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eBay Inc. (EBAY)

Q3 2006 Earnings Call

October 18, 2006 5:00 pm ET

Executives

Meg Whitman - President, CEO

Bob Swan - CFO

Lydia Ventura - Director IR

Analysts

Imran Khan - JP Morgan

Doug Anmuth - Lehman Brothers

Mark Rowen - Prudential

Scott Devitt - Stifel Nicolaus

Mary Meeker - Morgan Stanley

Anthony Noto - Goldman Sachs

Heath Terry - Credit Suisse

Ben Schachter - UBS

Justin Post - Merrill Lynch

Mark Mahaney - Citigroup

Christa Quarles - Thomas Weisel Partners

Operator

Good day, and welcome everyone to eBay's third quarter 2006 earnings result conference call. As a reminder, this call is being recorded. With us today from the Company is the President and Chief Executive Officer, Ms. Meg Whitman; the Chief Financial Officer, Mr. Bob Swan; and the Investor Relations Director, Ms. Lydia Ventura. At this time I would like to turn the conference over to Ms. Lydia Ventura. Please go ahead, ma'am.

Lydia Ventura

Good afternoon. Thank you and welcome to eBay's earnings release conference call for the third quarter of 2006. Joining me today are Meg Whitman, our President and CEO; and Bob Swan, our Chief Financial Officer. This conference call is also being broadcast on the Internet and is available through the Investor Relations section of the eBay website.

Before we begin, I would like to take this opportunity to remind you that during the course of this conference call we may discuss some non-GAAP measures in talking about our Company's performance. You can find a reconciliation of those measures to GAAP measures in the tables of our earnings press release.

In addition, management may make forward-looking statements regarding matters that involve risk and uncertainty, including those relating to the Company's ability to grow its businesses, user base and user activity. Our actual results may differ materially from those discussed in this call for a variety of reasons, including: our increasing need in established markets to grow revenue from existing users as well as from new users; an increasingly competitive environment for our businesses; the complexity of managing a growing company with a broad range of businesses; regulatory, tax and IP and other litigation risks, including risks specific to PayPal and the financial industry, and risks specific to Skype technology and to the VoIP industry; our need to upgrade our technology and customer service infrastructure to accommodate growth at reasonable cost while adding new features and maintaining site stability; foreign exchange rate fluctuations; and the impact and integration of recent end user acquisitions.

You can find more information about factors that could affect our results in our annual report on our Form 10-K and our quarterly reports on Form 10-Q available at investor.eBay.com. You should not unduly rely on any forward-looking statements, and we assume no obligation to update them. Now over to Meg.

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Meg Whitman

Thank you, Lydia and hello, everyone. Welcome to our third quarter earnings conference call. I'm pleased to report Q3 was a very good quarter for eBay Inc., with solid growth across all three of our business units: Marketplaces, Payments and Communications.

Today I will update you on the progress we are making to grow each of these businesses independently, and discuss some of the ways we are leveraging the strengths of each to grow the others. I will then turn the call over to Bob who will discuss our financial results in greater detail. Then Bob and I will answer your questions.

Earlier this year we outlined our Power of 3 strategy that builds on the core strengths of eBay, PayPal and Skype; three of the top five brands on the net today. The strengths of each brand allows us to operate each business as a successful stand-alone enterprise that sparks innovation and fuels growth in the others. Simply put, we believe the ultimate value of our portfolio is greater than the sum of the individual parts.

Q3 demonstrates the great progress we have made to deliver this vision, as well as the plans we shared with you at Analyst Day in May. Despite some bumps, 2006 is exactly the evolutionary year we thought it would be. We have grown in line with the guidance we have shared with you, generating better than expected earnings and outstanding cash flows, while we have also reinvested in the business. In Q3 our combined businesses delivered a record $1.45 billion in net revenues, a 31% increase over last year, and non-GAAP earnings per share of $0.26, up 28% from a year ago.

Now let me review the accomplishments of each business unit and then discuss our collective Power of 3 progress. I will start with Marketplaces, which is comprised primarily of our eBay site, Shopping.com and our collection of worldwide classified websites. With these assets we have deliberately and strategically crafted an excellent shopping portfolio.

Within Marketplaces our key focus remains reintegrating eBay's core business in the U.S., strengthening our global presence, and delivering tailored shopping experiences. And we are making good progress. In Q3 Marketplaces delivered solid growth in line with our expectations. Marketplaces segment revenue was $1.05 billion, up 22% from the year ago quarter. eBay is the world's number one e-commerce franchise and remains the cornerstone of our Marketplaces business unit. During the quarter eBay global GMV reached $12.6 billion, a 17% increase year-over-year.

During last quarter's call we discussed the growing imbalance between listing formats on eBay, particularly in the U.S., and our plans to reinvigorate our core auction format business. As you may recall, we were concerned that an overabundance of eBay Stores inventory listings was diluting our buyers' experience. Buyers were overwhelmed by many identical items at relatively uncompetitive prices, which led to higher exit rates and fewer return visits. In turn, this negatively affected conversion rates and eBay's GMV growth.

We shared with you two primary steps we were taking to help restore balance to eBay. First, we increased fees for store inventory listings. Second, we took a series of actions to promote core listings in both eBay and eBay Express among sellers and buyers. While price increases are never met with cheers from those affected, our community and customer support teams spent considerable time explaining the pricing changes to our sellers. We found that many sellers actually recognized the need to restore balance to their marketplace and were supportive of our efforts. Since most actions were initiated late in Q3, we expect to have more visibility after the fourth quarter, but we are cautiously optimistic and remain confident that these changes will help rebalance our marketplace, which means an optimum experience for buyers and maximized cash flow for sellers.

As we head into the holidays, we are also gearing up eBay.com as the place to shop this season with a new variation of our very successful It marketing campaign. You'll see that start in the next week or so.

Internationally, eBay had a good quarter with GMV growth of 21%. More than half of eBay's worldwide GMV now comes from outside the United States. In Europe GMV growth accelerated in a number of markets, including the UK, Italy, France and Spain. Germany listings and GMV continue to grow despite an overall slowdown in the market.

