Twilio Inc. (NYSE:TWLO) Q3 2023 Earnings Call Transcript

Twilio Inc. (NYSE:TWLO) Q3 2023 Earnings Call Transcript November 8, 2023

Twilio Inc. misses on earnings expectations. Reported EPS is $-0.00078 EPS, expectations were $0.35.

Operator: Good afternoon and welcome to the Twilio Third Quarter 2023 Earnings Conference Call. All participants are now in listen-only mode. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the call over to Bryan Vaniman, SVP of Investor Relations. Please go ahead, sir.

Bryan Vaniman: Good afternoon, everyone, and thank you for joining us for Twilio’s third quarter 2023 earnings conference call. Our prepared remarks, earnings press release, investor presentation, SEC filings, and a replay of today’s call can be found on our IR website at investors.twilio.com. Joining me today are Jeff Lawson, Co-Founder and CEO; Khozema Shipchandler, President, Twilio Communications; and Aidan Viggiano, Chief Financial Officer. As a reminder, we will disclose non-GAAP financial measures on this call. Definitions and reconciliations between our GAAP and non-GAAP results can be found in our earnings release and in our prepared remarks posted on our IR website. We will also make forward-looking statements on this call, including statements about our future outlook and goals.

Such statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those described. Many of those risks and uncertainties are described in our SEC filings, including our most recent Form 10-Q. forward-looking statements represent our beliefs and assumptions only as of the date such statements are made. We disclaim any obligation to update any forward-looking statements except as required by law. And with that, I’ll hand it over to Jeff and the team, who will discuss our Q3 results, and then we’ll open the call for Q&A.

Jeff Lawson: Thank you, Bryan, and thank you, everyone, for joining us today. Twilio delivered a strong third quarter, exceeding our revenue and non-GAAP profitability targets and generating another record quarter of non-GAAP income from operations and free cash flow. All told, we delivered $1.034 billion of revenue, $136 million of non-GAAP income from operations, and $195 million of free cash flow. On the back of our strong year-to-date results, we’re raising our full-year non-GAAP income from operations guidance to $475 million to $485 million. As you can see, the efficiency gains are rapidly showing in our quarterly results, reflecting the fundamental strength of our Communications business, which represented 88% of our revenue in Q3.

In fact, our Communications business was recently recognized by Gartner as a leader in their first ever Magic Quadrant for CPaaS, a terrific recognition, indicative of our attractive market position and the strength of our platform. We continue to focus on opportunities with our Communications go-to-market motion to win new customers, improve our self-service capabilities, and drive more cross-sell opportunities across our customer base. We’re also forming meaningful partnerships to help us win further market share, including a significant expansion of our Softbank partnership. We expect these efforts to drive durable, efficient growth in our Communications business moving forward. But the real story is how, over time, we believe we can continue to grow the top line of our Communications business while controlling costs.

With our more streamlined cost structure and continued innovation, we’re proving every day that this business can be a powerful driver of profit and cash flow for Twilio. As our Communications business continues to successfully execute in an environment where usage volumes are stabilizing, we’re also focused on driving improvements in our Data & Applications business. We’ve been rebuilding our go-to-market function and have seen some initial green shoots, including a modest uptick in bookings in the third quarter. We also continue to receive external validation for the strength of our products, as Segment was once again named as the CDP market share leader as of June 2023, and was also named a leader in the IDC CDP MarketScape for Financial Services.

While these early signals are encouraging, there is still more work to be done. Before I get further into the details of the quarter, I’d like to share that Elena Donio will be transitioning out of her role as President of Twilio Data & Applications and into an advisory role. Elena and I have partnered closely to decide on the best path forward to reaccelerate the business, especially in light of the AI opportunity ahead. With Elena as an advisor, I will run TD&A in the interim period until we recruit a seasoned leader to lead this part of our business. Thank you to Elena for joining the Twilio team at a critical time for our Company and leading us through a difficult, but necessary transition. I respect your partnership as a board member, executive and as an advisor.

