Twilio (TWLO) Q1 2020 Earnings Results Review

Twilio released their Q1 2020 earnings report on May 6. The results stunned the market – they beat Q1 estimates and raised projections for Q2 by a wide margin. Growth was across the board – benefitting from COVID-19 specific use cases and their broad platform offering, as companies flock towards digitizing customer communications. The market reacted the next day by driving TWLO stock up over 39% to close at nearly $171. All analysts raised their price targets significantly. Commentary on the earnings call was very positive. Let’s take a deeper look at the results, customer wins, overall market trends and then draw some conclusions for the investment thesis going forward.

This earnings report was a bit of a watershed moment for Twilio. After reaching a high of $151 in July of 2019, the stock dropped in 2H2019 and subsequently bounced around the low $100 range for the last 9 months. As the COVID-19 situation materialized, several analysts lowered expectations and even downgraded Twilio, anticipating that the associated economic downturn and impact on certain sectors would present a real headwind for the stock. Coupled with a few mixed quarters of performance prior, this conservatism was understandable.

However, as the ramifications of social distancing, work from home and the acceleration of digital transformation became clear, Twilio started showing signs that they actually would thrive in this environment. The company also spent much of 2019 laying a foundation for growth – completing the full absorption of SendGrid, building out the enterprise sales organization, expanding product capabilities and revamping internal business operations to scale.

I have been a long-time bull of Twilio, due to their programmable platform, developer friendly motion, leading position in a large market and technical founder/CEO. Interested investors not familiar with the story can check out my other posts related to Twilio. As the COVID-19 situation played out, Twilio started announcing several new projects and customer wins that reflected how their programmable communications services could be leveraged by developers to quickly spin up new solutions for addressing the challenges associated with social distancing. These included an open source video collaboration app, a few Flex contact center wins, chatbot templates for health organizations and several cool COVID-19 specific use cases for SMS/IVR. For more details, you can check out my blog post from March 29th.

As is now clear, this setup led to the blow-out earnings report on May 6th. It is great to see Twilio emerge with a strong sense of momentum and the market’s renewed appreciation for its underlying potential. Twilio’s favorable position is grounded in their programmable platform that makes common digital communications functions dead easy for developers to consume and rapidly create new customer experiences. COVID-19 accelerated the digital transformation trends that Twilio was already aligned with. As CEO Jeff Lawson said on the earnings call, “Twilio was built for this.” I couldn’t agree more. Now, let’s take a look at the financial results.

Headline Financial Results (EPS is Non-GAAP)

• Q1 2020 Revenue was $364.9M, up 56.5% year/year. Consensus estimates were for $327.6M, or 40.5% growth. This represents a beat of $37.3M or an extra 16% of annualized growth outperformance. Organic growth (removing impact of SendGrid) was 48% year/year. This compares to 36% organic growth in Q4, so a substantial re-acceleration of revenue growth in an apples-to-apples comparison of the core business.
• EPS was $0.06 vs. ($0.11) expected, representing a beat of $0.17. EPS in Q1 2019 was $0.05.
• Non-GAAP operating income was $6.1M, representing an operating margin of 1.7%. This compares to operating income of $3.4M and an operating margin of 1.5% in Q1 2019.
• Q2 Revenue estimate of $365-370M, representing growth of 33-35% year/year. Consensus revenue estimate was $323.4M, for growth of 22%, so a substantial raise here. Projected Q2 growth can be compared to the organic growth rate of 48% in Q1, but should take into account the 16% annualized outperformance from Q1 to evaluate concerns around deceleration.
• Q2 EPS estimate of ($0.11) to ($0.08) vs. ($0.14) expected, representing a raise of $0.05 at the midpoint.
• Q2 Non-GAAP operating loss estimated in the range of ($20M) to ($15M).
• Due to the uncertainly of the length of the COVID-19 situation, Twilio withdrew its 2020 guidance. I think this is reasonable, given that it’s possible the COVID-19 situation could get worse.
• Ended the quarter with cash, cash equivalents and marketable securities of $1.8B.

