Shopify SHOP Q3 2020 Earnings Call Transcript

Speaker 1: (00:01)
Thank you for standing by. This is the conference operator. Welcome to the Shopify Third Quarter 2020 Financial Results Conference Call. As a reminder, all participants are in listen-only mode, and the conference is being recorded. After the presentation, there’ll be an opportunity to ask question. To join the question queue, you may press star then one on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and zero. I would now like to turn the conference over to Katie Keita, Director of Investor Relations. Please go ahead.

Katie Keita: (00:39)
Thank you, operator, and good morning everyone. We are joined this morning by Tobi Lutke, Shopify’s CEO; Harley Finkelstein, Shopify’s President and Amy Shapero, our CFO. After some brief prepared remarks by Harley and Amy, we will open it up for your questions. We will make forward-looking statements on our call today that are based on assumptions and therefore, subject to risks and uncertainties that could cause actual results to differ materially from those projected. We undertake no obligation to update these statements except as required by law. You can read about these risks and uncertainties in our press release this morning, as well as in our filings with U.S. and Canadian regulators. Note that the adjusted financial measures we speak to you today are non-GAAP measures, which are not a substitute for GAAP financial measures. Reconciliations between the two can be found in our earnings press release, and finally we report in U.S. dollars, so all amounts discussed today are in U.S. dollars unless otherwise indicated. With that, I turn the call over to Harley.

Harley Finkelstein: (01:39)
Thanks, Katie, and good morning, everyone. We continue to see incredible demand as the decisive shift to digital commerce persisted in our third quarter and more entrepreneurs than ever before turned to Shopify to start, to run and to grow their businesses. Making commerce better for everyone is what we do, and Shopify is achieving this by lowering the barrier to entry to entrepreneurship. Last quarter, I outlined several initiatives we shipped to help merchants adapt quickly to a rapidly changing retail environment, triggered by COVID, getting them online fast and building resilience into their businesses at a really challenging time. We believe these changes in the landscape will endure, as consumers new shopping behavior stick and become the new normal. Shopify has always taken and always will take a merchant-first approach this year. This translated to an increased urgency around helping entrepreneurs to get online fast and start selling easily to get discovered and to get their products to buyers. Today, I’ll talk about how our efforts are paying off for our merchants and for Shopify.

In Q3, a record number of merchants became paid subscribers to Shopify, even excluding merchants who converted following the end of their 90-day extended free trial. The extended free trial made it easier for new source to get online fast and make sales, enabling many of these entrepreneurs to generate cash, while their physical stores were shut down at the onset of the pandemic. Some of these businesses made their first online sales faster than typical entrepreneurs coming online for the first time, proving out the power of omnichannel commerce for brick-and-mortar retailers. Fast transitions like this contributed to Shopify’s tremendous GMV performance, which increased 109% over the same quarter last year. Not only do we help merchants get up and running quickly, we give them more tools to get them discovered by new buyers, shipping native sales channels to integrations like Facebook Shops, Walmart and Pinterest.

It’s early days, but given the traffic to these venues from browsers and buyers, merchants are well-positioned to benefit from increased number of eyeballs on their brand and their products. Sales channels will continue to expand as TikTok will be testing with a limited number of Shopify merchants, features that make it easy for them to sell organically directly from their videos and their profile pages. Channels are supplemented by our expanding marketing capabilities that help drive traffic to our merchants stores, opening up their buyer universe with features like TikTok for Business and strengthening relationships with existing buyers. Ease of repurchase by fans that a merchant has already won over is critical. Research has found that 80% of the business’ future profits come from buyers they’ve sold to before.

Merchants are increasingly leveraging how easy we make it for them to remarket by using tools like Shopify Email through which merchants have sent 500 million emails through email campaigns, since launching the product in the first quarter of this year. After getting online and getting discovered, merchants need to get their products to buyers. Step one is helping buyers checkout quickly and easily, while giving them flexible payment options, both benefits shown to improve sales conversion. Providing an amazing shopping experience through fast and easy checkout is exactly what Shop Pay, our accelerated checkout does. Shop Pay has experienced phenomenal growth since its launch three years ago, facilitating over $14 billion in GMV with more than 60 million buyers opted in at the end of Q3, facilitating more Shopify GMV than Apple Pay, Google Pay and Amazon Pay combined.

Not only does Shop Pay offer frictionless check out, but it enables buyers to offset the carbon emissions produced by their deliveries. We started rolling out our buy now, pay later product Shop Pay installments in the U.S. in Q3. Shop Pay installments lets merchants give buyers more options by paying in installments with no interest and no fees. Installment products are gaining in popularity, as consumers look for alternative payment methods to credit cards. In addition to improving sales conversion, businesses offering buy now, pay later options have seen higher card sizes and an increase in repeat customers. Shop Pay is also integrated into the Shop app, a personal shopping out that helps merchants deepen their relationships with existing buyers through a fantastic shopping experience that includes a smooth, faster checkout, product recommendations from the merchants they love and order tracking; so buyers can keep up to date on delivery status. The Shop app has reached nearly 10 million monthly active users with thousands of merchants leveraging the built-in features to strengthen their relationship with buyers and increase customer lifetime value.