As I mentioned, the TD&A business saw a modest improvement in bookings this quarter, however, those are not yet where we want them to be. While this is a very small portion of our business today, only 12% of our revenue in Q3, we believe TD&A overall and the foundations of AI in particular are key assets for our future. We are committed to success in this business as we work to reaccelerate growth, drive further progress on our go-to-market scaling efforts and undertake investments to take advantage of the significant AI opportunity. We saw a number of exciting customer wins across both Flex and Segment in the quarter that are encouraging, and which I will detail later. And spending time with our customers at SIGNAL events in both San Francisco and London continues to reinforce for me the market demand for and unmatched capabilities of our software solutions.

Speaking of SIGNAL, in August, we revealed CustomerAI, a set of predictive and generative capabilities that pairs customer data with large language models to give companies AI that truly knows their customers. When I talk to our customers, they all know that AI will fundamentally re-wire the core of their companies, their workforce will need to change, the skills required to deliver their vision will change and importantly, their need for data to power their AI initiatives will grow. This is the initial set of opportunities we are working with customers using Segment to get their customer data AI-ready and then activating on that data with Twilio Communications. This communications and data flywheel will empower brands to enter the AI race steps ahead of their competitors armed with the AI-ready data, the platform that will allow them to interact with customers informed by that knowledge, and enable them to glean more insights from each message, call and email interaction.

We believe this will improve their customer data sets and in doing so, help them deliver more effective, personalized customer communications. Our teams have made immense progress over the course of 2023. In just nine months, we have delivered $360 million in non-GAAP income from operations and we’ve begun to generate meaningful levels of free cash flow. We are solidifying a strong foundation that positions us well to drive durable growth, deliver strong profitability and realize the benefits of our customer AI strategy over the long-term. I am excited to work more closely with our Data & Applications team to deliver a value proposition around customer AI that is truly differentiated to Twilio. And with that, I’ll turn it over to Khozema to talk about our Communications business.

Khozema Shipchandler: Thanks, Jeff. Twilio Communications delivered $907 million in revenue in Q3, up 5% year-over-year on a reported basis and 8% on an organic basis, with a non-GAAP gross margin of 49.8%. As a team, we continue to focus on driving efficient growth, landing new logos, cross-selling across our communications portfolio and generating meaningful non-GAAP profits. And we’re executing well against all of these objectives. We are continuing to push the bounds of innovation highlighted by our recent new product announcements focused on customer AI, including Voice Intelligence, Traffic Optimization Engine, Branded Calling, SendGrid Engagement Quality and Fraud Guard, which are already creating new opportunities for our communications customers and prospects.

For example, our customers can assign preferences for high priority messages such as one-time passcodes to be delivered leveraging the most timely route, whereas a marketing communication can be delivered via the most cost effective route. We continue to demonstrate solid traction in our ability to drive growth with a more efficient cost structure. Our go-to-market model has been streamlined and we’ve had success in expanding our ISV and global technology partnerships. As a result, we are seeing momentum with landing large new logos across our communications product portfolio and through focused cross-selling efforts. In fact, roughly half of our expansion deals in North America were in non-messaging use cases. A couple of cross-sell wins to highlight from Q3 include a long-standing communications customer in the financial services industry who adopted Verify to replace their legacy solution for identity and security.

Additionally, a leading Latin American ecommerce platform added Twilio Interactive Voice Response, while also expanding their voice business with us. We saw encouraging results in our voice business overall in the quarter. We also landed several new logos in Q3, beginning with one of the largest European airlines who chose Twilio Programmable Messaging based on our reliability and superior compliance standards to streamline their customer feedback workflows. Similarly, a global hotel brand chose Twilio’s account security capabilities to serve their millions of app users, again citing our ability to navigate global regulatory and compliance, while delivering a seamless customer experience. And finally, a leading AI company adopted Verify Pro, which allows customers to consume Verify as a subscription with upfront payments.

