PayPal Holdings, Inc. (PYPL) Earnings Call Transcript & Summary

And we are live. Thank you so much. This is Tien-Tsin Huang. I'm the payments, processing and IT services analyst at JPMorgan, and really excited to have John Rainey with us from PayPal back into the conference, this time virtually. So it's great to see you, John, virtually. I can't shake your hand but I'll give you a virtual high five here. So like the other sessions, we're going to do a fireside chat. I fielded a lot of these questions from the investors, John, so hopefully that's okay. We'll go through it. We'll also take some questions from the Q&A button here. So feel free to enter those questions, and I'll try and weave them into the rest of the questions that we have. So again, John, thank you for being with us. Hope life is treating you okay.

I can't complain, Tien-Tsin, and I wish the same for you and all of the attendees today as well.

No, for sure. Let's just hope my WiFi stays on the whole time.

Yes, no kidding.

So let's get right into it. So I've been thinking, John, PayPal and getting a lot of inbound flow on the name. I've been describing the last 10 weeks as a bit of a roller coaster, at least from my standpoint. I can't imagine how you've been thinking about it with sort of ups and downs and back up again. So is there a way maybe you can timetable for us some of the big inflections that you've seen in the last several weeks? And how your expectations have changed, just to start the session?

Sure. Sure. Well, it has been a roller coaster. That's a good way to describe it. And from a forecasting perspective, it is probably as difficult as a time that we've ever had in terms of trying to forecast the impact of this on the business. And it started in February, obviously, and that's when we came out and provided guidance or updated our guidance, I should say, around the impact of COVID-19, specifically with what was happening in China at that period of time. And it was pretty concentrated to China and some of the surrounding countries. And as you remember, we updated and said that we thought that, that was going to be about a point of headwind to revenue for us. And at the same time, we reaffirmed our EPS guidance. The first couple of months were actually pretty strong for our business. But then we got into March, and it was an entirely different situation. And I keep describing it as cross currents because there were these trends that were happening in different parts of our business that were going in the opposite direction. And like all of us in our own behaviors, the way that this unfolded sort of first started with all companies stopping international travel and then domestic travel, and then you saw events being canceled. And that's a fairly significant vertical for us. We'll maybe talk more about that later. But we saw a pretty dramatic decline in volume and, likewise, revenue in the first part of March. And then you had shelter-in-place take hold more prominently around -- certainly in the U.S. and other regions. And initially, when that happened, there was this -- we all remember like the hoarding of toilet paper and Lysol and things like that. So there was this dramatic surge in certain verticals and certain products. And then as we got into kind of the back half of March or even at the very tail end of it, we started to see what I would describe as a more consistent trend around e-commerce. It wasn't bouncing up and down as much, and that persisted into April. April had a little bit of noise simply because of the lapping of Easter and what that does to our business. But even through the second week of Easter, we were still seeing some pretty dramatic week-to-week swings. And I think to all of this, Tien-Tsin, what we wanted to provide an update in March to Wall Street to give them an indication about our business because it had changed so much from our update in February. But when we -- honestly like when we just -- it was a little bit like catching a falling knife at one point. We -- if we had updated investors one day or with information, like it would have been wrong the next day. And so we thought better to just wait this out. And we thought that our results also needed a little context. So that's why we waited until the end of April and into May for our earnings release because the trends in April were so strong.

Yes. I've been telling people it's a very humbling experience, like it was changing day by day. One day you think you're onto something, the next day it changed 180 degrees. So it's helpful to get that perspective. So I'll stick in some of the numbers and some of the metrics. I think the one that stood out to me was just the actives. And I know you're getting a lot of questions around actives. I wrote down here, well, in April, up 135% net new actives. So where are you seeing these activations? Is there any change in the type of demographics or the geos that you're seeing these new users come in?

