Twilio Inc Q2 FY2021 Earnings Call

Good day and thank you for standing by. Welcome to the Twilio Second Quarter 2021 Earnings Conference Call. Operator provides instructions to participants. I would now like to hand the conference over to Andrew Zilli, Vice President of Investor Relations and Treasury. Please go ahead.

Thanks, Ashley. Good afternoon, everyone, and thank you for joining us for Twilio's Second Quarter 2021 Earnings Conference Call. Our prepared remarks, our earnings press release, SEC filings and a replay of today's call can be found on our IR website at investors.twilio.com. Joining me today for Q&A are Jeff Lawson, Co-Founder and CEO; George Hu, COO; and Khozema Shipchandler, CFO. As a reminder, some of our commentary today may be in non-GAAP terms. Reconciliations between our GAAP and non-GAAP results and further information related to guidance can be found in our earnings press release. Additionally, some of our discussion and responses may contain forward-looking statements, which are subject to risks, uncertainties and assumptions. In particular, our expected business benefits and financial impact from our acquisitions, particularly Segment and Zipwhip, and our partnerships, including the associated transactions; Twilio's outlook for the quarter ending September 30, 2021; and our ability to manage changes in network service provider fees that we pay in connection with the delivery of communications on our platform and the impact of those fees on our gross margin are subject to change. Should any of these risks materialize or should our assumptions prove to be incorrect, actual financial results could differ materially from our projections or those implied by these forward-looking statements. A description of these risks, uncertainties and assumptions and other factors that could affect our financial results are included in our SEC filings, including our most recent report on Form 10-K and subsequent reports on Form 10-Q. Our remarks during today's discussion should be considered to incorporate this information by reference. Forward-looking statements represent our beliefs and assumptions only as of the date such statements are made. We undertake no obligation to update any forward-looking statements made during this call to reflect events or circumstances after today or to reflect new information or the occurrence of unanticipated events, except as required by law. With that, I'll hand it over to Jeff for a brief statement, and then we'll open the call for Q&A.

Thanks, Zilli. Before we get started answering your questions today, I wanted to touch on Twilio's commitment to helping 1 billion people get vaccinated equitably and globally. For many, it started to feel like life was returning to normal, with vaccines readily available, at least here in the United States. Yet the Delta variant, which originated in a part of the world without the same level of access to vaccines, has now rippled through the entire world, infecting both vaccinated and unvaccinated people at higher rates than we've ever seen before. To me, this underscores the importance of vaccinating the world, and I'm particularly proud of the role that Twilio has chosen to play using our product, our time, our people and our money to help ensure equitable vaccination globally. In March, we committed to the goal of helping reach 1 billion people with the aim of educating people and helping them get vaccinated. We partnered with 450 organizations and in just 3 short months, I'm proud to say our product has been used to help 297 million people get critical vaccine education, appointments or reminders. In June, we also committed $10 million to Gavi, the Vaccine Alliance, in support of COVAX, which is the largest global initiative to vaccinate lower-income countries against COVID-19. We're supporting the program's goal to purchase and distribute 1.8 billion COVID-19 vaccine doses to more than 90 low and middle-income countries, and we expect to have greater influence on how the coalition uses technology to effectively distribute the vaccines. I was honored and surprised to find that we were the second largest private company to contribute to Gavi's global vaccination program and the largest company in the tech sector. As a shareholder, you're part of the good work that Twilio is doing. To all of the Twilions out there, the work you do to build our product, to build this company are having an impact, so thank you. It's times like these when I see the impact that we can have, and I'm humbled and proud to lead you. And we will continue towards our goal of supporting 1 billion vaccinations worldwide. Now I'd like to open it up for questions.

Operator provides instructions to participants. Your first question comes from Michael Turrin with Wells Fargo Securities.

I wanted to start off with Segment. You mentioned in the prepared remarks the pull forward there in co-selling. It seems like it's maybe 6 months ahead of what you're expecting. Are there any points of feedback or interest you can share to start? And maybe in tandem with that, the sequential growth, I know we have a limited set of data. It was maybe a little lighter than we would have expected given just strong product synergies that we see between the two. Is it fair to assume this shift towards co-selling can maybe just change the shape of that trajectory as you work through that going forward?

This is George. I'll take the first half of that question on the co-selling and then Khozema can talk about the growth piece. As I mentioned in our previous call, we are seeing interest in Segment from our customers across a broad segment of our customer base. By opening up Segment to our entire sales force and letting the combined power of both sales forces really educate the market as well as sell the product, we think we can bring Segment to as many customers as possible and maximize the opportunity. We're very excited about this opportunity and I know our sales forces are as well.