We’re continuing to broaden our go-to-market footprint, leveraging our market leadership position to drive wins with ISVs and global technology leaders. In Q3, we signed a landmark agreement with SoftBank. SoftBank will offer Twilio services through its sales channels in Japan, which have a strong domestic customer base to drop on. SoftBank will also provide 24/7 support for Japanese customers. This is an exciting expansion of our partnership with SoftBank and we will continue to pursue strategic partnerships to efficiently capture additional market share. We’re also focused on improving our self-serve motion and automation efforts so customers can more easily purchase, build and grow with us. In the near term, we are expecting to bring more purchasing, billing and contract management capabilities into the Twilio Console where customers can seamlessly adopt new products and expand usage.

In addition, our teams will continue to automate compliance requirements and phone number provisioning that allow new customers to onboard much more quickly. As a reminder, we previously made a commitment to our carrier partners to only permit registered U.S.-bound 10 DLC, SMS, and MMS traffic effective August 31, 2023. I am very pleased with our success in executing against our 10 DLC registration deadline and exceeding our initial goals. Thus far, we’ve been able to register virtually all of this traffic, which has enabled us to mitigate much of the revenue risk we had anticipated for the second half of the year. We now expect the revenue impact in Q4 to be minimal in light of the amount of registered traffic going into the quarter. This is an improvement from the potential headwind of up to 300 basis points that we’d previously referenced.

Similar to our efforts in registering U.S.-bound 10 DLC, SMS, and MMS traffic, we will also be requiring our customers to register U.S.-bound traffic from toll free phone numbers as of today, November 8. We expect the revenue impact in Q4 and beyond to be immaterial. Our Q3 dollar-based net expansion rate for communications was 101% and 104%, excluding crypto customers. Similar to last quarter, new customers are driving a greater portion of the overall growth, while crypto, and social and messaging headwinds mask the success we are seeing with our cross-sell and expansion opportunities. Churn continues to remain relatively stable and we are seeing year-over-year volume growth across many industries. I am proud of the execution that our team demonstrated in the third quarter.

Leading the charge on compliance and enacting our 10 DLC registration deadline was no small feat. We continue to focus on streamlining our go-to-market, including improving our self-serve motion and capitalizing on cross-sell opportunities across communications. We are seeing encouraging results and there is still further opportunity to improve, so I am confident we will be able to make sustained progress over the coming quarters. And with that, I’ll turn it back to Jeff to talk about the TD&A business.

Jeff Lawson: Thanks, Khozema. Turning to TD&A’s results. Our primary focus continues to be reaccelerating growth. In Q3, this business unit delivered $127 million in revenue, up 9% year-over-year with a non-GAAP gross margin of 79.8%. The evolution of our TD&A business is ongoing. And while we’ve seen some initial encouraging signals from our go-to-market rebuild efforts, we need to translate early proof points to further bookings reacceleration. This business deserves to grow faster and has all the ingredients to do so. I believe that reconstituting our old go-to-market playbook was necessary but not enough. We have to continue to evolve it as well, given a rapidly changing market. Now that we have the selling team in place, I’ll be working with our go-to-market leadership to accelerate further changes to our playbooks, taking into account recent learnings.

At this stage, we continue to see increased churn and contraction in TD&A, reflecting the current dynamic environment and issues some of our customers are experiencing in growth with their businesses. Despite this market dynamic, we’re still continuing to land exciting new customer deals across both Flex and Segment. We saw several Flex customers win this quarter, including a competitive seven-figure deal with a leading insurance company, which was looking to migrate not only agents off of their legacy on-premises solution, but also their IVR and messaging and chat, ultimately consolidating all contact center flows onto Twilio. We also signed a cross-sell deal with Sweetwater, a musical instruments retailer. A long-time Twilio customer of voice, messaging and email, Sweetwater is now actively bringing all of their agents under the Flex platform from their previous on-premises vendor.

