PayPal Holdings, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. PayPal operates a global digital payments platform including PayPal, PayPal Credit, Braintree, Venmo and Xoom. PayPal became independent of eBay in July 2015, so prior-year comparisons include periods before separation and may not be fully comparable.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net revenue | $2.650 billion | $2.297 billion | $5.194 billion | $4.434 billion |
| Operating income | $371 million | $398 million | $778 million | $720 million |
| Operating margin | 14% | 17% | 15% | 16% |
| Net income | $323 million | $305 million | $688 million | $560 million |
| Diluted EPS | $0.27 | $0.25 | $0.56 | $0.46 |
| Operating cash flow | $696 million | $622 million | $1.434 billion | $1.166 billion |
| Free cash flow (non-GAAP) | $495 million | $391 million | $1.100 billion | $741 million |
Q2 revenue rose 15% year over year and six-month revenue rose 17%; total payment volume increased 28% in both periods. Active customer accounts grew 11% to 188 million, while payment transactions increased 25%. Transaction revenue rose 18% in Q2; other value-added services revenue was flat in Q2 and up 15% for the half.
Operating expenses grew faster than revenue: 20% in Q2 and 19% for the half. Transaction and loan losses increased 38% in Q2 and 40% for the half. Q2 operating income fell 7%, while six-month operating income rose 8%. Net income growth benefited in part from lower income tax expense; effective tax rates were 15% in Q2 and 14% for the half.
Balance sheet, cash flow and liquidity
- At June 30, 2016, cash and cash equivalents were $2.018 billion; short- and long-term investments were $2.939 billion and $1.315 billion. Total assets were $30.631 billion and total liabilities were $16.814 billion.
- PayPal reported $6.199 billion of cash, cash equivalents and available-for-sale investments available to the company, excluding customer-account assets and restricted cash. Customer funds and related accounts totaled $13.034 billion and corresponding funds payable and amounts due to customers were $13.834 billion; these balances primarily relate to customer obligations and should not be treated as unrestricted liquidity.
- Six-month operating cash flow was $1.434 billion. Investing activities used $1.481 billion, and financing activities provided $657 million. Capital expenditures were $334 million.
- No borrowings or letters of credit were outstanding under the $2.0 billion five-year revolving credit facility; the full stated capacity was available subject to conditions. The filing does not provide a clear total debt figure in the supplied text.
- PayPal repurchased $896 million of shares during the half, with $1.104 billion remaining under its $2.0 billion authorization.
Material changes and notable items
- Growth reflected higher transaction volume, customer engagement and Braintree activity, as well as contributions from Xoom. Revenue growth was tempered by prior-year items: $57 million of additional revenue under a Synchrony Financial credit-program agreement and a $26 million gain on an initial consumer-loan sale.
- PayPal’s transaction and loan loss expense increased amid a larger credit portfolio and higher estimated delinquency rates. Consumer loans were $4.2 billion, up 35% year over year; the annualized consumer net charge-off rate was 6.3%, compared with 5.8% a year earlier. PayPal Working Capital receivables were $555 million, up 147%, and 6.5% were more than 90 days beyond the original expected repayment period, versus 3.6% a year earlier.
- Management attributed higher operating costs partly to operating as an independent public company and to Xoom-related costs. The prior-year period also included eBay reimbursements for certain protection-program losses that no longer apply after separation.
- In March 2016, PayPal designated $800 million of European customer balances, with regulatory approval, for use in extending credit to European customers. The company said this supported funding diversification and did not change its credit strategy or risk appetite.
- Foreign exchange movements reduced Q2 operating income by $5 million but increased first-half operating income by $10 million, after hedging. The company noted that hedging reduces but does not eliminate currency exposure.
Outlook, risks and contingencies
The filing provides no specific numerical earnings or revenue guidance. Management said existing cash, investments, operating cash generation and expected access to capital, together with potential third-party funding, should be sufficient for foreseeable operating, investment and credit needs. It also said it continues to evaluate external funding sources for its growing credit portfolio.
- Regulatory and legal exposure includes an FTC Civil Investigative Demand concerning Venmo practices; continued OFAC inquiries and subpoenas related to self-reported transactions; and the suspension of operations in Turkey after the regulator rejected PayPal’s e-money license application.
- Brexit may create currency, economic and regulatory uncertainty, including possible changes to PayPal’s ability to serve the U.K. through its Luxembourg banking license.
- Key business risks include fraud and customer-protection losses, credit deterioration, changing payment-card funding costs and network rules, privacy and cybersecurity incidents, and extensive or changing payments regulation. PayPal highlighted that its Visa partnership could increase card-funded transactions and related costs.
- Management stated that probable legal and regulatory accruals were not material for the six months ended June 30, 2016, but warned outcomes are uncertain and could be material. The estimated maximum potential exposure under protection programs was $116.639 billion; management cautioned that this is not representative of expected losses. The recorded transaction-loss allowance was $192 million.
Most important facts for investors to verify
- Whether transaction and loan losses, delinquency trends and charge-offs continue to rise as consumer and merchant credit balances expand.
- Whether transaction-volume growth translates into revenue and profit growth despite a higher mix of lower-rate P2P activity and large merchants.
- Developments in the FTC Venmo inquiry, OFAC matters, Turkey operations and Brexit-related licensing or market changes.
- The composition and availability of reported liquidity, including the distinction between company funds and customer-related balances, and the funding needs of the credit portfolio.
- How much reported earnings and non-GAAP performance depend on tax effects, foreign-exchange hedges, stock-based compensation and acquisition-related adjustments; non-GAAP measures are not substitutes for GAAP results.
- The effect of the post-separation structure on year-over-year comparability, including prior-period eBay allocations and reimbursements.