Getting goods to buyers also means delivering a great post-sale experience through fast and affordable fulfillment. More than half of eligible merchants in U.S. and Canada adopted Shopify Shipping in our third quarter, up from 45% in the same period last year. Physical retail merchants also continue to offer buyers ways to receive their goods at a safe distance using curbside pickup and local delivery. And, of course, we continue to build the Shopify Fulfillment Network to help to democratize fulfillment for merchants of all sizes.

Turning to Shopify Plus, which had another incredible quarter, we added a record number of merchants for the second quarter in a row and Shopify Plus merchants use more merchant solutions including Shopify Payments and Shopify Capital, as they scale their businesses. Enterprise brands are realizing that center of gravity is shifting from digital commerce being an add-on to now being the control center, or as I like to say, their retail operating system for their business. These large merchants are realizing that having a modern, agile and flexible commerce solution is paramount and that Shopify Plus represents this on multiple fronts; offering multichannel commerce, flexibility and partner integrations, a fast and reliable tech stack and constant innovation. Considering its low cost of ownership, Shopify Plus is becoming the obvious choice. More notable brands across a variety of verticals launch stores at Shopify Plus in our third quarter including the following: the global luxury brand, Dior; women’s fashion brand, BCBG Max Azria; motion picture production house, Paramount Pictures; sustainable fashion brand, Magento; meat alternative food producer, Beyond Meat; nutrition bar company, Clif Bar; multinational telecommunications company, Telefonica; and weight loss brand, Jenny Craig.

Turning to our partner ecosystem, which has become a true competitive events for Shopify. As of Q3, more than 37,000 partners referred merchants to Shopify over the past 12 months. Our partners make Shopify better for every merchant, helping to extend Shopify’s functionality via our APIs, so merchants can customize their stores and meet their unique commerce needs. Partners also look at merchants to build their brand and stores on Shopify. Through these challenging times, they have played a vital role in helping our merchants get online fast, contributing to both the success of our merchants as well to Shopify. The majority of respondents to a recent merchants survey conducted by Shopify anticipate more online than in-store purchasing during this year’s Black Friday, Cyber Monday weekend.

In fact, more than half of the retail merchants that responded are actively making improvements to their online store to make up for anticipated lower in-store sales that weekend. Our merchants need our help navigate this new territory and we’re working hard to help merchants make the most of BFCM, not just of features and functionality, but with helpful content ranging from optimizing the performance of their online store to promoting their brands in a way that creates value beyond the holiday shopping weekend. Entrepreneurs are the backbone of our economies, and Shopify is doing everything we can to make more of them and make them stronger. Before I hand it off to Amy, I want to share our merchant interaction with Tenita, who owns Status Co. Leather Studio in Alabama that illustrates why Shopify exists. We are here to make the opportunity for entrepreneurship accessible to everyone because commerce is far better when more independent voices participate.

Speaker 2: (09:52)
Okay, perfect. Congratulations, Tenita.

Tenita: (09:55)
Well, I thank you, because I’m feeling … Can I express something to you?

Speaker 2: (10:01)
Please, please.

Tenita: (10:03)
This is on the side of the situation demographically being a woman, being an African American woman, in terms of traditional funding, many times it is just totally out of the question and not available because of whatever systems are in place. And I’m going tell you, Shopify providing this opportunity on a general level, you all really make an impact on a lot of people, a lot of women, and a lot of women of color who pursue businesses, and this was the only option that was available for actual capital funding, and I really appreciate you all for that. If people don’t know what Shopify does in that sense, I don’t think a lot of people realize how valuable that particular funding option is for a to of people. I just wanted to thank you all for that.

Amy Shapero: (11:16)
Thanks, Harley. As that conversation just illustrated, businesses of all sizes rely on Shopify during these challenging times. We are in lockstep with them on their journey, as demonstrated by another strong quarter, thanks to ecommerce tailwinds, our merchants’ resilience, and the continued strong execution by the Shopify team. Revenue nearly doubled once again in our third quarter to $767.4 million, up 96% over the same period last year, driven by strong performance from both our merchant solutions and subscription solutions segments.

Subscription solutions revenue increased 48% year-over-year to $245.3 million, largely due to exceptional growth in monthly recurring revenue. Our growth accelerated to 47% year-over-year to $74.4 million, as merchants from both the 90-day free trial offered from March 21 through May 31, and standard 14 day free trial offered from June 1 onwards converted into paying merchants in the quarter, creating a double cohort effect. While demand remains higher for subscriptions compared to pre-COVID levels, we do not expect the year-on-year MRR growth rate in Q4 to match what we saw in Q3, given the benefit to third quarter results from this double cohort effect. Shopify Plus contributed $18.7 million to MRR or 25% compared with 27% of MRR in Q3 of 2019, as the strong growth of standard MRR outstripped that of Shopify Plus, primarily due to the double cohort effect just discussed as Shopify Plus was excluded from the 90-day free trial. Merchant solutions revenue grew 132% to $522.1 million in Q3, compared to the same period in 2019. This tremendous growth was driven primarily by merchants strong sales with GMV increasing 109% year-over-year to $30.9 billion and increased adoption of Shopify Payments capital and shipping driving revenue from these products higher. $14 billion of GMV was processed on Shopify Payments in Q3, an increase of 124% versus the comparable quarter last year. Payments penetration of GMV was 45% versus 42% in Q3, 2019 and not more than a half a percentage point over Q2 this year. New merchants across all segments joining the platform after they used Shopify Payments and Shopify Plus and international merchants expanded their share of GPV year-over-year.

