PayPal Holdings, Inc. (PYPL) Q3 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to PayPal’s Third Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference, Ms. Gabrielle Rabinovitch, Senior Director of Investor Relations. Please go ahead.

Thank you, Esther. Good afternoon and thank you for joining us. Welcome to PayPal Holdings’ earnings conference call for the third quarter of 2016. Joining me today on the call are Dan Schulman, our President and CEO; John Rainey, our Chief Financial Officer; and Bill Ready, our Chief Operating Officer. We’re providing a slide presentation to accompany our commentary. This conference call is also being broadcast on the Internet. And both the presentation and call are available through the Investor Relations section of our website. In discussing year-over-year comparisons, including guidance growth rates for the full-year 2016, we have chosen to present non-GAAP pro forma metrics because we believe that these metrics provide investors a consistent basis for reviewing the company’s performance across different periods. We will also discuss some non-GAAP measures when talking about our company’s performance including the non-GAAP pro forma metrics mentioned above. You can find a reconciliation of these none-GAAP metrics to the most directly comparable GAAP metrics in the presentation accompanying this conference call. In addition, management will make forward-looking statements that are based on our current expectations, forecasts and assumptions, and involve risks and uncertainties. These statements include our guidance for fourth quarter and full-year 2016 as well as our outlook for 2017 and the next three years. Our actual results may differ materially from those discussed in this call. You can find more information about risks, uncertainties and other factors that could affect our operating results in our annual report on Form 10-K and quarterly reports on Form 10-Q filed with the SEC and available on the Investor Relations section of our website. You should not rely on any forward-looking statements. All information in this presentation is as of today’s date, October 20, 2016. We disclaim any obligation to update the information. With that, let me turn the call over to Dan.

