PayPal Holdings Inc (PYPL) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to PayPal's Q3 2015 earnings conference call.

(Operator Instructions)

As a reminder, today's conference is being recorded. I would like to introduce your host for this conference call, Mr. Tom Hudson, Vice President of Investor Relations. You may begin, Sir.

Good afternoon. Thank you for joining us and welcome to PayPal's earnings holding conference call for the third quarter of 2015. Joining me today on the call are Dan Schulman, our President and Chief Executive Officer and John Rainey, our Chief Financial Officer.

We're providing a slide presentation to accompany the commentary during call. In discussing year-over-year comparisons, we've chosen to present non-GAAP pro forma measures, which reflect items that are factually supportable, directly attributable to the separation of the Company from eBay Inc. on July 17 of this year. And we're expected to continued impact on the Company's results of operations, because we believe these measures provide investors a consistent basis for reviewing the Company's performance across different periods.

All historical measures for periods prior to Q3 2015, including year-over-year comparisons, are presented on a non-GAAP pro forma basis unless otherwise stated. As our potential growth rates are calculated by translating a term period of local currency results by the prior period's exchange rate.

This conference call will also be broadcast on the internet, and both the presentation and call are available through our investor relations section of the PayPal website at, investor.paypal/corp.com. You can visit our investor relations website for the latest companies news and updates. In addition, an archive of the webcast will be accessible for 90 days for the same length.

Before we begin, I'd like to remind you that during the course of the conference call, we will discuss non-GAAP measures and talk about our Company's performance, including the non-GAAP pro forma measures mentioned above. You can find the reconciliation of those measures or the most comparable GAAP measures in the slide presentation accompanying and the call. In addition, management will make forward-looking statements that are based on current expectations, forecasts and assumptions and involve risks and uncertainties. These statement include, but are not limited to, the future performance of PayPal as a standalone business, including expected financial results for the full year of 2015. Our forward-looking statements do not contemplate any impact in 2015 from the penny acquisitions of doing business. Our actual results may differ materially from those discussed in the call for a variety of reasons.

You can find more information about our risks, uncertainties and other factors that could affect our operating results in our registration statement on form 10, as amended in subsequent quarterly reports on form 10-Q, available at investor.paypal/corp.com.

You should not rely on any forward-looking statements. All information in this presentation is as of today's date, October 28, 2015. And we do not intend to undertake [no duties] updated information. With that, let me turn the call over to Dan.

Great. Thanks, Tom. Good afternoon, everyone. And thank you for joining us on our first earnings call as an independent company. I'm pleased to say we had strong results for the quarter.

But before I get into some of the details, I'd like to introduce you to John Rainey, our new Chief Financial Officer. I'm thrilled to have John join our leadership team. He is not just a seasoned public company CFO, but he is a world-class individual, whose judgment and integrity are a pleasure to see in action. I'm sure all of you will enjoy working with him. John will be providing a detailed overview of our financial performance later in this call.

Now, let me highlight some of our key results and initiatives in the third quarter. PayPal had a great start as an independent company, gaining market share, expanding our customer base, and deepening our engagement with our customers. In Q3, payment volume increased 27%, on an FX neutral basis, with PayPal processing $70 billion in total payment volume. This continues our track record of mid to high 20% growth in every quarter this year. Merchant services, TPV, continued at a strong pace, growing 34%, approximately 1.5 to 2 times the growth of e-commerce, further extending our global lead in online and mobile payments.

We're operating in a time when change is sweeping through the financial services industry, driven by the rise of mobile technology and the acceleration of money becoming increasingly digital. These two massive trends play directly to our strengths and give PayPal the unique opportunity to expand our reach and relevance to both consumers and merchants. We are making significant strides in our vision to use our platform to become a full-service solution provider to merchants, as they seek to form more intimate relationships with their customers.

And we strongly believe that our platform and our upcoming development efforts will enable PayPal to be an everyday part of the financial life of our consumers. Why do I consider our position so differentiated from our competition? It's not simply because we continue to build and expand our strong leadership position. Of course our increasing scale helps, but it is our focus that separates us from others. We are the only Company that is entirely focused on end-to-end digital payments across the globe.

Our brand continues to strengthen. For the first time we were named as one of the top 100 brands in the world, driven by the latest in our new product innovations, leading risk models, and outstanding customer service.

Each quarter we extend the strength of our key attributes and this comes through clearly in our results. As I have mentioned, there are four metrics that capture the health and strength of our business. They are the increasing scale of our customer base, the engagement of that base as measured by transactions per account, our top-line revenue growth and free cash flow. And the third quarter was our best quarter of 2015 in each of these important areas.

