eBay Inc (EBAY) 2005 Q2 法說會逐字稿

Good day everyone, and welcome to eBay's second quarter 2005 earnings results conference call.

This call is being recorded.

With us today from the Company is the President and Chief Executive Officer, Meg Whitman and the Chief Financial Officer, Mr. Rajiv Dutta.

At this time I would like to turn the call over to Mr. Matt Gustke.

Please go ahead, sir.

Good afternoon.

Thank you, and welcome to eBay's earnings release conference call for the 2005 second quarter.

Joining me are Meg Whitman, our President and CEO and Rajiv Dutta, 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 nonGAAP measures in talking about our Company's performance.

You can find the reconciliation of those measures to GAAP measures in the tables of our earnings release.

In addition management may make forward-looking statements regarding matters that involve risk and uncertainties, including those relating to the Company's ability to grow its business, user base and user activity.

Our actual financial results could differ materially from those discussed during this conference call.

Factors that could cause or contribute to such differences include, but are not limited to, the Company's need to manage an increasingly large Company with a broad range of businesses of varying degrees of maturity, the Company's need to increasingly achieve growth from its existing users as well as from new users in its more established markets, the Company's ability to deal with the increasingly competitive eCommerce environment including competition for its sellers from other trading sites and other means of selling and competitions for its buyers from other merchants, online and offline, fluctuations in foreign exchange rates, the litigation, regulatory, credit card association and other risks specific to PayPal as it continues to expand geographically, the Company's need to manage other regulatory tax and litigation risks even as its product offerings expand and its services are offered in more jurisdictions, the Company's ability to upgrade and develop its systems infrastructure and customer service capabilities to accommodate growth at a reasonable cost, the Company's ability to maintain site stability and performance on all of its sites while adding new products and features in a timely fashion, the Company's ability to profitably expand its model to new types of merchandise and sellers, and the Company's ability to profitably integrate and manage recent and future acquisitions and other transactions.

More information about factors that could affect our operating results is included under the caption "risk factors that may fact results of operations and financial conditions" and "management's discussion and analysis of financial condition and results of operations" in our annual report on form 10-K and quarterly reports on form 10-Q, copies of which may be obtained by visiting the investor relations section of our website.

Now, over to Meg.

Thank you, Matt, and welcome, everyone to today's conference call.

The Company delivered excellent results in Q2.

We saw strong growth across every part of the business around the world.

Clearly, eBay has strong momentum going into the second half of the year.

Let me now spotlight the key achievements of the quarter.

First, our two largest marketplaces, the U.S. and Germany, delivered accelerating year over year GMV in Q2.

It's clear that in Q2 eBay became an even more efficient platform for our buyers and sellers.

Second, PayPal delivered accelerating total payment volume and revenues, reflecting an ever expanding mix of customers on and off eBay and around the world.

As a result, total net revenues for Q2 totaled a record 1.1 billion, a jump of 40% year-over-year, an accelerating growth rate from Q1 and pro forma net operating income grew 47% year-over-year with a pro forma operating margin of 37%.

And just as notable, eBay has become a larger part of the entrepreneurial dream.

According to a survey we just completed, there are now more than 724,000 professional sellers in the U.S. for whom selling on eBay is a primary or secondary source of income.

And, another 1.5 million individuals sell on the site to supplement their incomes.

These are remarkable results, but taking a broader view of the business, they are not entirely surprising. eBay and PayPal are incredibly responsive platforms, adapting to near term challenges while building towards long-term success.

They are also very young businesses, with enormous potential for growth and many great achievements ahead of them. eBay's leadership team is managing both businesses to realize their fullest long-term potential.

Now I'd like to go into a bit more detail about how the strategy we discussed at our analyst day conference translated into this kind of growth.

For much of this year we have focus on increasing the value of the marketplace for our users.

We've done this by investing in high return initiatives and product innovation, and most importantly we've intensified our efforts to connect with our community of users, who are at the heart of our success.

The U.S. team in particular has devoted lot of time to reaching out to the community, listening to what our buyers and sellers have to say and translating their needs into improvements for the marketplace.

In Q2 we increased the scope of our community programs to include online town hall meetings, in-person events and open houses, where our members can engage in open conversations with eBay management about topics that affect the marketplace.

All of this activity set the stage for eBay live, which has become the most important touchstone in our ongoing dialogue with the community.

We just celebrated our fourth annual eBay Live three weeks ago in San Jose, California.

It was our biggest and best yet, with more than 11,000 participant coming together from more than 60 countries.

We're gratified by the response of the community to our efforts.

Our Q2 results clearly demonstrate that they continue to see great value in trading on eBay.

Ongoing communication with our community is just the beginning.

The input we received from them leads to innovation in the marketplace, with the end goal of meeting their needs and improving trading on the site.

For example, creating new formats for trade brings new opportunities for our buyers and sellers.

As part of our efforts to meet specific needs voiced by our community, we launched two new formats in the past six months that are proving to be very popular.

Want It Now allows eBay members to post requests about items they are looking to buy.

Best Offer allows buyers and sellers to haggle on fixed price listings, which can be especially useful for higher priced items.

In just a few months, these formats are boosting completed transactions and positively impacting conversion rates. eBay Stores is another example of format innovation that's proven to be very popular as well.

In fact, eBay now hosts 299,000 stores worldwide, the single largest collection of online stores on the net.

Now, as you know, in January, many sellers in the U.S. were concerned about our decision to raise some store-related fees.