Yes. Well, I think of all the important strong trends in our business in April, the level of net new actives is the one that stands out to me the most. We had 7.5 million, 7.4 million net new actives in April. And to put that in context, an average day in 2019, and even quite frankly in the first part of 2020, we would have 100,000 net new actives come to our platform on a single day. During the month of April, we were averaging 250,000, and some days, we're up around 300,000, and so it's just a dramatic increase as our platform is just, obviously, very relevant during this period of lacking in mobility and social distancing and shelter-in-place. And I can't just point to one area that is really outsized or accounts for a larger share than others. It's across the entirety of network. And both regionally, as we look across the world, it's in all the countries where we have a strong presence, but also across different parts of our product. We see like even on the merchants side, we added 700,000 merchants in the quarter. And as you've got shelter-in-place and many merchants that may have an in-store presence, they're now looking to be able to sell their products and services online. So many customers come to us that way. Xoom is another example. Because you see, while [ minutes also holding on ], certainly, the online share we're gaining is pretty pronounced because you've got the traditional brick-and-mortar money remittance companies that are closed. And as we said, like once you go to an online solution like Xoom and you understand how easy it is, how quick it is, how frictionless and less expensive, moreover, you don't go back to the old way of doing things. And so really, really strong trends there as well. And then I'd also say just around Venmo, we've seen some interesting trends there, as -- actually the use cases around Venmo have sort of changed through this. And we're seeing things like a higher average ticket size or average purchase price, as people are using them for different things. So it's really strength across the gamut of our platform.

Good. So you also mentioned the other thing that stood out was that your branded experiences. We're seeing some really great growth trends relative to pre-COVID levels. So I've been trying to think about this. And then, you're a basketball guy, so you can think about that analogy. Is this more a function of just more shots on goal? Is your field goal percentage up? If I'm thinking about the branded experience, what is going on there? How would you describe it?

Yes. I appreciate the analogy. It's both, Tien-Tsin. There's clearly, very clearly, been an increase in e-commerce, but we're also seeing an increase in our branded experiences as well. And that's both discretionary spending as well as nondiscretionary spending. I think during this time, when people are moving to purchase more products online, a company like PayPal that is a trusted brand in payments is what customers are relying on. And it's also about ubiquity. We're at 25 million, roughly 25 million merchants around the world. And that level of scale and relevance really matters to customers. And the thing that I think all of us sort of wonder about is how sustainable are these trends? Will -- when social distancing is relaxed, will people go back to their old behaviors? And so we've been doing a lot of customer survey. We're doing it weekly. And very consistently, we're seeing anywhere from 1/3 to around 50% of those customers who are saying that when coronavirus is over or social distancing is over and people can go to whatever the new normal is, is they're going to continue to use PayPal to shop online for things like groceries and restaurants and even big-box retailers. And so that's encouraging, but at the same point in time, it goes back to these cross currents. It's hard to really think about what the back half of the year looks like when you've got these elevated levels of e-commerce, which are clearly not going to stay that way forever as people are able to go back into restaurants. But at the same point in time, you tend to see permanent changes in consumer behavior around events like this. And we think that the movement to e-commerce and online is one of those.

Okay. That is good to hear. I agree. It's very thoughtful. So have you changed your thinking on prioritizations to your newer brands, let's say, Venmo and Honey? So I get this question a lot, John, with Venmo, less bill splitting because people aren't going out, hanging out. But you did mention there's more Pay with Venmo on the other side of it. So what's happening with the monetization on -- for both Venmo and also Honey, for people that are looking for deal?