We finished the quarter with 173 million active accounts, adding over 4 million new customers in the past three months, our best net add quarter in 2015. Of the 173 million, approximately 13 million are merchants who accept PayPal across the world. Think about that. Think about that scale in terms of both consumers and merchants. It's a powerful, very difficult asset to replicate. To put it in context, if our active customers were all citizens of a single nation, PayPal would now be the eighth largest country in the world.

Consumers across the globe and merchants large and small, are signing up for PayPal in record numbers. But our goal is not simply to grow our customer base. We are intently focused on creating more relevant relationships with every one of our customers.

In Q3 we processed 1.2 billion transactions for our customers, up 25% from last year. And perhaps most importantly, we increased transactions per account, which rose from 24 a year ago to 27, growing 12% as our new products and services begin to resonate with our large customer base. These strong customer numbers naturally led strong revenue growth. We grew our top line at 19% on an FX neutral basis and 15% on a stock basis in the third quarter, with revenues of approximately $2.3 billion. This obviously strengthens our conviction that we will deliver on our full-year FX neutral revenue guidance up 15% to 18%.

And finally, free cash flow expanded nicely, in line with our expectations. We had a significant increase in our cash flow and we are on track to deliver our guidance of $1.6 billion to $1.8 billion for 2015. While we're obviously pleased with our financial results, what's even more important is the strength of the underlying drivers of these results.

As I mentioned earlier, our brand just continues to strengthen. In October, for the first time ever, PayPal was ranked on Interbrand's top global 100 list, placing number 97. This honor is more than just a ranking. Being one of Interbrand's top 100 is the recognition that our brand is truly global and has successfully transcended geographic and cultural differences. In a recent Forrester study of US consumers, found that people trust PayPal to provide their mobile, digital wallet more than banks, credit card networks, or other technology companies.

The trust associated with our brand comes from assets that are difficult to replicate. These range from our sophisticated risk algorithms, driven by the billions of transactions on our platform and our 8000 customer service associates, where our net promoter score continues to rise year-over-year. Our value proposition is the force that attracts consumers to choose PayPal. It drives measurable sales conversion lift for merchants who offer PayPal as a way to pay. Simply put, merchants and consumers trust PayPal.

But interestingly, people are even more compelled to choose and use us once they have experienced the convenience of our newest innovations, like One Touch. I would like to highlight some of the progress we made in the quarter, innovating and enhancing our products for our customers.

Let me start with One Touch. I believe that One Touch is significantly forward in the commerce checkout experience in a key way in which we are creating more engagement with our customers, both merchants and consumers. It is a faster, simpler and more convenient way for consumers to checkout at merchant sites, whether in mobile apps, on the mobile web, or online across all foreign factors, OS platforms, and payment types. In Q3, we began to roll out One Touch to 16 markets and 100% of eligible US consumers and merchants. Today, more than 50% of the IR 500 and over 1 million merchants around the world, from the largest like Home Depot, to the smallest, have One Touch enabled for their customers.

And we are rapidly gaining consumer adoption. Today, some 7 million consumers have opted in to use One Touch globally and every day that number rapidly increases. We continue to see not just meaningful improvement in conversion rates when One Touch is used, but also interestingly, a significant improvement in customer engagement. The innovation behind One Touch came to us with the acquisition of Braintree, and the re-platforming of our PayPal software stack enabled its rapid global implementation.

We marked an important milestone with the two-year anniversary of our Braintree acquisition. It's now very clear that Braintree's early bet on mobile is paying off. Most of the best next gen mobile commerce companies use Braintree for payments. Two years ago, Braintree had 56 million cards on file. This quarter, Braintree had 185 million cards on file and has quadrupled the volumes it processes. Our increased customer growth and engagement is the direct result of our focus of providing a full solution to our merchant partners.

The PayPal sales force, across 46 markets in North America, Europe, Asia and Australia, is actively selling the full suite of services on our platform, focused on capturing 100% share of checkout. And we are seeing tremendous adoption, greatly expanding our base of merchants, which includes new companies like Jet.com, One Kings Lane, and Hungryhouse, as well as industry leaders like Uber and Aribnb [Inc].

