Shopify - Q2 2023

Transcript

Operator (participant)

Good afternoon, thank you for joining Shopify's second quarter 2023 conference call. Harley Finkelstein, Shopify's president, and Jeff Hoffmeister, our CFO, are with us today. 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 are 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 afternoon, as well as our filings with the U.S. and Canadian regulators. We'll also speak to adjusted financial measures, which are non-GAAP and not a substitute for GAAP financial measures. Reconciliations between the two are in the tables at the end of our press release.

Finally, we report in U.S. dollars, so all amounts discussed today are in U.S. dollars unless otherwise indicated. With that, I will turn the call over to Harley.

Harley Finkelstein (President)

Thanks, Carrie. Good afternoon, everyone. Back in June, Shopify entered its eighth year as a public company and seventeenth year in existence, an incredible testament to the resilience of our merchants who propel the economy and our team that shows up every day to help power their success. While a lot has changed since 2006 across the consumer landscape, commerce, and Shopify, our commitment to solving the biggest challenges in commerce remains front and center as we ship more products and solutions to make commerce better for everyone. As a founder-led company, Shopify contains a distinctive mix of passion, vision, and entrepreneurial spirit that drives innovation and a deep understanding of our customer base. In our 17-year history, we've demonstrated our commitment to investing in innovative solutions that simplify commerce and add value for merchants everywhere. Our Q2 results are clear proof points.

Revenue growth accelerated to 31%. Our product attach rate continued to expand, and we delivered our 3rd consecutive quarter of positive free cash flow, which we expect to continue to trend even higher throughout the rest of the year. We are quickly positioning ourselves to build on the momentum we are seeing across our business, making purposeful changes that support our core focus on commerce and unlock what we believe is a new era of data-driven entrepreneurship and growth. An era where AI becomes the most powerful Sidekick for business creation. Commerce is available everywhere, anywhere, and always, and Shopify's cutting-edge solutions will enable more businesses, large and small, local and global, to achieve even greater success. Last quarter, I talked about the evolving shape of the larger commerce ecosystem and changes we have made at Shopify to meet that moment.

We are already well underway in operating within the new shape of Shopify, a shape that can execute with greater speed and agility on a much larger scale to ship products faster, to bring more merchants onto the platform, and further supercharge our merchants' growth for years to come. To do this, we remain committed to the areas where we can add the most value for our merchants, including expanding from first sale to full scale, building consumer relationships, and going global. Let's dive into each area and the key accomplishments we are driving to execute on the massive opportunity ahead. Starting with helping our merchants expand from first sale to full scale, we recognize the immense potential of AI to transform the consumer landscape and commerce more broadly, and we are committed to harnessing its power to help our merchants succeed.

We believe AI is making the impossible, possible, giving everyone superpowers to be more productive, more creative, and more successful than ever before. Of course, we are building that directly into Shopify. In our Editions last week, we unveiled Shopify Magic, our suite of free AI-enabled features that are integrated across Shopify's products and workflows. Everything from inbox to online store builder and app store to merchandising, to unlock creativity and increase productivity. One of the most exciting products we will be launching soon in early access is our new AI-enabled commerce assistant, Sidekick. Powered by Shopify Magic, Sidekick is a new chat interface packed with advanced AI capabilities purposely built for commerce. Merchants will now have a commerce expert in their corner who is deeply competent, incredibly intelligent, and always available.

With Sidekick, no matter your expertise or skill set, it allows entrepreneurs to use everyday language to have conversations that jumpstart the creative process, tackle time-consuming tasks, and make smarter business decisions. By harnessing a deep understanding of systems and available data, Sidekick integrates seamlessly with the Shopify admin, enhancing and streamlining merchant operations. While we're at the very early stages, the power of Sidekick is already incredible, and it's developing fast. By integrating AI directly into Shopify, we are providing businesses with the most modern tools that will enable them to make data-driven decisions, optimize their operations, and ultimately achieve greater success from first sale to full scale in today's competitive market. That's just the beginning. As commerce has continued to evolve, pushing transactions far beyond the traditional retail or online stores, we are building the right tools for commerce to be available everywhere, anywhere, and always.

That is one of our superpowers, and why merchants of all sizes are coming to and building their future on Shopify. We've enabled our merchants to reach a larger base of audiences through deep partnerships with social platforms, apps, and creators. Q2 GMV through these channels nearly doubled year-over-year as merchants are adopting these new ways of reaching customers. It's really about leveraging our scale and the breadth of growing brands across the platform to unleash new opportunities that simply do not exist if you are not on Shopify. We are fueling the Shopify flywheel with things like our recently launched Shopify Collective, which creates new pathways for our merchants to not only sell their products, but also each other's products. Collective allows retailers to discover and sell from other top Shopify brands who will ship directly to their customers.

allowing them to expand their product offering without the cost and risk of buying inventory. This seamlessly aligns with the advancements we are making in establishing our wholesale presence, which we refer to as our B2B on Shopify offering. With B2B GMV up 61% in the first half of 2023, and over 45 customizable features tailored to the unique needs of wholesale businesses launched in the past year alone, we are getting traction. Some of the most well-known consumer brands around the world, including Kraft Heinz Company, Brooklinen, and Momofuku, have all adopted this product. We are working hard to create advanced features for B2B that we think will change how the industry works and help merchants grow in this area. Features like volume pricing, company account requests, and personalized storefronts are all seamlessly integrated into our core platform.

This makes the wholesale buying process better and makes it easier to find and win over potential wholesale customers. Even though B2B currently makes up a small portion of our revenue, it represents a huge untapped potential for Shopify and is a channel that we know is especially important for our enterprise-level merchants. It not only allows us to deepen our engagement with our existing merchants and help them grow this channel, but it also opens up opportunities to serve a new group of merchants who solely conduct B2B transactions. Within retail, our momentum continues. In Q2, offline GMV increased 23% year-over-year as we won larger multi-location merchants across the 14 countries where Shopify point-of-sale operates today.

