Twilio (TWLO) Q4 2019 Earnings Results

Twilio released earnings results for Q4 2019 on February 5, 2020. These results were met with mixed response. The market clearly expected more, with TWLO stock closing down 7.3% on the following day. Yet, analysts reacted favorably with 6 out of 7 raising their price target and reiterating a buy rating. Let’s dive into the details.

Headline Financial Results (EPS is Non-GAAP)

• Q4 2019 Revenue of $331.2M versus $312.4 expected, up 62% year/year and 12% sequentially. Organic revenue growth (without SendGrid) was 36%. The revenue beat was about 6%.
• Q4 EPS was $0.04 vs. $0.01. Beat of $0.03.
• FY 2019 Full Year Revenue was $1.130B vs. $1.116B expected. Note that original FY 2019 revenue guidance issued in Feb 2019 was $1.071B (included SendGrid), so about $60M increase by year end.
• FY 2019 Full Year EPS was $0.16 vs. $0.13. Note that original FY 2019 EPS guidance was $0.09, so $0.07 increase by year end.
• Q1 2020 Revenue guidance of $336.5M vs. $327.5M consensus, representing about 44.5% year/year growth over Q1 2019 (with 2 months of SendGrid). Raise of $9M or about 3%.
• Q1 2020 EPS guidance of ($0.10) vs. $0.01 consensus. Lowered estimate by $0.11.
• FY 2020 Revenue guidance of $1.482B vs. $1.465B consensus, representing about 31% growth year/year. Raise of $17M or about 1%.
• FY 2020 EPS guidance of ($0.17) vs. $0.24 consensus. Lowered estimate by $0.41. Majority of loss is front-loaded to Q1 and Q2, with Q4 anticipated at break-even.

Other Notes

• Twilio leadership provided an earnings call presentation, that included additional data about the influence of SendGrid revenue on various growth metrics. This is helpful to gauge growth of the organic business, separate from SendGrid.
• Using this data, we can calculate an apples-to-apples target revenue growth rate for Q1 2020 of 36%, versus the 44.5% absolute growth in the headline metric. This is due to SendGrid revenue only being included in 2 months of Q1 2019 (transaction closed on Feb 1, 2019). By extrapolating SendGrid revenue proportionally to January 2019, we can assume $247.5M revenue equivalent for Q1 2019. This implies growth of 35.9% for the Q1 2020 estimate of $336.5M. This is important to consider, as this revenue growth rate matches the Q4 2019 organic revenue growth rate of 36%. Also, management raised the FY 2020 outlook by $8M more than the Q1 raise, so we can expect a bit of upside to the estimated Q1 growth rate.
• Q4 DBNER of 124%, down from 132% in Q3. Accounting for SendGrid revenue, DBNER was 129% in Q3.
• WhatsApp made up 6% of revenue in Q4 2019.
• Management highlighted some new customer wins:
  • PayPal – SMS delivery
  • Southwest Airlines – Flex
  • Hubspot – Flex
  • Fortune 50 media company – Programmable video, click to call services
  • Fortune 100 company – Flex and conversations
  • Blablacar (EU car service) – Expansion from SendGrid email to SMS
  • Rappi (LATAM e-commerce) – SMS and Verify
  • Woolworths (AU grocery) – Proxy, voice and SMS
  • Unnamed customer that went live with Flex with several hundred agents in less than a month in Q4, who said, “Our prior vendor gave us Christmas presents, Twilio gave us a working contact center.”
  • Fortune 200 bank – Email and SMS
• Reported more than 179,000 customer accounts as of December 31, 2019, compared to 64,286 accounts as of December 31, 2018 (pre SendGrid). Reported 172,092 at the end of Q3 2019. Q4 represents about 4% sequential growth.
• Introduced plan to reduce dilution from stock based compensation, based on investor feedback. This is one of the drivers of increased Non-GAAP costs going forward, which in theory should be neutral for investors as it will reduce dilution.
• Flex was a major theme on the conference call. Highlighted that they delivered 70 new feature enhancements to Flex, including programmable dial pad, which has been a major customer ask.
• Jeff Lawson talked about “Act 2” of Twilio’s growth, which represents moving to engagement apps that sit on top of the core service (Act 1). Flex and Conversations are examples of these types of apps, and Jeff hinted that there would be more to come. For investors, revenue from apps will be higher margin than core services.
• Management addressed the about-face with 2020 EPS guidance, stating that they could have taken a profit easily but want to continue to invest in the business to maximize growth. This will target a couple of areas, including increased product development and scaling internal business systems. Another large component will be further investment in the sales team, as they see high ROI for hiring additional sales personnel.
• Other color on the increased spend in 2020:
  • Opening an R&D center in India.
  • Investing in go-to-market team for enterprise and international growth. Called out Flex opportunity in particular.
  • Implementing structural changes to stock based compensation, based on investor feedback to reduce dilution.
• Doubled the number of 7 figure sales in 2019 versus 2018, representing increased engagement with larger customers.
• Gross margin was 57% in Q4, which is within target of mid to high 50’s. They expect this range to continue to hold in 2020. This compares to 54% gross margin in Q4 2018.
• For full year FY 2019, gross margin was 58%, versus 54% in 2018.
• Penetration in Global 2k companies is still very low (50 companies mentioned on the call), representing a lot of greenfield opportunity. Twilio has some of these large traditional companies as customers, but are spending very little currently. They gave the example of a major car rental company that is spending $4/month, but could be spending hundreds of thousands with some sales consulting. This is why they are continuing investment in the sales team.
• IoT is still not a meaningful contributor to revenue, but may be the next big platform for Twilio, according to Jeff.

