PayPal Holdings, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Amounts are in U.S. dollars; financial figures are in millions unless stated otherwise. PayPal operates a global digital payments platform, including PayPal, Venmo, Xoom, Braintree and credit products.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net revenue | $3,857 | $3,136 | $7,542 | $6,111 |
| Operating income | $572 | $430 | $1,106 | $861 |
| Operating margin | 15% | 14% | 15% | 14% |
| Net income | $526 | $411 | $1,037 | $795 |
| Diluted EPS | $0.44 | $0.34 | $0.86 | $0.65 |
| Operating cash flow | $28 | $921 | $(321) | $1,672 |
| Free cash flow (non-GAAP) | $(170) | $747 | $(697) | $1,350 |
- Q2 revenue rose 23%; transaction revenue increased 20% and other value-added services increased 49%. Six-month revenue also rose 23%.
- Q2 TPV was $139.4 billion, up 29%; active accounts were 244 million, up 15%; payment transactions were 2.327 billion, up 28%. Six-month TPV increased 30% to $271.8 billion.
- Q2 transaction expense rose 28%, faster than revenue, while transaction and loan losses rose 8%. The transaction and loan loss rate declined to 0.24% of TPV from 0.29%.
- At June 30, cash and cash equivalents were $2.840 billion; short- and long-term investments totaled $3.494 billion. The company reported $6.083 billion of cash, cash equivalents and investments excluding customer-account assets and specified restricted cash and equity investments. Customer funds and related balances are not equivalent to unrestricted corporate liquidity.
- Total assets were $41.677 billion and total liabilities were $26.658 billion. Notes payable were $2.0 billion, outstanding under a 364-day facility at a 3.12% weighted-average rate; no capacity remained under that facility. The separate $2.0 billion revolving facility was undrawn, and approximately $350 million was available under regional uncommitted facilities.
Material changes and unusual items
- Net income growth reflected higher operating income and other income, partly offset by higher income tax expense. Q2 effective tax rate was 14%, versus 8% a year earlier; the six-month rate was 10% in both periods.
- Reported operating cash flow and free cash flow were materially affected by the U.S. consumer credit portfolio’s held-for-sale classification. The filing attributes $2.2 billion of the six-month operating cash flow reduction to the changed presentation of that portfolio, including its originations and collections; this weakens direct comparability with 2017.
- Restructuring and other charges were $116 million in Q2 and $269 million for the first half. These include held-for-sale portfolio cost-basis adjustments of $116 million and $244 million, respectively; first-half workforce and TIO wind-down restructuring charges were $25 million.
- PayPal repurchased $2.325 billion of shares in the first half; $2.674 billion remained under its existing $5 billion authorization at June 30. In July, the board authorized a further $10 billion program to begin after the existing program is completed.
Outlook, risks and contingencies
- No formal earnings or revenue guidance is stated in the provided filing text. Management expects the Synchrony transaction to reduce total revenue growth by 6% to 8% in each of Q3 2018 through Q2 2019, mainly due to lower other value-added services revenue. The U.S. consumer credit portfolio sale closed in July for stated consideration of $6.9 billion, including $6.5 billion cash and a long-term receivable; price adjustments remain possible. PayPal expects to earn a profit share on Synchrony’s portfolio.
- Management said available cash, investments, operating cash generation and expected capital-market access should fund operations, capital expenditures and credit products for the foreseeable future. It also noted that some cash supports customer obligations and regulatory requirements and is not available for general corporate use.
- Planned acquisitions included iZettle for about $2.2 billion, expected to close in Q3 subject to conditions, and Hyperwallet for about $400 million, expected to close in Q4 subject to conditions. Simility was acquired in July for about $120 million.
- Risks include extensive and changing payments, privacy, consumer-protection and anti-money-laundering regulation; cyberattacks and service interruptions; foreign-exchange exposure; credit and loan-loss risk; and dependence on financial-institution and technology partners. GDPR became effective in May 2018. Management reported no material off-balance-sheet arrangements.
- Regulatory and legal matters include DOJ subpoenas concerning the historical anti-money-laundering program, OFAC inquiries into possible sanctions violations, and litigation and inquiries related to TIO’s security breach, which potentially affected personal information of about 1.6 million customers. The FTC Venmo consent order requires changes to disclosures and practices but carries no monetary penalty; failure to comply could lead to further consequences. Management said accrued legal and regulatory amounts were not material, while outcomes remain uncertain.
Key facts for investors to verify
- How the held-for-sale accounting and July Synchrony sale affect future revenue, cash conversion, credit exposure and the expected profit-share stream.
- Whether transaction-loss growth, credit quality and merchant-loan growth remain manageable as payment volumes expand.
- Unrestricted corporate liquidity after accounting for customer funds, regulatory requirements, debt maturity and planned acquisitions and repurchases.
- The durability of reported earnings growth given restructuring and portfolio adjustments, tax-rate changes, stock-based compensation and non-GAAP exclusions.
- Developments in TIO-related security matters, DOJ and OFAC inquiries, FTC compliance, and other regulatory or litigation exposure.