Below, we review Twilio, Snap and Shopify. This quarter, Snap separated itself from other ad-tech companies in the ad rebound cycle. On the surface, this was accomplished through user growth and strong guidance. From a product perspective, our readers knew going into this quarter (and last quarter) that augmented reality has quietly begun its trajectory.

Twilio is a company that recently acquired Segment. This is not your typical acquisition, rather it is a hard pivot into first party data. Twilio’s future very much depends on management nailing this transition. We had presented this in granular detail in our Twilio LTBH (long-term buy and hold) webinar. We see no issues with Twilio’s report, in fact, with Segment Journeys Twilio is ahead of schedule on cross-selling, which began July 1st.

Shopify is a steady winner that we had stated in a Motley Fool podcast was a favorite pick of ours going into 2021 and during our two LTBH Top 10 portfolio review found here and our 2021 portfolio review here. Some of these LTBH positions are like hitting singles and doubles while others we swing for the fences. Shopify has the most potential to become a FAANG stock as the company has solidified its place at the e-commerce infrastructure layer. We discuss why Shopify shows evidence of taking market share from Amazon, and one area in particular where Shopify is stronger. Rarely, do we see such a strong product open the flood gates for distribution at this stage in its maturity; the flood gates for distribution are social media.

Summary:

In May, we disclosed that we were looking to increase our Snap position (and Shopify) and we closed our Pinterest position after reviewing our LTBH portfolio. We could not have been clearer in terms of our conviction on this augmented reality (AR) stock. We also broke down the company in great detail in June, which is worth a refresh if you’d like more product analysis and backstory on the company’s AR strategy and how it relates to Apple’s iOS updates.

There are a few key takeaways from Snap’s earnings. The first is that the product is going through rapid iteration to be a first mover in augmented reality. At the consumer level, you could say Snap is an only mover as there isn’t another company reaching early adopters with this much consistency. The second takeaway is that we’ve seen an ad rebound in many earnings results this quarter yet Snap stands out for its user growth in the face of tougher comps – both this quarter and next quarter’s guidance.

Here is a laundry list of AR product features that Snap discussed in the earnings call:

• Cartoon 3D Lenses turn people into 3D-animated cartoons. The Cartoon 3D Style Lens shows the potential for AR features to go “viral” with 2.8 billion impressions in the first week.
• Connected Lenses which enables real-time shared experiences, like building LEGO models together
• Scan which allows users to scan outfits and find recommendations or the right size/look
• A Unity plugin for personalized Bitmojis to be used in games
• Lens creators can use Lens Studio 4.0 for features like virtual classification, multi-person 3D body mesh and cloth simulation
• Spectacles with 3D reality display
• Content products like Snap Original Shows including 177 international channels
• Spotlight, where Snaps are showcased, grew a whopping 49% quarter-over-quarter

The keywords from this earnings report are “inside and outside of Snapchat.” Many of the AR features above will reach non-Snapchat audiences. Disney is using the Camera Kit at their theme parks. Bumble is using Lenses to create backgrounds and effects. Viber is a calling and messaging app that uses Snap’s lenses. Restaurant recommendations can be overlaid onto Maps and Poshmark is using Snap’s minis platform for daily shopping events. Although “minis” are technically on the Snapchat platform, they’re coming from developers outside the platform, such as Ticketmaster which uses minis to discover shows and buy tickets.

As far as App Tracking Transparency (ATT) is concerned, and the IDFA which we reviewed in a webinar, Snap believes the effects will be seen later down the line. “Apple’s rollout of the most recent iOS update came later in Q2 than initially anticipated, and the pace of updates by iPhone users has also been slower than we anticipated. This has given us more time with advertisers to navigate the transition but also means the effects of these changes will come later than we initially expected.”

Also, the company stated they are seeing higher opt-in rates than what is being reported “across the industry.” The obligatory disclosure that management dropped was this, “It is too early to determine how long it will take until these changes are fully adopted, the scale of the potential interruptions to demand, or the ultimate impact on the longer-term growth of our business.”

