PayPal Holdings, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; filed April 26, 2018. PayPal operates a global digital payments platform, including PayPal, Venmo, Braintree, Xoom and credit products. Financial statement amounts below are in U.S. dollars; unaudited.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net revenue | $3.685B | $2.975B | +24% |
| Operating income | $534M | $431M | +24% |
| Operating margin | 14% | 14% | Flat |
| Net income | $511M | $384M | +33% |
| Diluted EPS | $0.42 | $0.32 | +33% |
| Operating cash flow | $(349)M | $751M | Changed to cash use |
| Free cash flow (non-GAAP) | $(527)M | $603M | Changed to cash use |
Revenue growth reflected 32% growth in total payment volume (TPV), to $132.4B. Active accounts rose 15% to 237M; payment transactions increased 25% to 2.214B. Transaction revenue grew 22% to $3.197B, while other value-added services revenue rose 39% to $488M. Management attributed slower transaction-revenue growth than TPV growth partly to a greater mix of lower-rate person-to-person payments and large merchants, and foreign-exchange hedging losses.
Operating expenses increased 24% to $3.151B. Transaction expense rose 29% to $1.275B, while transaction and loan losses were $305M, up 2%. The transaction-and-loan-loss rate declined to 0.23% of TPV from 0.30%; transaction losses themselves rose 42% to $243M. The effective tax rate was 7%, versus 12%, mainly reflecting discrete stock-compensation tax benefits and foreign income taxed at different rates.
Balance sheet, liquidity and debt
- At March 31, 2018, total assets were $42.322B, total liabilities $27.681B and equity $14.641B. Cash and cash equivalents were $2.879B; short- and long-term investments totaled $4.914B.
- Cash, cash equivalents and investments available for corporate purposes, as presented by the company and excluding customer-account assets, restricted cash and equity investments, were $7.622B. Customer funds and accounts were $19.162B, matched by $20.662B of funds payable and amounts due to customers; these customer-related balances are not equivalent to unrestricted corporate liquidity.
- Notes payable were $3.0B at quarter-end, drawn under the 364-day term facility at a 2.88% weighted-average rate; no capacity remained under that facility. PayPal repaid $1.0B on April 5, 2018. A separate $2.0B revolving facility was undrawn, and approximately $350M was available under regional uncommitted facilities.
- PayPal repurchased $1.825B of shares during the quarter, including a $1.0B accelerated repurchase; approximately $3.174B remained authorized. Management said existing liquidity, operating cash generation and access to capital were expected to fund foreseeable needs.
Material changes and unusual items
- Operating cash flow and free cash flow were substantially affected by the U.S. consumer credit portfolio’s held-for-sale accounting: the filing attributes a $1.3B operating-cash-flow reduction to the presentation change. Cash flow also reflected changes in other assets and liabilities. The negative cash-flow figures therefore warrant review alongside the accounting and portfolio transition, not in isolation.
- Restructuring and other charges were $153M, versus $40M. This included approximately $128M of cost-basis adjustments to U.S. consumer credit receivables held for sale, primarily driven by charge-offs, and $25M of workforce-reduction charges, including the TIO wind-down.
- PayPal expected the sale of its U.S. consumer credit receivables portfolio to Synchrony Bank to close in Q3 2018. After closing, Synchrony was to become the exclusive U.S. PayPal Credit online consumer-financing issuer; PayPal expected to receive a profit share and no longer own the receivables, apart from charged-off receivables.
- The company adopted new revenue-recognition guidance retrospectively; it reported the impact as de minimis. It also adopted other accounting updates without material financial-statement impact.
Outlook, commentary and risks
The filing provides no quantified forward guidance. Management cited growth in TPV and payment activity, operating efficiencies, and the expected Synchrony transaction. It also stated that actual results could differ from forward-looking expectations and undertook no obligation to update forward-looking statements.
- Credit exposure: U.S. consumer receivables held for sale totaled $6.537B. The Synchrony sale remained pending. Merchant loans, advances, interest and fees receivable reached $1.227B, up from $1.012B at year-end; merchant credit growth and repayment performance merit attention.
- TIO and security: PayPal suspended TIO operations amid security concerns and reported potential exposure of personal information for approximately 1.6M customers. Government inquiries and a securities class action were ongoing; further investigations or claims were possible.
- Regulatory and legal: PayPal entered an FTC consent order concerning Venmo disclosures and practices, with no monetary penalty but required business-practice changes and ongoing compliance obligations. OFAC had received self-reports and issued additional subpoenas; PayPal was also responding to DOJ subpoenas concerning its historical anti-money-laundering program. Outcomes were uncertain.
- Other risks: The filing emphasizes cybersecurity, service interruptions, privacy and evolving payments regulation, foreign-exchange exposure, Brexit-related uncertainty, and potential credit-rating or funding effects. Management said no off-balance-sheet arrangements had a reasonably likely material effect.
Important facts for investors to verify
- Reconcile the $349M operating cash outflow and $527M negative free cash flow to the held-for-sale presentation change, loan portfolio activity and working-capital movements.
- Track the timing, terms and completion of the Synchrony portfolio sale, and how it changes PayPal’s credit risk, revenue mix, cash generation and profit-share income.
- Assess the sustainability of TPV and account growth against transaction-revenue growth, transaction losses, funding mix and operating costs.
- Monitor merchant-credit delinquency, allowances and charge-offs, along with the effect of the expanding merchant-loan portfolio.
- Follow TIO-related investigations and litigation, Venmo consent-order compliance, and OFAC/DOJ matters for potential financial or operational consequences.
- Confirm debt repayment and remaining liquidity after quarter-end, and distinguish corporate cash and investments from funds held to meet customer obligations.