eBay Inc. (NASDAQ:EBAY) reported second quarter earnings that beat the Zacks Consensus by 4 cents or 13.1%. This was much better than the average positive surprise of 7.54% reported in the preceding four quarters. As a result, shares jumped 3.27% after hours.
 
Analysts have been lowering estimates over the past 30 days or so, expecting the foreign exchange impact, softening marketplace, pricing and execution to negatively impact results, thus missing management guidance. However, eBay’s results were exactly in line with the guidance of 37 to 39 cents provided by management during the first quarter earnings announcement.
 
Revenues beat the Zacks Consensus by 2.2%.
 
Revenue
 
Gross revenue of $2.22 billion was up 0.9% sequentially and 5.6% year over year, beating the Zacks Consensus by 2.2% and just exceeding the high-end of management guidance. The company is accounting for its stake in Skype under the equity method, so these numbers do not include any contribution from Skype.
 
Around 88% of total revenue was transactions-based, while the remaining 12% came from marketing services. Marketing services (up 2.2% sequentially) drove the slight revenue surprise, with transaction revenue coming in relatively flat (up 0.7%). However, transaction revenue was much stronger compared to the year-ago quarter, increasing 6.0% versus a 2.7% increase for marketing services.
 
Revenue by Segment
 
The company reports revenue under the Marketplaces and Payments segments. The marketplaces segment essentially refers to the revenue earned from the sale of goods available on the eBay properties. The payments segment refers to revenues generated through Paypal. Consequently, both segments derive revenue from transactions, as well as marketing services.
 
Marketplaces revenue increased 0.8% sequentially and 11.1% from the year-ago quarter. The sequential revenue increase was the net impact of a 0.8% increase in transaction revenue and a 0.9% increase in marketing services revenue. The year-over-year increase was due to an 11.9% increase in transaction revenue and a 7.0% increase in marketing services revenue. Vehicles volume grew 8% sequentially, but continued to decline year over year (down 5%). Active users increased to the highest level in 5 quarters. Marketplaces generated 63% of total revenue.
 
Payments revenue increased 1.0% sequentially and 22.1% from the year-ago quarter. Revenue from transactions was up 0.5% sequentially and 8.4% year over year, with the revenue generated per transaction edging up from the first quarter, but declining from a year ago. Although the increase in the number of active users sequentially lowered the revenue per user, the metric showed positive movement when compared to the year-ago quarter. This is encouraging, as it indicates that users on average are opting for eBay’s payment platform more often than they did a year ago. Although the cost per transaction increased, management was able to contain the transaction loss rate. Revenue from marketing services was up 8.4% sequentially and 18.3% from the year-ago quarter. The Payments segment generated 37% of total revenue.
 
Revenue by Geography
 
Around 47% of total revenue was generated in the U.S., representing a sequential increase of 2.8% and a year-over-year increase of 7.5%. The balance came from international markets, which were flattish sequentially (down 0.7%) and up 0.4% year over year.
 
Management stated that sales into Europe, which is a net importer from both the U.S. and Asia were much slower in the last quarter, negatively impacting overall revenue. However, the important markets of U.K. and Germany were strong. Although China and Hong Kong remain the fastest growing regions, sales growth was tempered by currency in the last quarter.
 
Margins
 
The pro forma gross margin for the quarter was 72.7%, down 24 bps sequentially and up 32 bps year over year. Flattish volumes in both segments combined with an increasing number of active users and increasing cost per transaction processed negatively impacted the sequential comparison. Higher volumes offset these pressures in the year-over-year comparison.
 
Marketplaces margins are generally much higher than Payments margins. However, 59% of transactions in the last quarter were under the fixed price format, exposing the company to the severe price competition in the online retail market.
 
Operating expenses of $1.06 billion were higher than the previous quarter’s $998.2 million. The operating margin was 25.0%, declining 247 bps sequentially, but increasing 88 bps from the year-ago quarter. All expenses increased slightly as a percentage of sales, although management’s focus appears to be on selling and marketing expenses.
 
Excluding the impact of restructuring charges, the amortization of intangible assets and employer payroll taxes on a tax adjusted basis, the pro forma net income was $458.8 million or 20.8% net income margin, compared to $480.4 million or 21.9% in the previous quarter and $402.1 million or 19.2% in the year-ago quarter.
 
Including special items, the GAAP net income was $412.2 million ($0.31 per share) compared to $397.7 million ($0.30 per share) in the Mar 2010 quarter and $327.3 million ($0.25 per share) in the Jun quarter of last year.

Balance Sheet
 
The company has a solid balance sheet, with cash and short term investments of $4.90 billion, up $370 million in the last quarter. eBay generated $726.4 million in cash from operations and spent $207.2 million on capex, netting a free cash flow of $519 million (up $253.2 million during the quarter). It also spent $7 million on acquisitions.
 
Full-Year Guidance Lowered
 
Management expects third quarter 2010 revenue of $2.13-2.18 billion (down 2.7% sequentially and 3.7% year over year), GAAP EPS of 26 to 28 cents and non GAAP EPS of 35 to 37 cents. The relatively soft guidance was attributed to the impact of currency, which management stated would have a negative impact on both revenue and costs. The non GAAP EPS excludes intangibles amortization charges of $60-70 million, stock based compensation related charges of $90-110 million and restructuring charges of $5 million.
 
For the full year, management expects revenue of $8.8-9.0 billion (taking the high-end down by $0.1 billion), GAAP EPS of $1.23 to $1.28 (down from $1.29 to $1.34) and non GAAP EPS of $1.60 to $1.65 (down from $1.63 to $1.68). The non GAAP EPS excludes intangibles amortization charges of $230-245 million, stock based compensation related charges of $410-440 million and restructuring charges of $20-25 million.
 
Conclusion
 
eBay reported another good quarter, although results were negatively impacted by currency.  The negative impact could increase in the next few quarters. Although shares responded positively to the news, we expect downside once investors digest the currency headwind. Hence the Zacks rank on the stock is #4, meaning that we recommend investors to wait for a more attractive entry point.
 
That said, we continue to expect revenues to benefit from management’s new customer-centric approach, under which the company is making technological improvements to its online portals and increasing focus on the fixed price format. We believe eBay will continue to see higher volumes, the impact of which will be partially offset by higher costs, weaker pricing and shrinking margins.
 
Our longer term rating on eBay shares stays Neutral.

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