Sweetwater is a great example of a company who came to Twilio as a communications customer looking to deliver a bespoke experience to their customers and has since gone all in on the Twilio platform because of the customizability of the experience they’re able to deliver across our solutions. Turning to Segment. At SIGNAL London last week, we announced that we have processed more than 12 trillion data events in the last 12 months and resolved those data points into over 100 billion customer profiles on behalf of brands. And we can do all of that in milliseconds. This is the basis of our market share leadership recognition and underscores the need for a real-time CDP in the market, which Segment delivers. In Q3, the Segment team signed a deal with a leading fintech company and long-standing Communications customer who is driving a product-led growth initiative.

Their first use case is leveraging segment to process real-time transactional data across all of their data systems in order to identify cross-sell opportunities, all in real-time. We also established a new relationship with a software company in the construction space. As the company has been very acquisitive historically, they needed to consolidate data from multiple disparate systems to build a 360-degree view of the customer to inform their marketing journeys. We also inked a deal with a leading global toy company that will be using Segment’s reverse ETL capabilities with Databricks to offer their millions of customers real-time personalization across their most popular apps and games. What’s most exciting is that Segment will give hundreds of employees access to advanced customer data models and insights to help improve the customer experience for a globally recognized brand.

This exciting deal was won with a great GSI partner as well. We think this is a repeatable partner model and look forward to continuing to invest in our partner ecosystem around Segment. Segment’s capabilities are foundational to CustomerAI. We’ve already announced the general availability of our first TD&A CustomerAI product, predictions, which allows customers to create hyper-targeted audiences based on predictive traits like lifetime value, likelihood to churn or the propensity to take an action such as making a purchase, subscribing, et cetera. We have more than 100 customers using predictions already and they’re quickly seeing results. One company has seen their cost of customer acquisition fall by 85% with more targeted advertising based on propensity to convert predictions.

Another company saw a 2x improvement across all funnel metrics for their e-mail campaigns, including opens, click-throughs, et cetera, based on product recommendation predictions. Our early customers show that engagement is multiplying and costs are rapidly declining, and that’s just the first of several CustomerAI capabilities that we’re working on bringing to market. Our short-term goal is to help customers see how the coming AI use cases require better customer data, something that Segment can provide today. Our long-term goal is to provide unprecedented automation, cost savings and better customer relationships, thanks to AI. So we are seeing significant customer wins within TD&A and our investments in AI products are generating significant customer interest.

We have more work to do, and I intend to get closer to our field teams, our product teams, and most importantly, our customers to build on our foundation and deliver on the incredible potential of this business. I’ll now turn it over to Aidan to walk through the financials in more detail.

Aidan Viggiano: Thank you, Jeff. We continue to build a strong financial foundation for Twilio. We exceeded our Q3 revenue guidance and delivered another record quarter of non-GAAP income from operations and free cash flow. We came into the year targeting $250 million to $350 million of non-GAAP income from operations and have exceeded that goal in three quarters, delivering $360 million year-to-date. Our results demonstrate our ability and commitment to drive meaningful levels of profitability in our business over time. Third quarter revenue was $1.034 billion, up 5% and 8% year-over-year on a reported and organic basis, respectively. As a reminder, this compares to second quarter revenue of $1.013 billion after adjusting for the $25 million of revenue from our divested ValueFirst and IoT businesses.

Communications revenue was $907 million, up 5% year-over-year on a reported basis and 8% on an organic basis. Data & Applications revenue was $127 million, up 9% year-over-year. We continue to see stabilization in volumes across our usage-based products throughout the quarter. We also executed well against our 10DLC registration goal, mitigating revenue risk. Both of these factors helped drive our revenue beat in Q3. As we referenced during our Q2 earnings call, our Q3 revenue growth rate was negatively impacted by headwinds from customers in the crypto industry. Total Q3 organic revenue growth excluding crypto customers was 11% year-over-year. While the impact has started to moderate, we still expect about 200 basis points of crypto-related revenue headwinds in Q4, down from 370 basis points in Q2 and 290 basis points in Q3.

