eBay Q3 2009 Earnings Call Transcript

| About: eBay Inc. (EBAY)


Q3 2009 Earnings Call

October 21, 2009 5:00 pm ET


Mark Rowen - Vice President, Investor Relations

John J. Donahoe - President, Chief Executive Officer, Director

Robert H. Swan - Chief Financial Officer, Senior Vice President - Finance


Mark Mahaney - Citi

Christa Quarles - Thomas Weisel Partners

Jeffrey Lindsay - Sanford C. Bernstein

Brian Pitz - UBS

James Mitchell - Goldman Sachs

Imran Khan - J.P. Morgan

Youssef Squali - Jefferies & Company

Sandeep Aggarwal - Collins Stewart

Benjamin Schachter - Broadpoint Amtech

Scott Devitt - Morgan Stanley


Ladies and gentlemen, good day. Welcome to eBay's third quarter 2009 earnings results conference call. This call is being recorded and at this time, I would like to turn the call over to Mark Rowen, Vice President of Investor Relations. Please go ahead, sir.

Mark Rowen

Thank you, Operator. Good afternoon. Thank you for joining us and welcome to eBay's earnings release conference call for the third quarter of 2009. Joining me on today’s call are John Donahoe, our Chief Executive Officer; and Bob Swan, our Chief Financial Officer.

We are providing a slide presentation to accompany Bob’s commentary during the call.

This conference call is also being broadcast on the Internet and both the presentation and call are available through the investor relations section of the eBay website at investor.ebayinc.com.

Before we begin, I’d like to remind you that during the course of this conference call we will discuss some non-GAAP measures in talking about our company’s performance. You can find the reconciliation of those measures to the nearest comparable GAAP measures in the slide presentation accompanying the conference call.

In addition, management may make forward-looking statements relating to our future performance that are based on our current expectations, forecasts, and assumptions and involve risks and uncertainties. These statements include, but are not limited to, statements regarding expected financial results for the fourth quarter of 2009, anticipated future stability, and growth in the marketplace’s business unit, and the sale of Skype.

Our actual results may differ materially from those discussed in this call for a variety of reasons, including but not limited to the impact of recent global economic events and the global economic downturn, foreign exchange rate fluctuations, changes in political, business, and economic conditions, the impact and integration of recent and future acquisitions, the impact of divestitures, including Skype; our increasing need to grow revenues from existing users in established markets; an increasingly competitive environment for our businesses; the complexity of managing an increasingly large enterprise with a broad range of businesses; our need to manage regulatory tax, IP and litigation risks, including risks specific to PayPal, Bill Me Later, and the financial industry; and our need to upgrade our technology and customer service infrastructure at reasonable costs while adding new features and maintaining site stability.

You can find more information about factors that could affect our operating results in our most recent annual report on our Form 10-K and subsequent quarterly reports on Form 10-Q, also available at investor.ebayinc.com.

You should not unduly rely on any forward-looking statements and we assume no obligation to update them.

All information in the presentation is as of October 21, 2009 and we do not intend and undertake no duty to update this presentation.

And now, let me turn the call over to John.

John J. Donahoe

Thank you, Mark and good afternoon, everybody, and welcome to our Q3 earnings call. Our Q3 revenues topped $2.2 billion, with organic growth up 5% over the prior year. Our non-GAAP EPS was $0.38 and we generated free cash flow of $563 million during the quarter.

These are strong results for a strong company getting stronger. Our strategies are working and I continue to be pleased with our pace, our progress, and our performance. Our teams are executing well against the three-year growth strategies we outlined earlier this year. PayPal continues to gain share and drive strong global growth across e-commerce. eBay has stabilized and is beginning to show some positive trends. Core GMV accelerated for the second quarter in a row, and we announced the sale of Skype this quarter, setting this terrific business on a path we believe will enable it to achieve its full potential.

As a company, we are operating faster and more efficiently and we are making the right investments in our two core businesses, e-commerce and payments. We are delivering on our commitments and managing our portfolio with focus, discipline, and accountability. All in all, we continue to take the bold steps required to lead and win.

Now let’s look at our results from each of our business units. PayPal had a strong quarter with revenue, total payment volume, and active registered accounts up across the board. PayPal's penetration on eBay increased six points year over year to nearly 66% globally, drive by a more streamlined checkout experience and increased adoption of electronic payment.

And we just announced the integration of Bill Me Later into the PayPal wallet both on eBay and across e-commerce, giving consumers more choice when they pay online.

PayPal's merchant services business gained market share in all regions around the world, with total payment volume increasing 35% year over year on an FX neutral basis and acceleration from Q2. The integrated sales team for PayPal/Bill Me Later is driving a strong pipeline. More than 100 large merchants in the U.S. have been signed thus far this year, expanding addressable sales for PayPal and Bill Me Later by $27 billion.

