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Edited Transcript of SHOP earnings conference call or presentation 29-Oct-19 12:30pm GMT

Q3 2019 Shopify Inc Earnings Call

Ottawa Nov 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Shopify Inc earnings conference call or presentation Tuesday, October 29, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Amy E. Shapero

Shopify Inc. - CFO

* Harley Michael Finkelstein

Shopify Inc. - COO

* Katie Keita

Shopify Inc. - Senior Director of IR

* Tobias Lütke

Shopify Inc. - Founder, Chairman & CEO

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Conference Call Participants

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* Brad Alan Zelnick

Crédit Suisse AG, Research Division - MD

* Brian Christopher Peterson

Raymond James & Associates, Inc., Research Division - Senior Research Associate

* Christopher David Merwin

Goldman Sachs Group Inc., Research Division - Research Analyst

* Colin Alan Sebastian

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Darren Aftahi

Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst

* David E. Hynes

Canaccord Genuity Corp., Research Division - Analyst

* Deepak Mathivanan

Barclays Bank PLC, Research Division - Research Analyst

* Gus Papageorgiou

PI Financial Corp., Research Division - Head of Research

* Hoi-Fung Wong

Guggenheim Securities, LLC, Research Division - Senior Analyst

* Jonathan Allan Kees

Summit Insights Group, L.L.C - MD & Senior Application Software Analyst

* Josh J. Beck

KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst

* Kevin Krishnaratne

Paradigm Capital Inc., Research Division - Analyst of Technology

* Koji Ikeda

Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst

* Mark John Zgutowicz

Rosenblatt Securities Inc., Research Division - Senior Analyst

* Matthew Charles Pfau

William Blair & Company L.L.C., Research Division - Analyst

* Nikhil Thadani

Mackie Research Capital Corporation, Research Division - Analyst of Technology

* Paul Treiber

RBC Capital Markets, LLC, Research Division - Associate

* Samad Saleem Samana

Jefferies LLC, Research Division - Equity Analyst

* Suthan Sukumar

Eight Capital, Research Division - Principal

* Thomas Ferris Forte

D.A. Davidson & Co., Research Division - MD & Senior Research Analyst

* Todd Adair Coupland

CIBC Capital Markets, Research Division - MD of Institutional Equity Research

* Ygal Arounian

Wedbush Securities Inc., Research Division - Research Analyst

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Presentation

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Operator [1]

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Thank you for standing by. This is the conference operator. Welcome to the Shopify Inc. Third Quarter 2019 Financial Results Conference Call. (Operator Instructions) And the conference will be recorded. (Operator Instructions).

I would now like to turn the conference over to Katie Keita, Director of Investor Relations. Please go ahead.

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Katie Keita, Shopify Inc. - Senior Director of IR [2]

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Thank you, operator, and good morning, everyone. We are glad you can join us for Shopify's Third Quarter 2019 Conference Call. We are joined this morning by Tobi Lütke, Shopify CEO; Harley Finkelstein, our Chief Financial Officer; and Amy Shapero, our CFO. After 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 we projected. We undertake no obligation to update these statements except as required by law, you can read about these risks and uncertainties in our press release this morning as well as in our filings with the U.S. and Canadian regulators. Also, our commentary today will include adjusted financial measures, which are not GAAP measures. These should be considered as a supplement to and not as a substitute for GAAP financial measures, reconciliations between the two can be found in our earnings press release, which is available on our website. And finally note that because we report in US dollars, all amounts discussed today are in U.S. dollars unless otherwise indicated. With that, I turn the call over to Harley.

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Harley Michael Finkelstein, Shopify Inc. - COO [3]

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Thanks, Katie, and good morning, everyone. We continue to make great progress this past quarter, and I'll get in some more detail on that shortly. First, I'd like to take a minute to mention 2 major milestones. Last month, our counter hit the 1 million merchant mark, that means that 1 million businesses, large and small, have put their face in Shopify. For all of us working to build Shopify each day, it is incredibly validating and meaningful that we continue to help tens of thousands of more businesses each quarter, launch and thrive on our platform. And earlier this month, we closed the biggest acquisition in our history, and we welcome 6 River Systems to the Shopify family. This is another milestone, not just because it signals our commitment to solving some of the most critical challenges our merchant's face but because it is yet another way in which we are evolving to continue making commerce better for everyone. So thank you, to all of our merchants and partners who continue to put their trust on us.

As I mentioned previously, our momentum continued in Q3 as you can see from our third quarter results. Our international expansion efforts continue to pay off as merchants from outside our core geographies were once again, the largest component of new ads. GMV from these international merchants outpace GMV growth overall, and adoption of Merchant Solutions products continue to expand across Shopify Payments, Fraud Protect, multicurrency, Shopify Shipping and fulfillment and Shopify Capital as we make these offerings more attractive and accessible. We are also showing progress across the multiple product initiatives that are underway.

In October, we began rolling out our native video and 3D modeling features to Shopify Plus merchants with a broader rollout planned over the coming months, making Shopify the first commerce platform to natively support 3D and AR shopping experiences. These features create the more immersive online buying experience, which not only makes a purchase more likely but also just makes it really fun way to shop online. More buyers are opting into Shopify Pay with quarterly order volume increasing and GMV rising to over $1 billion in Q3. We continue to release more features to make it easier for buyers, such as giving buyers more payment options to complete their purchases using Shopify Pay. And we continue to work hard to connect merchants around the world directly to their buyers. In Q3, we enhanced our marketing and support tools and we introduced Shopify Chat, our first native chat function that helps merchants build stronger relationships with their customers through real-time conversations. Shopify Capital put up an excellent quarter, setting a new record in merchant cash advances with over $140 million issued in Q3. We started Shopify Capital to help solve another pain point for entrepreneurs, access to capital to grow their businesses. This is a especially true as merchants gear up for their busiest selling season of the year. As we mentioned last quarter, we introduced Shopify Capital to non-Shopify payment merchants and while it's still early we're seeing strong adoption from those merchants.

