The purchase price of our acquisitions in 2003 and 2004 exceeded the estimated fair value of the related identiÑable intangible and tangible assets because we believe these acquisitions will assist with our strategy of establishing and expanding our global online marketplace. The following table summarizes our acquired intangible assets by type related to the above purchase acquisitions (in thousands): Company Name EachNet ÏÏÏÏÏÏÏÏÏ Internet AuctionÏÏÏ mobile.deÏÏÏÏÏÏÏÏÏ Baazee.comÏÏÏÏÏÏÏ Marketplaats ÏÏÏÏÏÏ Internet AuctionÏÏÏ Year Acquired Customer List/ User Base Trade Name/ Trademarks Developed Technology Other Intangible Assets Total Acquired Intangible Assets 2003 2003 2004 2004 2004 2004 $ 919 11,080 20,400 600 Ì 46,510 $ 5,381 3,462 4,600 150 37,000 12,239 $ 525 439 5,500 100 1,500 1,394 $4,387 Ì Ì 1,500 Ì Ì $11,212 14,981 30,500 2,350 38,500 60,143 The results of operations for periods prior to our acquisition for each acquisition during 2003 and 2004, both individually and in the aggregate, were not material to our consolidated statement of income and, accordingly, pro forma results of operations have not been presented. EachNet, Inc. Acquisition On March 17, 2002, we acquired an approximate 38% interest in the outstanding common stock of EachNet, Inc. (""EachNet''), which was an approximate 33% interest on a fully diluted basis, in a purchase acquisition for $30.0 million in cash. EachNet provided an online marketplace for the trading of goods and services for both individual and business customers in the People's Republic of China. We accounted for our investment using the equity method of accounting and the total investment, including identiÑable intangible assets, deferred tax liabilities and goodwill, was classiÑed on our balance sheet as a long-term investment. 103 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. In July 2003, we completed the acquisition of all of the remaining outstanding capital stock of EachNet, increasing our ownership interest from approximately 38% to 100%. The total purchase price for this transaction was $144.9 million and consisted of approximately $143.3 million in cash and $1.6 million in acquisition-related expenses. Under the terms of the transaction, $104.9 million of the cash amount was paid at closing and the remaining $38.4 million was paid on March 1, 2004. We have accounted for the acquisition of the remaining outstanding capital stock as a purchase and, accordingly, the purchase price has been allocated to the tangible and intangible assets acquired and liabilities assumed on the basis of their respective fair values on the acquisition date. 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 oÅer 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. 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 oÅer 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 marketplace in countries that represent the majority of the world's e-commerce revenue. The estimated useful economic lives of the identiÑable intangible assets acquired in the increase in ownership of IAC are eight years for the user base, Ñve years for the trade name, and two years for the developed technology. The identiÑable intangible assets are being amortized using the straight-line method over their useful economic lives. mobile.de Acquisition On April 1, 2004, we acquired a 100% interest in mobile.de for a cash purchase price of approximately 121 million Euros. mobile.de is a classiÑed 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 104 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. 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 identiÑable 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. The identiÑable intangible assets are being amortized using the straight-line method over their useful economic lives. During the six months ended December 31, 2004, we recorded additional acquisition-related liabilities primarily in relation to a provision to terminate a lease for redundant facilities. At December 31, 2004, the balance related to these acquisition-related liabilities was approximately $3.6 million. The Ñnal purchase price allocation will depend primarily upon our Ñnal determination of the provision to terminate the lease for redundant facilities. 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 marketplace 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 identiÑable 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. The identiÑable intangible assets are being amortized using the straight-line method over their useful economic lives. Marktplaats.nl Acquisition On November 10, 2004, we acquired a 100% interest in Marktplaats.nl (""Marktplaats'') for a cash purchase price of approximately 226 million Euros. The total purchase price recorded was approximately $291 million. Marktplaats.nl is an online classiÑed website in the Netherlands. The acquisition allows us to expand our e-commerce position in the Netherlands while adding to our growing knowledge of classiÑeds-style trading. 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 identiÑable intangible assets acquired in the Marktplaats.nl acquisition are Ñve years for the trade name and eighteen months for the developed technology. The identiÑable intangible assets are being amortized using the straight-line method over their useful economic lives. PayPal Acquisition-Related Liabilities During the year ended December 31, 2003, we Ñnalized 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 Ñxed assets and leasehold improvements, resolve certain pre-acquisition legal contingen- cies, provide various employee-related beneÑts and exit certain contractual obligations. 105 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. The components of the acquisition related liabilities are as follows (in thousands): Balance at December 31, 2003 Cash Payments Non-Cash Amount Used Adjustments Balance at December 31, 2004 Excess facilities and Ñxed assetsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $32,952 $(5,756) $(2,998) $(452) $23,746 Other liabilities and contingencies ÏÏÏÏÏÏÏÏÏÏÏÏ 3,949 (662) Ì Ì 3,287 Total liability ÏÏÏÏÏÏÏÏÏÏÏÏ $36,901 $(6,418) $(2,998) $(452) $27,033 Excess facilities and Ñxed assets liabilities consist primarily of accruals for PayPal's remaining lease obligations, net of estimated sublease income, and the write-oÅ of certain leasehold improvements and other property and equipment at redundant facilities which we exited in February 2004. A substantial portion of the excess facilities and Ñxed assets liabilities recorded as of December 31, 2004 are expected to settle in cash during future periods. The non-cash amount used for the year ended December 31, 2004 primarily represents the utilization of accruals related to certain leasehold improvements and other property and equipment at redundant facilities. The adjustments for the year ended December 31, 2004 are due primarily to the Ñnal determination of the required write-oÅ of certain leasehold improvements and other property and equipment at redundant facilities. As of December 31, 2004, other liabilities and contingencies consist primarily of accruals for contract termination costs, which are based on estimated costs associated with the acquisition-related terminations of certain PayPal employees. Goodwill Goodwill information for each segment is as follows (in thousands): December 31, 2003 Goodwill Acquired Goodwill Disposals Adjustments December 31, 2004 Segments: U.S. Marketplace ÏÏÏÏÏÏÏÏÏÏ International Marketplace ÏÏÏ Payments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 121,039 524,914 1,073,358 $ 27,360 874,890 Ì $1,719,311 $902,250 $Ì Ì Ì $Ì $ 304 116,251 (962) $ 148,703 1,516,055 1,072,396 $115,593 $2,737,154 The increase in goodwill acquired during the year ended December 31, 2004, resulted primarily from our acquisition of the outstanding shares of Marktplaats, mobile.de, Baazee.com, and our acquisition of an additional ownership interest in Internet Auction as well as certain insigniÑcant acquisitions. Adjustments to goodwill during the year ended December 31, 2004, resulted primarily from foreign currency translation adjustments relating to goodwill associated with our current and prior period acquisitions. Investments accounted for under the equity method of accounting are classiÑed on our balance sheet as long-term investments. Such investments include identiÑable intangible assets, deferred tax liabilities and goodwill. As of December 31, 2004, the goodwill related to our equity investment totaled approximately $27.4 million. 