We engaged with our sellers and sought ways to provide even more value for store subscriptions.

And, those efforts were very successful.

We exited Q2 with more than 173,000 stores in the U.S., a 12% increase from when the new fees went into effect in mid February.

Even more important, store subscribers are telling us that they have been experiencing strong sales in the past few months and they plan to stick with their eBay stores.

At eBay Live we announced another format which we believe will further help our large sellers.

Pro Stores is a new type of online store for sellers off the eBay platform.

We recognize that many eBay sellers want to maximize their businesses by selling through different channels.

In fact for some sellers, eBay is already their second or third sales channel.

Pro Stores is the perfect answer for these sellers; it was developed from the technology of Current, which we acquired in January, and whose store front software is among the best in the industry.

Pro Stores is offered at four levels to serve everyone from the beginner to the enterprise level merchant and best of all it, allows seamless integration with eBay stores, as well as with PayPal, providing supreme flexibility in running a business online.

We're already seeing strong interest in Pro Stores from eBay sellers, as well as for merchants off eBay.

We believe that our focus on innovation, which extends into all areas such as marketing, customer support and trust and safety is demonstrably increasing the value of the marketplace for our community.

Our technology team innovates ahead of the curve, creating sophisticated solutions to meet the needs of our users.

For instance, you may not think of eBay as a search engine, but of course helping buyers find the item they want is a critical function of our platform, and our efforts here have already led to surprising results in the U.S.

The number of searches performed on eBay actually puts us on par with Google, and our searches are all about shopping, buyers looking for items to bid on.

You have just heard about some of the ways we're growing our business in the U.S.

Similar efforts have been going on in our international business, which now accounts for 52% of our users and 51% of our GMV worldwide.

One particular focus in Q2 was eBay Germany.

Last quarter we told you that we were seeing slower growth in Germany than we would like.

The team there concentrated on high return efforts such as online marketing, natural search optimization and category promotions to further build along our unparalleled in position German eCommerce.

As a result, eBay Germany accelerated GMV growth quarter over quarter.

We have more plans for the German market, but clearly the team is beginning to change the trajectory of the business there.

Our other international markets also continued to thrive in Q2. eBay UK reported year-over-year GMV growth of 94%, while France, Italy and Australia all experienced triple-digit GMV market year-over-year.

Our younger markets also grew nicely. eBay Spain, for example, achieved a new milestone, now reporting more than a million registered users in that market.

And our efforts in China are paying off. eBay EachNet added 1.6 million new users in Q2, bringing the total to 13.2 million, the largest online trading community in China.

More important, the conversion rate is up making eBay by far and away the best marketplace in China for people selling online.

We are building a strong and vibrant marketplace in China.

A marketplace that has all the features and functions that make trade reliable and a marketplace our buyers and sellers can depend on.

PayPal also had an excellent quarter, delivering strong growth across the board.

Increasing trade on eBay as well as growth in eCommerce overall boosted PayPal's business in Q2.

As a result, PayPal delivered net revenues of 244 million, a remarkable 51% higher than the year ago quarter.

Like at eBay, the PayPal technology team continues to create innovative solutions for our users.

Last month we launched Website Payments Pro, a product suite for small and medium size businesses off the eBay platform.

Merchants now have more flexibility in integrating PayPal and more control over the buyer checkout process.

For example, they can offer their shoppers greater choice in how they pay for items, and the payment process is more streamlined.

And Website Payments Pro can be integrated into Pro Stores.

This is an important step for PayPal's merchant services business and an early reception from merchants has been positive.

We believe it will make PayPal even more appealing to a wider array of businesses selling on the net.

PayPal also continues its international expansion with last week's launch of PayPal China, designed for use with any Chinese eCommerce site, PayPal China offers payments in the local currency and integration with 15 local banks and more than 20 different debit cards, and PayPal China also offers buyer protection off eBay, such as with the popular internet portals, Net Ease and Time Online.

China's eCommerce landscape presents a great opportunity for PayPal and we're excited about the possibilities for growth there and on the eBay platform.

With these two milestones in Q2, we have expanded the future opportunities for PayPal around the world and the untapped potential that remains is enormous.

Step by step, we are becoming the online wallet for an entire generation of internet shoppers.

This quarter's achievements clearly illustrate the Company's ongoing management philosophy.

We not only delivered outstanding results in Q2, we also made key investments in our future. eBay's business in China and the launches of Pro Stores and PayPal China are all [nation's] opportunities that show enormous potential for the future.

Along with rent.com and our international classifieds business, Kijiji, these initiatives demonstrate our ongoing commitment to plant seeds for today for the success of tomorrow.

Last month, we announced another investment for the future: our pending acquisition of shopping.com, a leader in online comparison shopping and consumer reviews.

Similar to eBay and PayPal, shopping.com is committed to bringing together online buyers and sellers everywhere.

As a result, we believe the combination of shopping.com and eBay will provide more opportunities for buyers and sellers on both websites.

The acquisition will give eBay seller as new sales channel and access to a new set of buyers, especially around in-season products.

On shopping.com, the shopping experience will be enhanced by the addition of eBay listings to the product selection already available and merchants will get traffic and leads from eBay.

Finally, there's no question that the consumer generated reviews on Epinion fit in well with eBay's own community-driven model.

The deal is expected to close by the end of Q3, and we're excited about the possibilities this acquisition will bring.

Together we believe we can create the premier online shopping experience for individuals and businesses of all sizes.

Now, we've accomplished a great deal in the first half of this year and we're poised to achieve even more in the near future.