Compared to even a year ago, our deep investment in our point-of-sale platform, coupled with transformation in our go-to-market process, are enabling us to sell our retail offering more effectively, especially with larger merchants. Among Shopify point-of-sale retailers with more than 20 locations, their Q2 GMV grew over 120% year-over-year, with more than 70% of their GMV coming through Shopify Payments, demonstrating our ability to monetize as we move upmarket. The work we have been doing to transform our go-to-market engine resulted in our Q2 retail point-of-sale business, delivering the highest quarterly GMV wins ever, and we believe our momentum is only growing. In addition to bringing on more new brands to point-of-sale in the quarter, we're also seeing existing merchants expand their retail presence, with brands like REEF adding more locations in the quarter.

We are also enabling online-first Shopify merchants, like Babylist, to venture into physical retail by opening their first flagship store, powered by Shopify Plus point-of-sale. Bringing all of the capabilities that we offer for online to point-of-sale remains a big opportunity for us, especially as our retail offering represents additional pathways to bring even more merchants and customers into the Shopify flywheel. One example of that integration is Shop Pay Installments for point-of-sale. This feature allows retailers using Shopify point-of-sale to offer their in-store shoppers the same flexible buy now, pay later options that they offer their online shoppers. Early results show a 5x increase to retail average order value from Installments transactions compared to standard in-store transactions. Beyond driving larger purchases, Shop Pay Installments is a major step towards increasing buyer attribution for offline sales, as all in-store Shop Pay Installment orders are associated with a customer.

More known buyers means more opportunity to build relationships and drive repurchase activity, which fuels our merchants' growth. Two years ago, we launched Hydrogen and Oxygen to give merchants that wanted to go headless an easier development path that would help them get to market faster. Hydrogen, our React-based toolkit, is a front-end web development framework used for building custom storefronts. This product just passed an incredible milestone, hitting the $1 billion in cumulative GMV mark, with 2023 GMV so far this year already 2x as much as we did in all of 2022, validating Shopify as their trusted commerce partner in their shift towards headless commerce. Beyond shipping great products and building more products for every level of complexity, from first sale to full scale, we have also been transforming our go-to-market engine.

Led by Bobby Morrison, our Chief Revenue Officer, over the past year or so, our team has been working on implementing new tactics, KPIs, and capabilities to accelerate sales, reduce costs, and ensure merchant success. It's working. In the past two quarters alone, we have seen sales volumes across key products like capital, retail, and payments gain momentum, leading to some of the highest cross-sell volumes we have ever achieved. That's not all. We're implementing an end-to-end sales process and methodology that's designed for increased effectiveness and efficiency, tailored to various merchant segments and industries, and consistently enabled for scalable execution throughout the revenue cycles. Shopify's go-to-market strategy is operating at an unprecedented level. Whether it's attracting new customers to the Shopify platform, delivering ongoing value to existing customers, or encouraging current customers to utilize more of Shopify's offerings, our team is working tirelessly and executing effectively.

With this powerful go-to-market engine beginning to fire on all cylinders, we are seeing more brands come to Shopify across the spectrum, from entrepreneur to enterprise. In particular, we continue to bring more of consumers' favorite brands to Shopify, including recently signed deals with women's fashion and apparel company, Soft Surroundings, beauty and skincare brand, JAFRA Cosmetics, boots and accessories company, Hunter, and Meta, who will sell Quest through integrations Shopify has with multiple channels. We also saw brands launch in the quarter, including subscription bellwether, Dollar Shave Club, workwear retailer for women, New York & Company, baked goods manufacturer, Mrs. Fields, as well as international launches, including Paris Fashion House, Nina Ricci, owned by Puig, international sites for American headwear company, New Era, along with more brands from CPG giants Nestlé and Unilever. Our platform remains the go-to for top celebrities and creators to build their brands.

In July, Taylor Swift launched her Eras Tour merch shop with us, experiencing unprecedented volume of sales and site visitors on launch day. We were ready for it, proving once again that our infrastructure is scalable, flexible, and most importantly, reliable. That same week, musician Drake released his new store, Drake Related, using our new product, Shopify Collective, that I mentioned earlier. Finally, MrBeast, one of the world's most popular YouTubers, revamped his store using one of Shopify's out-of-the-box free themes. This showcases the immense value, accessibility, and scalability we've integrated into every facet of our business. These brands, along with many others, are recognizing that the speed at which we deliver products and innovate is unmatched. We help them prepare for the future in a world where technology, customer needs, and markets are changing quickly.

Next is building consumer relationships, starting with Shopify Checkout, which has proven to be the best-converting checkout on the internet. We've invested and evolved our platform because we know that not all checkouts are created equal. Ours converts better. While we have known for years that our checkout is the best, a recent external study from a leading global management consulting firm has confirmed it. In fact, Shopify's overall conversion rate outpaced the competition by up to 36%, and on average, 15% more than others. The April study also revealed the power of Shop Pay, the highest-converting accelerated checkout on the internet. The data shows that the mere presence of Shop Pay, even when it is not used by a buyer, can boost lower funnel conversion by 5%, and when it is used, can lift conversion by as much as 50% versus guest checkout.