And Venmo continues to set the standard as the mobile payment app for millennials. A year ago, Venmo processed $700 million in volume in Q3. This quarter, Venmo processed $2.1 billion of volume, growing well over 200% year over year. This makes Venmo one of the fastest growing apps in the world and likely one of the top 10 apps in the US by dollar volume. And the typical customer engages with the Venmo app multiple times per week. I'm also pleased to share that we will shortly begin trials allowing Venmo customers to pay with Venmo at selected PayPal merchants. This provides even more value to Venmo customers and at the same time allows us to start the monetization of our Venmo asset. I'd like to close my remarks by highlighting three areas: credit, our in-store autonomy efforts, and end with a quick update on our announced acquisitions. These topics frequently come up in conversations I have with investors, so I thought some additional color might be helpful. Credit is an important way we deepen our relationship with our customers, both merchants and consumers, and we're committed to creating transparent and compelling credit products that help our customers have better control over their money.

I'm pleased but not surprised that PayPal Working Capital, our lending program that provides our merchant customers the capital they need to grow and succeed, has now exceeded $1 billion in credit extended to more than 60,000 small and medium businesses in the US, UK, and Australia. PayPal Working Capital uniquely leverages PayPal technology and data to assess credit worthiness, underwrite, and service loans, in ways the traditional lenders can't. We bet eligibility on a merchant's PayPal history and processing volume, not their business or personal credit score.

PayPal Working Capital loan amounts, which range from $1,000 to $85,000, fill a void in the traditional banking environment. And perhaps most importantly, PayPal Working Capital also powers our traditional business. 90% of the merchants who use PayPal Working Capital reapply for a loan and their net promoter scores and TPV go up significantly, which naturally results in meaningful churn reduction numbers. It's a true win-win proposition.

Let me now spend a couple of minutes on our multi-channel efforts and some of our early successes working with major merchants. Our goal is to help merchants provide a truly differentiated value proposition, in using mobile, across the web, in-app and in-store. The movement of in-app mobile payments to the in-store environment unleashes a tremendous new opportunity for us, opening our addressable market by almost 10 times.

Mobile provides a natural evolution for PayPal to move from the online and in-app world to the in-store environment. As our retail partners search for ways to use mobile across all channels in order to form ever more personal connections to their customers, they are looking for a full service platform to power their application across all payment types and loyalty. They desire a cloud-based solution that has point of sale technology, device, and operating system agnostic. Our merchants want to provide a consistent experience and value proposition to all of their customers, regardless of channel, device, OS, or payment type. And the combination of our Paydiant, Braintree, and PayPal platforms provides the capabilities they are looking for.

Unlike our previous in-store efforts, our merchant partners are driving the adoption of our open platform. PayPal is working to be a true payments partner to merchants, who are increasingly seeking to bridge the divide between online and in-store through mobile. By being truly technology and payments agnostic, we can focus on improving the entire commerce experience, by linking a merchant's loyalty, offers, rewards and private label credit cards into our platform and provide capabilities like split tender at point-of-sale and other innovative propositions, in order to help merchants create deeper and more powerful engagement with their customers.

In September, Macy's announced an integration with PayPal for Omni channel checkout capabilities online, in-store, and on mobile. The integration enables Macy's customers to pay in-store with PayPal payment codes and online and on mobile via the PayPal button and One Touch. These innovative payment options are now available at all Macy's, Bloomingdale's, Macy's Backstage, and Bloomingdale's outlet stores in the US.

Subway, with its 30,000 plus locations, is using Paydiant and PayPal for its order-ahead application. And with Shell Oil in the UK, we jointly announced a mobile payment service that allows drivers to fill up and go without having to go into the store and pay. Fill Up & Go is the first mobile payment service at the pump offered by a fuels retailer in the UK.

And finally, our Paydiant platform is the technology powering Target, CVS, Walmart, Wendy's, Sears, and Kmart, as they trial the MCX currency application in Ohio. As you can see, merchants are beginning to use our platform and capabilities to put forth true value proposition enhancements for their consumers. These Omni channel efforts are already well beyond anything we have done previously and we are just getting started.

Finally, I would like to touch on acquisitions. First, we expect to close our Zoom acquisition later this quarter. I'm more excited than ever to welcome Zoom to the PayPal family.

And in August, we announced the acquisition of Chicago-based Modest, a company that brought us world class talent and technology that will allow us to accelerate our lead in contextual commerce, allowing customers to pay for products and services in whatever context they discovered them, not just on a merchant website. Modest has deployed a leading set of APIs that allow contextual buy buttons to hook directly into a merchant's e-commerce, order management systems, which is essential in providing a full-services solution to our merchants.