In all, 44 of the top 100 U.S. retail sites now offer PayPal and 24 of these now offer both PayPal and Bill Me Later, twice as many as last year. That includes 1-800-FLOWERS, Toys R Us, and Walmart.

In the travel arena, nine of the 10 most popular airlines accept PayPal or Bill Me Later, and for charitable giving, consumers can now use PayPal on more than 100,000 non-profit sites across the web.

So whether shopping, traveling, or giving to charity this holiday season, consumers have more reasons than ever to use PayPal and Bill Me Later.

Outside the U.S., PayPal's merchant services momentum is just as strong. Total payment volume was up 63% in Europe and 55% in Asia on an FX neutral basis. This growth is being driven by merchants like Lufthansa Airlines globally, and Levi’s in Europe, both of which began broadly accepting PayPal in Q3.

In Asia, 12 of the top 100 online retailers now offer PayPal with a strong line of merchants in the pipeline. And we’ve intensified our efforts in Japan. PayPal signed agreements with two of the leading payment gateways in Japan, SP Veritrans and E-Context. These two gateways work with more than 22,000 Japanese merchants, representing an estimated $11 billion in addressable online sales. This will help accelerate adoption of PayPal on small and larger merchants in the important Japanese market.

With our growing focus on innovation, we are also making it easier to use PayPal in new ways and on new platforms. For example, PayPal launched its student account during the quarter. The student account is a fast and secure way for teenagers to shop online using PayPal. It provides parents full visibility into their kids’ budgeting and spending habits and offers a fast, easy way to send money when needed. As a father of four children, I can personally attest that this is a great product for the entire family.

On November 3rd in San Francisco, PayPal will take a big step forward with the official opening of our platform to third-party developers. For me personally, this is one of the most exciting opportunities ahead for PayPal. We are engaging developers as a new set of customers and we expect to see a wave of payments innovation unfold. Developers can now use PayPal's global platform to incorporate a fast, easy and secure payment service into a wide range of applications, including mobile payments and micropayments.

Now on to eBay -- simply put, we are seeing our turnaround efforts begin to pay off. While we still have a lot more work to do to improve trust, value, and selection, we are making progress. Core GMV and sold items were up, both accelerating from Q2.

Buyers and sellers continue to move to our fixed price format, which accounted for 56% of GMV in the quarter. While auctions declined, the drop was less than in Q2, reflecting the positive impact of new pricing for consumer-to-consumer auctions in the U.S. and U.K.

And eBay's most trusted sellers continue to win -- sellers with detailed seller ratings of [48] and above continue to grow their businesses at double-digit rates, faster than e-commerce. In fact, year over year same-store sales for these sellers in the U.S. were up about 13% in Q3, and accounted for almost 40% of total U.S. GMV.

And over the past year, our efforts to create a more trusted shopping experience on eBay are working for sellers and for buyers. In Q3, we took our seller ratings a step further, implementing a new top-rated seller status in our three largest markets, the U.S., U.K., and Germany. The new status highlights our best-performing and most trusted sellers, and all sellers, regardless of size, small, medium, or large, are eligible for this status. These sellers consistently receive the highest ratings from buyers, offer fast shipping, and guaranteed returns.

So for the first time, buyers who come to eBay looking for fast, trusted service, can easily spot top-rated sellers by the prominent badge in search results. About 150,000 U.S. sellers qualified at the launch of this program earlier this month.

So we are continuing to raise the bar in eBay to meet increasing buyer expectations and help sellers who meet those expectations succeed. And feedback from our customers shows that they are noticing. Our net promoter scores are up for both buyers and sellers.

eBay is also seeing increased traction with our daily deals, which reinforces our value message and demonstrates our ability to engage new buyers and move large volumes of merchandise in short time periods.

We are also bringing more secondary market inventory on to eBay, working with trusted retailers and brands to help them move merchandise at great value. In North America, for example, Dell recently opened an eBay store. Golf Smith and other leading Internet retailers have also recently added inventory.

And in Europe, we opened eBay online outlet malls in the U.K. and Germany, offering buyers dozens of brand names sold directly by the manufacturers.

Our product and technology teams, led by Mark [Hargiss], are making great progress in delivering better user experiences. Last March, you’ll recall, Mark spoke about how we are transforming search on eBay to take advantage of our unique data and we are making progress on that front.

We are also developing tools that enable richer shopping experiences in select categories. Across consumer electronics and media, you can already see the results as we move to a more product or catalog style shopping experience on the search results page.

Our team has also just launched a limited test of a [design a ring] diamond tool -- easy for me to say -- which you can try at diamonds.ebay.com. This tool enables consumers an easy way to find and design their own ring. So while it is still in beta, it’s an example of the kind of unique experiences we are going to be able to build on top of our platform and support sellers and create better shopping experiences for buyers.