With our accelerated checkout outperforming all other major players by nearly 10%, it is now a competitive disadvantage not to be on Shopify. Even as powerful as our accelerated checkout has become, we know every second matters when it comes to making a sale, that is why we introduced Sign in with Shop. This enables customers to use their Shop account to log into merchant online stores. By signing in with Shop, shoppers can access their customer account, speed through checkout with pre-filled payment and address details, and unlock discount codes that will automatically be applied at checkout. By lowering friction and giving faster access to payment details, Sign in with Shop is making the internet's best-converting checkout even better. Shopping behavior continues to shift to mobile, with over 70% of online checkouts happening on phones and other small screen devices in Q2.

With this shift, we've seen major brands like Thrive Causemetics, Vessi, and Todd Snyder launch custom Shop storefronts to optimize this shift. We can expect even more brands to follow. Not only because the Shop app offers an immediate, out-of-the-box mobile storefront, but also because they can tap in the rapidly growing audience of buyers to reach and retain new customers. For the quarter, Shop Pay facilitated $11 billion in GMV. That's up 37% year-over-year, and cumulatively, $98 billion since its launch in 2017. As of today, we have now surpassed $100 billion in cumulative dollars through Shop Pay, which is an incredible milestone for the company. Moving on to going global.

Our international solutions make it easier for our merchants to take their business to any customer around the world, and we continue to invest in helping merchants of all sizes start and scale their global business, all from within their Shopify admin. During the quarter, approximately 15% of total GMV were cross-border sales, supported by the continued adoption of our markets and Markets Pro offering. In the EMEA region, the rate of new merchant growth continues to surpass that of North America, contributing to the strong growth we witnessed in Europe in the quarter. This was led by Germany, France, Spain, and Italy, all of which experienced GMV growth exceeding 40%.

With our Markets Pro offering, which is still in early access and slated for a rollout later this year, we make it easy to expand our merchants' business to over 150 markets, all within a single view in the Shopify admin. We are simplifying the onboarding experience, expanding shipping support, and enabling Shop Pay to all international purchases to continue to enhance the product even further. As a result, more and more merchants across all sizes, from SMB to Plus, are adopting it, and we are excited to bring it to all our U.S. merchants later this year. On top of that, we continue to upgrade capabilities that give merchants more control when selling internationally. Merchants can now effortlessly tailor different experiences and product assortments for various markets.

An apparel merchant like Vuori can promote a summer collection in the U.S. and a winter collection in Australia at the same time, all from their online store. Our work here includes features like smart order routing, multi-currency payouts, and market support for Shopify Functions. These enhancements significantly benefit our merchants, making their global expansion goals more attainable, simpler to navigate, and more customized for each customer in every market that they penetrate. In closing, Shopify is rapidly strengthening its position as a leading enabler of global commerce and entrepreneurship. We have successfully established and expanded our unified commerce platform that has continuously gained the trust of our merchants, attracted new merchants, sped up our momentum, and broadened our market presence.

The new shape of Shopify is enabling us to make faster decisions, flex with the rapid pace of technology, and deliver innovative solutions that increase our merchants' odds of success. What's most exciting is that even after 17 years and all the changes we have made recently, we know that the opportunities for Shopify are only growing. Whether that's online or in person, SMB or enterprise, direct-to-consumer or wholesale, domestic or global, we are positioning ourselves to capture it all by innovating, pushing boundaries, and leaning even deeper into our mission to make commerce simpler, easier, more democratized, more participatory, and more common. With that, let me turn the call over to Jeff.

Jeff Hoffmeister (CFO)

Excellent. Thanks, Harley. We had another quarter of strong financial results. We are shipping products faster, growing our merchant base, expanding around the world, and improving our profitability. All of these factors contribute to our flywheel and ensure that we continue to build the best product in the world to make commerce better for everyone. Let's dive into our Q2 results, starting with GMV. GMV in Q2 was $55 billion, up 17% year-over-year, as merchants delivered another strong quarter of growth.

We achieved this GMV strength primarily through growth in our merchant base globally, with such being the largest driver of GMV outperformance this quarter, continued resilience of our merchants' consumers, with strength in Europe being particularly notable, not only in terms of the durable same-store sales strength of our existing European merchant base, but even more so on the new merchant acquisition front, and same-store sales growth for our existing merchants. Revenue for the second quarter was $1.7 billion, up 31% year-over-year.

Key contributors to our revenue growth included the GMV strength just discussed, the growth in our merchant solutions business, which was itself driven by a combination of increased penetration of payments and continued growth across a broad number of solutions, including capital and installments, growth in subscription solutions from adding more merchants, two months of contribution of Deliver revenue, which contributed approximately 3 points of the 31 points of growth in the quarter, and subscription pricing changes. Revenue in the second quarter outperformed our expectations, primarily driven by 2 things: stronger adoption of higher attach rates across our merchant solutions product suite, including payments, penetration, and capital, and more robust merchant retention after our recent pricing change. Our product attach rate, which is defined as revenue divided by GMV, is a key performance indicator of our business and our ability to generate greater value for our merchants.

Merchants continue to buy more and more solutions from us, which speaks to both the traction of new products and the trust that merchants put in us. In Q2, our attach rate was 3.08%, or 3.01%, excluding Deliverr. Continued gains in GPV were the largest contributor to year-over-year growth in our attach rate, along with growth in Shopify Capital and gains in newer products, including Markets, Installments, and our tax product. Moving to our revenue streams, starting with merchant solutions. Q2 Merchant Solutions revenue was $1.3 billion, increasing 35% year-over-year, with nearly half the increase due to the growth in GMV. Additionally, growth was driven by continued penetration of Shopify Payments, the partial quarter of contribution from Deliverr, and strength in some of our other solutions, particularly Shopify Capital, Markets, and Installments.