But as important as acquisitions are for us, our internal innovation efforts will always be our primary driver of value. Our technology re-platforming efforts have allowed us to dramatically accelerate our organic software development road map. We now have a powerful combination of internal innovation efforts and acquisition firepower working in tandem. That's a strong combination to drive and further differentiate our leadership position.

I'd like to conclude by saying thanks to the entire PayPal team. It's because of your focus, your passion for our mission and day-in and day-out efforts that we continue to make strides towards our ultimate goal of being a customer champion.

With that, let me turn the call over to John. John?

Thank you, Dan. It's a pleasure to be here for PayPal's first earnings call as a newly independent publicly traded company. I also would like to thank PayPal's 173 million customers and 16,000 employees worldwide for making this a great quarter. We have a tremendous opportunity ahead of us and I'm excited to be able to join Dan and the rest of the PayPal team to transform the movement and management of money.

Q3 was a strong quarter and we continue to execute on our plan. As Dan mentioned, we grew revenue 19% on an FX neutral basis and achieved earnings of $0.31 per share, an increase of 31%. We continue to grow our share of the market. Our share gain is an indication that our strategy is working, as we expand our product solution from a payment button to an end-to-end payment solution for merchants of all sizes.

As our results for the quarter show, we are delivering on the commitments that we outlined earlier in this year. We are expanding our reach and becoming more relevant, enabling us to deepen our engagement with our customers by increasing the number of merchants where PayPal is available to shop and pay.

In the quarter, we red-lined with a number of large retailers like Macy's, REI, and Symantec. As a result, the number of payment transactions per active account increased to 27, up 12% from a year ago. Importantly, our payment volume through the mobile channel increased 42% year-over-year to $16.5 billion. With mobile growing faster and continuing to gain share, it highlights the share and consumer behavior and the opportunity we have to leverage this trend as mobile technology bridges the divide to the significantly larger in-store opportunity.

I want to highlight our performance on a few operating metrics for the quarter. First, we expanded our active account base by more than 4 million in the quarter, to 173 million customers. The number of payment transactions increased 25%, driven by growth of the media, travel, and retail verticals. Total payment volume was $70 billion in the quarter, up 27% on an FX neutral basis. US payment volume grew 28%, a two point acceleration, while international growth was 25%, again on an FX neutral basis. Our US business benefited from strong results in both Braintree and Venmo, in addition to the transaction growth from our branded PayPal Digital Wallet product.

PayPal merchant service transactions in North America, which exclude Braintree and Venmo, accelerated one point to 25%. As we conduct business in 203 markets across the world, the stronger dollar had an impact on our results, not only from a translation perspective, but also on consumer demand. We experienced weakness in China exports, specifically from our merchants off of eBay, which were impacted by lower demand from both Australia and Europe.

For the quarter, PayPal generated $2.3 billion in revenue, up 19% FX neutral. Transaction revenue was up 18%, while other value-added services grew 26%. Transaction revenue benefited from rising engagement as reflected by the increase in the of number payment transactions per active customer account. This increase reflects the growing relevancy of Braintree's unbranded product in the evolution from a payment button, or a tender type, to payment partner, where we capture all the merchant's processing volumes.

Other value-added services benefited from the growing penetration of PayPal credit as well as an amended agreement with Synchrony Financial during the quarter, for which we will now record revenue each quarter versus historically recognized revenue annually in the second quarter of each year. The amended agreement extends our relationship with Synchrony, and importantly, no longer requires PayPal to purchase the credit portfolio in October of next year, freeing up more than $1 billion of cash for uses that are more accretive to shareholders.

Total expenses grew 12%, significantly less than revenue. On a per transaction basis, total expenses declined 11%. Our volume base to variable costs, which are our transaction expense and transaction and loan losses, were up 17%. Despite the additional costs associated with standing up an independent company, we gained economies of scale on our other expenses, which were up only 7%. The investment in our technology platform has both increased security and availability, but also reduced the platform cost per transaction. We are also experiencing good cost control in the other areas of our business as we begin to operate as an independent standalone company.

Our transaction margin for the quarter declined 80 basis points. This is a result of two things, both of which are a deliberate strategy on our part. First, as we expand our presence with large merchants, our corresponding take rate is lower as they benefit from volume-based pricing. And second, as Braintree becomes a greater percentage of our volume, the higher credit card mix results in increased transaction expense. While our transaction margin declined, our operating margin expanded 200 basis point in the quarter. This demonstrates our ability to maintain and even grow our margins with the operating leverage we have in the business as well as the discipline that this management team has around controlling costs.