Demand for Shopify Capital increased in Q3, with merchants receiving $252.1 million in funding across the U.S., the U.K. and Canada in preparation for the holiday selling season. This record quarter for capital represents a 79% increase in funding over the third quarter of 2019, while maintaining loss ratios in line with historical periods. Businesses need financial resources to survive and fulfill their potential, especially in these uncertain times, and as you heard just now capital greatly increases the value of Shopify to our merchants.

Adjusted gross profit dollars grew 88% over last year’s third quarter to $412.6 million, which reflects the significantly greater mix of Merchant Solutions revenue versus last year. The acquisition of 6 River Systems in Q4 of last year and our ramp up of investment in Shopify Fulfillment Network. Adjusted operating income was $130.9 million in the third quarter compared to adjusted operating income of $10.5 million in the third quarter of 2019.

… of $10.5 million in the third quarter of 2019, reflecting our strong revenue performance in the quarter. Adjusted net income for the quarter was $140.8 million or $1.13 per diluted share, compared with adjusted net loss of $33.6 million or 29 cents per diluted share in last year’s third quarter. Adjusted net income in this year’s third quarter excludes an unrealized gain on an equity investment of $133. 2 million or $1.7 per share. Stock based compensation and related payroll taxes of $75.4 million or 60 cents per share, and other adjustments totaling 7.5 Million dollars or 6 cents per share. Finally, our cash equivalents and marketable securities balance was $6.1 billion on September 30th, strengthened by the capital we raised in our third quarter, which provides us more flexibility to pursue our growth strategies. The pandemic has fast track commerce to digital domains, and there is incredible demand on both the merchant and consumer sides to enhance the commerce experience. Shopify is in a unique position to help entrepreneurs in this emerging landscape. Our investments in core, expansion, and ambition initiatives, which correspond to near, medium, and long-term return horizons paved the way for building a powerful global commerce operating system that is the one thing merchants need to start and scale a successful business.

[inaudible 00:16:34] already provided an update on Shopify Plus, a key core initiative, so I will start with progress on our expansion investments, international expansion, and retail POS. In Q3, we continued to build product market fit for our international merchants, making it easier for them to get online and start selling. Our merchant admin, partner admin, and theme store are now available in 20 languages. With the recent launch of Shopify payments in Belgium, which supports payments with credit cards, ban contact debit cards, and local payment method Ideal, Shopify payments is now available in 17 countries. The more intuitive we make our platform regionally, the more we’re seeing our merchants succeed as reflected in the strong year-over-year GMV growth from our international merchants in the third quarter. And our work localizing and focus international markets continues. We are digging into complex areas to deepen our product market fit such as evolving the merchant user experience, growing our partner ecosystem, launching more sales channels, simplifying cross border and mobile commerce, and introducing new ways to get products to buyers such as pickup points, which are quite popular in Europe.

Retail margins have been extremely resilient, finding new ways to reopen and operate safely, such as adjusting the flow of in-store traffic, appointment only shopping, using curbside pickup and local delivery features, or changing store hours to accommodate demand. As our merchants adapted, we saw retail GMV recover and exceed pre COVID levels in Q3. Retail merchants are increasingly adopting our all new POS software and tap and ship hardware for a seamless omni-channel experience. POS Pro features, and in particular smart inventory management, are especially resonating with retail merchants as they face capital constraints due to limitations relating to social distancing measures. Our smart inventory management capabilities enable merchants to effectively create and manage purchase orders, accurately transfer, receive, and track inventory across locations, and perform demand forecasting so merchants can proactively stock up with the right products, helping to reduce errors and optimize inventory decision-making.

Turning to our Ambition initiatives, first addressing Shopify Fulfillment Network. We made solid progress in Q3. As we continued to develop the foundation of our fulfillment network software infrastructure, activated more partner nodes in the US, added 6 River Systems technology and more partner nodes, expanded our set of transportation partners, and enhanced the merchant facing app and merchant support functions. We continue to enroll merchants and fulfill volumes at a rate where we can maintain high quality standards.

With Black Friday, Cyber Monday, and the holiday shopping season around the corner, our fulfillment network is preparing for a rise in demand in view of the dramatic shift to online commerce. We’re working with our partners to increase staffing within fulfillment warehouses, keeping health and safety top of mind, as well as with our carrier partners to mitigate capacity issues by optimizing processes. And we’re staying close to our merchants, communicating frequently and educating them on how they can best prepare for the selling opportunities and the challenges they may face due to higher demand on logistics networks. Building a vertically integrated fulfillment service is complex, and we continue to be in the testing stages of a very young product. We are committed to building a reliable fulfillment solution so our merchants can focus on building a successful business.

In Q3, 6 River Systems hosted its second annual user conference, Flow 2020, announcing a host of enhancements to its wall-to-wall fulfillment solution that gives warehouses more visibility into and control of their operations. Retailers are being impacted by the secular shift from pallets to parcels in the B2B space, along with increasing labor shortages and rising labor costs associated with the pandemic. As a result, 6 River Systems’ automated fulfillment technology is resonating more than ever as these businesses seek a flexible, scalable, and cost-effective solution. This translated into 6 River Systems’ strongest quarter ever for bookings as new customers signed on and existing customers added to their orders in preparation for the peak holiday shopping season.