Thanks, Gabrielle. I’m pleased to say that PayPal delivered another quarter of strong results. We made significant strides in the quarter, forging new partnerships and delivering continued innovation to our customers. We feel well-positioned for future growth and profitability. I’ll start my remarks with our financial performance. In the quarter, we reported $0.35 of non-GAAP EPS, at the high-end of our non-GAAP guidance of $0.33 to $0.35. We delivered $2.67 billion in revenues, an increase of 21% over last year on an FX neutral basis. And we generated $618 million in free cash flow. We increased the number of active customers and accelerated their engagement on the PayPal platform. We finished the quarter with 192 million active customer accounts, adding 19 million new accounts in the past 12 months. And transaction per account continued to increase, reaching 30 for the first time, up from 27 a year ago. In the quarter, PayPal processed over $87 billion in total payment volume, up 28% over last year on an FX neutral basis. These results reinforce our belief that the opportunities for PayPal to grow and gain share have never been greater. We are executing against our strategic plan with intensity and speed. And we are committed to seizing the opportunities in front of us by truly embracing the mantle of Customer Champion. Being a customer champion means always prioritizing the needs of our customers. It means continually reexamining our business to improve the customer experience on our platform, and to provide real differentiated value to both consumers and merchants. By making customer choice a priority for PayPal, we are creating a significantly better customer experience to accelerate adoption and drive engagement. In the quarter, we made meaningful progress in offering customer choice in our online and mobile checkout and in our P2P experiences. These have enhanced our customers in the U.S. can send money, shop and pay with PayPal. Our customers are now able to set their preferred funding type in their PayPal Wallet to sources other than their PayPal balance. This gives customers the option to default to their favorite debit card, bank account or credit card, and we’ve seen a corresponding increase in engagement. And as we have demonstrated over the past several months, customer choice is also allowing us to forge valuable new strategic partnerships across the ecosystem. Since our announced agreement with Visa, we have also entered into a strategic partnership with MasterCard, which offers consumers greater choice and flexibility to manage or move their money. It ensures that MasterCard cardholders can easily identify and choose MasterCard within the PayPal Wallet. Our joint U.S. customers will be able to use their tokenization services to make in-store purchases at MasterCard’s Contactless enabled merchant locations around the world. And along with our agreement with Visa, the deal with MasterCard exempts PayPal from current or future digital wallet fees and provides cost certainty for years to come. Thanks to our agreements with Visa and MasterCard, PayPal now has a seamless, quick and simple way to activate PayPal payments at the point of sale. Our agreements with payment networks are opening the doors to deeper and more engaged conversations with a host of financial institutions about how to drive incremental spend for their brands and better more innovative experiences for our mutual customers. These conversations have been very positive and we are encouraged by the progress we are making in partnering with issuers. We also are significantly extending our previous agreements with Alibaba. We just launched the first stages of becoming a payment option on Alibaba’s global retail marketplace, AliExpress. This partnership has the potential to drive meaningful cross-border traffic, as PayPal consumers outside of China shop on AliExpress merchants in China. And while we are excited by these new and expanded partnerships, we are equally pleased with the progress we’re making with previously announced partners, such as América Móvil which is set to go live this quarter. We are working with América Móvil to help their more than 140 million customers in Mexico and Brazil manage and move money with their Telcel and Claro digital wallets powered by PayPal’s platform. We also deepened our existing relationships with some of the world’s leading technology companies, including Facebook and Apple. With Apple’s new iOS 10 Venmo users with iPhone can now ask Siri to send and request money from friends, and also send P2P payments within the messages app. These new experiences make sending and receiving money even easier and increase the relevance of Venmo by introducing the service in more context than ever before. With each partnership agreement that we sign or extend, we further expand the ubiquity and value of the PayPal brand, and move closer towards our vision of becoming an everyday essential financial service for people around the world. We believe offering consumers choice in how they want to pay and where they want to pay is essential in becoming an everyday part of a customer’s financial life. As we’ve shared previously, the average Venmo user already interacts with the app more than two times per week. And we are beginning to see some additional proof-points that are strategy and partnerships are moving us towards our long-term engagement goals. For instance, our initial launch into Spain with Vodafone and Visa, which provides customers the chance to pay online, in app and in store is already generating over six in store transactions per month per active user. And the PayPal Vodafone service is now available in Italy and the UK. We also made a further announcement with Visa to include the integration of Visa Checkout into Braintree. Braintree also announced several other new payment options in Q3, including Apple Pay for web, MasterCard Masterpass, China UnionPay and PayPal Credit. Another way we’re executing against our customer champion vision, despite being a true payments partner to our merchants, to help them succeed in an increasingly connected and mobile-centric world. Mobile technology continues to raise the line that divides online from offline and commerce is moving into entirely new context. PayPal helps merchants navigate disruptive environment and is increasingly the payments partner of choice to merchants of all sizes. We continue to move aggressively towards our goal of processing 100% share of checkout for merchants. This