eBay Q2 2008 Earnings Call Transcript

| About: eBay Inc. (EBAY)
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eBay Inc. (NASDAQ:EBAY) Q2 2008 Earnings Call July 16, 2008 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


Jeffrey Lindsay - Sanford C. Bernstein

Brian Fenske - Lehman Brothers

Youssef Squali - Jefferies & Company

Scott Devitt - Stifel Nicolaus

James Mitchell - Goldman Sachs

David Joseph - Morgan Stanley

Christa Quarles - Thomas Weisel Partners

Brian Pitz - Banc of America


Good day and welcome, everyone, to eBay's second quarter 2008 earnings results conference call. Today’s call is being recorded. With us today from the company is the Chief Executive Officer, Mr. John Donahoe, and the Chief Financial Officer, Mr. Bob Swan. At this time, I would like to turn the conference over to Mark Rowen, VP of Investor Relations. Please go ahead, sir.

Mark Rowen

Thank you, Operator. Good afternoon, everyone. Thanks for joining us and welcome to eBay's earnings release conference call for the second quarter of 2008. Joining me today on the call are John Donahoe, our President and 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.ebay.com.

Before we begin, I’d like 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 the reconciliation of those measures to the nearest comparable GAAP measures in the slide presentation accompanying the 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, including those relating to the company’s ability to grow its businesses, user base and activity. Our actual results may differ materially from those discussed in this call for a variety of reasons, including but not limited to our increasing need to grow revenues from existing users in established markets; an increasingly competitive environment for our businesses; the complexity of managing a growing company with a broad range of businesses; our need to manage regulatory tax, IP and litigation risks, including risks specific to PayPal and the financial industry and risks specific to Skype's 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; changes in political, business, and economic conditions; our ability to profitably expand our business model to new types of merchandise and sellers; and the impact of integration of recent and future acquisitions.

You can find more information about factors that could affect our operating results in our most recent annual report on Form 10-K and our subsequent quarterly reports on Form 10-Q. You should not unduly rely on any forward-looking statements which are based on information available to us on the date hereof and we assume no obligation to update such statements.

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

John J. Donahoe

Thank you, Mark and welcome, everyone to our Q2 earnings call. I am delighted to report on my first official quarter as eBay's CEO. As I did on last quarter, today I will highlight our company’s financial performance, then I’ll give my perspective on each business units results and discuss progress against our priorities for 2008, and finally after a few closing thoughts, I’ll turn it over to Bob for more detail on our Q2 numbers and our outlook for the full year.

Let’s start with the financial performance. We delivered strong financial results in Q2. Net revenue was $2.2 billion, up 20% and non-GAAP EPS was $0.43, up 25%. We generated free cash flow of $617 million in the quarter and we repurchased more than $0.5 billion worth of our stock, on top of the $1 billion repurchased in Q1.

In our marketplaces business, we feel good about our overall results as we implement changes designed to make eBay more competitive, with better experiences for buyers and more opportunities for sellers. Marketplace’s revenue grew 13% for the quarter, with global GMV up 8% to $15.7 billion. Beneath these numbers we’re seeing some early, encouraging signs from the changes we are making, something I’ll talk more about in a minute.

Our global platform also continues to drive strong cross-border trade, which accounted for more than 18% of global GMV for the quarter. And our non-GMV, or marketing services businesses also continued to perform well, growing 43% this quarter, led by strong momentum in classifieds and advertising.

PayPal, which is celebrating its 10th anniversary this year, had another excellent quarter, growing both on and off eBay. PayPal revenue was up 33% to over $600 million and total payment volume grew 35% to $14.9 billion. We’re seeing increasing ubiquity at PayPal online. Today, anyone can conveniently and easily use PayPal to buy their favorite eBay item, purchase an airline ticket to their favorite destination, or rent their favorite movie. We’re only beginning to just tap the potential of PayPal's safer and more secure way to pay and be paid online.

Skype also generated strong results, with revenue growth of 51% to $136 million in Q2, its sixth consecutive quarter of profitable growth. User metrics were also quite strong at Skype, with registered users up 54% to $338 million and Skype to Skype and Skype out minutes accelerating for two consecutive quarters.

All in all, I am proud of what our teams are accomplishing. We’re delivering strong results in a tough economic environment while driving the changes necessary to build a stronger future for eBay. We’re focused on meeting our financial commitments while maintaining the financial flexibility to make the right growth investments in our businesses.

With that summary of our Q2 results, let me remind you of the priorities we set out for 2008 at the beginning of the year: one, make eBay easier and safer to use; two, improve value and selection through pricing and incentives and by weaving auctions and fixed price in a uniquely eBay way; and three, extend PayPal's leadership position in online payments both on and off eBay.

Now let’s take a closer look at each of our business units and the progress we are making against these priorities. In marketplaces, we remain extremely focused on improving the buyer experience on eBay. To that end, we are making a series of changes that we believe will create a healthier, more vibrant marketplace. Let’s look at what we’ve done during the first half of this year.