Mobile commerce is another area in which we are driving innovation to deliver a better user experience. The eBay iPhone app, which has been downloaded more than 4 million times, is expected to generate more than $0.5 billion in GMV this year. And consumers can more easily use PayPal for their purchases on the iPhone than ever before. We are rapidly iterating in mobile and will soon be introducing the next version of our eBay iPhone app with improved functionality and features.

With the improvements we are driving in trust, value, and selection, we are launching a U.S. marketing campaign this holiday season to re-engage and remind consumers of the great deals on eBay. Unlike previous campaigns, which were heavily focused on TV or last year on coupons, this one will be one of the most integrated campaigns we have ever done, with a more balanced offline and online media mix. The campaign, which breaks on November 2nd, will include digital spots featured for the first time on the home page of eBay.

Lastly, turning to our adjacent e-commerce format, classifieds and Stub Hub both had strong results this quarter with double-digit growth. In fact, Stub Hub is on track to sell its 30 millionth ticket by the end of the month.

Finally, let me highlight Skype, which had another great quarter with strong growth across all user metrics. This is a terrific business but one that stands outside our core focus of e-commerce and online payments. So we did what we said we would do -- maximize Skype's potential and its value for eBay shareholders. We are selling 65% of the business at a strong valuation of $2.75 billion and by retaining 35%, we have the potential for further upside longer term. The deal is on track to close in the coming weeks.

So in summary, let me repeat how I began my remarks -- we are a strong company getting stronger. We are doing what we said we would do and we are managing with focus, discipline, and accountability. I am pleased with our pace, progress, and performance.

Now with the sale of Skype, we are fully focused on our two core businesses, PayPal's got great momentum, and our eBay strategies are beginning to work. So delivering on our commitments, we intend to lead, compete, and win.

So now before taking questions, let me turn it over to Bob for more details on our performance.

Robert H. Swan

Thanks, John. During my discussion, I’ll reference our earnings slide presentation that accompanies the webcast. All growth rates mentioned in my prepared remarks represent year-over-year comparisons unless I clarify otherwise.

Overall, we delivered strong third quarter results. We exceeded the high-end of guidance on both the top and bottom lines due to stronger than expected GMV. We continue to execute against our strategic priorities in our two core businesses and we are pleased with the progress we made to date. We gained good momentum throughout the quarter and we are cautiously optimistic as we approach the upcoming holiday season.

Our combined businesses generated net revenues of $2.24 billion in the third quarter, a 6% increase. Organic revenue was up 5%, an acceleration of four points versus Q2. The acquisitions of G-market, [DBA Bill Bosson] and Bill Me Later added an additional five points of revenue growth, while a stronger dollar lower our revenue growth by four points.

Non-GAAP EPS was $0.38 in Q3, a 16% decrease. The $0.08 decline from last year can be fully explained by a lower yield on cash balances, a one-time tax benefit in the third quarter of 2008, and the impact of foreign exchange.

Strong productivity from our operational excellence initiatives, along with modest volume gains, fully offset a decline in take rate, dilution from acquisitions, and business mix. Non-GAAP operating margin was 28.4%, down 340 bps, again driven by dilution from Bill Me Later and a stronger dollar.

We generated $563 million of free cash flow in the quarter, or 25% of revenue. CapEx as a percentage of revenues was 8%, an increase compared to the first half of the year due to timing of expenditures on our new Utah data center. For full year 2009, we anticipate CapEx as a percentage of revenue will be similar to 2008.

Return on invested capital was 21.9% on a trailing 12-month basis. The decline over the prior four quarters is primarily attributable to recent acquisitions. While these acquisitions are causing near-term pressure on ROIC, we believe they will generate attractive long-term returns for our shareholders.

Now let’s take a closer look at our segment results. Starting with our payments business, PayPal posted another strong quarter. Total revenue was $688 million, a 15% increase. Total payment volume was $17.7 billion, an increase of 19%. TPV growth was 14% in the U.S. and 30% internationally.

PayPal merchant services business had another great quarter. Merchant services recorded $9.9 billion of global TPV in Q3, accounting for 56% of total TPV and representing 31% growth over last year. The number of payments in merchant services grew even faster at 47% while the average transaction size decreased.

PayPal's transaction margin remained flat at 62% in the quarter. While global take rate was down 22 bps, we were able to offset this decline by improvements in transaction expense rates and transaction loss rates.

PayPal's segment margin came in at 14.8% in the quarter. The 420 basis point drop from last year was primarily the result of dilution from Bill Me Later. The 130 bps sequential decline in segment margin was due to currency hedges which benefited Q2 margin, but reversed in the third quarter.

Let me touch on a few key operating metrics for Bill Me Later. Bill Me Later's gross receivable balance at quarter end was $561 million. We continued to manage the quality of new receivables we’re underwriting, which reduces receivables growth, but we believe this is the right trade-off in the current economic environment. Net charge-offs increased to 11.5% in the quarter, up 25 bps from Q2. However, risk adjusted margins remain better than industry average at approximately 9%.