strategic focus enables PayPal to grow its market share during the quarter. Our Merchant Services payment volumes once again grew faster than the growth of e-commerce. Merchant Services payment volume grew to $73 billion in the third quarter, up 34% year-over-year on an FX-neutral basis. And PayPal also continued its strong growth in global payments. In the quarter, we processed $26 billion in mobile payments, up 56% over last year. Mobile continues to become an increasingly relevant part of our platform, now representing approximately 30% of our volume. We are on track to process well over $100 billion in mobile payment volume in the next 12 months. This is a remarkable achievement, considering we’ve cumulatively processed some $200 billion in mobile volume over the past 10 years. Our growth online and in mobile is being driven by some of the world’s top merchants choosing PayPal. These include the American Red Cross, which expanded their integration with PayPal to include our Mass Pay product. We also worked with the American Red Cross in the quarter to support flood relief efforts in Louisiana by waiving on the fees on the donations raised. H&M, the global fashion retailer, launched with PayPal as a payment option on its websites in France, Italy, Spain and the UK. Costco de Mexico became the first subsidiary of the global membership-only warehouse club to integrate PayPal as a payment method for its online store. Yandex Direct, the paid search platform for Yandex, Russia’s most popular search engine went live with PayPal. And we expanded our relationship with Uber to make PayPal a way to pay for rides in Costa Rica, Panama, Columbia, Chile, Uruguay, Peru and Brazil. Braintree also had numerous new merchants, including Six Flags and Eon [ph]. Being a customer champion demands constant innovation for our customers. As One Touch demonstrates, when you create truly transformative experiences you drive engagement. We now have more than 32 million consumers and more than 4 million merchants using One Touch. By the end of the year, we now expect 5 million merchant accounts. We are offering One Touch to approximately 36 million consumer accounts. Venmo continues to expand its reach and is becoming a daily part of the lives of mobile and social media connected consumers. In the quarter, Venmo processed $4.9 billion in volume, an increase of 131% year-over-year. It is now just shy of a $20 billion annual run-rate. We are excited that Pay with Venmo is now generally available for all Venmo users and we are pleased that giving users a new way to use their Venmo account is resulting in increased engagement. Early data suggest that people who use Pay with Venmo are approximately 30% more engaged than other Venmo users. And we are now ready to more rapidly expand the number of merchants accepting Venmo as we exit 2016 and go into next year. Xoom is also driving significant innovation. Xoom recently added a new request feature, which allows remittances to become a two-way interaction between senders and receivers for the first time. Remittance recipients in 29 countries can now request funds, bill payments or mobile reloads from customers in the U.S. through the Xoom platform. Additionally, PayPal customers can now link their PayPal and Xoom accounts, giving customers access to their PayPal funding sources within Xoom. This will allow PayPal’s U.S. customers to send funds to multiple new markets and get access to new services. As we shared at the time of the acquisition, cross-selling Xoom to our U.S. PayPal customers is a meaningful way to drive additional adoption and engagement with PayPal’s 87 million active U.S. customers. And in the third quarter, Paydiant launched an exciting new mobile payment experience created for the Autogrill Group in Italy. Autogrill is the world’s leading provider for food and beverage services for travelers, operating mainly in airports, on highways, and in railway stations. This international application of Paydiant’s technology was made possible by PayPal’s global reach and the integration of our platforms. Finally, the third quarter saw PayPal receive some remarkable industry recognition. Venmo was named as one of Interbrand’s breakthrough brands in their 2016 ranking of 60 companies that are younger than 10-years-old that are driving significant change by creating new experiences for consumers. PayPal gained seven spots and increased its brand value by 14% on the 2016 Interbrand Best Global Brands ranking, making PayPal once again one of the 100 most valuable brands in the world. I’m also pleased to announce that PayPal has been included on Fortune’s 2016 Change the World list, a ranking of 50 companies that are doing well by doing good. This is a meaningful recognition for the PayPal team and we are very proud of achieving the number 19 spot on that list. And finally, Group XP, a part of WPP, named PayPal as one of the top three consumer experience brands in the world based on branding, design, content, online presence and user experience. The past six months have been historic ones for us. We have embarked on a course that enables us to become a true customer champion. We are partnering across multiple ecosystems from retailers to OEMs to wireless carriers, technology companies and with financial institutions and networks. We strongly believe that this positions us for long-term growth and profitability. Consequently, we are increasing our three-year outlook for revenue, the 16% to 17% FX neutral growth, in contrast to the 15% previously guided. We expect our free cash flow to grow in line with our revenue growth. And importantly, we believe our non-GAAP operating margin will be stable to growing. John will provide more detail on our outlook in his portion of the call. In the past two years, in the face of one competitive announcement after another we have attracted $35 million net new active accounts. Our engagement per active account has grown from 24 to 30 times per year. Our merchant base now totals $15 million active accounts. And our mobile payments’ volumes and unique innovative capabilities continue to drive our growth. We believe the partnerships we have signed enable us clearly, predictably and profitably pursue the $100 trillion total addressable market that is fully but surely digitizing. I believe we now have the platform, capabilities, scale and partnerships to enable us to drive profitable growth, not just next year but over the medium and long term. And with that, let me turn the call to John.