First, we began rebalancing our pricing, shifting from insertion fees to final value fees. We also began offering free gallery photos in the U.S. and U.K. Second, we implemented a series of initiatives to improve trust sand safety. For the first time, we began rewarding sellers who provide the best buyer experience, as indicated by their detailed seller ratings, or DSRs, and we began offering DSR-based discounts to qualified power sellers. We also made changes to feedback, such as offering sellers credit for repeat buyers and eliminating retaliatory feedback, a top concern of our buyers. Finally, we launched best match search, starting with some trust-based changes which provide more search exposure to sellers who provide the best customer experience.

Now I’d like to take a look at some of the early results from these changes. Rebalanced pricing has clearly increased listings and selection on eBay. New listings grew 19% in Q2 to $667 million, an acceleration of nine percentage points over Q1 and 15 points over Q4. Selection on eBay is unmatched by anyone else online and it’s getting stronger.

We’re also seeing some early results from our efforts to improve trust and safety on eBay. Our initiatives around feedback, DSRs, and best match are incenting sellers to lower shipping costs and improve the buyer experience. In fact, sellers, both large and small, are making customer satisfaction a competitive advantage on eBay.

And the early evidence is that buyers are taking notice. Since we first announced seller incentives in January of this year, the number of power sellers with DSRs of 4.8 or above has more than doubled. So buyers are beginning to see a difference in their experience and are reflecting that by rating sellers more highly.

More listings and improved buyer experience are also driving velocity. Sold items, a measure of unit volume, grew 9% in the second quarter in our three largest markets, the U.S., U.K., and Germany. This represents a one point acceleration of growth over Q1 in those markets. So there’s clear evidence of progress from our changes in listings and sold items and simply put, we’re about where we expected to be. Bob will provide more details in a few minutes about the relationship between these metrics and GMV and revenue growth.

We’ve also heard some criticism from our community as we’ve made changes during the first half this year. Now, when you have 84 million active users, anytime you make a change, someone is going to be upset. But we listen and we incorporate their feedback with what we believe is best for the collective good of the marketplace. This is the art and science of our business. An open, honest dialog with our community makes eBay stronger.

There are two areas where we have recently modified changes based on input from our community and on our own assessment. Just last week, we announced some refinements to feedback, changes that were well-received by sellers. And we refined our plans in Australia where we will continue to accept existing payment options while still protecting buyers who use PayPal for purchases up to $20,000 Australian dollars.

We’ve recently announced more changes that will take effect in the second half of this year. The most important of these are major enhancements to both buyer and seller protections that leverage the unique power of PayPal. Buyers who pay with PayPal on eBay now have unlimited coverage on most transactions. This gives buyers greater confidence when they shop on eBay and pay with PayPal.

PayPal will also now extend protections to all U.S. sellers offering unmatched protections on eligible transactions at no additional cost. These new protections for buyers and sellers underscore the power of eBay and PayPal together. We believe that PayPal buyer and seller protections will be a cornerstone of a safe, trusted, and convenient shopping experience on eBay.

So stepping back, this review shows that we are moving quickly. Our focus is on making the appropriate changes and investments necessary for eBay to compete in today’s environment. We’re committed to making bold changes over a 12- to 18-month period that will drive sustainable improvement and enhance the health and vibrancy of eBay. We’re off to a good start and the momentum in new listings and increase in sold items are positive early indicators, as are improved seller ratings. However, it is still early and we still have a lot more work to do. There are no silver bullets in a marketplace as diverse and dynamic as eBay, but we remain confident that we are moving on the direction and are on the right path.

Now let’s take a look at the operating details from PayPal and Skype. The more time I spend with the PayPal team, the more excited I am about the growth prospects for this business. It is a gem.

What’s clear is that PayPal and eBay greatly benefit from each other. eBay offers PayPal a steady source of customers, and global penetration increased five points year over year to almost 57% in Q2, but there’s still plenty of room for PayPal to grow on eBay. And growing PayPal is a priority for us, and we’ve made great progress. Across e-commerce, more people than ever are using PayPal. Active accounts increased by 19% to almost $63 million in the trailing 12 months.

We’re also pleased to announce that we’ve launched Buy Now, Pay Later -- PayPal buyer credit on eBay in Q2. We’re excited about the long-term opportunities this offering has for consumers.

On the merchant services side of PayPal's business, we’re seeing dramatic growth. Payments from e-commerce merchants now represent 49%, or nearly half of PayPal's total payment volume. Online retailers increasingly recognize PayPal's ability to deliver customers and increase conversion and sales.

Jet Blue, Delta Airlines, and Blockbuster Video are just some of the companies that have begun offering PayPal for their customers this quarter. Today, 32 of the top 100 U.S. retailers on the web and 13 of the top 50 in the U.K. accept PayPal.

In Europe this quarter, Arcadia Group, CD Wow, and two of the largest German flower retailers, [Fleura] and Valentine’s, have added PayPal. PayPal is available as a payment option on almost 140,000 European websites. And in Asia-Pacific, PayPal also had a strong quarter, reaching nearly $1 billion in total payment volume for the first time.