Free cash flow for the quarter was $519 million, up 20% year over year, with CapEx coming in at 6% of revenue. I would like to take a moment to discuss capital allocation. There are a few companies of our size with our balance sheet and growth rate that are generating the free cash flow and operating margins of PayPal. We have a tremendous opportunity to increase shareholder value with the deployment of that cash flow, be it through organic investment, acquisitions or returning cash to shareholders. I will discuss our plans for each of those on our next earnings call as we lay out our strategy for 2016.

From a balance sheet perspective we ended the quarter with cash and cash equivalents of $6.7 billion, including approximately $2.4 billion in the US. In July, we announced our agreement to acquire Zoom, a digital money transfer provider, and have made good strides towards closing this transaction. Zoom shareholders approved the acquisition and, pending regulatory approvals, we expect this to close in the fourth quarter. This transaction will have a negligible impact to our full-year 2015 results.

And now to guidance. For 2015, we are executing on our strategy and our strong performance in the third quarter only reinforces our confidence in our guidance, both for 2015 as well as the midterm guidance we provided at the time of our separation. We are firmly on track to deliver on our full-year 2015 pro forma guidance of FX neutral revenue growth of 15% to 18% and EPS of $1.23 to $1.27.

The US dollar was a headwind to our spot revenue growth in the third quarter, representing a four-point difference between a reported revenue growth of 15% and our 19% revenue growth on a currency-neutral basis. And we expect a similar impact in the fourth quarter.

In closing, we have created a leading sustainable financial model which allows us to keep innovating and growing at scale. We are a global company with a trusted and recognized brand. We operate in 203 markets across the world with 173 million customers. We are growing our top line at a 15% to 18% annual clip. We had a 20% operating margin in the quarter and generated almost $0.25 of free cash flow for every $1 of revenue earned. And along with our revenue growth, our good cost control, and operating leverage enabled us to grow EPS by over 30% in the quarter. And lastly, we have a management team that is laser-focused on creating shareholder value.

With that, let me turn it back to the operator for questions.

(Operator Instructions)

Dan Ferlin, RBC Capital Markets.

The question I have is, there's two of them real quick. One is, you talk about this monetization strategy around Venmo and it's clearly, it's obviously driving a lot for account growth it's obviously driving part of the takeaway degradation, so it's key.

I'm trying to understand really the process that you're going to go through in order to do that and is the pricing model going to be similar to what we have come to expect in terms of your take rate?

Let me take that. Thanks for the question. We will start trials with pay with Venmo at selected PayPal merchants this quarter. And basically what this does is it opens up the Venmo base to our PayPal merchants and it will be exactly the same take rates.

So depending on where they're buying, it'll be just as if a PayPal customer is purchasing at a PayPal merchant. So those will be very familiar economics to you.

We're trialing this in the fourth quarter, assuming from a technological perspective, this works. Obviously we have millions upon millions upon millions of Venmo users. Merchants are eager for them to start to buy at their locations.

We would start to roll that out next year and by the end of next year, really expect to fully monetize the Venmo asset. So you'll start to see that come into next year and hopefully be fully rolled out so that any Venmo user can pay at pretty much almost any PayPal merchant location. That is the goal and objective that we have with similar take rates. No change in take rate.

Excellent. One other real quick one. Can you just put a finer point on this growth driven by the amendment with Synchrony? You called it out a second ago and I see it in your slide deck. Can you explain specifically is there a gain and that? Or is it pricing? Or is it something else? If you could just [flatten it out]. Thanks.

Sure, Dan. This is John. In the quarter we amended our agreement with Synchrony, which provides the PayPal branded credit card. That agreement was set to expire in 2016 and as I called out in my prepared remarks, that required us to have a significant outlay of cash to purchase that credit portfolio.

The amendment now extends the agreement through 2023 and we no longer have that obligation to purchase the credit portfolio although we do have the option at that point in time. But, importantly, as it relates to our economics there are two things I would point out. One is that there are better economics and in the quarter we recognized about $37 million related to this transaction.

Probably 25% of that number is more one-time in nature. Then the rest is what we would expect on a quarterly basis going forward. That's a little bit different than what we've done in the past, where we settled all of the revenue in the second quarter of each year. So we'll see a more consistent earnings stream from this transaction going forward.

Okay. Thank you.

Sanjay Shakhrani, KBW.

Thank you. Dan, I was just wondering if you could comment on the Chase Pay MCX deal. I was wondering if you think it impacts PayPal in any way, and specific to your MCX relationship with Paydiant. Is there any change to that?