Shopify Shipping adoption continue to grow with 44% of eligible merchants using shipping into third quarter, up for more than 1/3 of merchants in the same period last year. Shopify Shipping empowers merchants to speed up their packaging and fulfillment process and save time. After a merchant buys a shipping label directly from the Shopify Admin, they can print it, fix it to the package and then ship it from any post office. This is why we continue to provide competitive shipping rates and add best-in-class features like parcel insurance, which we launch in Q3 for U.S. merchants.

Moving to Shopify Plus, which had yet another strong quarter. Shopify Plus continues to solidify its position as the preferred commerce platform for high-volume merchants. Some of the brands that launched this quarter, include footwear brands, Aerosoles; Harrys of London, the Frye boot Company; and Nicholas Kirkwood from luxury brand, LVMH. The shop for the iconic British broadcaster, the BBC; and the space exploration disruptor, SpaceX. Sports drink behemoth, Gatorade; Australian electronics giant, JB Hi-Fi; appliance brand, BISSELL; additional iconic toy brands such as GUND. More brands from some of the world's largest influencers like Kim Kardashian's new shapewear line called SKIMS; and Victoria Beckham's makeup line, Victoria & Beckham Beauty (sic) [Victoria Beckham Beauty]. And finally, more launches from the world's largest consumer packaged good companies that have been leveraging our platform for some time, including Heineken and Unilever. Shopify Plus is becoming the most relevant platform globally for both iconic as well as the fastest-growing model retail brands. As a quick anecdote, I recently spoke with an executive, one of the largest food and beverage conglomerates on the planet, after they went live on Plus. He said that this was the most successful product launch probably in the history of the company, and the best part is that I hear stories like this all the time from Fortune 500s to SMBs.

While these brands represent different verticals, they have one thing in common. They are growing in complexity. This is reflected throughout their evolving business from the global reach of their marketing, manufacturing and distribution to the management of their inventory and the growth of their employee base. Shopify Plus features like Flow, Launchpad and Scripts are built to help solve those complexities by making it easier for our larger volume merchants to manage the increasing scale of their businesses.

Turning to our partner ecosystem, which continues to play a critical role in the success of our merchants. 23,000 partners have referred a merchants to Shopify in the past 12 months. And we've added more than 300 apps on App Store, bringing the total to 3,200 at the end of the quarter. International partners are becoming a larger part of our partner ecosystem as well, and we see an opportunity to further leverage this community to help develop localized features in specific markets. At Shopify, we build product that make it easier for anyone to become an entrepreneur, and then we level the playing field so that they can grow and succeed. As our merchants scale and face new challenges and new levels of complexity, Shopify is designed to grow with them, revealing new capabilities as merchants require them. With this formula, we cannot only help mint the next million merchants, but we can arm them with everything they need to thrive. More entrepreneurs reaching for independence means more choice for buyers, which ultimately makes commerce better for everyone.

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Amy E. Shapero, Shopify Inc. - CFO [4]

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Thanks, Harley, and good morning, everyone. We delivered strong growth this quarter and continue to execute on our strategic initiatives. With more than 1 million merchants building their businesses on Shopify, we are more focused than ever on making entrepreneurship easier and helping our merchants succeed. Revenue in our third quarter was up 45% year-over-year to $390.6 million. Subscription Solutions revenue increased 37% to $165.6 million, primarily due to strong merchant ads as well as level settings subscription pricing for legacy plans, growing monthly recurring revenue to $50.7 million, which is up 34% over the same period last year and the same place as last quarter.

Shopify Plus continue to increase its contribution to MRR, accounting for $13.5 million or 27% compared with 24% of MRR in Q3 2018. Subscription Solutions revenue grew faster than MRR in the quarter, primarily due to strong growth in apps revenue as well as from Shopify Plus platform fee revenue. Merchant Solutions revenue grew 50% over the same period in 2018 to $225 million. This growth was driven by GMV expansion, up 48% year-over-year to $14.8 billion with international being the fastest-growing contributor.

Both international and Plus continue to grow their share of GMV mix, while POS channel GMV growth gained momentum, accelerating for the second quarter in a row.

$6.2 billion of GMV was processed on Shopify Payments in Q3, up 51% versus the comparable quarter last year.

Shopify Payments penetration of GMV grew to 42% in the third quarter versus 41% in Q3 2018, primarily due to increased Shopify Plus penetration, as well as the addition of new Shopify Payments geographies.

Newer products like multicurrency are gradually being adopted and adding further value to merchants using Shopify Payments, contributing to year-over-year revenue growth as we continue to improve their product-market fit.

Gross profit dollars grew 45% from Q3 of 2018 to $216.7 million, consistent with revenue growth in the quarter. Adjusted operating income in Q3 was $10.5 million or 3% of revenue, compared with a loss of $2.4 million or 1% of revenue in the third quarter of 2018.

We achieved better-than-expected adjusted operating results in Q3, due in part to strong revenue contributions from higher-margin products and lower marketing spend. Note that we have updated our definition of non-GAAP financial measures to also now exclude the impact of amortization of acquired intangibles and related taxes, in addition to the stock-based compensation and related taxes we've always excluded. This is consistent with our peers and provides a clear view of operational results in the period.

In the third quarter, amortization of acquired intangibles was $1.7 million. Adjusted net loss for the quarter was $33.6 million or $0.29 per share over adjusted net income of $5.8 million or $0.05 per share for the same period last year.

Our third quarter 2019 adjusted net loss includes a tax provision of approximately $48 million, net of certain tax offsets, related to a one-time capital gain triggered by the transfer of certain rights from our Canadian entity to regional headquarters, which allows us to develop and maintain merchant and commercial operations in their respective regions as we expand internationally.

Finally, our cash, cash equivalents and marketable securities' balance was approximately $2.7 billion, which increased around $700 million largely due to proceeds from a share offering we completed in September.

As Harley said, we're building a global commerce operating system that helps solve problems at critical points along the merchant journey. We have thoughtfully developed and implemented a portfolio of investments that addresses many of these pain points and fuel our growth to date. These include multichannel integrations, enhancements to marketing functionality for merchants, expansion of Shopify Payments and related services, further development of Shopify Plus capabilities, Shopify Shipping functionality and expanding the availability of Shopify Capital to more merchants among others.