Let’s now move to our marketplaces business -- overall this business achieved net revenues of $1.4 billion, a 1% decrease from last year but a 13 point improvement from the second quarter. Organic revenue was down two points, acquisitions added six points to growth, and currency lowered growth by five points. Transaction revenue was down 1% while marketing services and other revenue growth was flat.

We saw strong growth in our international business, especially in our two largest European markets. Purchased items increased 10% in Germany and 19% in the U.K. Our international business accounted for 56% of marketplace’s revenue this quarter, up from 53% in the third quarter of last year.

We continue to be pleased with the growth we are seeing in our fixed price format. On an FX neutral basis, fixed price GMV excluding vehicles grew 37% or 17% excluding G-market. Auctions GMV excluding vehicles declined 12% in the quarter, a five-point improvement from Q2. Vehicles GMV declined 15% during the quarter on an FX neutral basis, representing an improvement from prior quarters mainly driven by easier comps.

Let’s turn to marketing services and other, which we view as alternative formats for bringing buyers and sellers together. Our classifieds business continued its strong growth trajectory with 20% revenue growth, or 27% on an FX neutral basis. Total global advertising revenue declined by 2%, as we experienced continued pressure on CPCs and click-through rates. We continue to optimize the user experience on eBay sites in order to increase transaction frequency and this had the effect of modestly reducing advertising revenues.

Shopping.com, [inaudible] and other revenue declined by 16%. This decline was primarily driven by shopping.com’s lower monetization as we continue to focus the business on merchant lead generation while CPCs and traffic remain under pressure.

A couple of quick highlights on marketplace’s operational metrics -- sold items grew at 31% in the quarter. Excluding G-market, growth was 8%, primarily driven by strength in the U.K., China cross border, Germany, and Stub Hub. The number of tickets sold on Stub Hub increased 40% in the third quarter.

Cross-border trade accounted for 18% of core GMV, up one point from Q2. Marketplace’s segment margin was 42% in Q3, down 70 bps. The marketplace’s team generated solid productivity, which gave us the capacity to reduce take rates for our sellers and invest in the user experience.

Global take rate was 7.9% in the quarter, down 27 bps from last year. Excluding the impact of vehicles, Stub Hub, FX, and G-market, take rate was down more than 40 bps compared to last year as our power sellers continue to earn higher discounts on a significantly larger portion of GMV and consumer sellers take advantage of our recently introduced [inaudible] auctions.

Now let’s turn to our communications business -- Skype posted revenue of $185 million in the third quarter, an increase of 29%. On an FX neutral basis, growth was 36%. Skype to Skype minutes increased 74% to 27.7 billion, and Skype out minutes increased 44% to 3.1 billion. Skype segment margin came in at 24.2%.

As John said earlier, the Skype deal is expected to close in the coming weeks. The buyers are funding the cash portion of the purchase price through a combination of debt and equity financing. The consortium has initiated the transfer of funds for the equity portion of the purchase price to an escrow account, where the funds will be held pending the closing.

Switching to eBay inc. operating expenses, in the third quarter sales and marketing as a percentage of revenue was up 50 basis points, mainly due to the addition of G-market but partially offset by increased efficiencies in Internet marketing spend. Product development came in 30 basis points higher than last year, driven by continued investment in the user experience and our technology platform.

G&A costs increased 60 basis points from last year, predominantly due to deal related costs partially offset by efficiencies and cost controls. Our provision for transaction loan losses was up 10 basis points due to the inclusion of our dispute resolution program on eBay and BML credit losses, partially offset by a decrease in transaction loss at PayPal.

As I mentioned earlier, we generated strong free cash flow during the quarter. Cash and cash equivalents was $2.6 billion at quarter end, of which $2.4 billion was held internationally. We paid down $200 million on our line of credit during the third quarter, leaving an outstanding balance of $200 million at quarter end.

Now let me turn to guidance, which assumes that the Skype deal will close in the middle of Q4. We anticipate Q4 revenue of $2.2 billion to $2.3 billion, including approximately $100 million from Skype. This represents growth of 8% to 13% compared to last year, or 11% to 15% on an adjusted basis, excluding Skype from the back half of Q4 2008.

We anticipate non-GAAP EPS of $0.38 to $0.40, including approximately $0.02 from Skype, a 2% to 7% decline compared to last year, or a minus 3% to plus 2% on an adjusted basis, excluding Skype.

Now let me take a minute to discuss the impact of the sale of Skype on eBay inc. From a financial perspective. Once the deal closes, we will account for our minority stake in Skype as equity income. However, keep in mind that going forward, Skype will earn minimal net income in the near term due to interest expense on debt and amortization of intangible assets. On a pro forma basis, excluding Skype from our full year 2009 results, we anticipate generating full-year 2009 revenues of $7.95 billion to $8.05 billion, and non-GAAP EPS of $1.41 to $1.43.