Thanks, Dan. I also want to thank all of PayPal’s customers and our employees worldwide for making us another great quarter. As Dan discussed in the third quarter, we made great strides executing against our Customer Champion strategy and partnering across the payments ecosystem to drive ubiquity. We enhanced our value proposition for both consumers and merchants and laid the groundwork for long-term sustainable growth across our platform. First, I will walk you through the financial highlights for our third quarter. On a currency neutral-basis, total payment volume increased 28% to $87 billion. U.S. payment volume grew 25% and international volume grew 30%. Our Merchant Services business grew 34% to $73 billion, primarily driven by core Braintree and Venmo. We ended the quarter with 192 million active accounts, adding 4.4 million active customer accounts in the quarter, and increasing our active accounts by 11% from the third quarter last year. Our core PayPal business, Venmo and Xoom, were strong contributors to account growth. The number of payment transactions per account increased to 30, up 13%. Increased engagement in conjunction with continued double-digit growth in active accounts resulted in payment transaction growth of 24% year-over-year. In the third quarter, we generated revenue of $2.67 billion, up 21% on a currency neutral basis and 18% on a spot basis. Q3 revenue growth accelerated both sequentially and year-over-year as a result of strong performance in our core business and Braintree. Transaction revenue increased 20% on a currency-neutral basis in the quarter. Performance was driven by growth in our core business, in particular with larger merchants and strengthened the Braintree business. This resulted in a transaction take-rate of 2.65% for the third quarter. The 19 basis point decline was primarily driven by the growth of our P2P business and the mix shift towards Braintree and larger merchants. Revenue from other value added services grew 28% versus last year, driven by growth in our credit products. In the quarter, transaction expense, and transaction and loan losses were $830 million and $271 million respectively. In the aggregate, these volume based expenses increased 29% resulting in a transaction margin of 58.7% versus 62.3% in Q3 2015. The transaction margin decline year-over-year was primarily driven by the mix shift in our business toward Braintree and increased provisions in our credit business, partially offset by Xoom. As we have discussed previously, in the third quarter we made investments to further drive customer acquisition and engagement and compliance efforts in corporate functions, which increased operating expenses in the quarter. Despite these investments, other operating expenses grew 13%, well below revenue growth and drove 200 basis points of leverage. To give you a bit more color on our non-GAAP operating expenses in the quarter, I will quickly run through the line items. Customer support and operations expense was $304 million. Sales and marketing expense was $212 million. Product development was $181 million. G&A cost were $229 million, and depreciation and amortization expenses were $150 million. Excluding the acquisition of Xoom, our other operating expenses increased only 9% or approximately half the rate of revenue growth, once again demonstrating good cost control. We continue to be focused on expense discipline and see significant opportunities to manage our other expense line items over time. In the third quarter, leverage in our other operating expenses partially offset the transaction margin decline, resulting in a non-GAAP operating margin of 18.4% and non-GAAP operating income of $490 million. Our third quarter non-GAAP effective tax rate was 15.3% versus 17.7% in Q3 2015, due primarily to discrete tax items. Non-GAAP EPS grew 14% to $0.35 for the quarter. Strong cash earnings generation resulted in 19% growth in free cash flow year-over-year. Our free cash flow for the third quarter was $618 million, representing $0.23 of free cash flow for every dollar of revenue. Third quarter capital expenditures were $183 million or approximately 7% of revenue. During the quarter, we returned approximately $50 million to shareholders by buying back an additional 1.3 million shares. Year-to-date, we have returned approximately $945 million to shareholders by repurchasing 26 million shares at an average price of $36.37. We ended the quarter with cash, cash equivalents and investments of $6.4 billion, including approximately $1.3 billion in the U.S. At the end of the third quarter, the total outstanding balances in our pool of consumer and merchant receivables were $4.5 billion and $581 million respectively. For our consumer portfolio, the principal charge-off rate in the quarter was 6%, and we’ve recognized $114 million as the provision from loan losses. The balance amount of our allowance for consumer loans and interest receivable is now $282 million. We’ve frequently spoken about moving to an asset-light credit strategy. I’m pleased to say that we recently signed a strategic partnership agreement with Latitude Financial Services to develop new consumer financing products for PayPal’s customers in Australia. The relationship will leverage PayPal’s strengths in technology but the receivables will be funded by Latitude. We’ll share more on this, as well as a more comprehensive off-balance-sheet strategy as we move through 2017. As Dan mentioned, given the partnerships we’ve established, the response we’ve seen in our platforms at the initial rollout of our choice experiences and the ongoing momentum in our business, we are better positioned today to provide you with an updated three-year outlook as well as a framework for how to begin thinking about 2017. Over the next three years, we expect total payment volume growth of mid-20% on a currency neutral basis. We are raising our outlook for revenue growth to 16% to 17% on a currency neutral basis up from the 15% which we shared at Analyst Day in May of this year. We expect operating margins to be stable to growing on a non-GAAP basis. We also expect free cash flow to grow in line with revenue. Further, as we pursue a more asset-light credit strategy, we expect less of our free cash flow to be directed towards funding credit in the future. For 2017, we estimate our revenue growth to be in line with our updated three-year outlook or 16% to 17% on a currency neutral basis. We also expect that the incremental expense related to our customer choice initiatives will be offset by other revenue and cost initiatives, resulting in an operating margin consistent with full year 2016. More detailed guidance for 2017 will be provided when we report fourth quarter and full year 2016 earnings. Finally, I would like to discuss our financial guidance for the fourth quarter and full year 2016. Year-to-date we have delivered strong performance and outstanding growth across our platform. For the full year, we expect revenue in the range of $10.78 billion, to $10.85 billion or 20% growth on a currency neutral basis. We expect non-GAAP earnings per share in the range of $1.48 to $1.50, representing growth of 18% at the high-end. We now expect free cash flow for the full year to exceed $2.2 billion. We are also reaffirming our prior year - prior full year 2016 guidance on CapEx and non-GAAP effective tax rate. For the fourth quarter, we expect revenue in the range of $2.92 billion to $2.99 billion, or 16% to 19% growth on a currency neutral basis. And we expect non-GAAP earnings of $0.40 to $0.42 per share. In conclusion, our third quarter results demonstrate our ability to deliver exceptional revenue growth and free cash flow, while advancing our strategic priorities. Our scale affords us continued leverage opportunities across our other operating expenses. In addition, the cash flow generating power of this business gives us great flexibility as we allocate capital with discipline. We are focused on creating value for our shareholders and strengthening our position as the world’s leading digital payments platform for our customers. With that, I’ll turn it over to the operator for questions. Thank you.