I will focus my comments today on more recent additions to this portfolio, international expansion, building brand awareness of Shopify, Shopify Fulfillment Network and the acquisition of 6 River Systems.

Shopify is taking a disciplined and localized approach to achieve optimal product-market fit in our international markets. Over the past year, we more than tripled the number of languages, which the Shopify Admin is available. And in Q3, introduced Shopify Payments in Italy and continue to roll out multicurrency to merchants using Shopify Payments, which is now available in 14 countries versus 10 the same time last year.

Our efforts internationally are bearing fruit, as the pace of merchant ads from outside our core geographies accelerated in Q3. As a result, international merchants continue to grow their share of our overall merchant base.

Merchants around the world need to know that entrepreneurship is an option, so we have begun to build our brand awareness of Shopify outside our core geographies. We kicked off first-ever brand campaigns in Germany and France in Q3 and expect to continue brand testing and learning into Q4.

We've spent roughly 2/3 of our approximately $30 million budget allocated toward our brand campaigns and Shopify Studios so far this year and plan to invest the remainder of this budget in Q4.

Moving to Shopify Fulfillment Network. Our solution to further democratize commerce and help merchants provide fast and affordable shipping for their buyers. We have to get this right for our merchants, that's why we're taking a thoughtful and gated approach to the development of Shopify Fulfillment Network.

We continued working with our warehouse partners to bring more nodes online through the third quarter, and we're happy with the performance of our network so far. We are seeing strong demand and continue to add select merchants and partners, as we focus on high performance and optimizing further merchant experience.

With the 6 River Systems acquisition now closed, we are better positioned to deliver faster, high-quality fulfillment. Once implemented, we expect to expand throughput and capacity at our partner nodes, boosting productivity by 2 to 3x that of manual processes.

We will continue to operate, build and sell 6 River Systems solution in addition to making it available to our warehouse partners. As a result of extending this innovative technology beyond Shopify's current market, not only are we helping to change the broader fulfillment industry, we're also expanding our total available market.

While the acquisition of 6 River Systems had no impact to our third quarter results given a close on October 17, we expect the acquisition will be additive to Shopify's top line over time.

Given our strong third quarter results and acquisition of 6 River Systems in the fourth quarter, we're updating our full year 2019 and fourth quarter outlook. To be clear, this updated outlook includes 2 new items that were not included in our August guidance and includes our acquisition of 6 River Systems and it includes the change in the definition of adjusted operating income to now exclude amortization of acquired intangibles.

Accordingly, for full year 2019, we are raising our revenue expectations to be in the range of $1.545 billion to $1.555 billion, with an adjusted operating income between $27 million to $37 million, which excludes stock-based compensation expenses and related payroll taxes of $180 million and amortization of acquired intangibles of $15 million.

For the fourth quarter, we expect revenue of $472 million to $482 million and an adjusted operating income between $10 million and $20 million, which excludes stock-based compensation expenses and related payroll taxes of $57 million and amortization of acquired intangibles of $10 million.

Our outlook includes expectations for 6 River Systems' ownership in the fourth quarter as follows: we expect no material impact to Shopify's revenue given most of 6 River Systems' revenue is recognized over the multiyear lifetime of each contract and also reflects the reduction of acquired deferred revenue under purchase accounting.

We expect incremental expenses to Shopify of $25 million, including $10 million of cash and operating expenses, $7 million in stock-based compensation and $8 million of amortization of acquired intangibles.

We're excited about our progress in Q3 and going forward. As we continue to democratize commerce by bending the learning curve, adding more tools and capabilities to make entrepreneurship easier and leveling the playing field, we are unlocking the power of commerce for those who want to reach for independence all over the world. With that, I'll hand the call back to Katie.

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Katie Keita, Shopify Inc. - Senior Director of IR [5]

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Thank you, Amy. (Operator Instructions)

Ariel, can we have our first question, please.

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Questions and Answers

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Operator [1]

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Our first question comes from Colin Sebastian of Robert Baird.

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Colin Alan Sebastian, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [2]

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Congrats on another customer milestone. Shopify Capital, obviously, a big step-up in the merchant cash advances alone, as Harley mentioned. So how are you thinking longer term about the role of capital and customer acquisition and retention and the ability to manage that risk because you expand outside of the payments group?

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Harley Michael Finkelstein, Shopify Inc. - COO [3]

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Thanks for the question. Harley here. So certainly, it was a record quarter for Capital. We gave more than $140 million of advances to merchants. And, again, as you mentioned, part of this is making sure that we help merchants in the entirety of their journey to success. Certainly, things like having additional cash for things like inventory and marketing, very important to them. And there's not that many places to get that sort of capital. So we think we're really helping merchants by doing this. It also serves, of course, as a way to retain merchants because we're not only now their e-commerce platform or the point of sale provider or their payments provider, we're also now, in some cases, playing the role of their capital provider. So this is a meaningful part of our of business, and it keeps growing and certainly, it's something we're very proud of. And in terms of the managing of the risk, it's something we keep close eye on. We do a ton of trend forecasting and ensuring that we look at the data to update our models as we see trends changing. That being said, it's important to remember that most of the capital that we put out there is insured by our partner, EDC. So we think that we'll continue to grow the capital business but at the same time manage the risk. And so we're not doing anything that is outside of that loss ratio and risk exposure. It's comfort zone that we think we have right now.

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Operator [4]

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Our next question comes from Matt Pfau of William Blair.

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Matthew Charles Pfau, William Blair & Company L.L.C., Research Division - Analyst [5]

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Just wanted to ask on the Fulfillment Network. So how is the supply of fulfillment partners been relative to the demand and fulfillment that you're anticipating? And correlating to that, any updated thoughts on if you're going to need to operate some of your own fulfillment centers to help supplement the supply?