Through the ongoing partnership for our community of users and our employees around the world, we are finding new ways to grow our current businesses and expand into new ones.

Our Q2 results underscore the power of our community of users and the potential of what we can do together.

Our success also cements our belief that eBay and PayPal are the best eCommerce franchises in the world.

We are building these businesses to last, which means evolving to meet the ever-changing needs of our users and that requires a long-term outlook grounded in positive near-term results.

As the internet evolves, we're not only building our business; we're shaping the future of eCommerce and that future holds greater opportunities for success, both for our community of buyers and sellers and for our Company.

And that's why I so firmly believe that eBay's next ten years will be even more exciting than our first ten.

Now I'll turn it over to Rajiv for a closer look at the financials.

Thanks, Meg.

Q2 was an outstanding quarter for eBay on a number of dimensions.

First, eBay's Q2 revenue exceeded the top end of our guidance by $36 million on an actual reported basis and $45 million on an FX neutral basis.

This revenue performance was driven by accelerating year-over-year GMV growth and accelerating year-over-year total payment volume growth.

Second, pro forma operating profits were about $67 million higher than we had expected, driven by strong revenues, combined with operational efficiencies, including improvements in PayPal's cost structure.

This resulted in pro forma EPS of $0.22 cents, or $0.04 cents higher than our guidance and record operating and free cash flows of $497 million and $406 million.

And while our total expenses were lower than expected in Q2, we intend to follow through on all of the strategic investments we laid out for you a couple of quarters ago.

And finally, our core business momentum is strong.

Even considering the stronger dollar, we are raising both revenue and profit guidance for 2005.

So let's discuss each of these in a bit more detail, starting with the top line.

EBay added more than 10 million confirmed registered users during the quarter, which brings eBay's totaled registered users to more than 157 million worldwide.

In addition, PayPal added 7.3 million new accounts, bringing their total to nearly 79 million worldwide.

Active eBay users grew more than 34% year-over-year to a record 64.6 million and these eBay users listed a record 440 million listings, representing 32% year-over-year growth consistent with a 32% year-over-year listings growth achieved in Q1.

Q2 total listings included 402 million from the auction and fixed price formats and 38 million from stores inventory format listing, 29 million of which were in the U.S.

This listings growth translated into even faster eBay GMV growth of 36% year-over-year to $10.9 billion, up from 32% year-over-year growth achieved in Q1.

In addition to strong listings growth, year-over-year GMV growth benefited from strong ASB increases.

Even excluding the GMV contribution from motors, GMV growth accelerated on a year-over-year basis, and once again this growth was broad based reflecting accelerating performance in the U.S. and Germany and continuing strong performance in other markets.

Overall, GMV per active user increased $4.00 quarter over quarter to $570, reflecting increases in all of our largest markets including Germany.

At PayPal, strong account growth combined with stronger than expected addressable GMV and continuing penetration gains in key markets led to a record total payment volume of $6.5 billion, up 49% year-over-year, representing accelerating growth versus the 44% reported in Q1.

Collectively, these trends followed consolidated net revenue for eBay of $1.86 billion, up 40% year over year and as Q1 [inaudible] this growth represented an accelerations from Q1 growth rates.

Now in addition to organic eBay trends, the acquisitions we've made within the past 12 months, which include rent.com, market plots and Current, though in their early stages of buildout, are performing very well.

Rent.com in particular delivered a strong Q2, benefiting from strong traffic and apartment listings growth.

Even excluding revenues from these acquisitions, the Company's organic year-over-year revenue growth in Q2 was 38% compared with a 33% organic growth in Q1.

And further, excluding acquisitions and the impact of foreign currency translation, year-over-year growth on an organic FX neutral basis was 35% and acceleration from 30% in Q1.

Taking a close look at the business units, in the U.S., Q2 results reflect another strong quarter as well as significant progress against the objectives we laid out last quarter.

Last quarter we had told you that we were optimistic about the opportunities in the U.S. and that our strategy is to maximize the efficiency of our marketing investments, drive significant levels of product innovation, and intensify our efforts to connect with the community.

We did exactly that, and the early results are positive.

In terms of marketing efficiency, we continue to benefit from the fact that the majority of eBay users arrive directly on eBay.

In addition, natural search continues to grow as a source of traffic.

We also continued to further optimize state search and selectively use off line marketing in high return areas.

Marketing program spend as a percent of revenue in the U.S. was 19.4% in Q2, compared with 18.5% in Q1.

Now, 1% of that relates to eBay live, demonstrating a significant improvement in our marketing effectiveness.

Overall, Q2 was a very good quarter in the U.S. U.S.

GMV growth was 22% year-over-year, up from the 17% we reported in Q1.

Reflected in this growth rate are accelerating year-over-year listings growth, strong ASP increases and robust conversion rates.

Particular category standouts in Q2 included clothing, shoes and accessories, home and garden, health and beauty, technology and business and industrial, all of which accelerated on a year-over-year basis.

Also, both the motor vehicles and the parts categories saw strong growth in the seasonally strong Q2.

This GMV growth powered U.S. revenue growth of 27% year-over-year in Q2, which was up from the Q1 rate of 20%.

In our international business, we continued to see impressive rates of growth.

In Europe, eBay's business delivered GMV growth of 47% year-over-year.

Last quarter we had mentioned our focus on Germany, to build that business to its full potential; while there is still work to do, results are encouraging.

Year-over-year revenue growth in Germany was 21%, including mobile [duct DE] which for the first time as a year-over-year comparison.