My Take-aways

• Interesting that the actual Q4 revenue of $331M significantly surpassed the estimates for Q4 that were issued in Q3, both the original analyst estimate of $320M and Twilio’s lowered guidance to $312M, due to billing issues. As investors recall, this lowered guidance caused a 10% drop in TWLO stock after Q3 earnings. This turned out to be a non-issue, or indicates that there was even more upside in Q4.
• Rumors in November 2019 that WhatsApp was scaling back usage didn’t appear to have a noticeable impact on overall revenue or their share of revenue (at least so far with 6% reported in Q4).
• The fact that the Q1 2020 estimated (adjusted for SendGrid) organic revenue growth rate of 36% matches the Q4 2019 organic growth rate is encouraging. If actual Q1 2020 results beat estimates, we could see some acceleration. A beat of another 3% is implied by the incremental raise to FY 2020 revenue guidance.
• If these results were simply graded on just actual Q4 performance, they would have been strong. Twilio’s forward estimates caused the negative market reaction.
• The management team clearly needs to do a better job setting expectations with analysts and the market. The about-face on 2020 profitability could have been telegraphed better.
• However, with revenue guidance in particular, I suspect that Twilio is up to its old pattern of setting revenue expectations low at beginning of year, allowing for beat-and-raise quarters through the year. For example in 2019, the difference between estimated annual revenue set at beginning of year to actuals was about $60M, or about 10% of 2018 revenue. If this pattern repeats, we could see actual 2020 revenue in the 36 – 40% range.
• While disappointing on the surface, I can get comfortable with the reduction in earnings for 2020, given that this will be invested in growth opportunities that have a clear ROI. Incremental sales people should help drive Flex sales and usage growth of core products at existing customers (like the car rental company spending only $4/month). TWLO has $1.8B in cash, so it makes sense to apply some of this capital towards further growth. I think of it like a small acquisition.
• Establishing an R&D center outside the U.S. is smart. It should provide a reduction in costs for more repeatable development work (like maintenance of existing products), allowing the core engineering team to focus on new product development.

Some Items to Watch

While I liked aspects of the earnings report, there were some potential issues to watch going forward.

• DBNER is trending down. Management now discounts this as expected for larger engagements and that they don’t guide the business to it, but they did trumpet DBNER when it was over 140 in past years. Stabilization around 120% would be a good signal, as this would support future high revenue growth rates. I am expecting the continued investment in sales to expand existing customer usage (like the rental car company example) to drive this.
• Flex adoption has been slower than hoped. There were more wins announced in Q4, so adoption seems to be picking up. On the call, George Hu mentioned that they have ironed out the sales process and are better targeting companies with a builder mentality.
• The pace of new product launches seems to be slowing, but I have to account for the SendGrid acquisition as effectively launching a whole new product category. If Twilio had built the email offering themselves, then I would consider it a major new product launch. I imagine the integration with SendGrid consumed a lot of development resources in 2019.
• Management hinted at some new apps as Twilio “Act 2” and a focus on vertical solutions. I would like to see other, high-margin product offerings. IoT is interesting, but won’t be material for a while.
• The reset on earnings for 2020 is acceptable, as long as it is one-time. TWLO needs to demonstrate profitability at some point and can’t keep hiding behind “investing for growth”. Although, it is interesting to remember that Jeff Lawson spent his early days at Amazon.

Investment Plan

I think investors’ opinions of Twilio’s earnings results will vary, based on their investment horizon. Short term investors were clearly disappointed, driving the stock price down over 7% the following day. This is understandable, as anyone planning to sell the stock in the next couple of months would do so now to mitigate the risk of further losses after nearly a 30% share price gain in 2020. For long term investors, I think the earnings results were fine. I like the continued drive towards revenue growth and expanding product leadership in the rapidly growing CPaaS market. This should result in multi-billion dollar revenue run rates over the next several years.

I personally have a 5 year investment horizon for TWLO and these results don’t change my investment thesis. In some ways, it improves where I think Twilio will be in 2024, given that plowing profit back into the business should drive incremental revenue. Of course, this comes at the expense of profitability, which was part of the argument for valuation growth in 2020. Net of all this, I am maintaining my 2024 price target of $320, but will continue to monitor performance closely over 2020.