Michael, this is Khozema. On the guide, I think you may be reading a little too much into it. For the third quarter guidance, it's a really strong growth rate of 50% to 52%. We remain really optimistic about our performance in the near term as well. We previously provided guidance of 30% plus growth over the next four years and feel really good about that over the medium term. Segment will continue to enhance where we're going over the long term.

Yes, my comment was more reflective of the sequential — I think it's a 4% increase on Segment Q2 to Q1. My thought was that as you work towards co-selling, there's reason to believe the sequential growth rates could pick up there over time. The other observation — international picked up quite significantly as well. Is that a result of some of the on-the-ground-focused investments you've been talking about, Khozema, or were there specific regions to call out as contributors that drove the uptick in mix there as well?

So two things. On international, the uptick we saw is a benefit of our continued global expansion. As you'll recall, Michael, we've talked in the past about that being one of our focused areas of investment. On top of that, there's a small impact from ValueFirst. We did that acquisition; it was a very small contribution in late March, but we got a full quarter in Q2, and that's 100% international revenue based on the way we classify it. Regarding co-sell, we're very excited about it as George described. It won't show up in our financials for some period of time. We haven't even started in earnest; we basically just started a few weeks ago, and it will take some time to bleed into our financials.

Your next question comes from Derrick Wood with Cowen.

Nice to see a reacceleration in organic growth. Just to get a pulse, what would you say the strongest outperformance areas were in the quarter maybe on a product basis? And then it sounds like you guys are seeing a lot more momentum with SI Partners. Can you talk about what kind of use cases these partners should open up new doors for you? Is it predominantly in the contact center? Or what other kind of solution areas do you see them becoming more instrumental?

Derrick, it's Khozema. In the quarter overall, we experienced broad-based strength across a number of facets of the business. One area I particularly point out is that our messaging product continues to deliver outstanding results. Segment also had a very strong quarter. On top of that, we had strong net expansion and good new customer growth. We've been talking for a while about the significant secular shift that's driving customers towards Twilio and our customer engagement platform. There's a lot we can do to accelerate digital transformation, and we're seeing a continuation of that.

This is George. On the SI front, we've always believed Twilio is a great fit as a builder platform for systems integrators that build custom software. Flex in the contact center opportunity has really been the engine powering many of our discussions with customers and SIs, and that's going to continue to be true. These production SIs building contact center solutions are also opening us up to other customer engagement opportunities where Twilio is part of a broader solution, whether around marketing or other customer engagement solutions.

And George, if I could squeeze one more: your headcount was up almost double year-on-year. Of course, there are acquisitions that contribute to that. But I'm curious how much growth you've built in the sales capacity roles and if you're planning to continue to be aggressive in hiring in the second half?

At a macro level, we don't comment on specific sales capacity numbers. We continue to invest in people broadly, and distribution is part of that. We are excited about the opportunity and continue to invest; we believe there is still a large untapped opportunity in customer engagement in the market today.

Your next question comes from Taylor McGinnis with UBS.

When you think about the uptick you saw in dollar-based net expansion rate, are you seeing any interesting mix shift trends of different products driving that beyond messaging? And since messaging growth was so strong last year, can you speak to what you're seeing from customers on the potential for messaging growth levels to be more sustainable in the back half of this year relative to the first half?

I'll take the first part, Taylor. We've seen fantastic growth on the messaging side, and that product has been reaccelerating over prior periods, which has been exciting. That leads to additional growth opportunities in other channels. Another area we're equally excited about is application services revenues — those not associated with telephony-based cost structures — which continue to grow at accelerated levels, above other products. That includes Flex and Segment. Over time, those products will contribute more meaningfully, though it will take time for those pieces to show up fully in our financial statements. Overall, this is a favorable dynamic: our core business is growing fast, and other pieces will follow.

I don't think my answer would be very different. Messaging, even at its size and scale, continues to be a strong performer. Customers are finding new ways and use cases for messaging, whether for reaching customers, operations, customer service or security. Globally, messaging will continue to grow as a market and an opportunity for us.

Your next question comes from Meta Marshall with Morgan Stanley.

I wanted to ask about M&A strategy. For the past couple of years, it's been more around platform extensions. Since the beginning of the year, it has included more service improvements or continuity acquisitions. How are you viewing and balancing those strategic imperatives and what you can do organically and inorganically?

Meta, this is Jeff. We look at where our customers want us to go in terms of our product roadmap. Sometimes that manifests in capabilities we build, sometimes in geographies where we'll deepen presence. If there's a company that has built what is on our roadmap and buying them would accelerate our ability to serve customers and our time to market, that's something we consider. We're always evaluating options on an active game board. If a company accelerates us with a great team and technology that's additive, those are the opportunities we pursue.

