eBay Inc. (EBAY) Q2 2014 Earnings Conference Call July 16, 2014 5:00 PM ET
Tom Hudson - Vice President, Investor Relations
John Donahoe - President and Chief Executive Officer
Bob Swan - Chief Financial Officer
Douglas Anmuth - JPMorgan
Heath Terry - Goldman Sachs
Colin Sebastian - Robert W. Baird & Company
Mark May - Citi
Justin Post - Merrill Lynch
Brian Pitz - Jefferies
Eric Sheridan - UBS
Gil Luria - Wedbush Securities
Good day, ladies and gentlemen and welcome to the eBay’s Second Quarter 2014 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded.
I would now like to introduce your host for today’s conference, Tom Hudson, Vice President of Investor Relations. Please go ahead.
Tom Hudson - Vice President, Investor Relations
Good afternoon. Thank you for joining us and welcome to eBay’s earnings release conference call for the second quarter 2014. 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. All growth rates mentioned in John and Bob’s prepared remarks represent year-over-year comparisons unless they clarify otherwise. And all segment’s results are adjusted for the effects of foreign currency exchange.
This conference call is also being broadcast on the Internet and both the presentation and call are available through the Investor Relations section of the eBay website at investor.ebayinc.com. You can visit our Investor Relations website for the latest company news and updates. In addition, an archive of the webcast will be accessible for 90 days through the same link.
Before we begin, I’d like to remind you that during the course of the conference call, we will discuss some non-GAAP measures in talking about our company’s performance. You can find the reconciliation of those measures to the nearest comparable GAAP measures in the slide presentation accompanying this conference call. In addition, management will make forward-looking statements relating to our future performance that are based on our current expectations, forecasts and assumptions and involve risks and uncertainties. These statements include, but are not limited to, statements regarding expected financial results for the third quarter and full year 2014, the future growth in Payments, Marketplaces and eBay Enterprise businesses; the company’s plans regarding its share repurchase programs; and the impact of the cyberattack on the company’s results of operations.
Our actual results may differ materially from those discussed in the call for a variety of reasons. You can find more information about the risks, uncertainties and other factors that could affect our operating results in our most recent Annual Report on our Form 10-K and our subsequent quarterly reports on our Form 10-Q available at the investor.ebayinc.com. You should not rely on any forward-looking statements. All information in this presentation is as of today’s date July 16, 2014 and we do not intend and undertake no duty to update this information.
With that, let me turn it over to John.
John Donahoe - President and Chief Executive Officer
Thanks, Tom and good afternoon everyone and welcome to our Q2 earnings call. We enabled $62 billion of commerce volume in the second quarter, up 26%. Mobile and cross-border trade continued to be major contributors to enabled commerce volume. Mobile attracted 6.6 million new buyers in Q2 and cross-border trade was up 26%. Overall, revenue was up 13% in Q2 and non-GAAP EPS was up 9%, and eBay and PayPal both generated double-digit customer growth, with PayPal surpassing more than 150 million active registered accounts.
Our company faced two extraordinary events in the first half, the proxy fight in Q1 and the reset of eBay user passwords in Q2. In the phase of these challenges, we have remained focused on execution and we have maintained our strong commitment to creating sustainable value for all shareholders. As I said before, the proxy fight in Q1 gave us the chance to engage with our largest shareholders and hear what’s most important to them. They told us three things. First, they see significant value creation in our plans and want us to execute. Second, they want us to aggressively pursue our announced $5 billion share buyback. And third, they believe that synergies make eBay and PayPal better together for now, but they want us to continue to be open-minded to alternatives. We agree with all three points.
We are blessed with two great businesses and will continue to aggressively drive growth for PayPal and eBay investing to enable each business to fully capitalize on the respective growth opportunities and will continue to capitalize on our synergies. In addition, we and our Board will remain objective and open-minded in assessing alternatives, which we continue to do. We will make decisions that maximize long-term shareholder value and we will do what’s best for PayPal and eBay to enhance their growth and competitive positions.
Now with that, let me give you a little detail about the second quarter. PayPal had a great quarter. Merchant Services TPV grew 33% in Q2, accelerating for this fifth consecutive quarter. Revenue was up 20% on an FX neutral basis. And in spite of David Marcus’ unexpected departure in the quarter, the team did not miss a beat. They stayed focused, are executing well and PayPal’s momentum is accelerating. Increased consumer adoption and expanded merchant coverage help drive strong results. Braintree had a strong quarter gaining new merchants and accelerating growth. And Braintree just launched a new set of software tools that allow developers to integrate both Braintree and PayPal in a single integration into apps in less than 10 minutes. At eBay Marketplaces, global GMV grew 8% and revenue was up 6%. Top-rated Sellers in the U.S., UK and Germany grew their same-store sales 14% and our global fixed price volume was up 19%.