In Asia, the markets are extremely diverse and highly competitive. In Korea we had good GMV growth driven by several initiatives, including a new buyer reward program and a seller coupon tool. Our smaller markets, India, Hong Kong and Singapore, continue to thrive as we build out these Marketplaces. In China, GMV growth is solid, and we are adapting our strategies to best participate in this complex market over the longer-term.

During Q3 we continued to work on tailored shopping experiences that meet diverse buyer and seller needs and increase activity across Marketplaces. eBay Express, which debuted in Q2, offer buyers a great source to find new items they might otherwise search for elsewhere. Early results show eBay Express is having the intended effects. 89% of shoppers who have made a purchase on eBay Express say the experience met or exceeded their expectations. And buyers who shop both eBay.com and eBay Express are spending significantly more time, and nearly 25% more money with eBay, than those who have yet to try Express.

We have already taken Express overseas. In August we successfully launched eBay Express in Germany. And just last week we officially launched eBay Express in the UK. Participation by local market retailers is appealing to more in-season buyers, and we are encouraged by the early response.

eBay Motors is our original tailored shopping experience that connects private sellers and auto dealers to a vast number of car buyers. eBay Motors is the seventh most trafficked e-commerce site in the United States, with more than twice the visitors of any other auto-related site. Inspired by our success in driving synergies between eBay Motors Germany and Mobile.de in Q3 we also began integrating vehicle classified listings on eBay Motors in the UK, Italy, France and Australia. This provides car buyers greater choice from one online force, while helping car sellers increase their reach and sales.

The other tailored shopping businesses within our Marketplaces portfolio are also delivering terrific performance across the board. Shopping.com had another excellent quarter with significant growth in revenue, leads and traffic. Now in five countries, Shopping.com is the number one comparison shopping site in the United States, the United Kingdom and Australia. As part of our holiday launch, Shopping.com recently unveiled several new site features to enhance the shopping experience and make it easier to quickly find and buy products.

Our classified portfolio, which includes Kijiji, MarketPlus and Gumtree, among others, is continuing its upward trajectory. This is a business we weren't even in two years ago, and now we're in more than 400 cities. While this is still a largely nascent business, we see great opportunities to further expand and monetize classifieds. As an example, we have recently introduced advertising in some markets, and the early results are promising.

So no matter who you are, where you live, your preferences or budget, our Marketplaces collection of e-commerce brands offer the ideal shopping experience. From Barry Bonds' 715th homerun baseball to the oceanfront property in Mexico, like the one that recently sold on eBay for $1.7 million, to this season's must-have accessory, that pristine classic Camero, or a nearly-new leather couch, we match all types of buyers to the most appropriate sellers.

Now let me turn to PayPal, which is the number one online payment service in the world. In PayPal we are focused on extending our services and financial products globally, both on and off eBay. Q3 was another excellent quarter for PayPal, which now contributes 24% of our total Company revenue. During the quarter PayPal's total payment volume grew by 37% year-over-year to $9.1 billion.

PayPal continues to increase its relevance on and off eBay through the convenience and choice it offers merchants and consumers. With nearly 123 million accounts globally, PayPal appeals to consumers by offering the convenience of multiple payment methods through its easy and secure online wallet.

On eBay, PayPal global penetration continues to climb. These gains are more pronounced in newer markets such as Italy, Australia and France where we recently announced our 3 millionth account holder. We are also enjoying continued growth in our more developed markets like the UK and Canada. Germany is continuing to gain traction with solid growth.

PayPal's off eBay business, or what we refer to Merchant Services, had a terrific quarter. In Q3 Merchant Services revenue grew 89% year-over-year, including VeriSign payment gateway revenue. During the quarter we welcomed multiple new large e-retailers, including Barnes & Noble's, Hewlett-Packard, Electronic Arts, 1-800-Flowers, Sony Ericsson, DHL and Pixmania, one of Europe's largest consumer electronics retailers.

The appeal for merchants is PayPal's unrivaled suite of services that can be customized to meet the size and needs of any business. PayPal recognizes a one size fits all model is not optimal for most businesses today, and we offer several scalable and secure solutions to easily integrate PayPal into the merchant's checkout flow. Our merchants tell us they appreciate this flexibility, that also allows them to maintain their valuable connection to the consumer. And our merchants love the customers PayPal delivers because our users are savvy Internet shoppers who, according to a recent consumer survey, makes 50% more purchases online per month than average online consumers.

Last week PayPal reached another important milestone as the world's ubiquitous payment standard. We have added ten new currencies and 48 new markets to our networks. The addition of the Hong Kong, Singapore and New Zealand dollars, the Swiss franc, and several others raises PayPal's global portfolio to a total of 17 currencies in 103 markets. No other online payment provider today provides merchants and consumers the scale and security PayPal offers.

Now let's turn to our Communications segment with our newest business, Skype. It has been a year since we first announced the acquisition, and we are pleased with Skype's innovation, growth and overall momentum. Skype is strategically focused on attracting and activating new users, developing its ecosystem, and expanding its product offering.

In Q3 Skype added nearly 23 million users, or about 250,000 new users per day, for a total of nearly 136 million users spanning more than 200 countries. There are few, if any, businesses that can claim such mass global appeal in such a short period of time. Skype's popularity is being fueled by an active ecosystem that includes more than 3,500 developers and 400 partners. Today there are more than 150 Skype certified products developed by leading partners who recognize the advantages of tapping into the world's growing demand for Skype. Our own developers work within this growing ecosystem to make Skype easier to use as part of everyday life, both on and off the desktop.

Skype users are already making calls through WiFi phones, like the Skype-certified ones from NetGear, Belkin and Sony's new portable Milo personal computer that also runs the Skype client, complete with contact lists. Skype for Pocket PC, which is used with smart phone devices, just hit the 5 million download mark. These are all receiving industry accolades for innovation. You can expect to see more applications, products and services that deliver all Skype has to offer. I think we're in the early stages of something big here.

