PayPal Holdings, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited results compared with Q1 2016. PayPal operates a global digital payments platform, including PayPal, PayPal Credit, Braintree, Venmo, Xoom and Paydiant.
Financial results and liquidity
- Revenue: $2.975 billion, up 17%. Transaction revenue was $2.599 billion (+16%); other value-added services revenue was $376 million (+23%). TPV rose 23% to $99.327 billion; payment transactions increased 23% to 1.732 billion, and active customer accounts increased 11% to 203 million.
- Profitability: Operating income was $431 million (+6%), with a 14% operating margin versus 16% a year earlier. Net income was $384 million (+5%); diluted EPS was $0.32 versus $0.30. Effective tax rate was 12% versus 14%.
- Non-GAAP measures: Non-GAAP operating income was $643 million, margin 22%, and diluted EPS $0.44. These exclude items including stock-based compensation, acquired-intangible amortization and restructuring; they are not GAAP measures. Free cash flow was $603 million versus $605 million.
- Cash flow: Operating cash flow was $751 million versus $738 million. Capital expenditures were $148 million, compared with $133 million. Investing activities used $1.058 billion; financing activities used $54 million. Cash and cash equivalents declined to $1.240 billion from $1.590 billion.
- Liquidity and debt: Cash, cash equivalents and available-for-sale investments totaled $6.301 billion, excluding customer-account assets and restricted cash. PayPal reported no borrowings or letters of credit under its $2.0 billion revolving facility, leaving $2.0 billion of capacity. Customer funds and corresponding amounts due to customers were $14.941 billion and $15.741 billion, respectively; these customer-related balances are distinct from corporate liquidity.
- Credit portfolio: Loans and interest receivable, net, were $5.354 billion at quarter-end. Consumer loan receivables were $5.1 billion; merchant working-capital receivables were $566 million. Transaction and loan losses rose 18% to $300 million, including loan losses up 32% to $129 million.
Material changes versus Q1 2016
- Revenue growth was supported by 23% TPV growth, particularly in PayPal and Braintree. Revenue grew more slowly than TPV and payment transactions because of a higher mix of lower-rate person-to-person activity, including Venmo, and large merchants with lower pricing.
- Operating expenses increased 19%, faster than revenue. Transaction expense rose 31% to $987 million, reflecting TPV growth, higher processor assessments and unfavorable funding mix. The transaction expense rate increased to 0.99% of TPV from 0.93%.
- Transaction and loan losses increased to $300 million from $255 million. Transaction losses rose 9%, though transaction losses as a share of TPV improved by two basis points; loan losses rose with portfolio growth and higher forecast delinquency assumptions.
- Operating margin fell by two percentage points, partly due to the $40 million restructuring charge. Management cited operating efficiencies: specified other operating expense categories increased 11%, below revenue growth.
- International customers generated approximately 46% of revenue, versus 47% a year earlier. Foreign exchange movements had an approximately $1 million net adverse effect on operating income in Q1 2017, after hedging.
Outlook, risks and unusual items
- No specific revenue, earnings or cash-flow guidance for upcoming periods is provided in the filing. Management said existing cash, investments, operating cash generation and expected capital-market access should fund foreseeable operating needs, capital expenditures and credit products.
- The global workforce reduction approved in Q1 carries an expected total cost of approximately $40 million, substantially completed by year-end 2017. Management expects approximately $75 million in annual savings, but said those savings are expected to be reinvested in the business.
- PayPal agreed to acquire TIO Networks for approximately $233 million in cash, with closing expected in the second half of 2017, subject to conditions including required consents relating to money-transmitter licenses.
- The board authorized a further $5 billion repurchase program in April 2017, effective after completion of the existing program. PayPal repurchased $517 million of stock in Q1; $488 million remained under the existing authorization at March 31.
- Key risks include evolving payments regulation; the FTC investigation into Venmo and related securities and derivative litigation; DOJ requests concerning the historical anti-money-laundering program; and OFAC inquiries regarding self-reported transactions. Management says it intends to defend the securities case; outcomes and possible losses are uncertain.
- Other exposures include consumer and merchant credit performance, dependence on third-party U.S. lending banks, Brexit-related market and regulatory uncertainty, foreign-exchange movements, and consumer-protection requirements. Management reported no material off-balance-sheet arrangements and no material accrued legal losses for the quarter.
Important facts for investors to verify
- Whether TPV and customer growth translate into revenue growth despite lower monetization from P2P activity and large merchants.
- Whether transaction costs and credit losses continue to outgrow revenue, and how consumer and merchant portfolio delinquency and charge-off trends develop.
- How restructuring savings, reinvestment, stock compensation and repurchases affect GAAP margins, cash generation and share count.
- Availability and use of corporate liquidity as the credit portfolio grows, distinguishing corporate funds from customer balances.
- Developments in the Venmo-related FTC and court matters, DOJ and OFAC inquiries, TIO acquisition conditions, and Brexit-related regulatory arrangements.