Now, the cyberattack clearly impacted eBay’s performance in Q2. And Bob will speak to this in more detail in his remarks, but I want to provide a little context. For the first half of the quarter, eBay was performing in line with our expectations. Then in early May, we discovered unauthorized access to our corporate network. We subsequently found that an eBay database had been compromised. This database contained non-financial information on eBay users, including encrypted passwords. Now, I will reiterate that no financial information was compromised in this incident and we have no evidence that the compromised encrypted passwords were breached in anyway. But our focus was to do what’s right for our customers and to ensure a safe and trusted marketplace. So, realizing the potential short-term impact to our business, we made the right decision to ask all eBay users to reset their passwords.
Our focus is now on recovery. Buyers representing approximately 80%, 85% of affected volume, have reset their passwords, but some of these buyers have not yet returned to their previous activity levels. So, we are stepping up targeted marketing efforts in the second half to full reengage these and other users who have not yet reset their password. I am proud of the way the eBay team, which is dealing with these challenges, is working to get the business back on track.
At eBay Enterprise, gross merchandise sales were up 15% and revenue was up 3%. We are thrilled to have Craig Hayman join the company from IBM as the new Head of eBay Enterprise. Craig brings the perfect blend of experience to lead this business going forward.
Before closing, let me take a moment to highlight our continued progress in the four competitive battlegrounds: mobile, local, global, and data. In mobile, our total mobile volume grew 68% in Q2 and we have hit 260 million downloads of our apps. Mobile continues to dramatically influence consumer behavior. For instance, 59% of eBay buyers shopped across multiple screens in Q2 and PayPal mobile continues to accelerate its momentum, with PayPal’s mobile volume off of eBay now surpassing its mobile volume on eBay. We intend to continue to be a leader in the mobile commerce and mobile payment space.
In local, eBay announced plans with Argos in the UK to expand Click & Collect to approximately 650 stores. The expansion puts this convenient shopping experience within 10 miles of most of the UK population. By year end, we expect 65,000 eBay sellers to offer items that can be purchased online and picked up at an Argos store. On the global front, cross-border trade continues to be a competitive strength. PayPal is accelerating this volume. In fact 79% of international shoppers identified PayPal as their preferred payment method when making cross-border purchases. To enhance the consumer experience PayPal is testing free returns on cross-border purchases in four European markets. And PayPal’s passport program was launched in Q2 to help merchants grow their cross-border businesses.
And last but not least, data. We continue to leverage the power of our closed loop transaction data to help merchants grow and deliver better experiences for our customers. For example PayPal is now leveraging eBay Inc. wide data to extend credits to small merchants to help them grow. This program is now loaning $1 million a day to our small business merchants giving them access to much needed capital. In summary, we faced unexpected challenges in the first half, but our teams remain focused on execution and doing what’s best for our customers and strong execution will continue to be our focus in the second half. Meanwhile, we will continue to invest for the long-term strengthening our core commerce platforms and positioning our company to win in the key competitive battlegrounds and we will stay focused on delivering sustainable shareholder value.
Now I will turn it over to Bob who will provide more details on the quarter and then we will take your questions.
Bob Swan - Chief Financial Officer
Thanks John. During my discussion I will reference our earnings slide presentation that accompanies the webcast. As a strategic partner of choice for merchants of all sizes the role we play in global commerce continues to grow. eBay’s commerce ecosystem continued to gain share and enabled $62 billion of volume, up 26% at a take rate of 7.1% for the quarter. Our take rate declined 80 bps driven primarily by business mix as our fastest growing business PayPal has a lower take rate. Mobile ECV increased 68% to $12.3 billion representing 20% of volume. And cross-border trade grew 26% representing 13.4% - $13.4 billion or 22% of volume. Revenue increased 13% and non-GAAP EPS was $0.69, up 9%. We generated $1.2 billion of free cash flow and we executed $1.7 billion of our stock buyback program and had $2.2 billion left in our authorization for further repurchases.
In Q2 we generated net revenues of $4.4 billion, up 13%. Organic revenue growth was 10% in the quarter. Currency contributed a little more than 1.5 points of growth while the Braintree acquisition added about 0.5 point. Second quarter non-GAAP EPS was $0.69, up 9% which was driven by solid top line growth, good productivity, the stock buyback and the weaker dollar which were partially offset by a lower take rate. Non-GAAP operating margin was 24.4%, down 190 basis points. The decline in operating margin was driven by expenses related to the cyberattack and increased investment to increase the vibrancy of the site, partially offset by an expanding PayPal transaction margin and good operating expense leverage across the company. Operating expenses were 45% of revenue, up 110 basis points due predominantly to increased investment in marketing.
