PayPal Holdings, Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. PayPal became an independent publicly traded company on July 17, 2015, after separation from eBay. Prior-period results reflect eBay’s payments business and allocated corporate costs; they may not be directly comparable with PayPal’s results as a standalone company.
Financial results and operating metrics
| Metric | Q3 2015 | Q3 2014 | Change |
|---|---|---|---|
| Net revenue | $2.258 billion | $1.975 billion | +14% |
| Operating income | $330 million | $272 million | +21% |
| Operating margin | 15% | 14% | +1 percentage point |
| Net income | $301 million | $234 million | +29% |
| Diluted EPS | $0.25 | $0.19 | +28% |
| Operating cash flow | $652 million | $604 million | +8% |
| Free cash flow (non-GAAP) | $519 million | $431 million | +20% |
For the nine months, revenue was $6.692 billion (+15%), operating income $1.050 billion (+14%), net income $861 million versus $133 million, diluted EPS $0.70 versus $0.11, operating cash flow $1.818 billion, and free cash flow $1.260 billion (+3%). The large year-over-year increase in nine-month net income primarily reflects the prior-year $650 million deferred tax liability charge related to undistributed foreign earnings; it is not a like-for-like measure of operating growth. Nine-month operating margin was 16% in both periods.
Q3 total payment volume (TPV) grew 20% to $69.7 billion; payment transactions grew 25% to 1.216 billion, and active customer accounts increased 10% to 173 million. Transaction revenue rose 13%; other value-added services revenue rose 25%. Management attributed growth principally to increased customer engagement and Braintree and Venmo, while a larger share of volume from lower-rate large merchants constrained revenue growth relative to TPV.
Transaction and loan losses were $201 million in Q3 (+12%); the nine-month amount was $564 million (+25%). The nine-month transaction-and-loan-loss rate was 0.28% of TPV versus 0.27%. Transaction expense rose 21% in Q3, and its rate edged up to 0.93% of TPV, reflecting processor assessments and funding mix. Foreign exchange movements reduced Q3 revenue by approximately $101 million, including a $38 million favorable hedge impact; management estimated a net $11 million adverse effect on Q3 net income.
Balance sheet, liquidity and financing
- At September 30, 2015, cash and cash equivalents were $1.880 billion; short- and long-term investments totaled $4.811 billion. Management reported $6.665 billion of cash, cash equivalents and available-for-sale investments available for corporate use, excluding customer funds.
- Funds receivable and customer accounts were $11.802 billion, matched by $11.802 billion of funds payable and amounts due to customers. These balances are customer-related and should not be treated as unrestricted corporate liquidity.
- Total assets were $27.896 billion and total liabilities $14.682 billion. Long-term liabilities were $1.610 billion; the filing text does not provide a clear breakdown here of this balance as funded debt.
- PayPal had a $2.0 billion five-year revolving credit facility, with no borrowings or letters of credit outstanding at quarter-end. A cash-pooling arrangement showed $2.0 billion of withdrawals offset against $2.2 billion of aggregate cash deposits. The company reported investment-grade ratings from S&P and Fitch.
- Nine-month investing cash outflow was $5.132 billion, largely reflecting investment purchases, capital expenditures and acquisitions; financing cash inflow was $3.034 billion, primarily including an approximately $3.8 billion cash contribution from eBay, partly offset by repayments of eBay borrowings. Cash declined $321 million to $1.880 billion over the period.
Material developments, outlook and risks
- Separation and standalone costs: Increased public-company, professional-services, customer support and technology costs affected expenses. Management cautioned that historical results may not represent standalone performance.
- Credit products: Loans and interest receivable were $3.602 billion at quarter-end. PayPal purchased or extended approximately $5.3 billion of credit receivables during the first nine months, versus $3.8 billion a year earlier. Merchant Working Capital balances grew to $352 million from $103 million at year-end 2014. Credit expansion increases funding and loss exposure; consumer loans and merchant advances are subject to default risk.
- Synchrony agreement: The amended and extended program generated $37 million of additional Q3 revenue, including $30 million of gain-share revenue. Management expects quarterly gain-share revenue under the amended agreement. PayPal’s obligation to purchase the related receivables portfolio was terminated, though it retains an option to purchase at the end of the new contract term.
- Acquisitions: PayPal completed Paydiant, CyActive and another acquisition during the first nine months for aggregate consideration of approximately $283 million, net of cash acquired. The announced Xoom acquisition was expected to close in Q4 2015 for approximately $890 million, subject to customary conditions and regulatory approvals.
- Regulatory matters: A May 2015 CFPB consent order requires $15 million in consumer redress, a $10 million civil penalty, and changes to PayPal Credit disclosures and practices; review of compliance and redress plans remained pending. An OFAC settlement concerning earlier practices had no material financial statement impact, but other possible transactions remained under discussion with OFAC.
- Protection programs and contingencies: Estimated maximum potential exposure under buyer and seller protection programs was $101.762 billion; management cautioned this is not representative of actual expected exposure. The related transaction-loss allowance was $218 million. The filing says legal accruals and reasonably possible monetary losses above accruals were not material based on available information, but outcomes—including non-monetary remedies—remain uncertain.
- Management outlook: No numerical revenue or earnings guidance is provided in the filing. Management believed available cash, investments, operating cash generation and potential external funding would be sufficient for operations, anticipated capital spending and credit products for the foreseeable future. It also noted that further credit growth could increase liquidity needs.
- Principal risks: Foreign exchange and funding-mix volatility; fraud, transaction protection and credit losses; cybersecurity and service availability; intense payments competition; evolving global financial-services, privacy and consumer-protection regulation; and reliance on third-party banks, processors and the continuing eBay relationship. Management reported disclosure controls effective and no material change in internal control over financial reporting during the quarter.
Investor verification points
- Separate underlying operating growth from the prior-year tax charge, separation-related items, non-GAAP adjustments and the different standalone cost structure.
- Track credit portfolio growth, delinquency and loss trends, allowance adequacy, external funding availability and the impact of participation-interest sales.
- Confirm execution and integration of the Xoom acquisition, and evaluate the economics and recurring contribution of the amended Synchrony agreement.
- Monitor CFPB consent-order compliance and any additional regulatory, OFAC, litigation or consumer-redress exposure.
- Assess corporate liquidity separately from customer funds, including foreign-held cash, cash-pooling balances, capital expenditures and any future use of the revolving facility.
- Evaluate whether TPV and transaction growth can translate into revenue and margin growth despite large-merchant mix, processor costs, foreign exchange and post-separation expenses.