Per my previous coverage on IDFA, we aren’t trying to be heroes by making big calls here. With that said, the I/O Fund did strategically think through what companies will be comparatively stronger than others. Our portfolio reflects this, which you can find here. Despite the obligatory disclosure on the ultimate impact of IDFA, Snap is guiding very strong for the next quarter.

Financial Report:

Snap’s Q2 results beat expectations with sales accelerating by 116% YOY to $982.1 million, which beat analyst estimates by 16% ($135.7 million). The topline beat was driven by an acceleration in both DAU and ARPU during the quarter.

Daily active users (DAU) increased 23% YOY to 293 million, an increase of 55 million and an acceleration from the 22% growth reported in the prior quarter, and also surpassed the 17% growth rate posted in the year-ago quarter.

The rise in DAU was also accompanied by an acceleration in average revenue per user (ARPU), which increased 76% YOY to $3.35, and represented the fastest rate of growth in the last four years. SNAP also guided for Q3 sales to increase 59% YOY to $1.08 billion at the midpoint, which came in ahead of the consensus estimate by 8%.

Revenue growth was driven by the North American market, as sales increased 129% YOY to $701.7 million. The strong topline growth in North America was driven by a surge in ARPU, which increased 116% YOY to $7.37, and was well above the $1.95 and $1.07 ARPUs in Europe and the “Rest of World”, respectively. SNAP’s CBO, Jeremi Gorman, explained during the Earnings Call that “we are continuing to accelerate our investments in sales and sales support beyond North America in order to capture our global ARPU opportunity faster in the years ahead”. An acceleration in global ARPU’s will materially benefit SNAP’s topline going forward. To be complete, we note that Europe’s sales grew 94% YOY to $152.3 million while the Rest of the World grew 86% YOY to $128.1 million.

Continuing down the income statement, adjusted gross margin improved 800 bps YOY to 55% during Q2. Furthermore, SNAP reported that adjusted EBITDA grew by $213 million YOY to $117 million. We note that absent a small loss in Q1, SNAP has reported a positive (and rapidly growing) adjusted EBITDA metric in 3 out of the last 4 quarters. We believe that if SNAP can continue to demonstrate the leverage in its business model by reporting strong topline growth and positive cashflows, the company can sustain a high multiple. Finally, the firm’s adjusted EPS of $0.10 beat the consensus estimate of -$0.01 by $0.11.

Notably, Snap’s earnings included numerous one-time benefits which in aggregate accounted for 60% of the firm’s adjusted earnings during the quarter. For example, SNAP reported $79.9 million in gains from non-marketable securities during the quarter, up from $0 in the prior year quarter. SNAP also early adopted a new accounting standard which cosmetically improved its interest expense by $20.1 million during the quarter. In aggregate, these one-time items provided a $0.06/share benefit to SNAP’s Q2 adjusted EPS and accounted for ~55% of the firm’s $0.11 beat during the quarter. Nevertheless, the firm’s results were still robust after excluding these one-time items.

As we’ve seen, social media is putting up triple-digits after the Covid dip from last year. In this case, Snap reported 116% and Pinterest reported 125% growth. Where Snap separated itself was not on revenue growth, rather on user growth with a 23% increase in daily active users to 293 million. This was primarily driven by DAUs in the Rest of World, which was up 55% YoY. The fact Snap is profitable now for three quarters doesn’t hurt either with impressive gains in ARPU.

Snap’s guidance on user growth is also strong at a rate of 21% year-over-year for an estimated 301 million users. The company expects to see between 58% to 60% in Q3.

Snap was not completely unscathed from the tougher comps that covid created in terms of usage. The company noted that there was a decrease in daily time spent watching Stories and a decline in volume of Story posting activity although the number of daily users grew year-over-year.

Twilio Quarterly Earnings

Summary:

Despite Twilio coming in better than expected on revenue, EPS and dollar-based net expansion rate, it was Segment’s sequential growth that concerned analysts. As stated in the April webinar, Twilio’s acquisition of Segment is an important pivot and the true story we want to analyze and track closely.