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Harley Michael Finkelstein, Shopify Inc. - COO [6]

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It's Harley, again. I'll take that question. As of right now the demand for SFN, it's coming from both sides of the coin. It's coming from our merchants, who want to use it but also coming from partners. It's important to understand that there are warehouses all over the U.S. where -- which is our first geography that has spare capacity but are looking to find a way to increase their business and this is just a great -- by being part of this network, it's a great way for them to do that. As of right now, the 7 nodes that will be operational by the end Q1 in 2020, all of those will be third-party fulfillment warehouses. So whether or not we build our own, we hope we don't have to and if we do it, it's likely be just to test to do some development work. But as of right now, we feel we can do a lot with third parties and still achieve the type of service and cost that we want to get for our merchants. So into 2020, it'll be a geared approach to SFN, and we'll be adding more and more partners. But there's been significant demand on both sides from merchants and also from partners ever since the announcement at Shopify Unite in June. So we're quite pleased with the progress.

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Operator [7]

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Our next question comes from Ken Wong of Guggenheim Security.

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Hoi-Fung Wong, Guggenheim Securities, LLC, Research Division - Senior Analyst [8]

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So some of your e-commerce peers have called softer than expected holiday trends. Can you maybe talk a little bit about what you're seeing across your merchant base as we head into the typically strong Q4?

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Tobias Lütke, Shopify Inc. - Founder, Chairman & CEO [9]

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Yes, sure. I'm taking this. This is Tobi. So far -- I mean it's all trend forecasting at this point. Like we're all sort of looking at probably some of the data. We don't see any weaknesses right now. It looks pretty much on track to the previous years. Some dates are falling on different parts of the year so there's some change to that in terms of seasonality. But right now, we don't see anything that gives us an indication that there's a difference in purchasing behavior at least from our segment of where we can see.

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Operator [10]

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Our next question comes from Mark Zgutowicz of Rosenblatt Securities.

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Mark John Zgutowicz, Rosenblatt Securities Inc., Research Division - Senior Analyst [11]

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Maybe just a quick follow on to that, last point, Toby. I think we have one -- essentially one last week between Black Friday and Christmas this year, roughly speaking. I'm just curious if there's -- if that's contemplated in your guidance. And then maybe separately, Harley talked about Capital? And I'm just curious if you can provide any color in terms of the impact that's having on GMV growth?

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Amy E. Shapero, Shopify Inc. - CFO [12]

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So I'll take the one last week. Yes, it is built into our guidance. We had a strong Q3 in terms of GMV growth. We're pleased with our performance going into our peak selling season. And that is one of the reasons why we upped our guidance on the top line.

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Harley Michael Finkelstein, Shopify Inc. - COO [13]

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On the capital piece. We've now given about $770 million of cumulative cash advances, that will continue to grow. It's up 85% since -- if you look year-over-year from last Q3 in 2018. So our capital business continues to grow. Is it going to have a material effect on GMV? Probably not a material effect on it. Obviously, people will use this -- these merchants will use this money to do things like advertising inventory, which will have a correlation to GMV. But just given the amount of GMV happening across our entire platform in 175 countries. I don't think that's going to be a material increase in our GMV by itself.

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Tobias Lütke, Shopify Inc. - Founder, Chairman & CEO [14]

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I thought they're not good. So like on the capital side, we don't see -- sometimes we keep it low and then people just accelerate or increase in inventory order, and it has an immediate effect. What happens a lot more is that business could otherwise not access loans get them. And therefore, actually continue building the business. So the effects of -- on GMV of the loans end up being delayed. But we might end up with an additional customer who would never actually have taken -- become a customer because of them. So it's hard to cause an effect, it's secondary tertiary effect, which end up affecting the GMV in the long run.

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Operator [15]

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Our next question comes from Gus Papageorgiou of PI Financials.

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Gus Papageorgiou, PI Financial Corp., Research Division - Head of Research [16]

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If you look at your numbers, it looks like the year-over-year growth in GMV per merchant is very strong, kind of, double-digits, and it looks like it's been double digits all year long. I'm assuming that's from an increased number of Plus customers, but also it seems like probably the conversion rates are improving for your merchant customer base. Can you talk about what are the kind of main features that you guys have been implemented that have helped your merchants convert? And if you look into the future, how do you expect conversion to improve, with the stuff like augmented reality and whatever other features you think you're -- going to influence that?

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Harley Michael Finkelstein, Shopify Inc. - COO [17]

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Yes. In terms of the conversion, look, the things that we're doing, we're trying to ensure that anyone -- that any browser turns into a buyer for our merchants. So things like augmented reality or three-dimensional product listings, things of that nature as I mentioned, it not only makes it a more fun experience for consumers but it also increases the conversion rate. But even beyond that, things like Shopify Pay, more of our accelerated checkout options. What you're beginning to see more and more is that we are trying to reduce the amount of friction that any browser has, so that they do become a buyer and hopefully, buy a lot from these merchants. So I mean that's -- we've been doing that for almost 15 years now, trying to make it easy for anyone to checkout as easy as possible from a Shopify Store. We'll continue to do that, of course.

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Amy E. Shapero, Shopify Inc. - CFO [18]

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Yes. And I'll just add one point at the end. That the GMV per merchant growth is pretty much across the board, across all of our merchant segments. But yes, in particular, Plus has been very strong.

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Operator [19]

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Our next question comes from Deepak Mathivanan of Barclays.

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Deepak Mathivanan, Barclays Bank PLC, Research Division - Research Analyst [20]

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So I wanted to ask about how we are approaching the fulfillment rollout. Are you using initiatives like all year outer discounts or value promotions for some of the large merchants at this point already as you prepare for the holiday season? Can you talk a little bit more about kind of the go-to-market strategy for fulfillment, near-term and maybe in 2020 as well?

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Amy E. Shapero, Shopify Inc. - CFO [21]

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Yes. So with respect to fulfillment, we're still in our early access program and we're onboarding merchants as we speak. We're happy with our progress and absolutely on track. Each contract is competitively priced. We look at each merchant based on the size, weight and complexity of their fulfillments. And that's largely how we have approached it and will continue to approach it moving forward.

