Okay, well, hello everyone. Thanks so much for attending this session with Twilio. We have Aidan here, Twilio's CFO. And for anyone in the room that might not know me, my name is Taylor McGinnis, and I'm one of the software analysts here at UBS. So Aidan, thanks for coming.
Thanks for having me. It's great to be here.
Yeah, of course. Maybe a good place to start would just be on the macro environment, given that that's, you know, very topical. I know you guys have been talking about seeing more stable trends on the communication side. The data and apps business still sounds like it's under pressure. But could you just talk about, you know, what you guys saw throughout 3Q, how things like trended towards the start of 4Q as a start?
Sure, yeah. So let's just break it down into the two different businesses. So I think, as you know, the largest portion of our business, almost 90% of the revenue, comes from our communications platform.
Mm-hmm.
What we've said in that business is we have seen stabilization in volumes. And when you think volumes in our business, think number of messages sent, number of voice calls made, number of emails sent, et cetera. And, you know, kinda coming out of last year, I would say that we saw volumes declining, right? And kind of through, I would say, mid to end of Q1, and then it started to stabilize, which gave us, you know, more comfort in given our usage-based business. And we've kinda seen that stabilization through Q2 and again in Q3. And, you know, we expect... You know, we're optimistic that would continue, I would say.
Mm-hmm.
But just given the fact that it is our biggest business, it is usage-based, we just continue to plan prudently. On the Data and Applications side, so a relatively smaller portion of the business, that's about 12% of our revenue today. You know, revenue is primarily a function of prior period bookings.
Mm-hmm.
And as we said on our earnings call, like, while we saw a modest improvement in bookings sequentially from Q2 to Q3, they're not yet where we hoped they would be. And so we continue to really focus on building on that improvement that we saw and reaccelerating bookings into Q4 in 2024. And then, kinda as you know, there are other just back on the comm side, some short-term headwinds that we're dealing with as it relates to crypto-
Right
... and certain industries that have kinda plagued us for most of 2023.
Yeah. Maybe to dive in on the communication side in particular-
Mm-hmm
... So I know, 4Q tends to be a big quarter for you with the consumer vertical. So any vertical level commentary you can give in terms of the trends that you're seeing with consumer or others? And then as we look at, you know, the 4Q guide, I'm sorry, I'm giving you, like, a two-parter here, but we can break it up. But, but as we look at the 4Q guide, I think what was interesting, at least by our math, when we tried to strip out some of the headwinds you guys talked to on the communication side, it looked like growth was, let's call it, in the, like, low to mid-single digits for 2Q and 3Q sequentially.
And then it looks like the 4Q guide, sequential growth assumes something more flattish, and I know that typically tends to be a higher seasonality quarter for you guys. So is that just simple conservatism or, you know, as we think through maybe some of these vertical trends, is there something to keep in mind in terms of headwinds?
Sure. Why don't I start with your second question, then go back to the first?
Yeah.
So yeah, I wouldn't say that there's an explicit headwind to call out in Q4. Really, at the end of the day, communications business, most of our revenue, usage-based, which is just more variable than other business models and a little bit more difficult to forecast. And so, you know, we just continue to plan kind of prudently in terms of, you know, the forecast for the business. As it relates to consumer-
Mm-hmm
... or e-commerce or, you know, the question you had before, you know, we were calling that out as a headwind kind of at the back half of last year, maybe through, like, Q1. But we've seen stability recently on our consumer vertical. So, like, that hasn't been a headwind for us as of late.
That's really helpful. And then switching over to that data and app side, so I know last quarter, you guys talked about seeing a slight acceleration on, on the booking side. So in terms of the drivers of that, was that just a function of, you know, now greater than 50% of the, your reps on that side are ramped, and so, you know, there was more self-help? Was that a reflection at all of the environment improving? Maybe you can talk about the drivers there. And then, as we look, you know, ahead, because you're starting to see that acceleration, I guess, do you expect that to continue into 4Q, and could we start to see some of the metrics, related to NRR and things like that start to, start to bottom at these levels for that business?
As it relates to the bookings improvement, it's a function of the sales rebuild.
Yeah.