As companies embark on digital transformation initiatives, are you seeing any changes in how customers are purchasing — making bigger investments upfront, or still trying out one product and building from there? How have initial purchase patterns changed?

Twilio has always thrived on a land-and-expand strategy given we work with builders. Developers typically start with one use case, then expand to others. During the height of the pandemic, we saw different use cases emerge and more urgency around particular ones, but it didn't change the fundamental shape of how we work within customer accounts. Developers learn the product, build with it, introduce it to others and expand. That's the magic of the platform and what we'll continue to build on.

Your next question comes from Rishi Jaluria with RBC.

I wanted to ask two related questions on Zipwhip. First, can you give a little more detail on the plans with the asset and the rationale for buy versus build or partner? Second, regarding guidance, I understand the puts and takes of deferred revenue write-down. Can you give a general sense for what the unaffected size and growth rates look like so we can model more accurately?

Rishi, I'll give the first part. We're excited about Zipwhip; they are an innovator in toll-free messaging with strong carrier relationships. Their CEO, John Lauer, has a great track record helping carriers productize toll-free messaging. They are the sole channel for toll-free messaging in North America, which points to the strength of their relationships and the fact they are the only way to get into toll-free messaging in North America. We closed the transaction a couple of weeks ago and are starting to make joint integration plans. There's a lot we can do together, especially around trusted communications. We see a future where every call and message comes from a trusted identity — not just a phone number but a business name with a padlock, like a web browser where you know it's authentic. That's the world we're building towards, and Zipwhip will be a big part of evolving the ecosystem to make texting and calling businesses safer and more trustworthy.

Rishi, we're not disclosing anticipated financial impacts right now, consistent with how we've operated with prior acquisitions. We're still working through the integration plan and purchase accounting impacts as we consolidate. We excluded the effects of Zipwhip from our guidance to keep it clean and will provide an update when we report Q3.

Your next question comes from Matt Stotler with William Blair.

You mentioned Segment Journeys. It looks interesting as it builds consumer journeys from marketing applications. The breadth of the opportunity seems substantial. Can you share early feedback on interest and what people are looking to build with this and how you expect the opportunity to develop?

Matt, Segment Journeys is an exciting addition. Segment helps companies take all the information they have about customers — website behavior, mobile app usage, purchases — and use that to improve customer engagement across touch points. A tailwind right now is privacy changes that reduce reliance on third-party cookies and data brokers, forcing companies to get better at first-party data. Segment has taken a hard stance to only deal in first-party data, focusing on privacy-enabled customer engagement. That helps companies understand customers and guide them through their journeys. If you use what you know about a customer to help them progress toward being an ideal customer, that's intelligent customer engagement. Segment Journeys lets companies take the 360-degree view and use that to drive next steps in the journey. It's a natural extension of Personas and was conceived and built with customer input.

Last quarter you talked about changes in the R&D org structure, splitting into three separate organizations. Any commentary on progress, how the teams are working together and early feedback?

The reorganization is going well. We're consolidating many business units under three discrete leaders who report to me. This change will better align the business to help Twilio grow in scale and is enabling greater engagement, visibility at the executive level, and improved alignment and clarity around roadmaps. When you're growing as fast as we are, you need to periodically reconsider the org chart. This change has been well received and the teams are executing well.

Your next question comes from Samad Samana with Jefferies.

Congrats on another great quarter. On Zipwhip, can you talk more about the strategic value of having that direct carrier connection? I know you're not guiding for revenue, but any color around Zipwhip's growth to contextualize the acquisition would be helpful.

I can speak to the value of direct connections. The more direct relationships you have, the better situated you are to cooperate with carriers and build products together. In places like North America, with three carriers, having direct relationships is tremendously valuable. We've seen the Zipwhip team build those relationships and bring products to market with carriers. That's an important part of building up the ecosystem.

If we think about net expansion implying revenue from new customers being strong in the quarter, can you give context around new customer revenue? Was it more on traditional messaging or other products stepping up?

A crude way to think about it is to take the dollar-based net expansion number and look at the difference between that and our organic growth rate to sense new customer contribution, then add inorganic effects. Overall, it's broad-based strength. Messaging has done really well and reaccelerated over the last year. Application services areas like Segment, Flex and SendGrid are also showing great traction. I wouldn't point to any one thing other than messaging's strong performance and Segment's great quarter; across industries and verticals, it's broad-based strength.