Now that I have discussed the progress and growth in each of our individual business units, I want to spend a couple of minutes talking about the innovation and synergies we're delivering across Marketplaces, Payments and Communications. We have already proven our ability to identify and capture synergy opportunities when we bought and integrated PayPal onto eBay. Introducing Skype to the mix enables us to further reduce barriers and create new synergies that we expect to pay dividends over the long term.

Adding Skype to eBay is beginning to do exactly what we expected; helping buyers establish more trust with sellers to complete more transactions. Although still very early, we see great promise in the “Skype Me” buttons, particularly on higher price categories like motors, jewelry and electronics where buyers often have detailed questions for sellers. We're now testing the buttons in 20 markets, spanning 150 categories, and our eBay sellers are already asking us to add more. “Skype Me” buttons were recently introduced to our Kijiji sites and already 10% of our global listings are opting for the “Skype Me” feature. Skype users are fueling PayPal adoption as PayPal is fast becoming the preferred way to pay on Skype, just as it did on eBay. Skype users can pay for services, such as outbound calling or voicemail using a credit card, bank account or PayPal. PayPal's global reach and simplicity makes it an ideal payment solution that now already accounts for nearly one-quarter of Skype's payments globally.

Our unique portfolio of brands also allows us to offer incredible value to strategic partners, as evidenced by our recent multi-brand agreements. In Q2 we announced our partnership with Yahoo! in the United States and in late August we announced an agreement with Google that involves Skype globally and eBay outside the United States. The Yahoo! advertising tests are underway on eBay and late in the quarter we extended the test to cover more types of search results and eBay Motors. We also recently started working with Yahoo! to test PayPal integration options. We are generally encouraged by the early results, and we will continue to monitor these tests to make sure that we implement broadly beneficial features to our joint community of users.

In early 2007 we will begin testing text-based ads with Google on eBay in select markets outside the United States. We are also excited about the potential for quick to call lead generation that will utilize Skype with both Google and Yahoo!. This opens up a new advertising market that combines search and advertising with voice communications.

As our third quarter results demonstrate, we are executing on our strategy to grow each business individually and collectively. By using our combined strengths to innovate new products, technologies and business models, we can deliver greater value to our communities of users and to our shareholders. Let me now turn it over to Bob for a closer look at our financials.

Bob Swan

Thanks, Meg. Today I plan to discuss our Q3 financial performance and update on our efforts to rebalance the eBay Marketplace, and our financial outlook for the fourth quarter and 2007.

First, our financial results. Overall third quarter was a very good quarter for the business. We delivered solid revenue growth, strong earnings and free cash flow. In total, our business generated record net revenues of $1.449 billion, representing 31% year-over-year growth. Organic revenue, excluding acquisitions and foreign exchange, were up 20% versus last year. Acquisitions we made over the last 12 months contributed 8 points to our top line growth. Foreign exchange due to a weaker dollar contributed an additional 3 points of growth.

Our non-GAAP operating income was $464 million for the quarter, up 18% over the year ago period, and representing a non-GAAP operating margin of 32%. Our non-GAAP EPS was $0.26, a 28% increase from last year and $0.03 higher than the top end of our guidance range. Our EPS strength was driven primarily by better than expected revenue, a more favorable tax rate and higher interest income. Operating and free cash flows were $522 million and $385 million, respectively.

Let's take a closer look at each of our segments. The Marketplaces business achieved record net revenues of $1.049 billion, up 22% versus the year-ago period. In the U.S., revenue was $540 million, up 20% over last year, while international revenue was up 25% to $509 million.

Taking a closer look at the eBay platform, we added over 9 million new users in the quarter, bringing the total registered user base to 212 million users. eBay new listings in the quarter were 584 million, representing year-over-year growth of 27%. Core listings were up 20%, and store inventory listings grew by 85% to 95 million new listings in the quarter. As we anticipated, store inventory listings growth decelerated, a result of the price changes we implemented in the quarter as part of our eBay Marketplace rebalance efforts.

eBay GMV was $12.6 billion, a 17% increase over last year. Excluding the impact of foreign exchange, GMV grew 15%. GMV growth was highlighted by accelerating growth in categories such as consumer electronics, home and garden, toys and tickets and travel.

In the U.S. new users grew by 3.7 million, reaching a total of 94 million registered users. New listings in the U.S. grew by 16%, leading to $6.1 billion of GMV, representing a 13% growth rate versus the year ago period. GMV growth was strong in nearly every category in the U.S., benefiting from successful fall marketing campaigns. Excluding Motors, U.S. GMV year-over-year growth rates were stable with last quarter.

As Meg indicated, we undertook several initiatives in the quarter intended to help rebalance the eBay Marketplace. In looking at Q3 seller activity, some of the changes we made are beginning to have an impact. In the U.S. new store inventory listings declined by 16% on a sequential basis, and now make up 77% of total live listings, down 6 points from when we announced the changes in July. At the same time, we had fewer store closures than we were anticipating.

On the buyer side, it is too early to draw conclusions on our rebalance efforts as the last of the low-price store inventory listings expired in late September. We will monitor the buyer metrics which were originally impacted by the imbalance, including exit rates, return visits and buyer activity, over the course of the fourth quarter and update you in January.

In our international eBay business, new users grew by over 5 million, bringing the total to more than 118 million users. New listings grew by 38%, driven by growth across all regions. GMV was $6.5 billion, growing at 21% versus the same period last year, and representing nearly 52% of global GMV. Excluding the impact of foreign exchange, GMV grew 16% versus the third quarter in 2005.

In Europe, performance was driven by good GMV growth in several of our markets. In Germany growth slowed due to a couple of dynamics. First, we lapped a very strong prior year third quarter. Additionally, the first half of the quarter was impacted by an overall market slowdown, although we exited the quarter with good momentum.

In the UK, GMV growth accelerated, and we're building on our success by leveraging product innovation and cross-platform promotions to drive user activity. France and Italy remain our top performers in the region with impressive growth rates.