In summary, we delivered strong third quarter results above the upper end of our expectations on both the top and bottom lines. Our strong momentum continues at PayPal. We are executing against our turnaround strategy in marketplaces, and we are on track to sell 65% of Skype this quarter. And our operational excellence initiatives continue to drive efficiencies, which is allowing us to invest in our customer facing initiatives.

And now we’d be happy to answer your questions. Operator.

Question-and-Answer Session


(Operator Instructions) We will begin with Mark Mahaney at Citi.

Mark Mahaney - Citi

Two questions -- first on the payments margins, can you talk about how we should think about those going forward? Once they anniversary, once you anniversary the acquisition of Bill Me Later, do they stabilize and start growing from there or is it uncertain? Could they just as likely they go up as down? And then marketplace, could you provide anymore color, anything on the linearity of the quarter, particularly products or areas or segments that seemed to have picked up better than others? Is there something that makes you think, particularly in the marketplace business, that Q4 should be materially better than just comps? Thanks.

Robert H. Swan

Yeah, Mark, first on PayPal operating margins, I’ll give you a bit of a macro picture and then a path forward. We indicated earlier this year that we expect to roughly double the PayPal business from 2009 through 2011, and that operating margins will expand to 18% to 20%. This year, essentially each quarter Bill Me Later has impacted our margins by roughly 350 to 400 basis points and as we go forward, we expect Bill Me Later to gradually be accretive to earnings and then accretive to operating margins between now and 2011. We do not expect that to change dramatically in the fourth quarter. We are not expecting any dramatic growth from Bill Me Later as we continue to make the trade-offs of top line growth versus risk.

On the second question on marketplace, I’ll make a couple of comments, John, and have you engage as well. I’d say a couple of things -- one, we saw continued trends overall throughout the quarter, so just timeline wise, the last time we spoke to you we had June and early July, a little bit better than earlier in the second quarter. Those trends kind of continued throughout the course of the quarter. On a geography basis, we saw great momentum in the U.K., good momentum in Asia, particularly in Korea with the combination of IAC and G-market. Good momentum in Germany and accelerating progress in the U.S. While we are still down in the U.S., we saw a five point improvement on GMV from Q2 to Q3 so we felt pretty good about relative to how the market performed in the quarter.

And that -- you know, both by geography and just timeline, we expect continued momentum going into the fourth quarter.

John, any thoughts from your perspective?

John J. Donahoe

You know, Mark, I would just say as Bob said, the economy, we see stable and we are cautiously optimistic about consumer spending going into the holiday. But what is more important from our standpoint is we actually see some progress on our turnaround metrics and as Bob mentioned, they are kind of across geographies and across categories a little bit, and the three outcome metrics that I continue to look at are net promoter scores, which is both for buyers and sellers, the willingness they are to recommend eBay to a friend, and those are up both across buyers and sellers. Second, the [velocity] on our site, which as I mentioned earlier, has accelerated to 8% growth, both sold and purchased items in the quarter. And then most importantly, the market share, which we measure by GMV growth and our global GMV growth in Q3 was 4%, which we believe will end up being faster than the market grew in the third quarter.

So we feel like we are making good progress. We will continue to make progress into the fourth quarter and into next year. I don’t see anything discontinuous but I do see good progress across the board.


Your next question comes from the line of Christa Quarles at Thomas Weisel Partners.

Christa Quarles - Thomas Weisel Partners

I was wondering if you could give us some greater color around the international TPV growth acceleration. Is Japan -- could that be material next year? I’m just trying to better understand the color on the international side.

And then just one quick housekeeping item -- have you reserved for the Skype lawsuit? Thanks.

Robert H. Swan

First on PayPal international growth, I’d tell you this has been a trend that you’ve seen continue dramatically. It’s been primarily in Europe across the board. We’ve continued to make good traction, both on eBay through higher penetration and off eBay. And John had kind of highlighted from a merchant adoption standpoint the focus on larger merchants and how that has gotten good coverage, increasing coverage in Europe and in Asia as well.

The second area that’s been large for us and in particular a focus out of Asia has been cross-border trade, leveraging some of the unique attributes at PayPal to enable merchants in Asia, particularly in China, to sell product around the globe and give consumers the trust they have come to expect from PayPal by buying from cross-border transactions and that’s been a significant addition over the last -- really the last couple of years.

We are using that, building relationships with cross-border trade in markets where eBay doesn’t necessarily have a big presence, like Japan, as a point of entry -- get familiar with merchants that are trying to grow their cross-border trade, use that knowledge of the market to then grow a domestic business. And that’s the relationships that John talked about earlier. I would not -- so over -- I mean, the Japan market is obviously one of the biggest in the world and we expect to be a player in Japan. I do not expect that to have any meaningful impact on our business in 2010.