Thank you. [Operator Instructions] Our first question comes from the line of Bryan Keane with Deutsche Bank. Your line is now open.

Hi, guys. John, do you have concerns about the performance of the credit portfolio? And can you provide any more detail on how you are feeling about the credit business short-term and long-term and the use of free cash flow towards credit?

Sure. And, Bryan, it’s good to speak with you. I’ll start higher level, I think it’s important to get context here. Credit is a very small part of our business, it’s about 2% of our overall volume, but it’s also a very important part of our business. It complements a holistic set of payment offerings for our customers. And our merchants ask for it to be integrated into the checkout experience, because they see firsthand that the benefits of improved conversion and higher basket size. That said, as I discussed in my prepared remarks, we can obtain a lot of the benefits from credit by doing it in a more asset-light way, which we’ll disclose more about later. Overall, we’re very comfortable with the performance of our portfolio. And I would suggest that it’s in line with our expectations. We did increase our provision and as I discussed on the last earnings call, we have seen some deterioration in our late stage delinquencies. But we’ve also seen a lot of signs of health too and that our weighted average FICO scores improved from the last quarter. We’ve also seen the lowest quarterly charge-off rate in four quarters this year. We were obviously coming off of historic lows in credit and I think getting to something good as a more normalized rate going forward. But that rate is very consistent with both our underwriting expectations as well as our return goals for the business. So we’re comfortable with credit. Thinking longer-term about what we do, the agreement with Latitude is a good indication of how we’re thinking about moving forward with credit. We also can do something with our existing portfolio. And we’ve got several different options that we’re evaluating. Some of those take time, because they could be bigger in nature and we plan to discuss those in the coming quarters. Thanks, Bryan.

Okay. Yes, and then just a quick follow-up, looking at the three-year outlook the FX-neutral revenue growth is 100 to 200 basis points higher than the previous midterm guidance. But the FX-neutral TPV growth is the same at mid-20. So what drives that higher revenue growth with the same volume expectations? Thanks so much and congrats on the quarter.

You bet. And I would read too much into that Bryan. The mid 20s TPV growth is a broader range than the 16% to 17%. While that’s not updated, we obviously do have some expectation about an improvement in payment volume as well.

Okay, thanks.

Our next question comes from the line of Darrin Pellar with Barclays. Your line is now open.

Thanks, guys. Just looking for a little more color on the dynamics behind margins in 2017 and your medium-term outlook, I guess, margins being down about 150 bps in the quarter. First of all, I guess, if you could just tell us, maybe what it would have been without any maybe hedging impacts or Xoom investments? And then looking at the outlook you gave, I think you mentioned certain revenue or products that would help offset margin pressure from customer choice. I mean is that PayPal Credit or are there other products around that? Thanks guys.

And so, what was the last thing which you said there?

Just trying to figure out, you mentioned in the longer-term or I think the 2017 outlook that margins could be holding up for 2016 levels based on basically other products, other revenue and some cost initiatives. Just wondering if those other products is PayPal Credit or if there is other products in there?

Okay, yeah, sorry, I didn’t hear that. Okay. I’ll start and maybe a couple - the other guys can jump in. Specifically, you asked about the effect of hedging in the quarter. Hedging was about 1 point of EPS for the quarter versus last year for us. Our hedge gain was about $28 million to $30 million in the quarter and it was $10 million to $15 million higher last year. So that certainly affected the margin performance in the quarter. But I would - but we want to emphasize though that we indicated this when we gave the guidance last time in the last call, we made some investments in our business in the quarter. And there you typically think of the seasonality of our business. Our fourth quarter can be 15% to 20% larger than the third quarter. And so we tend to staff up in certain areas to prepare for that. We’re also - we look at the opportunity that we have in front of us, which everyone recognizes with the huge addressable market. That does require some investing and we’re not going to shy away from that. We’ve indicated that we expect margins to be stable to growing over time. But we’re not going to be a slave to margin performance from one quarter to the next, particularly if it means that it’s at the expense of investing in the business. That said, we also recognize that we don’t get a pass from the market. And we’re going to continue to drive revenue growth and earnings performance like we’ve seen. With respect to some of our products, we’ve got a host of different things that Bill and his team are working on. I wouldn’t necessarily pinpoint credit as the opportunity in terms of product expansion next year. What we are thinking more broadly is just in terms of how we can offer other types of products and experiences for our customers.

All right. Thanks, guys.

You bet.

Our next question comes from the line of Tien-tsin Huang with JPMorgan. Your line is now open.

Great, thanks. Thanks for all the details here. I just wanted to dig into the raised revenue outlook. How much of that raise is coming from customer choice may possible by Visa, MasterCard deals? I’m asking for both next year and also in the mid-term. For example, is there a backlog of new issuer partnerships, just trying to gauge where your confidence is coming from?

