eBay Inc. — Q2 2017 Form 10-Q
Business context and period. eBay operates Marketplace, StubHub and Classifieds as one reportable segment. This unaudited quarterly report covers the three and six months ended June 30, 2017; comparisons are with the corresponding 2016 periods.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net revenue | $2.328B | $2.230B | $4.545B | $4.367B |
| Gross profit | $1.767B | $1.737B | $3.469B | $3.397B |
| Operating income | $478M | $531M | $1.024B | $1.145B |
| Income from continuing operations | $27M | $437M | $1.062B | $919M |
| Diluted continuing-operations EPS | $0.02 | $0.38 | $0.97 | $0.79 |
| Operating cash flow | $699M | $764M | $1.281B | $1.405B |
- Q2 revenue rose 4% as reported and 7% FX-neutral; first-half revenue rose 4% reported and 7% FX-neutral. International revenue was $1.349B in Q2, or 58% of revenue.
- Q2 gross margin was approximately 75.9%, versus 77.9% a year earlier; operating margin was approximately 20.5%, versus 23.8%. First-half operating margin was approximately 22.5%, versus 26.2%.
- Q2 Marketplace GMV increased 3% reported (6% FX-neutral); StubHub GMV declined 5%. Total transaction take rate rose to 8.46% from 8.37%. Higher Marketplace volume and take rate supported transaction revenue; StubHub’s higher take rate partly offset lower GMV.
- Q2 cost of revenue increased 14%, attributed principally to Korea first-party inventory and Brands4friends, acquired-business costs, and expanded Marketplace customer support. Q2 operating expenses rose 7%; general and administrative expense increased 23%, including acquisition integration, data and information security, and employee-related costs.
- Cash and cash equivalents were $2.636B at June 30; short- and long-term investments were $6.381B and $4.754B. Total debt was $11.466B, including $2.215B short-term debt. Current assets were $10.906B versus current liabilities of $4.596B. The company reported $13.6B of cash and non-equity investments in aggregate.
- First-half operating cash flow was $1.281B; investing activities used $2.126B, including $317M of property and equipment purchases; financing activities provided $1.514B. Cash increased $820M to $2.636B, including a $151M favorable currency effect.
Material changes and notable items
- Q2 net income fell to $27M from $435M, chiefly reflecting a $433M income tax provision and lower operating income. The quarterly effective tax rate was 94%, versus 16% in Q2 2016. The filing attributes the tax charge principally to foreign-exchange remeasurement of deferred tax assets and loss of certain tax rulings during the legal-structure realignment.
- For the first half, eBay recorded a $44M tax benefit versus a $195M provision in 2016. A $695M tax benefit from a foreign Classifieds tax-basis step-up was partly offset by a $376M noncash charge from deferred-tax-asset remeasurement and higher foreign tax rates. The effective tax rate was negative 4%, versus 18%.
- Q2 operating cash flow declined to $699M from $764M; first-half operating cash flow declined to $1.281B from $1.405B. The company cited changes in assets and liabilities and other items as a significant cash-flow offset.
- During Q2, eBay issued $2.5B of senior notes. Total debt rose from $8.960B at year-end 2016 to $11.466B at June 30. No commercial paper or credit-agreement borrowings were outstanding; $500M of the $2B credit facility remained available for other purposes after reserving $1.5B to backstop commercial paper. Debt covenants were met.
- eBay repurchased $857M of stock in the first half, with $479M remaining under the existing authorization at June 30. In July, the board authorized a further $3B repurchase program.
Outlook, risks and contingencies
- The filing provides no specific revenue or earnings guidance. Management said it expected sufficient liquidity from existing cash, investments, operating cash flow, borrowing capacity and capital-market access to fund foreseeable needs. Repurchases remain subject to market conditions and management discretion.
- eBay expected the legal-structure realignment to continue into 2018, primarily affecting international entities. Management said it should provide cash tax benefits, subject to foreign-platform performance, while changing tax rates and creating noncash tax effects.
- The planned India transaction would transfer eBay.in in exchange for a Flipkart ownership interest and a $500M cash investment. Closing was expected in the second half of 2017, subject to customary conditions.
- Management identified a material weakness in internal control over financial reporting relating to tax accounting for legal-structure transactions. Disclosure controls were not effective as of June 30, 2017. Remediation procedures were operating and being tested; management’s goal was remediation by year-end, but the weakness was not yet considered remediated.
- Legal and regulatory proceedings are ongoing; recorded probable-loss accruals were not material for the first half. Outcomes are uncertain, and the company said it could not estimate potential losses from non-monetary remedies. Risks highlighted include competition, foreign exchange and international operations, privacy and cybersecurity, regulation and litigation, tax uncertainty, and substantial indebtedness.
- Revenue-recognition guidance was scheduled for adoption in Q1 2018. eBay expected possible timing changes for certain seller fees and was assessing whether some user incentives would be recorded as expenses rather than reductions of revenue; it did not expect principal-versus-agent changes to materially alter revenue presentation.
Important facts for investors to verify
- Whether revenue, GMV and take-rate growth continue, particularly Marketplace growth and StubHub’s GMV trend.
- How much of the Q2 earnings decline reflects unusual, noncash tax effects, and the future cash-tax and effective-tax-rate effects of the legal-structure realignment.
- Progress and testing results for remediation of the tax-accounting material weakness.
- Debt and liquidity implications of the $2.5B note issuance, planned buybacks, and the $500M Flipkart investment; note that $8.7B of cash and investments was held by foreign subsidiaries, with repatriation potentially subject to additional taxes.
- Completion and accounting treatment of the Flipkart transaction, and the eventual impact of the new revenue-recognition standard.
- Developments in litigation, regulatory matters, cybersecurity exposure and other contingencies, for which outcomes may be difficult to predict.