Now let me move briefly to Skype, which had another great quarter and continues to be a terrific business. Revenues grew 51% in Q2 and Skype is on track to surpass $500 million in revenue this year, with double-digit profit margins. As importantly, growth in user metrics have accelerated for two consecutive quarters, and Skype offers a killer communications application, with free peer-to-peer video, which is now used for more than 25% of Skype-to-Skype calls. This momentum is remarkable for a company not yet five years old and Josh Silverman and his team are doing a terrific job leading Skype since moving into their roles earlier this year.

Finally, before turning it over to Bob, I’d like to announce some executive changes. Rajiv Dutta, head of global marketplaces, has decided to retire from eBay after 10 extraordinary years with the company. Rajiv has been one of eBay's most talented and inspirational leaders over the past decade. He has served as our CFO and then moved to various leadership roles at Skype, PayPal, and eBay. Rajiv has worked tirelessly with me, Lorrie Norrington, Stephanie [Telenius], and others on the marketplaces team this year to put a strong strategy in place for the eBay marketplaces and drive necessary change.

With the right strategy and the right team in place, Rajiv feels now is the time to conclude his career with eBay and he leaves many friends behind at eBay and I know he will continue to be one of our most passionate champions and closest friends.

Lorrie Norrington will succeed Rajiv as head of global marketplaces, reporting to me. Lorrie has been instrumental in developing and implementing our strategies this year. She is an exceptionally focused and talented executive with strong marketplaces experience, and she is an avid buyer and seller.

After more than 20 years running global operations at GE and Intuit, Lorrie joined eBay three years ago with the acquisition of Shopping.com, where she was CEO. Following that, Lorrie became President of eBay International, where she had full responsibility for more than half of our overall marketplaces business. And this year, she has served in a COO type role for marketplaces, so stepping up to lead eBay is a natural next step.

Now, Rajiv will be around for the next couple of months to ensure a smooth transition with Lorrie and the team, but I know you will join me today in thanking Rajiv for his extraordinary contributions to eBay over the past 10 years.

So with the strong leadership team in place and another strong quarter behind us, I feel very good about our progress to date. In January, I described the dramatic changes we intended to make to improve our business this year while meeting our financial commitments. I also said that we intend to finish 2008 in a stronger, more competitive position. Halfway through the year, my view remains largely the same.

First, we have a strong set of assets, and we’re making the bold changes necessary for eBay to compete in today’s environment.

Second, we’re making changes that are necessary for the collective good of our eBay community, which requires give-and-take and honest conversation. We’re committed to improving experiences for buyers, which in turn will create more opportunities for sellers.

Third, we’re leveraging the strength of eBay and PayPal together, and investing in PayPal to grow beyond eBay and capture its extraordinary full potential.

And lastly, we’re executing our strategies in a more uncertain economic environment than we saw six months ago, but we remain confident in our direction and in the strength and potential of our increasingly diverse portfolio. We have great businesses.

So we’ve accomplished a lot in a short period and this is exactly what we said we would do, and what the eBay marketplaces needs to compete more effectively longer term. Meanwhile, PayPal and the rest of our portfolio continue to perform well with substantial growth opportunities.

I look forward to updating you again on our progress in October during our Q3 earnings call, and now I’ll turn it over to Bob for a closer look at the numbers.

Robert H. Swan

Thanks, John. Now I’ll review our financial performance in some detail. During my discussion, I’ll reference our earnings slide presentation which accompanies the webcast.

Before I dive into the numbers, let me try to give you some context on how dramatically our business has evolved over the last several years. In just the past two years, the size of our business has increased by more than 50% and today, eBay Inc. represents a portfolio of increasingly diversified revenue streams. We’ve expanded our global reach in marketplaces and PayPal and begun to capitalize on new areas of opportunity, such as classifieds and advertising.

Two years ago, 66% of our revenues were associated with marketplace transactions, while today these account for just 57%. PayPal transactions are now 26% compared to 23%; marketing services, which includes our fast-growing advertising and classifieds businesses, is 11% versus 8%; and Skype is now 6% compared to just 3% two years ago.

We are also more globally diverse today, with 54% of our revenues coming from international markets, compared to 47% back then. And finally, even though our lower margin businesses have grown faster and we’ve accelerated the level of investment in the business, our company-wide operating margins have remained relatively stable over the last two years as productivity and leverage have increasingly been part of how we operate.

As a result of our diversification efforts, we have a healthy portfolio of businesses today that is far less dependent on a single stream of revenue. Our Q2 results demonstrate continued progress in diversifying our revenues while maintaining strong operating margins.

Now I’ll review our Q2 financial performance. Overall, as John said, we achieved strong financial results in the quarter despite a tough economic climate. We generated strong revenue growth, even stronger non-GAAP earnings growth and significant free cash flow. We continue to opportunistically execute our stock buy-back program, repurchasing $566 million worth of eBay shares.

