PayPal Holdings (NASDAQ:PYPL) continued to impress across a range of vital metrics upon release of its second-quarter 2018 earnings report on July 25. The payments processing giant also displayed the strength of its operational cash flow and growing balance sheet resources over the last three months. We'll dive into the quarter's details after reviewing headline numbers directly below.

PayPal: The raw numbers

Metric Q2 2018 Q2 2017 Year-Over-Year Change
Revenue $3.86 billion $3.14 billion 23%
Net income from continuing operations $526 million $411 million 28%
Diluted earnings per share $0.44 $0.34 29.4%

Data source: PayPal Holdings Inc. 

What happened this quarter?

  • Payments revenue continued to exhibit an extremely strong trend. Total payments volume (TPV), which measures the aggregate payments volume transacted over PayPal's platform in a given period, climbed 29% against the prior-year quarter, to $139 billion. The company reported 2.3 billion transactions processed, an increase of 28%.

  • Net new active accounts expanded by 7.7 million, outpacing the second quarter of 2017 by 18%. Sequentially, this result was slightly off the pace of 8.1 million new accounts added in the first quarter of 2018.

  • Mobile payments volume expanded by 49% to $54 billion. Transactions processed over mobile devices accounted for 39% of overall TPV during the quarter.

  • Total Person to Person (P2P) volume jumped by 50% over the prior year, to $33 billion, and accounted for 24% of TPV.

  • PayPal's popular social payments app Venmo grew volume by 78% over the prior-year quarter, reporting $14 billion of TPV. The monetization of Venmo continues: In June, Venmo introduced its first branded debit card via PayPal's primary card network partner Mastercard.

  • PayPal added 600,000 merchants to its system, bringing its total number of global merchants to 19.5 million at the end of the period.

  • Shortly after quarter-end, on July 2, PayPal completed the sale of its consumer credit receivables portfolio to Synchrony Financial (NYSE:SYF), for total consideration of $6.9 billion.
  • PayPal's transaction "take rate," the amount of revenue the company makes on the transactions it processes, declined by 19 basis points to 2.38%. The metric is derived by dividing transaction revenue by TPV. Management attributed the marginal decline in take rate to higher P2P volume and a headwind from hedging losses compared to the prior-year quarter.

  • Operating expenses climbed as PayPal invested more in product development and customer service, and as it incurred costs related to the sale of its credit receivables to Synchrony. However, strong top-line growth outpaced the rise in non-transaction expenses: Operating margin climbed roughly one percentage point against the second quarter of 2017, to 14.8%. More impressively, after adjusting for $116 million in restructuring charges, the company's operating margin hit 17.8%, against 13.7% in the second quarter of 2017.
Young craftsman ordering materials on a tablet in his workshop.

Image source: Getty Images.

PayPal's growing cash resources: dispositions, acquisitions, and shareholder-friendly plans

Earlier this year, I explained the advantages of the credit receivables deal that would accrue to both PayPal and Synchrony. PayPal's benefits include the freeing up of capital from a non-core business (lending to customers), which carries a lower margin than the company's transaction processing revenue streams. Just as significantly, the disposition places a cool $7 billion of sale proceeds into PayPal's coffers. 

This bounty only adds to the fruits of PayPal's cash prowess. PayPal's consistent double-digit top-line improvement is creating margin expansion, which is resulting in extremely healthy cash flow. After adjusting for an accounting classification of receivables related to the Synchrony transaction, free cash flow in the second quarter hit $737 million. As CFO John Rainey pointed out during the company's earnings conference call, this equated to $0.19 of free cash flow tied to every dollar of revenue.

It became apparent this quarter that PayPal has started to deploy its cash resources in earnest; it announced four new acquisitions during the period. The company purchased Swedish mobile point-of-sale device specialist iZettle for $2.2 billion in a transaction that will close in the third quarter.

PayPal also announced the acquisition of Hyperwallet, a business-to-business e-commerce payout platform, for $400 million in cash in a deal that should settle in the fourth quarter. The company closed the purchase of risk management and fraud detection provider Simility for $120 million in cash in July. Finally, PayPal picked up Jetlore, an AI-powered predictive platform used by retailers, for $16 million in cash in May. 

The company's capital allocation strategy going forward anticipates many more bolt-on acquisitions in the interest of maintaining double-digit revenue and earnings growth. Management expects to utilize the Synchrony transaction proceeds and PayPal's vigorous cash flow to fund $1 billion to $3 billion in strategic acquisitions annually over the next four years.

PayPal also aims to reward its investors and has outlined returning 40% to 50% of annual free cash flow to shareholders in the form of share repurchases. Based on the last four trailing quarters, this amount at the midpoint should equal roughly $1.5 billion per year. Alongside second-quarter earnings, PayPal announced a new $10 billion share repurchase authorization to cover these buybacks. 

Interior of contemporary office with large "Venmo" signage in entrance lounge.

Venmo's New York office. Image source: Venmo, LLC.

Moving forward

Looking ahead to the third quarter, PayPal expects revenue of $3.62 billion to $3.67 billion, which would mark an expansion rate of between 12% and 13%. Diluted earning per share (EPS) are slated to fall in a range of $0.31 to $0.34.

PayPal also increased its guidance for the full 2018 year. Management now expects revenue growth of 17% to 19%, translating to a top line of between $15.3 billion and $15.5 billion. This compares to a previous band of 16% to 18% growth, or $15.2 billion to $15.4 billion in revenue. Full-year diluted EPS, adjusted for recent acquisitions, is now slated to fall between $2.32 and $2.35, versus a previous adjusted EPS estimate of $2.31 to $2.34. Considering PayPal's recent performance, it's entirely possible the EPS target may be nudged up another few cents next quarter.

Asit Sharma has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Mastercard and PayPal Holdings. The Motley Fool has a disclosure policy.