Paypal Holdings, Inc. quarterly report, Q1 FY2019

PayPal Holdings, Inc. — Q1 2019 Form 10-Q

Reporting period: Three months ended March 31, 2019; comparative period is Q1 2018. PayPal operates a global digital-payments platform, including PayPal, Venmo, Braintree, Xoom, PayPal Credit and iZettle. Figures are unaudited.

Financial and operating performance

Metric	Q1 2019	Q1 2018	Change
Net revenue	$4.128 billion	$3.685 billion	+12%
Operating income / margin	$518 million / 13%	$534 million / 14%	Income down 3%
Net income	$667 million	$511 million	+31%
Diluted EPS	$0.56	$0.42	+34%
Operating cash flow	$1.027 billion	$(349) million	Improved
Investing cash flow	$(4.860) billion	$5 million	—
Financing cash flow	$1.502 billion	$793 million	—

• Payment volume (TPV) rose 22% to $161.5 billion; payment transactions increased 28% to 2.838 billion; active accounts rose 17% to 277 million. Transactions per active account increased 9% to 37.9.
• Transaction revenue grew 17% to $3.731 billion. Other value-added-services revenue declined 19% to $397 million, principally reflecting the sale of the U.S. consumer-credit receivables portfolio.
• Operating expenses increased 15% to $3.610 billion. Transaction expense rose 21%, while the transaction expense rate remained 0.96% of TPV. Transaction and loan losses increased 12% to $341 million; the loss rate declined to 0.21% of TPV from 0.23%.
• Net income benefited substantially from $180 million of unrealized gains on strategic investments, recorded in other income. Operating income fell despite higher revenue, and operating margin narrowed by one percentage point.
• At March 31, cash and cash equivalents were $4.515 billion; short-term investments $3.334 billion; long-term investments $1.695 billion; and notes payable $1.999 billion. Management’s cash, cash equivalents and investments measure was $8.227 billion, excluding customer funds, restricted cash and strategic investments. This is distinct from the $10.903 billion cash-flow total, which includes specified customer-account and restricted-cash balances.
• Funds receivable and customer accounts were $22.738 billion, against funds payable and amounts due to customers of $24.238 billion. These customer-related balances are not equivalent to unrestricted corporate liquidity.

Material changes and management commentary

• Revenue growth reflected 22% TPV growth, partly offset by lower interest and fee income after the July 2018 sale of U.S. consumer-credit receivables to Synchrony Bank. Management expected that sale to reduce total revenue growth by approximately 7–8% through Q2 2019; the impact was uncertain.
• Management attributed slower transaction-revenue growth than TPV growth to a higher mix of lower-fee P2P transactions and a lower cross-border TPV mix. Cross-border TPV declined to 18% from 21%.
• The $1.027 billion operating cash inflow compared with an outflow in Q1 2018, when changes in loans held for sale were a significant use of cash. Q1 2019 investing outflows primarily reflected investment purchases, increased funds receivable, loan growth and capital expenditures.
• PayPal repurchased $750 million of shares under an accelerated share repurchase, receiving approximately 7.7 million shares. At quarter-end, approximately $724 million remained available under the April 2017 program; the separate $10 billion July 2018 program had not yet begun.
• Q1 2019 workforce actions generated $78 million of restructuring charges in the note disclosure; the income statement reports $73 million of restructuring and other charges. Management expected restructuring cash payments to be substantially complete by year-end 2019 and said most savings from the affected workforce, whose estimated annual employee-related costs were approximately $175 million, would be reinvested.
• On April 5, 2019, PayPal drew an additional $500 million under its credit facility, taking borrowings under that facility from $2.0 billion at quarter-end to $2.5 billion after the draw.

Outlook, risks and contingencies

• The filing provides no formal earnings or revenue guidance. Management stated that existing liquidity, operating cash generation, capital-market access and potential third-party funding were expected to fund operations, anticipated capital expenditures and credit products for the foreseeable future. Not all cash is available for general corporate use because of customer obligations and regulatory requirements.
• Key business risks include evolving payments and financial-services regulation, privacy and cybersecurity, anti-money-laundering and sanctions compliance, foreign-exchange movements, credit losses, and the ability to maintain customer trust and transaction growth. The filing describes uncertainty about Brexit and potential effects on regulation, markets and operations.
• PayPal reported ongoing OFAC inquiries concerning self-reported transactions that may have violated sanctions. Its FTC Venmo consent order requires changes to disclosures and business practices; failure to comply could lead to further action or penalties.
• A securities class action relating to TIO Networks’ security incident remained pending; a motion to dismiss had been filed, with a hearing scheduled for July 11, 2019. The company said it could not estimate losses from potential non-monetary remedies in disclosed proceedings; accrued legal and regulatory amounts were not material.
• The U.K. Competition and Markets Authority’s review of the iZettle acquisition could affect integration and expected benefits; a final decision was due by May 21, 2019. The filing also identifies risks from acquisition integration and strategic investments.
• Strategic investments totaled approximately $1.2 billion at quarter-end. Management cautioned that fair-value changes could create material future net-income volatility; a hypothetical 10% decline would reduce portfolio value by approximately $124 million.

Important facts for investors to verify

• Whether underlying operating profitability and margins improve, given operating income declined while revenue grew and transaction costs increased.
• How much reported net-income growth depends on investment gains, and whether those gains recur.
• Whether TPV, accounts and transaction growth translate into revenue growth despite lower-fee P2P mix and reduced cross-border share.
• The realized revenue impact of the Synchrony portfolio sale after the expected Q2 2019 headwind period.
• Credit portfolio performance, particularly growth in merchant receivables and the consumer and merchant delinquency and loss trends disclosed in the filing.
• Progress and outcomes in the TIO, OFAC, Venmo, Brexit and iZettle CMA matters, and any resulting financial or operational effects.
• Corporate liquidity available after distinguishing company resources from customer funds, restricted balances and strategic investments; also verify debt following the April 5 draw.