Shopify Q3 2022 Earnings Review: hiding behind revenue growth
Shopify (NYSE: SHOP 0.00) stock price rallied following the Q3 2022 earnings report, as investors welcomed revenue growth that exceed analysts’ estimates. However, a closer look at the company’s financials reveals a continued decline in gross profit margins, and still escalating operating expenses. The layoffs, that the company announced in July 2022, had only a marginal financial impact and the company continues to invest aggressively in scaling its existing products and launching new ones.
I guess, Shopify will continue investing with a long-term perspective in mind (as they are building a “100-year company”), even if it takes a period of losses. Let’s take a look at the financials!
If you are new to Shopify I suggest reading a profile I published last month:
👉🏻 “Shopify Profile (NYSE: SHOP): making commerce better for everyone”
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Gross Merchandise Volume
Shopify reported $46.2 billion in Gross Merchandise Volume (or GMV) for the quarter, which represents a 10.5% growth compared to Q3 2021, and a 1.5% decline compared to Q2 2022. I believe it would be fair to say that the key driver behind GMV growth was historically high inflation. For instance, inflation in the United States, the largest market for the company, exceed 8% in Q3 2022, so in real terms, GMV grew in single digits.
Gross Payment Volume (or GPV) reached $25.0 billion, which represents a 22% growth compared to Q3 2021, and a 1.5% growth compared to Q2 2022. The company attributed the growth in GPV to the strong performance of merchants using Shopify Payments, new merchant adoption, and expanded availability of Shopify POS. In the case of GPV, inflation was also a factor; however, the growth rate of 22% YoY suggests that there was a real and meaningful gain in volumes.
As you can see from the chart above, the payment penetration rate (share of GMV processed via Shopify Payments) increased from 46.4% in Q3 2022 to 54.1% in Q3 2022, or a $4.4 billion increase in absolute terms. Shopify continues to invest in Shopify Payments capabilities and expand the service availability globally (i.e. in Q3 2022 the company launched Shopify Payment in Finland, Czech Republic, Switzerland, and Portugal, as well as launched Shopify POS in Finland and Singapore).
Shopify reported total revenue of $1.37 billion for the quarter, which represents a 21.6% growth compared to Q3 2021, and a 5.5% growth sequentially. Per the earnings release, the appreciation of the U.S. dollar had a negative impact on YoY revenue growth of approximately 2%. Subscription solutions revenue grew by 11.9% YoY, and merchant solutions revenue grew by 25.7% YoY. Merchant solutions revenue contributed 72.5% of total Q3 2022 revenue (vs. 70.1% a year ago).
Revenue growth was a bright spot in this earnings report, as the reported number exceeded analysts’ expectations. As per the company’s filings, the growth was “primarily a result of Shopify Payments revenue, relating to payment processing and currency conversion fees,” which, in turn, the company attributes to the increase in Shopify Payments penetration rate and the number of merchants using the platform. As noted above, the payment penetration rate increased from 46.4% in Q3 2021 to 54.1% in Q3 2022.
One more positive development this quarter was an uptick in Merchant Solutions Take Rate from 1.98% in Q2 2022 (and 1.88% in Q3 2021) to 2.14% in Q3 2022 (this metric is referred to in the company’s materials as “Merchant Solutions attach rate”, and calculated as Merchant Solution Revenue divided by GMV). As the result, the Total Gross Take Rate (Total revenue divided by GMV) climbed from 2.76% in Q2 2022 (and 2.69% in Q3 2022) to 2.96% in Q3 2022.
In summary, Shopify managed to deliver improvements across all key revenue drivers, including growth in Gross Merchandise Volume, an increase in Shopify Payments penetration rate, and an uptick in Take Rate.
Shopify reported $662.3 million in gross profit for the quarter, which represents an 8.8% growth compared to Q3 2021 and a 1.0% growth compared to Q2 2022. Gross profit from the Subscription solutions segment grew 9.3% YoY, and contributed 44.4% of the total company’s gross profit (or $294 million), and gross profit from the Merchant solutions segment grew 8.3% YoY, and contributed 55.6% of the total (or $368.3 million).
Gross profit growth was way more modest than revenue growth with the key reason being the declining gross profit margin. Total gross profit margin declined from 54.2% in Q3 2021 to 48.5% in Q3 2022. The decline was driven by two factors: a) a higher share of merchant solutions revenue (which has a lower gross profit margin and subscription solutions), and b) a declining gross profit margin of this revenue stream (partially explained by the increasing share of fulfillment services revenues, including consolidated revenue from the Deliverr acquisition).
As the chart below illustrates, the gross profit margin for merchant solutions declined from 43.2% in Q3 2021 to 37.2% in Q3 2022, while the share of the merchant solutions revenue increased from 70.1% in Q3 2021 to 72.5% of the total revenue in Q3 2022. The company does not unpack the composition of merchant solutions revenue (and the breakdown between payments and fulfillment services), only mentioning higher processing costs due to changes in the payment type mix (processing credit cards is more expensive), and consolidation of Deliverr expenses.