So this has kinda been a complete rebuild this year. I think you've got the history on the fact that we moved our kinda sales force to a generalist model. We realized that was not the right strategy. We ended up having to rehire the sales force. We spent most of this year hiring, enabling, ramping. We're at a point now where we've done those things-
Mm-hmm
... and now it's really about execution. And so the improvement that you saw from, you know, Q2 to Q3 on bookings, that modest improvement was really just—it was driven by that.
Yeah.
You know, as it relates to... Can you just repeat your second question? You're good at asking many questions at once. I have that good of a memory.
No. So no, no, and then the second question was just, is that, you know, as we look into, like, 4Q and beyond-
Yep
... could you start to see, you know, this continuation of accelerate, of an acceleration in bookings off easier compares? And, you know, given that that's the leading indicator to revenue, could you start to see revenue and also NRR start to at the levels that we saw this last quarter?
Yeah. I'm not gonna call, you know, like, bottoms or-
Yeah.
... specific forecasts, because we don't, we don't do that by business unit. As you think about Q4, like, we really wanna build on the momentum that we saw in Q3-
Mm-hmm
... and really focus on accelerating bookings into Q4. Like, we're intensely focused on that. We saw a modest improvement in Q3 on bookings on things like sales productivity, but they were relatively modest, and we're shooting for much better than modest in this business.... as it relates to, you know, NRR and things like that, you know, I would say for Q4, again, we'd expect sequential revenue growth to be more muted into Q4. And beyond that, I think we'll cover more of that as we get into our Q4 earnings call.
Perfect. And then staying on this topic with Elena's departure, any anticipated changes off the back of that? I know Jeff's stepping in, taking a bigger role there.
Mm-hmm.
But just in terms of, you know, what needs to happen to, you know, really start to, like, push that business to a further acceleration, I guess, how are you guys thinking about some of the near-term sales dynamics?
Yeah. So Jeff is stepping into, you know, as we look for a new leader.
Mm-hmm.
you know, we're looking at everything, right? And so, as we've said, the business, we're seeing green shoots, not yet where we want it to be. And so Jeff is spending a lot of time with that team and the sales org, in particular, really dissecting what are we seeing, you know, starting from MQL to QOs, like, all the way down to win rates and ASPs and all the different metrics that with sales productivity, and understanding it and slicing it a number of different ways-
Yeah
... by use case, you know, by vertical, by region, et cetera, by, you know, enterprise versus mid-market versus growth, kind of smaller customers, and really try to dig in and look at kind of what are we seeing, where is it breaking down in a way that we wouldn't expect it to. Like, one of the things that we are doing is looking at our target persona, historically, a marketing persona, and, you know, pivoting a bit to more of a technical buyer, where we find that we are more successful just given the strength of our product. And so there's a number of things like that that are underway, that, you know, will be underway for a couple of, you know, more months, and it will take time. You know, once you go through a sales rebuild, it takes time.
Yeah.
We're seeing that, but, you know, some positives, we're seeing some really good deals being won, but more work to do to really kind of drive that, you know, I would say, a higher level of bookings.
Yeah, makes sense. Maybe enough with the near-term stuff, and let's talk,
Right
... longer term. So you guys have a medium-term guide out there for 15%, I think, to 20% or 25% growth-
Yeah
... on the top line. So I think today the communications business is growing in the teens. You have the data and apps business growing in the single digits. So in order to get up to those levels, it requires a pretty big acceleration. So just in terms of what gives you guys comfort with those outlooks, maybe you could talk about the underlying drivers there.
Yeah, so a couple of things. First of all, Communications is nearly 90% of the revenue.
Mm-hmm.
You know, it drives most of our growth. Then on the path to 15%-25%, like, that business needs to do much of the heavy lifting.
Mm-hmm.
Right? Just given the relative size of it. And so when you think about that business, a couple of things. Number one, it's usage-based. It's a consumption model. And so we feel the macro effects, both on the downturn, but as well as on the upswing, more quickly than other business models. And so over a longer-term period, like the medium term, we do expect that the macro does improve.
Mm-hmm.
And so some of the short-term headwinds that we're dealing with start to abate a bit, and we do have a bit more of a stable macro environment. We're not assuming it goes back to where we were in like, you know, 2020, 2021, or even 2022, but just a more stable operating environment. That's not to say that all we're doing is banking on the macro. There's a number of things that we're undertaking in that business to drive growth. So just to name a few. So first, just new products like Verify, really driving kind of focus and sales incentives around some of our newer products. Second is cross-sell.