In Asia, we're making progress in the face of tough competition. In Korea, listings growth accelerated for the third quarter in a row, highlighting our continued efforts to innovate our product offerings and attract new and existing users to the site. In China, we believe we're maintaining share in a highly competitive environment. Strong local GMV growth was partially offset by slower cross-border trade growth as we tightened seller restrictions to limit fraudulent seller activity. Australia continues to be a standout performer in the region. We're also pleased with our smaller markets in Asia as they enjoy healthy growth driven in part by our thriving cross-border business.

Marketplaces growth was also driven by our non-eBay branded businesses. More specifically, we saw tremendous strength at Shopping.com, driven by growth in lead store merchants and continued geographic expansion. Our classifieds business is rapidly gaining traction in all of our served markets. Globally, we now get over 22 million unique visitors per month, growing at close to triple-digit rates and we're beginning to monetize some of our classified sites via contextual advertising.

Overall, our Marketplace business exited the quarter in better shape than where we entered. We will continue to closely monitor our rebalance efforts and adapt where necessary to ensure the success of the cornerstone of our e-commerce franchise.

Now let's turn to our Payments business. PayPal had another excellent quarter, posting record total revenue of $350 million, a 41% increase versus the same period last year. New accounts totaled 8.8 million, and PayPal now boasts a network of 123 million accounts. These accounts helped drive record TPV of $9.1 billion representing 37% year-over-year growth.

Internationally, TPV grew by 59% year-over-year, driven by continued geographic penetration both on and off eBay. In PayPal's on-eBay business global penetration of addressable GMV grew to 58% in the quarter, driven by penetration gains in some of our newer markets, such as Germany, France and Italy. In the U.S., UK and Canada penetration rates were 79%, 71% and 86% respectively. We are pleased we continue to grow our developed markets while quickly gaining traction in our more nascent markets. These penetration gains, along with GMV growth, helps drive year-over-year on-eBay TPV growth of 27%, a slight acceleration versus Q2.

Our global Merchant Services business continues to post impressive results, generating $3.3 billion in TPV, up 59% year-over-year. While our Merchant Services business is still predominately a domestic franchise, it is rapidly gaining relevance internationally, and will benefit greatly from our recent expansion of currencies and markets.

This quarter PayPal transaction expense was 1.07%, down 4 basis points from a year ago period and up 5 basis points from the second quarter. The year-over-year decline is a result of favorable processing rates we negotiated early this year. The sequential increase was driven by an increase in our credit card funding mix, partially driven by new products and enhancements we have introduced in recent quarters, and the growth of Merchant Services.

While these products drive incremental payment volume, they tend to be more weighted toward credit card funding, which increases our cost. Our strategy over time is to migrate customers to higher involvement and higher value relationships.

The PayPal transaction loss rate in the third quarter increased to 35 basis points, up 11 basis points from a year ago period and 8 basis points from the second quarter. These increases are largely the result of increases in unauthorized charge card transactions, again, partially driven by newer, faster-growing products which have an increased credit card funding mix. We're constantly adapting our fraud models and capabilities to effectively manage our loss rates over time. In summary, PayPal had an excellent quarter and continues to execute well against our long-term strategy.

Looking at our Communications business, Skype continues to grow at a healthy pace this quarter, posting total revenue of $50 million, a sequential increase of 13% over last quarter. Skype's user base grew by 136 million, an increase of nearly 23 million users over the second quarter. This represents a sequential increase of 20%, and an increase of 137% from a year ago. User growth continues to be strong across all of our regions.

Skype-to-Skype minutes in the quarter were 6.6 billion minutes, down 8% sequentially from the second quarter, but up 77% on a year-over-year basis. The sequential decline is largely a summer seasonal impact. The Skype Out minutes grew to over 1.1 billion, representing 32% sequential growth and 235% growth versus the prior year. The strong growth of Skype Out minutes is partially the result of our free Skype Out promotions in the U.S., Canada and France. We continue to be excited by our progress with Skype, highlighted by rapid user acquisition and development of the Skype ecosystem.

Let's now take a look at our business unit performance translated into non-GAAP operating profits. As I indicated earlier, eBay delivered record revenues of $1.449 billion, up 31% year-over-year, and operating margins of 32%, down 3.5 points from last year.

Taking a look at the P&L in a bit more detail, first, gross margins were 79%, down 3 points from the year ago period, reflecting the inclusion of Skype and further investments in site operations capacity, primarily related to data center expansion to support our growth.

Next, sales and marketing was 26% of revenue in the quarter, down 1 point from the year ago period, and consistent with last quarter. We held our marketing program spend flat as a percentage to revenue versus last year, while continuing to leverage our fixed based costs.

Product development was 7% of revenue, on par from a year ago. We continue to increase our capacity, primarily at PayPal, to support major initiatives such as geographic expansion, while driving down our cost per unit to maximize our product spend.

Lastly, general and administrative at 14% is up 1 point from the year ago period. The year-over-year increase is driven by higher transaction losses at PayPal, as well as investments in trust and safety programs.

Collectively these factors translated into $464 million of non-GAAP operating income, 18% growth on a year-over-year basis. Consolidated non-GAAP net income was $367 million, up 31% over the year ago period, or $0.26 per diluted share. Our strong year-over-year net income growth benefited from a favorable tax rate, as well as increases in interest income due to higher cash balances and interest rates.

On a GAAP basis, Q3 net income was $281 million, or $0.20 per diluted share. This includes $74 million of gross stock option expense, primarily related to our implementation of FAS 123 R, in line with our previously stated guidance.

Our business model continues to deliver excellent cash flows. We generated $522 million of operating cash flow and $385 million of free cash flow in the quarter. Capital expenditures were 9% of revenue in Q3, and 10% of revenues year-to-date. We have generated $1.2 billion of free cash flow for the first nine months of 2006, while increasing investments to expand capacity in both Marketplaces and PayPal.

In July we announced our first-ever share repurchase program. We indicated the $2 billion program would be executed over the next two years, although we would be opportunistic at existing share prices. During the quarter we successfully repurchased approximately 24 million shares at a cost of $667 million, or one-third of our total program. Going forward, we will continue to execute against the program at its current share prices. Even with the repurchase of these shares, we ended the quarter with nearly $3.8 billion in cash and marketable securities.