Well, Venmo is quite interesting. In the first part of the first quarter, first couple of months, Venmo was growing in the mid-50% in terms of volume. As we got into March, we saw that decline to around 30%. And that was related, Tien-Tsin, to exactly what you said, a lot of the Venmo use cases are around social experiences. So as people are not going to bars or restaurants and splitting tabs, we saw that level of volume drop off. I mean, going back to the basketball analogy, even March Madness, the NCAA tournament, is something that had a pretty dramatic impact on our business. And the cancellation of that, we saw very clearly in our numbers. But as we got into the back half of March and then into April, we started seeing some newer trends or some emerging trends where we've been -- where not only we're seeing like the demographic slightly changed with the users and it being skewing more towards [ Silver Jaguar ] and older demographic. The level of spend associated with those people, obviously, influenced our numbers, too, because the TPV got back up to those pre-COVID levels, but in large part, not because of increased transactions but because of the increased purchase size of things. And so very clearly, we're seeing that people are wanting to use Venmo, whether it's yoga instructors that are getting paid that way or people that are getting tips that way. And we think that these are some sustainable trends in our business. And to that point, we actually want to capitalize on some of these trends and really push into the offline world with QR code, the ability to Pay with Venmo with a QR code. And we'll be doing the same thing with PayPal. We've actually launched PayPal in many international markets and announced Germany today. So we're excited about that. With Honey, I'd argue that Honey is probably more relevant than it's ever been before right now. The strategic rationale for the acquisition is actually increased related to this. This is a way for consumers to basically select the products they want in a very price-sensitive way. In any type of recessionary environment where people are concerned about their level of pay or if they have a job, this caters to some of those concerns. At the same time, it allows merchants to gather insights and data that allow them to target communications and promotions to those customers, which in a time period where offline sales have dried up, that online channel is really important. And one of the, I think, more encouraging trends around Honey was also what we saw on their level of net new actives. So when we included Honey into the PayPal portfolio at the beginning of the year, we added a little over 10 million of their existing customers that they had. Within the first quarter though, new additional customers for Honey were 680,000, so 680,000 for 3 months in the first quarter. In April alone, we added 640 new customers related to Venmo. So I think it really underscores the importance and relevance of this product.

Okay. No, it's good to have those metrics. I don't think I caught that before. And you're breaking my heart bringing up March Madness again, John, but it is what it is. So let's -- you mentioned that the nondiscretionary element earlier in one of your answers. I get this question a lot, so I want to ask it here. Just help us dimension your TPV, right? How much is travel and events? This whole idea of giving more users hooked on spending for nondiscretionary is so important for all of our payment companies. So catch us up on what's happening there post-COVID/

Sure. So a little context first. In the first quarter, TPV growth for us on a currency-neutral basis was 19%. And we said that, if not for coronavirus, we think that, that would have been 24%. And the way that played out in the quarter was very different. January and February, there was really strong growth in the business. TPV was up in the mid-20s, 26%, I think. And then it was only growing 7% in March. And again, the way that, that unfolded in the quarter and even into April was pretty dramatic in terms of some of the crosscurrents. So initially, we saw the very large impact to the travel and a bit vertical. And for us, that's about 9%, almost 10%, and 9% of our overall portfolio in terms of volume. And as you see, whether it's event companies or companies that are selling airline tickets or even airlines themselves, all of those companies saw like 80% to 90% drops in volume in that period of time. And not only did we see drops in volume, like there were actually periods where the overall TPV was negative. And I don't mean the growth rate. I mean the actual TPV as the level of refunds actually well outweighed any sort of new bookings that were occurring. And I think as -- just as we think about how this unfolds, whenever we come out the other side, these are longer lead time purchase items. And so even if we sort of get back to whatever the new normal is, it's going to take some time for people to book their vacation again or for Taylor Swift to hold a concert and people to buy tickets to that. So there's kind of a longer tail in terms of how this plays out. But at the same time, we saw strengths in our business across many verticals, as people were beginning to shelter in place. And again, there was that initial hoarding period. But it's really like, if you look across all verticals: electronics, home and garden, fashion, you just -- you go across the board, we're consistently seeing growth rates that for some of these were 70% to 80% higher year-on-year. And then groceries, obviously, being the largest increase -- and groceries is 3% or 4%, or was 3% or 4% of our total volume, but that's consistently growing around 100% per year. And the thing for us is like -- again going back to the sustainability of these trends. So one of the things we looked at were some of the countries where they have relaxed the compulsory shelter-in-place measures earlier, so Austria and Germany were 2 of those examples. And there was some hypothesis that maybe we would go right back down to the pre-coronavirus levels. That's not what happened at all. In fact, in these countries that I mentioned as well as many others, we're still seeing year-on-year growth rates that are 2 to 3x as high as what they were pre-coronavirus. And so I think it goes back to kind of the relevance of our platform. On your point on discretionary versus nondiscretionary, I sort of jokingly made the comment on the earnings call last week like, PayPal just isn't used for buying baseball cards on eBay, right? We really have seen some dramatic shifts in terms of how PayPal is used. I mean even think about the use cases around Venmo where college-aged kids are -- [ gather ] for rent, and you've got things like monthly subscriptions and things that are a lot more nondiscretionary or staples versus maybe the nice to haves. And so that doesn't completely insulate us from a recession, but I think that combined with the fact that e-commerce trends have had stood through the test of times in terms of continuing to grow even through a recessionary period, that's a trend that I think is just continuing to happen. And that's a sort of a natural [ turbulence ] to our business.