Before we review the ER in-depth, let’s look at Segment’s growth:

Segment Sales:

Q2 = $46.6m

Q1 = $44.6m

QOQ growth = 4.5%

Here is a note from our new financial analyst, Bradley Cipriano: “Segment was acquired on November 2nd 2020 and Q2 2020 Segment sales were $23m. It’s not apples to apples to do QoQ calculations since Q4 only included 2 months of Segment sales. By dividing quarterly sales into months, Q4 Segment monthly revenue was $11.5m while Q1 was $14.87m and Q2 was $15.5m, so monthly sales growth did decelerate from 29% QoQ to 4.5% QoQ.”

We are not too concerned with the sequential growth as an immediate impact is unpractical and management stated they began to cross-sell on July 1. In fact, the July 1 date is six months early from management’s previous expectations of when they will be ready to cross-sell. Here is what the CFO said in the prepared remarks: “For go-to-market, we began co-selling Twilio and Segment on July 1, accelerating our timeline by approximately six months, due to the excitement from businesses wanting to leverage the technologies from our combined offering. Lastly, the integration of the back office and G&A functions is mostly complete. We expect to finish this portion of the integration by the end of the year. We are very much on track and excited about what we can do together. “we began co-selling Twilio and Segment on July 1, accelerating our timeline by approximately six months, due to the excitement from businesses wanting to leverage the technologies from our combined offering. Lastly, the integration of the back office and G&A functions is mostly complete. We expect to finish this portion of the integration by the end of the year. We are very much on track and excited about what we can do together. “

The product that Twilio is using to cross-sell is called Segment Journeys. Segment Journeys is a product that unifies the customer experience with some retailers stating they’ve seen 400% revenue growth, such as Rugs.com. The platform allows marketers to know if a customer has seen specific messaging – whether its ads or emails, how the customer has engaged and what step the customer is ready for next on a granular basis with over 300 tools.

Twilio stated the following in terms of forward growth and Segment’s contribution: “Michael, this is Khozema. In terms of the guide, I mean, I guess what I would say is I think you're maybe you're reading a little too much into it. I think in terms of what we see for the third quarter guidance, it's a really strong growth rate of 50% to 52%. And I think on top of which we remain really optimistic about our performance in the near term as well. And we provided guidance previously, for example, of 30% plus growth over the next 4 years and feel really, really good about that over the medium term …. It won't show up in our financials for some period of time. And we haven't even started, right? I mean we basically just started a few weeks ago, and it will just take some time for it to bleed into our financials.I think in terms of what we see for the third quarter guidance, it's a really strong growth rate of 50% to 52%. And I think on top of which we remain really optimistic about our performance in the near term as well. And we provided guidance previously, for example, of 30% plus growth over the next 4 years and feel really, really good about that over the medium term …. It won't show up in our financials for some period of time. And we haven't even started, right? I mean we basically just started a few weeks ago, and it will just take some time for it to bleed into our financials.

While Segment’s sequential growth led to flat price action for Twilio following the ER, one positive point was the slight increase in DBNER from 133% to 135% (more below). This is the pulse or vital sign for a cloud company and it’s nice to see it remain steady while the company ramps up for post-acquisition cross-selling. Analysts also pointed out that Twilio has doubled its headcount in the most recent year. Here was a nice way that management put this: “We just have this sort of really good problem, is how I would characterize it, in that our core business is growing at such a fast rate. You're just — it's going to take some time for the other pieces to start showing up in our financial statements.”

One risk facing Twilio is the increase in fees from AT&T that will now be passed on to customers. Twilio had been absorbing those costs and there could be some falloff as these costs will negatively impact customers moving forward. Total impact is about $4.5 million per month (to the company). The acquisition of Zipwhip may help offset this into the future as the company provides lower cost toll-free messaging. This is more important than you may imagine as telephony costs in a world of readily available web apps (and push notifications) competing with Twilio was making the SMS product cost prohibitive.

In addition to IoT for future growth potential not reflected in current earnings, there is also a product called Frontline that is in public beta and will help workforces that are not located at desks (i.e. mobile workforces). According to the earnings call, this market exceeds the call center market. For instance, many sales people take calls while on the road or between appointments.

Financials:

Twilio’s Q2 sales grew 67% YOY to $668.9 million, which represented the fastest pace of YOY growth since Q3 2019 and beat the consensus estimate by $69.8 million (12%). Twilio’s Segment business, acquired in November of 2020 and central to our thesis, grew its sales 4.5% QOQ to $46.6 million, while active customers increased 2% QOQ. It will be important to monitor these two metrics going forward as Twilio builds its customer data platform and pivots the company around the Segment business.