And so we've incentivized our sales teams differently coming into 2023 than we have historically, and that will incentivize the cross-sell of products within our portfolio. And then third, I would say, is international expansion. Like, we have historically been, like, relative to the U.S., underpenetrated-
Mm-hmm
...internationally, and so we think that we have a lot of opportunity to go into the international markets and grow there. So a lot of work being done on the communication side. I'd say the one assumption around getting to the medium-term framework is we do assume a more stable operating environment. As it relates to the smaller portion of the business, data and applications-
Mm-hmm
... I'd say it's two things: number one, a more stable operating environment will help that business. So what we're seeing there as it relates to the macro is increased levels of kind of churn and contraction, and it's really driven by two things, like, customers are cost-cutting just like we are.
Yeah.
And when that happens, like, we are seeing instances where they'll either they will come up for renewals and possibly churn off of our platform, or what we're seeing more often is that as customers come up for renewal, they're contracting. So they entered into a contract a year or two ago. They had assumed a certain trajectory from a volume perspective.
Yeah
... within their own business. That has played out very differently given just what we've seen over the last, you know, three or four quarters, and they're right-sizing the volumes and their contracts to reflect their volume realities. And so we, we are seeing higher levels of churn and contraction. In that business, we think a lot of it's macro, so we do assume a more stable macro environment to be operating in with TD&A as well, but also better execution, right? And so we've talked about the fact that we've now rebuilt the sales force. We've enabled the sales force. Now we need to see the sales force executing and getting productivity up to, you know, our expectations.
Yeah. And on the first part that you mentioned on the optimization side, so do you feel like we've gotten through a lot of the renewal activity in terms of, you know, peak COVID time frames, when everyone thought, you know, growth was gonna look like this, and then obviously, the macro hit, and you had, to your point, you know, a lot of companies having to contract there? In terms of what you guys see in the renewal base for that, do you feel like we've largely gotten through that activity? There might be, you know, a few more quarters left to go on the optimization side, I guess, where do we stand there?
I'd say, you know, we've gotten through some of it. I would expect for it to play through for a few more quarters.
Yeah.
You know, so, like, you know, on average, probably our terms are, I don't know, one year to 1.5 years on average. Some are longer, some are shorter, and so I think we have a few more quarters to go … to play through on that.
Yeah, makes sense. Maybe moving on to the long-term communications growth profile. So one area that tends to be an investor concern is on the passwordless opportunity, right?
Mm-hmm.
And what that could mean-
Mm-hmm
For Twilio longer term. So I know you have, like, three, you know, main buckets of use cases, whether that be, you know, notifications, the, multi-factor authentication, and then on the marketing side. But I guess first on the authentication side, I guess, how do you guys think about, you know, that risk longer term? I know earlier you mentioned Verify. I think there's things that you guys are doing on that front to, you know, make your value proposition stronger. But would love to, you know, hear how you think about that in terms of the longer term growth profile of communications.
Yeah. So a couple of thoughts on that. So first, you know, that is not creating, like, increased churn today.
Yeah.
I'll come back and talk about, you know, churn in this business, which is that has been low and, you know, continues to be low. I'd say, as it relates to verification, what we're actually seeing in the short term is that with, I would say, bad actors, fraud actors in particular, becoming more sophisticated, the need for verification is actually increased-
Mm-hmm
-right now. And so, you know, that's something that we deal with. We have a lot of products and like Fraud Guard and Verify and other things that help protect against fraud. But, you know, bad actors are becoming more sophisticated, and so the need for verification, at least, you know, here in the foreseeable future, has not dropped off.
Mm-hmm.
The other thing is, when you look at the majority of our verification traffic, it's actually for the initial verification of the device. It's less so the second, third, fourth kind of verifications or 2FAs that you get-
Mm-hmm.
... or the password resets and things like that. It's not all, understand, but the majority of it is, the initial verification of the device. And then within our products, like Verify-
Mm-hmm.
or we have a product called Verify. We're trying to meet customers where they are. So that means that if they want to verify through SMS, that's one channel they can use. If they want to verify through email, we will verify through email. If they want to verify through WhatsApp, we'll, you know, verify through WhatsApp. And so we're trying to meet customers where they are within our products, and not just be kind of limited to SMS, 2FA. And so I think there's a number of things. You know, in the short term, like, I don't see that kind of risk. I understand like longer term, that's, that's a, a question we deal with often.