Our Q3 Dollar-Based Net Expansion Rate was 101%. As Khozema mentioned, Dollar-Based Net Expansion for Communications was 101%, or 104% excluding crypto customers. Dollar-Based Net Expansion for Data & Applications was 96%, driven primarily by instances of higher contraction and churn among Segment customers. We continue to see some customers experiencing growth slowdowns and facing cost cutting initiatives in their own businesses given the current macro environment. We delivered non-GAAP gross profit in Q3 of $553 million, growing 11% year-over-year and representing a non-GAAP gross margin of 53.5%. That was up 270 basis points year-over-year and up 120 basis points quarter-over-quarter, driven by Messaging termination mix and product mix within Communications.

Gross margins also benefited from our recent divestitures. Non-GAAP gross margins for our Communications and Data & Applications segments were 49.8% and 79.8%, respectively. Q3 non-GAAP income from operations came in meaningfully ahead of expectations at $136 million, representing a non-GAAP operating margin of 13.2%. This was due to our revenue beat and our continued focus on driving more efficiencies across business. Q3 GAAP loss from operations was $109 million, which includes $7 million of expenses associated with restructuring and real estate impairment charges. Stock-based compensation as a percentage of revenue was 17.9% in Q3 excluding approximately $0.5 million of restructuring costs, up 320 basis points quarter-over-quarter but down 180 basis points year-over-year.

The sequential increase was primarily driven by the timing of employee refresh grants, which occurred later than in prior years. We expect stock-based compensation as a percentage of revenue to decline modestly in Q4. In Q3, we generated free cash flow of $195 million, driven in part by heightened collections. While we do not expect this level to recur each quarter, free cash flow remains a focus for us as we drive greater profitability in the business. Lastly, we continued to execute against our $1 billion share repurchase program that we announced in February, and have now completed approximately $620 million of repurchases to date. Moving on to guidance, for Q4, we’re initiating a revenue target of $1.03 billion to $1.04 billion, representing year-over-year growth of 1% to 2% on a reported basis and 4% to 5% on an organic basis, which accounts for our recent ValueFirst and IoT divestitures.

We expect Q4 non-GAAP income from operations of $115 million to $125 million and we are raising our full year non-GAAP income from operations guidance to $475 million to $485 million. I’m pleased with the progress we’ve made on our profitability targets to date. The teams are executing well, which provides a good set up as we look to deliver a strong finish to the year and enter 2024 with momentum. And with that, let’s open it up for questions.

Operator: Thank you. [Operator Instructions] Your first question comes from Taylor McGinnis with UBS. Please go ahead.

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Q&A Session

Jeff Hickey: Hey, everyone, this is Jeff Hickey, on for Taylor. Thank you so much for taking the question. Congrats on the quarter. On the Data & Apps business with the net retention falling to 96% from 99%, seems like things continue to soften a bit there. What are you seeing in terms of trends when we could maybe hit a bottom and is gross churn something that could be impacting the gross margins of that segment currently?

Jeff Lawson: Thanks, Jeff. I’ll take the first part of the question, and maybe if there’s a gross margin aspect of the question, then I’ll let Aidan take it. As we noted, we’ve been working through some of the churn and contraction headwinds, particularly as customers are realizing lower growth in their own businesses. They’re focused on cost cutting efforts as you’d expect. And this results in reduced deal sizes at renewal and in some cases outright churn. Several initiatives we have in place to try to mitigate the churn and contraction, we’re making a concerted push with our post sales teams to drive faster and easier implementations with customers, as well as mandating professional services in certain instances to make sure customers implement successfully.