Wrapping up, Shopify is helping merchants adapt and thrive in today’s environment and to succeed over the long-term. Through a steady pace of innovation that solves merchant pain points over different time horizons, we’re building a global commerce operating system that aims to stand the test of time and future-proof our merchants’ businesses. The immediate future remains uncertain however, as the second way that the COVID pandemic hits regions around the world. What is clear is that the spirit of entrepreneurship is strong and access to entrepreneurship needs to be in the hands of the many, not the few. Shopify remains committed to lowering the barriers to entry to entrepreneurship so that anyone with an idea and a desire is able to reach for their independence.

With that, I’ll turn the call back to Katie.

Katie: (21:55)
Thanks Amy. Before I turn the call over to the operator for your questions, I want to remind everybody to please try to limit yourself to just one question. And let’s get going. Ariel?

Ariel: (22:10)
We will now begin the question and answer session. To join the question queue, you may press star then one on your telephone keypad. You’ll hear a tone acknowledging your request. If you are using a speakerphone, please pick up your headset before pressing any keys. To withdraw your question, please press star then two. We will pause for a moment as callers join the queue. Our first question comes from Thomas Forte of D.A. Davidson. Please go ahead.

Thomas Forte: (22:40)
Great. Thanks for taking my question. So I know you discussed this at length in the prepared remarks, but I wanted to highlight my question and get your short answer on it. So I think this is going to be a very challenging holiday from a supply chain and logistics standpoint. So what gives you confidence in your merchants’ ability to have in-stock inventory for the upcoming holiday and for Shopify fulfillment network’s ability to deliver products in time for holiday? Thanks for taking my question.

Harley: (23:10)
Thanks for that question. It’s Harley here. So a couple of things to point out. First of all, as we mentioned in the prepared remarks, we now have 51% of our merchants, elder merchants, using Shopify shipping. That’s up from 45% last year. Now see more merchants use Shopify shipping means that as the entire macro environment for shipping has issues, we think Shopify merchants are better positioned. We’re also working with them now to ensure that they advise customers when purchasing that there may be some delays based on either supply chain or on the last mile side of things.

Harley: (23:42)
That being said, our focus in 2020 around SSN is to achieve product market fit, which we plan to continue into 2021. We want to ensure that the foundation of the fulfillment network is strong and the merchant’s experience is outstanding before we enter sort of the scale phase. But in terms of how we’re arming our merchants, or arming the rebels to ensure that they have a great holiday season. We’re doing everything we can to make sure that we give them the tools, the information, and the context so that they can ensure that their end consumers understand and appreciate what is happening, but so far so good. We see that there has not been too much of a slowdown. And again, more people using Shopify shipping means that more people have, more merchants have more information.

Ariel: (24:24)
Our next question comes from Ken Wong of Guggenheim Securities. Please go ahead.

Ken Wong: (24:33)
Great. Thanks. Thanks for taking my question. Another solid quarter guys. And I just wanted to maybe pick your brain, Harley, in terms of what you guys saw from a linearity perspective, as far as merchant growth and GMV volumes through the quarter. And then to the extent that you’re able to comment, just kind of higher thinking about the shape of the holiday season. Lots of moving pieces there from macro, to elections, to social distancing and just the surge online. How might this comp to maybe Black Friday last year?

Harley: (25:07)
Yeah, thanks for the questions, Ken. A couple of things, first of all, I think the Black Friday, Cyber Monday weekend is now becoming an entire season. So we’re certainly seeing merchants start much faster. We also know that more consumers have already decided to do the majority of their holiday shopping online and so obviously that’s going to provide some good tailwinds to our merchants. In terms of GMV, as Andy mentioned, and Plus merchants certainly continue to grow their share of GMV. And we’re one of the biggest contributors to GMV in absolute terms. International merchants also maintain their share of GMV and continued to grow quickly year over year.

Harley: (25:40)
This is mostly coming from apparel, accessories, and cosmetics. Those are sort of the largest ranking categories and verticals for us. That said, with the onset of COVID and the pandemic, we are seeing food, beverage, and tobacco continue to experience strong growth in Q3 as well. So the nice part about our GMV growth is that it’s not coming from any one particular vertical. It’s not coming from any one particular type of merchant. It’s coming across the board. And we look forward to a very strong Black Friday, Cyber Monday, and holiday season.

Yeah. And I think if I could just add, you had asked at the very beginning of your question about merchant growth. So I want to just highlight that we did have a record quarter in Q3 for merchant growth due to the double cohort effect that I talked about in my opening remarks. But I think it’s really important to emphasize that even excluding the 90 day free trial-ists who converted in Q3, we still would have seen an acceleration in our merchant growth over pre COVID levels. Which tells you that there are more merchants coming to the platform with this shift to online commerce and COVID. The demand for the platform has increased as we’re seeing more business generation occur in this environment and a desire for multichannel commerce.

Ariel: (27:04)
Thank you, Ken. Our next question comes from [Sidi Pinigrafi 00:27:10] of [Mizzou 00:12:10]. Please go ahead.

Josh Beck: (27:15)
Thanks for taking my question. I just wanted to just a follow-up to last question. You’ve mentioned 71% increase in new store creation an in Q2 and mostly they are 90 days free trial. So how was the conversion rate from that free trial considering subscription revenue grew 48%? And how has the new [inaudible 00:27:37] this quarter?

