PayPal Holdings, Inc. — Q3 2019 Form 10-Q
Business context and period. PayPal operates a global digital payments platform that includes PayPal, Venmo, Braintree, Xoom, PayPal Credit and iZettle. This unaudited filing covers the quarter and nine months ended September 30, 2019; comparative periods are 2018.
Key financial results
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net revenue | $4.378 billion | $3.683 billion | $12.811 billion | $11.225 billion |
| Operating income | $697 million | $490 million | $1.920 billion | $1.596 billion |
| Operating margin | 16% | 13% | 15% | 14% |
| Net income | $462 million | $436 million | $1.952 billion | $1.473 billion |
| Diluted earnings per share | $0.39 | $0.36 | $1.64 | $1.22 |
| Operating cash flow | Not separately stated in the summary table | Not separately stated in the summary table | $3.297 billion | $4.349 billion |
Q3 revenue rose 19%, operating income 42%, and net income 6% year over year. For the nine months, revenue increased 14%, operating income 20%, and net income 33%. The filing reports no gross margin measure.
- Payments activity: Q3 total payment volume (TPV) was $178.7 billion, up 25%; payment transactions were 3.09 billion, up 25%; active accounts reached 295 million, up 16%. Transaction revenue grew 18%, slower than TPV, partly due to a greater mix of lower-fee P2P payments and fewer cross-border transactions.
- Cash flows: Nine-month investing cash flow was negative $5.334 billion and financing cash flow was positive $3.837 billion. Cash, cash equivalents and restricted cash increased $1.751 billion to $14.984 billion. Operating cash flow declined year over year, in part because the prior-year period included a $1.4 billion cash inflow from changes in loans held for sale.
- Liquidity and customer funds: The company reported $11.378 billion of cash, cash equivalents and investments, excluding strategic investments, restricted cash and customer funds. Separately, funds receivable and customer accounts were $22.511 billion, with corresponding funds payable and amounts due to customers of $24.011 billion; these customer-related balances should not be treated as unrestricted corporate liquidity. Management said available resources and expected cash generation should fund foreseeable needs.
- Debt: PayPal issued $5.0 billion of senior unsecured fixed-rate notes in September, with maturities from 2022 to 2029. Carrying value was $4.964 billion at quarter-end. It repaid $2.5 billion under a prior delayed-draw facility. New revolving facilities provided $6.0 billion of undrawn capacity; additional regional facilities had about $230 million of capacity, substantially all available.
- Credit portfolio: Loans and interest receivable, net, were $3.477 billion, versus $2.532 billion at December 31, 2018. Merchant loans and advances grew substantially; nine-month loan losses were $210 million, up 24% year over year.
Material changes and unusual items
- Q3 other expense was $213 million, versus $43 million of other income a year earlier, primarily reflecting $228 million of unrealized losses on strategic investments. For the nine months, other income was $224 million, including $170 million of gains on strategic investments.
- Q3 tax expense fell to $22 million from $97 million; the effective tax rate was 5%, compared with 18%. The nine-month effective rate was 9%, versus 13% in 2018. Management attributed the lower rates mainly to discrete tax adjustments and the mix of earnings.
- Nine-month revenue growth was partly offset by lower consumer-credit interest and fee income following the July 2018 sale of the U.S. consumer credit receivables portfolio to Synchrony. PayPal now earns revenue share on that portfolio.
- PayPal adopted lease accounting in January 2019, recording $511 million in right-of-use assets and $521 million in lease liabilities at adoption; management reported no significant impact on earnings or cash flows.
- Operating expense captions were reclassified in 2019, including consolidation of platform operating and product-development costs into technology and development. The reclassification did not change prior-period total expenses, net income, financial position or cash flows.
Outlook, risks and contingencies
- No specific quarterly or full-year financial guidance is provided in this filing. Management stated that cash, operating cash generation, capital-market access and potential third-party funding were expected to be sufficient for foreseeable operating, capital and credit-product needs.
- Expected credit loss accounting was scheduled for adoption January 1, 2020. PayPal estimated that its allowance for loans and interest receivable could increase approximately 65%–85% compared with the then-current incurred-loss model; the actual impact would depend on portfolio quality and economic conditions.
- Key exposures include extensive and changing payments regulation, privacy and cybersecurity, fraud and transaction losses, foreign exchange, strategic-investment valuation volatility, credit quality, and dependence on partners such as Synchrony and financial institutions. Brexit uncertainty was identified as a potential source of regulatory, economic and currency risk.
- PayPal reported an AUSTRAC notice requiring an external audit of aspects of its Australian AML/CTF compliance. It had also self-reported possible sanctions-related transactions to OFAC and received additional subpoenas. The filing says legal and regulatory accruals were not material for the nine months, while warning outcomes remain uncertain.
- A securities class action related to TIO was dismissed with prejudice in September 2019; plaintiffs appealed. The CMA imposed a £250,000 penalty concerning compliance with an interim order during its iZettle review, but the decision did not require PayPal to delay or change integration.
- Strategic workforce reductions generated $78 million of charges in the first nine months. Cash payments were expected to be substantially completed by year-end; management expected most of the estimated $175 million in annual employee-related cost reductions to be reinvested in the business.
Important facts for investors to verify
- Whether TPV and account growth translate into durable revenue and margin growth despite lower-fee P2P mix and rising transaction costs.
- Trends in merchant-credit delinquencies, loan-loss provisions and the expected allowance increase under the new credit-loss standard.
- How much of reported cash and investments is available for corporate use after regulatory and customer-fund requirements, and how the new debt proceeds are deployed.
- The sensitivity of reported earnings to strategic-investment valuations, foreign exchange and tax-rate changes.
- Developments in OFAC, AUSTRAC and other regulatory matters, the TIO appeal, and the planned GoPay transaction in China.
- The effect of the July 2020 expiration of PayPal’s eBay operating agreement and the outcome of the referral-fee arbitration on revenue and operating income.