Mm-hmm.
But, actually, in the shorter term, with just the enhanced, kind of focused on making sure that our traffic is traffic our customers want to receive, we probably, we really haven't seen that. And as it relates to just back to churn in this business, so this is the communication side of the business.
Yeah.
Churn in this business has been low and historically been low. It continues to be low. You know, we've played through. We're playing through a very tough macro. We've played through two layoffs that have impacted our sales team.
Mm-hmm.
We really haven't seen it move, right? And so it's been kind of that historically trended low, and it continues to be low. And so I just say that because I guess the concern that you're raising would result in kind of churn-
Yeah
... churn of customers off of our platform.
Yeah, that's really helpful. Thanks for all of that. And maybe sticking on the communication system, so let's turn to margin.
Sure.
So I think one of the highlights of last print was the communications gross margin-
Yeah
... which was up, you know, 160 basis points. And then when you look at the total company gross margin, I think that's the highest we've seen since 2021. And that, you know, historically has always been a focus for investors. So in terms of some of the drivers there, I'd love to, you know, hear you elaborate a little bit more. I know you guys are doing more on the incentive side, you know, more so incenting for gross profit, and you've made, like, some changes there. So maybe you can talk to the group about, you know, what those drivers were and the durability of that as we, as we look ahead.
Yeah. So, as it relates to the margin accretion that we saw in this third quarter, I think Communications margins were up like 160 basis points.
Yeah.
We've kind of seen that trend over the course of the year. It's been trending up. So a couple of things. Number one, part of it was driven by the divestitures that we did at the end of the second quarter-
Mm-hmm
... beginning of the third quarter. I would say that was 70 basis points or so. And so that will obviously be sustained because those businesses are no longer with the company. The other piece of it was actually really driven by termination mix, and in particular, the mix of where messages terminate geographically. And what you find is that messages terminating in the U.S. tend to have higher gross margins than messages terminating internationally. Despite the fact that the unit economics for both are very strong, and actually, the unit economics of an international message are slightly better than the unit economics of a U.S. message.
Mm-hmm.
Depending on where messages terminate, which is somewhat beyond our control, right? It's depending on where the customer is sending messages, you will see variability in our gross margin line.
Yeah.
And so this quarter, you know, we had more messages terminating in higher margin geographies like the U.S. than we did internationally, and that mixes us up. Which is why, you know, we're really focused on gross profit dollar generation, not just gross margin rate. I think if you just focused on gross margin rate in this business, it might lead you to make the wrong, you know, economic decisions, right? The unit economics we look at the unit economics as the message is being sent, and so long as those are attractive, that's business we want to keep doing-
Mm-hmm
... even though it might drive some variability in the gross margin line in the short term. Now, as it relates to the sales incentive structure that you referenced-
Yeah
... and the impact on margin. So I would say in the quarter, you know, we, you know, we are very focused on cross-sell, but and maybe just to give, like, a little summary of what it is we've changed. We are focused on compensating our portion of our communication sales reps on revenue and gross profit dollar generation, which is different than how we've compensated them in the past.... That did drive a little bit of a more of a mix to higher margin products like voice and email.
Mm-hmm.
Not significant.
Yeah.
In terms of the impact on the margin, sure, it was a little bit, but it wasn't anything that was worth calling out. So, but over time, we're gonna continue to incentivize that. Our voice product, our email product is a very high margin product, and they're products that we want to cross-sell. So some traction, more work to be done there. Like, we would like to see that trend continue. Wasn't a big driver in the quarter, but we'll continue to focus there as a company.
Got it. And then as we think about the other side of the business, I know that there's been some pressure on that front.
Yeah.
So on the data and app side, you saw gross margins dip below 80%.
Mm-hmm.
I know that there's some back-end cloud infrastructure changes that you guys are making-
Yeah
that are, you know, pressuring that near term. But could you maybe, like, talk about, you know, what are some of those headwinds? And as we look into the future, like, should we see a rebound back to 80%+ ? I guess, how do you think about the longer term gross margin structure of that business?