106 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. Intangible Assets The components of acquired identiÑable intangible assets are as follows (in thousands): December 31, 2003 Gross Carrying Amount Accumulated Amortization Net Carrying Amount December 31, 2004 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Weighted Average Useful Economic Life (Years) Weighted Average Useful Economic Life (Years) Intangible assets: Customer lists and user base ÏÏ $223,158 $(42,093) $181,065 Trademarks and trade names ÏÏÏ 75,269 (13,992) 61,277 Developed technologies ÏÏÏ All otherÏÏÏÏÏÏÏÏ 30,396 19,605 (16,147) (2,139) 14,249 17,466 7 7 3 5 $300,929 $ (80,097) $220,832 139,239 (30,811) 108,428 40,686 33,895 (28,488) (7,534) 12,198 26,361 7 6 3 4 $348,428 $(74,371) $274,057 $514,749 $(146,930) $367,819 All of our acquired identiÑable intangible assets are subject to amortization. Acquired identiÑable 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 signiÑ- cant residual value is estimated for the intangible assets. The increase in intangible assets during the year ended December 31, 2004 resulted primarily from an increase in our ownership in Internet Auction totaling approximately $60.1 million, certain intangible assets acquired as part of our acquisition of the outstanding shares of Marktplaats and mobile.de totaling approximately $38.5 million and $30.5 million, respectively, as well as our acquisition of an equity investment, as noted in ""Note 5 Ì Investments'' of these consolidated Ñnancial statements. As of December 31, 2004, the net carrying amount of intangible assets related to our equity investment totaled approximately $4.9 million. Aggregate amortization expense for intangible assets totaled $16.3 million, $53.2 million and $70.2 million for the years ended December 31, 2002, 2003 and 2004, respectively. As of December 31, 2004, expected future intangible asset amortization is as follows (in thousands): Fiscal Years: 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2008 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2009 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Thereafter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 86,650 73,027 67,177 64,986 49,307 26,672 367,819 Note 4 Ì 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 Ñnancial information, and overall materiality considerations. The U.S. Marketplace segment includes U.S. online marketplace trading platforms other than our PayPal and Billpoint subsidiaries. The International Marketplace segment includes our international online marketplace 107 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. trading platforms other than our PayPal and Billpoint subsidiaries. The Payments segment includes our global payments platform consisting of our PayPal and Billpoint subsidiaries. The Payments amounts reÖect Billpoint's historical operations and PayPal's operations for the post-acquisition period from October 4, 2002 through December 31, 2004. We completed our planned wind-down of Billpoint in the Ñrst half of 2003. Direct contribution consists of revenues less direct costs. Direct costs include speciÑc 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 site operations costs, product development expenses, and certain general and administrative costs, are monitored by management through shared cost centers and are not evaluated in the measurement of segment performance. The following table summarizes the Ñnancial performance of our reporting segments (in thousands): Year Ended December 31, 2002 U.S. International Marketplace Marketplace Payments Consolidated Net revenues from external customers ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Direct costsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $816,596 300,659 $302,136 123,784 $95,368 68,107 $1,214,100 492,550 Direct contributionÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 515,937 178,352 27,261 721,550 Operating expenses and indirect costs of net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income from operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest expense ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impairment of certain equity investmentsÏÏÏÏÏÏÏÏÏÏÏÏ Income before income cumulative eÅect of accounting change, taxes and minority interests ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 367,353 354,197 49,209 (1,492) (3,781) $ 398,133 Year Ended December 31, 2003 U.S. Marketplace International Marketplace Payments Consolidated Net revenues from external customers ÏÏÏÏÏÏÏÏÏÏÏÏÏ Direct costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,062,834 389,376 $664,640 257,888 $437,622 243,179 $2,165,096 890,443 Direct contribution ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 673,458 406,752 194,443 1,274,653 Operating expenses and indirect costs of net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income from operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest and other income, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impairment of certain equity investments ÏÏÏÏÏÏÏÏÏÏ Income before income cumulative eÅect of accounting change, taxes and minority interests ÏÏÏ 108 645,412 629,241 37,803 (4,314) (1,230) $ 661,500 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. Year Ended December 31, 2004 U.S. Marketplace International Marketplace Payments Consolidated Net revenues from external customers ÏÏÏÏÏÏÏÏÏÏÏÏÏ Direct costs ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,399,848 465,834 $1,173,759 473,239 $697,702 371,621 $3,271,309 1,310,694 Direct contribution ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 934,014 700,520 326,081 1,960,615 Operating expenses and indirect costs of net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Income from operations ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest and other income, net ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Interest expenseÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Impairment of certain equity investments ÏÏÏÏÏÏÏÏÏÏ Income before income cumulative eÅect of accounting change, taxes and minority interests ÏÏÏ 901,373 1,059,242 77,867 (8,879) Ì $1,128,230 The following tables summarize the allocation of net revenues and the long-lived assets based on geography (in thousands): United States net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ International net revenuesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 897,701 316,399 $1,406,512 758,584 $1,889,936 1,381,373 Net revenuesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,214,100 $2,165,096 $3,271,309 2002 December 31, 2003 2004 December 31, 2003 December 31, 2004 United States long-lived assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ International long-lived assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $1,997,140 598,013 $2,040,601 1,741,875 Total long-lived assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $2,595,153 $3,782,476 Net revenues are allocated between U.S. and International geographies based upon the country in which the seller, payment recipient, advertiser or end-to-end service provider is located. Long-lived assets are allocated between U.S. and International geographies based upon the country in which the long-lived asset is located or owned. 