Hi, Sanjay. Thanks for the question. First of all, we have a very close relationship with the folks at MCX, whether that be with Brian Mooney and his team, or with the merchants that are part the MCX consortia.

And obviously, Paydiant is the technology provider that powers the currency application, Chase Pay will be integrated in through the Arkady platform. My view on all of this is that you have gotten exploding marketplace right now for digital payments. The number of opportunities is immense and honestly, putting those in order of priority, selecting which people to work with, making sure that fits within our full development pipeline is a big task that we have because of the amount of interest in working with our platforms in working with us.

I think you're going to see obviously numerous different people coming into the payment space, their announcements all the time, Chase Pay is another way to pay, as many other payment forms are and mostly, they integrate through our platforms. I would say we have a very close relationship with MCX, continue to have a close relationship with MCX, we're exploring different opportunities with MCX and the more successful that they are, that is helpful for us because we have a close relationship with them and their merchant partners.

Just maybe one related follow up. A key component of the value proposition is the idea that the loyalty numbers can be attached to the tender or something. Could you talk about -- I think you guys have that capability and how important it is to your merchants for that to occur.

Great question. I think it is crucial because what I think merchants really want to do, in fact, what I know merchants want to do is not a form factor change. They're not looking to just substitute a card swipe for a mobile tap. What they're looking for is a true value proposition change.

Part of these true value proposition change is, one, knowing the customer when they come in, because you now know who they are when they come into the store, but rewarding them as well. A lot of the merchants are creating applications that give rewards instantaneously and then, those rewards hook up into our platform through a set of APIs. So, we're not creating the rewards program, the merchant is.

We are powering it through our platform so that when a consumer checks out, they can immediately see, okay, I got rewarded for those purchases and then have the option to do split tender at the point-of-sale. So, they could pay for a part of that purchase with their rewards points, a part of that with a certain tender type. You can automatically, for instance, when a customer walks into a store, have the private label credit card pop-up as the default.

There are all sorts of great things you can do when you have a robust platform that goes across payment types, across [the last] types and across form factors and it also works in multiple POS environments. And that is really why we have pulled together this set of assets from [Hadient] to Braintree to PayPal and are integrating those platforms together so that we can provide a robust platform solution that enables merchants to write their application, tie in their offers, loyalty rewards into our platform. And then we can also bring with that 173 million customers we have to our PayPal button into that platform to light up that platform. It is a very strong combination of both unbranded and branded that merchants are excited about working with us.

Craig Maurer, Autonomous.

Thanks for taking my questions, two questions for you, first, would you discuss the directionality of the payment yield that you stripped out on Venmo and Braintree? And then secondly, in walking the floor at Money2020 we caught up with a few very large merchants and discussed PayPal acceptance at the point-of-sale, and almost universally they discussed a reluctance to do business with a quote unquote, middlemen, due to PayPal's current construct.

Looking at what Walmart is able to do directly with Chase, asking Sanjay's question a different way, does this send a precedent that could severely impact PayPal's prospects at point-of-sale with large merchants?

Let me take that first question. I think what you asked is, stripping out the effect of Venmo and Braintree on our take rate. That is not something that we break out to the public. We really want our customers to think of that as one product as we continue to integrate that into the overall PayPal payments platform, so we do not disclose that separately.

Second, Craig, to your point, we're working with one large merchant after another throughout not just the country here, but across the world. In talking to them about how they want to use mobile across, online, in app and in store. And that neutral third party is actually the strength that we bring to that.

There are all sorts of ways of thinking about how we use technology to help merchants, but that consistency of being able to use some of the unique assets we have, like our funding mix, to be able to help merchants at point-of-sale, to look across payment types. Not just that one payment type and have a different experience with it, a different operating system and have a different experience with that, but create a consistency across payments, across loyalty, across different technologies, and that is hitting a real core with merchants.

Of course, not every merchant is going to want to do business with us throughout the world, we don't think this is going to be a winner take all model. But the assets that we are bringing are really resonating and we are having more strategic conversations on a daily basis with the largest merchants than we have ever had before.

If I could just follow up real quick, I just want to understand the sustainability of margin gains in the quarter because it looked like reinvestment in the business seemed to slow a bit in the quarter. Just to understand how we should think about the run rates for OpEx?

Sure, let me address the margin piece first and come back to the run rate for OpEx. As I said in my prepared remarks, we did see some compression in our take rate. But there's actually validation that we are executing on our strategy because we become more relevant to our customers and enable them to use PayPal with large merchants and expand Braintree.