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Operator [22]

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Our next question comes from Brad Zelnick of Crédit Suisse.

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Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [23]

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So with take rate flat quarter-on-quarter. How much of this was driven by mix shift? And if we dig into the different segments, Plus and international, what does take rate growth look like on a segment level basis?

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Amy E. Shapero, Shopify Inc. - CFO [24]

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Yes. It -- if you look at it the segment level, each of our merchant segment has continued to increase take rate year-over-year. So the entire impact from Q3 to Q4 is a mix. We're still seeing strong growth in international and that take rate is improving quarter-over-quarter, year-over-year, it's just weighing down the average a little bit.

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Operator [25]

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Our next question comes from Richard C. of National Bank Financial.

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Unidentified Analyst [26]

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With respect to the fulfillment network. As it becomes like growing part of your mix, how should we be thinking about the margin profile here for the business going forward?

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Amy E. Shapero, Shopify Inc. - CFO [27]

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Yes. So let me just talk a little bit about Shopify Fulfillment Network and what we sort of expect here, so let's take Q3 to begin with. There was minimal impact to gross margin, given we're still ramping the early access program. As we're enter Q4 in our peak selling season and we start to ramp fulfillment volumes, we do expect to have slight dilution on our gross margin from that. This is all factored into our Q4 and full year guidance. We do have a path to profitability that we announced at Unite. And we expect to be in product market fit phase through early 2021. So we likely will be dilutive on the gross profit line for Shopify Fulfillment Network until we hit the scale phase which, again, we expect early 2020. But we believe the short-term dilution is the right long-term decision for our merchants. We expect fast and affordable fulfillments will energize our flywheel by helping our merchants to sell more.

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Katie Keita, Shopify Inc. - Senior Director of IR [28]

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And that would be hitting the scale phase in early 2021.

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Operator [29]

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Our next question comes from Darren Aftahi of Roth Capital Partners.

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Darren Aftahi, Roth Capital Partners, LLC, Research Division - MD & Senior Research Analyst [30]

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Maybe Amy, could you expand on gross margins, it looks like Subscription Solutions gross margin dipped a little bit sequentially. I'm just kind of curious what's driving that, and then your thoughts going forward?

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Amy E. Shapero, Shopify Inc. - CFO [31]

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Yes. On the Subscription Solutions margin line for Q3 quarter-over-quarter, we did see a slight dip. It was due to infrastructure investments to increase the performance for merchants, speed performance and also some additional infrastructure and anticipation for our peak selling season. I will say for the full year, for Subscription Solution margins, year-over-year, we are still anticipating an improvement because of post-cloud migration this year versus last year.

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Operator [32]

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Our next question comes from Jonathan Kees of Summit Insights Group.

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Jonathan Allan Kees, Summit Insights Group, L.L.C - MD & Senior Application Software Analyst [33]

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Can you hear me now? Hello, can you hear me now?

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Amy E. Shapero, Shopify Inc. - CFO [34]

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Yes. Go ahead.

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Jonathan Allan Kees, Summit Insights Group, L.L.C - MD & Senior Application Software Analyst [35]

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I really want to ask about one topic. Amazon, during their call, talked about one day shipping, really materially had an uplift on their volume on their GMV. At Unite, you guys talk about 2-day shipping. Does that change your planning, your table stakes offering in terms of what you're planning to rollout for your merchants. And if I may, on the same topic here, I know you consider Amazon to be more of a partner. It's a sales channel for your merchants. I guess at what point do they become a competitor, especially as more merchants defect from their network over to yours?

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Tobias Lütke, Shopify Inc. - Founder, Chairman & CEO [36]

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Yes. I'll take that. Tobi, here. Again, as I said this before, it seems to have resonated. Like, Shopify and Amazon, we are partners. Again, we offer Amazon pay to the customers who want it, to the merchants who want it. Often when you buy something on Amazon, there's a Shopify store that, that particular order flows into and from which the merchant [does have a certain mandate on]. It's a partnership. So we're not competing with Amazon. It's -- some of our customers are competing in some segments. We certainly help them with that. So in a very indirect way, you can draw the power level of -- that we are competing. But like I don't think either of us thinks about it this way. But Amazon also serve as a best practice. They've kind of -- I mean they're certainly the retailer on -- take it out how to sell perfectly on Internet. The things that people really, really need, they order from there because it arrives. Often now, next day as they announce. The products from Shopify are often the things that people really want rather than ones they need. It's a bit geeky kind of products. And there's a little bit more tolerance for the shipping because of that. So we are not aiming at 1-day delivery because that's just -- it's an incredibly expensive kind of thing to do. And isn't -- like the return on investment in -- for the category of products that are on Shopify isn't there. Like it will happen in certain instance because frankly, a lot of our partner warehouses will be close to population centers and will be able to do this. But to create any kind of guarantees around this, that's not something we are planning on doing. So no, there's no change because of the announcements there.

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Operator [37]

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Our next question comes from Kevin Krishnaratne of Paradigm Capital.

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Kevin Krishnaratne, Paradigm Capital Inc., Research Division - Analyst of Technology [38]

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Congrats on the milestone. You had strength in ads from international. I'm wondering if you can provide any color on growth ads in core markets sort of whether trends are like there versus a year ago or prior quarters, stronger or weaker? Just trying to understand how this quarter might compare to other peak periods for gross ads. I'm just trying to unpack the different markets.

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Amy E. Shapero, Shopify Inc. - CFO [39]

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We continue to see solid growth in merchants in our core geographies. Merchant count is something that we look at as a metric, but we're also looking at GMV growth and the growth in our core geographies and GMV-wise was quite strong. So the combination of the 2 of them, we're happy. And that's another reason why we upped our guidance for the year.

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Operator [40]

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Our next question comes from Nikhil Thadani of Mackie Research Capital.

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Nikhil Thadani, Mackie Research Capital Corporation, Research Division - Analyst of Technology [41]

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I wanted to go back to Harley's comments about your native 3D support and augmented reality. Maybe if you could help us understand how that would scale? Can merchants use their smartphones to scan different SKUs or do they need like specialized hardware or perhaps new partners to help them out in that area?

