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Shopify (NYSE: SHOP) has had tremendous success growing its e-commerce solution from one retailer in 2004 to over 325,000 online merchants today. This success has seen Shopify to grow its monthly subscription revenue at a compound annual growth rate of 81% since 2012. During this period of tremendous growth Shopify has not reported a profit, ever. When will Shopify be profitable? In order to answer that question, we need to look at the past history, present financials and future plans for Shopify.
Shopify's past history
In Shopify's filing to go public, it noted that, "At March 31, 2015, we had an accumulated deficit of $33.6 million." Since then, Shopify has racked up $18.8 million loss in 2015 and $27 million loss year to date in 2016. As with other growth companies, these losses are due to investments in growth. In its public filing, Shopify talks about what these investments have been used for. (Emphasis by author.)
We expect to increase our investment in sales and marketing as we continue to spend on marketing activities and expand our partner referral programs. We plan to increase our investment in research and development as we continue to introduce new products and services to extend the functionality of our platform. We also intend to invest in maintaining our high level of merchant service and support, which we consider critical for our continued success. In order to support the continued growth of our business and to comply with continuously changing security and operational requirements, we plan to continue investing in our data center and network infrastructure.
As an investor, I like that Shopify is investing in its business for the long term, but I expect these costs to become a smaller percentage of overall revenue over time, or for the business to "scale." Shopify is scaling these costs and creating operating leverage.
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In the chart below, you can see how Shopify's Sales & Marketing (S&M), Research & Development (R&D) and General & Administrative (G&A) non-GAAP costs have all decreased as a percentage of revenue from 2012 to 2015.
Shopify has invested in growing its business and at the same time been able to scale its costs, but is this enough to generate a profit? Let's look at the company's financials in the most recent quarter.
Shopify's present financials
In Shopify's most recent third quarter release, it reported a $9.5 million operating loss despite its key business segments having healthy gross margins. The subscription services business has gross margins of almost 79% and the merchants solutions a 26.5% gross profit. These margin numbers have been stable over time (see below chart), which means to me that Shopify's core business has the potential to be profitable.
Source: Author chart and calculations from Shopify's earnings releases
But in order to make a profit, Shopify needs to spend less in operating expenses. In the current quarter, Shopify spent $62 million in GAAP operating expenses and subtracted $7 million in stock based compensation to report that their non-GAAP operating expenses have dropped to 55% of revenue. Regardless of GAAP or non-GAAP, these expenses are still not low enough for Shopify to report a profit. Shopify's guidance for the fourth quarter is not much different, guiding for its GAAP operating loss to be $10 to $12 million. Let's look to the future and what 2017 could bring for Shopify's profitability.
Shopify and its future
Shopify deferred its 2017 guidance to next earnings call in February, but Russ Jones, Shopify's Chief Financial Officer, offered some insight into the financials for next year.
...we believe the primary reason we will continue to gain share of this growing pie is ... our strategic focus on merchant success. This means continually reevaluating the platform capabilities necessary for merchants to strive at every stage of growth and also investing in the partnerships and projects that we believe will help future proof their success.
Shopify is continuing to invest strategically, and this is paying off with great growth for its business. Russ went on to say that these investments may have long payback periods, but that they felt comfortable "with our profitability target for the fourth quarter of 2017." So, the answer to when will Shopify be profitable is not until Q4-2017.
Foolish bottom line
Shopify is growing at a tremendous rate, and that growth requires investment. I like that Shopify is focused first on the success of their customers. Tobi Lutke, Shopify's founder and CEO, reiterates that fact on its investor relations website.
Shopify is exactly this: the only platform you need to build your empire. Shopify is the first thing our merchants log into in the morning and the last thing they log out of in the evening. It's at the heart of their businessa responsibility that we take very seriously. Chances are that you've already bought products through stores that use Shopify and you didn't even realize it... Yet, as a brand, we are virtually invisible to consumers. This is by design, as our job is to make our merchants look their very best in every interaction they have with consumers.
Shopify is continuing to satisfy customers, investing smartly for growth, and being fiscally responsible with a line of sight to profitability. With this approach, Shopify should keep long-term investors happy.
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