Before diving into its quarterly results, we wanted to provide a little background on the company itself. TWLO owns and operates a platform that develops APIs (Application Programming Interfaces) that enable customers' software developers to add voice communications, text messaging, video, and now email, thanks to its October 15 acquisition of SendGrid, into their software applications.
Its two largest customers are Uber and Whatsapp, accounting for 6% and 4% of total revenue, respectively. When using Uber, for example, TWLO provides the technology within that app that allows you to communicate with the driver. As another example, when you make a dinner reservation using OpenTable, and you receive a text confirmation saying that your table is ready, that is also powered by TWLO.
Now, circling back to its Q3 results, TWLO posted EPS of $0.07, beating analysts' expectations by $0.05, with revenue surging by 68% to $168.9 million, easily topping the $151.6 million consensus. But, what's perhaps the most impressive is that revenue growth actually improved from last quarter's 54% mark. In fact, revenue growth has been trending higher over the past few quarters, going from 40.5% in 4Q17, to 47.8% in 1Q18, then 54.1% last quarter, and finally 68.0% this quarter. This is extremely rare for a high-growth tech IPO. Typically when a company goes public, it has already -- or is nearing -- the height of its growth curve.
Driving the strong growth was a 32% jump in Total Active Customer to 61,153. During the quarter, TWLO announced the general availability of its new "Flex" product, which is a contact center application platform. It describes the product this way: "Flex combines the scalability and reliability of our cloud platform with the ability to programmatically customize every element of the contact center experience."
Demand for Flex was solid as it signed a number of deals in the quarter. Most notably, Uber competitor Lyft - which is already a TWLO customer - added Flex to bolster its customer support capabilities. Additionally, TWLO added high growth cloud software Medallia to their customer base.
The addition of these two new deals, along with other significant wins in the financial services sector, pushed its dollar-base net expansion rate to a robust 145%, up sharply from 122% in the year ago quarter.
Another positive was that gross margin came in at 55%, which is above its recent performance over the past several quarters. With the surge in topline growth, and the improved gross margin, TWLO generated Non-GAAP operating income of $4.3 million, compared to an operating loss of ($7.7) million in 3Q17.
That said, during the earnings call last night, management did comment that its focus right now is not to maximize gross margin, but, rather, it is on growing the business. Therefore, investors should expect some volatility around gross margin. For example, starting in 1Q19, Verizon will be creating a new service which will tack on a $0.0025 for each person-to-person text, for each business with Application to Person messaging services. TWLO estimates that this will negatively impact its gross margin by about 100 basis points on a quarterly basis, when it goes into effect in February.
Outlook & Conclusion
Turing to its guidance, TWLO is forecasting Q4 EPS of $0.03-$0.04 vs. the $0.02 consensus, on revenue of $183-$185 million versus the $160.6 million consensus. At the mid-point, this would represent year/year growth of 60%, fairly consistent with its Q3 performance. In addition to the aforementioned SendGrid acquisition, and the successful launch of its Flex product, the company is also expecting artificial intelligence to provide another growth catalyst for the company. TWLO recently announced its first machine learning product, "Understand", and at this year's SIGNAL conference, it also launched "AutoPilot", the next evolution of Understand, with a natural language understanding engine, a conversational application platform and an omni-channel hub.
To conclude, TWLO is clearly hitting on all cylinders right now, and it has established itself as one of the premier growth names in the technology space. With a 1-year forward P/S of about 11.5x, the stock certainly isn't cheap. But, the stock also deserves a premium valuation due to its superior growth rates and growth potential.
All in all, there was very little complain about in regards to TWLO's performance and the underlying momentum in the stock suggests more happy days ahead for TWLO investors.