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Harley Michael Finkelstein, Shopify Inc. - COO [42]

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Thanks for the question. So in terms of new hardware, no. I mean the great part about things like augmented reality is that now everyone that has the new iOS has it built into the -- with AR kits. So there's nothing new you need. Now in terms of getting the 3D modeling done, that is something that we're actually helping merchants with. So if you go to our services marketplace, where we connect merchants with experts and photographers and agencies and freelancers and developers to help them with their business-specific needs and requirements of their business, that's an area where you now can find 3D modelers as well. So we are playing at -- we are matchmaking them with people that can help with that. But from a consumer perspective, the best part of that this is that the consumer doesn't have to do anything. Consumer can now go to that particular merchants online store, and they can have a much better experience given the work they were doing with 3D and AR. And we think it's going to lead to higher conversions, ultimately. But there is no onus on the consumer, and we're making it really easy for merchants to adopt this.

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Operator [43]

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Our next question comes from Chris Merwin of Goldman Sachs.

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Christopher David Merwin, Goldman Sachs Group Inc., Research Division - Research Analyst [44]

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In terms of profitability, it looks like you flowed through the fiscal 3Q beat on non-GAAP EBIT into the full year guidance. I think you mentioned that the updated full year guidance also includes $10 million of OpEx, this is on the non-GAAP. And I guess just given all the runway ahead for Shopify Fulfillment Network, Plus, international. Maybe can you just talk a bit about flowing through kind of that level of profitability? And how you think about the pace of investments going forward?

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Amy E. Shapero, Shopify Inc. - CFO [45]

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Yes. Let me talk specifically to our outlook that we just updated because there are multiple factors going on with respect to 6 River as well as the change in definition. So if you think -- if you start with our outlook in August, that did not consider the 6 River acquisition. We were at $20 million to $30 million of adjusted operating income for the full year. If our outlook in August were adjusted to -- also exclude amortization of existing acquired intangibles of $7 million, so the new definition, it would have been $27 million to $37 million. So apples to apples, our updated outlook for adjusted operating income for the full year under the new definition is essentially unchanged. And so what does that mean? That means that the $10 million in OpEx from 6 River in the fourth quarter is essentially being offset by the organic performance of Shopify. So we're going to continue to invest in these important growth areas. And that will be something that we're working on in 2020 planning, and we'll have more to say in February on that. But the performance of the overall company, including 6 River for the fourth quarter we think is very strong.

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Operator [46]

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Our next question comes from Thomas Forte of D.A. Davidson.

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Thomas Ferris Forte, D.A. Davidson & Co., Research Division - MD & Senior Research Analyst [47]

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So regarding your Shopify Fulfillment Network efforts, what was the rationale for purchasing 6 River Systems? And do you believe you need to engage an additional M&A to advance the initiative?

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Tobias Lütke, Shopify Inc. - Founder, Chairman & CEO [48]

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Yes, Tobi here. No plans right now on more M&A, but it's definitely a possibility. Again, this is a completely new field for the company, and they're trying to do this right. The rationale specifically is -- in this particular world of fulfillment warehouses, like efficiency and quality metrics, everything. And those are things that are massively improved by robotics. And the part of our -- significant reason for a lack of robotics build out in this particular space has been that people have experienced like a great robotics providers coming on the market about a decade ago, it was Kiva and that then disappearing and the robotics then no longer available. So that seeded a good set of horror stories in the market, which made people just not want to go for this particular option. I was bringing in 6 River Systems, brings a lot of fantastic talent in-house, people who have known the space for -- like and has build hardware/software in the space for many decades. And also they can go out to this world and just say, hey, we've -- like it's demonstrable that we will want this to be available over the next decades and that people can do long-term planning with robotics in mind and just keep it in the space and make it a part of the Fulfillment Network buildout. And that increases, again, the efficiency and e-commerce picking ability of warehouses, which currently are doing this until it became pretty obvious that this would be a good move, and this is a significant part for rationale what I did.

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Operator [49]

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Our next question comes from Koji Ikeda of Oppenheimer.

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Koji Ikeda, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [50]

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I had a question on the conversion of mobile eyeballs to mobile dollars. So Shopify does a great job with that mobile conversation rate. I think it's well above the industry metric we see out there. But there's still a gap between mobile eyeballs and mobile dollars, even for Shopify. Could you talk about, what is the factor or factors that is causing that gap? And what Shopify is doing to help close that gap over time?

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Tobias Lütke, Shopify Inc. - Founder, Chairman & CEO [51]

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I don't think anyone -- I mean this is really, really hard to know. It's from -- like I think the default device just has shifted. Like it's a massively more traffic on mobile and people use mobile a lot more in sort of cracks of a day. And sitting down computer's becoming more and more a deliberate act. So people might have -- it might be the same people who have bounced on that stool will then sit down on a desktop to then do a purchase and these kind of things end up skewing the numbers a little bit. I think the correct way to think about the word of -- the Internet really is -- it exists for serving mobile devices. There's couple of fallback systems for desktops. That was super clear, a long time ago. And it's actually -- it's a -- some retailers are surprisingly unprepared for it. Mobile device have tons and tons of advantages, like the fact that we came to use of biometrics as a form of securing access to credit cards. Mobile devices have payments systems directly built in on the platform level, which is, again, at the moment, the lack of -- of the prowess of doing this over the last decades, many times. And the mobile vendors have done such an amazing job building secure elements into the hardware and bringing these ideas into reality. And it's -- like I think the experience of purchasing on mobile, on Shopify stores is now equivalent. Like I don't think friction is a differentiator for conversion rate anymore. And so now it's purely based on intent. And so I think that was -- that took over long time to get there. But now I think we are there between Apply Pay, Google Pay, Samsung Pay and all kind of the things that have supported. And of course Shopify Pay is sort of making up the difference in the fallback cases.

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Operator [52]

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Our next session comes from David Heinz of Canaccord.