Fortunately for us, we expanded our operating margin 200 basis points in the quarter, and that is a good indication of the operating leverage that we have in the business. Our other costs that are not volume related in the quarter represented about 42% of our revenue. That is down 3 points from the previous year where it was 45% of our revenue. This is something we will continue to do going forward as we focus on free cash flow generation and increasing our margins.

With respect to the overall level of operating cost in the business, I think the third quarter is fairly representative of what we should look like going forward. We did have some noise in our year-over-year comparisons as we stood up an independent organization. And if you go through the individual line items for our expenses, you see some year-over-year increases and decreases which are not necessarily representative of the run rate as we had to add an infrastructure for PayPal separate from eBay.

Just to add a couple things, there are numerous areas of the business where our re-platforming is making us more and more efficient, whether that be our ability to handle customer service on a more efficient way because when we deploy in less [bugs], less calls coming in, it is a much more efficient system now. And as we continue to do that, we continue to see the ability to have increased operating leverage. I think John's remarks (technical difficulty). I continue to see operating leverage for us.

Bryan Keane, Deutsche Bank.

John, the transaction revenue was 15% year-over-year last quarter. It dropped 200 basis points to 13% this quarter. I think FX is playing a role, maybe you can talk about what it is on a constant currency basis and any moving pieces in there.

Sure, so transaction revenue on a constant currency basis was 18% up for the quarter versus 13% on a spot basis.

What was it in the June quarter?

Bryan, I do not have that number right in front of me, but we can have [Tom and Tina] back to on that.

Okay, but there was nothing materially different in the business that caused the drop? I think most people in the street were modeling more a 15% growth rate and the 13%. I'm just trying to figure out if it was just FX popped up a little bit that could be the difference.

We did see continued pressure from FX. And as you might remember, we initially guided to about a 3-point difference for the full year and we saw a 4-point different in the quarter. I will remind you that as we go into the fourth quarter, we're beginning to lap the period last year where we saw the dollar strengthen. And why that is relevant is we tend to hedge currency out about six quarter, and we are lapping a period where we were taking advantage previously of the better exchange rates.

The hedges that we have in place in the fourth quarter will not be as good as what you've seeing in the second and third. And just for more transparency there, in the third quarter the year-over-year difference in hedges was up $55 million for us. And perhaps more to your point, that decline from about an $80 million impact in the second quarter. That could be some of what you see in the transaction revenue.

Okay, that's helpful. And then Dan, just on pricing, if you look at it like for like, I understand the mix and large merchants as they take over the take rate drops, but just pricing in general for the like to like merchants, are you seeing a lot of pressure there?

We really aren't. It's obviously a competitive environment, but when we look at the attributes of take rate decline, it is overwhelmingly explained by the mix shift of product and the mix shift towards large merchants and that has been relatively consistent over time for us as well.

No real change on that, and as John said, we have repeated this time and time again, we are consciously making a strategy choice to be a 100% share of checkouts, to be a full service solution provider to merchants. It is making a real difference in our ability to be a strategic partner with them. When we do that, the PayPal button is always implemented in a way that typically improves our share of checkout. It's our most advanced integration on that.

With every one of those implementations we add additional revenues and additional profit dollars, so although our take rate may come down, that is absolutely the right thing for us to do. And as we move towards more and more ubiquity for PayPal consumers to shop and move to more and more larger merchants, as John also mentioned, the more volume, the lower the take rate on that.

But that is just a part of how the payments industry works. It is all about strategy and strategic choices driving the environment has remained relatively constant.

One last quick question on the guidance, on revenue guidance in particular. Constant currency, you stay the same, you reiterated at 15% to 18%, but you are tracking 19% year to date. Is there anything to think about in the fourth quarter why necessarily the rate would drop into that range, or you are just making sure you are conservative and sticking with the guidance?

When we gave our guidance, it wasn't quarterly guidance, it was guidance for the year, and we are still comfortable with that range. I will say that both from a revenue and a EPS perspective, our bias is probably towards the upside of that.

[Tin Sev Wang], JPMorgan.

On the margin side, how are you balancing showing margin expansion like you talked about versus investing in growth? And I wanted to clarify, it looks like year to date you are up 60 bips or so in non-GAAP margin, if our math is right, and your full year target is up 0 to 100. With one quarter to go, is it safe to say you will be in the upper half of that range?

As John said, we are maintaining our guidance, but are biased, obviously, because of our results is towards the upper end of that. And as John also mentioned, we gave guidance for the year, not for any of the quarters. But our results are certainly coming in at the higher end of this guidance on all of those metrics, and most of the Street is there, and that is how we are performing.