109 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. Note 5 Ì Investments: At December 31, 2003 and 2004, short and long-term investments were classiÑed as available-for-sale securities, except for restricted cash and investments, and are reported at fair value as follows (in thousands): Short-term: Restricted cash and investmentsÏÏÏÏÏÏÏÏÏÏ Municipal bonds and notes ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Corporate debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Government and agency securities ÏÏÏÏÏÏÏÏ Time deposits and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term: Restricted cash and investmentsÏÏÏÏÏÏÏÏÏÏ Corporate debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Government and agency securities ÏÏÏÏÏÏÏÏ Equity instruments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Short-term investments: Restricted cash and investmentsÏÏÏÏÏÏÏÏÏÏ Corporate debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Government and agency securities ÏÏÏÏÏÏÏÏ Time deposits and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Long-term investments: Restricted cash and investmentsÏÏÏÏÏÏÏÏÏÏ Corporate debt securities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Government and agency securities ÏÏÏÏÏÏÏÏ Equity instruments and equity method Gross Amortized Cost December 31, 2003 Gross Gross Unrealized Unrealized Losses Gains Estimated Fair Value $ 14,859 8,065 223,400 60,419 48,474 $ 355,217 $ 127,544 458,997 462,879 14,252 $1,063,672 $ Ì Ì 2 259 Ì $261 $328 365 236 Ì $929 $ Ì $ Ì (43) Ì Ì 14,859 8,065 223,359 60,678 48,474 $ (43) $ 355,435 $ (440) (491) (2,067) Ì $ 127,432 458,871 461,048 14,252 $(2,998) $1,061,603 Gross Amortized Cost December 31, 2004 Gross Gross Unrealized Unrealized Losses Gains Estimated Fair Value $ 156,130 581,058 80,274 23,979 841,441 $ 1,397 827,505 397,211 $ 25 33 Ì Ì 58 $ 21 107 Ì $ (750) (2,908) (432) Ì $ 155,405 578,183 79,842 23,979 (4,090) 837,409 $ Ì $ (2,137) (4,733) 1,418 825,475 392,478 investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 48,336 Ì Ì 48,336 $1,274,449 $128 $(6,870) $1,267,707 110 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. 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, 2004 (in thousands): Less than 12 Months Gross Unrealized Losses Fair Value 12 Months or Greater Gross Unrealized Losses Fair Value Total Fair Value Gross Unrealized Losses Restricted cash and investments ÏÏÏÏÏÏ $ 54,694 $ (559) $ 13,116 $ (191) $ 67,810 $ (750) Corporate debt securities ÏÏÏÏÏÏÏÏ 1,129,456 (3,521) 223,915 (1,524) $1,353,371 $ (5,045) Government and agency securitiesÏÏ 226,366 (1,410) 270,938 (3,755) $ 497,304 $ (5,165) $1,410,516 $(5,490) $507,969 $(5,470) $1,918,485 $(10,960) 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 ten months. The estimated fair value of short and long-term investments classiÑed by date of contractual maturity at December 31, 2004 are as follows (in thousands): One year or lessÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ One year through two years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Two years through three yearsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Restricted cash and investments expiring in less than one yearÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Restricted cash and investments expiring in one year to Ñve years ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Restricted cash and investments expiring in more than Ñve yearsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Equity instruments and equity method investments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ December 31, 2004 $ 682,004 853,667 364,286 155,405 1,156 262 48,336 $2,105,116 During 2002 and 2003, we recorded impairment charges totaling $3.8 million, $1.2 million, respectively, as a result of the deterioration of the Ñnancial 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. Equity method investment On August 13, 2004, we acquired a minority ownership interest in craigslist, inc. of approximately 25%. craigslist is an online community featuring classiÑeds and forums. We account for the investment in craigslist using the equity method of accounting and the total investment, including identiÑable intangible assets, deferred tax liabilities and goodwill (see ""Note 3 Ì Business Combinations, Goodwill and Intangible Assets'' of these consolidated Ñnancial statements), is classiÑed on our balance sheet as a long-term investment. Subsequent to the acquisition, our consolidated 111 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. Ñnancial results include approximately 25% of the net income or loss of craigslist together with amortization expense relating to acquired intangible assets. Note 6 Ì Derivative Instruments: We entered into two interest rate swaps on June 19 and July 20, 2000, with notional amounts totaling $95 million to reduce the impact of changes in interest rates on a portion of the Öoating rate operating lease for our primary oÇce facilities. The interest rate swaps allow us to receive Öoating rate receipts based on the London Interbank OÅered Rate, or LIBOR, in exchange for making Ñxed rate payments of approximately 7% of the notional amount, which eÅectively changes our interest rate exposure on our operating lease from a Öoating rate to a Ñxed rate on $95.0 million of the total $126.4 million notional amount of our corporate headquarters facility lease commitment. The balance of $31.4 million remains at a Öoating rate of interest based on the spread over 3-month LIBOR. The fair value of the interest rate swaps as of December 31, 2004 was an unrealized loss of $662,000, net of tax beneÑt, and is recorded in accumulated other comprehensive income on the balance sheet. The interest swap will mature in March 2005, at which time the lease expires and we will purchase the San Jose headquarters facility. Transaction Exposure: As of December 31, 2004, we had outstanding forward foreign exchange hedge contracts with notional values equivalent to approximately $316 million with maturity dates within 11 days. The hedge contracts are used to oÅset changes in non-US dollar denominated functional currency value of assets and liabilities as a result of foreign exchange rate Öuctuations. Transaction gains and losses on the contracts and the assets and liabilities are recognized each period in interest and other income, net. Translation Exposure: Foreign exchange rate Öuctuations may adversely impact our Ñnancial position and our results of operations. Foreign exchange rate Öuctuations may adversely impact our Ñnancial position as the assets and liabilities of our foreign operations are translated into U.S. dollars in preparing our consolidated balance sheet. The eÅect of foreign exchange rate Öuctuations on our consolidated Ñnancial position for the year ended December 31, 2004, was a net translation gain of approximately $140 million. This gain is recognized as an adjustment to stockholders' equity through accumulated other comprehensive income. Additionally, foreign exchange rate Öuctuations may adversely impact our results of operations as exchange rate Öuctuations on transactions denominated in currencies other than our functional currencies result in gains and losses that are reÖected in our consolidated statement of income. In addition, at December 31, 2004, we held balances in cash, cash equivalents and investments outside the U.S. totaling approximately $467 million. We consolidate the earnings of our foreign 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 Öuctuate 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. The aggregate notional amount of these hedges entered into in 2004 was 109 million Euros and 43 million British pounds. The loss on these hedges for 2004 totaled approximately $2.0 million, which were recorded in interest and other income, net. All contracts that hedge translation exposure mature ratably over the quarter in which they are executed. 112 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. Economic Exposure: We currently charge our foreign subsidiaries on a monthly basis for their use of eBay's intellectual property and technology and for corporate services provided by eBay Inc. such as insurance, tax and legal. This charge is denominated in Euros and these forecasted inter-company transactions at eBay Inc. represent a foreign currency cash Öow exposure. To reduce foreign exchange risk relating to these forecasted inter- company transactions, we entered into forward foreign exchange contacts during the year ended December 31, 2004. The objective of the forward contracts is to ensure that the U.S. dollar-equivalent cash Öows are not adversely aÅected 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 these forecasted transactions to be highly eÅective in oÅsetting potential changes in cash Öows 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 other income, net, related to the forward contracts that do no receive hedge accounting treatment pursuant to FAS 133. There were no outstanding forward contracts that receive hedge accounting treatment at December 31, 2004. The following table shows the notional amount of our economic hedges entered into in 2004, together with the associated losses, net of gains, recorded in our consolidated statement of income for the year ended December 31, 2004, and the amounts recorded to accumulated other comprehensive income at December 31, 2004: Notional Amount Net Loss Recorded to Interest and Other Income, Net (In thousands) Accumulated