Excluding mobile and currency impacts, organic revenue growth in Germany accelerated on a year-over-year basis driven by ongoing improvements in internet marketing and natural search, strong motors growth, significant improvements in how users view the safety of the site, as well as strong PR.

Elsewhere in Europe, the story is one of continuing stellar growth.

The UK continues to grow at very strong rates and in the process, reached an important milestone.

The UK achieved its first ever 100 million revenue quarter in Q2.

In France and Italy, strong triple-digit GMV growth continues with 154% and 192% year-over-year growth respectively.

France and Italy combined represent an eCommerce opportunity the size of Germany and they have become significant growth drivers for eBay.

In fact in, Q2 the two markets together produced more year-over-year GMV growth than Korea.

Turning to Asia, internet auction company of Korea once again produced strong results, turning in 78% year-over-year transaction revenue growth.

In China, we are pleased with our progress to date across key metrics, users, GMV and conversion rates, as we successfully navigate a very rapidly evolving market.

In India, the recent migration to the eBay platform has gone very well.

Our business there with more than 1.7 million users is off to a great start.

In total, eBay International added 7 million new CRUs to bring the cumulative base to nearly 82 million.

These users generate a GMV growth of 53% year-over-year, which in turn drove record revenues of $419 million, up 51% over the Q2 of last year.

And in our payments business, Q2 was a spectacular quarter on all fronts.

Better than expected addressable GMV, combined with strong penetration gains in North America and Europe led to record eBay generated total payment volume.

Penetration rates reached 76% in the U.S., 78% in Canada, and 65% in the UK, and in France, Italy, Australia and Spain, we are also seeing increasing PayPal penetration together with rapidly increasing and in some cases accelerating GMV.

There is no doubt that PayPal is a major driver of GMV growth in these eBay markets and as Meg mentioned, just last week we announced that PayPal is now available in China.

As a result, total payment volume on eBay transactions grew 51% year-over-year to $4.5 billion, up from the 47% reported in Q1.

PayPal's global merchant services business also had a very good quarter, generating more than $1.9 billion in total payment volume, up 45% year-over-year, reflecting an acceleration from the Q1 growth rate.

Much of this growth came before the launch of Website Payments Pro in mid June.

Now, let's take a look at how these record revenues translated to profits and cash flows.

Revenues that were $36 million about the high end of our guidance, combined with cost improvements in our payments business, carefully managed sales and marketing expense, and a slower than planned ramp of certain investments led to a $67 million outperformance in the pro forma operating income line versus our guidance.

Taking a walk down the pro forma P&L: eBay's gross margins were 83.2% in Q2, up from 81.9% in Q1, due mainly to higher gross margins at PayPal where we continue to benefit from cost reduction initiatives in payment processing and favorable funding mix trends.

We expect PayPal's gross margin will decrease in Q3, due primarily to increased investments in customer support.

Sales and marketing expense totaled $287 million in Q2 or 26% of net revenues.

This was consistent with the 26% reported in Q1, despite our outplay for eBay Live, continuing price increases in internet marketing and ramping investments in many of our developing markets.

Product development spending in Q2 represented 6.7% of revenues, down from 7.1% of revenues in Q1 and 7.7% of revenues in Q2 of last year.

The decrease as a percent of revenues reflects operating efficiencies, resulting from a transition from contractors to full-time employees, as well as a slower than planned ramp of investments.

General and administrative expenses in Q2 represented 11.8% of revenues, down from 12.9% in Q1 and 13.2% in Q2 of last year.

The decrease of the percent of revenues was driven by overall cost efficiencies, as well as significant cost savings in our payments business, where benefits from PayPal's new fraud models have more than offset the costs associated with our expanded purchase protection programs.

We expect G&A costs will increase as a percent of revenue over the near-term due largely to higher seasonal loss rates at PayPal as well as increasing purchase protection expenses at both eBay and PayPal.

As a result, pro forma operating income grew 47% year-over-year to a record $406 million, representing a pro forma operating margin of 37%.

Consolidated pro forma net income in Q2 totaled $307 million or $0.22 cents per diluted share, a full $0.04 cents above our guidance.

And consolidated GAAP net income totaled $292 million, or $0.21 cents per diluted share.

Operating cash flows in Q1 were $497 million, representing an all time record, and including cash -- capital expenditures of $90 million, free cash flows of 406 million were also an all-time record.

In sum, Q2 was an outstanding quarter for eBay.

We are very excited about the emerging opportunities we see in categories, such as real estate and motors and in new business, such as shopping comparison and classified.

As a result, we remain confident in our strategy to invest in this expanding portfolio of growth opportunities and remain focused on creating significant long-term shareholder value.

With that, let's turn to our guidance.

As you will recall, our original guidance for 2005, first provided in October of last year, called for net revenues of $4.2 billion, a pro forma operating margin of 35% and pro forma EPS of $0.75 cents.

Clearly, our actual results over the first half of the year have been considerably stronger.

This outperformance reflects higher than expected revenues across the business, significant cost efficiencies, and a slower than planned ramp of investments.

At the highest level, we expect the strong revenue performance in cost savings will carry forward and we intend to follow through on our investment plans.

As a result, we now expect full year 2005 net revenues to range between 4.34 and $4.41 billion, representing an increase of 140 million to $210 million versus our original guidance in October of last year, and $60 million higher than our most recent guidance provided last quarter.