In terms of margin versus investing in the business, we gave medium-term guidance that said that we felt that our margin could be flat to expanding over the medium term, so we feel very comfortable with that. There's a tremendous amount of operating leverage in our business. We think we have plenty of room to invest in the growth opportunities in front of us and still maintain our margin or slightly grow our margin going forward. That hasn't changed.

As I mentioned, there are tremendous amount of opportunities in front of us. You may have seen in the press release we just signed a major deal with America Movil in Latin America, the largest wireless provider there, that will make a significant difference in results down there. It is going to be a pretty extensive partnership. Those opportunities are around us all over, and we have the product development capabilities to go and implement those and the investment capacity to make sure those partnerships are successful.

As John mentioned, we're laser focused on the cost, but we are laser focused on the cost the right way. We're not cutting costs for short-term gains one way or another. We're cutting costs because we are operating more efficiently, and that really is the major takeaway for this. We're very comfortable, as John mentioned, with the medium-term guidance that we have given.

I would add one more thing to what Dan said. I think a good example in response to your question about margin expansion versus growth is our Xoom acquisition. We've disclosed that Xoom would be slightly dilutive to our results in 2016, but we obviously, every decision we make is through the lens of creation of shareholder value.

And we're not going to manage the business for next month's revenue or next month's earnings, we're going to manage it in terms of, how do we create long-term shareholder value. And Xoom is a great example of that as we get to expand into the money remittance business and leverage what is already done there today with PayPal's 173 million customer base.

One follow up, still trying to learn the press release and whatnot, did you give large merchant TPV mix? And then also, Dan, I think you said the pipeline for new merchant pipeline is strong. I'm curious if the sale cycle for adding new merchants changed at all, given so much new activity on the payment side?

We did not give the large merchant mix in the press release. That will be in the Q, which is coming out I believe tomorrow. The number is 46% for the quarter.

As John mentioned, we added three large merchants, REI, [Symantec] and Macy's, but we have an immense pipeline of booked business waiting to come on to our platform. It takes a little bit of time to bring that on, it depends on how major the merchant is, I think we're doing 100% of the processing, which most is moving towards. But no, you will see a constant drum beat of that occurring, given our backlog right now.

Heath Terry, Goldman Sachs.

One technical question, I want to make sure that we're thinking about the right way to start with. You mentioned the 400 basis points of FX headwind in the quarter and then the FX hedge timing. As we look at the guidance for 300 to 400 basis points in Q4, how does it work where we are seeing that impact declining, or roughly declining, quarter over quarter with the rolloff on the hedge timing? I just want to make sure we're thinking about that the right way.

And then Dan, when you say immense pipeline of booked business, how much of that is in the pipeline because it is fourth quarter and nobody wants to mess with their payments going into the holiday season versus more linear addition of customers and it is just the challenge of any new implementation?

I will take the first piece there. As we go into the fourth quarter, the year-over-year decrease or the way the dollar has -- what am I trying to say here -- the exchange rate environment is better in the fourth quarter than it is in the third quarter on a year-over-year basis.

However, the offset from the hedge position is not as good for us in the fourth quarter as it is in the third quarter. At today's exchange rates, our hedge gain in the fourth quarter would be in the $20 million to $25 million range.

And then on the immense pipeline of booked business, which by the way, should have been the headline on your press release.

It is much more linear. Obviously, we have got the fourth quarter moratorium coming up, but that is not the reason for the pipeline. It is a pipeline that has grown each quarter.

A lot of it coming into the Braintree platform, all of it with PayPal buttons on it. My -- as we have come through this quarter with 19% revenue growth on our topline, a real nice improvement on our EPS, and as I look forward, I have got a tremendous amount of enthusiasm to where this business can go.

We just came off of our off-site for our 2016 planning. But not only do they come out of that with enthusiasm for what 2016 could look like, but I felt the most important takeaway was we came out of that thinking about really how that sets us up for a great 2017. That is really the way that we're thinking about business, what are all the capabilities that we are building, our internal development efforts are accelerating in a very nice fashion right now.

We will start to have some of our acquisitions come on board and will be able to leverage some of that. Customers are really responding to the new PayPal, and you pull all of that together and we are obviously reiterating our medium-term guidance on this. But we feel good about the strength of our business in the momentum of it.

Ladies and gentlemen, this does conclude the question and answer portion of this conference. I'd like to turn the conference back over to our host.

Thank you very much everybody, for joining us, and we look forward to talking with you later on today, tomorrow and throughout the quarter. Thank you.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.