Other Comprehensive Income Amount receiving hedge accounting treatment under FAS 133 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $140,196 $(3,357) Amount not receiving hedge accounting treatment under FAS 133 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 30,772 (333) Total ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $170,968 $(3,690) $Ì Ì $Ì No economic hedges were entered into during the year ended December 31, 2003. Note 7 Ì Balance Sheet Components: Accounts receivable, net: Accounts receivable ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Allowance for doubtful accounts ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Allowance for authorized credits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $273,940 (43,194) (4,875) $319,489 (67,853) (10,780) $225,871 $240,856 December 31, 2003 2004 (In thousands) 113 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. December 31, 2003 2004 (In thousands) Other current assets: Customer accountsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Prepaid expenses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Deferred tax asset, netÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 29,990 33,101 24,134 15,945 $270,918 54,159 10,427 43,911 $103,170 $379,415 In February 2004, PayPal obtained a license to operate as an ELMI from the United Kingdom's Financial Services Authority. As a result of regulatory requirements associated with this ELMI license, PayPal transferred the accounts and funds of its European Union users from its U.S. parent to its U.K. subsidiary. Customer funds in the U.S. are held in deposit accounts insured by the Federal Deposit Insurance Corporation, or FDIC, and are held by PayPal as an agent for the beneÑt of its customers. These funds are not reÖected on our balance sheet. ELMI regulations require that customer balances in the U.K. subsidiary be represented as claims on the subsidiary and invested only in speciÑed types of liquid assets. These customer balances are therefore included on our balance sheet as current assets with an oÅsetting liability. At December 31, 2004, the amount recorded within customer funds on our consolidated balance sheet related to the funds in the U.K. subsidiary was $206.4 million. December 31, 2003 2004 (In thousands) Property and equipment, net: Computer equipment and software ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Land and buildings, including building improvements ÏÏÏÏÏÏÏÏÏÏÏÏÏ Aviation equipmentÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Leasehold improvements ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Furniture and Ñxtures ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Vehicles and other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 462,971 293,238 30,473 49,645 35,026 80 $ 683,716 278,709 30,398 99,623 43,689 211 Accumulated depreciation ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (269,648) (426,573) $ 871,433 $1,136,346 $ 601,785 $ 709,773 During the years ended December 31, 2002, 2003 and 2004, we capitalized $15.5 million, $38.5 million and $41.3 million of software development costs, respectively, the majority of which relates to major site and other product development eÅorts. Total depreciation expense on our property and equipment was $60.7 million in 2002, $105.8 million in 2003 and $183.5 million in 2004. From time to time and in the ordinary course of business, we elect to sell real estate properties previously held for lease, or purchase properties or property interests for future rental. No real estate properties were sold 114 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. during 2003. During 2004, we sold the remaining property related to our former ButterÑelds subsidiary for approximately $12.7 million in cash and recognized a loss of approximately $800,000. December 31, 2003 2004 (In thousands) Accrued expenses: Acquisition related accrued expensesÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Compensation and related beneÑtsÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Advertising ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Contractors and consultants ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Professional fees ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Transaction loss reserveÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other current liabilities ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 78,527 61,429 45,498 11,638 49,330 12,008 98,061 $ 17,679 110,146 65,499 21,464 51,029 10,986 145,166 $356,491 $421,969 Note 8 Ì Long-Term Obligations: The following table summarizes our long-term obligations, including the current portion: December 31, 2003 2004 (In thousands) Consolidated facilities lease ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Capital leases ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $122,498 4,818 $ 122,498 1,849 SubtotalÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Less: Current portionÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 127,316 (2,840) 124,347 (124,272) Long-term portion ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $124,476 $ 75 As of December 31, 2004, we had $126.4 million included within current restricted cash and investments relating to our San Jose headquarters lease facilities. In February 2004, we elected not to exercise certain rights to extend the lease period and, as a result, will purchase the leased facilities on March 1, 2005. Accordingly, we have reclassiÑed the restricted cash and the liability relating to this lease as short-term in nature. At December 31, 2004, we were in compliance with our Ñnancial covenants under the lease. Capital leases consist of various computer and other oÇce leases that totaled $4.8 million and $1.8 million at December 31, 2003 and 2004, respectively. Minimum annual repayments on our consolidated facilities lease and capital leases at December 31, 2004, are as follows (in thousands): Year Ending December 31, 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Thereafter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total $124,272 75 Ì $124,347 115 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. Approximately $122.5 million of the 2005 obligation payable represents the payment to the lessor, which excludes the $3.9 million in relation to the non-controlling minority interest, for the corporate headquarters in San Jose, California. The future lease payments through March 2005 under this lease arrangement are included within our obligations under operating leases. See ""Note 9 Ì Operating Lease Arrangements'' of these consolidated Ñnancial statements. Lease payments related to our corporate headquarters in San Jose, California are estimated based on market interest rates (LIBOR) at December 31, 2004, adjusted to reÖect our two interest rate swaps and certain collateral assumptions. We entered into two interest rate swaps on June 19, 2000 and July 20, 2000 to reduce the impact of changes in interest rates on a portion of the Öoating rate operating lease for this facility. The interest swap will mature in March 2005. See ""Note 6 Ì Derivative Instruments'' of these consolidated Ñnancial statements. Note 9 Ì Operating Lease Arrangements: 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, 2004, are as follows (in thousands): Year Ending December 31, 2005 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2006 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2007 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2008 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 2009 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Thereafter ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Operating Leases $19,987 15,522 11,238 9,371 7,435 26,634 Total minimum lease payments ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $90,187 Rent expense in the years ended December 31, 2002, 2003 and 2004, totaled $3.6 million, $8.6 million, and $7.7 million, excluding payments under our consolidated facilities lease, respectively. Note 10 Ì Commitments and Contingencies: 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 aÇliates in the regional court of Cologne, Germany. The suit subsequently was transferred to the regional court in D usseldorf, 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 D usseldorf, 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. In March 2004, the German Federal Supreme Court ruled in favor of Rolex in a case involving an unrelated company, ricardo.de AG, but somewhat comparable legal theories. The court issued its written decision in that case in September 2004. Although it is not yet clear what eÅect the reasoning of the German Federal Supreme Court's ricardo.de decision would have when applied to eBay, we believe the Court's decision will likely not require any signiÑcant change in our business practices. 