Yes. So an important dimension to TPV, at least historically, was eBay, right? You mentioned the baseball cards story here. But with the expiration of the operating agreement coming up here in, what, July? Catch us up on that. What is the impact to PayPal? And sort of, as managed payments transition, does it change or get moved around by the pandemic at all, John?

I don't think so. Our expectation is that things will play out exactly as we've expected. And as a reminder, they have the ability right now to, up until that mid-year time frame, to have a 10% of the payment volume in 2 countries shifted to this managed payments experience that they have. In the U.S., they've gone the full 10%. In Germany despite having the ability to move 10% of that volume, they've only moved 6%. And I think that is maybe some ways reflective of this is not an easy task to begin with, but also just the receptiveness of merchants who want that. They've got -- I think around 32,000 is the number that I heard merchants that have moved over to that experience. But I think, very importantly, for our business, like we've often said that our expectation is that we will, as a payment option, PayPal, maintain a fairly significant share of checkout even in the new managed payment experience. And that's consistent with what we're seeing. In the U.S., we're right around 50%; and in Germany, we're appreciably higher than 50%. And so this is -- I don't really expect this will change much related to coronavirus or anything that we're going through right now, or for that matter, even a recession. And again, right, we feel like we've got our arms around the impact of this, and that's included in the guidance that we've provided.

Understood. Understood. So what does all of this mean for take rate, John? With -- we dimensioned TPV a little bit. There are a lot of dynamics there, eBay, cross border, Braintree. Help us think about the short term and maybe the long term as well, if that's changed.

Sure. Well, we quote 2 different take rates. We have our total take rate and our transaction take rate. And total take rate is influenced by things like our credit business, even the revenue from Honey is there as well as things like interest on customer balances. And because of all these I mentioned, there's a lot of noise even with like the transitioning from -- of servicing to Synchrony last year. And so I think if one wants to really understand what's happening with the trends around take rate, that transaction take rate is a better number to look at because it's more of an apples-to-apples comparison. And for several years now, we've been seeing some declines in this number related to mix in our business. And most notably, I think the growth of P2P and Venmo is a big piece of that. And as we've said, we'll happily accept that because that's good for our business overall. But more recently, with the growth in the branded PayPal transactions, we've seen a lot of strength in this area. And so it depends probably on what your expectation is about how long that will continue, but that's sort of a natural sort of buoyant to that number. And then over time, as we continue to monetize Venmo, which overall the Venmo take rate is relatively low today because it's a lot of volume, not a lot of revenue, as we began to allow our customers to use Venmo to buy online and even in store going forward, we think that, that will provide some buoyance into that number as well.

Yes. I know there's a lot of moving pieces, so it's good to go through some of those, so the big one. So you mentioned credit in your answer there when you've mentioned total transaction take rate. Your exposure to transaction and loan losses was a topic on the call. And I think your coverage ratio now is, what, 17%? Much higher than some of the consumer credit names. I don't want to go into a deep credit accounting discussion here, but how protected is PayPal here? Because my reaction was that the reserve was pretty aggressive and should provide a lot of coverage here, but what else do we consider?

Yes. So just a little context first on CECL, which is the new accounting standard around this. In finance parlance, maybe the way to think about this is, with CECL, we effectively are marking this to fair value each quarter or kind of a mark to market, if you will. So the full expectation of future losses that can be based upon economic events or things that we see, we have to recognize that at that point in time versus the prior model, which you did not recognize losses until they were incurred or you could see those trends in your business. And so to your point, we increased our reserve ratio in the first quarter to 17%, and that's an increase from 11%. And if you look historically in periods of economic decline, loss rates have been about 2x, what they normally are, and that's effectively where we are reserved right now. Tough to say like what happens to the economy going forward and the impact of things like higher unemployment rates going forward. But it's also -- it's worth noting that there are some things that are different this time, notably the amount of stimulus that's been provided, the forbearance measures that companies like PayPal are providing. And even the actual unemployment numbers themselves, like there's this -- some postulate that there is this -- a significant number that are just on furlough and will get their jobs right back as soon as we get out of shelter-in-place. And so I think to simply look at unemployment numbers relative to where they historically and then project out what that can mean for losses is maybe not a responsible way to go about this right now because of some of these differences. That said, the overall charge that we took in the first quarter was $237 million related to the macro adjustments. And when you put that in the context of we still have a 20% operating margin, we generated $1.5 billion of operating cash flow, $1.3 billion of free cash flow in the quarter, we think that this is, I think, the appropriate size for our business. And the risk is well contained. There could be some additional impact related to CECL in the second quarter. We did not include anything in our guidance. We'll have to see how that plays out, but early to tell right now.