With that, let me turn to our non-GAAP guidance for the fourth quarter and 2007. Looking to the fourth quarter, we feel good about the strength of the business as we exit Q3 and head into the holiday season. We expect Q4 consolidated net revenues to be in the range of $1.615 billion to $1.675 billion, and an assumed U.S. dollar to euro exchange rate of $1.25.

On the bottom line, we expect consolidated Q4 GAAP dilutive EPS of $0.27 to $0.28. This guidance reflects a revised full-year effective tax rate of 28% to 29% on a non-GAAP basis. This Q4 guidance implies full year 2006 revenues of $5.865 billion to $5.925 billion, with approximately $195 million coming from Skype, and including the FX benefit of a weaker dollar.

In our original 2006 guidance rate at $1.20 per euro, this full year revenue guidance is consistent with the guidance we gave on our July earnings call. We also expect to deliver approximately 32.5% full year operating margins, 0.5 point lower than our previous guidance, the result of stronger growth in PayPal, and fourth quarter promotional efforts to drive PayPal ubiquity across the Web. Even with this change, we are increasing our EPS guidance range to $1.01 to $1.02 per diluted share.

Looking forward to 2007, we expect net revenues to grow in the range of 17% to 21% versus this year. There are several factors that will provide more clarity on our outlook as we close out the year:

First, our business is becoming increasing seasonal. The growth of our eBay fixed-price offerings, the addition of Shopping.com, and the growth of PayPal Merchant Services have combined to drive fourth quarter to be a larger part of our full year results and an important factor in our 2007 projections.

Second, we will continue to monitor the impact of our eBay U.S. Marketplace rebalance initiatives to ensure they drive the intended results.

Third, we will monitor the progress of our new product offerings, such as eBay Express, and our advertising partnership with Yahoo.

Finally, Skype momentum to the fourth quarter will further inform our outlook.

Our Q4 performance in these areas should provide us with additional insight to refine our 2007 outlook in January.

With respect to operating margins, we expect to deliver at least 0.5 point of improvement versus 2006. The higher growth from our structurally lower margin businesses will negatively impact our margins, but we will offset this mix by driving productivity in our operating expense base.

On the bottom line, we believe we can grow earnings per share by at least 20% versus 2006, based on a more favorable tax rate and the benefit from our share repurchase program. 2007 will be another exciting year for eBay as we continue to focus on top line growth in each of our business units, while delivering increasing profitability and cash flow for shareholders.

In summary, we are pleased with our strong Q3 results and while we face challenges this year, we have continued to meet and exceed our revenue and EPS guidance through the first three quarters. We remain confident in the strength of our portfolio of businesses and our ability to consistently deliver on the guidance we provide.

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

Question-and-Answer Session

Operator

Your first question comes from Imran Khan - JP Morgan.

Imran Khan - JP Morgan

First, a housekeeping question. Is next year’s guidance including the contribution from Yahoo!? And then I have a follow-up.

Bob Swan

Yes, next year's guidance of 17% to 21% growth reflects our best view of how things are going to play out at this stage. As I indicated, there are several things that we expect to get more visibility to as we close out the fourth quarter, which includes the testing that we are currently doing with Yahoo!.

Imran Khan - JP Morgan

Meg, moving on to Asia, recently you announced a partnership with PC Home, and there are a lot of press discussions on a potential joint venture in the Chinese market. I was trying to get a sense what is your thought process in terms of thinking in China? Do you feel comfortable as a standalone company, or what do you think about doing a potential joint venture?

Secondly, in terms of Skype Me buttons, I was wondering if you give us some sense what kind of conversion rate you're seeing people who are using Skype Me buttons? Thank you.

Meg Whitman

Sure. In China we continue to see healthy growth in GMV and listings. This quarter, particularly healthy growth in the local market. As I mentioned in the script, we actually tightened seller restrictions on sellers selling out of China on eBay.com, Germany, France and Italy because of the fraudulent seller issue that we began to see emerge. So our local market growth is quite healthy. We believe we're actually maintaining share in what is becoming an even more competitive market. There are many new entrants in the business, but we feel pretty good about where we are.

That said, the robust monetization path there is unclear. We do charge, as you know, for eBay China, but at a much lower rate than any other market in the world. So we're constantly evaluating how to strengthen our long-term position. What are the alternatives that we can look at there? One thing we most recently did is we realized that PayPal and eBay in China are much more closely linked, and need to be much more closely linked, than they are in any other market. It is a bit more like Korea, where escrow is actually part of the flow on an Internet auction company in Korea. So we combined the entity under one leader. Those are the kind of things we're looking at and we're committed to China for the long term. The other question was --?

Imran Khan - JP Morgan

About the Skype Me buttons, yes.

Meg Whitman

Skype Me buttons, yes. On eBay we launched Skype Me buttons in 150 categories in 20 markets, including 14 categories on eBay.com. The early indications are quite positive. What is fun is that we see indications of a higher conversion rate when there are Skype buttons that are used, so we're excited about that. It is early days, and we're going to continue to test and monitor it. But we're excited about it.

Operator

Your next question comes from Doug Anmuth - Lehman Brothers.

Doug Anmuth - Lehman Brothers

I know that you said that you were cautiously optimistic about the sea change, and then you will have more visibility after Q4. But can you give us a sense of whether you're seeing any evidence that buyer demand in the core is strengthening?

Then also in your '07 guidance, can you give us a sense of what is built in there in terms of profitability for Skype for '07?

Meg Whitman

Sure. We are cautiously optimistic, and I will tell you why. First is fixed listings growth actually as a percentage of total has declined appropriately. Meaning we're seeing less identical items at relatively uncompetitive prices, which means that the buyer experience is improving. We are seeing early signs of core auction conversion rate improving. As you know, if you look at the data, our unique visitors to eBay.com in particular remain very strong. What we are seeing is more buyers at higher conversion rates, although it is very early. That is why I say we're cautiously optimistic.

What you have to remember is most of the changes didn't really take effect until well into September. But I would say cautiously optimistic with more updates at the end of Q4.