116 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. In September 2001, a complaint was Ñled by MercExchange LLC 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 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, eÅectively 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 Ñnding that eBay had willfully infringed one and Half.com had willfully infringed both of the patents in the suit, awarding $35.0 million in compensatory damages. Both parties Ñled post-trial motions, and in August 2003, the court entered judgment for MercExchange in the amount of $29.5 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 Ñled 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. Oral arguments for the appeals were heard on October 5, 2004. The U.S. Patent and Trademark OÇce recently granted our request that it reexamine the three patents at suit, and on January 26, 2005, the Patent and Trademark OÇce issued a ruling rejecting all of MercExchange's claims under the patent that related to online auctions. We continue to believe that the verdict against us in the trial was incorrect and intend to continue to pursue our appeal and defend ourselves vigorously. However, even if successful, our appeal of and defense against this action will continue to be costly. In addition, as a precautionary measure, we have modiÑed certain functionality of our websites and business practices in a manner which we believe makes them not infringe the two patents that we were found to have infringed. Nonetheless, if we are not successful in appealing the court's ruling, we might be forced to pay signiÑcant additional damages and licensing fees or modify our business practices in an adverse manner. We recorded an operating charge in the amount of $30.0 million, reÖecting the $29.5 million judgment, together with our estimate for pre-judgment interest of $0.5 million. The charge and the related estimated tax beneÑt of $12.1 million were reÖected in our consolidated statement of income as patent litigation expense in the year ended December 31, 2003. In August 2002, Charles E. Hill & Associates, Inc. Ñled 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, unspeciÑed damages, including treble damages for willful infringement, and interest, costs, expenses, and fees. In January 2003, the case was transferred to the U.S. District Court for the Southern District of Indiana. After pending in Indiana for almost a year, the case was transferred back to the U.S. District Court for the Eastern District of Texas in December 2003. A scheduling conference was held in November 2004 and a preliminary trial date has been set for February 2006. The case is currently in fact discovery and claim construction discovery. We believe that we have meritorious defenses and intend to defend ourselves vigorously. In February 2002, PayPal was sued in California state court (No. CV-805433) in a purported class action alleging that its restriction of customer accounts and failure to promptly unrestrict 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-Ñled with a diÅerent named plaintiÅ in June 2002 (No. CV-808441), and a similar action was also Ñled 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 restrictions of customer accounts and failure to promptly unrestrict 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 117 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. reached a proposed settlement. The settlement received approval from the federal court on November 2, 2004, but the court's approval could be appealed. 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 will be eligible to receive payment from a settlement fund of $9.25 million, less administrative costs and the amount awarded to plaintiÅs' counsel by the court. That sum will be distributed to class members who have submitted timely claims in accordance with the settlement's plan of allocation, which still must be approved by the court. The parties expect that a plan of allocation will be submitted to the court in the Ñrst quarter of 2005. The amount of the settlement was fully accrued in our consolidated statement of income for the year ended December 31, 2003. In July 2004, a purported class action lawsuit was Ñled 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 Ñled in January 2005, dropping one plaintiÅ, changing the capacity of the other plaintiÅ to that of representative plaintiÅ, and adding seven additional eBay users as plaintiÅs. The amended complaint expanded its claim to include numerous alleged improper billing practices from September 2003 until the present. In February 2005, eBay Ñled a motion to strike and a demurrer seeking to dismiss the complaint. We believe that we have meritorious defenses and intend to defend ourselves vigorously. 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 artiÑcially inÖating 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. The plaintiÅs have not yet served eBay with the complaint. We believe that we have meritorious defenses and intend to defend ourselves vigorously. 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 notiÑed 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 business. 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 that arise in the ordinary course of business. The number and signiÑcance of these disputes is increasing as our business expands and our company grows larger. Any claims against us, whether meritorious or not, could be time consuming, result in costly litigation, require signiÑcant amounts of management time, and result in the diversion of signiÑcant operational resources. While we currently believe that the ultimate resolution of these unresolved matters will not have a material adverse impact on our Ñnancial position, results of operations or cash Öows, the litigation and other claims noted speciÑcally or generally above are subject to inherent uncertainties and our view of these matters may change in the future. Were an unfavorable Ñnal outcome to occur, there exists the possibility of a material adverse impact on our Ñnancial position, results of operations or cash Öows for the period in which the eÅect becomes reasonably estimable. We are unable to determine what potential losses we may incur if these matters were to have an unfavorable outcome. 118 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. IndemniÑcation Provisions In the ordinary course of business, we have included limited indemniÑcation 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 indemniÑed party for losses suÅered or incurred by the indemniÑed 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. To date, no signiÑcant costs have been incurred, either individually or collectively, in connection with our indemniÑca- tion provisions. Note 11 Ì Related Party Transactions: We have entered into indemniÑcation agreements with each of our directors, executive oÇcers and certain other oÇcers. 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 aÇliation with us. Commercial agreements A member of our Board of Directors is a general partner of certain venture capital funds that beneÑcially hold in the aggregate a greater than 10% equity interest in several public and private companies. We engaged in the following transactions with such companies: In April 2000, we entered into an advertising and promotions agreement with a privately held company that provides a marketplace for live advice. Under this agreement, we recognized revenues of approximately $200,000 in 2002 and none in 2003 and 2004. In 1999, we invested $2.0 million in capital stock of such company and received a warrant to purchase additional shares, which if exercised, would bring our total ownership to less than 5% of its capital stock. In 2000, we invested $3.0 million in capital stock of a privately held 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 eÅected an initial public oÅering of its common stock in 2004. 