Yeah, so the new store creation in Q2 were the new stores coming on the platform associated with a 90 day free trial. So we were not able to count them as merchants in Q2. We saw many of them convert to paying merchants in Q3. The conversion rates that we’ve seen on the 90 day free trial-ists is slightly lower than cohorts historically on 14 day free trials, but we think that’s okay because they’re more intentional when they convert, because they’ve got a longer time period. The data that we have in the three months and some of the earliest 90 day free trial cohorts and converted suggests that those merchants have a higher retention than 14 day free trial-ists. We know many of them coming online in Q2 are established businesses, looking for a multichannel platform. And so we believe that those 90 day free trial-ists will be more sticky than the 14 day free trial-ist cohorts historically.

Josh Beck: (29:03)
Thank you.

Thank you, Sidi.

Ariel: (29:06)
Our next question comes from Colin Sebastian of Baird. Please go ahead.

Colin Sebastian: (29:13)
Good morning. Thanks for taking my question and congrats to Harley on the new title. I was hoping you could talk about the combination of Shop Pay and the Shop app in terms of how this benefits merchants, I assume in areas such as conversion rates or repeat order volume. And if there are plans to push adoption of these more consumer facing services more aggressively in the year ahead through more marketing, advertising, or other promotions? Thank you.

Toby: (29:40)
Hi, this is Toby. Yeah. So I mean Shop app and Shop Pay, they’re connected in as much as this is like the brand [inaudible 00:00:29:55]. This is always a little bit hard to appreciate from [inaudible 00:29:58] you all have a good understanding of Shopify the company. But again, Shopify is a brand…

Toby: (30:02)
… understanding of Shopify as a company. But again, Shopify is a brand to merchant entrepreneurs, and we decide to go shop on a buyer-facing side. So this is clearly something we are doing more of now. I don’t have specific plans for media purchases or so and amplification. Our Shop and Shop Pay are growing really, really, really good on merit, I think, right now, because they solve real problems, it’s a focus of ours. We want to try to figure out how to make … All of commerce s very, very, very … The weight organically sort of coalesce onto the Internet. There’s a very strong line of delineation.

Toby: (30:53)
We started in the 2000s where you go to a browser and you hopefully make your way some way to an online store, and the moment you place the purchase, the role of the e-commerce software has really stopped. It might have sent you some emails, but you had to go and email client to figure out where your order is. Maybe it had a tracking number. It takes you to USPS, and there you figure out. Maybe they can look up the thing wherever your package is, and if you ever want to do a return you go find the email ideally via search, if you can even find it.

Toby: (31:29)
It’s a janky as hell experience. We all got used to it, so we are familiar with it, but that doesn’t mean it’s good. We are trying to, as much Shopify can, we try to aim for global maxima, accepting sort of a winding path towards there. And Shop Pay specifically avoiding that anyone has to enter their address with their thumbs in the shop, then taking the [inaudible 00:32:01] to their personal computer four times, which is a phone and telling you exactly where your packages is and when it might be arriving and sort of into the relationship process. So this is sort of a vision around at all, and you’ll see a lot of broadcast I think from us over the next while of all those lines.

Speaker 3: (32:20)
All right. Thank you, Colin.

Ariel: (32:25)
Our next question comes from Josh Beck of KeyBanc. Please go ahead.

Josh Beck: (32:33)
Thank you for taking the question. You mentioned that Six River, I believe, had its strongest bookings quarter ever, I think, which is a great example of the product and the interest. I’m a little bit curious about its application within SFN. Really, if you could maybe just talk about how that’s progressing and how important the robotics automation component is to really be able to scale SFN over time.

Toby: (33:08)
Yes. So SFN and Six River Systems exist at two different levels. What Six River Systems does, the role it has within Shopify is to modernize the insights of a warehouse and really gets the fulfillment warehouse to the point where it’s almost a software addressable black box. It’s obviously not leading this, but from our perspective of most of Shopify, which is a company that mostly does things in software and in bites. This is the idea, because once we can treat warehouses as basically a task management system, where we just say, “Okay, this package has to go there and here’s a pallet of things that need to be stocked,” and so on. And this can happen to 99 point something reliability and all these kind of things and the exceptions are managed.

Toby: (34:03)
Then, if I can think about warehouses globally right, and say we can have tens, hundreds, potentially thousands potentially in partners and some homegrown ones around the world and balance the products that our customers need to where they need to be stored. So the robotics are very really, really important for warehouse. They increase efficiency enormously. They’ve just gotten more important because it’s easier to social distance amongst people when robots do a lot of moving things, and we’ve seen really great results. It’s a great product, and those two things absolutely need each other to be successful.

Ariel: (35:05)
Our next question comes from Paul Treiber of RBC Capital Markets. Please go ahead.

Paul Treiber: (35:11)
Thanks very much and good morning. This is a follow-up a little bit of a follow-up to Tobi’s previous comment or first comment. But there has been obviously, mass acceleration in e-commerce, but it’s been a unique environment for so many people working from home. Broadly, what’s your view on the biggest remaining points of friction for e-commerce into what degree is it possible for Shopify to develop solutions to address these remaining points of friction, or are some outside of the control of the company?