Bob Swan

In terms of Skype and '07 guidance, we do expect Skype to continue its rapid growth trajectory into the new year. We do expect that we will exit 2006 in pretty good stead, and that we will be breakeven during the course of the full year of 2007, while making significant investments to continue to build out the ecosystem and expand the product offering.

Operator

Your next question comes from Mark Rowen - Prudential.

Mark Rowen - Prudential

Thanks. A couple of questions. Number one, you mentioned that the business is becoming more seasonal. It looks like the listings growth in the first part of the fourth quarter decelerated a little bit in the major markets. Are you expecting that to reaccelerate when your ad campaign starts to hit the airwaves, or was there something going on in the first couple of weeks of last year that is causing that deceleration?

Meg Whitman

I think what we're actually seeing is the effects of the rebalancing of the marketplace, that we're still seeing appropriately deceleration in the listings in the store inventory format. That is what is driving the overall listings number. As we look at the larger markets and core listings, actually we're right on where we expected to be.

Bob Swan

I would just add that for the first couple of weeks of the quarter I would say things were more or less on track around the globe.

Mark Rowen - Prudential

Is your ad campaign, is that about the same time as last year and will run the same duration?

Meg Whitman

Yes. In the United States it launches in about a week or ten days. It will have roughly the same weight and run the same length of time. We're also doing a television advertising campaign in Germany as we have in the past. That should be unchanged, and we're excited about the new generation of the It ad.

Mark Rowen - Prudential

Then on the advertising partnerships with Yahoo! and Google, now you have been testing at least with Yahoo! for a certain period, can you help us understand what you're discovering, and does it look like is going to be a bigger opportunity than you first thought, or a smaller opportunity, or how do you see it now that you've had a chance to test some of it?

Meg Whitman

Let me describe what we have done, and then I can let Bob take a crack at whether we think it is bigger or smaller. The teams I think first of all are working very well together between Yahoo! and eBay. What we started with was testing contextual-based ad for –[Break in Transmission]

Operator

Please stand by.

Meg Whitman

So maybe we ought to do a test. I wonder whether we know whether we're still connected?

Operator

You are still connected. We can hear you now.

Meg Whitman

They can hear us now. Okay. Sorry about that. So we started testing, as I said, the contextual-based ads on null search results, and those appear to be quite positive and non-cannibalizing. We are extending that test to what we call complementary searches. The early results are good.

We also launched graphical ads served by Yahoo! in the Motors category, and we feel good about what we're learning. I don't think we're actually prepared to tell you what the numbers are, or whether we think it is bigger or smaller, but I will let Bob take a crack at that.

Bob Swan

I would just say so far we feel pretty good, but we've got a couple of months of testing. As we indicated, both us and Yahoo! are going to be very cautious that the introduction of these text-based and graphical ads on our site don't negatively disrupt the experience for both buyers and sellers. We're very cautious. Null results are a positive. General or complementary search is just early days, and graphical we just started. We feel pretty good, but we're not going to be able to provide a heck of a lot more visibility of this until we get to January.

Mark Rowen - Prudential

You expect the test to run until January?

Meg Whitman

Yes, it will run through the fourth quarter.

Mark Rowen - Prudential

Then last question on Skype. It looks like the revenue per user on Skype in the quarter was down just slightly. I mean not that that is concerning, but can you just talk about any ways that you're discovering that you might be able to monetize the users, other than the Skype buttons on eBay?

Meg Whitman

One of the reasons that the revenue per user was down just a tad in the third quarter was explosive growth of users in Asia. This is a remarkable phenomenon that is taking place throughout most countries in Asia, obviously including China. That sort of explains why there is a slight decrease.

We're looking at a variety of incremental revenue streams in terms of monetizing Skype beyond Skype in, Skype out and voicemail. We will be bringing those to market in the first part of 2007. We're also going to continue to work Skype Me buttons on eBay and develop the pay per call, pay per lead business that we have talked about for some time. Stay tuned, Mark, we've got other revenue streams coming online for Skype.

Operator

Your next question comes from Scott Devitt - Stifel Nicolaus.

Scott Devitt - Stifel Nicolaus

Thank you. Two questions. First, the marketplace GMV, excluding Motors, grew 6 percentage points faster than the reported number. That is the first time that the non-motors GMV has accelerated in quite some time. In three of the four largest non-Motors category -- electronics, home and garden and collectibles -- actually had material growth acceleration in the quarter. I'm wondering if you could talk about initiatives, specifically in those categories that may have driven the acceleration, whether it is related to something about distribution and channels, Shopping.com, or eBay Express, or if it is category/program related? And if those initiatives could be broadened out over time? And then one follow-up.

Meg Whitman

Yes. I think it is a couple of things. One is our rebalancing effort around stores had a disproportionate effect on some of those categories because store owners had really accelerated store listings in those categories. I think that is another positive sign that the rebalancing efforts are taking hold.

We have four teams up against all the different categories. I don't think there was anything particularly in the quarter that was unique around those categories. I think it was really a result of the store inventory pricing format that drove those results.

Scott Devitt - Stifel Nicolaus

Bob, could you define the organic rate of growth in 2007, and what that does exclude? There's about an 8 percentage point spread now between reported and organic. How does that look in '07?

Bob Swan

Essentially we have assumed no acquisitions in that growth rate, and an exchange rate roughly where we are today of a euro/dollar exchange of $1.25.

Operator

Your next question comes from Mary Meeker - Morgan Stanley.

Mary Meeker – Morgan Stanley

A question for Bob and perhaps for Meg as well. On the '07 growth rate question, if you could drill down on that a little bit more. Perhaps if you're willing to give us some ranges perhaps for PayPal and also for eBay U.S., international.

Meg, you talked about Skype growth. I assume the Yahoo! revenue, if you're willing to break it down between eBay and PayPal how it would probably fall in the eBay bucket. That would be great.