DBNER remained stable at 135%, highlighting how Twilio has been able to sell new services to its existing customer base. Management also guided for Q3 sales to increase 51% YOY to $675 million at the midpoint, which was 6% ahead of the Street’s estimate (management’s guidance does not include any sales from its recent $850 million acquisition of Zipwhip, which occurred after the close of 2Q21).

The company’s adjusted operating profit declined YOY from $9.5 million down to $4.2 million during the latest quarter. This cost pressure flowed down the income statement as TWLO’s non-GAAP EPS declined YOY from a $0.09 profit in 2Q20 down to a -$0.11 loss during the most recent quarter. The cost pressure is expected to continue into 3Q21, as management guided for a non-GAAP loss of -$0.16/share at the mid-point, which was below the Street’s estimate of a -$0.07/share loss.

Gross margin for Twilio were 54%, a 200 bps YOY decline from 56% and a 100bps QOQ decline from 55%. This is down from 59% gross margins two years ago in Q2 2019. This is the lowest gross margin for Twilio at least two years back. However, during Q2 2021 call, management stated no change to the long-term gross margin guide of 60-65%: "I wouldn't say there's any real change in our long-term framework around gross margins. I mean we're still targeting 60% to 65%."

As discussed previously, TWLO is making investments in enterprise sales, Flex and new growth products coupled with infrastructure investments. While these investments will generate near term losses, they will support the company’s growth in the long run.

Possibly a sign that TWLO’s recent investments are benefitting the firm, we note that deferred revenue has surged in recent quarters, most recently growing by 239% YOY to $98.7 million. As the name implies, deferred revenue will convert into sales in the near term, which provides support for future sales. Furthermore, receiving cash upfront is a favorable trend for TWLO, as it allows the firm to immediately deploy the funds into investments that support future growth.

Shopify Quarterly Earnings

I like to come up with taglines for the stocks I cover, like “dark horse” for AMD and “royal flush” for Roku. I would say Shopify would be “ML-FAANG” or “most likely to become a FAANG.” There are others that we cover that have potential for massive global scale – Nvidia, and even Zoom. In fact, I think Nvidia will become one of the world’s most valuable companies, but the path won’t look or feel like a FAANG.

Regarding Shopify’s potential, it’s not as easy as saying “because they are building a fulfillment center, they will rival Amazon.” Amazon has the store front so these two are not apples-to-apples. However, due to various distribution methods, Shopify could be even bigger than Amazon on e-commerce (notably Amazon’s AWS is roughly half of its EBIT) because Shopify is building the e-commerce infrastructure that will extend well beyond a single storefront. I can’t help but wonder if some of Amazon’s miss is because of Shopify’s new dominance. It’s a natural thought to have when one competitor is thriving and the other guides lower than expected.

Please reference this forum post from our new team member Bradley Cipriano on Amazon’s miss.reference this forum post from our new team member Bradley Cipriano on Amazon’s miss.

You are likely familiar with Shopify’s online products as these are the core products for the company. However, offline was quite strong this quarter as merchants adopted Shopify’s point-of-sale (POS) products. This, in particular, helped Shopify during the re-opening while Amazon struggled to capture growth during the transition of the economy re-opening.

This quote is especially potent from management as to how Shopify plans to dominate online, offline and social combined: “In terms of the legacy point of sale market, we are also starting to see more legacy merchants that are starting to offline begin to use Shopify point of sale as well. They're using it because the product is really good but also because every business today, and frankly, for the next, the next 100 years is going to be omnichannel. Talking about omnichannel going forward will be like talking about color television. Every business by default will be omni-channel and Shopify is the platform that enables that.”because every business today, and frankly, for the next, the next 100 years is going to be omnichannel. Talking about omnichannel going forward will be like talking about color television. Every business by default will be omni-channel and Shopify is the platform that enables that.”