In total, our combined businesses generated record net revenues of $2.2 billion in the second quarter, a 20% increase over last year. Organic revenue growth excluding acquisitions and FX, was 13%. Overall revenue growth was once again propelled by the high growth PayPal merchant services, classifieds, advertising, and Skype.

Non-GAAP EPS was $0.43 in Q2, a 25% increase from last year and $0.02 above the high-end of our guidance range. The EPS performance was driven by stronger-than-expected top line growth, increased productivity, a lower tax rate, and a lower share count.

Operating margin came in at 31.9% in the quarter, 50 basis points below last year, solely driven by a business mix shift towards our higher growth, lower margin, PayPal, and Skype businesses, as margins in all three of our reported segments increased over prior year levels.

We generated free cash flow of $617 million in the second quarter, an increase of 16% from the prior year, primarily driven by earnings expansion, while CapEx as a percent of revenues has held at 6% for the past four quarters. For the first half of 2008, free cash flow increased by 23% over the prior year.

Return on invested capital on a trailing 12-month basis was 28%. This measure has shown continuous improvement over the last several quarters, as we’ve been able to generate higher earnings on roughly the same level of capital employed.

Now let’s take a closer look at our segment results. Overall, our marketplaces business segment achieved net revenues of $1.5 billion, an increase of 13% over the year-ago period. Transaction revenue grew by 9% and marketing services revenue increased 43%. The growth in marketing services was fueled by our text and graphical advertising partnerships, which posted hyper growth of 183% as we further optimized ad placements, and our classifieds business, which increased 65% over last year.

Marketplaces growth was negatively impacted by approximately three points related to our efforts around price rebalancing, power seller discounts, and customer loyalty couponing.

Global GMV was $15.7 billion in the quarter, an 8% increase. GMV growth was impacted by lower average selling prices and a rapid decline in vehicle GMV. I will cover this in more detail shortly.

Now let’s take a look at some of the key operating metrics. More than 84 million active users were active on eBay's marketplaces over the trailing 12 months, an increase of 1% over last year, or up 6% excluding China and Taiwan. U.S. GMV was $7 billion in the quarter, an increase of 4% year-over-year, while international GMV grew 12% to $8.7 billion, accounting for 55% of global GMV. Excluding benefits from foreign exchange, international GMV grew by 4% over last year. GMV in the fixed price format increased 19% over last year and now accounts for 43% of global GMV as we execute against our initiatives to optimize fixed price offering.

As John stated earlier, we continue to implement changes to make eBay more competitive, with greater opportunities for sellers and better experiences for buyers. Let me take a moment to give you a little perspective on how we view the impact of the changes being made on our marketplaces.

One of our key initiatives in 2008 is to increase selection on our sites. With this goal in mind, we reduced up-front fees for our seller earlier this year. The data suggests that the pricing changes have had their desired effect on selection, as new listings grew 19% in the second quarter.

With selection increasing fairly dramatically, we experienced a natural and somewhat expected decline in conversion rate. Sold items, a function of listings, items per listing, and the conversion of listings to sales, is a measure of our unit volume. Sold items growth for total marketplaces was 10% in the quarter, a one point decrease from last quarter. In our three largest markets, the U.S., the U.K., and Germany, sold items accelerated by one point in Q2, but this was more than offset in other countries, particularly in Korea and Australia, where growth decelerated from Q1 levels.

We believe the trend in our largest three markets is an early but clear indication of increased velocity on our sites.

Our average selling price declined by 6% compared to last year due to three reasons: first, specific promotions we ran in Germany brought a significant amount of low-priced inventory onto the site, reducing ASPs; second, we’ve enhanced safety and reduced fraud on our sites, and we’re doing a better job of removing bad, high ASP listings before they convert to GMV; and third, we believe the slowing economies, particularly in the U.S. and the U.K., have caused consumers to trade down to lower priced items.

Collectively, these dynamics in supply, conversion, and ASP resulted in FX neutral GMV growth of 4% year over year, a four-point deceleration from Q1. A portion of this decline is related to weak vehicle sales, as the entire used car market experienced a significant slowdown in recent months, and we continue to experience a mix shift from transactions to the classifieds format.

While we are pleased that sold item growth accelerated in our big three markets, we recognize that many of the challenges we’ve embarked upon will take time to gain traction and impact our overall metrics in a meaningful way. But we remain convinced that we’re focused on the right set of priorities to strengthen the marketplace over the long-term and that we are moving in the right direction. As John said earlier, there’s no silver bullet and there’s still significant work to be done, so we remain focused on executing on our ’08 priorities.

Now let’s turn to our payments business. PayPal posted yet another very strong quarter, with total revenue coming in at $602 million, a 33% increase versus the same period last year. Total payment volume was $15 billion in Q2, a year-over-year increase of 35% and a point of acceleration from Q1. Total payment volume grew by 30% in the U.S. and 45% internationally.

We believe the strong growth trajectory we’ve seen at PayPal is a reflection of continued progress in our efforts to achieve ubiquity for PayPal on the web through increased penetration on eBay and an expanded footprint beyond eBay.