Bob Swan

As you might imagine, we had a pretty healthy debate about whether to give guidance on '07 at this stage. We concluded that while we didn't have all the answers, we had a bias for transparency and communicated to you what in fact we did know. But there are several things that as we become an increasingly seasonal business, as we have new things like eBay Express, and advertising really launching in the fourth quarter, as we are doing the rebalancing to the Marketplaces there are things that we just don't know.

But we feel confident in the 17% to 21% range, and that earnings will in fact grow faster than revenue. Our intention is to, as we always do, give you more insight after we get through this critical holiday season, and more visibility on really how we see the components of growth materializing during the course of the new year.

Mary Meeker – Morgan Stanley

Just one more question. You had a very aggressive stock repurchase in the quarter. Probably frankly far more aggressive than most companies relative to the time they announce and the time they act. You have some cash overseas. Could you give us a sense of how much of what you could do, you did in the quarter?

Bob Swan

As you know, we announced the program back at the end of July, a $2 billion program for a 24-month period. We indicated that based on trading values at the time, that we believed it didn't really reflect the long-term value of the Company, so we were going to be very opportunistic in the early stages. In fact we were, and we will continue to be at today's trading levels.

In terms of our cash balances, we have $3.8 billion in cash at the end of the quarter. The cash balances relative to the revenue are not dramatically different, and we will continue to think about ways to have available liquidity for us to execute on the opportunistic program that we have in place.

Mary, if I could, I would like to just close out one more comment just on the whole '07 guidance dialog. In the context of a healthy debate we had at this end, and a bias to just be more transparent and tell you everything we know at this stage, despite the fact that we don't know everything and have a bunch of moving parts, I would be remiss if I didn't say that our intentions next year would probably be to more fall in line with our peers and not provide '08 guidance at the end of the third quarter of '07, and get the benefit of getting the more and more important fourth quarter behind us. I would be remiss if I didn't convey that to you. I think and hope you appreciate our trying to balance the utmost transparency with just getting a little more knowledge behind our back as we project forward.

Meg Whitman

With regard to Yahoo! I think it is fair to characterize that the bulk of the revenues will in fact accrue to the eBay side of the business through the shared advertising revenue to the extent that we build a contextually-based ad business on eBay. That isn't to say that PayPal integration into Yahoo! isn't incredibly strategically important, it is because it furthers our advantage of ubiquity on the net. We obviously will share those revenues with Yahoo!, but strategically PayPal integration onto Yahoo! is very important.

Operator

Your next question comes from Anthony Noto - Goldman Sachs.

Anthony Noto - Goldman Sachs

Two questions, first for Bob and then Meg. Bob, it looks like your core U.S. listings accelerated to 10% year-over-year growth versus 6% and your revenue per listing decline improved to down 5% versus down 10%. It begs the question; if you are seeing these improvements in the second derivatives, what could offset that to cause the trends not to continue to improve on a second derivatives basis as we go into to the fourth quarter and 2007?

Meg, you had mentioned a stat on eBay Express. You said, people that buy on eBay and eBay Express spend 25% more. Will you focus on trying to get a greater percentage of people to use eBay Express or to use eBay, or will your marketing efforts focus on those that shop online that don't shop at eBay to come to eBay Express? And when will that start?

Bob Swan

On the first one, in the U.S. business as we indicated, we felt a little bit better as we exited the quarter versus when we entered the quarter. Our guidance reflects about a 14% acceleration of revenue in the aggregate from Q3 to Q4. We are expecting a decent acceleration. It is consistent with what we said before. The trends we have witnessed during the course of the quarter give us comfort as we go into the key holiday season.

Meg Whitman

With regard to eBay Express, the focus of the eBay Express marketing for the fourth quarter is going to be around our core eBay buyers and getting an increased share of wallet. What we know is that our core eBay buyers love eBay, but they do shop at other sites for new items in a more convenience-oriented format. What eBay Express, although early, has convinced us of is that they will shop on eBay if they have an opportunity to in a slightly different format. So the marketing is all around our core consumer share of wallet. We may get some new users. We have seen some new users based on the television campaign that ran in September. But priority number one, two and three is more share of wallet from our existing very loyal eBay buyers.

Anthony Noto - Goldman Sachs

I forgot to ask you about pay per call. Will that be a first half initiate next year with Google, the announcement that was made?

Meg Whitman

I don't believe it will be. There is a chance, but I suspect you'll see more activity around that in the second half of 2007.

Operator

Your next question comes from Heath Terry - Credit Suisse.

Heath Terry - Credit Suisse

I was wondering if you could give us a little bit more on the success that you have seen with eBay Express? Can you tell us whether or not it is attracting a new user base versus traditional eBay buyers that could have been buying on either core or stores in the past?

Meg Whitman

Sure. As you recall, eBay Express is a tailored shopping experience for the convenience-oriented shopper. We were targeting existing buyers to increase the share of wallet. As you know, it has new finding experience, a great finding metaphor, by the way, if you haven't tried it. Mostly new items, all fixed-price, a streamlined check out and a multiseller cart, which is actually very interesting because you can buy multiple items from the same seller.

I would say the early results suggest that we are in fact getting a higher share of wallet from our existing consumers, that 25% increase in spending that I mentioned versus the control group. That said, we have seen some incremental new users come who maybe don't shop on eBay at all. But I think it is too early to declare victory on that. I would say you need to really measure us, and we're going to measure ourselves, on whether we take our existing buyers and get a higher share of wallet.

Operator

Your next question comes from Ben Schachter - UBS.

Ben Schachter - UBS

I was wondering if we could talk a little longer term about the monetization models of how they're going to evolve with classifieds and Kijiji? You mentioned there was contextual ads running there. I was wondering if you could talk about how that is working today? Are there partners? Are you doing it alone?

And then also the relationship with craigslist. Any change there? Are you working with them any more closely? Do you see that relationship expanding?

Then a related question on fixed-price goods. You are up to 37%. Do you have a target for where you think that can go in the relatively near term?

Meg Whitman

Let me give you an update on classifieds. We're really pleased with the growth of our overall classifieds business. As I said, we are in 400 cities with Kijiji, Gumtree, Marketplaats, and it is really actually going quite well. Marketplaats is probably the best demonstrated practice of our classified sites. That is largely monetized through advertising. I think we actually do that with Google in the Netherlands, and that has actually worked quite well for Marketplaats. We are rolling out similar programs to our other classified sites.