Toby: (35:47)
That’s a good question. I mean, I don’t think there are insurmountable challenges in the world. It’s just question of time and capital allocation. So it’s certainly in scope for us to make the whole thing as simple as possible. I mean, literally the ideal way for us to do the Shopify within the network is employee teleportation. If you can figure out the physics related to that and can just make things appear on the desk right when you want them, then that would be awesome. Failing that, this is actually our starting point. This is literally the first line in the memo I wrote for SFN, and then we worked backwards towards what’s possible. Of course, the business is hard. I know you hear this from everyone in the logistics world, but it’s hard. It’s really, really, really harder than people think, even for those that know that it’s hard.

Toby: (36:48)
So there’s a lot of friction in this process, and a lot of that is hard to see right now how to avoid it. Processes can only get you so much and software can only do so much. There is headroom, but it’s finite headroom. In the end you will have to … The way you’re dealing this things going wrong is then something much more important than the quality of the processes when everything goes right. I mean obviously, everyone knows that this is true everywhere now thanks to COVID, and there is piece of writing [inaudible 00:37:28]. So we want first to [inaudible 00:37:32] friction. Logistics has a lot of it.

Toby: (37:36)
There is information. A lot of the friction exists right now in different systems not talking to each other. The systems of logistics knows how long it will take to get the package to people unless something goes really, really, really wrong, but the systems aren’t sophisticated enough to really resurface the spec to the buyer at the time when they want to purchase, and so that’s a lot of our work goes into bridging some legacy systems to modern systems. There’s a lot of machine learning that can help getting more specificity around this, and we’re chipping away one step at a time.

Speaker 3: (38:19)
Thank you, Paul.

Ariel: (38:21)
Our next question comes from Brad Zelnick of Credit Suisse. Please go ahead.

Brad Zelnick: (38:27)
Thanks so much and congrats again on all the success. Tobi, I actually want to follow up on that last question. In the past, you’ve talked about how the pandemic has accelerated e-commerce trends by a decade, and in terms of solving the problems ahead of us and things to come, there’s no doubt Shopify is capitalizing on this opportunity today, but you said these adjacencies and really, it comes down to time and capital allocation. But with $6 billion in cash why not deploy more capital to even further distance Shopify ahead of everybody else to ensure your leadership for more years to come?

Toby: (39:14)
I mean, that’s a fantastic question, and I don’t know the best way to answer that. I think we have the money in the bank for optionality, and we will use it, but there is … I mean, I think I hope that we are showing that we are prudent capital allocators, and I think actually we’re probably not the best company in the world with capital allocation. That’s from a financial thing. But I think we might be amongst the best companies in the world in attention allocation, which is actually the much more finite resource. So this is the tricky thing like. There is a lot of reductionist thinking especially about M&A, where people think that a deal ends up at a transaction time or when the money is in the bank. The opportunity cost of integrating is enormous, and so we’re trying to take a broad picture perspective, this has made us potentially more careful, but I also think just more realistic about what M&A can do for a company like in the past.

Toby: (40:31)
But we are also like rethinking every one of our previous approaches and biases as we learn from it, so it very well may be that we’re going to see a lot of things that could help us accelerate the roadmap, but that’s going to be the way to do it. We will want to accelerate our roadmap through M&A. That’s all the M&A deals we have done in this way. I’m not a huge fan of M&A for acquiring revenue, so it’s going to be the strategy going forward.

Speaker 3: (41:12)
Right. Thank you, Brad.

Ariel: (41:16)
Our next question comes from Richard Tse of National Bank Financial. Please go ahead.

Richard Tse: (41:21)
Yes, thank you. So it’s obviously been a challenging environment. Outside of the obvious operating response, has there been any change from your former strategic plans going forward because I know some organizational changes in this quarter. Perhaps you could sort of talk about that.

Toby: (41:43)
I mean, what hasn’t changed? The first thing I asked the company to do was delete our plans when COVID happened. Times of significant change are times where the most adaptable are doing well. Now, I think we have a better idea for the shape of what’s happened. We’ve seen the acceleration of e-commerce. I think we’ve seen the final truth in that’s like it’s really retail. Ecommerce is sort of … It’s a tactical channel. It all has to be combined. We saw that. This was really the content of my kick off in 2012. It was about, hey, this has all got to go together, so it’s like this was not a surprise. It was not a surprise for anyone in the industry, but we have now I think shifted a lot of what we needed to do. Like I said, we are working on a lot of really sort of detailed machine learning modeling to try to make sure that we can do an even better job forecasting demand and assessing risk and telling people when their packages arrive and all those kind of things.

Toby: (42:57)
So, we’re now going really, really deep on the various things that we’ve launched over the last half year, so now what organizationally for us? A really important thing now is to go and build infrastructure again, because I think great products … I mean, great products are basically just pick important topic and get a million tiny details right, but the only way to get details right is to be able to draw on infrastructure you’ve built and built up over years. And so this is maybe going to organizationally just make sure that we are building up the infrastructure that a company that can serve millions and millions businesses around the world can support, so there’s lots of things. This is not what I’m thinking of when I say that because there’s a million things that are related to this, but around the world thing is really important.

Toby: (43:49)
We need to spend a lot of time, for instance, on performance work. In some cases we’re now serving people in Australia from Australia, which is sort of a global deployment. This is the kind of thing, again, we can do at scale for the entire platform, but no individual retailer could really … Small and medium business, but not invest in this kind of deployment otherwise, so there’s a lot of these kind of things that we can do now because infrastructure work we’ve done a couple of years ago. And it’s really important to keep that balance that the … Infrastructure is basically a fuel that you run the engine off, and we rev the engine pretty hard for COVID, so being able to make sure we fill the fuel again.