Other Performance Indicators

• Part of the revenue outperformance is attributable to the new A2P (application-to-person) charges introduced by some cellular carriers this year (Verizon). This represents an additional fee per text message. Twilio (and other SMS providers like BAND) just pass this fee through to the customer. This started on Feb 1 and represented about $4M in incremental revenue for Q1. Going forward, these fees will increase revenue by about $6M per quarter, according to the CFO on the earnings call. So, while the revenue outperformance for Q2 was significant, we should consider about 2% of annualized growth is attributable to these additional fees.
• On COVID-19 impact, Twilio had an interesting mix of some industry segments that saw reduced usage and others that experienced increased activity. Headwinds came from travel, hospitality and ride sharing, but offsetting benefits were generated by education, healthcare and retail. Impacted sectors averaged less than 10% of revenue and beneficiaries contributed more than the contraction. This balance insulated Twilio from COVID-19 impact much more than other software companies, and was overlooked by some sell-side analysts. Jeff Lawson telegraphed this trade-off in usage at the Morgan Stanley TNT Conference on March 2nd, when asked about potential impact of COVID-19 on the business.
• On the earnings call, the COO identified six use cases for Twilio that have opportunistically materialized from the COVID-19 situation. They are remote contact center, customer self-service, contact list delivery, distance learning, telehealth and mass notifications. These are expected to maintain their momentum after the situation clears. 
• Q1 Non-GAAP gross margin was 57%. This compares to 58% in Q1 2019 and 58% for all of 2019. The new A2P charges from carriers accounted for 70 bps of this reduction. This makes sense, as A2P is zero margin and would pass directly to COGS. Non-GAAP gross margin was 54% in 2018, so Twilio is making progress. Higher margin software solutions (like Flex, email marketing, etc.) will also help raise gross margin over time.
• Breaking down Non-GAAP expenses by category, we see a 1% uptick in sales and marketing expense and a nice drop in general and administrative.
  • R&D = 21% (same as Q1 2019)
  • S&M = 24% (23% in Q1 2019)
  • G&A = 10% (13% in Q1 2019)
• Customer count grew to 190,000 at end of Q1. This compares to 154,797 at end of Q1 2019, representing annual growth of 22.7%. This compares to 179,000 at end of Q4, for sequential growth of 6.1%. Interestingly, Q3 to Q4 2019 customer count growth was 4.0%, so Q1 represented an acceleration in new customer adds.
• DBNER was 143% for Q1, versus 125% in the prior quarter and 142% a year ago. However, when adjusted for SendGrid, the Q1 number drops to 135%. Still, a marked improvement over Q4 (125%) and even Q3 2019 (132%). I consider a DBNER value over 130% to be exceptional.
• Revenue from Top 10 customers ticked up to 15% in Q1, compared to 14% in Q4 and 14% in Q1 2019. Whatsapp is still the largest customer, making up 7% of revenue, also up 1% from Q4. Investors will recall rumors in November 2019 that WhatsApp was scaling back usage. It doesn’t appear that has materialized. On the earnings call, leadership mentioned that this usage is primarily for account verification.
• During the quarter, Twilio announced that they joined the anti-robocall coalition and started signing enterprise customer calls using the new SHAKEN/STIR protocols to help reduce illegal robocalling. This benefits Twilio in two ways. It should help reduce public backlash against automated voice calls, allowing growth for legitimate uses. Further, it widens the technical moat for new competitive entrants into the space.

• On the earnings call, management highlighted several customer wins from the quarter:
  • Epic, a digital provider of health records for 250 million people, built its own telehealth application, powered by Twilio’s programmable video service. The solution allows providers to launch a video visit with a patient, review relevant patient history and update clinical documentation directly within Epic.
  • Cover, an online insurance buying service, selected Flex to power its customer communications. Cover sought the control to build a fully customized contact center to deliver a differentiated customer experience. Other contact center solutions did not offer the desired level of programmability, which is the whole point of Flex.
  • Comcast needed a way to facilitate service requests for their customers without requiring in-person contact with the technician. In just a few weeks, Comcast developers integrated Twilio voice with their homegrown customer management database, enabling technicians to place calls to customers directly. They also used Twilio video to allow a customer to use their phone’s camera to show the technician their cable configuration. The technician could then guide the customer remotely through troubleshooting steps and repair without entering the home. Very cool.
  • Blackboard, an online education platform, started using Twilio SMS to connect teachers and students.
  • The city of Pittsburgh had to quickly transition their 311 operators to perform critical work outside of the on-premise call center. They spun up Twilio Flex in four days and all operators transitioned to their homes.
  • Expanded the relationship with Nubank, the largest fintech company in Latin America. Nubank became a Twilio email customer in 2019. In Q1, they chose Flex to power their contact center for several thousand agents.
  • Signed a Flex deal with AB InBev, a fortune 150 conglomerate.
  • Entered into a new relationship with Standard Chartered Bank, a Global 2000 company and leading international banking group with more than 87,000 employees across 60 markets. They selected Twilio to build their new enterprise messaging platform.
  • Expanded their relationship with a Fortune 100 brick and mortar and online retail company, that has been a customer for several years. They’re building a new workflow that expands usage of Twilio SMS for their mobile and web applications. This new workflow will offer order and shipping notifications via text messaging to guests who purchase through those channels.
  • Large car manufacturer chose Twilio’s email and SMS solutions.
  • Expanded their relationship with one of the world’s largest consulting firms, adding email to power marketing campaigns and customer notifications across several products.
• The COO called out performance of their Partner program to bring new deals. In Q1, more than 40% of Flex deployments involved a partner.
• Twilio achieved HIPAA compliance in February, which was almost perfectly timed with the increased need for telehealth solutions.
• Leadership anticipates heightened spend in messaging for the period leading up to the November election.