With regard to craigslist, we have a good working relationship with craigslist. We have learned a lot from craigslist. I think they have learned a lot from us, particularly in the trust and safety arena. But no new news there in terms of a closer working relationship. It is just we have a great relationship with them, but that is really all there is to report.

With regard to fixed price, we actually don't have a target on fixed price. We go where the buyers take us. I think over the years there has been a steady increase in fixed price. That said, the auction business is the core of what makes eBay different, and we will continue to invest against the auction business. So we don't have a particular target.

Operator

Your next question comes from Justin Post - Merrill Lynch.

Justin Post - Merrill Lynch

Quickly, we look at the GMV growth, and it looks like it has stabilized here a bit, 17% in the quarter, maybe a little less ex currency, but that looks good. Do you still have intentions of trying to get that back towards e-commerce growth? What do you think are two or three key initiatives to do that?

Secondly on Skype, it looks like a very nice attractive user base, a lot of monetization opportunities. Maybe you can help us, walk us through what you think are the biggest opportunities there to get more revenue per user going forward.

Meg Whitman

Sure. Let me talk about GMV. We do have an aspiration to grow at or faster than e-commerce growth rates in every market in which we participate. I think actually in most cases that is still the same, that we actually are growing faster than e-commerce. We have a couple plans to continue to do that.

One is the continued rebalancing of the Marketplace so that we have a terrific buyer experience. We want to continue to revitalize the core business in auctions in particular. We've got a host of demand generation activities, most notably our advertising campaign across our two biggest markets in the fourth quarter. So very much our objective is to reaccelerate GMV growth in our largest markets. I actually think we will be able to do that.

With regard to Skype, the key objective for Skype actually is new user acquisition, active new users, as well as the development of the ecosystem. This is a three-year-old business. While I am interested in the revenue per user, I am more interested in the development of the ecosystem and the growth of new active users. As we head into 2007, the main monetization models are going to be Skype Out, e-commerce, and pay per lead. Stay tuned for more details on that, but I wouldn't be focused and we're not focused on the revenue per user in 2007, because the business is really too young to do that. We want to get as many people on Skype, using the Skype client with that desktop presence as we can by the end of 2007.

Bob Swan

Meg, the only thing that I would probably add is Meg talked about the tailored shopping experiences and how that is one of the key initiatives we have to kind of reaccelerate GMV and get a little bit of insight into what we're doing in Motors, both now and going forward.

Obviously, Express is a very important TSE for us to get more share of wallet. We want to continue to look at other categories that we think we can expand our tailored offering to grow within those and potentially new categories.

Meg Whitman

Operator, I think we have time for two more questions.

Operator

Your next question comes from Mark Mahaney - Citigroup.

Mark Mahaney - Citigroup

First, welcome back to Lydia. Second, on eBay Express, two questions. Would that have been part of the improvement in conversion rates that you think you have seen in the marketplace?

In terms of the advertising, how do you handle the risk that all the advertising you have had about eBay Express has somehow led people to just to come to the eBay site, not to eBay Express? To what extent do you have to worry about I guess mixing your messages, particularly as you bring back the It campaign later on in the quarter?

Meg Whitman

I don't know the precise answer to your question. My hypothesis is that eBay Express would not have materially affected the increase in conversion rate, because it is still a relatively small portion of the total. Especially if you look globally, because really it was only in the U.S. in Q3.

With regard to Express and eBay, what is true is that when you go to the eBay.com home page today there's a lot of promotion around eBay Express. We're trying to introduce our core users to eBay Express. That actually has worked quite well.

With regard to the ad campaigns, they were down through the same general look and feel of the It campaign. It had a slightly different feel, as you may have seen in September, but It is the umbrella. It is the umbrella for both Express, as well as eBay.com, and they were designed to be effectively a brand and a flanker brand. I think that is working pretty well. Our consumer feedback suggests that people do understand the difference between eBay and eBay Express.

Meg Whitman

I think we have time for one more.

Operator

Your last question comes from Christa Quarles - Thomas Weisel Partners.

Christa Quarles - Thomas Weisel Partners

Hi, the first question is on China. I was wondering if you could discuss the pros and cons of going through the Yahoo! strategy, deconsolidating your China businesses and partnering up with some local player, or even more broadly partnering with maybe a local portal or search player to help your penetration of those markets?

Then the second question is just on Shopping.com. I am just wondering if you could highlight specifically what was so positive there? I think the results against Shopzilla were not quite as positive? Are you developing new products? We heard something around maybe a CTA product.

Meg Whitman

With regard to China, the only thing I can say is I just want to reiterate that we are seeing healthy growth in our local GMV and listings. We are maintaining share in what I perceive to be a very, very competitive market, with low rates of monetization. I just actually don't think it is the right thing to do to comment and speculate on portal versus a Yahoo! strategy in China. We're committed to the Chinese market for the long term. We think it holds great potential. I think that is probably the right way to characterize our view at this point.

With regard to Shopping.com, it actually is the leading online comparison shopping site in the United States, having actually regained the lead from Shopzilla in the quarter. We had a quarter with accelerating revenues. I think innovation in the user experience is what is setting Shopping.com apart. If you have not shopped Shopping.com, I would suggest you do. They have a fantastic rollover feature that really allows you to look at a whole host of products in an incredibly consumer-friendly way. It includes more dynamic navigation, larger images and a really great visibility into the content. I would say innovation, innovation, innovation is what is driving Shopping's performance.

Christa Quarles - Thomas Weisel Partners

Does the innovation include a CPA product?

Meg Whitman

We're looking at a whole host of things. Can't comment on that right now.

Christa Quarles - Thomas Weisel Partners

Great. Thanks.

Meg Whitman

Okay. Thank you very much for listening. We appreciate your time. Take care.

Operator

That does conclude today's conference call.

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Source: eBay Q3 2006 Earnings Call Transcript
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