Yeah. So you've seen gross margins decline in Data and Applications-
Mm-hmm
Over the last couple of quarters, which is when we started actually providing that information publicly. It's two things: So in the short term, there is a capitalized software headwind, and so as we continue to innovate and build new products and add new features, both within the core CDP, within Flex, as well as on the AI front-
Mm-hmm
... that is resulting in higher, I would say, capitalized software amortization expense kind of flowing through our P&L. So that's part of it. The piece that you're referring to, which is more the infrastructure headwind-
Mm-hmm
... I would expect that to actually continue for probably most of 2024, and after which, we would reap the benefits of having kind of built a more sustainable infrastructure.
Yeah.
It's really a couple of things. So it is shifting of vendors. So in some cases, we are moving to different vendors for cost reasons, in some cases, we're moving to different vendors for design reasons. It's really driving a scalable infrastructure within our kind of TD&A businesses, and it's things like eliminating some redundancies as well, around things like hosting costs, things like warehousing costs, data lakes, things like that. And so, we're really looking at all of it. We're really focused on making sure it's sustainable and we have the right infrastructure in place and at the right cost point. During that transition, so most of 2024-
Mm-hmm
... the reason you have a headwind is because there will be a double bubble of expense, right? Because we don't just go cut off one vendor and move to another vendor. That would obviously be very risky.
Yeah.
We don't want to, you know, really present that risk to our customers. So there's a period of time where you're actually paying two vendors, and you got to play through that until you ensure that the new infrastructure and vendor, you know, profile that we have is sustainable and manageable. So I think that we'll play through that for probably most of 2024, and then see margins start to improve again in 2025.
Yeah. Makes sense. And then on operating income margins, you've seen incredible improvement this year.
Yeah.
And so I guess, you know, at, like a common question we'll get from investors is: Okay, you know, they've shown all this amazing improvement next year as we look into, or, sorry, this year, as we look into-
Yeah
Next year, like, where are the levers of continued operating efficiency? So maybe you can comment on that and how, as you guys look into next year, how you're thinking about balancing growth and profitability.
Yeah, I think we'll be balanced in terms of, like, focusing on both growth and profitability. You're right, in this year, in 2023, you know, we, we came out of the gates really fast, right?
Yeah.
So last year, we were roughly break even on a non-GAAP basis. We lost a little bit of money. And Q3 to date, we've generated $360 million of profit. We came into the year saying $250 million-$350 million. Year to date, we're at 360. And so year to date, you've seen something like 12-13 points of, like, OM expansion year-over-year.
Mm-hmm.
So doing what we said we were gonna do on that front-
Yeah
which I, I think is important. I wouldn't expect that level of leverage to continue, right? I, I think that that was on the back of two kind of big restructurings and a number of different changes that we made around our real estate portfolio and another, other cost actions. So I'd expect more modest improvements in 2024.
Mm-hmm.
In terms of where we expect to see additional leverage, I think it's a couple of things. Number one, broadly, we have, as a company, we're remote first. And we've actually closed a number of our offices. We still have an office footprint, but being remote first gives us the option and the flexibility to hire employees where it makes sense to, from both a talent perspective as well as a cost perspective. So I think we have some opportunities to continue to shift to some lower-cost geographies. Second, in functions like my function, like finance and accounting, we've actually done a lot of that work in, like, say, my accounting work, to actually shift to lower-cost geos. And now the next wave of it is, like, how do we actually leverage technologies to automate?
And so there's a lot of work that we can, we can do to automate work and to make workflows more seamless so that as we move forward, we can, we don't have to continue to add heads as we scale, right? We can get leverage on, on lines like, you know, my, my call center. And then, as you think about, you know, other parts of the business, say communications-
Mm-hmm
You know, one of the areas we've been really focused on this year is self-serve. We've done a lot there. There's still more work we need to-
Yeah
... get done. But once we get some of that work behind us, I think, you know, when you talk to Khozema, who leads our communications business, like, I think he, he firmly believes that once we're on the other side of some of these builds on things like self-serve and some infrastructure stuff, that we can get a lot of leverage by not having to add resources as we grow revenue in that business.
Mm-hmm.
Those are just some of the areas that we're focused on and really driving efficiencies over the long term for the company.
Yeah. And then, are those all the longer term drivers then of your long-term target, where, you know, if you look out, you guys are calling for 30-40 basis points, I think, of operating improvement per year.
