PayPal Holdings, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Financial statements are unaudited. Unless otherwise noted, figures are in U.S. dollars.
Business context
PayPal operates a global digital payments platform, including PayPal, Braintree, Venmo, Xoom, PayPal Credit and other services. Its revenue is primarily transaction fees, with additional revenue from credit products and other value-added services.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net revenue | $3.239B | $2.667B | $9.350B | $7.861B |
| Operating income | $423M | $348M | $1.284B | $1.126B |
| Operating margin | 13% | 13% | 14% | 14% |
| Net income | $380M | $323M | $1.175B | $1.011B |
| Diluted EPS | $0.31 | $0.27 | $0.96 | $0.83 |
| Operating cash flow | $1.006B | $801M | $2.678B | $2.235B |
| Free cash flow (non-GAAP) | $841M | $618M | $2.191B | $1.718B |
- Q3 revenue increased 21%; operating income rose 22%; net income rose 18%. Nine-month revenue increased 19%, operating income 14%, and net income 16%.
- TPV grew 30% in Q3 and 26% for the nine-month period. Active accounts reached 218 million, up 14%; payment transactions grew 26% in Q3 and 24% year to date.
- Transaction revenue grew more slowly than TPV, partly because of a greater mix of lower-rate person-to-person payments, foreign-exchange hedging effects and acquisitions.
- Transaction expense rose 33% in Q3, faster than revenue, partly reflecting higher payment-processor assessments. Transaction and loan losses rose 34% in Q3; management attributed loan-loss growth mainly to the expanding credit portfolio.
- Non-GAAP operating margin was 20% in Q3 and 21% for nine months, compared with 18% and 20%, respectively. These measures exclude specified costs, including stock compensation and acquired-intangible amortization, and are not GAAP results.
Balance sheet, liquidity and capital
- At September 30, cash and cash equivalents were $2.330B, short-term investments $2.591B and long-term investments $2.217B. Management’s liquidity measure of cash, cash equivalents and investments was $6.972B, excluding customer-account assets, restricted cash and cost-method investments.
- Funds receivable and customer-account assets were $17.175B, against $17.975B of funds payable and amounts due to customers. These customer-related balances should be distinguished from corporate liquidity.
- Loans and interest receivable, net, were $6.321B, up from $5.348B at year-end 2016. The related allowance was $429M, compared with $339M.
- PayPal had $800M outstanding on its $2.0B revolving credit facility at a 2.36% weighted-average rate, leaving $1.2B of capacity subject to customary conditions. The company reported investment-grade ratings.
- Nine-month investing cash outflow was $4.400B, including $1.154B of net principal-loan investment and $323M for acquisitions, net of cash acquired. Financing cash inflow was $2.427B, including increased customer funds payable and facility borrowing.
- PayPal repurchased $706M of stock in the first nine months. The filing reported approximately $5.3B remaining under authorized repurchase programs.
Material changes and unusual items
- PayPal acquired TIO Networks for $238M in July to expand bill-payment services and Swift Financial for approximately $183M in September to strengthen merchant financing and underwriting. Purchase accounting was preliminary; the acquired businesses’ reported-period results were not material.
- A workforce-reduction plan generated $40M of restructuring expense in the first nine months; management expected the plan to be substantially completed by year-end 2017. Management said resulting savings were expected to be reinvested in the business.
- Stock-based compensation expense was $522M for the first nine months, up from $317M. The Q3 income-tax rate was 16%, versus 10%; the nine-month rate was 12%, versus 13%. Tax accounting changes and discrete items affected the comparisons.
- Foreign-exchange cash-flow hedges had a net fair-value liability of $134M at quarter-end; $107M of net hedge losses in accumulated other comprehensive income was expected to be reclassified into earnings within 12 months.
Outlook, risks and contingencies
- The filing provides no specific forward-looking revenue, earnings or margin guidance. Management stated that available liquidity, expected operating cash flow, capital-market access and potential third-party funding were expected to be sufficient for foreseeable operating needs, capital expenditures and credit products.
- Key risks include rapid changes in payments regulation, consumer-protection and privacy requirements, cybersecurity and service outages, foreign-exchange movements, Brexit-related uncertainty, and dependence on partner banks for U.S. lending products.
- Credit risk is material and growing: consumer and merchant lending balances expanded, and the consumer-loan net charge-off rate was 6.4%, versus 6.0% a year earlier. The filing also reports changes in consumer credit-score mix and loan-loss provisions.
- Regulatory matters include an FTC investigation concerning Venmo, OFAC inquiries into potentially sanctions-related transactions, and DOJ subpoenas concerning the historical anti-money-laundering program. A Venmo-related securities class action was voluntarily dismissed without prejudice; shareholder derivative litigation remained pending. Recorded legal accruals were not material, but outcomes and potential non-monetary remedies were uncertain.
- Management reported effective disclosure controls. A customer and transaction sub-ledger implementation changed certain financial-reporting processes; management said it would continue monitoring related controls.
Investor facts to verify
- Whether TPV growth converts into revenue growth and improves transaction economics, given lower-yield P2P mix and rising processor costs.
- Whether loan-loss rates, delinquency trends and allowance levels remain appropriate as consumer and merchant credit balances grow.
- How TIO and Swift Financial perform, and whether integration, goodwill and acquired receivables create additional costs or credit exposure.
- Developments in the FTC, OFAC, DOJ and shareholder-derivative matters, including potential costs or required business changes.
- Liquidity available for corporate use after separating customer funds, and the effects of repurchases, borrowing and foreign-exchange exposure.