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 $1,348,000 in January 2003 in accordance with the terms of the agreement. In addition, in July 2003, the 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 $156,251 of revenue in 2003, and $323,184 of revenue in 2004. The revenues expected to be recognized by us is approximately $35,500 per month for the remainder of the term, which is through May 2006. All contracts with related parties are at rates and terms that we believe are comparable with those entered into with independent third parties. 119 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. Notes receivable from eBay executive oÇcers At December 31, 2003 we held notes receivable from certain executive oÇcers totaling $630,000. During 2003, all but one of such outstanding notes were pre-paid in full. The remaining outstanding note was paid in full during 2004. Note 12 Ì 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 Ñx the rights, preferences and privileges of the shares of each wholly unissued series and any related qualiÑcations, 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, 2003 and 2004, there were 10 million shares of Preferred Stock authorized for issuance, and no shares issued or outstanding. Note 13 Ì Common Stock: Our CertiÑcate of Incorporation, as amended, authorizes us to issue 1,790 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, 2003 and 2004 there were 34,000 and 140,000 shares subject to repurchase rights, respectively. At December 31, 2004, we had reserved 250.0 million shares of common stock available for future issuance under our stock option plans, including 137.2 million shares related to outstanding stock options. In addition, we had reserved approximately 4.0 million shares of common stock available for future issuance under our deferred stock unit plan, and approximately 6.0 million shares of common stock available for future issuance under our employee stock purchase plan. Note 14 Ì Employee BeneÑt 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 oÅering period with a maximum duration of two years at 85% of the lower of the fair market value on the Ñrst day of the applicable oÅering period or on the last day of the six- month purchase period. Employees may purchase shares having a value not exceeding 10% of their gross compensation during an oÅering period. During the years ended December 31, 2002, 2003 and 2004, employees purchased approximately 704,000, 1.2 million and 1.2 million shares at average prices of $11.31, $12.79 and $20.66 per share, respectively. At December 31, 2004, approximately 6.0 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. 401(k) Savings Plan We have a savings plan, which qualiÑes 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 matching contributions were $2.3 million in 2002, $3.9 million in 2003 and $5.6 million in 2004. 120 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. 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). These deferred stock units vest 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. Deferred stock units are payable following the termination of a director's tenure as a director. All eBay oÇcers, 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, 2004, 15,586 units have been awarded under this plan. Equity Incentive Plans We have equity incentive plans for directors, oÇcers 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 lapse over the vesting period. Restricted stock issued under these plans are subject to repurchase by us at such times as determined by the Board of Directors, typically Ñve years. At our Annual Meeting of Stockholders held on June 24, 2004, our stockholders approved amendments to certain of our equity incentive plans to increase the number of shares of common stock that may be issued under the plans by a total of 48 million shares. At December 31, 2004, 112.8 million shares were available for future grant. The following table summarizes activity under our equity incentive plans for the years ended December 31, 2002, 2003 and 2004 (shares in thousands): 2002 Weighted Average Exercise Price Shares Year Ended December 31, 2003 Weighted Average Exercise Price Shares 2004 Weighted Average Exercise Price Shares Outstanding at beginning of period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Granted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Exercised ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Cancelled ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 140,416 67,466 (39,076) (20,092) $11.56 13.36 6.54 13.50 148,714 53,388 (52,288) (11,404) $13.43 22.63 12.96 16.18 138,410 43,628 (38,718) (6,112) $16.93 38.27 16.17 23.73 Outstanding at end of period ÏÏ 148,714 13.43 138,410 16.93 137,208 23.63 Options exercisable at end of period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 52,496 $13.15 45,010 $13.92 49,346 $16.77 121 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. The following table summarizes information about Ñxed stock options outstanding at December 31, 2004 (shares in thousands): Range of Exercise Prices $ 0.08 Ì $13.24 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $13.25 Ì $14.51 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $14.51 Ì $18.10 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $18.24 Ì $18.85 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $18.85 Ì $19.39 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $19.39 Ì $27.38 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $27.43 Ì $33.40 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $33.46 Ì $34.62 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $34.63 Ì $57.21 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $57.37 Ì $58.21 ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Options Outstanding at December 31, 2004 Number of Shares Outstanding Weighted Average Remaining Contractual Life Weighted Average Exercise Price Options Exercisable at December 31, 2004 Number of Shares Exercisable Weighted Average Exercise Price 15,990 21,332 15,254 2,836 15,842 20,590 5,624 24,412 14,246 1,082 137,208 5.7 years 7.3 6.8 6.8 8.0 8.1 8.8 9.2 9.6 10.0 7.9 $ 8.21 14.17 16.06 18.70 19.38 24.61 29.14 34.58 43.91 58.03 $23.63 12,514 9,632 8,426 1,770 5,256 7,056 1,150 3,494 48 Ì 49,346 $ 7.57 14.21 16.03 18.72 19.35 24.12 28.80 34.61 39.20 Ì $16.77 Exercisable Unexercisable Total In-the-money ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Out-of-the-money ÏÏÏÏÏÏÏÏÏÏÏÏÏ 49,346 Ì Shares Weighted Average Exercise Price $16.77 Ì Weighted Average Exercise Price $27.44 58.21 Shares 87,756 106 Weighted Average Exercise Price $23.60 58.21 Shares 137,102 106 Total options outstanding ÏÏÏÏÏÏÏ 49,346 $16.77 87,862 $27.48 137,208 $23.63 In-the-money options are options with an exercise price lower than the $58.17 closing price of our common stock on December 31, 2004. Out-of-the-money options are options with an exercise price greater than the $58.17 closing price of our common stock on December 31, 2004. 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 Ì an interpretation of APB Opinion No. 25'' and EITF 00-23 ""Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No. 44'', to remeasure the portion of the 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, 2004 totaled approximately $3.7 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, 2.9%; eÅective contractual life 3.5 years; dividend yield, 0%; and expected volatility, 36.0%. 