PayPal Holdings, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. PayPal operates a global digital payments platform, including PayPal, Venmo, Braintree, Xoom, PayPal Credit and iZettle. Financial amounts below are in U.S. dollars; millions unless stated otherwise.
Financial results and key metrics
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net revenue | $4,305 | $3,857 | $8,433 | $7,542 |
| Operating income | $705 | $572 | $1,223 | $1,106 |
| Operating margin | 16% | 15% | 15% | 15% |
| Net income | $823 | $526 | $1,490 | $1,037 |
| Diluted EPS | $0.69 | $0.44 | $1.25 | $0.86 |
| Operating cash flow | $1,174 | $28 | $2,201 | $(321) |
- Revenue and activity: Q2 revenue rose 12%; transaction revenue increased 17% to $3,878, while other value-added services declined 21% to $427. Total payment volume (TPV) rose 24% to $172.4 billion; payment transactions increased 28% to 2.973 billion; active accounts grew 17% to 286 million.
- Costs and margins: Q2 operating expenses rose 10% to $3,600. Transaction expense increased 19%, slower than TPV growth, and the transaction expense rate improved to 0.94% from 0.98%. Transaction and loan losses were $318, down 5%; the transaction loss rate fell to 0.14% from 0.19%.
- Cash flow: First-half investing cash flow was $(5,957) and financing cash flow was $2,498. Cash, cash equivalents and restricted cash ended the period at $11,974, down $1,259 from year-end 2018.
- Liquidity and debt: Management reported $8,613 of cash, cash equivalents and investments, excluding customer funds, restricted cash and strategic investments. Customer-related funds and accounts were $23,573, largely matched by $25,073 of funds payable and amounts due to customers; these funds are not all available for general corporate use. Notes payable were $2,499, at a weighted-average interest rate of 3.47%. The $5 billion delayed-draw facility had no remaining borrowing capacity; approximately $130 million of uncommitted credit facilities was substantially available.
- Credit and capital: Net loans and interest receivable were $3,166. Merchant loans, advances and related receivables totaled $2.4 billion, with 9.0% past the original expected repayment period. Consumer receivables were $909 million; 94.1% were current. PayPal repurchased $750 million of shares in an accelerated repurchase completed in March.
Material changes versus prior periods
- Q2 revenue growth was driven by TPV and account activity, but transaction revenue grew more slowly than TPV, reflecting a higher share of lower-fee person-to-person payments and a lower share of cross-border TPV.
- The sale of the U.S. consumer credit receivables portfolio to Synchrony in July 2018 reduced interest and fee income, contributing an estimated seven percentage points of negative impact to revenue growth. PayPal now earns a revenue share on the Synchrony portfolio rather than holding the receivables.
- Q2 net income included $218 million of gains on strategic investments, versus $31 million a year earlier. These gains were the primary reason other income rose to $238 million from $37 million; first-half strategic investment gains were $398 million.
- Operating cash flow improved substantially year over year, while investing cash flow moved from a $563 million inflow to a $5,957 million outflow, reflecting investment purchases, growth in customer funds receivable and loan funding.
- The company adopted lease accounting on January 1, 2019, recording $511 million of right-of-use assets and $521 million of lease liabilities. It also reclassified certain operating expense captions; prior-period net income and total expenses were unchanged.
Outlook, commentary, risks and unusual items
- Management stated that cash, investments, expected operating cash generation, capital-market access and potential external funding were expected to be sufficient for operating activities, anticipated capital expenditures and credit products for the foreseeable future. The filing provides no specific quantitative earnings or revenue guidance.
- Management cited growth in PayPal, Braintree and Venmo activity, and improved risk management as contributing to transaction-loss-rate improvement. It also cautioned that transaction loss rates may not predict future losses.
- Strategic investment gains are recorded through earnings and may create material net-income volatility. A hypothetical 10% decline in the strategic investment portfolio would reduce its carrying value by about $201 million.
- Credit exposure is increasing: merchant receivables grew 71% year over year, and the consumer receivables net charge-off rate was 3.5%, versus 2.7% a year earlier. The company noted that credit growth increases liquidity needs.
- Key risks include evolving payments, privacy, cybersecurity, consumer-protection and anti-money-laundering regulation; Brexit uncertainty; foreign-exchange exposure; dependence on third-party bank partners, including Synchrony; and competition and execution risks in point-of-sale expansion.
- PayPal had self-reported possible sanctions-processing violations to OFAC and received additional subpoenas. The TIO data-security matter involved potential exposure of personal information for approximately 1.6 million customers; related litigation remained pending. The filing said legal accruals were not material and that potential losses for certain matters could not be estimated.
- The FTC Venmo consent order requires changes to disclosures and business practices; noncompliance could bring additional consequences. The CMA cleared PayPal’s iZettle acquisition in June 2019. 2019 restructuring charges were $78 million in the first half, with related cash payments expected to be substantially complete by year-end; most expected employee-cost savings were to be reinvested.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much reported earnings growth is repeatable after excluding strategic investment gains and other non-operating items.
- Whether TPV and transaction growth can translate into revenue growth despite lower-fee payment mix and the loss of U.S. consumer-credit interest income.
- Credit quality, loss allowances and funding needs as merchant and international consumer receivables expand.
- Cash available for corporate use after accounting for customer-fund safeguarding, regulatory liquidity requirements and debt obligations.
- Developments in OFAC, TIO-related litigation, the FTC consent order and other regulatory matters, including any material financial or operational consequences.
- Effects of foreign exchange, Brexit and strategic investment valuation changes on subsequent-period results.