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David E. Hynes, Canaccord Genuity Corp., Research Division - Analyst [53]

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Can you talk about first year GMV for new Plus accounts maybe versus a year ago? I'm trying to get the sense of increasing contribution we're seeing there is more a function of adding Plus merchants t a higher velocity or landing larger accounts. I suspect it's a bit of both but anything you can provide to help quantify would be helpful?

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Harley Michael Finkelstein, Shopify Inc. - COO [54]

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It's Harley, I'll take that question. We certainly are seeing more complex merchants coming to the Plus platform. We announced Staples Canada coming on a couple of months ago. More recently, companies like JB Hi-Fi have come on who are some of the larger electronics retailers in the world and based in Australia. So we are seeing more of these complex merchants. But traditionally, we saw mostly home-grown success stores coming at Plus and upgrading through the different plans. Now obviously, we're seeing merchants that frankly, even 5 years ago we didn't anticipate they'd be coming to us. They come with a whole bunch of nuances that we just weren't aware of. And I think now we're getting better at understanding what they require. And that even extends some of the government agencies are working with -- in place like Canada for things like cannabis, where they come with a whole set of requirements. I think we're getting much better and much smarter and much more effective in onboarding then and getting them up and running. The neat part about this particular merchant is they come with an existing business and so GMV obviously, for them accelerates fairly quickly relative to a brand-new direct-to-consumer brand that's just trying to build up their business. That being said, relative the entire stack of GMV across all of Shopify, which again was $15 billion for the quarter. It's not necessarily going to over overly material. But I do believe you will continue to see more large, complex, very well-established brands come onto Shopify Plus in the coming years.

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Operator [55]

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Our next question comes from Paul Treiber of RBC Capital Markets.

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Paul Treiber, RBC Capital Markets, LLC, Research Division - Associate [56]

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Just in regards to Shopify Pay, the adoption does seems quite strong. What's your thoughts on some of these more consumer-facing services like, pay, creating a consumer brand around Shopify itself. And then how do you -- it relates to, how do you think about striking a balance between any Shopify-related branding with consumers and the merchants on branding?

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Tobias Lütke, Shopify Inc. - Founder, Chairman & CEO [57]

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Those was perennial of evergreen conversations within Shopify, again, we've grown up as sort of a total brand behind brands, like even putting Powered by Shopify on the stores that the hosted on Shopify. That's something that people get manually at some point and only then did we sort of created as an option. So the success of the company has traditionally been just making other people look good rather than ourselves. So we're very, very careful with any exposed branding. I mean we are certainly, like agreeing with our customer who are saying that, hey, you guys have a pretty good brands, let's use it. So this is why Shopify Pay was something we reengaged in. It certainly was -- been very successful. But like it's just going to be something we're going to do very, very carefully. That's basically the best thing I could say about it. I think this direction is so frauds of potential pitfalls and going overboard, I think it's important that we stick to what we know.

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Operator [58]

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Our next question comes from Ygal Arounian of Wedbush Securities.

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Ygal Arounian, Wedbush Securities Inc., Research Division - Research Analyst [59]

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I just wanted to ask the macro question on holidays just from a different angle, and there's obviously, been a lot more discussion around the macro environment potential recessions and just flowing growth. And it would seem to indicate from all your numbers that you're not seeing any real negative sentiment out of I guess particularly your SMB cohorts, but to any degree you could kind of talk about the overall business investments and sentiment you're seeing from newer merchants. And then real quick, you guys then touch on POS on this call. And you rolled out a pretty meaningful software upgrade at -- earlier in the year and I wanted to see if there's any early reads from that, customer reactions, and any lessons you're learning.

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Tobias Lütke, Shopify Inc. - Founder, Chairman & CEO [60]

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Yes. But update hasn't hit yet. This is still coming out in the future. We are super excited about it. And then generally the scenario we're building up, point of sales is doing pretty well. Macro -- we have visibility in purchasing behavior where we don't see any indication of diminishing confidence. We have visibility in new business formation, which seems strong, and it's not tracking in any meaningful way different from how it has through the last 10 years of a bond market. So we are not seeing anything coming from our side as everyone who has witnessed recessions have. They usually come from this side where you don't expect them from. So it doesn't look like our side. If something is happening, it doesn't look like our side. It's -- the thing that's causing it, and it's tracking ahead.

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Katie Keita, Shopify Inc. - Senior Director of IR [61]

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Sure. Thanks. (Operator Instructions)

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Operator [62]

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Out next question comes from Josh Beck of KeyBank.

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Josh J. Beck, KeyBanc Capital Markets Inc., Research Division - Senior Research Analyst [63]

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I wanted to ask about B2B. I think it's been approaching 6 months since you purchased Handshakes. So any updates you can provide us on what the key strategic objectives are for you within that opportunity?

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Tobias Lütke, Shopify Inc. - Founder, Chairman & CEO [64]

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Yes. So as you mentioned, we did acquire Handshake about 6 months ago. It's an incredible team of people that have been thinking more about modern wholesale and modern B2B probably more than anyone else in the planet. Remember that Plus historically had a very small B2B business that was sort of -- we didn't necessarily to go there, our merchants pulled us there. We were noticing that some of our merchants had a very successful and thriving retail business but also we're looking to use Shopify for their wholesale and B2B business. We felt that although we could probably get there ourselves, we wanted to accelerate that. And we felt, with team over and Handshake, we'd be able to get there a lot faster. So again, we're still working together to figure out exactly what the go-to-market will be for that? What exactly their final product will look like for that? But certainly, we have the greatest team we think on planet thinking about modern retail and modern B2B, and that will continue to grow overtime. But it's not yet a material part of the Plus business or the Shopify business. But it does allow us eventually to get an entire different segment of the market to think about Shopify, who currently we are not talking to.

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Operator [65]

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Our next question comes from Brian Peterson of Raymond James.

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Brian Christopher Peterson, Raymond James & Associates, Inc., Research Division - Senior Research Associate [66]

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Just wanted to hit on the success you've had internationally. And I'm curious if the merchant ads you've seen, have those been more traditional Shopify merchants? Or have you also seen quicker than expected adoption for net new Plus merchants as well? Any color on that.