• Mentioned a statistic on the call that before COVID-19, analysts estimated that 17% of the roughly 15 million contact center seats in the market were served from the cloud. Updated projections now show this will expand to 50% of all seats by 2025.
• Total headcount outside of the U.S. has increased from roughly 19% to 27% in the past year. This is reflective of Twilio’s investment in pursuing more business internationally.

• The CFO commented on progress against several of the spending initiatives introduced for 2020:
  • R&D Center in India. Have leased office space and hired several employees who are working remotely.
  • Continuing to build out the go-to-market team, with a focus on enterprise reps, international expansion and Flex specialists. 
  • Investing in business operations infrastructure, including updating billing systems.
• On the call, the management team highlighted a number of product enhancements during Q1:
  • Launched Flex Dialpad to public beta. Allows for outbound calling from Flex call centers. This was the most consistently requested feature from prospective Flex customers. Delivering this may unlock more Flex deals.
  • Announced Flex Boost. Targeted at companies and public organizations that need to transition to a remote contact center quickly. Provides technical resources and operational guidance, plus 10,000 free usage hours per month until June 30th. Interestingly, a Twilio blog post featured advice on how to successfully run a remote contact center from Twilio’s existing Flex customer Shopify.
  • Launched Video Boost. Provides three months of free use of the Video API product for customers in the healthcare, education, and the nonprofit sectors. This can be used to build a video collaboration app and even includes open sourced starter code for web, iOS and Android clients. This launch also highlighted the fact that MDLive already uses Twilio’s programmable video, voice and SMS solutions to deliver their telehealth service to their 40M members.
• Rescheduled the annual user conference, Signal, as a virtual event in late September. This is normally held in May. Twilio usually unveils big product announcements at Signal, so we have that to look forward to in the late summer.
• In Jeff Lawson’s (CEO) introduction on the earnings call, he summarized Twilio’s platform positioning for the COVID-19 environment. This underscores the flexibility and implementation speed offered to developers at enterprises charged with modernizing customer communications.

While we wouldn’t have wished it this way, in many ways, Twilio was built for this. Our platform provides three things the world needs, digital engagement, software agility, and cloud scale. Technologies such as messaging, email, voice and video have enabled many parts of the economy to continue working, while keeping its participants safe. Moving quickly, building prototypes and iterating as our needs evolve has been critical for nearly every kind of organization. That’s the essence of agility. And Twilio has enabled organizations to reimagine many of their communications workloads in days and weeks, not months and years.

Twilio Q1 2020 Earnings Call

Analyst Reactions

Following Twilio’s Q1 earnings results, 13 analysts provided updated coverage ratings. In reviewing Q4 2019 results, I could find only 7 analysts that immediately posted updates. It seems this earnings report was enough of a trigger to get more analysts to update their targets. That could drive new institutional buying.

Of the 13 analysts providing updated coverage ratings, they all raised price targets significantly. All but two rated the stock at a Buy equivalent. The average price target for these updates is a little over $167, representing a 2% reduction from the closing price of nearly $171 on May 7th.

Date	Analyst	Rating	Price Target
5/7	Canaccord	Buy	Raised from $140 to $170
5/7	Robert Baird	Outperform	Raised from $110 to $175
5/7	DA Davidson	Buy	Raised from $144 to $175
5/7	Wells Fargo	Overweight	Raised from $140 to $175
5/7	Northland	Outperform	Raised from $140 to $170
5/7	Morgan Stanley	Overweight	Raised from $125 to $160
5/7	Piper Sandler	Neutral	Raised from $90 to $135
5/7	Needham	Buy	Raised from $130 to $170
5/7	Cowen	Outperform	Raised from $135 to $180
5/7	RBC	Outperform	Raised from $140 to $180
5/7	Mizuho	Buy	Raised from $125 to $180
5/7	Rosenblatt	Hold	Raised from $80 to $150
5/7	Oppenheimer	Outperform	Raised from $125 to $160

After the earnings results, Mizuho set one of the highest price targets, raising from $125 to $180. Analyst Siti Panigrahi provided this commentary.