Okay. Can't let you go without asking some margin questions as a CFO of the company. So let me give it to you here. So just thinking about -- how should I ask this? I always like to look at gross profit growth versus SG&A leverage. And I know you guys -- you've attacked that pretty hard, done a great job with it. Are those dynamics changing here, given what we've learned from the pandemic?

I don't think appreciably, Tien-Tsin. I mean, we've been growing gross profit or our transaction margin in terms of absolute dollars. The growth rate has been in the kind of low to mid-teens pretty consistently here. That could be impacted somewhat. We'll just have to see how the back half of the year plays out. But we've consistently demonstrated that we've been able to achieve that growth at a very low marginal cost. And that marginal cost -- well, then I guess, there's a couple of elements there. In more -- this more recent time period, we've seen really good trends around transaction expense and transaction loss. Transaction expense is related more to the mix change in our business, so maybe that's a more of a transitory trend. Transaction loss, we've achieved record levels for 4 or 5 quarters now. And so that's a very sustainable trend. But it's the everything else, the non-volume-related expenses where we've just continued to see really good disciplined expense management but doing it while still investing in the business. And even looking at like the time period that we're in right now, there's some real learnings from this work-from-home scenario. So you take customer operations as an example. That's -- for us, it's a 5,000 internal employees, and we have a similar number of outsourced employees that serve our 325 million customers around the world. And in the tending time period, we moved the entirety of that operation to work from home. And that was kind of thought to be impossible prior to this, but that's the way that we're serving our customers right now. And there's some really interesting trends that we're seeing around that. So for example, historically, about 70% of our contact volume would come through the phone channel. Now chat accounts for about 50% to 70% of that contact volume. And customers are actually becoming quite adept at being serviced that way, and they understand that this is kind of a newer normal. We'll have to see if those trends persist, but it's a pretty inexpensive way to serve a customer because of the ability to do concurrency of chat, have multiple chats going on at one time. The other thing that we're seeing, and it's maybe sort of counterintuitive, but we have the highest level of productivity among that workforce that we've ever seen in our history. And so that's encouraging. And it actually would suggest that we're not going to go back to entirely the old way of serving customers. We will certainly put people back in call centers, but we will keep a work-from-home workforce as well. And lastly, that actually allows us to better optimize our schedule. Because the difficulty in any call center environment is perfectly matching your resources to the incoming demand, and the challenge with that is, you don't want to schedule people in a 1- or 2-hour shift for this peak in demand at 3 in the afternoon because it's unreasonable to ask someone to come into work for an hour or 2. But if you're working from home, that's not unreasonable. And so we think that there's some interesting trends here that actually portend some pretty good things for our business from an efficiency perspective.

Yes. No, I don't think -- forget how difficult that work is to get people work from home and, yes, turning over seats is a lot easier, right, when you're working from home. So your confidence level, John, in the margin expansion here in short term, long term, it sounds like you've found some opportunities here to be more productive on the cost side. Is that fair to summarize it?

That's true. And we've got a lot of levers on the cost side. And look, we're still investing in our business. We've got a very long-term perspective in the way that we manage this company. We believe that we have a significant opportunity in the space that we operate in and are playing to win. And so we continue to invest, and we certainly won't over-rotate to goal save to a certain operating expense growth in any one quarter at the expense of what's best for the company long term. But we have a tremendous amount of levers. And I continue to believe and have conviction that we will continue to see operating margin expansion. I think how much is maybe the better question. Just -- but given the scalability of our business, the disciplined expense management and the growth opportunities that we've had and continue to have, we're going to see margin expansion at PayPal.