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Harley Michael Finkelstein, Shopify Inc. - COO [67]

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Okay. I'll take that question. From an international perspective, the interesting part about our expansion there, it differs by different by countries. In certain countries, we're seeing a lot larger merchants come on. They look a lot more like the Plus merchants segment. They're coming out with GMV. They have dozens of employees, if not more, working at their companies. In other segments, we're seeing very small merchants, very similar to what we'd see signing up for $29 plan in North America. So the new part about our strategy there is that we're actually tailoring our product in the go-to-market on a per country basis. And that's the reason why we do things like country-specific and language-specific applications. We need a partner ecosystem each country that differs from other countries. And obviously, language is something we've been working on for a while. So we currently have Shopify now in 19 languages. And obviously, the diversification of the merchant base increases out TAM. So we're excited about that. The other thing that obviously, Amy had mentioned in her prepared remarks was that, GMV from international is actually growing faster than other segments. And that's really great. And we still have not penetrated the international market with merchant solution in the way we have in some of our core markets, so that remains an opportunity in the future for us.

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Operator [68]

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Our next question comes from Samad Samana with Jefferies.

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Samad Saleem Samana, Jefferies LLC, Research Division - Equity Analyst [69]

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Amy, I think I'm in your prepared remarks, you mentioned, level setting subscription pricing for legacy plans. I was wondering if you can maybe help us understand how much legacy pricing there still is? What the impact of that was on the quarter? And maybe the philosophy around price increases now and what drove that?

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Amy E. Shapero, Shopify Inc. - CFO [70]

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Yes. The migration to standard pricing is largely done now. And it was merchants -- legacy merchants that were not on standard plans? And for simplicity, we just wanted to clean that up. And we called it out. The MRR growth would have been significant without it, but it did have about 1 percentage point of growth year-over-year impact. So we wanted to call it out. But it is largely done now.

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Operator [71]

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Our next question comes from Todd Coupland of CIBC.

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Todd Adair Coupland, CIBC Capital Markets, Research Division - MD of Institutional Equity Research [72]

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Great. Just following up on the international questions. Which countries did the best in the quarter? And how do you expect that to trend in the fourth quarter?

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Harley Michael Finkelstein, Shopify Inc. - COO [73]

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So we've mentioned in the past, there are some countries we're focusing on, places bases like Germany and France and Japan and other places like that. But in terms of doing best, again, some of them are areas and geographies where we're going to merchant growth and other places we're going to see higher GMV growth depending on the type of merchants we have there. But we're constantly -- we're taking a very nuance approach to this country based and what they actually require. And then try to find product market fit based on that. So I wouldn't say, there's any one country that is [clipping] every other one internationally.

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Operator [74]

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Our final question comes from Suthan Sukumar of Eight Capital.

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Suthan Sukumar, Eight Capital, Research Division - Principal [75]

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Just wanted to touch on POS. So historically, this has been more of a cross-sell to your online merchant base expanding into off-line. Given that you're now making more focused investments in the segments with the launch of the new platform and new hires. How do you anticipate evolving your go-to-market plan going forward here?

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Harley Michael Finkelstein, Shopify Inc. - COO [76]

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So in terms of the point of sales and our go-to-market efforts, we now have a sales team around it, so we didn't have it in the past. Now this is mostly inside sales, so we feel there still remains a significant low hanging fruit inside the platform, people that are already using Shopify but may not be using us for point of sales. And so that's where we're focusing. Now we are seeing some new merchants come to the platform, just for point of sales. And as Tobi mentioned earlier, as point of sale next rolls out in the future, we think that's going to be a very compelling reason to come to Shopify strictly for the POS product and then taking more of our products. But right now, the majority of our sales efforts around point of sale are inside sales selling to our existing merchant base.

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Katie Keita, Shopify Inc. - Senior Director of IR [77]

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Thanks for your time. Thank you. And then we'll hand it over to Tobi for closing remarks.

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Tobias Lütke, Shopify Inc. - Founder, Chairman & CEO [78]

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Yes. So as you probably saw, like we also announced that we have now 1 million active merchants on the platform, which is roughly around this time, 15 years ago, I launched store number 1. Certainly, didn't imagine to be able to say that one day. So this is kind of blowing my mind right now. I think here's an interesting thing. A lot of what's working about Shopify is 2 levels of -- I don't have a good term of it, but let's -- it's more like, I would say, business model to customer needs harmony. So I think software-as-a-service as a business model is one of those things, which I think is a little bit underappreciated. Because here's what's going on. The vast majority of our customers are subscribing mark-to-market. But what it does is it keeps us as a company incredibly honest, right? Like we are getting a ton of suggestions, ideas. We're seeing a lot about the word of e-commerce. Harley pointed out earlier, but we actually have some data on the mobile question. Now that's -- 81% of all traffic is mobile phones and 74% of our orders complete on mobile. So think about that compared to 15 years ago, The iPhone wasn't even out there yet, right? So what SaaS competitors do is just really understanding what's happening, and rolling out all these updates for everyone to appreciate them for free rather than making big like additional charges for this. And so it aligns our interest with our customers, and I think this is a dynamic, which forges software of just simply higher quality. Because, again, there's no long-term commitments that you can rely on. One zoom level down, this is -- like this, a similar dynamic around the D2C situation, right? Like that's -- our customers now selling without intermediation directly to their customers also puts them into direct visualization of their customers, and they create significantly better product. And of course, that -- in a loop feeds back to us doing well as a company. For those of you who have been on a bunch of these calls so far I, at some point, mentioned that, I had a investor who ended up not investing because they thought maybe that the worldwide market for online stores was about 40,000 stores. So it's just amazing to zoom out and just see, hey, here what happened? How many people are actually building successful businesses from every downtown area in every city to the most remote island in the middle of Atlantic. And they just -- all of them integrating themselves perfectly into the global network of commerce. And it's just really, really gratifying.

So here's some thoughts to leave you with, and thank you for joining us.

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Operator [79]

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This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.