In addition, we now expect full year pro forma EPS could be as high as $0.82 to $0.83 cents, $0.07 to $0.08 cents higher than our original guidance provided in October of last year, and $0.05 to $0.06 cents higher than our most recent guidance.

And on a GAAP basis, GAAP EPS could be as high as $0.77 to $0.78 cents.

We continue to believe that a 35% pro forma operating margin is appropriate, although this will now be delivered against a higher revenue base and thus generate higher profits.

With respect to Q3, we continue to expect a strong quarter, updated for a higher Q2 baseline.

Notwithstanding a stronger dollar and expected seasonality, net revenues in Q3 could be as high as 1.45 billion to $1.70 billion, or $10 million higher than our most recent guidance.

It is important to note that because the U.S. dollar has strengthened to approximately $1.20 per Euro, our revenue guidance is effectively reduced by about $25 million.

Put another way, if FX rates had remained unchanged, we would be raising our [inaudible] guidance by about $35 million.

Also, when making Q3 growth comparisons, please keep in mind that we will be lapping last year's comp where we experienced significantly above trend results in certain key markets, especially in Europe.

Also, please note that our Q3 guidance does not assume any contributions from the shopping.com acquisition, which we expect will close in Q3.

And on the bottom line, we now expect consolidated pro forma EPS in Q3 will be $0.19 cents compared to the $0.18 to $0.19 cent range provided most recently.

On a GAAP basis, we now expect consolidated GAAP diluted EPS to be as high as $0.18 cents.

Within this EPS guidance are several important investments, including product innovation on eBay sites around the world, buyer protection programs, [nacent] eBay markets, such as China and in India, PayPal international, especially in China and Germany, PayPal merchant services and both eBay and PayPal customer support.

As we've said in the past, these investments are not linear over the calendar quarters.

That said, we've remained committed to following through on these investments in whichever quarter they are recognized.

In summary, I am very pleased with Q2, which was marked by accelerating GMV, TPV and revenue growth and strong performance across all of our key business.

We will continue to make investments consistent with our strategy of enabling anyone, anywhere to buy or sell practically anything online.

And with the fabulous business model as our foundation, we believe we can realize this vision while providing significantly higher bottom line returns than we once thought possible.

Now we would be pleased to answer your questions.

Operator?

Thank you, sir. [Operator Instructions] We'll take our first question from Mark Rowan from Prudential.

Thanks.

Couple of questions.

First, Rajiv, if I look at transaction revenue per listing and gross merchandise volume per listing, both of them are up sequentially, particularly the transaction revenue per listing.

I was wondering if you could give us some detail about what's causing that to go up.

I have it up a little over 3%.

And then second, Meg, if you could talk about the PayPal opportunities off of eBay; the percentage of your payment volume that's come off of eBay has remained relatively constant, and I was wondering if you expect that to grow over the rest of the year.

Thanks.

Mark on, your first question, on transaction revenue for listing and GMV for listing, almost all of this growth has really been volume-driven overall, and in particular, when you look at transaction revenue per listing, this is really about stronger ASPs, that is the single largest contributor to the revenue per listing and the GMV per listings that you have seen, and that actually ties in with the statement that we made about eBay really becoming a stronger and more efficient platform in the quarter as we sort of saw these trends.

You do recall that we had some pricing changes that we had made in Q1.

These are sort of relatively small and targeted on a number of different areas.

Cumulatively, all put together, pricing actually did not have a material impact on revenue growth rates.

I think all put together, it must have been just about 2% in terms of its contribution to revenue growth rates.

So this is largely a volume story and in turn, a story that's actually a function of listings accelerations, ASP increases and very strong conversion rates.

With regard to PayPal, Mark, remember, the first year after acquisition was all about focusing on eBay.com.

Then 2004 was focusing on integration on eBay International, and really 2005 is the first year of real focus against product development and investment against the off-eBay opportunity.

So you're seeing eBay -- or PayPal on eBay still continuing to grow very rapidly because we're reaping the results of the investments that we did two years ago and one year ago.

I think as we go forward, we continue to see off-eBay opportunities as a very big opportunity for PayPal.

You might recall from our analyst day the size of the market is, you know, ten times as big, if not more, than the on-eBay opportunity and we should start to see the results of the investments next year that we're making this year.

So I would expect -- it's hard to know how fast eBay --- PayPal and eBay will continue to grow, but I think you may see that continue to be an increasingly important part of PayPal's revenues.

Great.

Thanks.

Next question?

Our next question comes from Scott Devitt.

A great quarter.

Had just two questions.

Beyond ASPs, there also seems like domestic conversions seemed to be up fairly considerably in the quarter.

I wonder first if that assumption is accurate and if so, what drove the impact.

Then related to that, could you comment on the progression of Magellan and finally separately, if you could just touch on some of the intellectual property constraints you're facing in China from a listing standpoint versus your competitor.

Thanks.

Sure, Scott.

Thanks for the compliment, and let me first talk about the domestic conversion rates.

Actually when you take the U.S. listing and you sort of start peeling the onion on that, there are sort of two components to it.

One is the regular listings and then there is the stores inventory format listings, and we have seen some very strong growth in the stores inventory format listings and those tend to be, generally speaking, at a lower conversion rate relative to the rest of eBay, but even when you adjust for that in fact the conversion rates were very robust in the quarter.

And in fact, the other thing that's kind of notable is that typically when you see an increase in average selling prices, you would expect to see a proportionate decrease in conversion rates, because as you understand there is a correlation between the higher the selling price typically the lower the conversion rate; and in fact those conversion rates are very robust as pointed out in Q2.

