Shopify Inc. (SHOP) CEO Tobias Lütke on Q2 2022 Results - Earnings Call Transcript - Seeking Alpha

Summary

Shopify Inc. (NYSE:SHOP) Q2 2022 Earnings Conference Call July 27, 2022 8:30 AM ET

Company Participants

Shopify Inc. (NYSE:SHOP) Q2 2022 Earnings Conference Call July 27, 2022 8:30 AM ET

Company Participants

Katie Keita - Senior Director, IR

Harley Finkelstein - President

Amy Shapero - CFO

Tobias Lütke - Founder, Chairman & CEO

Conference Call Participants

David Hynes - Canaccord Genuity

Mark Zgutowicz - The Benchmark Company

Thomas Forte - D.A. Davidson

Colin Sebastian - Robert W. Baird

Paul Treiber - RBC Capital Markets

Gabriela Borges - Goldman Sachs

Daniel Chan - TD Securities

Bhavin Shah - Deutsche Bank

Josh Beck - KeyBanc Capital Markets

Katie Keita

Good morning, and thank you for joining Shopify's Second Quarter 2022 Conference Call. Tobi Lutke, Shopify's CEO; Harley Finkelstein, Shopify's President; and Amy Shapero, our CFO, are with us this morning. After their prepared remarks, 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 assumptions, risks and uncertainties in our press release this morning as well as in our filings with U.S. and Canadian regulators.

We'll also speak to adjusted financial measures, which are non-GAAP measures and not a substitute for GAAP financial measures. Reconciliations between the 2 are in the tables at the end of our 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

Thanks, Katie, and good morning, everyone. The extraordinary journey that we have been on with merchants continues. As seen in our Q2 results, we continue to grow our merchant base and GMV, and deliver more value to merchants via our mission-critical tools that prepare them well for the future. Anticipating their future needs is a key reason merchants choose us. Our multichannel platform has prepared them for the pivots of the last few years, but we do not get the future right 100% of the time. So now, for some real talk.

Shopify has always been a company that makes the big strategic bets our merchants demand of us. This is how we win. During the pandemic, we made a bet that retail spend would disproportionately favor e-commerce at a much higher pace than it has. Our belief was that the channel mix, the share of dollars that travel through e-commerce rather than physical retail, would permanently leap ahead. As we built for the digital leap, we stepped our efforts and we expanded the company accordingly. We couldn't know for sure at the time, but we did know that if the prediction came true, we would have to rapidly scale the company to meet that future.

Fast forward to now, as things have turned out differently. While the normalized rate of spend online, which is where most of our merchants orders occur, has reset certainly higher than where it was in 2019, the rate is lower than we had planned for. In short, we overshot our prediction. Recalibrating our investments and spending, we are making sure we do not sacrifice the components we feel are critical for Shopify remains in an enviable position in a massive growing market as enabler of multichannel commerce.

Amy will describe later the financial implications of how we are building for long-term success. I will speak to the investments we are making to drive top line and merchant growth by helping merchants build buyer relationships, go global, grow from first sale to full scale and simplify logistics.

Let's start with building buyer relationships. We have been investing to extend ways for merchants to connect with more buyers and deepen those relationships across more channels and services. With people shopping in stores again, e-commerce is trending back to a more normalized growth curve. We've seen incredible growth in offline GMV on Shopify as more merchants come to us to modernize their point-of-sale software. Our world-class Retail Point-of-Sale offering, which gives merchants a seamless view of their online and off-line operations, is quickly becoming the point of sale of choice.

During the second quarter, top-tier brands, including Beyond Yoga, Our Place and James Perse implemented our Point-of-Sale Pro solution for their locations. June was the best month ever for merchants adding Pro, and our Q2 offline GMV grew 47% year-over-year as we continue to take market share. This growth is even more remarkable, considering it was achieved off of a 266% year-over-year growth in online GMV in Q2 of last year as the world began reopening after the COVID lockdowns. With the vast majority of all commerce in North America happening offline, the investments we are making in Shopify Point-of-Sale this year will increase its scalability to handle a much greater number of stores, deepen integration with more third-party apps and further improve our hardware. Tap to Pay on iPhone and Google Local Inventory Sync are 2 more ways we are modernizing the offline retail experience for merchants and their buyers.

Another significant opportunity lies with consumers looking to connect with brands and purchase goods across digital services. While still a relatively small percentage of overall GMV, GMV through key partner services, including our native checkout integrations on Facebook, Google and Instagram, grew 5x over Q2 last year. We expect GMV growth through these integrations to continue as more channels integrate with us, making their platform stickier while enabling our merchants to show up where their buyers are.

For instance, we announced Twitter Shopping in late June. And just last week, we announced YouTube. Our new YouTube channel allows merchants to add a store tab to their YouTube channel that has their entire product selection and show a curated list of products below on-demand videos and to tag products during a live stream with Picture in Picture, so viewers can check out while still watching the live stream. And best of all, shoppers can round out a great shopping experience in YouTube by quickly checking out with Shop Pay.

It's far easier for a merchant to find new buyers when they have targeting data leading them to their brand's most likely new fans. By tapping the combined power of Shopify Plus merchants who opt in, Shopify Audiences is a tool that helps merchants find new customers. It's essentially a 3-step process. A Shopify Plus merchant selects the product they want to sell more of. Machine learning algorithms build an audience of high-intent buyers tailored for that product, and the audience list is directly and securely exported to the merchant's ad network of choice, which we are launching first with Facebook and Instagram.

Merchants are finding that audiences makes a real difference. They are seeing a meaningful increase in conversion rates and return on ad spend. For example, early access merchant, BlenderBottle, has seen its return on ad spend increasing as high as 6x. Another fast-growing merchant, L'AMARUE, saw a 48% uptick in its click-through rates, a 2.5x return on ad spend on its targeted campaign, and 73% of revenue from paid acquisition attributed to Shopify Audiences. All this, plus a 26% decline in customer acquisition costs. Audiences is off to a very promising start, and we're excited to see what it will do for merchants, especially ahead of the holiday selling season.

A second way we are investing in merchants is by helping them go global. International selling should be as simple as selling domestically. With our new cross-border management tool, Shopify Markets, merchants can identify, set up, launch, optimize and manage their international markets from a single store. Our own studies indicate that merchants can drive up to 40% higher conversion rates in the international regions by customizing their storefronts for each market to improve the buyer experience for customers. We are seeing strong engagement with Shopify Markets since launching it in Q1, with well over 100,000 merchants now offering a localized experience to their buyers.

Our team sales and marketing activities continue to drive expansion of our international subscriptions, and we continue to expand to the feature set available to merchants everywhere. In Q2, we launched Shopify Payments and Shopify Shipping in France, and we launched Shopify Point-of-Sale with integrated payments in Italy in Q2, which we also brought to Singapore earlier this month. In May, we introduced localized subscription pricing plans over 200 countries to better reflect this country's purchasing power and lower the financial barrier to access Shopify. This builds on last year's rollout of billing in certain local currencies, including British pounds in the UK and euros for Eurozone countries to reduce friction and encourage more international entrepreneurs to start building their businesses on Shopify.

Third, we are investing to help merchants grow from first sale to full scale. Features such as Shopify Shipping and Shopify Capital make commerce easier for entrepreneurs, while features like Shopify Functions empower merchants to extend the platform through customization. With Functions, developers can help merchants build unique experiences for consumers, starting with customized discounts. Particularly important for our larger merchants, we have significantly enhanced our B2B solution. Not only does our B2B offering allow us to penetrate our merchant base more deeply, we are also able to enter a completely new market of merchants who conduct only B2B transactions. Both segments represent immense opportunities.

Our existing base is significantly underpenetrated. We estimate over half of Shopify Plus merchants could utilize B2B, which now enables merchants to use the same store to sell B2B as they would for direct-to-consumer, and includes features like customer-specific pricing and assigned payment terms. For our non-Plus merchants who are also selling B2B, this could be a compelling recent upgrade. In Q2, we continue to see evidence of merchants growing by the number of merchants upgrading Shopify Plus as well as new merchants coming on to Plus.

New to Shopify Merchants came from across a broad spectrum verticals, driving significant growth of Shopify Plus GMV in Q2, which continues to outpace overall GMV growth. Numerous household names became Plus merchants during the quarter, including popular beauty magazine, Allure; leading athletic shoemaker, ASICS; furniture manufacturer, Ashley HomeStore; and national fitness chain, Gold's Gym. A laptop collaboration by Hewlett Packard, HP Dev One, also joined Plus this quarter, as did leading security company, Master Lock; and century-old iconic companies looking to modernize their commerce operations such as skincare brand, POND'S; and Tetley Tea, one of the world's largest tea brands.

Notable wins with celebrities looking to get closer with their fans and consumers continued as well. In Q2, we welcomed Greatness Wins, a new brand of athletic wear founded by former New York Yankees player, Derek Jeter and hockey legend, Wayne Gretzky. Also joining Shopify Plus during the quarter were Gabrielle Union and Dwyane Wade with their plant-based Proudly line. In addition, Kim Kardashian launched her new SKKN BY KIM line of spotlight skin care products. And lastly, Haley Beiber also joined Shopify Plus with a newly launched skincare essentials line called Rhode Skin. These celebrities, as well as many others, have made Shopify Plus the de facto platform to expand their personal brands and turn them into businesses and products for their millions of fans.

With the addition of B2B, expanding our partner program for ERP and systems integrators and our exceptional value proposition in an inflationary environment, we expect Shopify Plus' momentum to continue. We've also made some recent changes to our commercial organization, which tie our sales efforts more closely to our marketing investments and provide our merchants with a more consistent and intuitive growth journey. By streamlining its structure, our cross-functional groups will be better coordinated to implement a far more effective go-to-market approach. We expect that, armed with data, our teams will be better able to help merchants by selling the right solutions at the right time. We are confident these changes will generate improved cost of customer acquisition, expand merchant lifetime values, and more importantly, increase our merchants' odds of success by bringing more of Shopify to more merchants.

Last, I'll give more color regarding our fourth major investment theme, which is simplifying logistics. Our vision in building Shopify Fulfillment Network for the long term starts with simplifying the end-to-end supply chain at 3 critical stages that are really hard or close to impossible for independent businesses across freight, distribution and fulfillment as inventory moves from port to porch. When this is done well, we greatly simplify logistics for merchants and enable them guaranteed delivery times, which provides a meaningful uplift to conversion. This also feeds our flywheel of lowering the barrier to entrepreneurship within this domain.

Let's start with freight. Inbounding inventory from suppliers is incredibly difficult for independent merchants to handle on their own. Today, merchants who manufacture abroad have to work with upwards of 10 vendors to receive inventory from suppliers, ship across the ocean and receive it at ports. Even if a merchant centralizes this through a freight forwarder, many of the processes are manual and fractured, designed for big businesses with large volumes and consistent demand.

To help with this, SFN has launched a pilot program with Flexport so merchants can more easily and cost effectively inbound freight. It enables merchants to ship inventory at the pallet level versus container level, and have just-in-time access to prebook containers that deliver goods directly to an SFN hub. This prevents tying up our merchants' excess capital and inventory and allows them to remain nimble to changing buyer trends. Early pilot runs have shown that SFN merchants can expect service from origin ports up to 50% faster, with cost per pallet much less expensive than average.

Once their inventory arrives at domestic ports, merchants have to tackle the second challenge mentioned, distribution. Historically, preparing and routing inventory for distribution across multiple channels has been hard for independent businesses until now. In July, we closed the acquisition of Deliverr and have begun integrating SFN and Deliverr software, network and operations, which we expect we'll keep for several quarters.

Through Deliverr, we are accelerating the simplification of the distribution phase. The first example of this will be at our Atlanta hub warehouse. Using software and machine learning, these SFN hubs, leveraging Deliverr's capabilities, will unpack, scan and inspect all inventory, then compare against metadata in Shopify's back office throughout the goods to merchants' various distribution channels as well as forward position inventory into SFN's spoke direct-to-consumer fulfillment centers based on expected buyer demand. With this software-based approach, Deliverr is helping us expand 2-day delivery across SFN.

Deliverr already fulfills more than 1 million orders per month, and its asset-light, technology-driven service is trusted by thousands of merchants across the U.S. We are thrilled to welcome Deliverr’s experienced team of software engineers, operations experts and merchant champions to Shopify.

Finally, the third and most critical step is 2-day fulfillment and delivery. Affordable and timely fulfillment has been nearly impossible for independent businesses to do on their own, but it is important. Just getting buyers' confidence that an order will arrive when promised, even if it's 3 or 4 days, is enough to increase conversion.

By leveraging Deliverr’s software in SFN hubs and SFN's spoke partner warehouses all equipped with 6 River Systems technology, we can forward position merchants inventory to support timely fulfillment with a minimal inventory commitment for merchants.

We've also continued our early access to Shop Promise, which lets merchants offer 2-day delivery promises across online storefronts and channels like Google, Facebook and Instagram. Deliverr data suggests that as Shop Promise reaches scale, many merchants will be able to increase average conversion rates by more than 30%.

SFN made other significant strides in Q2 to simplify fulfillment for our merchants. We completed our migration of SFN merchants to the updated version of our new simplified offering. We also completed our warehouse management system rollout with 100% of SFN fulfillments processed using the 6RS fulfillment system software that is highly integrated into Shopify. Orders with predicted delivery of 2 days or less have now increased from less than 2% prior to software updates to over 70% after the updates, and we are just getting started. We are really excited about the evolution that's underway in fulfillment. When merchants and brands can provide accurate delivery timing that's guaranteed, consumers gain greater confidence in independent businesses, and that is good for commerce overall.

I know I covered a lot here from a new product standpoint. Much of this is highlighted in our first ever Shopify Editions, which we published on June 22. Featuring more than 100 product releases, Editions is our semi-annual publication, showcasing the speed and the breadth of innovation at Shopify to build for the future of commerce.

Our platform serves as the backbone for millions of merchants who depend on Shopify for their long-term growth and success. This is why every time you talk to our merchants, consistently, they tell you that they love Shopify. We are committed to solving the toughest problems facing merchants so we can continue to make commerce better for everyone.

And with that, let me turn the call over to Amy.

Amy Shapero

Thanks, Harley, and good morning, everyone. Harley provided you with an overview of everything that we are doing for merchants to succeed in any cycle, including the one we now find ourselves in of high inflation. By helping merchants find more buyers on more surfaces, saving them money by passing along our economies of scale and empowering them with mission-critical tools, I will first provide an overview of our Q2 results and then talk about how we will build for long-term success with the same operating discipline that we have always demonstrated.

Before turning first to our financial performance, note that our Q2 results were not impacted by the Deliverr acquisition given it closed this month on July 8.

I'll begin with GMV. As a reminder, last year's second quarter GMV growth was 40% year-over-year, fueled by online consumer spending on goods in large part from COVID-related government stimulus checks. Fast forward to 2022, our total GMV in the second quarter was $46.9 billion, which continued to grow year-over-year and was up 11%, significantly higher than retail growth overall in the U.S. of about 7%.

While the macro environment exited tough COVID year-over-year comps in mid-Q2, consumer spend on services and in-person shopping remained high and persistent inflation at 40-year highs dampened online sales globally. In the face of rapidly escalating prices for essential goods and energy, consumers have been favoring discount retailers and reducing their spend on other goods categories.

Our online GMV growth year-over-year was 8%, and our offline GMV grew 47% year-over-year as we continue to take share in both, thanks to multiple channels and thousands more POS locations added in the quarter.

Our revenue for the second quarter grew to $1.3 billion, 16% higher than the same period last year. Given the significant strengthening of the U.S. dollar relative to foreign currencies in Q2, total reported revenue growth year-over-year for Q2 was negatively impacted by approximately 1.5 percentage points.

Revenue growth in Q2 was driven by Merchant Solutions as merchants continue to trust us with more parts of their business in this inflationary environment. Merchant Solutions revenue grew to $928.6 million, increasing 18% year-over-year, driven by increased GMV penetration of Shopify Payments, Shopify Capital and Shopify Markets on the back of GMV growth, as well as by growing revenue from partners. The significant strengthening in the U.S. dollar relative to foreign currencies was most felt here, with Merchant Solutions reported revenue growth year-over-year negatively impacted by approximately 2 percentage points.

Approximately $24.9 billion of GMV was processed on Shopify Payments in Q2, 23% more than in last year's second quarter. Payments penetration of GMV or gross payments volume was 53% versus 48% in Q2 2021, and up 200 basis points quarter-over-quarter. Over the past 5 quarters, we've seen GPV benefit from strong performance by merchants on Shopify Payments, and an increasing percentage of which is Shopify Plus GMV, new merchant adoption both in North America and internationally, penetration gains in Shop Pay, which has facilitated $58 billion in GMV since inception, and expanded availability of our POS Pro hardware in brick-and-mortar stores with integrated payments now being used by merchants in 13 countries.

Subscription Solutions revenue grew to $366.4 million, which was 10% higher than a year ago, driven by more merchants on the platform and the strong growth of Shopify Plus, offset by a 4 percentage point negative impact on year-over-year growth from the change in app and theme revenue share model for partners that we implemented in Q3 of last year.

In May, we began making a greater number of localized subscription pricing options available to provide a better experience for our international merchants, as Harley explained earlier. And while early days, we saw promising traction in select countries as we exited Q2. We expect this to pay off in terms of more merchants from outside North America on our platform, taking more of our services over time. In Q2, merchants outside of North America continued to increase as a percentage of total merchants year-over-year.

Monthly recurring revenue was $107.2 million, up 13% year-over-year on higher number of merchants on the platform year-over-year, on Shopify Plus, which increased its share of total MRR to 31% from 26% in Q2 of last year, and on an increased number of retail locations using POS Pro.

Adjusted gross profit was $665 million compared to $627 million in the second quarter of 2021. Compared to the second quarter of 2021, adjusted gross profit was affected by a greater mix of our lower-margin Merchant Solutions revenue, lower margins in Shopify Payments due to merchant and card mix shifts and increased investments in our cloud infrastructure.

Adjusted operating loss was $41.8 million in the second quarter compared to adjusted operating income of $236.8 million a year ago, largely due to investments in talent as well as marketing program spend. The additional talent has enabled us to expand and strengthen our R&D and sales and marketing teams, significantly step up our marketing efforts internationally and initiate a new off-line performance marketing program.

While we saw a sequential quarterly increase in the year-over-year growth of operating expenses from Q1 to Q2, we took measures during Q2 to slow spend that resulted in a sequential monthly deceleration of operating expense growth year-over-year as we exited the quarter.

Adjusted net loss for the second quarter was $38.5 million or a loss of $0.03 per diluted share compared with adjusted net income of $284.6 million or $0.22 per diluted share in the second quarter of 2021.

Turning to our balance sheet. Our cash, cash equivalents and marketable securities balance on June 30 was $6.95 billion. This amount does not reflect the acquisition of Deliverr, which closed in July for approximately $2.1 billion comprising approximately $1.7 billion in cash and $400 million in Class A shares, some of which relates to post-transaction services that will be accounted for as stock-based compensation. Our strong cash position reflects our approach to prudent capital allocation and rigorous operating discipline. We allocate capital to opportunities that we expect will significantly expand the opportunity set for merchants, accelerate our product road map or have strong paybacks from improved operating efficiency.

Consistent with this, we are taking actions to recalibrate our investment spending to build for long-term success. We are keenly aware of what's happening around us. We anticipate that inflation and the continued softness in consumer spending on goods will persist through the remainder of the year. Throughout the organization, our teams are mindful of the macro environment and have been rigorously evaluating and adjusting our spending priorities. And we have taken this time to also make adjustments to ensure we have an efficient, productive and highly motivated team.

We began by conducting more rigorous reviews of our workforce throughout the organization with the aim of more fully maximizing our team's performance. This had the effect of slowing the number of net headcount additions to our team in Q2 versus Q1. Upon completion of a comprehensive and careful analysis of the company, we identified certain areas where we could improve our operations and team that resulted in the elimination of approximately 10% of Shopify's total headcount on July 26. This was an action we did not take lightly given its impact on people, both those leaving and those staying. We expect the streamlining of our workforce throughout the company and realigning our commercial organization, as Harley described earlier, will more effectively deliver Shopify's value to merchants.

For the remainder of 2022, we expect a slow hiring to only the most strategic, and with the addition of Deliverr, exit this year with only a modest increase in total headcount versus the beginning of 2022. We have recalibrated our team so we can continue to operate with rigorous discipline and invest thoughtfully into the enormous opportunity ahead of us. And we are implementing a market competitive compensation system to recruit reward and retain the best talent in the world. We believe this new framework will also better equip us to manage total compensation, both cash and equity, for our global workforce. We expect the increased cost of this new compensation system to be approximately $50 million for the remainder of 2022. While the final compensation split can only be determined after employees have made their elections with the guardrails and default settings in place, we anticipate a split between cash and stock, fairly similar to the current composition. We will provide more details next quarter after the new framework rolls out this quarter.

In addition, for the remainder of 2022, we expect to reduce spend in lower priority areas and non-core activities that we do not believe would be effective in this environment, focus our sales and marketing spend on activities with shorter payback periods and realign our support teams under a more efficient operating model.

Turning to our outlook. Since our beginning, we have grown the business with operating discipline, allocating capital to the best opportunities to help merchants grow, and have grown our adjusted operating income over the past 5 years through 2021. We expect 2022 will be different, more of a transition year in which e-commerce is largely reset to the pre-COVID trend line and is now pressured by persistent high inflation. We expect our multichannel superpowers and strong value proposition will continue to help our merchants in this environment, and we are excited about our critical investments like Deliverr that will position us well for the future of commerce. We believe we will emerge from 2022 and this macro cycle stronger, and our prospects for long-term growth and profitability remain significant. Given the long-term growth trajectory and expansive opportunity set that commerce presents and our leading position within it, earned over years of providing the best technology that merchants and partners build their futures on.

Our financial outlook for the rest of 2022, which includes the impact of Deliverr and our new compensation system, assumes that higher inflation will persist for the foreseeable future and, combined with rising interest rates, will pressure consumers' wallets for purchases of goods. In light of these assumptions, our expectations for our own results for 2022 are as follows.

Our GMV growth, though impacted by persistent inflation, will continue to outperform the broader retail market in the second half of 2022, aided by our multichannel capabilities. Merchant Solutions revenue will continue to grow as a percentage of GMV, driven by mission-critical tools like Shopify Payments, Shopify Capital, Shopify Markets, Shop Pay Installments and Shopify Fulfillment, including Deliverr, and continue to benefit from the growth of partner revenue. The number of new merchants joining the platform in the second half of 2022 will be higher than in the first half of 2022 as our localized subscription pricing and other commercial initiatives gained traction. Merchant Solutions revenue growth year-over-year will be more than double that of Subscription Solutions revenue growth for the full year 2022. Both GMV and total revenue in 2022 to be more evenly distributed across the 4 quarters similar to 2021, given the increasing pressure on consumer spending on goods and currency headwinds from the stronger U.S. dollar we are expecting in the back half of this year.

Because of this larger mix of merchant solutions contributing to overall revenue and Deliverr, which we expect to be dilutive, gross profit dollar growth will trail revenue growth and operating expense growth, excluding severance, to meaningfully decelerate in Q3, and again in Q4.

Factoring in these expectations, we expect to generate an adjusted operating loss for the second half of 2022 with Q3 adjusted operating loss, excluding severance costs expected to materially increase over Q2, reflecting time needed for the streamlining of our operations to take effect, the implementation of our new compensation framework, the first quarter of Deliverr operations, including approximately 450 team members and related integration costs, and up to an estimated $50 million for certain other operating items associated with these and other areas. As we significantly decelerate operating expense growth into Q4 and with Q4's higher seasonal GMV and revenue, we expect an adjusted operating loss in Q4 that is significantly smaller than in Q3, but larger than in Q2.

Finally, the estimates of stock-based compensation and related payroll taxes, CapEx and amortization of acquired intangibles are now $750 million, $200 million and $62 million, respectively.

In closing, we're ready to keep building the future of commerce. We will continue to prioritize building the software and solutions for merchants to enable entrepreneurs and independent merchants to compete in a world that relies increasingly on technology to succeed, and we will continue to be nimble and adjust our plans to exit the cycle with improving profitability. Our investments will help independent brands get started and compete, bring more modern selling tools for our larger brands, and equip merchants around the world with a richer set of capabilities, all of which fortify our long-term competitive position and value proposition. Over time, the investments we make now will become an integral part of our commerce operating system as Shopify advances to be a 100-year company with sustainable, profitable growth.

I'll now turn the call back to Katie.

Question-and-Answer Session

A - Katie Keita

We will now open the call for questions. As we did last quarter, please use the raise hand feature in Zoom to ask your question. We will take them in the order we see them come in. [Operator Instructions]

Our first question comes from DJ Hynes at Canaccord Genuity.

David Hynes

With the investments you guys have earmarked for SFN, I think we've got $1 billion 5-year cash neutral plan and then now, $2 billion on Deliverr. What percent of GMV do you think that will give you the capacity to manage? I think investors are trying to wrap their arms around the full scope of potential investment here, so any color along those lines would help.

Amy Shapero

Sure. We've said from the very beginning of launching SFN, it doesn't change with Deliverr that we expected to be able to address the majority, the vast majority of our North America GMV at scale. So today, we're a subset of a subset as we build and make sure that we're focusing on merchant delight. Obviously, the Deliverr acquisition adds more fulfillment volume and more merchants starting in July, which is freight. We'll continue to build the integrated network and operations and scale that, over time, to be able to address that GMV.

Katie Keita

Thanks, DJ. Our next question comes from Mark Zgutowicz from Benchmark.

Mark Zgutowicz

Just regarding your commentary on second half growth in merchants over first half, I'm curious sort of what the mix looks like there? I know you had earmarked some incremental marketing spend or acquisition spend at the lower end or the entrepreneurial segment, and I just wanted to get a sense of how that has progressed? I know that has trailed. Obviously, you've had pretty strong Plus growth, but just curious how that mix looks and how you're seeing or what progress you're seeing on the entrepreneurial segment and how important that still is in terms of broadening out your merchant base?

Amy Shapero

Yes. So we talked a little bit in the opening remarks about some -- the commercial initiatives that we have been working on, namely, the localized pricing and billing in markets outside of North America. We're really excited about that launch. It was late in May, around May 25, so it's very early days. As we exited Q2, we saw good traction in select international markets. So continue to be very excited. And as I said earlier, international merchants continued to increase in the mix year-over-year. So we -- our expectations were built into our outlook for the second half because of that.

And yes, as you said, Plus continues to do extraordinarily well. And keep in mind, that's just -- that's not just new merchants coming to Plus, that's standard merchants upgrading. We're still seeing a healthy number upgrade to Plus. We expect that to continue into the back half. And then our POS Pro locations are increasing in the thousands year-over-year, and we expect that to continue to increase into the back half.

Harley Finkelstein

One thing I would just add to that. I think some people have missed this often, but the reason that I think Plus has been successful is not just because it is the best place for existing brands to either go direct to consumer for the first time or scale or modernize their retail operations. I mentioned some big household names on -- in my opening remarks. But it's also because we have an unfair advantage that Shopify is where people go to start businesses and those that are successful, and in some cases, very successful. They migrate up to Plus and stay with us indefinitely.

So the fact that we have both existing large brands coming on but also have this feeder from the small businesses that are successful, makes Plus especially compelling.

Amy Shapero

Yes. And I might just add one more thing on the POS side. We're seeing more merchants take POS from our existing merchant base. The majority of those -- those adds are coming from the existing base, but we're also seeing a healthy number of new merchants come to Shopify for our POS product. And so there are multiple levers there that are growing our POS business.

Katie Keita

Great. Thank you, Mark. Our next question comes from Thomas Forte from D.A. Davidson.

Thomas Forte

So when you think about the long-term growth rate for your mission to enable merchants to exploit commerce-related opportunities on a global basis, how do you think about your relative growth rate for headcount? In other words, if that market is growing at a 10% CAGR, do you think you need to increase your headcount at that rate or a higher one or lower one?

Tobias Lütke

Yes. Certainly, times we are thinking about headcount this week. Well, look, I think the company wants to be highly effective. The company is not interested in having linear growth of headcount with -- at least that's not an ambition. That is -- we want this to be sublinear. And it's hard to say what, like, the natural, like, sizes or is -- that there would be some kind of formula that tells you exactly what's needed. I mean, right now, we are -- this week, we, of course, had to say goodbye to some of remarkable individuals that we've been working with, partly because we got the exact number of people we need for the current situation wrong.

So honestly, I think the best thing to think about this is we are building capability to take advantage of opportunities. And everything a software company does is about productivity, everything that the software company does is be able to automate things that need to be automated. And especially, like, Shopify has been the last 2 years very much heads down, lots of focus on R&D, roadmap shipping, as you can see with our Editions release.

And now, we are going to take the principles of organization and tooling again to the broader company and looking at all the systems. And, I mean, we found huge efficiencies in the past and things like underwriting for our capital product and obvious areas. And so we will -- this is what we are going to invest in now. And so very hard to have a specific number there, but Shopify is committed to being operationally extremely efficient.

Harley Finkelstein

There are also a bunch of things, just to add to Tobi's point on some of the automations we can do here. In May, for example, we introduced localized subscription pricing plans to over 200 countries. That automatically reflects those countries' purchasing power, and also it just makes it easier to sign up for Shopify. We added things like Point-of-Sale and Shopify Payments to new areas. Shopify Shipping in places like France, for example, so there's a lot we can do in terms of getting more international merchants to the platform that don't necessarily require more headcount but rather require us to think a little bit differently about the software. And that's been -- that's something that we're currently working on. You'll see more of that in the future as well.

Katie Keita

Great. Thank you, Tom. Our next question comes from Colin Sebastian at Baird. Colin, are you muted? Did you mute your phone?

Colin Sebastian

Yes. Sorry, can you hear me now, Katie?

Katie Keita

Yes, we hear you right.

Colin Sebastian

Okay. Yes. So sorry about that. I was just hoping you could talk a little bit more about that balance between maintaining the longer-term product initiatives while recalibrating operations. I guess the question would be, are you sacrificing anything from the roadmap given the adjustments you're making to the macro backdrop? Or is your view that you can still achieve these milestones even on a lower expense base?

Tobias Lütke

Yes. I mean, not sacrificing on anything in this.

Katie Keita

Okay. Thank you, Colin. Our next question comes from Paul Treiber at RBC. Paul, you can go ahead.

Paul Treiber

Yes. Just in the prepared remarks, you mentioned that Shopify makes strategic bets that your merchants demand of you. What's the biggest strategic bet that the company is making right now?

Tobias Lütke

Well, it's the vertical integration of logistics. It's a bet. And there are various things that we are doing on Shop. I mean, I think it's worth saying, it's a characteristic of innovative companies that they think in bets in general. Like, I mean, every -- I think starting any company is a bet that you have some insights that -- some insights that, like, different from orthodoxy but you know something better. Or you know that something is needed in the market that currently doesn't exist. That's your first bet.

And I think, sort of founder-run companies in general tend to be very bets-driven. And therefore, the growth patterns are different, right? Like especially this week, I feel it, why more managerial-run companies tend to not engage in bets. Mathematically, they make a lot of sense. Obviously, you ought to take a 20% chance at a 10x increase. But it's -- you feel it when they don't work, and it tends to be a somewhat public thing.

So I know there's generally not a lot of appetite for this kind of risk taking, but I think our company, especially as defined by us not following some kind of orthodox playbook. There's no -- this is how you put Shopify on the shelves of Barnes & Noble, and we have to make it up on the fly. And for that, we try to have a really, really good model of the world. And macroeconomics influence and -- hopefully, a lot of data points from history that are influencing these things because history is -- you will be heavier rolled up in front of you for inspection and allows you to understand how things might evolve in the future. And based on this, you make choices, in our case, as it relates to retail and e-commerce.

I think it's very, very -- it's a very, very, very easy bet to make that humans will be engaged in entrepreneurial activities. That there's going to be a lot of trade, a lot of retail, a lot of products that people innovate with and that other people want. So all these kind of things are long term with us no matter what happens. And so Shopify wants to make sure that we are helpful in any kind of way and shape this takes. And we would like Shopify to be ubiquitously helpful in all context and channels. And so this is how we make our decisions, every given one of them is one such bet, and some of them fail.

And -- but that's -- I would be extraordinary voiced to be invested into a company that isn't sometimes failing the bet because that just means they are not totally ambitious, I would say.

Katie Keita

Thank you, Paul. Our next question comes from Gabriela Borges at Goldman Sachs.

Gabriela Borges

I wanted to follow up on the commentary on the normalized trend line. Fully appreciate that Shopify can outgrow the industry. Would love to hear a little bit about your medium-term planning assumptions on what you're expecting for e-commerce industry growth? What are you hearing from your industry ecosystem partners that informs that planning assumption? And then, is there any risk that we grow below the trend line for a little bit due to macro before they come back up to trend?

Harley Finkelstein

So I think we mentioned this on the call, but what we're seeing at Shopify is both on off-line retail and in online retail, we are up growing from a GMV perspective year-on-year, the larger market. Shopify now is around 10% of all e-commerce in the U.S., and we continue to take a larger market share.

In terms of the sort of recalibration of retail, obviously, with things reopened last year, we saw more retail shift away from e-commerce directly to physical retail. But one of the things we prepared for, and we did this pretty much when the pandemic got started, was we knew that physical retail was eventually going to reopen. And so we went to work building what we think is the best Point-of-Sale physical retail product in market. And we were able to add the functionality to it, we created a new hardware for it. We also were able to expand the locations so that more merchants can use our Point-of-Sale product in more areas.

But even if you sort of just look back in the last couple of weeks and now since we've made, whether it's selling across new surface areas like YouTube, for example, or increasing our partnerships with -- with companies, with other surface areas like social media companies, what we're doing right now with TikTok and what we're doing right now with Instagram, we believe the future of retail is retail everywhere. And I think that the -- when you come to Shopify, what we are doing is we're future-proofing your business so that no matter where the additional increase in retail is coming from, where the momentum is, you can do so directly from Shopify. And so whether or not retail e-commerce in particular, obviously, is -- it continues to grow. It's still somewhere around the 15% mark of total retail in the U.S., but in places like the UK, where you're seeing far more increase in e-commerce, and that is very, very sticky.

But what we are trying to do is make it so when you come to Shopify, you never have to think about where to sell because you're able to sell across every single service area where you may have customers. And that is important. That is not something you see at other companies.

Katie Keita

Thanks, Gabriela. Our next question comes from Daniel Chan at TD Securities.

Daniel Chan

It looks like you guys have done some work on your GMV, to say that your GMV is going to outpace the growth overall retail. Just wondering whether you could share some of the findings of what your GMV is composed of, in particular, whether you can share how much of your GMV do you think is more discretionary spending than non-discretionary?

Amy Shapero

I'll take that one. So we obviously track our GMV by consumer vertical categories. Apparel, cosmetics, beauty, home goods have tended to be the mainstays and the majority of the GMV. We saw every category continued to grow in the quarter year-over-year, and what was really kind of interesting is food and beverage, which really took off during COVID, actually grew sequentially quarter-over-quarter. So you're kind of seeing the robustness of the platform ability to sell multiple kinds of goods and different environments. And so it's the combination of those and the vast variety of merchants that we can serve successfully, I think it shows the power of the platform in addition to the multichannel capabilities that Harley just talked about.

Katie Keita

Thanks, Ken -- I'm sorry, thank you, Daniel. Ken, our next question goes to you.

Unidentified Analyst

Great. Katie. So just a question around the reduction in force. One thing I've been getting asked a lot is, should investors see it as a deeper change in management's operating philosophy, so perhaps a more balanced approach to growth? Or is this simply a rightsizing of expenses to line up with the lower revenue run rate that's expected because of the normalization?

Tobias Lütke

Well, it's -- we didn't come at this from a potential perspective like we're trying to hit it sort of. Like, this is -- we build capacity for dealing with potential growth rates like -- with an accelerated growth rate.

In my letter, there is a chart, of course, which we share about the e-commerce penetration as a percentage of all of retail. If you look at that chart, you see why we needed to jump ahead in headcount, too, because there was just -- Shopify had, for instance, a lot when business are created, especially in those times where everyone had millions of questions, right? So like just from customer support and like inbound and all those kind of things, you needed people to help with us. And without that demand, like, we will converge on -- with e-commerce penetration rate having normalized back to the trend line, we are going to a staffing level where we would be if COVID wouldn't have happened.

So it's -- this is the reason. So it wasn't -- obviously, it hits the expenses because, of course, payroll is involved. But like, that wasn't the goal over imperative.

Katie Keita

Thanks, Ken. Our next question comes from Bhavan Shah at Deutsche Bank.

Bhavin Shah

Just following back up on SFN. Given the change in pace of headcount investments along with the evolving macro backdrop, is there any change in the amount or timing of the $1 billion in CapEx for SFN over the next few years? And along those lines, can you remind us of the other costs associated with the build out such as leases? And any change in pace of the investments for these costs as well?

Amy Shapero

No, there's no change in the current investments that we plan for SFN and Deliverr. I want to just remind you that the CapEx that you referred to relates to a handful of backbone self-operated hubs in key geographies that will serve a multifunction capability that we believe actually brings operating costs down and makes the network really efficient. And with the acquisition of Deliverr and their 40 partner warehouses, we'll act as spokes -- spoke warehouses as well as sort centers. And so this is a very capital-efficient plan.

We'll have more to say in the coming quarters as we bring those networks together, but there's no current plan right now to change that view.

Katie Keita

Thank you, Bhavin. Our next question comes from Josh Beck at KeyBanc.

Josh Beck

I wanted to ask a little bit about the embedded assumptions for the second half with respect to merchant. Certainly, it sounds like you're having good momentum with some of the commercial initiatives that you've put in place, I'm sure that's part of it. But I'm also curious on how you thought about business formation and retention as we do get into a little bit of a tougher macro?

Amy Shapero

Yes. I think we largely answered that this question earlier with respect to the commercial initiatives and our excitement about localized pricing and billing, and some other things that we began towards the end of Q2 that we think will provide lift in the second half in addition to Plus and POS continuing to contribute significantly.

So I don't think our answer changes there. Really continue to believe that we'll see more merchants coming to the platform in the second half than we saw in the first half. New business formation has been shown to actually increase sometimes in recessionary environments. We don't think that would be any different. And Shopify is an amazing place for merchants to be in an inflationary or a recessionary environment because of some of the things that we said in the opening remarks about passing our economies of scale onto merchants to help them make every dollar count in that type of a market.

Harley Finkelstein

The same thing goes also for the Shopify Plus merchants. The existing brands that are migrating over Shopify Plus, many of them now are using this opportunity to recalibrate and rethink exactly what they need from a commerce partner. In some cases, it's obviously cost effectiveness. In other cases, they just want to modernize our systems, and Shopify Plus is the best place to do that.

Just back to your original question, just around merchant growth. Remember, though, that it's not just more merchants coming to Shopify, it's also the merchants on Shopify are taking more of our products. We talk a lot about this sort of product usage metric, which is Merchant Solutions revenue divided by GMV. Now, that continues to increase, and we believe that you will see sequential increases from this quarter to next quarter and certainly in the next -- and certainly year-on-year. And that's not just because of Deliverr, that is happening also because of organically us adding more features and solving more problems. I mean, you've seen things like capital obviously increase in Shopify Installments, in Shopify Markets, Shopify Payments. All of these things make Shopify more and more -- the most important piece of software that these millions of merchants use.

And so it's not just more merchants, it's also more merchants taking more from Shopify. And we are the heart of their businesses, and that matters. It allows us to not only solve more problems, but it also is very good for our business.

Katie Keita

Great. Well, thank you very much, Josh, and everyone else for joining this morning. That does conclude our conference call for the second quarter of 2022. Thanks again all for dialing in. Bye, bye.

Shopify Inc. (SHOP) CEO Tobias Lütke on Q2 2022 Results - Earnings Call Transcript - Seeking Alpha
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