Twilio Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Twilio provides a cloud communications platform and earns most revenue from usage-based voice, messaging and other communications services. Unless noted, financial amounts below are in USD millions.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $168.9 | $100.5 | $445.8 | $283.8 |
| Gross profit / margin | $91.9 / 54% | $52.3 / 52% | $241.2 / 54% | $155.9 / 55% |
| Operating expenses | $116.9 | $76.3 | $312.5 | $201.8 |
| Operating loss | $(25.0) | $(24.0) | $(71.2) | $(45.9) |
| Net loss | $(27.1) | $(23.5) | $(74.8) | $(44.8) |
| Net loss per share, basic and diluted | $(0.28) | $(0.25) | $(0.78) | $(0.49) |
- Growth and customer metrics: Revenue increased 68% year over year in Q3 and 57% for the nine-month period. Active Customer Accounts rose 32% to 61,153. Q3 Base Revenue grew 68% to $154.3 million; Dollar-Based Net Expansion Rate was 145%, versus 122% a year earlier. Usage-based fees were 83% of Q3 revenue.
- Cash flow: Operating activities generated $12.8 million in the first nine months, compared with $7.1 million used in the prior-year period. Investing activities used $148.4 million, including $29.7 million for acquisitions and $15.3 million for capitalized software development. Financing activities provided $504.0 million, principally from the convertible note offering, partly offset by the capped-call purchase.
- Liquidity: At September 30, cash and cash equivalents were $469.1 million and short-term marketable securities were $276.2 million. Current assets were $850.7 million and current liabilities were $125.4 million. Restricted cash was $20.2 million.
- Debt: Twilio issued $550 million of 0.25% convertible senior notes due 2023. Net carrying value at quarter-end was $428.8 million; disclosed fair value was approximately $744.4 million. The company purchased capped calls for $58.5 million, intended to reduce dilution or offset certain conversion-related amounts, subject to a cap. Management stated its current intent was to settle note principal in cash.
- Other financial items: Stock-based compensation was $22.7 million in Q3 and $61.3 million for the nine months. The company reported an accumulated deficit of $324.5 million.
Changes versus prior comparable periods
- Q3 gross margin improved to 54% from 52%, which management attributed mainly to foreign-exchange effects on network costs, operational improvements and product mix. For the nine months, gross margin declined to 54% from 55%, reflecting foreign-exchange effects, prior price adjustments, higher international usage mix and higher network-provider fees in some geographies.
- Operating expenses rose 53% in Q3 and 55% for the nine months, driven primarily by higher personnel costs and increased sales and marketing investment. GAAP operating losses widened for the nine-month period; Q3 operating loss was broadly similar to the prior year.
- Other expense included substantial non-cash amortization of the debt discount and issuance costs associated with the 2023 notes: $6.0 million in Q3 and $8.9 million for the nine months.
- International revenue increased to 26% of Q3 revenue from 24% and to 25% of nine-month revenue from 22%.
Outlook, risks and unusual items
- Outlook: No specific revenue or earnings guidance is provided in the supplied filing text. Management expects operating costs to increase and says it is prioritizing platform reach, scale and revenue growth over maximizing near-term gross margins. It believed cash, cash equivalents, marketable securities and operating cash flows would cover anticipated working-capital and capital-expenditure needs for at least 12 months, while cautioning that this could prove incorrect.
- SendGrid transaction: On October 15, 2018, Twilio announced a proposed stock acquisition of SendGrid, expected to close in the first half of 2019, subject to approvals and other conditions. The announced exchange ratio was 0.485 Twilio Class A shares per SendGrid share; approximately 26.3 million Twilio shares were expected to be issued based on shares then outstanding. Twilio disclosed a potential $120 million termination fee in specified circumstances and said the deal, if completed, would significantly affect its liquidity, financial condition and results.
- Leases and commitments: A San Francisco sublease covers 259,416 square feet, with lease payments ranging from $0.8 million to $2.2 million per month and terms extending into 2025–2028. Future minimum operating-lease payments totaled $225.6 million. The company secured the lease obligation with a $14.7 million letter of credit, recorded as restricted cash.
- Legal and tax contingencies: Twilio estimated $1.5 million liability for a proposed settlement in the Flowers privacy class action and recorded a reserve. In a separate Telesign patent case, the court entered judgment for Twilio after quarter-end; Telesign appealed. The company recorded $22.7 million for potential historical sales and other taxes and noted that actual exposure could differ from estimates.
- Network-cost risk: A major U.S. cellular carrier was expected to introduce a new fee for application-to-person SMS messages in February 2019. Twilio planned to pass the fee on to customers; management expected no impact to gross profit dollars per message, but acknowledged a mathematical reduction in gross margin.
- Controls: Disclosure controls were reported ineffective because of an unremediated material weakness in tracking and categorizing internal-use software development costs for capitalization. Management said the financial statements fairly presented results in all material respects and that remediation was underway.
- Accounting: ASC 606 was adopted January 1, 2018 using the modified retrospective method, with an opening retained-earnings adjustment of $0.7 million and an otherwise insignificant reported impact. Prior-year figures were not restated. The company expected the new lease standard to increase reported assets and liabilities, but had not determined the full impact.
- Principal risks: Continued losses and uncertain path to profitability; reliance on usage and large customers (WhatsApp accounted for 7% of nine-month revenue and Uber 4%); network-provider and AWS dependence; competition, pricing and international expansion; privacy, security and telecommunications regulation; sales-tax exposure; convertible-note cash-settlement obligations; and execution, dilution and integration risks related to SendGrid.
Important facts for investors to verify
- Whether customer growth, expansion rates and usage sustain revenue growth, and how large-customer usage—especially WhatsApp and Uber—changes.
- Whether gross margin can be maintained amid international mix, network-provider pricing and the planned SMS fee, including the extent to which costs can be passed through.
- Progress remediating the software-capitalization control weakness and any effect on future financial reporting.
- SendGrid approval, closing, share issuance, transaction costs, potential termination fee and post-close integration performance.
- Cash requirements and potential dilution or cash settlement associated with the 2023 notes, alongside the substantial lease commitments.
- Developments in sales and telecommunications tax assessments and litigation, including approval and final terms of the Flowers settlement.