Let me take the Magellan question.

For those of you who are on the phone who don't know what Magellan is, Magellan is our next generation search capability on eBay, which is in beta right now and will be rolled out over the next couple of months.

It is an evolution in the fact that finding is incredibly important on eBay.

The more effective we can make finding, the higher the conversion rates, the more robust marketplace it is for buyers and sellers, so we're excited about Magellan.

We think it will make finding on eBay even better because what Magellan does is actually characterize free text listings in a much more robust way than we've been able to do it thus far.

So we're excited about it and we'll know more about it the end of this year, beginning of next on how much impact it has on the marketplace.

With regard to IP constraints in China, we have been very thoughtful about making sure that we run a clean and well-lit business in China, just as we do in every other market of the world, and we want to make sure that to the extent possible, we control all, you know, all manner of IP violations and it has been more challenging in China than has been in other markets, but we think we know how to do it.

I can't speak for our competitors, but we have to follow the IP laws and this is the absolute right thing to do for eBay in China and in eBay around the rest of the world.

Great.

Thanks a lot.

Thanks.

Next question.

Our next question comes from Jeetil Patel from Deutsche Bank.

Great.

Thank you.

Couple of questions.

You alluded to earlier Best offer and Want It Now becoming important formats that's boosting completed auction conversion rates.

Can you talk about specifically which categories or where you're seeing pretty good interest for those types of formats?

Second question: listings growth has been pretty good at 25 to 27% on a core or organic basis, excluding the new stores listings.

Can you talk about -- is that going to be the kind of run rate we should expect going forward, and then the store side will catch up from a conversion standpoint as you progress with shopping and other initiatives?

Let me take a stab at those metrics and then have Meg provide any background context as well.

Sure.

On Want It Now and Best offer, actually the returns that we've been seeing, and it's very vibrant, lots of postings, actually pretty broad based.

It isn't specific to any categories, and I would sort of classify the impact of these sort of new formats as sort of their early days.

These are -- what we like about them is these are biodriven formats and naturally has a strong, you know [inaudible] to what we try to do for the community, but I don't think it has actually had a material impact to the overall revenues and certainly the ASPs and conversions that we've seen in the quarter.

The categories that actually have really been very strong in the quarter is everything from apparel to home and garden, business and industrial, and in the stores inventory format, we've seen some very good growth in the books, movies and music category as well as computers and consumer electronics.

So, you know, the growth across these categories has actually been very broad-based and that's one of the things that's very promising.

With regards to listings growth, your question was: do we expect to see the same sort of rate of growth over the next couple of quarters?

Well, typically we do see a slowdown in Q3, so this is -- whether it's in Europe or in the U.S., there is typically a slowdown on activity.

Now, what we had seen was even as we were entering into Q3 towards the tail end of June, things kind of slowed down, seemed to have picked up again in the early part of July, but it has actually -- there is variability, I would say, week to week, generally speaking I would say that we would expect to see some seasonality in the third quarter and when you are thinking about year-over-year growth rates, very important to remember the comp, which is what happened in Q3 of last year, which, as you know, was a particularly strong quarter for us.

So keep that in mind.

One of the things I urge people to look at is not just year-over-year, but also year over two years growth rates as you are talking about what are the trends in the business.

Let me just add one thing on the Best Offer and Want It Now.

The fun thing about Want It Now is it virtually has 100% conversion rates, because our sellers are incredibly entrepreneurial and they see that a buyer wants to buy a product.

They will actually go out and find a product that meets that specification.

So that's an incredibly robust thing for our sellers.

And Best Offer works, as Rajiv said really well in high priced categories, particularly in motors, high end consumer electronics; things that people are used to bargaining for or know that there's some price flexibility, so that's where we're seeing takeup in those categories.

Great.

Next question?

We go next to Anthony Noto from Goldman Sachs.

Thank you.

Historically many of your price increases have been driven to improve through to try improve the vibrancy of the marketplace and it was our understanding that the price increase for stores, some of which was aimed at trying to get some of the listings that were in stores that were inappropriate for that back into the core auction, and that would result in better velocity, better conversion rate and ASP.

I wondered if you were starting to see any of that benefit with the change prices within stores for the overall core marketplace.

And second question, obviously the number one reason why a lot of people do not shop on eBay continues to be the concern about fraud and it was our understanding you were testing a new fraud protection program called You're Covered and you may launch a big marketing push behind that later on in the year, if you could update us on that.

Last, Rajiv, the conversion rate of EBITDA to free cash flow was pretty significant at like 87% of EBITDA fell through to free cash flow.

Could we expect it to continue at that rate?

Thanks.

Let me take the first two Anthony.

Yes, you characterize it exactly correctly that virtually all of our pricing changes are designed to better manage the marketplace and we saw exactly the phenomenon that you described; listings migrated back to the appropriate place, conversion rates responded, and we believe it exactly had the desired effect.

It's early days.

We'll know more, but the first full quarter of those pricing increases had exactly the desired effect in terms of managing the health of the marketplace.

I believe on the PayPal issue you're talking about is Pay with PayPal and You're Covered.

That is on the road map for Germany in the August timeframe, and we will be launching it there first to test how effective it is, to test how robust our fraud models are with a significant stepup in PayPal buyer protection, so we will not be rolling that beyond Germany 'til we see where we stand there, but we're excited about the German launch and so is our German team over there.