300, 400.
300, 400.
Yeah.
Yeah. So curious if, you know, some of the things that you mentioned are, you know, things that are just going to take time, and you're going to see-
Yeah
That gradual improvement over time? Or is there things that as you look out, right, maybe they're not drivers today, but you would say, "Hey, in a couple of years," like, these are other things to keep in mind?
Yeah, I think those are a lot of... Many of these things are multi-year efforts.
Yeah.
It's not something that you just do, and you're done. It takes time to work through it. And some of them, you know, like, we're in the early stages of investing in order to reap the benefits on areas. So, I would say those things. I think the other things, like cross-selling into kind of higher margin, higher gross profit dollar-
Mm-hmm
-type products, will also drive improved OM expansion as well. And so I think it's a combination of the actions we're taking on the top line to incentivize different increased sales, and then combined with not having to add cost at the levels we were historically, as well as some of the actions that I spoke to earlier.
Yeah, that's really helpful. And then just how this translates into cash flow. So free cash flow margins-
Mm-hmm
-have been trailing EBIT margins. So as we think about, you know, the guide that you have set out for EBIT, what does that mean on the cash flow side? Are there certain, you know, cash flow tailwinds to keep in mind, any, you know, headwinds that we could see in the near term? How do we think about the puts and takes there?
Yeah, so we've kind of... You know, we just got to free cash flow positive this year, in line with our non-GAAP operating margin.
Mm-hmm.
The last two quarters, we actually generated meaningful levels of free cash flow for the first time as a company. What I would say is that, I would expect those two things correlate, right?
Yeah.
Like, as you reduce the cost structure of your business, obviously, like, you would expect that your profitability increases and your free cash flow increases. And so I would expect that as we continue to get more and more profitable over time, free cash flow, you know, follows. Whether those two things converge, we haven't committed to that, but I do-
Yeah
... I would expect that over time, those two things trend in the same way. I think that's pretty obvious. I think, you know, within any one given period, there's always variability on cash flow. So like, for example, in the third quarter, we actually had a tailwind from collections. We improved our DSOs by, like, three days.
Yeah.
You know, like, that, that won't necessarily continue every quarter. Flip side, in the first quarter, we had the restructuring payments and severance payments that we were making, so we had a cash headwind. So there's always variability in cash, and so within a given quarter, you might see that those two things don't exactly correlate, but over time, that trend should, you know, continue.
Yeah, perfect. Maybe with the last minute, we'll end on a fun question with generative AI and all the other AI initiatives that you guys have been doing too. So could you maybe talk about the opportunity with customer AI? So I know that you had Predictions that just went GA recently. What's been the customer feedback? How are you, like, from the CFO seat, thinking about the, you know, potential revenue opportunity longer term and how we could see that ramp?
Yeah. So we had our Signal conference, which is our customer conference, in August, and then we've actually had some regional Signal conferences in EMEA, APJ, I think, we're in Latin America this week, over the course of, like, November.
Mm-hmm.
And, you know, it's been really exciting to talk to customers about our product and kind of feature roadmap. You called out Predictions. That is, you know, one of the products that we talked about. I think we have, like, 100 or so customers-
Mm-hmm
Leveraging that feature. You know, another one is, like, the Voice Intelligence, where, you know, we basically can make a voice, at least like a transcription engine powered by AI, that makes a voice call more intelligent and action-oriented and actionable, and like, Traffic Optimization in terms of optimizing when and what, over what routes you're sending your marketing messages or other messages, depending on the importance of delivery and cost. And so we have a number of initiatives underway. Like, we have a pretty robust product roadmap that we talked-
Mm-hmm
about at Signal. In terms of the financial expression, I think it's early days, candidly.
Yeah.
Like, in the near term, like, I'm not banking on that and to be like a meaningful contributor to revenue. I think everyone's kind of figuring out, like, what is the commercial structure, what is the pricing and packaging structure of all of this? And so I don't have much to add there today. We're excited about the excitement that we've seen, but more to come over time on how it all plays out with the financials.
Perfect. Awesome. Well, that's it for time. So yeah, right. So thank you so much-
Thank you
... Aidan, for taking the time. This was great, and thank you to everyone in the audience for joining as well, too.
Thank you.