Mizuho analyst Siti Panigrahi raised the firm’s price target on Twilio to $180 from $125 and keeps a Buy rating on the shares. The company’s “strong” Q1 results and above-consensus Q2 guidance highlighted that Twilio stands to be a “significant beneficiary” of COVID-19 in the short term, boosting usage volumes dramatically, Panigrahi tells investors in a research note. Longer term, the analyst expects the company to sustain “robust” growth.

TheFly.com, May 7, 2020

My Take-aways

• Twilio has been laying the groundwork for 2020 outperformance for several years. Even without the pandemic, I think performance would have been elevated. The COO talked about how they have been preparing their go-to-market playbook and combined that with a new enterprise sales team that can engage the c-suite strategically. Layering this on top of their bottoms-up developer evangelism will make for a powerful combination.
• Revenue growth re-accelerated in Q1 after trending downward in 2019. Q1 organic revenue growth was 48%, compared to 36% in Q4.  We do need to keep in mind that A2P will goose revenues in 2020 by about $4-6M per quarter, but even accounting for this, Q1 growth was 10% higher than Q4.
• Also, profitability is tracking much better than expected. Twilio stock took a hit in February with preliminary 2020 estimates projecting a significant reversal in profitability.  For Q1, the fact that they had estimated an EPS loss of ($0.11) and swung to a $0.06 gain is very encouraging.  Twilio didn’t need to spend incrementally to realize this gain.  Sales and Marketing expense for the quarter was roughly inline with the prior quarter (24% vs. 23%) and G&A expense dropped 3%.  This portends well for the remainder of 2020, as investors had discounted Twilio’s growth opportunity for 2020 because they reversed course on profitability.  In a similar vein, Q2 EPS estimate of ($0.09) was raised by $0.05 at the midpoint.  Still negative, but hopefully will outperform as well. This is important, as elevated revenue growth, coupled with increasing profitability, usually drives higher multiples for software stack companies.
• Twilio only generates 28% of revenue internationally (72% from U.S.), so this represents a sizable growth opportunity.
• Twilio’s competitive positioning hasn’t changed. With roughly $1.5B in revenue anticipated for 2020, they are several times larger than competitors in core CPaaS.  The total market for Twilio’s offerings is estimated to be over $50B by 2023, growing at a 40-50% CAGR from now.  Jeff Lawson has discussed how their size will continue to drive more spend on R&D and maintain their competitive advantage.  In Q1, Twilio spent $77M (after backing out stock based comp) on R&D, up from $49M in Q1 2019.  Annualized for 2020, that would be over $300M.  That amount will pay for a lot of engineers – who can continue to build new features and product offerings.  I like that Twilio is investing heavily in the large market opportunity.
• The sales motion seems to be reasonably efficient.  To achieve this kind of growth in Q1, Twilio allocated 24% of revenue to Sales and Marketing.  This is low, due to Twilio’s efficient developer evangelism motion and strong DBNER.  It compares favorably to fast-growing software peers. Assuming it can be continued, this should help drive profitability down the road.  Twilio is often discounted due to its gross margins in the high 50’s (57% in Q1), but if the S&M percentage can remain low, this may be less of a handicap on profitability.