On the Skype lawsuit, we’ve been -- we’re very focused on positioning to close that transaction. We feel good about where we are. We feel very good about our 35% interest on an ongoing basis and I would say our position on the legal disputes has been pretty clear all along, that we are highly confident in the position that we’ve taken on lawsuits.

John J. Donahoe

There’s no new news and the business continues to perform very well and we expect it to close in the fourth quarter.


Your next question comes from Jeffrey Lindsay at Sanford C. Bernstein.

Jeffrey Lindsay - Sanford C. Bernstein

Could you give us an update on the percentage of PayPal accounts that use Bill Me Later? And could you give us any sense of how rapidly that might increase and what you might be doing to try and promote that? Thank you.

John J. Donahoe

Sure, let me take a cut at that. As we said in earlier calls, Scott Thompson did a great job once we bought Bill Me Later of immediately consolidating the sales forces, because Bill Me Later had a real strength in large merchants, which was their historical sweet spot. PayPal focused [inaudible] [to more around] [inaudible] and small to medium sized merchants, so -- and actually the sales force is now being led by a Bill Me Later executive.

They have a sort of focus for 2009 and then a focus for 2010. For 2009, it’s quite simply a cross-sale where they are going to PayPal customers that don’t have Bill Me Later and getting them to add Bill Me Later, going to Bill Me Later customers that don’t have PayPal and getting them to add PayPal. And so as I mentioned earlier, over 100 new accounts have added one or the other this year and we now have several of the largest that offer both.

In 2010, now it’s going to even the next level because we are going to integrate the product or the pipe that is going into the merchant. So today, the merchant may experience it as two separate products. In six months time, we’re going to be able to go to a merchant and offer them one integration into their checkout flow that will have both Bill Me Later and PayPal built within it. So we feel very good about the merchant adoption.

And then on the consumer side, the other part of the fly wheel is getting Bill Me Later into the PayPal wallet and that just launched last week. I was using it over the weekend. Next time you check out with PayPal, when you confirm your funding source, if you are pre-approved for a credit and you have a high enough FICA score, you will have the alternative to select Bill Me Later as your funding mechanism, which is just great. And for those of you that don’t have that offering, I would check into your FICA score.

Robert H. Swan

And Jeff, that was, as John said, that was launched last week or the week before and now Bill Me Later is in the PayPal wallet and on over 150,000 merchants, including eBay. So it’s both on and off eBay and during the course of the fourth quarter leading up to the holiday time, we’ll expand that presence of Bill Me Later in the PayPal wallet on millions of merchants in the near-term, so we are pretty excited by both the sales -- the merchant adoption but also the product that we just launched a week or so ago.


Your next question comes from Brian Pitz from UBS.

Brian Pitz - UBS

Could you talk about where you think you are in terms of improving search on the platform, as well as cataloging your products? And then second, what prompted you to switch your monetization on eBay.com from Yahoo! to Google? Thanks.

John J. Donahoe

On search, you’ll recall back at our March analyst day, Mark Carr just laid out both the challenges and opportunities of search on eBay, the challenge being we had the most unstructured data and the largest data set of any e-commerce provider on the net; the opportunity being we are the largest source of unstructured data and the largest data set of any retailer or e-commerce provider on the net. And so as he mentioned then, the focus this year has been two-fold -- one, to get as many of the categories for which a catalog exists cataloged on eBay and I was just with the search team yesterday and they told me that the product-based GMV, which would be catalog based GMV, hit 17% of our GMV on -- well, Tuesday of this week, which is more than a doubling of where it was at the beginning of this year. So Mark and Chris Hayne and Dane Glasgow have the search team all over rapidly adding catalogs in those categories where it exists.

Then the second part of what Mark is doing is building in essence a search platform which will allow us to begin cataloging the uncataloged categories and through community generated tagging and other ways, and we will really begin to see that platform is now built and in the first half of 2010, you will begin to see some of the fruits of those labors, particularly in the clothing, shoes and accessories category. So I would say on -- I don’t know, on a scale of 1 to 10, we have gone from a two to a four, but I feel like the pace is accelerating and I am very pleased and optimistic about the progress we are going to make over the next 12 to 18 months, in ways that you will be able to see as a user, and see in our numbers.

Robert H. Swan

In terms of advertising, as you know we look at advertising as another format to connect buyers and sellers on the web. This has grown from essentially a non-existent business for us to almost a quarter of a billion dollar business and we continue to look at ways to improve our effectiveness and efficiency in serving up the most relevant ads, and sometimes that means ads above the fold, sometimes it means below the fold, sometimes it’s with banners and other times it is with text. Most recently here in the U.S., we are using Google text ads because we think we can provide more and more relevant ads for our community of users. So advertising continues to be an attractive way for us to connect buyers and sellers and we are using Google ads here on our site in the U.S. while we continue to use Yahoo! banner ads or graphical ads here in the U.S. as well, both important partnerships for us, both that we continue to work with to figure out how to provide the best experience for our users.

Brian Pitz - UBS

Very helpful, thanks.