Speaker 3: (44:33)
Thank you, Richard.

Ariel: (44:35)
Our next question comes from Walter Pritchard of Citi. Please go ahead.

Walter Pritchard: (44:40)
Hi. I’m wondering if you could update us on how you’re thinking about the marketing channel your email product that’s been out there and the partnerships, you have and sort of what impact that’s having driving the front-end. Obviously, demand is very strong generally, so may be hard to tell, but just curious how the current environment and what you’re seeing there may impact your views?

Harley: (44:58)
Thanks for that. It’s Harley, here. So, couple things. On email …

Harley: (45:03)
Thanks for that. It’s Harley here. So a couple things. On email, as you heard earlier, merchants have now sent out more than 500 million emails in Q3, and there’s now a monetization model around emails. So 2,500 emails are free and then it’s a dollar per thousand emails after that. The reason we’re doing email and the reason that we were spending time investing in the marketing channels, and generally, marketing for merchants, is that for a lot of merchants, getting the products, making the products, building the online store, building the retail model, they can do that, we’d give them the tools to do so. But finding customers is something that remains a challenge. So anything we can do that further levels the playing field, so they can have a single dashboard where they can see where their traffic is coming from, what’s converting better than other traffic sources, and therefore they can go and invest further in those channels. That is going to be helpful.

Harley: (45:55)
Tobi mentioned earlier that retail in itself is not overly complicated, but bringing it all together into that centralized retail operating system, that relieves the value of Shopify, that we take all the different pain points, all the different challenge areas, and we simplify them so that small businesses can become very large businesses on our platform in the long run. So whether it’s email or it’s new things we’re doing with Tik Tok, for example, or if any of the other marketing channels we have, what we’re trying to do is make it easier for merchants to get started and then to scale their businesses indefinitely on Shopify, and email, and some of the other stuff we’ve announced recently are just more for furthering that goal and that objective.

Great. Thanks for your question, Walter.

Ariel: (46:38)
Our next question comes from Darren Aftahi of ROTH Capital Partners. Please go ahead.

Darren Aftahi: (46:45)
Yeah good morning, guys. Thanks for taking my question and congrats on your results. Question on the mix of the domestic versus a non English speaking merchant adds in the quarter, and then I’m kind of curious about the relative conversion rate of those two segments. Thanks.

So we saw similar trends across all of the regions, very comparable to the overall trend that you saw. So it was strong internationally, as well as in our core English speaking, and the conversion numbers were similar as well.

Toby: (47:24)
I think one thing I’d like to add is, conversion numbers are one of our super and obvious things. I know they matter a lot in the enterprise space, but in the SMB space, the company might actually get significantly better, while the conversion rate goes down, because you’re feeling like your marketing is better, you’re filling more people in the funnel that’s more general interest in the topic of entrepreneurship. As people are developing their models, I would encourage not to use conversion rate as a proxy for health. [inaudible 00:48:01].

Harley: (48:04)
Yeah. One final point on that. I think many of you know, but Q3 2020, the United States had record number of new business creations, actually the highest it’s been since 2004. What we’re trying to do is we want to capture anyone who’s thinking about starting a business, whether or not they become the next Jim Shard or the next Allbirds remains to be seen, but the idea is that we want to capture anyone who has any ambition to start a business on Shopify.

Great. Okay. Thanks, Darren.

Ariel: (48:33)
Our next question comes from Brian Peterson of Raymond James, please go ahead.

Brian Peterson: (48:39)
Hi everyone. Thanks for taking the question. So Harley, I just wanted to hit on the plus strength, obviously that was strongest quarter. I’m curious, how should we think about the upgrades versus net new logos? Anything you can share on competitive dynamics. Thank you.

Harley: (48:52)
Thanks for the question. Yeah. So plus head its second consecutive record quarter of net new merchants in Q3. It wasn’t just upgrades. It was also a lot of strong new brands are the platform coming online, in some cases for the very first time. We also continue to see these replatforming from other providers, and they’re coming to us because of flexibility, cost effectiveness of the platform. What seems to be happening is that the world is refactoring off of old legacy systems to modern platforms. And you see that effect. You will see that effect on our GMV in the future with Plus. So a part of it is, we’re seeing upgrades, we’re seeing more merchants become more successful on our platform, but we’re also seeing continued migrations.

Harley: (49:33)
And as I mentioned earlier, brands like Dior or Telefonica or Jenny Craig, some of these brands didn’t sell online ever before. Some of them were migrating from legacy platforms. And with new products that we’re never developing for these larger merchants, whether it’s automation, enhancing flow to make it easier for merchants to automate their business tasks, or integrate with other platforms, or it’s the new Plus admin, which allows for far more flexibility, and the multi shop admin on itself, it’s been quickly adopted because it allows large brands to manage large organizations, have all the security that they require. And I think, as I said, I think last quarter in the earnings call, Shopify Plus remains the best solution, and certainly the best value for enterprise and fast-growing brands.

Thank you, Brian.

Ariel: (50:24)
Our next question comes from Samad Samana of Jefferies. Please go ahead.