In key operating metrics, global active PayPal accounts grew to 63 million for the 12 months through Q2, an increase of 19% year over year. On eBay, PayPal's global TPV grew by 19% year over year. TPV growth was fueled by increases in addressable GMV coupled with a five point increase in the global penetration rate to 57%, as buyers increasingly use PayPal as a safer way to pay online.

Beyond the PayPal platform, PayPal merchant services business posted another phenomenal quarter, recording $7.3 billion of global TPV, representing 57% year over year growth and accounting for 49% of total TPV.

PayPal's Q1 transaction expense rate was 123 basis points and the transaction loss rate was 27 bps. Transaction margin was 61% in the quarter and has been above 60% in each of the last six quarters.

Our merchant services business has had tremendous success in signing up new merchants and increasing its share of checkout. Our share of e-commerce in the U.S. excluding eBay has increased to over 5%, more than doubling in the last few years. We remain focused on the tremendous growth opportunities for PayPal and will continue to strive towards achieving ubiquity for PayPal across the web.

In summary, PayPal notched another great quarter and is one of the key pillars of our company-wide growth strategy.

Now let’s turn to our communications business -- Skype posted total revenue of $136 million in the second quarter, an increase of 51% over last year. Total registered users grew to an impressive $338 million, representing an increase of 54%. Key user metrics drove the growth in revenues, as Skype-to-Skype minutes were up 38% to 14.8 billion, and Skype out minutes increased 42% versus last year to 1.9 billion. Growth in both Skype-to-Skype minutes as well as Skype out minutes accelerated significantly for the second quarter in a row.

Let me touch briefly on incremental operating expense and cash position before I discuss guidance. We recorded $700 million of non-GAAP operating income, up 18% from last year, and non-GAAP net income of $568 million, up 20%. Sales and marketing as a percent of revenue improved by 260 basis points from the year-ago period, due in part to a more efficient online marketing spend and in part through investments in buyer loyalty and retention, some of which get recorded as contra revenue instead of expense through sales and marketing.

Product development came in 40 basis points higher than last year as we continue to make enhancements to the customer experience, while G&A was 20 basis points lower than last year as we gained leverage and decreased PayPal fraud losses by 4 basis points.

We ended the second quarter with more than $3.7 billion in cash and cash equivalents, up slightly from the end of the first quarter. $2.9 billion of our cash sits outside of the U.S.

During the quarter, we repurchased approximately 19 million eBay shares at a cost of $566 million, or $29.68 per share.

So with that, let me turn to guidance -- in the third quarter, we expect to generate net revenues of $2.1 billion to $2.15 billion, and we anticipate non-GAAP EPS in the range of $0.39 to $0.41.

For full year 2008, we now expect revenue to be in the range of $8.8 billion to $9.05 billion, and non-GAAP EPS in the range of $1.72 to $1.77, up from previous guidance of $1.70 to $1.75.

We now anticipate free cash flow for the year to be $2.35 billion to $2.45 billion, up $50 million from prior guidance.

We are raising our full year outlook to reflect our Q2 out-performance and we’re tightening the revenue range. This reflects increasing confidence in our ability to deliver our full-year results.

In summary, we posted strong financial results in the second quarter and the first half of the year. Strong top line growth, even stronger bottom line growth, and significant free cash flow. We’re doing what we said we would do. We remain focused on our initiatives to drive change in our marketplaces business in order to provide the best value and experience for our customers. We feel good about our progress this year and know we still have a lot more work to do. We recognize it will take time for these initiatives to come to fruition, but we’re committed to seeing them through.

The outlook for the rest of the year provides us the flexibility to weather the tough economic climate and make continued investments in our initiatives, which we believe will strengthen our competitiveness in the long run.

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

Question-and-Answer Session


(Operator Instructions) Our first question comes from Jeffrey Lindsay with Sanford Bernstein.

Jeffrey Lindsay - Sanford C. Bernstein

Could I ask, what do you think is the impact of couponing on eBay's total revenues and take rate? And could you give us a sense of the relative magnitude of couponing and seller discounts? My question is about as eBay shifts to larger institutional power sellers, can we expect more discounting?

And then secondly, could you indicate financially how these discounts and couponing are recorded? Are they contra revenues or costs? Thank you.

Robert H. Swan

I will try to take them all. First, we indicated that our marketplaces revenue in the quarter were impacted by three points, and that was a function of three things: a modestly lower take rate from the price changes we made; secondly, higher discounting for the power sellers who continue to improve their overall service levels; and third, coupon as it relates to retaining our buyers as opposed to acquiring new ones. So a combination of those three things impacted marketplace revenue by three points in the quarter. That impacts overall Inc. level revenues by about two points.

In terms of the power seller discounts, we think this is a great program to incent our power sellers to continue to provide a better experience for our buyers, so to the extent that they keep providing great service, we think that will help grow the business; in turn, we’ll reward those power sellers with discounts at the back end.