$31.7 billion of GMV was processed on Shopify Payments in the second quarter, 27% higher than in the second quarter of 2022. The penetration rate of Shopify Payments as a percentage of GMV was 58%, compared to 56% in Q1 of 2023. Several factors drove the quarter's higher gross payments volume compared to the prior year, including the strong performance by those merchants utilizing Shopify Payments, an increasing percentage of which are Shopify Plus, new merchant adoption across the globe, greater penetration of Shop Pay, and continued growth of our integrated point-of-sale solution in physical retail stores. Subscription solutions revenue was $444 million, up 21% over Q2 of 2022, primarily due to the growth in the number of merchants on both our Standard and Plus plans.

The increase was also driven by the price increases for the existing merchants on our standard pricing plans that went into effect in late April and growth in our variable platform fees. Q2 MRR was $139 million, up 30% year-over-year. The pricing change was the largest contributor of growth in absolute dollars in the quarter. We saw year-over-year and quarter-over-quarter growth in MRR across each of Standard, Plus, and Point-of-Sale. All three segments are performing well. Our Plus merchants, as a percentage of total MRR, decreased to 29% from 31% in Q2 of last year, but that decrease was simply a function of the growth in our standard MRR from the pricing change. Let's talk a little bit more about the pricing changes that went into effect for our existing merchants at the end of April.

Merchants spoke loud and clear regarding their trust in the unmatched value that Shopify provides through our unified commerce platform. We are seeing our merchants continue to remain on the platform rather than using the price change to move off platform and largely remain on monthly plans versus moving to annual. For Shopify, it provides us with more gross profit dollars to invest back into the business, balanced with improved profitability. For the rest of the year, we expect these pricing changes to continue to benefit our subscription solutions business and MRR. Moving to gross profit. Gross profit was $835 million for the quarter, up 27% year-over-year. Gross margin for subscription solutions was 80.9%, compared to 76.7% in Q2 of 2022.

Our subscription solutions gross margin increase was driven primarily from hosting and support efficiencies, with pricing changes also having a positive impact. Gross margin for merchant solutions was 38.1%, compared to 40.3% in Q2 of 2022. Our merchant solutions gross margin was primarily affected by the dilutive impact of Deliverr. Excluding Deliverr, our merchant solutions gross margin was essentially flat year-over-year, as the same factors we experienced in the first quarter, including growth of our lower-margin Shopify Payments business, were offset by growth in other higher-margin merchant solutions, including Capital, Installments, and FX revenue. This brings our overall Q2 gross margin to 49.3%, compared to 50.7% in the prior year. Excluding the dilutive impact of Deliverr, gross margin in Q2 increased year-over-year, driven by our higher-margin subscription solution business.

OpEx on a GAAP basis were $2.5 billion for the quarter, which includes $1.7 billion in one-time charges, comprised of $1.3 billion on the impairment on the sale of our logistics businesses, $165 million in accelerated SBC, also pertaining to the sale of our logistics businesses, and $148 million related to severance. When you exclude these items, our Q2 OpEx were $818 million, down from $846 million in Q2 2022. The decline year-over-year was driven largely by lower marketing expenses this past quarter, as we maintained strict discipline around returns on marketing spend.

Moreover, the $818 million is a sequential quarterly decline of 10% compared to Q1 2023 operating expenses of $910 million, all while revenues were up 12% sequentially Q1 to Q2. We have reset the bar for the scale that we can deliver off of a more consistent operating expense base. The sequentially lower expenses are primarily a result of Q2 having only one month of the higher headcount and two months of the expenses from the logistics businesses. Operating loss was $1.6 billion, which includes a $1.7 billion for impairment, SBC acceleration, and severance that I just mentioned. Excluding these charges, operating income was positive for the quarter, compared to a loss of $190 million in Q2 of 2022.

Stock-based compensation for Q2 was $280 million, or $115 million, excluding the $165 million for the SBC acceleration related to the sale of our logistics businesses. This compares to $139 million for the same period a year ago, primarily driven by the lower headcount. Adjusted operating income for the quarter was $146 million. Capital expenditures were $21 million for the quarter. We have now delivered three consecutive quarters of free cash flow, delivering Q2 free cash flow of $97 million, or 6% of revenue. Turning to the balance sheet, our cash and marketable securities balance was $4.8 billion as of June 30th, we had a net cash position of $3.9 billion after consideration of the outstanding convertible notes.

Before moving to our Q3 outlook, some comments regarding the completed sale of our logistics businesses and what it means for us as we look ahead to the back half of 2023. We are now approximately two months post the closing of the transaction. We continue to work closely with Flexport on the integration in order to make it easier for our merchants to access fast and reliable logistics solutions. While we are still working through the terms of the commercial agreement, we are pleased with how the transition has gone thus far and are excited to be a part of Flexport's mission moving forward. Let's take a moment to discuss how the sale of the logistics businesses will impact our financials in terms of comparability for the third quarter.

We expect a headwind of approximately 300-400 basis points of revenue growth in Q3 related to the lapping of our logistics businesses. This results in approximately 300-400 basis points of tailwind to our gross margin rate compared to Q3 of last year. With that in mind, our expectations for the third quarter are as follows: First, on revenue. We expect our third quarter revenue to grow at a low 20s % rate year-over-year, which translates into a year-over-year growth rate in the mid-20s when you adjust for the 300-400 basis points headwind from the sale of our logistics businesses. We anticipate pricing changes, along with adoption of our merchant solutions products, led by payments, will continue to drive our strong top-line growth.

Q3 gross margin percentage is expected to be approximately 2-3 percentage points higher than our Q2 2023 gross margin of 49.3%, driven by a full quarter of benefit from the sale of our logistics businesses and a full quarter of benefit from the pricing changes. We believe that our Q3 operating expenses will be flat to up slightly compared to our Q2 operating expense dollars of $818 million, when excluding one-time items from Q2. Lower headcount and the removal of the logistics operating expenses are expected to be counterbalanced by targeted increased investments in marketing and the impact of our standard employee compensation review cycle. Starting with marketing. I mentioned earlier in my remarks regarding the Q2 results, that lower marketing spend was a leading cause for the year-over-year Q2 OpEx decrease.

