PayPal Holdings, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. PayPal operates a global digital-payments platform, including PayPal, Venmo, Braintree, Xoom and PayPal Credit. Financial amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Change |
|---|---|---|---|
| Net revenue | $3.683 billion | $3.239 billion | +14% |
| Operating income / margin | $490 million / 13% | $423 million / 13% | +16% |
| Net income | $436 million | $380 million | +15% |
| Diluted EPS | $0.36 | $0.31 | +17% |
| Non-GAAP operating margin | 21% | 20% | +1 percentage point |
For the nine months, revenue was $11.225 billion (+20%), operating income $1.596 billion (+24%), net income $1.473 billion (+25%), and diluted EPS $1.22 (+27%). GAAP operating margin was 14%, unchanged year over year; non-GAAP operating margin rose to 22% from 21%. Non-GAAP figures exclude specified items and are not GAAP measures.
- Q3 total payment volume (TPV) rose 24% to $143.0 billion; payment transactions grew 27% to 2.463 billion, and active accounts increased 15% to 254 million. Nine-month TPV increased 28% to $414.8 billion.
- Q3 transaction revenue grew 17% to $3.343 billion, while other value-added-services revenue fell 11% to $340 million. Management attributed slower transaction-revenue growth than TPV growth to a greater mix of lower-rate P2P payments and large merchants, and fewer cross-border transactions.
- Q3 transaction expense rose 24% to $1.366 billion, broadly in line with TPV growth; transaction and loan losses decreased 19% to $295 million, mainly because of lower U.S. consumer-loan losses after the portfolio sale.
- Cash and cash equivalents were $8.147 billion at quarter-end, versus $2.883 billion at year-end 2017. Cash, cash equivalents and investments available for corporate purposes were $10.263 billion, excluding customer-account assets, restricted cash and equity investments. Customer funds and related obligations are substantial and are not equivalent to unrestricted corporate liquidity.
- Current and total liabilities were $26.640 billion and $28.609 billion. Notes payable were $2.0 billion, outstanding under a facility due in December 2018; the separate $2.0 billion revolving facility was undrawn, as were approximately $350 million of regional facilities.
- Nine-month operating cash flow was $4.349 billion and capital spending $599 million; free cash flow was $3.750 billion. These cash-flow measures were materially boosted by presentation effects related to the U.S. consumer-credit portfolio held for sale: the filing identifies benefits of $1.4 billion for the nine-month period and $3.7 billion for Q3.
Material changes and unusual items
- PayPal completed the sale of its U.S. consumer credit receivables portfolio to Synchrony Bank in July for $6.9 billion of consideration, including $6.5 billion cash and a long-term receivable recorded at $261 million. PayPal no longer owns newly generated U.S. consumer-credit receivables, but earns revenue share and provides transition servicing. The sale included an approximately $28 million net loss and was subject to post-closing adjustments.
- Management expected the sale to reduce total revenue growth by approximately 6%–8% in each of Q4 2018 and the first two quarters of 2019; actual impact could differ. It also expected other value-added-services revenue growth to be negatively affected over that period.
- PayPal acquired iZettle in September for approximately $2.2 billion, primarily to expand in-store merchant services, and acquired fraud-management firm Simility for $107 million. The iZettle purchase-price allocation was preliminary; U.K. competition authorities were reviewing the transaction, with the businesses kept separate pending review. A proposed $400 million Hyperwallet acquisition was expected to close in Q4, subject to conditions and regulatory approval.
- Nine-month restructuring and other charges were $297 million, including $244 million of held-for-sale portfolio cost-basis adjustments, $25 million of workforce/TIO restructuring charges and the sale-related loss. PayPal had suspended TIO operations after identifying a security breach that potentially affected personal information of approximately 1.6 million customers.
Outlook, risks and contingencies
Management stated that cash, operating cash generation and expected capital-market access should be sufficient to fund operations, investment and credit products for the foreseeable future. The filing does not provide broader quantified earnings or revenue guidance. Key risks include cybersecurity and service interruptions, evolving payment, privacy and anti-money-laundering regulation, foreign-exchange exposure, credit losses, reliance on banking and technology partners, and acquisition integration. The FTC Venmo consent order requires changes to disclosures and practices but carries no monetary penalty; compliance failures could lead to further action. OFAC inquiries and TIO-related litigation and regulatory inquiries remain potential exposures. Management said probable legal accruals were not material, while noting legal outcomes are uncertain.
Important facts for investors to verify
- Track the Synchrony revenue-share transition and the stated 6%–8% near-term revenue-growth headwind.
- Separate reported cash flow and free cash flow from the disclosed held-for-sale presentation benefits.
- Confirm repayment or refinancing of the $2.0 billion facility due in December 2018 and assess cash availability after customer and regulatory needs.
- Monitor iZettle regulatory review and integration, the proposed Hyperwallet acquisition, and TIO breach-related proceedings.
- Assess whether TPV and transaction growth translate into revenue growth and margins given payment mix and rising transaction expense.