And lastly in terms of how we account for both couponing and power seller discounts, they -- power seller discounts is in effect a reduction of our take rate and couponing is treated as contra revenues, so they both impact our top line growth rate.

I should say you also will have noticed a dramatic decrease in sales and marketing percent, as a percent of total revenue and that is a function of the trade-off we’re making in terms of we’re using contra revenue couponing for better retention as opposed to more acquisition related sales and marketing expenses. So sales and marketing came down quite a bit during the course of the quarter.


Our next question will come from Doug Anmuth with Lehman Brothers.

Brian Fenske - Lehman Brothers

This is actually Brian Fenske on the line for Doug. A quick question; there had been discussion about rolling out category specific pricing. In the U.S., you’ve rolled out media. Is there any sort of timeline for rolling out more category specific pricing in the U.S.?

And secondly, can you comment a little bit more about the deal you are doing with buy.com and how the economics work there, and I guess how you manage that with other power sellers? Thank you.

John J. Donahoe

Sure, Brian, I’ll take that. First on category based pricing, as you mentioned we did roll out specific media pricing in the first quarter and we’ve communicated that it’s our intention to move in that direction, and most likely in the second half of the year. And the rational is quite simple, that sellers make very different margins in different categories, and so we think over time that our pricing has to reflect that.

With respect to buy.com, the buy.com relationship is one that really symbolizes what we want to do going forward, which is really incent and reward those sellers to provide low prices to buyers and great service, and buy.com has -- they’re in the process of doing that.

I might point out that the movement to incent and reward great prices and great service to buyers is not limited to larger sellers. In fact, we have many small sellers who are achieving very high DSRs and are providing great prices and great service to our buyers, and so I really want to emphasize that we have many small sellers succeeding under these conditions, as well as larger sellers. And so we intend to continue to incent and reward that across sellers large and small.


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

Youssef Squali - Jefferies & Company

Thank you very much. A couple of questions; first, if I look at the GMV growth, both in the U.S. and outside, it was around 4%. That’s kind of the lowest we’ve seen in years. When you kind of work on your guidance, can you provide us or tell us what you baked into your guidance, both in terms of GMV growth and just how we should be thinking about ASPs?

And second, can you speak to any areas of weakness, maybe economy related? I think you spoke to the auto sector. What other areas are you seeing weakness in that may be causing you to maybe be a little more cautious in your Q3 guidance. Thanks.

Robert H. Swan

Youssef, a few things; first, we indicated at the beginning of the year that our primary focus is on increasing velocity on the eBay platform and we do it through a combination of improving selection, improving trust, and improving findings, so when we laid out our plan at the beginning of the year, John talked about those three initiatives and the most important metric for us in the near-term is successful item growth. And that’s a measure of velocity and level of activity on the site.

So in the quarter, we had 11% successful item growth in Q1, 10% successful item growth in Q2, and we felt reasonably good about that. You know, we feel like we are making some decent progress on successful item growth.

That being said, GMV growth was dramatically impacted by lower average selling prices, and I kind of walked through the three different things that were driving lower average selling prices and that’s -- you know, the good news is buyers are getting better deals on eBay, lower selling prices; the bad news is we don’t convert that to higher GMV, but I won’t walk through the changes in selling price again.

So the good, okay successful item growth, decline in average selling prices is what translated to the 4% GMV growth.

The only additional item is vehicles. Our vehicles business grew by 7% in the first quarter of 2008, and that went down to 0% in the second quarter. And that’s primarily a function of two things; one, the economy overall unit growth in the overall secondary market in the quarter was down 6% to 7%. Our business was relatively flat, so clearly we’re impacted by unit volume. Secondly -- as a result the market was down 6% to 7%. We went from 7% growth in Q1 to 0% growth in Q2.

The second thing that’s impacting our vehicles business is just a shift in formats and how that volume gets monetized. Format shift is to more classifieds, more local and that’s why we have our [Mobilay] brand and Kijiji brand and other classified brands around the globe to capitalize on a shift in vehicles, how vehicles get transacted. And the second thing is we monetize differently. We monetize today more through subscriptions and ad-based fees as opposed to GMV based transaction fees.

So vehicles was down considerably Q1 to Q2; part of it was the economy, part of it was different formats that we think we’re well-positioned to win in, and I should just close on vehicles overall and say our revenues for vehicles grew by 11% in the quarter. It obviously doesn’t get reflected in a declining GMV type metric.

John J. Donahoe

So just to clarify, Bob, the GMV -- vehicle GMV growth went from 7 to 0; GMV revenue, or vehicle revenue, went from -- was that 11%?

Robert H. Swan


John J. Donahoe

Which reflects the shifting format.


Our next question will come from Scott Devitt with Stifel Nicolaus.

Scott Devitt - Stifel Nicolaus

Thank you. Two quick questions; the first one, back on the motors question, if you strip out motors against the metric slide that you put out, GMV growth was up 11% and then parts seemed to be weak as well, and I assume that's associated with vehicle sales to a certain extent. If you strip that out, GMV was up 12%. And so my question is just in terms of calculating the FX impact, if you were to look at the business excluding the autos business, is it still a 400 basis point or would there be some differential given the location of the Motor transactions?