Over the past few quarters, we have done a lot of work analyzing our return on marketing dollars, including tightening payback periods, assessing where our marketing dollars are having the most impact, automating where possible, and reducing our spend. This work has also highlighted some areas where we think we should invest more based on the strong paybacks we are seeing and the opportunity to support the success and momentum in our business. In Q3, we expect to increase marketing spending in two areas in particular, where we historically spent limited amounts and where we are seeing strong returns: point of sale and offline marketing. For point of sale, Harley talked through the strength in that business, and we plan to lean in further.

Regarding offline marketing, we have utilized offline marketing in North America and now see an opportunity to replicate that playbook in Europe, which, as I mentioned, this year, has been a source of GMV strength for us. Talent and compensation. We just went through a compensation review cycle, as it had been almost a year since we last did that process, specifically, not since the FlexComp rollout last September, and we will see some compensation increases for existing employees in Q3 as a result of that comp review. That said, we will continue to be extremely disciplined regarding our approach to talent and compensation. Q2, excluding one-time items, achieved significant operating expense savings, largely driven by the quarter, including only one month of the higher headcount. Q2's results already reflect approximately 2/3 of the impact to our OpEx base.

As a reminder, the $818 million in Q2 OpEx, excluding one-time items, is a sequential quarterly decline of 10% compared to Q1, all while revenues were up 12% sequentially Q1 to Q2. While we expect Q3 operating expense dollars to be flat to slightly higher than Q2, our Q3 operating expenses on an absolute dollars basis are expected to be lower than Q1 of this year and each of Q2, Q3, and Q4 of last year, excluding any one-time items in those quarters, demonstrating our commitment to driving increased productivity and efficiency across our teams with a disciplined approach to our spending. Moreover, the flat to slight increase in Q3 operating expenses relative to Q2 should be kept in context with the continued growth in revenue scale. Moving to stock-based compensation. SBC is expected to be approximately $110 million in Q3.

We now expect capital expenditures to be approximately $45 million for all of 2023, which includes $33 million that we incurred related to logistics in the first two quarters of the year. This reduction in capital expenditures expectation versus our previous outlook is driven by changes in our expectations related to leasehold improvements for some of our office spaces. Some due to timing and some due to a reduction in total planned spend. Just as with OpEx, we continue to be diligent in our spend as we look to drive strong free cash flow. Finally, we expect free cash flow for Q3 to be higher than the entire first half of the year. In closing, Shopify is moving quickly to capitalize on the momentum we are seeing across our business. Our pace of new product introduction remains excellent.

We highlighted some of the additions from additions, including Sidekick, Shopify Magic, Collective, and the extended functionality of Checkout, among others. We talked about how we continue to see success in our point-of-sale business and how we continue to enhance that solution in order to allow merchants to offer in-store shoppers the same flexibility that we offer online, with the integration of Shop Pay Installments as the latest manifestation of that. We are constantly evolving to meet the changing needs of our customers, expanding our solutions across channels like B2B and point of sale, while making it easier and faster for our merchants to make a sale with our accelerated checkout and login with Shop features. The top-line growth of our business remains very strong.

Our focus on operating expenses remains unwavering, and our free cash flow generation continues to strengthen, now with three consecutive quarters of positive free cash flow. As we lean into the new shape of Shopify, we believe that we will be able to execute with even greater speed and agility on a much larger scale, and deliver a business model that achieves a compelling combination of growth, operating leverage, and free cash flow generation. With that, I'll now turn the call back over to Carrie for your questions.

Operator (participant)

We will now open the call for your questions. Please use the Raise Hand feature in Zoom to ask your question. If you are dialing in by phone, you will need to press star nine to join the queue and star six to unmute yourself. We ask that you limit yourself to one question, so we can try to get to as many questions as possible. Our first question comes from Richard Tse at National Bank.

Richard Tse (Managing Director and Technology Analyst)

Yes, thank you. You know, in light of the recent pricing changes that have been quite successful, how do you think about extracting increasing value from your customers as you add meaningful features like Shopify Magic going forward?

Harley Finkelstein (President)

Hey there, it's Harley. I'll take that question. Look, in terms of the pricing increase, that was, you know, that increase we did a couple of months ago, that was the first increase we've done in a very long time, and we saw that, you know, merchants were absolutely willing to pay for it, which I think evidences that the value to cost ratio of Shopify, the product, is very much on the side of value. Certainly, there is opportunities for us to continuously review our pricing and figure out where the right pricing is, and we, we, we will continue to do that. In terms of, you know, features like Magic and Sidekick, which we're really excited about. Remember, when our merchants do better, Shopify does better.

That's the, that is the business model, and so the more they can sell, the faster they can grow, the, the more we can share in that upside. The other part that we talked about on, in the prepared remarks, that just worthwhile mentioning again, is that product attach rate. The fact that we're still, that we're growing that, that we're still above 3%, which, which is, you know, which is really high. It means that as we introduce new products, new merchant solutions, whether it's payment solutions, shipping, things like audiences, anything, you know, anything like collabs, collective, more of our merchants are taking more of our solutions. That is very important because it means that Shopify is becoming the most important piece of software that, that the millions of merchants on the platform use.

We were happy to see that merchants felt that the additional increase in price was still really good value for the product.

Operator (participant)

Thank you for your question. Our next question comes from Gabriela Borges at Goldman Sachs.