We talk about Gross Merchandise Volume (GMV) below under financials, which was a blowout and the highest in company history, yet on a more granular level we see that GMV in the United Kingdom outpaced the overall GMV despite being one of the first economies to re-open. Here’s a quote from management: “And so we use the UK as an example of one of the economies that reopened first and our UK GMV grew faster than our average suggesting that when we equip merchants with multi-channel, they do better in a very fluid commerce environment.”

This is a key point as Shopify is (perhaps) exploiting Amazon’s biggest weakness: which is too many irons in the fire. We see Andy Jassy, who comes from AWS, taking the helm. If we read between the lines, this means Amazon is prioritizing cloud infrastructure and AI/ML. This isn’t a bad decision, as we are ultra-bullish on AI, but it does leave an opening for strong competitor with a fresh angle and laser focus on e-commerce.

This is seen in Shopify’s ongoing strategy to become the infrastructure – this means Shopify will perform the checkout process, process the payment and other e-commerce services on the backend regardless of: your store front, what country you’re in, if you’re on a website or social media or a mobile app, or regardless of if their fulfillment center processes the order or a global merchant fills the order. Shopify aims to be omnichannel and omnipresent with a full stack offering. Speaking of “[regardless] of what country you’re in,” we will focus on international the next time we write on Shopify. The main takeaway here is that Shopify can quickly move across borders by being more of an infrastructure play than a store front.

We also can’t forget the distribution firehose that is social commerce. This impact will come in future quarters and I imagine it will eventually take over offline POS. Here is what management said: “The rank order of our GMV mix continues to be the online store, offline POS as second, and then all social channels and marketplaces third, and the social channels and marketplaces today represent a small percentage of the mix, but growing very rapidly.”

Pictured Above: Simulation of the open flood gates of social commerce 😉

Financial Overview:

Shopify grew sales 57% YOY to $1.12 billion in the most recent quarter, exceeding estimates of $1.05 billion, while gross merchandise volume (GMV) increased 40% YOY to $42.2 billion. This is impressive considering Q2 2020 GMV grew a stunning 119% YOY last year. The firm’s ability to post strong YOY growth after a blockbuster year raises our conviction that SHOP will be able to continue to compete with Amazon and take share, as discussed above and in our prior coverage of SHOP here and our 2019 coverage here.

Merchant sales increased 52% YOY to $785 million, aided by the expansion of Shop Pay, which took market share during the quarter. Shop Pay increased its GMV penetration rate YOY from 44.6% of GMV in Q2 2020 to 48.0% of GMV for the most recent quarter, perhaps taking share from other payment options such as PayPal.

At the same time, subscription sales increased 70% YOY to $334.2 million, while monthly recurring revenue rose 67% YOY to $95.1 million.  Adjusted operating margins increased to 21%, up YOY from 16%.

Notably, SHOP excluded $778 million in gains from equity investments during the quarter and $2.0 billion of gains YTD following a couple of well-timed investments in FinTech companies. Specifically, in April 2021, SHOP received shares of Global-E (GLBE) in lieu of cash payments for its services helping the company build an international payment network.

The GLBE shares had an initial fair value of $192.3 million. GLBE went public one month later in May 2021, and SHOP’s stake in GLBE was worth $1.0 billion as of June 2021, nearly a 10x return in one month. SHOP also received $24.7 million investment in Affirm ($AFRM) last year (July 2020) for non-cash consideration due to its strategic partnership with AFRM. When AFRM went public in January 2021, SHOP’s stake was worth $1.4 billion, resulting in a 55x return in one year.

Despite excluding these large gains from earnings, Q2 2021 non-GAAP EPS still more than doubled YOY from $1.05 to $2.24 and came in well above consensus of $0.96. Likewise, YTD free cashflows nearly tripled YOY from $64.9 million to $188.7 million. The firm’s cash balance of $7.8 billion remains at all-time highs, suggesting that SHOP has ample liquidity to finance growth going forward.

While SHOP does not provide quantitative guidance, management expects 2021 sales to continue to “grow rapidly”, albeit at a slower rate than 2020. However, management expects adjusted operating profit to be above the level in 2020, this is despite the investments SHOP is making in its fulfillment center, which we explored in greater detail in our prior research coverage.

Bradley Cipriano contributed to this analysis.