So Anthony, on your question regarding cash flow, you know, the metric that I look at is slightly different, but directionally the same thing, which is I look at free cash flow less the tax benefit from stock options as a percent of revenue, and that was an all-time record at 35% of revenues in the quarter.

In fact, I can't remember a quarter where it was approaching these numbers.

You know, in particular when we are looking at cash flow, I would not get overly fixated on the quarter.

I think we have to sort of look at this on a longer-term basis.

I think the fundamental pieces that eBay is a business that generates considerable amounts of cash is very, very much true, and as we go forward, we are looking at modest levels of capital expenditures.

We are looking at strong profitability, looking at continuing to grow our cash flows, and sort of continue to generate more operating cash.

Great.

Thank you very much.

Thanks.

Next question?

We go next to Mary Meeker from Morgan Stanley.

Brian and I had a couple questions on the seller base and also on shopping.com.

Meg, you mentioned that you had just done a survey and that your base of sellers made all or a part of their living on eBay in the U.S. was significantly higher than the last time you had given us that data point and the question there is do you think that your seller base has mirrored revenue growth for the Company?

The second question relates to the reception of the potential -- the rollout of shopping.com and the integration of shopping.com into the site, with your sellers at eBay Live.

And the third question is that should obviously cause a huge ramp in your seller base, so how should we think about that?

And the last question is how should we think about PayPal and your integration with the shopping.com site and sellers.

Thanks.

Okay.

Let me talk about our seller base.

It's a little hard to know, but we do think that the sellers that make virtually all of their living selling full-time on eBay probably grows a little bit slower than the overall seller base, particularly because we've got new countries like China, India, Poland where we're just bringing on massive numbers of new sellers.

But we were pretty excited about that $724,000 -- 724,000 individuals making most of their living on eBay, because it really underscores the efficiency and vibrancy of the platform as the best place to start a new business.

With regard to shopping.com, we will talk more about the precise integration plans of shopping after the deal is closed, because shopping is still a publicly held company, we have to be quite careful about what we say with regard to how eBay listings will be integrated, the future role of PayPal and things like that.

But, you know, we still are --- we're very excited about the acquisition, but we have to be quite careful of what we say.

And the shopping.com acquisition is on track.

We expect the shareholders to vote on this in a couple of weeks, and we should be able to close -- the shopping.com shareholders to vote on this in a couple of weeks, and we should be able to close a month thereafter.

And I think at our next earnings call, we'll lay out a lot more specificity about the future for shopping.

Thank you.

Okay.

Thanks.

Next question?

We go next to Heath Terry from CSFB.

Great.

Thank you.

I was hoping you could talk a little bit about the PayPal merchant services beta test that you're going through right now and just what kind of experiences you're having there and what those experiences in terms of things like payment volume and customer adoption tell you about what you expect to see from the full rollout of PayPal merchant services later this year.

Okay.

Yes, let me tell you what we know to date.

Let me just recap what the merchants are telling us that they really liked about this product.

First it, allows a lot more flexibility when integrating PayPal and a lot more control over the checkout process.

Let me give you three quick examples.

First, there's an express checkout, which is a quick three-click payment flow with actually prepopulated user information.

There's also a direct payment API.

That means that credit card transactions --- that's processing for buyers is easy.

They don't actually have to have a PayPal account.

In other words, it's sort of a guest checkout.

Let's say I'm a visitor for the very first time for your site, I'm not a PayPal account holder, I can still pay you as a merchant via PayPal without being a PayPal account holder.

This was the number one thing that the sellers really like about this.

Secondly there's a virtual terminal.

That means that -- it's a new feature that supports not only orders that come in over the net, but orders that come in over phone, fax and through the mail, so these three things, I think, are quite revolutionary for Website Payments Pro and is the top three things our sellers are telling us they like.

Early days for payment volume, we have many, many applications.

They all have to be actually integrated into these merchant sites.

So it's too early to say what it does for growth, what the payment volume is going look like coming through here, but the early returns are --- that we've designed and priced the product exactly right.

Thanks.

We go next to Paul Keung, CIBC.

Hey, Meg, how are you?

First, you put some impressive number on the --- in a tough environment, and I'd like to see your [inaudible] traffic conversions.

Can you give some color in terms of how you're going to achieve these efficiencies it a time when I think everyone is telling us you're seeing the same thing, you're getting some improvements, but yet their costs on the marketing side of revenues continue to go higher, specifically is that a function of mix or are there certain strategies [inaudible] competitive and sustained only to you?

The second question has to do with China and the PayPal launch there --- the architecture there is much different than what you're used to seeing here and in the U.S. and across Europe, so is the margin return opportunity in China from a PayPal standpoint any different than what you expect in our current markets right now?

Yes.

Let me talk about internet marketing and how we've been able to optimize paid search.

First of all, you have to remember that we are probably one of the top two largest marketers through internet marketing on the net in every country in the world in which we do business, so we are accumulating experience faster than anyone else about what works.

And that has to do with exactly which key words you buy, what the ROI is on those key words, whether you do strings of words or just words, and what the click-through rates and conversion rates are into sellers for us and this is all about paid search optimization.

It's a very metric-driven capability, and I think we're getting better at it faster than anyone else.

With regard to natural search optimization, which also helps us because of course it lowers our average cost of users because natural search is free, we've done a good job, I think, in understanding how to make sure that eBay and our sellers turn up very highly ranked in natural search.

And then also, it is a great brand. eBay is a great brand and more than half of our sellers --- our buyers still come directly to eBay.com and that's very useful in terms of bringing down the weighted average costs, but I would point mostly to experience.