Yeah, I’ll take that and then turn it over to either Bill or John from there. Thanks for the question. I think just in general, if you step back, we think we have an incredibly large opportunity in front of us. I mean, think about it, we are 10% of the e-commerce, and e-commerce is 10% of retail. So when we look at the addressable opportunity in front of us, we think we have maybe 1% share or something like that. And so there is a tremendous amount of opportunity in front of us. And we are seeing very good momentum in the business right now. Bill and his team have put into place over the course of this year, a number of new services, a number of new products. We’ve upgraded of our work flows by the upgrading of our platform. And so we see a tremendous amount of momentum coming into the business. Obviously, as we think about choice, we think about choice more over the medium and longer terms pieces of this in terms of its impact in terms of growth for us. And so, as we think about next year we think really about the momentum of the business carrying us into that. As we think further out, obviously, the increased adoption, engagement, and the other services and offerings that we are putting out beyond choice that will go into the market will all fuel that growth. And then on the margin side, as John mentioned, we feel we have a lot of room in our cost structure, a lot of OpEx room. But we also in addition to that are putting out new services and new enhancements that have increased margins associated with them. And so as we looked at our medium term or our three year outlook, we felt very comfortable taking that revenue outlook up and maintaining our margin guidance.

Okay. That’s great. Thanks so much.

Our next question comes from the line of Ashwin Shirvaikar with Citi. Your line is now open.

Yeah, so my question is with regards to the 2017 guide itself. And any specific assumptions you are making in there with regards to the market implementation of Visa and MasterCard deals? And in what form do you expect some of the deals to take? I mean, what’s the purview, what you are actually discussing with the issuers?

Yeah. So I’ll let Bill answer some of the issuer things that we are talking about. But I would just say that as you look into 2017 the vast majority of that is the current momentum of the business. So Visa, MasterCard and the issuer implementations, those will happen as we go through next year. But we don’t assume a lot of either revenue or volume increase as a result of that. So we are trying to be reasonably conservative on the - on what we will see next year from that. And as I mentioned in my opening remarks, and then Bill can expend on this, we are having quite a number of conversations with issuers, both large and small in terms of ways that we can partnered together. I’ll let Bill get into the details of that. But the overall tenor of the discussions are extremely positive. And one other thing, I’ll just say before I turn it to Bill is with the tokenization schema that we have from the networks, the issuers don’t need to do anything. They just need to opt into it. So we don’t need to put out announcements for every one of these and we don’t plan to go and do that either. There’ll be some that we’ll announce no doubt, but the majority of those, since there is really nothing that needs to be done, usually just needs to opt in, we’ll just start to implement.

Yeah. I’ll just add that - to Dan’s point, while the issuers don’t need to do things to enable us to use tokens and those types of things that we’re receiving from Visa and MasterCard is just an opt in, it’s also the case of the things we’re doing around choice. We’re able to do and deliver value to our customers in the ecosystem without them having to do work on their end. So this isn’t really a framework of a lot of one-off announcements, but one where we set a framework of how we work with the broader industry. And we’re seeing from the experiences we’ve rolled out already that, as was mentioned earlier in the call by Dan and John, engagement lift, those types of things that we have been seeing from consumer choice even ahead of our deals with Visa and MasterCard in the broader ecosystem. We’re seeing those things play out in the way this is very much in line with how we thought about going into choice overall.

It just seems like you are assuming cost, but not assuming potential revenue benefits.

I think that’s predominantly right on that, that there will be smaller amounts of revenue benefit in 2017. But we are able to cut out not just cost in our OpEx. I’ll give you one example of that. Obviously, we have a good percentage of our calls coming into our customer care centers are around funding type, and since we’re going to be implementing that, those costs are something that we can take out of our business immediately. And so, there are other pieces of the cost structure that we can elaborate on if you’re interested that we will address. But on top of that we have had quite a number of new products this year that are giving us incremental margins, incremental lift and engagement such as One Touch is the perfect example of that. And now they carry over into next year as well.

Great. Thank you.

Our next question comes from the line of Jason Kupferberg with Jefferies. Your line is now open.

Good afternoon, guys. I just wanted to start with a very quick clarification. I know you said next three years on the medium-term guidance. So through 2019, would that be accurate?

Yes, it’s more or less. Three years is probably too precise, as you can fully appreciate when you get into a longer-term plan horizon, that there is less certainty with each passing year. We tend to think of how we’re growing the business in that multiyear, three-ish year timeframe. And so I think that that’s accurate. I don’t know that, where we want to be so specific as to say that it ends at December 31, 2019.

Okay.

The way that we set our three-year outlook, yes, end of 2019, but I think John’s point is a good one.