We’re also ensuring our sales incentives are aligned to not just driving new bookings, but also mitigating churn and contraction as well. And ultimately, we need to drive bookings improvements and continue to deliver on the value of our products to those customers in order to improve DB&E. And I think we did see modest improvements in bookings in Q3 relative to Q2. And we have an ambitious product roadmap for TD&A around customer AI as well, which is driving a lot of early interest in meetings given we announced it just over a month ago. But most importantly, we’re not seeing an increase in competitive churn. And I think that’s the most important part of what we are seeing in the churn and contraction. Aidan, is there anything you would add about gross margin?

Aidan Viggiano: Yes, sure. So I don’t think the churn is not what’s impacting gross margins and data and applications. So they are down year-over-year and they’re down quarter-over-quarter. So a couple of dynamics just to understand there. So first, as we mentioned last quarter, we continue to invest in innovation in this business and that’s driven an increase in capitalized software expenses, which is flowing through our P&L. And obviously, these innovations are focused around things like customer AI and our next gen products and features. We’re also seeing and expect to continue to see higher infrastructure and hosting costs in data and applications. We’re continuing to invest in AI capabilities across the portfolio, as I said, and to ensure efficient scaling of these products, we’re migrating certain back end functionality and infrastructure type functionality to new vendors in 2024, and that’ll optimize our spend over the longer term.

So there will be a period of time where we have overlapping or double expenses and you’ll see that in the margin rates, on the back end, obviously, we expect to reap the benefits of these investments.

Operator: Our next question comes from Meta Marshall with Morgan Stanley. Please go ahead.

Meta Marshall: Great, thanks. Maybe sticking with the data and applications business, Jeff, just what do you see as the keys to the reacceleration of this business maybe outside of overall macro? Is it still room to go on go-to-market or product advancements and just kind of what are you looking for as you look for new leadership for this business? Thanks.

Jeff Lawson: Thanks, Meta. There’s two things that really speak to the growth trajectory of TDNA. Number one is a resting churn and contraction. And number two, new bookings, right? So that’s what we’ve been focused on all year. We just talked a bit about churn and contraction in terms of what other things we can do to make sure customers are successful. Make sure customers, when it comes time for renewal, are most likely to renew, and those are things that are in control. Customers out of business, not a lot you can do or something like that, but that’s really not the majority of it, really, a lot of this is in our control. The second thing, of course, is new bookings. And so we are very focused, as you know, on the reconstitution of the sales team, which is something we’ve spent the greater part of the last year doing, so hiring up the sales reps, enabling them, training them, building pipeline, et cetera.

And like I said, we’ve been seeing bookings growth throughout the year. We’d love to see it continue to grow and grow even more aggressively than it has. But we are seeing the bookings growth happen and meaningful logos, expansions, cross sells, I mean, we talked about all those things on the call today. So those are all the positive signals that we’re looking for, especially as we go into the fourth quarter. And it’s also worth noting that we see win rates and enterprise ASPs remaining healthy and stable.

Meta Marshall: And just new leadership kind of what you are looking for. Is it somebody with more sales or product focus?

Jeff Lawson: That’s a great question. We’re looking for a leader to – I think with a good go-to-market background, but also obviously some degree of technology, given that AI is becoming increasingly important, especially for the segment business, the contact center business, as well as obviously our big customer AI initiative. So we’re looking for someone who primarily, I would say, has go-to-market really good product market fit understandings, both with the current products we have, as well as we bring new products to market in the form of customer AI.

Meta Marshall: Great. Thanks.

Operator: Next question comes from Mark Murphy with JPMorgan. Please go ahead.

Mark Murphy: Thank you very much. Jeff, thinking back to the SIGNAL conference, you spoke with Sam Altman, and he brought up this idea that the cost of intelligence could fall by a factor of a million. And so I’m wondering, even if it moves in that direction, if Twilio ends up being the mechanism that allows bots to understand who they’re talking to and who the customer is, how much do you think that could amplify Twilio’s value to the typical customer as all of these generative AI projects gather scheme? I mean, I’m just wondering if you could see cases where the customer spend on Twilio would really kind of ratchet up pretty materially.