Good. Good. So let me get some of these questions here, if you don't mind, John. I've got a couple of questions on offline. You mentioned QR code extending that from Venmo, PayPal. What about iZettle, anything new there?

iZettle, obviously, being primarily offline, was hit pretty hard related to coronavirus. We saw their volumes come down in the 70% range from where they were pre-coronavirus. They since have stabilized them. But the iZettle team has taken a lot of steps to help merchants, be it reducing fees in certain areas or removing SaaS fees in Europe. And so that's had some impact on our business. But that's an exceptionally strong team there that is going to help lead the charge in terms of what we do in the offline world. And we think that right now, with the fear around holding cash or touching a keypad at a point-of-sale device in store, there's an opportunity to really capitalize on contactless or touchless payments. And so this is a strategy that we've re-prioritized to be at the top of the list. And I think a lot of us have speculated that the sort of movement to touchless or contactless pay in store in the U.S., anyway, was something that was going to be pretty slow to play out because it just candidly wasn't that difficult to carry a debit or credit card. That's changed. I think we all recognize that now, and we want to help shape that trend.

Another one here on marketplaces. I know there was a backlog and a pipeline there, MercadoLibre, others coming in. Anything new to report there, both on the backlog conversion as well as the pipeline? We only have, what, 2.5 minutes left, John.

Yes. So we continue to be a partner for marketplaces, both on our platform and look for other opportunities there. Nothing to announce right now, but we continue to have discussions with some of the largest and most relevant technology platforms that are out there that are embarking on their own marketplaces experiences. And I think as we've demonstrated, just by some of the others that have already selected us to be a partner, that PayPal is one of, if not, the best partner out there to provide these type of experiences.

Okay. Good. So I know you issued guidance with some conservatism, I call it, looking out into May, June. Just to maybe leave us with some thoughts on what indicators we should be tracking here in the weeks and days ahead.

Sure. Sure. So our guidance was for revenue growth of approximately 15%. And that was different than what we've normally done. We normally provide a range, but we really just tried to give it our best guess. And that assumption is that, as we go through the quarter, we'll decline from some of the trends we saw in April where we had 20% revenue growth, as shelter-in-place measures are relaxed and people are able to go back to some of the shared experiences or social experiences in store. The EPS guidance that we provided was for 15% to 20%. And that range is partly dependent on our ability to invest in the quarter on things like QR code and how much we can do in the last 2 months that we have in the quarter. It's -- I underscore, it's exceedingly difficult to forecast right now because you're actually having to make some assumption around what happens with coronavirus, the path of it, the duration of it. Does it rear its head again after social distancing is relaxed? And so that's a challenge. Certainly, if the trends in April continue -- and the first part of May is encouraging, but if those trends continue, they never could be better than that. But it's tough to say. But I think from us, what we're focused on is how do we become even more relevant than we were before with these trends, with people wanting to shop for new things online like groceries. So let's do things that allow customers to continue to do that, and moreover, allow them to use PayPal and Venmo in ways that they haven't imagined before, so that we can help shape the outcome here and be even more relevant. And as I said on the earnings call, like I think we're demonstrating that. If your hypothesis or your guess is that coronavirus continues for quite some time, then PayPal is a good company to bet on. And if your guess is that we're going to get right back to the way that we were prior to coronavirus, then PayPal is still a really good company to bet on. The trends, I think, are very supportive of our business overall.

Yes. No, I agree, and I think you've been really thoughtful about laying it all out for us. So I appreciate that, John. I know you're -- again, I've been saying this to those who I know, you are very, very busy. You would -- were in the customer ops hat as well there at PayPal. So again, thank you for the time. If you want to stick around and watch my son's piano lesson, you're welcome to, starting in 5 minutes. But otherwise, I'll let you go, John. Thanks for the time.

Yes. Well, thank you, Tien-Tsin, and thank you to your audience as well. Tien-Tsin, thanks for all that you do for this business, for this industry. I think events like this are really helpful. And I appreciate the opportunity to be able to speak about PayPal.

Yes, I know. It's always fun to have you, John. Thank you, sir. Be safe and good.