122 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. The following table summarizes additional stock option information related to grants made to our employees and grants made speciÑcally to named oÇcers, which include our chief executive oÇcer and the other four most highly compensated oÇcers during the year (in thousands, except percentages): Year Ended December 31, 2003 2004 2002 Total outstanding shares of common stock (at period end) 1,245,108 1,298,586 1,338,608 As a percentage of total outstanding shares of common stock: Grants during the period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total outstanding ""in-the-money'' grants ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total outstanding grants ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Grants to named oÇcers during the periodÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total outstanding grants to named oÇcers ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total stock option grants during the period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 5% 10% 12% * 1% 4% 11% 11% * 1% 3% 10% 10% * 1% 67,466 53,388 43,628 Grants to named oÇcers during the period as a percent of total grants during the period ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Total outstanding stock option grants (at period end) ÏÏÏÏÏ 5% 9% 7% 148,714 138,410 137,208 Total outstanding grants to named oÇcers as a percent of total stock option grants outstanding ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 9% 11% 11% * Less than half of a percentage point Non-stockholder approved stock option grants Prior to our initial public oÅering 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 oÇcer 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 nonqualiÑed option grants made under the stock option plan in eÅect at that time. At the time of such grants, members of our Board of Directors (and their aÇliates) beneÑcially owned in excess of 90% of our then outstanding voting interests. We have previously disclosed such option grants in our Prospectus Ñled with the Securities and Exchange Commission on September 25, 1998 in connection with our initial public oÅering under the headings ""Management Ì Director Compensation'' and ""Management Ì Compensation Arrangements.'' Prior to 2004, one director and the executive oÇcer had exercised all available options under their respective grants. At December 31, 2004, one grant remained outstanding to one independent director, with 1,690,000 shares to be issued upon exercise of the outstanding options at an average exercise price of $0.39. There were no shares remaining available under these non-stockholder approved plans for future grants as of December 31, 2004. 123 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. Note 15 Ì Income Taxes: The components of pretax income excluding minority interest in consolidated companies for the years ended December 31, 2002, 2003 and 2004 are as follows (in thousands): Year Ended December 31, 2003 2004 2002 United States ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ International ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $266,152 131,981 $449,078 212,422 $ 820,892 307,338 $398,133 $661,500 $1,128,230 The provision for income taxes is composed of the following (in thousands): Year Ended December 31, 2003 2004 2002 Current: Federal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State and localÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreign ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $103,606 18,992 10,062 $124,075 36,646 10,378 $246,795 57,099 23,546 132,660 171,099 327,440 Deferred: Federal ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State and localÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Foreign ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 8,091 5,195 Ì 40,619 (1,041) (3,939) 27,836 (3,565) (7,826) 13,286 35,639 16,445 $145,946 $206,738 $343,885 The following is a reconciliation of the diÅerence between the actual provision for income taxes and the provision computed by applying the federal statutory rate of 35% for 2002, 2003, and 2004 to income before income taxes (in thousands): Year Ended December 31, 2003 2004 2002 Provision at statutory rate ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Permanent diÅerences: $138,543 $228,873 $394,881 Foreign income taxed at diÅerent rates ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Change in valuation allowance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Subsidiary loss not beneÑted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Tax-exempt interest incomeÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ State taxes, net of federal beneÑt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Tax credits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Other ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (5,406) Ì 1,052 (2,378) 15,722 (2,021) 434 (45,190) 5,756 Ì (1,272) 23,297 (7,943) 3,217 (84,094) 2,000 Ì Ì 35,008 (6,975) 3,065 $145,946 $206,738 $343,885 124 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. Deferred tax assets and liabilities are recognized for the future tax consequences of diÅerences between the carrying amounts of assets and liabilities and their respective tax bases using enacted tax rates in eÅect for the year in which the diÅerences are expected to reverse. SigniÑcant deferred tax assets and liabilities consist of the following (in thousands): December 31, 2003 2004 Deferred tax assets: Net operating loss and credits ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Accruals and allowances ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net unrealized (gains)losses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 186,142 38,344 9,469 $ 165,673 57,648 (6,596) Net deferred tax assets ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Valuation allowance ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 233,955 (165,831) 216,725 (158,602) Deferred tax liabilities: Acquisition-related intangibles ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Depreciation and amortization ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ (107,064) (16,164) (129,310) (54,357) 68,124 58,123 (123,228) (183,667) $ (55,104) $(125,544) As of December 31, 2004, our federal and state net operating loss carryforwards for income tax purposes were approximately $605.8 million and $138.6 million, respectively. If not utilized, the federal net operating loss carryforwards will begin to expire in 2019, and the state net operating loss carryforwards will begin to expire in 2006. Our federal and state research tax credit carryforwards for income tax purposes are approximately $35.9 million and $35.3 million, respectively. If not utilized, the federal tax carryforwards will begin to expire in 2021. We receive tax deductions from the gains realized by employees on the exercise of certain non-qualiÑed stock options for which the beneÑt is recognized as a component of stockholders' equity. 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 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 beneÑt from these amounts. When realized, the tax beneÑt of tax deductions related to stock options are accounted for as a credit to additional paid-in capital rather than a reduction of the income tax provision. We have not provided for U.S. federal income and foreign withholding taxes on $669.2 million of non-U.S. subsidiaries' undistributed earnings as of December 31, 2004, because such earnings are intended to be indeÑnitely reinvested in the operations and potential acquisitions of our International Marketplace 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. Note 16 Ì Subsequent Events: On February 23, 2005, we acquired all outstanding securities of Rent.com for approximately $415 million plus our acquisition costs, net of Rent.com's cash on hand. Rent.com is a leading Internet listing website in the apartment and rental housing industry. 125 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. In January 2005, our Board of Directors approved a two-for-one split of our shares of common stock to be issued in the form of a stock dividend. As a result of the stock split, our stockholders received one additional share of our common stock for each share of common stock held of record on January 31, 2005. The additional shares of our common stock were distributed on February 16, 2005. All share and per share amounts in these consolidated Ñnancial statements and related notes have been adjusted to reÖect the stock split for all periods presented. Supplementary Data Ì Quarterly Financial Data-Unaudited: The following tables present certain unaudited consolidated quarterly Ñnancial information for each of the 12 quarters ended December 31, 2004. 