Okay, understood. And just on operating margin. So in the quarter what was the headwind on operating margins from Xoom and it looks like in your Q4 guide, we’re seeing implied operating margins to be modestly up year-over-year. Is that accurate?

Yes. You could take the guidance range and throw that. Xoom has been - as we’ve talked consistently this year, little bit of a drag on our margins. I would actually point though that the bigger impact in the quarter on operating margin was related to the increased provision around credit. And we’ve talked for a long time about the different leverage we have in the business, even despite having that increase in cost in the quarter. I think we demonstrated our ability to pull those levers by still coming at the high-end of our guidance range.

Okay. Thank you for the color.

Our next question comes from the line of Scott Devitt with Stifel. Your line is now open.

Hi, thanks for taking the question. First, Dan, you mentioned in the press release the roll out of the customer choice in the U.S. I’m just wondering if you can talk a little bit more about where you are with that in the U.S. and the roadmap on a global basis in coming quarters. And then secondly, as you think about the business strategically, now that you are in all these different areas of financial services layered on top of the B2C payments platform, I was wondering if you can just talk a little bit about your interest in being other verticals, and if so, what those are or should we think about the business more in terms of where you are now in terms of businesses and growing wallet share within those businesses? Thank you.

Yeah. So let me take the more strategic part of that question, which is where we see ourselves going, and then turn over to Bill to talk explicitly around where we are in the customer choice piece of it. And so, we talked a little bit about PayPal moving from being well beyond just a button on a website to really two things. For merchants, we want to be a full service solution provider. As the world move towards mobile, merchants are looking to write applications to take advantage of that mobile across online, in app, mobile web and in store. And they are trying to create those applications to enable them to get closer to consumers and create distinct differentiated value propositions. We basically want to power those applications with our platform. We want to do a 100% share of checkout. We want to integrate rewards capabilities through API and toolsets into our platform. We want to integrate contextual commerce into our platform, credit into our platform, so that merchants of all sizes can write the applications to get them closer to their customers and we can power that with our platform. And then we take the extensive number of consumers we have, the 177 million consumers we have, on top of the 15 million merchants we have. And we drive those consumers in a friction-free way to be able to sign up for those merchant apps. So we are really trying to be a much more extensive partner to merchants, as they make this change in a mobile-centric world, things like the One Touch and conversion rate, and all that is tremendously powerful for them. On the consumer side, we are looking to be much more in the middle of how consumers manage and move money. We’ve talked about our longer-term engagement goals, which are to go from, but we’re now 2.5 times a month, we were 2 times a month when we started that, but we to go to something like 2 times a week. And we know that’s a longer term goal. But if you look at what we’ve done with choice in enabling consumers to not just say, how they want, but where they want. And this is why I gave the example in Spain, I mean, it’s obviously very early days and not a significant number of customers to get, but those customers just offline are using the service 6 times a month on there, so you can start to see that engagement. And we were looking at a host of other things we’ve now integrated into Xoom, so that U.S. customers of PayPal can now use international remittances. It’s another service offering on top of that. And I don’t want to give away any future off my hands right now on the call. But you can expect us to continue to grow the set of offerings that we give to consumers. And so, as you look out over the medium term, you can expect us to continue to expand and grow our business, not just take the business we have. And follow the tailwinds of digitization, which will really drive that.

On the point of the roadmap for the customer choice implementation, as we’ve discussed previously, I call out that many of those core concepts we have been testing even prior to these deal. And so we have rolled out, I would say, much of the core concepts of choice. Dan called out one of those earlier in the call around the ability to pay with things other than your PayPal balance. And as we have rolled those out importantly we are seeing consumer behavior on those really in line with how we expected that to play out from our prior testing around these things. So very much going as planned on that front. And then as we come into next year, we’ll have some more of these things that will sort of layer in as we come into the first-half of next year. But the core concepts around users being able to pay however they want and us not influencing them or requiring them to use things of our preference. Those core concepts have been implemented and/or you were seeing consumer behavior as we would have expected from our prior testing around those things. And finally, I will just call out some of the really beneficial points around what we get from those, access to tokens, instant withdrawals, those types of things we expect to have coming as we get into the first-half of next year.

Yeah. I’ll just add on that, Bill. I think there are a couple of things that we did get from choice. Choice was a proactive strategic choice we made well before we started into negotiations with the networks. Actually our move to choice enabled us to open those conversations and to really start to think about how do we become the allies with financial institutions and networks to drive digital payments together. And I mentioned in my remarks the elimination of digital wallet fees and the cost certainty. They will talk about tokens. And that allows us to move in a very seamless way into in-store environments. But it also enabled us to have like the equivalent of what you would think of as card present rates coming into the in-store environment. It’s a profitable way for us to move into the in-store environment. And the other thing we obviously got some network discounts on top of that, as well as instant access to fund when somebody is trying to remove funds from the PayPal account through their bank account. And that was an important value proposition gap that we had. And we saw in other countries like the UK, where we do have that today, that people actually increased their balance on the PayPal platform, when they know they can take that money off instantaneously. So it’s a little counterintuitive to what most people are seeing that we got a lot of experience and know-how in that.