Gabriela Borges (Managing Director and Software Equity Research)

Good afternoon. Thank you. Jeff and Harley, I wanted to follow up on how you're thinking about the long-term margin profile of this business, given your comments on the 3 positive quarters of free cash flow and the exit of logistics. Would love to hear your thoughts. What sort of free cash flow or EBITDA margin profile do you think Shopify can support long term? Thank you.

Jeff Hoffmeister (CFO)

Yeah, Gabrielle, thanks for the question. We obviously gave some guidance on Q3 in terms of how we think about gross margin, and you saw in terms of the movement we saw in our margins on the subscription solution side, very positive, up 400 basis points over the quarter. We talked obviously about some of the margins on the merchant solution side, which with the removal of logistics, obviously, those will be some strong tailwinds for us. We, we haven't obviously given guidance as it relates to Q4 or long term in terms of what the operating model looks like.

You can sense clearly, though, from what we've said about margins on both of those pieces, both subscription solutions as well as merchant solutions, that we've gotten to a gross margin profile, which is more similar to where we were, for example, Q1, Q2 of last year, before we got into logistics. Our goal is to, as I alluded to when we were talking about operating expenses, continue to make sure that we stand with this, I guess, step function, I would say, that we've done in terms of when I talked about the 10% sequential decline in operating expenses and the 12% sequential increase in revenue. Talking about a new ratio between those two in terms of how we can sustain that going forward, and continue to make sure we're doing as much as we can with every OpEx dollar.

I'd love to give you more clarity on what the long-term margin looks like, but I think as you look at Q3, it's a pretty good snapshot for what the future looks like based on the removal of logistics.

Operator (participant)

Thank you for your question. Our next question comes from Keith Weiss at Morgan Stanley.

Keith Weiss (Managing Director and Head of U.S. Software Research)

Awesome. Thank you for taking the question, and a really nice quarter. Maybe following on Gabriela's question, but talking more about the top line. You guys have a broad solution portfolio already, but the fulfillment business was a big initiative for you guys, and definitely a big part, I think, of investors' models on, like, how take rate expands over time. Is there a replacement we should be thinking about? Is there, like, one initiative or new initiatives that we should think about taking the place of what we had in our model for fulfillment, or is it just fundamentally a new type of growth profile on a go-forward basis?

Harley Finkelstein (President)

Hey, Keith, thank you for the kind words, and good to hear from you. Look, part of the model of Shopify is that to get as many merchants using our product as possible, whether they're small merchants or they're large merchants, like Mattel, Mars, Black & Decker, Staples, Glossier, some of the ones I mentioned, like Dollar Shave Club, and, now Meta using the product. The key, though, is that if we want to qualify and requalify to be the central nervous system of their business, we have to ensure that whatever issue they have when it comes to commerce and retail, we can serve them. So for example, you know, we, we talked a little bit about collabs and, and, and what we're doing there.

This idea that we can actually match incredible audience, you know, content creators that have massive audiences with incredible brands, that's not gonna be for every merchant or every content creator, but the ones that, that it is for will use it with great efficacy. Things like Audiences, for example, we talked about Audiences 2.0, which in some cases, are showing a 50% lift in ROAS. Not every merchant is always going to use every single merchant solution, but as we build more and more, what it means is that we can, we can help them with a larger piece of their business, and that is really what we're focused on.

Then when you think about some of the new things, some of the new areas we're going into, for example, B2B, which historically we really focus on the direct-to-consumer point, we know there's pent-up demand to use Shopify for B2B, and so you're seeing us introduce new things like Collective, for example. There's about 45 new features that have come out around just B2B by itself in the last 12 months. Again, there's not gonna be one particular merchant solution that, you know, that every merchant is going to use. I mean, obviously, Shopify Payments is, is one of those because everyone needs to accept payments. The idea really is to ensure that we, we fix merchant pain and give them this incredibly scalable product, no matter what they want to achieve on the platform.

Operator (participant)

Thanks, Keith. Our next question comes from Mark Zgutowicz, The Benchmark Company.

Mark Zgutowicz (Equity Research Analyst)

Thank you, Carrie. Just a follow-up on the Flexport. Jeff, I know you'd said that you haven't yet signed the, the commercial agreement, maybe just two related questions. One, you talk about the integration of Deliverr with Flexport right now, how much of your holiday GMV will be supported by Flexport capacity? At a very high level, is it safe to say the considerations in terms of Flexport economics are predominantly profit versus any type of revenue share? Thanks.

Jeff Hoffmeister (CFO)

Yeah, thanks for your question. I think firstly, as it relates to just the timing of the commercial agreement, to your point, these are obviously agreements which involve a lot of data flows, co-marketing, a bunch of other things, just in terms of integration of the products. We wanna make sure that we, of course, get that right and get our merchants up and running. I don't have guidance for you in terms of what % of our holiday traffic will be going through Deliverr. I wish I could give you that perspective. We obviously just don't have that yet at this point. We're still very excited about the partnership. We think the world of that team over there. We've known Ryan, the founder, for a long, long time. Dave was a great addition.

That management team is really strong, so we think that's going to really assist our merchants in accelerating what they're trying to do. We're excited about it. I just don't have a snapshot for you in terms of holiday traffic and how much will be going through them.

Operator (participant)

Thank you for your question. Our next question comes from Andrew Boone at JMP Securities.

Andrew Boone (Managing Director)

All right. Thanks for taking my questions. I wanted to go back to Shopify Magic and Sidekick and just ask about the near-term vision for the products. What do you think is the easiest thing that gets solved, and then what do you guys see as you guys involve your own data as well as relationships and knowledge? Where does this go over time? Thanks so much.