• Digital transformation acceleration will be a big tailwind going forward.  Twilio management commented on the call that some of next year’s IT projects for enterprises were quickly moved to next week.  Other software companies have made similar comments about the impact of COVID-19 and digital transformation acceleration (NOW, FSLY, OKTA, etc.)
• Customer growth accelerated in Q1 sequentially to 6.1% versus 4.0% quarter/quarter growth in Q4.  Even more impressive was another stat that leadership shared on the call:  “We saw 25% increase in average daily signups from March 18 through April 30 compared to the first 11 weeks of the quarter.”  If this trend continues, Twilio should realize an even more substantial quarter/quarter increase in customer growth for Q2.  This is probably one of the most important take-aways from the earnings results, given Twilio’s historic ability to drive > 130% DBNER from customers over time. 
• Adoption of Flex is picking up.  This is encouraging as Flex was initially considered to be a game changer for Twilio, when it was announced back in March 2017. However, it has taken some time to build up traction.  This required getting it to GA in Oct 2018 and then rounding out features and sales support in 2019.  At this point, I think Flex is ready for primetime.  Like other products, this is timed perfectly for the acceleration of remote workforce and digital transformation.  Granted, there are several other cloud-based contact center solutions in the market (RNG, FIVN), but Twilio’s solution provides the most native programmability.  This will be valued by a subset of customers, who need heavy customization and integration with their other digital native operations.  This preference for programmability was evidenced by the Cover win mentioned above and early Flex adoption by Shopify. 
• The programmable video solution is similarly well positioned.  I don’t expect it to compete directly with Zoom or other end-user video collaboration apps.  Rather, it is a great option for companies that are building their own custom software application that needs video functionality.  The previously mentioned examples from Epic and Comcast provide evidence of this.  For Zoom investors, there is a parallel motion.  I tried to consider the opportunity in a prior post, as Zoom does appear to have the underlying APIs available for outside developers to consume. Zoom does list some customer examples on their video solutions page, so the underlying trend appears valid.
• Email, which is a new Twilio product gained from the SendGrid acquisition, will also provide a reliable incremental revenue stream going forward.  While not as sexy as video streaming and contact center, it is still a necessary communication function.  Twilio appears to be delivering on the “cross-sell” potential that had been originally expected as part of the SendGrid acquisition.  As mentioned above, Nubank was an email customer that added Flex in Q1.  One of the “world’s largest consulting firms” was an existing Twilio customer and added email to their mix in Q1.  This cross-sell will continue to drive DBNER going forward.

Risks and Items to Watch

While Twilio has regained its momentum, there are still a few items for investors to monitor as we progress through 2020.

• Twilio pulled their 2020 guidance, which had called for $1.482B in revenue or growth of 31%. Given the outperformance of Q1 (beat their original Q1 estimate by $28M) and presumed outperformance in Q2, investors can assume 2020 revenue guidance will be revised upwards. However, the economic downturn could persist or get worse. Also, while I think the increased usage will persist after the pandemic, there may be some reduction in activity on Twilio’s services for COVID-19 specific use cases.
• A big part of the bull case now is that Twilio is both growing revenue rapidly and has returned to profitability on a Non-GAAP basis. Original EPS estimate for 2020 issued in February was ($0.17) vs. $0.24 consensus. However, Q1 actual was $0.06, beating by $0.17. Also, Q2 EPS estimate was raised by $0.05 to ($0.09), which might also beat for actual Q2 earnings. This good start to the year will likely pull the full 2020 performance into positive EPS range. A risk would be if Twilio reversed course and surfaced more expenses in order to sustain the projected growth.
• International expansion represents both an opportunity and a risk. Twilio is largely under penetrated internationally, relative to peers operating this long. Currently, 28% of revenue is generated from companies based outside the U.S. Twilio is investing in this sales motion and has seen some initial traction, but if not successful, could start capping overall revenue growth.
• While initial sign-up for developers is low friction, enterprise sales and expansions have relied on some higher touch tactics, like the annual Signal conference and on-site hackathons. While these could be moved virtually, they might lose some impact.
• Competitive positioning. It does seem that a number of smaller providers have popped up in the last couple of years offering look-alike services. I don’t think these represent a real threat, but could create a distraction for some customers who are seeking the lowest price. Perhaps the economic downturn will shake out some of these smaller players who are VC backed.

Investment Plan

After getting moved to the back-burner for most investors in 2019, Twilio has re-emerged in 2020 with renewed momentum. While the COVID-19 situation made the need for digital communications more acute, the trends that Twilio addresses are not new. As enterprises are rushing to move customer and employee experiences online through digital transformation, the companies that provide the software building blocks will benefit. Developers need a reliable toolkit of programmable services that are agile, scalable and thoroughly documented to plug into their software applications. I am seeing a convergence of use cases in particular categories of programmable software services that are dominated by independent, hyper-focused providers, often not one of the big cloud vendors. Examples of winners in well understood categories are Okta for identity and Docusign for agreements. There are also emerging, but not fully proven, category leaders like Fastly in edge compute and Elastic in generalized search. All of these companies provide specialized and critical services that developers use to build modern software applications. I will posit that Twilio leads the category of programmable communications and will similarly benefit from digital transformation tailwinds going forward.

In terms of an investment plan, my original recommendation for investors to own Twilio for the long term still stands. In November 2019, when Twilio traded at $98, I had set a five year price target of $320. Given the recent run-up in share price over $170, I am confident that price target is still achievable and will probably be hit sooner. I will wait until the end of 2020 before I update my price target. In the meantime, for new investors with a long term investing horizon, I recommend Twilio be added to your portfolio.

For my personal portfolio, I have a 16% allocation to TWLO currently, as a result of the recent share appreciation. I will likely add a little to my position over the next couple of weeks.