Thank you for the color. Thank you.

Okay, you bet.

Our next question comes from the line of Dan Perlin of RBC capital. Your line is now open.

Thanks. I had a question about - and you talk a little bit about it - but the engagement side of the equation. You’ve seen obviously numbers increase quite a bit. I’m wondering how much of it up to this point at least is really a function of this mix shift to different types of transactions? You talk about Venmo users, obviously a much higher frequency. But I want to parse that with the types of merchant relationships that you’re now able to engage in, because it would seem as though from the legacy business you’re in with eBay, you didn’t have a lot of frequency with those merchants, you might go to eBay a lot, you don’t necessarily go to those merchants a lot. And the announcements you guys keep making seem like just the consumer proposition to go back to that same merchant seems materially higher. So I’m just trying to think about how do those two kind of, I guess, shifts drive, kind of the forward look. Thanks.

Yeah. I first start off at, obviously, eBay is a large and incredibly important customer to us. We work, though hand in hand, with that team to try and drive as much business as possible through that partnership. But, obviously, as we split apart from eBay, part of the premise of that was that as a truly neutral third-party digital payments platform that we could partner with numerous merchants and retailers that might have seen the relationship that we have with eBay as competitive to them and so that we wouldn’t have been independent. I think a great example of that is Alibaba. We have been nurturing that relationship with them. We’ve done a couple of different announcements through the quarters. We started with wholesalers with them. But now really AliExpress is the main marketplace of Alibaba. That’s where really all their merchants are. And we’ve already started with PayPal being a team in options on that. It’s really a great example of it, because we have great strengths outside of China with consumers. They have great strengths with merchants inside China, who are already a major cross-border player in the Chinese corridor. So that match would never happen have we not been an independent third party. And that’s happening with numerous retailers as well, especially as we expand our value proposition now to really appeal to a mobile-centric world, that one retailer after another of all sizes are thinking about.

Yeah, in addition to that I would also add that, while we have expanded reach with merchants, it’s also the case that our core experiences, as Dan mentioned earlier on the call, things like PayPal One Touch with now more than 30 million consumers and active in 200 markets around the world, we’re seeing increasing engagement from those products on - or those consumers on our core products. So, yes, we have new experiences like Venmo that are highly engaged. But we’re also improving engagement on our core products. And interestingly, as you’ve seen some third-parties validate, such as the comScore’s value that looked PayPal conversion versus other new entrants to the market in standard checkout, our conversion is nearly 40 points higher that our nearest competitor with us at 87.5% and the nearest competitor at 51%. That’s an example of our increasing relevancy with consumers as they move to mobile and are demanding more and seamless experiences as evidenced by the higher conversion rate that we have. So it is on multiple fronts that we’re seeing that improvement in engagement. But the core product itself we are seeing great increasing relevance with our consumers.

Great, thank you.

We have time for one last question from the line of Bill Carcache with Nomura. Your line is now open.

Thanks. I had a follow-up question on some of your earlier comments around just your partnerships. Is it reasonable to conclude that part of the focus in your discussions is around not just existing PayPal customer TPV, but also aligning incentives and finding ways to both issuers and PayPal to benefit from the addition of incremental volumes from new PayPal customers? Just trying to understand how much focus there is in kind of the discussions around the addition of new users beyond the existing base?

Yes, Bill, great question. First of all, the networks nor PayPal would have done the deal that we did, have we not already been speaking with issuers and have we not known that issuers were going to be very favorably inclined to this. And so, this wasn’t sort of a one-two punch, where the first punch was the network deals and the second one was going out to issuers, where many conversations happening simultaneously. And I would say all of the conversations that we are having with issuers involve incremental volumes and incremental customers. There is not one conversation that’s just about, well, let’s just talk about PayPal base, let’s say, we’re going to talk about the base that’s within that issuer base. It’s all about how we increase volumes, how we increase the adoption and the number of accounts utilizing PayPal. So, yes, well, that is pretty much the focus of the conversations that we’re having with issuers.

That’s perfect. Thank you. I appreciate your responses.

Yes, well, thank you for that question and thank you, everybody, for joining us today. We really appreciate the time out of your busy schedules and we look forward to speaking with you again in the near future. Thank you, operator.

This concludes today’s Q&A session. Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program and you may now disconnect. Everyone have a great afternoon.