Your next question comes from James Mitchell at Goldman Sachs.

James Mitchell - Goldman Sachs

Could you discuss why sold items growth was so rapid in the United Kingdom relative to the United States as it reflects local competitive conditions or eBay actions? And could you talk about sold items versus ASP trends for U.S. GMV?

John J. Donahoe

To be honest, I am pleased with the sold items progress across the board. As I said, globally up 8%. Now the U.K. just had a phenomenal quarter on that front. That is partly driven by currency movements and the U.K. has become a real exporter this year and so because of the weakness of the pound, you will see a lot more U.K. sellers selling outside of the U.K. into continental Europe and into the U.S. So that’s part of what is going on.

And secondly, the U.K. e-commerce market is doing better relative to their offline retail market than in other countries because what looks to be happening as new consumers are coming online trying to save money is in essence the best way to put it, so we believe we are gaining share in the U.K. with GMV growth that hit 20% in the quarter, but it’s also market that is growing faster than others because of the new people coming online.

And your -- oh, sold items to ASP -- simply put, our sold items are improving and ASPs continue to go down. And if you peel beneath that, people are continuing to trade down. Where they may have bought a brand new BlackBerry, they are buying a refurbished BlackBerry, or where they may have bought a designer sweatshirt, they are buying a private label sweatshirt. And so -- and the good news is we have good offerings across all of those, so ASPs continue to come down both on eBay and on PayPal, we see it in the off-eBay business as well in the PayPal gateway.

Robert H. Swan

The only thing I would add is when John says ASPs coming down, that’s year over year. We haven’t seen any dramatically different trend during the course of the year. ASPs started to fall rather precipitously late last summer into the fall and they kind of stayed that way. In the last six months, I wouldn’t say they’ve gotten any better but they haven’t gotten any worse either.


Your next question comes from Imran Khan at J.P. Morgan.

Imran Khan - J.P. Morgan

Thank you so much for taking my questions. It seems like the take rate was down year over year, like around 30 bps or so, so could you please help us understand why did the take rate go down? And secondly, after the Skype transaction, you will have a significant amount of cash in the international market. Can you give us some color on the use of that cash? Thank you.

Robert H. Swan

Imran, I knew that we were in trouble despite the warning by the moderator to limit your questions to one when you had an s on the end of your question word. So quickly, two things -- yes, take rate did come a little over 40 bps when you strip out some of the noise, like step up in vehicles and G-market on the core eBay platform. You know, a few things -- in the U.S. and in the U.K. during the course of the quarter, we essentially took to stimulate our auction business, we took insertion fees on C-to-C items to zero for your first five listings. Earlier in the year, we made some modifications to some features that have impacted us in the second quarter and again more in the third quarter. And then just a little bit of a forewarning that was reflected in the guidance we gave you, John referenced a series of announcements we made, announced in June, put into effect at the end of September where we will continue to provide incentives or deeper discounts for our highest valued sellers and we eliminated some of the feature fees that impeded a wonderful shopping experience -- both of those things will result in continued kind of take rate erosion that you’ve experienced in the third quarter and into the fourth quarter.

On your related question of cash, yes, we do end the quarter with $2.6 billion in cash. We generated almost $600 million in free cash flow. We are expecting well over $2 billion in free cash flow for the year, so coupled with the sale of Skype, we will have over $5 billion in cash on hand at the end of the year.

You know, I’d say our priorities haven’t changed. First we will continue to maintain a conservative posture on our balance sheet. Secondly, we will continue to work for efficient and effective ways to get a more equal distribution of our cash domestically and internationally. As you know now, almost all of our cash is offshore.

And then as we work through those opportunities, we will do the same things, and that is we will continue to look for acquisitions that will strengthen our two core businesses and we will look to opportunistically redistribute cash to shareholders when we don’t believe the value of the firm is adequately reflected in the stock price. That’s what we have been doing over the last couple of years and we’ll continue to do that.

The last point I would make is we will be extremely disciplined in how we go about growing the business through acquisition. So thanks for your questions, Imran.


Your next question comes from Youssef Squali with Jefferies & Company.

Youssef Squali - Jefferies & Company

Bob, just a quick one on free shipping coverage -- could you tell us what it was last quarter versus I guess the quarter before that? And where does that fit in the marketing campaign that you are starting in early November?

Robert H. Swan

On the first one on the free shipping, no dramatic change Q2 to Q3. We’ve been hovering around 30% mark, just a tad lower. In terms of the campaign --

John J. Donahoe

It’s not a point of distinction, the campaign. The campaign is more around just the great values you find and great deals you find on eBay. So the nice thing about the free shipping, this is a very nice case of the interaction between our marketplace and our selling community, we saw that buyers cared a lot about free shipping. We put an incentive in place in terms of a discount to those that offered free shipping for almost a year, and then we stopped and the sellers in those categories for which free shipping matters continue to offer free shipping and those in which categories that it is less of an issue, heavy goods or high value goods, they don’t. So it’s kind of held even without the artificial stimulus of an incentive. And that’s the way the marketplace works. I think that’s one of the strengths of our marketplace.