And then separately, and if I missed this, I’m sorry, could you give the direct contribution margin for PayPal? Thank you.

Robert H. Swan

Scott, in terms of the FX impact, yes, still 4 points, and secondly, transaction margins for PayPal were about 61% in the quarter, so that's about six quarters in a row where the transaction margins for PayPal have continued to be above 60%.

Scott Devitt - Stifel Nicolaus

I'm sorry, the direct contribution margin for PayPal, that's in the Q?

Robert H. Swan

Yeah -- well, no, the transaction margin is about 61%. The direct contribution margin in the quarter will be approximately 19, so up about a point on a year-over-year basis and down a few points from Q1 as we continue to make investments to accelerate PayPal's growth.

Scott Devitt - Stifel Nicolaus

Okay. Thank you.


Our next question will come from James Mitchell with Goldman Sachs.

James Mitchell - Goldman Sachs

Thank you for taking the question. If I look at the GMV deceleration and disaggregate into a vehicle hit of about 1%, a Korea hit, a fraud hit and an ASP hit, is it safe to assume that the vehicle and ASP weakness, all else equal, ought to continue while Korea and fraud ought to normalize in the next couple of quarters?

Also, is it safe to assume that vehicles in Korea have very low take-rate activities which have less impact on transaction revenue, while the reduction in ASPs would flow through to lower transaction revenue because of lower final value? Thank you.

Robert H. Swan

James, yes, on your second point, less of an impact on revenue. On your bifurcation of GMV deceleration in terms of how you broke it out, lower ASPs, vehicles and Korea, yes, that's the right kind of numeric breakout. In terms of implications going forward, we expect the GMV from vehicles to continue to be relatively weak compared to prior period performance. One, you know, hopefully temporarily due to the economy, but two and more importantly on a long-term basis, just a continued change in format and how we monetize that business. So that will be a constant theme as we go forward.

ASPs, I think there’s a couple of things in ASP that we laid out. One, it is more economy sensitive, and that is we've seen a slowdown -- or not a slowdown, but consumers migrating to lower-priced items within categories and we believe that is more economy sensitive and I think we'll continue to feel the effects of that until the economy rebounds. I think the lower mix is a result of promotional activity, I think that's more a temporary kind of move.

John J. Donahoe

But James, let me just build on what Bob said; this is one of the reasons why I think we're going to be increasingly focused on sold items during 2008, because at the end of the day sold items is the best indication that buyers are coming back and they're buying. We can't manage ASPs and as Bob said, if in a tougher economy people are trading down, they're finding better values at cheaper prices, that's not a bad thing in the long-term. And sold items is the indication that buyers are coming back, they’re increasing their frequency, and over time that will translate into good GMV and revenue and through ASP. So we internally are very much focused on the buyer retention metrics of buyer retention and sold items as the key variables.


Our next question will come from David Joseph with Morgan Stanley.

David Joseph - Morgan Stanley

Thanks for taking my question. The first question is really just related to take rate. You might have touched on this before but I haven't heard the full answer; 9.3% versus about 8.1% in Q1, I know a lot of that has to do with the lower ASP and the vehicles softness but it seems like it might be unsustainable going forward and I'm wondering if you might give us a little bit of a feel for that.

Secondly, higher level, we're trying to make a -- really kind of understand what's going on with the business and really, we're not sure how to take the quarter. Looking at 13% organic growth for transaction revenue, 4% GMV growth, you're seeing relatively decent strength in PayPal and Skype, but it's not enough to offset the weakness in the core marketplace. And when we look at those trends in the core marketplace, it doesn't really give us a feeling that they are necessarily going to improve anytime soon and you really need to give us a better feel for that because at your shareholder meeting, you suggested that your shares might be undervalued. But if we're thinking that these trends should be forecasted out over the next couple of years and that we really shouldn't expect an acceleration in 2009, I'm not sure how your shares are undervalued at current levels. If you could help us understand that, that would be great. Thank you.

John J. Donahoe

Maybe, Bob, you take the first and I'll take the second?

Robert H. Swan

Yeah, first, David, on take rate overall, our take rate in the quarter was just under 7.9%, which is roughly in line with Q1 and modestly higher than Q2 of last year; so no dramatic change, but several dynamics going on. First, the things that are negatively impacting our take rate I highlighted -- more couponing, less sales and marketing is negatively impacting our take rate. Secondly, the modest reduction in take rate as a result of our pricing efforts is impacting us, and third, the improved trust on the site as power sellers earn higher and higher discounts negatively impact take rate.

So those three things work against us and frankly, those are conscious decisions we made that we think are good for the health and vibrancy of the marketplace. The things that are offsetting that that are actually increasing take rate are primarily mix. StubHub had another great quarter and as you know, the take rate on StubHub is pretty high, so with a high growth, high take rate business, that positively impacts the overall take rate. And vehicles at the other end is a low take rate, slowing growth business and that increases the take rate overall.