While revenue growth gets all the attention, I believe it is worth monitoring closely gross profit margins; especially, given the expectation that merchant solution revenue will continue outpacing subscription solution revenue (and further diluting total gross profit margin).
The company reported $1.0 billion in total operating expenses for the quarter, which represents a 64.4% increase compared to Q3 2021, and a 19.1% increase compared to Q2 2022. In July, 2022 the company executed a round of layoffs impacting approximately 10% of the staff. Thus, Q3 2022 operating expenses include $30.5 million of severance-related costs. Excluding severance-related costs, operating expenses grew 15.5% QoQ, so the impact of the layoffs was limited given that the company operated with a “reduced” workforce for most of the quarter.
The company’s management committed to instituting operational efficiency (i.e. “exit the year with OpEx growth decelerating”), but for now operating expense growth looks really scary. It is not only the growth in absolute terms (i.e. from $354 million in Q3 2020, to $613 million in Q3 2021, to $1,007 million in Q3 2022), but the growth of operating expenses relative to the company’s revenue (i.e. from 46% in Q3 2020, to 55% in Q3 2021, to 74% in Q3 2022). Before the pandemic, in 2017-2019, the company consistently operated with an operating expense ratio of ~64%. Shopify is currently at 62% on the trailing twelve months basis.
Loss from operations increased from $4.1 million in Q3 2021 to $345.4 in Q3 2022. Shopify posted operating losses in all years of being a public company, except for 2020 and 2021. However, what is concerning, is that the company is returning to the historic level of operating expense ratio of 64%, but this time around the gross margins are falling due to a higher share of payments and fulfillment revenue, i.e. gross profit margin over twelve trailing months was 50.5%.
On an adjusted basis (that is excluding stock-based compensation and related taxes, amortization of intangible assets, severance-related costs, and litigation expenses), the company reported an Adjusted operating loss of $45.1 million.
Net Income (Loss)
The company reported a Net loss of $158.4 million, compared to a Net income of $1.15 billion in Q3 2021, and a Net loss of $1.20 billion in Q2 2022. It should be noted that in Q3 2021, Shopify booked a net gain of $1.34 billion on its investment in Affirm (NASDAQ: AFRM) and Global-E (NASDAQ: GLBE). The same investments lead to a $1.02 billion net loss in Q2 2022 and a $171.9 million net gain in Q3 2022. Shopify became an investor in Affirm and Global-E, as an incentive for partnerships (i.e. partnership with Affirm on Shop Pay Installments).
The Adjusted Net Loss was $30.0 million, compared to the Adjusted Net Income of $102.8 million in Q3 2021, and the Adjusted Net loss of $38.5 million in Q2 2022. As the table below illustrates, key adjustments that Shopify makes in calculating the Adjusted Net Income are stock-based compensation and net (gain) loss on equity investments discussed above. Shopify reached profitability on an adjusted basis in 2017, and it seems like the company is returning to an adjusted net loss in 2022.
At the end of Q3 2022, Shopify had $4.9 billion in cash, cash equivalents, and marketable securities, which was $2 billion less than at the end of Q2 2022 (reflecting a $1.7 billion cash portion of the Deliver acquisition price).
Things to Watch
GMV vs. Revenue growth. Revenue growth was definitely a bright spot in this earnings report. Gross Merchandise Volume growth (11% YoY) was clearly “boosted” by inflation, but the revenue growth (22% YoY) outpaced GMV growth thanks to higher take rates. Shopify has been consistently increasing its take rates (primarily by upselling Shopify Payments) during the last couple of years. Let’s see if this trend continues.
Gross margin vs. Operating expenses. The gross profit margin and operating expenses ratio are moving in opposite directions. Thus, while the company’s gross profit margin has been declining (due to a higher share of payments and fulfillment revenue), the company’s expense ratio has been steadily increasing toward the historic average. The company’s management committed to decelerating expense growth, but let’s see what this means in practice.
Continued product innovation. Despite negative sentiment and a clouded economic outlook, Shopify continues to innovate, expand its existing products globally and pursue new opportunities. Some initiatives are proven winners (i.e. Shopify Payments), while others should be treated as bets (i.e. Shopify Fulfilment Network). It is always fun to listen to Shopify earnings calls, and I hope the company stays true to its innovation DNA.
In summary, revenue growth has probably restored investor enthusiasm about the company, and the share price rallied following the earnings reports. However, objectively, revenue growth might have overshadowed the problems of the declining gross profit margin and (still) escalating operating expenses. Looking forward to the next quarterly earnings report!
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Source of the data used above: Investor Relations
Disclosure & Disclaimer: despite rocky performance in 2021 and 2022, I own shares in several companies covered in this newsletter, as I am extremely bullish on the long-term transformation in the financial services industry. However, none of the above is or should be considered financial advice, and you should do your own research.