We generated free cash flow of $1.2 billion in the quarter. CapEx was 6% of revenue, lower than full year expectations due to investment timing. We continued to expect full year CapEx to be 7% to 9% of revenue.
We ended the quarter with cash, cash equivalents and non-equity investments of $12.4 billion including approximately $2.6 billion in the U.S. We improved our financial flexibility funding 70% of the PayPal credit principal loan portfolio with offshore cash. In the quarter, we opportunistically repurchased 32.4 million shares of our common stock for approximately $1.7 billion. And we utilized $1.2 billion of commercial paper to fund the buyback.
Now, let’s take a closer look at our segment results. PayPal had a great quarter. Revenue reached $1.9 billion, up 20% on an FX neutral basis. Revenue growth was mainly driven by accelerating Merchant Services growth, which included strong growth from PayPal credit. A few quick highlights on PayPal operating metrics. Total active accounts growth was 15%. TPV on an FX neutral basis grew 26%, driven primarily by continued expansion of PayPal on merchant sites around the world and a 260 basis point increase in PayPal penetration on eBay.
Merchant Services FX neutral TPV accelerated 1 point to 33% in the quarter. Transaction margin increased 70 bps, resulting from an increase in our annual GE share gain, lower transaction expense and loss rates partially offset by a lower take rate from large merchant mix, losses on our foreign currency hedges and lower cross currency transaction growth. PayPal segment margin came in at 24.5% for the quarter, up 150 basis points. The increase was due primarily to a 70 bps increase in transaction margin and good operating leverage while we continue to invest in the business.
Let me touch on a few quick highlights for our credit business. Credit is still in its early stage of growth. It allows PayPal and eBay merchants to increase their volume growth by providing financing choice to consumers. In addition, it improves the company’s ability to manage its transaction expense. Bill Me Later TPV growth accelerated 5 points in the quarter driven by increased usage of eBay Inc. data for credit approvals as well as adding Bill Me Later on PayPal’s recurring subscription products. BML as a funding source represented a 4.9% share of U.S. addressable GMV and 2.5% share of Merchant Services U.S. TPV.
Additionally, PayPal signed an agreement with GE Capital to extend our relationship, where we offer a dual-branded retail credit card. We also committed to purchase the associated loan portfolio in 2016 for an estimate of $1 billion based on the size of the portfolio at that time. This increases PayPal’s flexibility to expand its credit offerings to consumers and merchants, while improving its ability to manage transaction expense and reinvest back into the business to accelerate payment volume.
Now, let’s turn to the Marketplaces business. Marketplaces delivered $2.2 billion in revenue, which grew 6%, GMV grew 8%, and operating margin declined 340 basis points. It was a challenging quarter. As John indicated, we got off to a good start, but we had significant obstacles late May. The combination of the cyberattack and the Google SEO had an immediate and dramatic impact on GMV growth. June GMV growth was 7% driven by slower active buyer growth and lower conversion. In light of these events, we have made significant investments to get eBay users reengaged, including couponing, seller incentives and increased marketing spend. We have begun to see some recovery in the first part of July and we are confident we will get these challenges behind us, but it will take a bit longer and we will invest more as we work to get back to double-digit growth.
Now, let’s turn to eBay Enterprise. eBay Enterprise generated $940 million in gross merchandise sales for its clients. GMS grew 15% driven by the addition of new logos and same-store sales growth of 14%. Revenue was $267 million, up 3% driven by increased volume growth. Marketing services revenue growth continues to be impacted by replatforming and branding efforts to consolidate nine companies into one. Segment margin came in at 1.1%, flat year-over-year.
Now, let me turn to guidance. We have had a challenging start to the year. As we entered the second half, our PayPal business has good momentum, our eBay Enterprise business has stabilized, but our Marketplaces business has to dig out of a hole. While we are confident we will work through the global password reset and the SEO changes it will take longer and cost more.
As a result we are lowering our high end full year revenue guidance by $200 million from $18.5 billion to $18.3 billion. We are now at $18 billion to $18.3 billion representing growth of 12% to 14%. We are maintaining our full year non-GAAP EPS guidance of $2.95 to $3 per share, representing growth of 9% to 11%. We expect that PayPal’s strong operating leverage and a lower share count will offset the impact of the slower revenue growth.
For the third quarter of 2014 we expect revenue of $4.3 billion to $4.4 billion representing growth of 10% to 13%. And we anticipate non-GAAP EPS of $0.65 to $$0.67, representing growth of 2% to 5%. In summary, we had a challenging first half of the year with several distractions. However, through the first six months of the year we enabled $120 billion of volume, 13% revenue growth and we met our EPS commitments and we delivered $2.2 billion of free cash flow and bought back $3.5 billion of stock. This is a testament to the power of the portfolio and the resiliency of our team.
And now we would be happy to answer your questions. Operator?
Earnings Call Part 2: