Shopify & Palantir Earnings Reviews

Digesting the results of these two disruptors.

1. Shopify (SHOP) – Earnings Review

a. Demand

Beat revenue estimate by 2.4% and beat low 20% revenue growth guidance comfortably. The 24.8% growth rate would have been roughly 30% without the headwind from selling its fulfillment business. 30% marks an ex-Deliverr acceleration vs. 28% Y/Y growth last quarter.

Gross Payment Volume (GPV) was 58% of Gross Merchandise Volume (GMV) vs. 54% Y/Y. The Shopify Payments proliferation continues.

Pricing changes helped prop up subscription revenue growth just a tad. These price changes were for non-plus tiers. This is why Plus Merchant monthly recurring revenue (MRR) as a percent of total fell from 33% to 31% Y/Y.

b. Profitability

• Beat 52% GAAP gross profit margin (GPM) estimates by 60 basis points (bps) and beat its GPM guide by 80 bps.

• Beat Free cash flow (FCF) estimates by 43% and beat its guide by 51%. FCF of $276 million compares to -$148 million Y/Y.

• Beat EBIT estimates by 65%.

• Beat $0.21 earnings per share (EPS) estimates by $0.04 (19% net income beat).

c. Fourth Quarter Guidance

Shopify roughly met revenue estimates & also met GPM estimates. It handsomely beat FCF estimates by 42%. This 42% beat assumes its “high teens free cash flow margin” guidance means 18%. Finally, it told us that operating expenses would continue to fall Q/Q as it remains laser focused on growing profitably.

d. Balance Sheet

• $4.9 billion in cash & equivalents.

• $915 million in senior notes.

• Diluted share count rose 2% Y/Y while basic share count rose 1% Y/Y.

• Stock comp dollars fell by about 30% Y/Y via layoffs.

e. Call & Release Highlights

Brick & Mortar:

Shopify grew offline volume by 26% Y/Y thanks to its point of sale (POS) and payments suite. 26% Y/Y growth accelerated vs. 23% Y/Y growth last quarter. It’s also signing larger physical retailers. This quarter, it landed the Sacramento Kings, Banana Republic and Princess Polly; a third of offline’s overall growth is coming from Plus merchants. Subscribers to its full service POS Pro software rose 34% Y/Y as well.

In response to this continued outperformance, Shopify launched a new “Retail Plan.” This includes the POS hardware and Pro software subscription with “tools to build a simple online presence.” This plan, since launching in August, already represents 16% of its POS Pro subscription growth. It costs $89/month. Beyond the Retail Plan, it also debuted new POS hardware called “POS Terminal.” This pulls from the mobility and broad use cases of its POS Go product pictured below.

It allows POS Go to plug into a fixed terminal to transform the mobile POS into a “connected countertop payment device.”

Partnerships & Pricing:

• The announced Buy with Prime app will go live on Shopify in the coming weeks.

• Shopify and Flexport finalized their deepened partnership following the sale of Shopify Fulfillment Network (SFN) to Flexport.

Its partner network is 4x the size of its closest competitor. This means more use cases, more interoperability and more unique value delivered by Shopify. That value directly translates into pricing power. This is why Shopify’s subscription price hikes this year were met with 0 material churn. That success is leading the company to contemplate more price hikes in the near future. It thinks its “value to cost” ratio is sharply skewed to value and that it can strike a better balance.

Checkout Upgrades:

Shopify revamped its single page checkout during the quarter. This is speeding up time to checkout by 4 seconds. Every second saved means more shoppers converting. Furthermore, its Checkout Extensibility product for more customization features is going very well. The product is faster than others and so converts at a higher clip. Supreme, Mr. Beast and Thrive are among the early users. This tool is fully integrated into Shop Pay which is Shopify’s consumer-facing checkout accelerator. That integration makes this the only fully customizable one-click checkout on the market. That’s how you stand out in a commoditized, crowded field.

Shop Pay is in the early days of opening up to non-Shopify merchants. This will pin it more directly against PayPal, Apple and others.

Europe:

After a few warnings from European Fintechs on Western Europe weakness, some investors were rightfully nervous about Shopify. It does a ton of business in Germany, France and other nations that were called out for soft demand. Shopify isn’t experiencing this headwind. European GMV rose by over 40% Y/Y as it continues to rapidly take share in that region.

Shopify Markets Pro, which is its full-service cross-border tool, could help more. This localizes shopping experiences by market while handling compliance and currency headaches. It’s only available for U.S. merchants selling globally (starting this quarter), but will expand to Europe in 2024. That could offer meaningful upside to the 15% of its volume coming from cross-border trade. Cross-border is higher margin than domestic volume.

Wholesale:

Shopify’s wholesale unit is thriving. Its wholesale volume is up 100% Y/Y while it passed total 2022 wholesale volume in August. Not only does this mean more revenue, but it gives Shopify a foot in the door for giant merchants that it didn’t previously have. Virtually all massive enterprises that sell consumer products utilize wholesale channels. Now Shopify can help them do so more seamlessly.

Shopify Plus Wins Highlighted this Quarter:

• Pucci (LVMH)

• QuickSilver & Billabong (Board Riders)

• Snow Peak (largest win in Japan to date)

Merchant Solutions & Margins:

The attach rate gains were driven by Shopify Capital, Markets, Installments, Payments and its newer tax products. The price hikes for subscription tiers helped too. 

The explosion in gross margin is as expected and related to selling SFN. Merchant Solution gross margin adjusted for this boost actually fell 100 bps Y/Y due to rapid payments growth. Importantly, Payments revenue entails very little operating expense which means the EBIT associated with it is actually similar to subscriptions. Gross margin overall was flat Y/Y without the fulfillment sale boost.

The overall GPM expansion, when paired with OpEx falling 23% Y/Y, leaves us with the profit explosion. OpEx was lower than expected as Shopify resumed hiring at a slower pace than it initially planned.

Gross margin will again expand next quarter thanks to selling Deliverr, but will again be flat without this help.

Macro:

Shopify called the consumer “quite resilient.” It’s seeing no signs of weakening. This offers credibility to the argument that best in class companies are enduring macro headwinds better than weaker firms. That outperformance hints at issues being more micro-related and not actually exogenous.

f. Take

The theme of the call was Shopify being ready for “sustained profitable growth.” Under new CFO Jeff Hoffmeister, the team sharply changed its growth at all costs mindset to one that prioritized free cash flow generation as well. It fixated on halting operating expense growth. It focused on profitable growth vectors while continuing to briskly grow the top line. Last quarter was the beginning of that playing out.

This quarter was the first in which layoffs and selling SFN were fully reflected in results. As you can see from these numbers, its plan is working perfectly. Gross margin soared higher and revenue growth has remained impressively strong. This is fostering rapid free cash flow growth well beyond what was expected… just as I said would happen in the newsletter a few weeks ago. This ship has been fully righted.

2. Palantir (PLTR) – Earnings Review

a. Demand

Palantir beat revenue estimates by 0.4% & beat guidance by 0.1%. Its 19.3% 2-year revenue CAGR compares to 24.1% Q/Q & 25.7% 2 quarters ago.

• Commercial revenue rose 23% Y/Y and 33% Y/Y in the USA

• Government revenue rose 12% Y/Y and 10% Y/Y in the USA.

• Revenue per employee is up 100% since 2019.

• Revenue per top 20 customers rose 13% Y/Y to $54 million.

• It closed 80 $1+ million deals, 29 $5+ million deals and 12 $10+ million deals during the quarter.

• Billings rose by just 8% Y/Y. This needs to pickup (like it’s expected to) for revenue growth to remain brisk.

b. Profitability

Palantir beat EBIT estimates by 17.6% & beat guidance by 19.2%. It also beat $0.01 GAAP earnings per share (EPS) estimates by $0.02.

c. Guidance

Palantir’s guidance beat revenue estimates by 0.3% & beat EBIT estimates by 5.1%. It reiterated positive GAAP net income guidance for next quarter as well.

The team committed to expenses growing more slowly than revenue going forward.

d. Balance Sheet

• $3.3 billion in cash & equivalents.

• Undrawn $500 million credit revolver.

• Basic share count rose 4.2% Y/Y while diluted shares rose 12.2% Y/Y.

e. Call & Release Highlights

Artificial Intelligence Platform (AIP):

AIP was cited as the source of strength for the U.S. Commercial Business. Its AIP Bootcamps are the firm’s go-to-market approach for the product which seems to be working. The bootcamp gets customers from “0 to use case” in 5 days with hands-on support from Palantir engineers to craft custom tools. The bootcamps not only help users, but Palantir’s bottom line too. The more efficient sales approach is “vastly improving unit economics from initial contract to customer conversion.”

The presentation consisted of several quotes from executives praising the product for condensing months of productivity into a few hours. Customers of this product are up 200% Q/Q (small base) and so far include:

• Cisco

• Cleveland Clinic

• Intuit

• Kinder Morgan

• Molson Coors

• Cleveland Clinic Ukraine’s Ministry of Digital Transformation

• Panasonic

Great start here.

FedStart:

FedStart is the firm’s federal accreditation as a service product. It gets companies to Impact Level 5 (IL5) status in a small fraction of the time and cost vs. other solutions. This product pairs very nicely with its newer Government Web Services (GWS) tool to “provide defense industry companies with software to operationalize capabilities at scale.” FedStart is a key piece of GWS along with Apollo.

U.S. Commercial Demand:

The rapid growth for this segment was even faster when excluding strategic commercial contracts. These contracts are multi-year with lumpy revenue recognition and significant upfront payment. They make Y/Y growth comps noisy.

Growth excluding these contracts was 52% Y/Y. Revenue overall rose by 21% Y/Y without this comp headwind. Commercial deal count rose 140% Y/Y and total contract value (TCV) rose 55% Y/Y. It’s enjoying shorter times to conversion as sales cycle elongation was not cited as a demand headwind this quarter.

Geopolitics:

Palantir sees the outbreak of war as feeding Government demand for its products. It sees this as the catalyst to “re-accelerate U.S. government business.” The budgeting environment remains uncertain for the public sector, but it was “encouraged by a pickup in activity towards the end of the quarter.”

(Key) Large Language Models (KLLMs):

Large Language Models (LLMs) are wonderful for building broad use cases and layers of automation. They often lack unique context to be local enough to actionably deploy in niche, business-specific use cases. For example, Bard would not work as well for a language learning app as it does for general querying.

Palantir, with KLLMs and tools like AIP, provides a fix for this issue. It lets companies tap into many model providers while “anchoring the models to your data on your private network” to uplift use case granularity and utility. Palantir can further season these KLLMs with only the most important 3rd party data sources to ensure relevance.

KLLMs importantly allow businesses to “harness critical workflows” and keep them intact as foundational models rapidly evolve. KLLMs are a key piece of its Generative AI approach and are building rapid traction.

f. Take

This was a good quarter. The dilution does bother me, but nothing else in the report did. Some rightfully argue that the dilution is related to options vesting. Still, many companies reset and eliminated some comp packages over the last couple years to control this issue. I would have loved to see Palantir do that or anything else to get this in check. Dilution is fully expected to slow going forward and that simply must happen.

Aside from that, this was very good. The AIP traction is impressive and normalized growth is also impressive. What’s most impressive, however, is the profit growth well beyond what anyone expected. It continues to engrain itself more deeply into customer lives while the world’s chaos is an unfortunate tailwind to its demand. Good results for a fascinating company.