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 Ñnancial data have been adjusted to reÖect all previous stock splits, including our two-for-one stock split, eÅective February 16, 2005. Quarterly Financial Data (Unaudited, in thousands, except per share amounts) March 31 June 30 September 30 December 31 Quarter Ended 2002 Net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 245,106 $ 266,287 $ 288,779 $ 413,928 Gross proÑt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 203,829 $ 221,726 $ 243,405 $ 331,264 Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Net income per share-basic ÏÏÏÏÏÏÏÏÏÏÏÏ Net income per share-diluted ÏÏÏÏÏÏÏÏÏÏ $ $ $ 47,584 0.04 0.04 $ $ $ 54,308 0.05 0.05 $ $ $ 61,003 0.05 0.05 $ $ $ 86,996 0.07 0.07 Weighted-average shares: Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,113,328 1,139,564 1,122,828 1,141,664 1,129,068 1,146,364 1,234,576 1,257,580 126 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued) eBay Inc. March 31 June 30 September 30 December 31 Quarter Ended 2003 Net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 476,492 $ 509,269 $ 530,942 $ 648,393 Gross proÑt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 384,394 $ 410,119 $ 421,589 $ 532,936 Income before cumulative eÅect of accounting change ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 104,191 $ 91,868 $ 108,663 $ 142,462 Cumulative eÅect of accounting change, net of tax ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì $ (5,413) Ì Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 104,191 Net income per share-basic ÏÏÏÏÏÏÏÏÏÏÏÏ Net income per share-diluted ÏÏÏÏÏÏÏÏÏÏ $ $ 0.08 0.08 $ $ $ 91,868 $ 103,250 $ 142,462 0.07 0.07 $ $ 0.08 0.08 $ $ 0.11 0.11 Weighted-average shares: Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,254,632 1,285,036 1,273,360 1,312,294 1,285,458 1,324,462 1,293,638 1,332,330 March 31 June 30 September 30 December 31 Quarter Ended 2004 Net revenues ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 756,239 $ 773,412 $ 805,876 $ 935,782 Gross proÑt ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 621,881 $ 626,881 $ 648,755 $ 759,377 Net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 200,100 $ 190,395 $ 182,349 $ 205,379 Net income per share-basic ÏÏÏÏÏÏÏÏÏÏÏÏ Net income per share-diluted ÏÏÏÏÏÏÏÏÏÏ $ $ 0.15 0.15 $ $ 0.14 0.14 $ $ 0.14 0.13 $ $ 0.15 0.15 Weighted-average shares: Basic ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Diluted ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,305,002 1,347,596 1,316,138 1,364,842 1,323,144 1,369,954 1,333,486 1,385,694 127 eBay Inc. FINANCIAL STATEMENT SCHEDULE The Financial Statement Schedule II Ì VALUATION AND QUALIFYING ACCOUNTS is Ñled as part of this Annual Report on Form 10-K. Allowance for Doubtful Accounts and Authorized Credits Year ended December 31, 2002 Year ended December 31, 2003 Year ended December 31, 2004 Allowance for Transaction Losses Year ended December 31, 2002 Year ended December 31, 2003 Year ended December 31, 2004 Tax Valuation Allowance Year ended December 31, 2002 Year ended December 31, 2003 Year ended December 31, 2004 Balance at Beginning of Period Charged/ Credited to Net Income Charged to Other Account (In thousands) Charges Utilized/ Write-OÅs Balance at End of Period $ 29,024 30,702 48,069 $25,455 46,049 90,942 $ Ì $(23,777) (28,682) (60,378) Ì Ì $ 30,702 48,069 78,633 Ì 10,107 12,008 129,212 145,182 165,831 7,832 36,401 50,459 15,970 20,649 (7,229) 8,848* Ì Ì (6,573) (34,500) (51,481) 10,107 12,008 10,986 Ì Ì Ì Ì Ì Ì 145,182 165,831 158,602 * Assumed liability in connection with PayPal acquisition on October 3, 2002. 128 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 25th day of February, 2005. SIGNATURES eBay Inc. By: /s/ MARGARET C. WHITMAN Margaret C. Whitman President, Chief Executive OÇcer and Director POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Margaret C. Whitman, Rajiv Dutta 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 conÑrming 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. Principal Executive OÇcer: Principal Financial OÇcer: By: /s/ MARGARET C. WHITMAN By: /s/ RAJIV DUTTA Margaret C. Whitman President, Chief Executive OÇcer and Director Rajiv Dutta Senior Vice President and Chief Financial OÇcer Principal Accounting OÇcer: By: /s/ DOUGLAS JEFFRIES Douglas JeÅries Vice President, Chief Accounting OÇcer 129 Additional Directors By: /s/ PIERRE M. OMIDYAR By: /s/ FRED D. ANDERSON Pierre M. Omidyar Founder, Chairman of the Board and Director Fred D. Anderson Director By: /s/ PHILIPPE BOURGUIGNON By: /s/ SCOTT D. COOK Philippe Bourguignon Director Scott D. Cook Director By: /s/ ROBERT C. KAGLE By: /s/ DAWN G. LEPORE Robert C. Kagle Director Dawn G. Lepore Director By: /s/ RICHARD T. SCHLOSBERG, III By:/s/ THOMAS J. TIERNEY Richard T. Schlosberg, III Director Date: February 25, 2005 Thomas J. Tierney Director 130 EXHIBIT INDEX No. 3.01 3.02 4.01 4.02 Exhibit Description Registrant's Amended and Restated CertiÑcate of Incorporation. Registrant's Amended and Restated By-laws. Form of Specimen CertiÑcate for Registrant's Common Stock. Investor Rights Agreement, dated June 20, 1997, between the Registrant and certain stockholders named therein. Filed with this 10-K Incorporated by Reference Form File No. Date Filed 10-Q 000-24821 8/4/2004 10-Q 000-24821 333-59097 S-1 11/13/1998 8/19/1998 S-1 333-59097 7/15/1998 10.01° Form of Indemnity Agreement entered into by S-1 333-59097 7/15/1998 Registrant with each of its directors and executive oÇcers. 10.02° Registrant's 1996 Stock Option Plan. 10.03° Registrant's 1997 Stock Option Plan. 10.04° Registrant's 1998 Equity Incentive Plan, as amended. 10.05° Registrant's 2001 Equity Incentive Plan. 10.06° Registrant's 1998 Directors Stock Option Plan. 10.07° Registrant's 2003 Deferred Stock Unit Plan. 10.08° Registrant's Amended and Restated 1998 Employee Stock Purchase Plan. S-1 S-1 S-1 333-59097 333-59097 333-59097 7/15/1998 7/15/1998 7/15/1998 S-8 333-117913 10-Q 000-24821 333-107832 S-8 333-117913 S-8 8/4/2004 5/15/2003 8/11/2003 8/4/2004 10.09° Registrant's 1999 Global Equity Incentive Plan, as S-8 333-117913 8/4/2004 amended. 10.10° Employment Letter Agreement dated January 16, 1998, between Margaret C. Whitman and Registrant. S-1 333-59097 8/19/1998 10.11° Employment Letter Agreement dated August 20, S-1 333-59097 9/1/1998 1998, between Michael R. Jacobson and Registrant. 10.12° OÅer Letter to Maynard G. Webb, Jr. dated S-3 333-88205 9/30/1999 July 17, 1999. 10.13° Retention Bonus Plan dated January 10, 2001, between Registrant and Maynard G. Webb, Jr. (Corrected). 10.14° Stock Option Agreement dated June 9, 1998 between Registrant and Scott D. Cook. 10.15° OÅer Letter to JeÅrey D. Jordan dated July 30, 1999. 10.16° Retention Bonus Plan dated May 16, 2000, between Registrant and JeÅrey D. Jordan. 10.17° Retention Bonus Plan dated April 3, 2001, between Registrant and JeÅrey D. Jordan. 10-Q 000-24821 8/14/2001 10-K 000-24821 3/31/2003 S-3 333-88205 9/30/1999 10-K 000-24821 3/28/2001 10-Q 000-24821 8/14/2001 10.18° OÅer Letter to William C. Cobb dated 10-K 000-24821 3/25/2002 November 22, 2000. 10.19° Supplemental Retention Bonus Plan dated 10-Q 000-24821 8/6/2002 April 14, 2002, between Registrant and William C. Cobb. 10.20° Special Bonus Plan between Registrant and 10-Q 000-24821 11/14/2002 Matthew J. Bannick, dated as of September 6, 2002. No. 10.21 10.22 Exhibit Description Lease dated March 1, 2000, between eBay Realty Trust and Registrant. Cash Collateral Agreement between Registrant and Chase Manhattan Bank as Agent, dated March 1, 2000. Filed with this 10-K Incorporated by Reference Form File No. Date Filed 10-K 000-24821 3/30/2000 10-K 000-24821 3/30/2000 10.23° Form of Stock Bonus Agreement under eBay Inc. 10-Q 000-24821 10/27/2004 1998 Equity Incentive Plan. 10.24° Form of Stock Option Agreement under eBay Inc. 10-Q 000-24821 10/27/2004 1998 Equity Incentive Plan. 10.25° Form of Stock Option Agreement under eBay Inc. 10-Q 000-24821 10/27/2004 1999 Global Equity Incentive Plan. 10.26° Form of Stock Option Agreement under eBay Inc. 10-Q 000-24821 10/27/2004 2001 Equity Incentive Plan. 10.27° Description of eBay Inc.'s Executive Management 10-Q 000-24821 10/27/2004 Incentive Plan. 10.28° OÅer Letter to Christopher Corrado dated 8-K 000-24821 1/3/2005 November 19, 2004. 10.29° OÅer Letter to Scott Thompson dated January 12, 8-K 000-24821 2/7/2005 2005. 10.30° OÅer Letter to John Donahoe dated November 16, 8-K 000-24821 2/24/2005 21.01 23.01 24.01 31.01 31.02 32.01 32.02 2004. List of Subsidiaries. PricewaterhouseCoopers LLP consent. Power of Attorney (see signature page). CertiÑcation of the Registrant's Chief Executive OÇcer, as required by Section 302 of the Sarbanes-Oxley Act of 2002. CertiÑcation of Registrant's Chief Financial OÇcer, as required by Section 302 of the Sarbanes-Oxley Act of 2002. CertiÑcation of Registrant's Chief Executive OÇcer, as required by Section 906 of the Sarbanes-Oxley Act of 2002. CertiÑcation of Registrant's Chief Financial OÇcer, as required by Section 906 of the Sarbanes-Oxley Act of 2002. X X X X X X X ° Indicates a management contract or compensatory plan or arrangement 

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