We are accumulating experience on how to do this better on the net than anyone else at a faster rate.

With regard to PayPal China and what the ultimate monetization there is going to be, early to tell.

It's free right now.

We launched it free, as we have in other countries, and I think it's too early to know.

I think it really depends on what the takeup is, who our major partners are, and I would say we'll know a lot more about that in the next six to ten months.

Okay, great.

Thanks.

Great.

Thanks.

Next question?

We go next to Christa Quarles from Thomas Weisel.

Couple of questions on PayPal.

I notice a pretty substantial basis point in terms of your transaction contribution and 500 basis points sequentially, 800 basis points year over year.

Could you discuss maybe just what the upper bound of profitability would be there?

I know you indicated some near term impact there.

Then the second question on PayPal would be just around buyer protection.

How were you able to feel comfortable, I guess, offering it in the China marketplace, and then you if you could also give the funding mix and then I have a quick followup.

Thanks.

Sure, Christa.

Let me take some of these.

We've actually had some very significant improvements in some of the cost elements PayPal, but I would caution you.

This is a business that is rapidly evolving, rapidly meeting its -- the needs of buyers and sellers in whole new markets, so we're very pleased with sort of where we are at.

I -- before we go talking about what the upward bounds are, I actually am much more interested in what the next several quarters and the next year is going to actually hold for PayPal, because even as we are thinking about many of the cost components, let's just take loss reserves on PayPal.

We've always said our goal over here is not to minimum loss reserve.

It's actually to optimize them.

Because you can always sort of maximize volume and sort of try to balance both the volume and the cost components.

So I don't think in any one of these cases a single minded focus over here is to minimize.

It's really sort of to balance many of these cost components in relation to overall volume growth and revenue growth.

With sort of transaction processing costs in particular we have been helped with regards to things that we have been able to do that have driven down our transaction costs.

We have industry-leading fraud expertise over here and of course with all fraud models, the more you process, the more you learn and that is actually helping us.

But, as we go into brand new markets, you pointed out China, there's no question; we will actually be increasing some of our cost components in PayPal rather than decreasing right away.

That's the sort of overall point I would make.

In -- with regard to PayPal buyer protection in China, we are developing fraud models there that leverage our expertise in fraud models that we have developed in other countries.

The other thing about China is that we believe, and this is true in the earliest days, is the direct payment will actually be a higher percentage than it is in many other countries because credit cards are not as prevalent in China, so the funding mix actually ought to be more favorable to us in China and when we have direct payments, person -- account to account or ACH, the fraud loss rate is much lower on that part of the funding mix, so that's one of the reasons that we feel comfortable.

With regard to the overall funding mix, unchanged quarter over quarter --

Actually it went down slightly, just about a point in terms of credit card, went down from 54 to about 53%.

Exactly and an improvement obviously versus year ago.

Could you update us on what China GMV was or just the whole Asian marketplace, if you're not giving specific countries?

Actually, Christa, we are not releasing specific GMV by country.

In China in particular, we have had our GMV numbers that we've put out actually twisted and used against us in the local market and we are choosing this quarter not to put out the GMV number.

Great.

Can we have another question?

We go next to Imran Khan from JP Morgan.

And one moment, please.

Got it.

Can you hear me?

Mr. Khan, please go ahead.

Hi.

Rajiv and Meg, I was wondering if you could talk a little bit about your pro -- do you think, what kind of take rate you might expect out of that [inaudible] division and do you think it might cannibalize your [inaudible] store front.

And second question is you had very strong growth in the UK market and we saw strong penetration might slow down the growth that we saw in Germany.

Are you taking any pre-emptive action in the UK market to maintain the strong growth rate?

Thanks.

Let me answer the second question first.

We are a learning organization, and so we are taking some of the learnings of what happened in Germany and obviously sharing those across the globe, and so we're being very proactive with regards to the UK, as well as even France and Italy that are still at their hyper growth phases, so I think one of the core strengths of this Company is actually sharing a best practices across Company and --- across country and across business unit.

With regard to Pro Stores, I actually do not know what we think the ultimate take rate will be.

We know it's competitively priced.

It's a subscription-based model and I think it's going to take us a little while to understand what the take rate is.

With regard to cannibalization, I don't actually believe it will be cannibalistic.

I think it will be additive overall, but again our philosophy is we want to serve our sellers and if our sellers want to add additional channels of distribution, we want to be the people that provide that as opposed to having them go away from eBay to another provider of web store fronts.

Really too early to tell right now.

We just launched the product.

Yes.

Great.

Can I ask one quick follow-up question in terms of the take rate.

Take rate seems to have went up 7.55%.

I think it's because of your conversion rate.

Is your conversion rate higher than your historical norm, like historically range between 48 to 52%.

Thanks.

The take rate went up by about 20 basis points on a quarter over quarter basis, and that is driven by a number of things.

Part of it is actually related to the strong metrics that we've talked about.

Also there is actually seasonality and variability in those take rates, so I would say it's a number of things.

There's no one big standout with regards to what's happening on the take rates, but you would expect to see, and you should expect to see some variability on that rate.

Great, thank you.

Thanks.

Let's maybe have time for one more question.

And we'll go to Douglas Anmuth from Lehman Brothers.

Actually all my questions have been answered, but thank you.

Great quarter.

Okay.

Thank you.

Well, thanks everyone.

Thanks for joining us.

Goodbye.

That does conclude today's conference.

Everyone have a great day.