So there’s puts and takes on the overall take rate. It was essentially flat quarter on quarter and year on year, and our expectations on a go-forward basis are that we will likely drive loyalty with more couponing and continue to lower sales and marketing. We will likely make category-based price changes along the way, which are less up-front fees and more back-end, and we hope that our power seller discounts continue to increase service levels, which in turn we think will drive a more vibrant marketplace. So that’s some of the dynamics on just take rate overall in the quarter.

John J. Donahoe

David, why don’t I take your second question on the changes to the marketplace -- as I said earlier, we are about where we expected to be at this stage. In January, we said that we were going to focus on this year in making the aggressive changes to make the eBay business more competitive and in the first quarter, we announced the first series of those changes that in essence went into effect roughly March 1st. And if you sort of look at the variables we’re looking at on selection, the movement in pricing drove selection relatively quickly with new listings up. And then perhaps more importantly, on many of the trust and safety changes we're making, and best match changes to make eBay easier and safer to use, some of the early metrics where we'd expect to see those show up, such as buyer retention, the ratings buyers are giving sellers on DSRs, bad buyer experience is down -- that's a measure we track, that's down 15%; shipping costs are down roughly 8% to 10%; net promoter score, which is a buyer metric we track internally, is up. And so the first place we expect to see that show up is in sold items or successful items, and as I said earlier, we see some improvement there.

We're going to continue to make changes in the second-half of the year and we think those changes will continue to drive that sold item count up and it's one we're going to stay very focused on. As we said earlier, the ASP equation is not something we can manage but it's something that will play its way out, but we're confident that with buyers coming back and increasing their frequency, over time GMV and revenue will go up as well.

So halfway into the year, we've increased guidance $300 million and $0.10 of EPS. We're going to focus on the second-half of the year on continuing to make changes and we're continuing our second-half guidance to give ourselves the latitude to take these actions and bear the short-term risks and also absorb any uncertainty in the economy.

But we feel like we're on the right path and we're going to stay with it.

Robert H. Swan

John, if I could; David, I’d like to just emphasize a point that John made as well -- when he talks about increasing velocity on the site and the significance of increasing velocity, that's because we will monetize that traffic in new ways, in different ways on a go-forward basis. So when you look at just transaction revenue growth of 9% in the quarter, that's a function of velocity on the site. But the other things, PayPal's on-eBay revenue growth was up 19% year over year. That's because of increased velocity and increased penetration on transactions on the site. Advertising was up 183% year over year; that is a function of increased velocity and people coming back to the site.

So as we focus on improving velocity, we know we're going to monetize that in different ways over time, not just through insertion fees and final value fees, but also through progress we make on penetration and our ability to monetize in new and different ways on an advertising basis.


Our next question will come from Christa Quarles with Thomas Weisel Partners.

Christa Quarles - Thomas Weisel Partners

One question on the marketing side; it seems as if, given the fact that if I go to the page, for example, the only monetization that's happening above the fold is an ad from Yahoo!, and I was just curious if that's indicative of its ability to better monetize relative to what you think your listings can monetize, and/or if you think that ultimately improves the buyer experience? Thanks.

John J. Donahoe

Christa, yes, the bottom line is we think our listings, especially as we improve search, are the best way to monetize that above-the-fold real estate. So we do have the graphical display ad from Yahoo! at the top of the page but listings are still monetized most effectively and are consistent with the real core focus on the transaction marketplace.

We're finding where the text ads really monetize best are on null search results, where in those rare cases we don't have inventory, or on complementary items that are made to fold down at the bottom, and so overall both text ads and graphical advertising, as Bob said, is growing. We continually test that to make sure what placements optimize our advertising but by and large, above-the-fold listings monetize better.

Christa Quarles - Thomas Weisel Partners

So you think that you can continue to see high double-digit growth, even in this environment, given what's going on in the display marketplace?

John J. Donahoe

I think we look at advertising overall and we continue to be optimistic that advertising is a nice complementary way to monetize our traffic.


Our last question will come from Brian Pitz with Banc of America.

Brian Pitz - Banc of America

Thank you. Two quick questions; would you talk about any noticeable benefit you realized from tax rebates stimulus checks in the quarter? And then separately, can you give us any color on the traction regarding PayPal's 1.5% cash-back promotion? Thanks.

Robert H. Swan

First on the tax rebate in the quarter, we saw in the U.S. some -- we indicated successful item growth quarter over quarter, so we feel good about that. It is hard to isolate, given the changes that we are making, down to whether the tax rebate check really had a discernible impact on that or not, but I would say probably not.

Secondly, I didn’t break down the -- yeah, I think on the PayPal promotion, too early to say. We just launched it a little bit ago and we think it’s a unique way to leverage the inherent synergies between PayPal and eBay but I’d say a little too early to say at this stage.

Brian Pitz - Banc of America

Thank you.

Mark Rowen

Thank you, everyone, for joining us and we’ll see you on the next call.


That does conclude today’s conference. We thank you for your participation. Have a great day.

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