Harley Finkelstein (President)

Yeah, it's a great question. Look, we're taking a very, very practical approach here when it comes to AI, and we think that Shopify is uniquely positioned to harness the power of AI in order to unlock incredible capabilities that we think will help our merchants grow their business. Starting with Shopify Magic, I mean, unlike other generative AI products, Shopify Magic is specifically designed for commerce, and it's not just embedded in one place, it's embedded throughout the entire product. For example, the ability to generate blog posts instantaneously or write incredibly well, you know, high-converting product descriptions or create highly contextualized content for your business. That is where we feel like AI really can, can play a big role here in making merchants' lives better.

Built on top of that, of course, is Sidekick, which Tobi announced over video about two weeks ago, right before Editions, that really is the first of its kind AI-enabled assistant, again, built for commerce. With Sidekick, you can do these incredible things, like you can analyze sales, and you can ideate on store design, or you can even give instructions on how to run promotions. When you think about these things altogether, ultimately, what we are giving merchants is a better, faster, more creative way to build businesses. I think that it's something that only Shopify can offer, and by embedding it across the entire product rather than simply one area of the product, merchants are going to see this, this, this efficacy and the speed of building and scaling only on Shopify.

Again, back to that business model, you know, comment I made a couple of minutes ago, when our merchants succeed, we succeed. So we think that, you know, leveraging the power of AI to give every entrepreneur, incredible superpowers is gonna be really incredible, and it's something we're very excited by. You'll see more of that roll out in the next couple weeks.

Operator (participant)

... Thanks, Andrew. Our next question comes from Kevin Krishnaratne at Scotiabank.

Kevin Krishnaratne (Director and Equity Research Analyst)

Hey there, good evening. Just, just on the Shop Pay strength, I think, $11 billion of the $55 billion in GMV, it just keeps tracking higher. How do we think about the opportunity there, and maybe thoughts on penetration of Plus versus SMB and how much of the GMV it can drive? You know, it also just seems like Pay is helping to stimulate GMV, so also wondering how it's helping to influence a merchant's same-store sales growth. Thanks.

Harley Finkelstein (President)

Thanks for the question, Andrew. Yeah, for the quarter, I mean, Shop Pay facilitated about $11 billion of GMV. That's up 37% year-on-year. Now, as of today, we've now surpassed $100 billion in cumulative dollars, which is an incredible milestone for the company. The most important part of it is that it is the highest converting accelerated checkout on the internet. It's also the most popular accelerated checkout on Shopify. Actually, a study that we recently did with a big three consulting firm shows that the mere presence of showing Shop Pay adds a 5% boost in terms of funnel conversion, and when it is used, the conversion can be as much as 50% versus guest checkout.

It is, it is something that a lot of merchants want, and that is not necessarily just small merchants. That is also very large merchants, large brands want that. One of the reasons that we think Shopify Commerce Components are so important is because it allows us, if, if a, a large brand that's not, that's not ready to migrate entirely over to Shopify but wants to begin a business relationship with us, things like checkout as a commerce component is a great way for us to do so. Again, this incredible this incredible way to check out for consumers around the world is only available on Shopify, which means that if you want to be able to offer that to your consumer, you have to be on our platform.

Operator (participant)

Thank you for your question. Our next question will come from Michael Morton at MoffettNathanson.

Michael Morton (Senior Research Analyst)

Hi, thank you for the question. As Shopify is starting to approach the one year point from when you began entering the partnerships with the large system integrators, we were wondering if you could provide an update on how these relationships are materializing and if they're contributing to the funnel for enterprise commerce players. Like, following through with that, like, you've discussed 2023 being an investment year for the enterprise. It would be great to hear how you view the enterprise sales team and if there's an opportunity for additional investment around that channel. Thank you so much.

Harley Finkelstein (President)

Yeah. Thanks for the question on that. You know, more unequivocally, more large retailers are coming to Shopify. I mentioned some household names like Dollar Shave Club and Nina Ricci, and Anastasia Beverly Hills, but also Hunter Boots and Meta citing for the quarter. In that way, we are certainly seeing more large brands, more large merchants come to the platform. That obviously helps us sign even further. As of now, we have, you know, signed partnership agreements with Deloitte, EY, KPMG, Accenture. Last earnings call, we mentioned IBM Consulting, Cognizant. They continue to build practices around Shopify and Shopify Plus and Commerce Components inside of their own sales teams, and what we've been spending time on is training them up to how to best sell Shopify most effectively.

In some cases, it's actually leading to really wonderful new brands, even on the international side, like New Era, for example, or Purina in Israel, from Nestlé. We are working hand-in-hand with a lot of these systems integrators. A lot of these sales cycles are a little bit longer than traditionally we are used to, they do bring on very, very large brands and merchants to Shopify, so we're really excited about that. In terms of the go-to-market, I think that's really important. We have been transforming this go-to-market engine at Shopify for, you know, for, for a number of years, this is really led by Bobby, our Chief Revenue Officer.

Over the past year or so, that team has been working to implement new tactics, new KPIs, but really, focusing on not just bringing on large merchants to Shopify but also ensuring that we also cross-sell. This end-to-end sales process and, and, and, and methodology, it's really designed for us to increase the, the pace and, frankly, the, the velocity of bringing on these larger merchants. The, the end result is, in the last two quarters alone, we have seen sales volumes across key products like Capital, retail, and Payments gain momentum, which has actually led to some of the highest cross-sell volumes we have ever achieved. The team is working tirelessly.

They're executing it really effectively, but this go-to-market engine is now starting to crank, and the, the results, are, you know, the, the results are, as we mentioned today, are more merchants coming to Shopify, much more larger merchants coming to Shopify.

Operator (participant)

Thank you for your question. Our next question will come from Mark Mahaney at Evercore ISI.