Samad Samana: (50:31)
Hi, good morning. Thanks for taking my questions, and a great quarter. First, Tobi, we won’t factor in teleportation into economics into our take rate, but we’re hopeful you’ll get there. But for the short term, Amy, my question is, on sales and marketing, Shop is seeing incredible efficiency, with record net adds without really a material dollar increase in sales and marketing. How should we think about that S&M efficiency? And is this leverage sustainable? And maybe just, what’s the short, I guess, shorter, medium term philosophy on investing in that sales and marketing line? Thanks again for taking the question.

Yeah. So we have seen efficiencies or operating leverage on the sales and marketing line, and really first and foremost, driven by the significant growth in revenue. But also, keep in mind that with COVID, it’s reduced some of our event marketing. We’ve also been more intentional about brand and studio spend into COVID. And really, we decided to pull back on some of the brand work that we did in 2019, and focus more on meeting the immediate needs of merchants during COVID, with like the 90 day free trial instead. And actually, I would say we’re leaning into this opportunity that we see with new business formation increasing, and spending more for online marketing and some other initiatives that we’re doing, including the operation hope announcement that we made, where we see some real opportunity to widen the upper part of the funnel and continue to democratize commerce. So there is leverage there, but where we see opportunity, we’re going to lean into it.

Thanks Samad.

Ariel: (52:38)
Our next question comes from Koji Ikeda of Oppenheimer. Please go ahead.

Koji Ikeda: (52:44)
Oh, great. Thanks for taking my questions and congrats on a really great quarter. I wanted to ask you a question on take rate. Our model shows that there was really just a slight compression in the take rate quarter in this quarter, and I know it’s really nitpicking, but I wanted to ask, since we haven’t seen take rate compression in our models since 2016, and also considering there are a lot more GMV monetization levers today compared to four years ago, so was there anything meaningful that would have caused that compression in the take rate this quarter that we should be aware of?

Yeah. So let me review that with you. But first, let me start by saying we did see a compression quarter over quarter, but we still posted a healthy gain year over year in our take rate. The quarter over quarter decrease was driven by Shopify payments and payment transaction fees, and it was more a function of Q2 than anything specific to Q3. So let me walk you through Q2 first. In Q2, with the rush to online given COVID and the extended free trial that we offered, we saw two things happen. First, a jump in our GMV mix processed at the higher payment rates associated with lower cost subscription plans, our basic plan, for both Shopify payments, as well as for the transaction fee for those not on Shopify payments.

The second thing, we saw a dip in average order value in Q2, resulting in a higher fixed per transaction fee on a percentage or take rate basis. So fast forwarding to Q3, we saw a return to a mix more similar to our pre-COVID distribution with increased plus GPV mix quarter over quarter. As you know, Plus has lower payment take rates than basic, and Plus had a very strong Q3 growth in GPV. Second thing in Q3, we saw a return to an average order value to pre-COVID levels, similar to Q1, it went up versus Q2. So we fully expect our take rate will continue to rise over the long-term. And we’ve been clear that mix shifts and other movements like AOV may play a factor quarter over quarter.

Thanks Koji.

Ariel: (55:03)
Our next question comes from Ygal Arounian of Wedbush Securities. Please go ahead.

Ygal Arounian: (55:11)
Hey, good morning, everyone, and thanks for taking my question. I want to ask about SFN and as logistics obviously takes center stage a little bit more, [inaudible 00:55:23] understand. What are merchants considering when they’re thinking about SFN versus another 3PL or another shipping partner, even if it’s whether they’re fulfilling on their own versus moving to a 3PL? What’s the consideration set for them? And as you move up and look at larger merchants, what are the missing pieces? What do you need to kind of do around SFN to get your largest merchants on board? I would think that they have a lot more complexities in their needs. And then just lastly, on the same topic, the past couple quarters, you updated on kind of penetration volumes. Any update you can give around the numbers and volume during 3Q? Thanks.

Harley: (56:19)
Yeah, so the number of merchants enrolled in Q3 was fairly consistent with Q2. We’re continuing to manage enrollment. We want to build volumes at a rate that we can maintain really, really high quality standards. Demand continues to increase in the quarter, just because commerce is accelerating, but also to your point, merchants generally, and retailers generally, find that fulfillment is not something that is easy for them. Either they are not able to maintain a particular two day delivery at a reasonable price that consumers are now beginning to expect and demand. What we think we can do is we can simply… We now have about nine partner nodes operational in the US. That’s in addition to the R&D center we have in Ottawa, which opened in Q1. Four of those nodes are using 6RS technology.

Harley: (57:06)
So what we’re trying to do is we’re trying to make it so that merchants don’t have to think about fulfillment. They don’t have to think about their shipping. Now, who is going to be the exact target for SFN longer-term? Well, the nice part of having some time to experiment is that we can figure out which merchants should put which products into our fulfillment network. And it may not be for every merchant. There’s going to be smaller merchants who simply outgrow their living room as a fulfillment warehouse. There’s going to be very large merchants who simply are unsatisfied with their existing 3PLs, and we think we can attract both sides of it. But we’re trying to be, like everything else to do at Shopify, incredibly thoughtful of who we accept and how we deliver a great SFN service to them. And that’s the reason why we are taking our time and building something that we think is going to be really high quality.

All right, thanks, Ygal.

Ariel: (57:54)
This concludes today’s conference call. You may disconnect your lines. Thank you for participating and have a pleasant-

Shopify SHOP Q3 2020 Earnings Call Transcript

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