Youssef Squali - Jefferies & Company

That’s helpful. Thank you.


Your next question comes from Sandeep Aggarwal of Collins Stewart.

Sandeep Aggarwal - Collins Stewart

John, how high can the fixed price format as a percentage of total GMV? And can you give us some idea in terms of the economic differential between the auction and fixed price format?

John J. Donahoe

Sure, Sandeep. You know, the interesting thing about format is we don’t choose -- our buyers and sellers choose and the actions we took last year made us economically indifferent between the two formats, so our take rates are roughly the same. So in terms of the second part of your question, we are indifferent. And then our platform now allows buyers and sellers choice and it’s not biased one way or another. And so it’s gone from 30% or 70% auction to 30% fixed price -- today it’s more on the 60-40, or 40-60 I should say -- 40 auction, 60 fixed price and I don’t know where it would land. Maybe 30-70 -- we don’t know. We won't drive that; consumers will.

What’s interesting is it differs significantly by category, so again this is -- so you take collectibles, collectibles is an auction heavy category because they are items of uncertain value in which an auction is the most efficient way of transacting and doing -- establishing value. The other end of the spectrum would be tickets or books, music, and video which are more commodity based items for which there is a clear market price and those are predominantly fixed price.

And so we think one of the real strengths and sources of differentiation of our marketplace is it will fall into an equilibrium, category by category, and over time be the only marketplace that has the balance of both formats.

Mark Rowen

And Bob, do you want to take the economics piece of that question?

Robert H. Swan

I think John pretty much touched on it in terms of the take rate differential between the two formats, so I think it’s covered. Sandeep, thanks for the question.


Your next question comes from Benjamin Schachter with Broadpoint Amtech.

Benjamin Schachter - Broadpoint Amtech

I was wondering if you could give an update on the consumer loyalty programs. You’ve talked about that in the past but it didn’t come up on this call and I was just wondering why it hasn’t seen that much traction yet and will it be a strategic focus? And then just a very quick clarification -- do the marketplace global active users include G-market? Thanks.

John J. Donahoe

Let me take the first, Ben, and --

Robert H. Swan

No on the second.

John J. Donahoe

Yeah, I think it’s -- on consumer loyalty, it’s still moving ahead. In fact, when I talked about the improvements in the net promoter score, we measure a net promoter score of both our top buyers, which in essence are our most loyal buyers, as well as all active buyers and we saw very positive improvements in both.

And we continue to focus on improving the user experience so that they come back and buy more.

We’ve also tested -- you know, we did a lot of couponing last year and we are still continuing to do some couponing with experienced eBay buyers that helps them start buying in a new category, and we are being very targeted in that and we think on a targeted basis, that can work.

And then lastly, some people on the call may have been in our pilot around eBay Bucks, which is our loyalty program. And we had a -- we’ve gotten a very good experience and feedback from that thus far and we continue -- we anticipate continuing to expand and roll that program out that rewards repeat purchases on eBay.

So our focus -- believe me, our focus on great customer experiences and customer retention and loyalty is as strong or stronger today than in any time in the last couple of years. And interestingly, one of the things that I think is also making a difference is I changed the senior management incentives so the top 600 people in the company, part of their annual bonus is driven by improvements in essence in customer loyalty, as measured by net promoter scores. So we made good progress.

Mark Rowen

Operator, we have time for one last question.


Thank you. That will come from Scott Devitt at Morgan Stanley.

Scott Devitt - Morgan Stanley

I have a follow-up question just on PayPal segment margins -- could you discuss the segment margin profile of merchant services versus the on-eBay business and whether that mix shifts over time actually has an effect on margin as well? Thanks.

John J. Donahoe

Scott, the way we try to run the business is transaction margin base and transaction margins has three components -- take rate, transaction expense, and transaction losses. And what you have seen really over the last couple of years almost quarter to quarter, despite the rapid growth in merchant services and merchant services becoming a much bigger component of PayPal overall, we have been able to ensure that transaction margins stay above the 60% level. And we kind of laid out the business model and the trade-offs between growth in those three levers. You know, we said that in our kind of three-year outlook, we expect to keep transaction margins in the 60% level. They have stayed that way. Q3 was 62%, which was essentially flat year over year and flat Q-on-Q. So we will continue to manage those three levers, global take rate, transaction expense, and transaction losses to drive growth and roughly 60% margin business and expect that to continue despite the fact that merchant services is becoming a bigger and bigger component of the overall portfolio.

Mark Rowen

Okay, thank you for joining us and we will talk to you soon.


Ladies and gentlemen, once again that will conclude today’s conference call. Thank you so much for joining us. Have a good rest of your day.

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