Speaker 13

Hi, this is Jocelyn asking a question for Mark. Could you hear me?

Harley Finkelstein (President)

Yes.

Speaker 13

Okay, cool. Could I ask a quick question, maybe on Amazon? Just I know, before the sale, Flexport-Amazon partnership was on the table. I wonder, is that still possible? N- not maybe not just in terms of Buy with Prime, but also payments. Just kind of help us think about what are some considerations you have there.

Harley Finkelstein (President)

Yeah, I mean, conversations with Amazon remain productive, but no news to share right now.

Speaker 13

Okay, got it. Thank you. Then maybe.

Operator (participant)

Thank you for your question. Our next question will come from Samad Samana at Jefferies. Oh, it looks like he dropped out of the queue. Our next question will come from Paul Treiber at RBC Capital. Paul, are you there?

Paul Treibe (Director)

Yes, sorry, I was muted. Thanks very much. Just on large enterprise, you called out a number of wins. Should we assume that most of the growth that you're seeing in large enterprise is Shopify Plus, or are you seeing-

... a lot of the, the growth and momentum pick up in, in Commerce Components. Is there any metrics that you can share just on, the, the, the growth in Commerce Components in general?

Harley Finkelstein (President)

Yeah, I mean, look, in terms of Shopify Plus, you know, very strong year-on-year Plus growth in Q2. We actually outpaced GMV growth from standard merchants. You know, we'll continue to see that Plus business grow. The Plus merchant base saw really strong year-on-year growth as a result of both upgrades and also new brands joining. That's important to us because we wanna make sure that the most successful brands, you know, the homegrown success stories, graduates on Shopify never leave us, and we're seeing that. We're also seeing a lot of new brands join the platform as well. The reason that CCS or Commerce Components is important to us is, again, it starts the business relationship that with businesses that aren't necessarily ready to fully migrate over.

By giving them a really, you know, a selection of 30 modular components from storefront to checkout to omni-channel capabilities, it means that we're able to begin that relationship, and over time, get more and more of their business. A lot of the names that you're hearing about today, you know, obviously there's a little bit of a longer sales cycle with some of the large enterprise brands. A lot of them, you know, those conversations started before we announced Commerce Components.

The fact that we have this incredible, you know, you know, enterprise solution in a box with Plus, and we also have this alternative, which is this modern composable commerce stack for enterprise retailers, means that we, we can have conversations with, with frankly pretty much every major brand, pretty much every retailer on the planet, and that wasn't possible years before.

Operator (participant)

Thank you for your question. Our next question will come from Todd Coupland at CIBC.

Todd Coupland (Managing Director)

Good evening, everyone. I wanted to ask about your GMV strength and what you think it, it says about the possibility of a recession. Thanks a lot.

Harley Finkelstein (President)

Yeah, I...

Jeff Hoffmeister (CFO)

Go ahead, Jeff.

Harley Finkelstein (President)

Go ahead, Harley. I'll just kick off, then I'll hand it over to Jeff. I mean, obviously, you know, GMV being up 70% year-on-year, Q2, you know, we outpaced the broader U.S. retail market. In terms of trends, I mean, you know, Shopify has so many... We have millions of merchants and stuff, and so the one thing that, that connects most of the merchants, if not all the merchants on the platform, is that fundamentally, the merchants on Shopify are consumers' favorite brands. We continuously see, and we've seen this, you know, for, for a long time now, that consumers are voting with their wallets to buy from their favorite brands, and we are fortunate, and we work hard at this, but those favorite brands are on, on Shopify.

You know, whether it's, you know, something like the Barbie effect that is happening right now, obviously, we're the commerce partner for Mattel. Across the board, we're seeing doll sales up 56% and play vehicles up 70%. Ultimately, you know, I think it's important, this direct-to-consumer trend is happening. It continues to grow, but the key for us is to make sure that the best, most important, and the brands that consumers love are on Shopify. Jeff, do you wanna

Jeff Hoffmeister (CFO)

Yeah.

Harley Finkelstein (President)

Sure.

Jeff Hoffmeister (CFO)

Todd, the only points I think we all see the same economic data that you're watching. We talked before, both Harley and I did, talked about the strength we're seeing in Europe. I think we're doing better in Europe than others are. I think that is one spot of particular strength for us. What we're seeing in North America continues, as it was last quarter, to be a good mix in terms of same-store sales growth for our existing merchants, as well as a strong customer merchant acquisition model. I don't, I don't think I have anything that I can extrapolate into broader comments around the probability of a recession. I can just speak to the strength of our business, and we're really firing on all cylinders.

Operator (participant)

Our final question will come from Trevor Young at Barclays.

Trevor Young (Director and Equity Research analyst)

Great, thanks. Just on audiences, any update on whether monetization of that has moved up in terms of priority, and then the possible mechanisms for monetizing that, whether it'll be like a per-use or subscription-type fee? Just timing and method for monetizing audiences?

Harley Finkelstein (President)

Yeah, I mean, Audiences, we had we talked a bit about this at Editions, which happened last week, where we rolled out Audiences 2.0. The algorithm keeps getting better. We keep seeing increased adoption. Right now, the monetization is happening indirectly, obviously, through GMV. No, no necessarily news on that, but we feel like the better Audiences become, the more it becomes something that, that every merchant wants to use and, and, and effectively becomes their must-have when they're running ads across the major ad platforms. That, that provides us with incredible leverage, and, and again, that's something that's only available for on Shopify. Right now, we're focused on indirectly monetization for Audiences, but that obviously, that lever is available to us in the future.

Operator (participant)

This concludes our second quarter of 2023 conference call. Thank you for joining us. Goodbye.