Your next question comes from Fred Havemeyer with Macquarie.

I wanted to ask about your IoT business. Can you give a general overview of where your IoT business stands and initial customer perceptions around Super SIM? And do you think Segment will play a role in how businesses consider data collection and utilization in the IoT space?

We're happy with the IoT business. We recently hired Andrew Cohen from Samsung to lead it. With 5G rolling out, many areas remain to be digitally enabled, especially in industrial and smart-city contexts. Consumer IoT devices are just version 0.1 of what's coming. Super SIM addresses a real customer problem: when you deploy a device globally, you don't want different vendors, SIM cards or carriers based on where the device ends up. You want to manufacture once, ship globally, and reduce complexity, allowing devices to improve over time via software. Super SIM moves connectivity to a software value proposition in the cloud, enabling continuous upgrades to connectivity performance and cost. That said, IoT adoption has been somewhat challenged by global supply chain issues, which have delayed some use cases, especially industrial. I expect those are not durable trends and that 5G and narrowband technologies will enable a wave of innovation in the years to come.

Can you give an update on your relationship with Syniverse? Are you materially routing A2P messages for Syniverse with your wholesale agreement?

We've worked with Syniverse for a long time; they've been a partner for many years. We haven't needed to make a material change to our business as part of that relationship, and the partnership work is still pending closure. A lot of that work will be forthcoming as we close the partnership.

Your next question comes from Alex Zukin with Wolfe Research.

Two metrics-focused questions. Going back to Michael's question about Segment: if we normalize Q4 for Segment, the sequential growth from Q4 to Q1 was maybe high teens or 20%, and it stepped down to 4.5%. Is there heightened seasonality with this business later in the year, or is the sequential movement just noise? Also, a quick follow-up on A2P.

On Segment, I wouldn't point to a specific seasonal dynamic. We feel great about the acquisition's performance and the way that business is progressing. Anything you're seeing sequentially is a bit of noise, ups and downs from quarter to quarter, which I expect to normalize. We feel optimistic about the acquisition and what we can do with the business. Regarding A2P, what's your follow-up?

On the A2P piece, you talked about the AT&T contribution. Can we get a better understanding for Verizon A2P fees this quarter or last quarter? If we do the math, it looks like underlying organic growth excluding A2P is accelerating Q1 to Q2, and I'd like to confirm if that's the case.

In general, that's the case. We aren't breaking out Verizon anymore; it's in the base rate. We broke out AT&T and T-Mobile only and gave you numbers there. If you take all that stuff out, you'll see we're growing nicely organically with or without the fees and we are seeing a reacceleration.

Your next question comes from Brent Bracelin with Piper Sandler.

Question on demand for two-way messaging via Twilio Conversations versus traditional one-way SMS messaging API. In the new wins you highlighted a couple of Conversation use cases. What is the benefit as customers move from SMS to Conversations? Is it primarily higher volumes, or does it include higher pricing? How fast could the industry move, given consumer frustration with one-way texts?

If you think about how companies added messaging, the natural first step was notifications because it's easy and high value. Consumers, however, expect two-way dialogue and they reply. Often they get nothing or a prompt to call. Companies expect to reach a person or a system to answer questions. We've focused on Conversations to turn one-way messages into two-way conversations. On top of Conversations, we've built Flex for contact centers and Frontline for frontline workers, creating vehicles for companies to have two-way conversations. Adding value to the channel makes customers happier and enables us to build software products that help companies succeed in two-way messaging. These experiences are nontrivial to build, so our products help companies create meaningful relationships via message threads. We're seeing interest from financial services and others who see this as the future of customer relationships, and we're helping them deliver it with Flex, Frontline and Conversations.

Your next question comes from Will Power with Baird.

Thanks for the vaccination efforts. I wanted to ask about Twilio Live mentioned in the prepared remarks. Can you better understand the market you're addressing, early use cases and how you think about the opportunity?

If you look at live media on the Internet, early use cases were one-to-one or one-to-few. Now the market for broadcast-scale, live interactive experiences is growing. COVID accelerated experimentation in live audio and interactive video at scale. Twilio Live addresses this emerging market: large-scale audio experiences, webinars and live interactive video with many participants. Commerce opportunities are arising with live video. One launch customer was Reddit Talk, which used Twilio Live to add voice talk features into communities. We're at the beginning of experimentation in live media at scale, and we look forward to powering many new ideas.

Any thoughts to help frame gross margin outlook as we head into Q3? You have a full-quarter impact of the A2P fees, but aside from that, any puts and takes to model moving forward?

I wouldn't say there's any change in our long-term gross margin framework. We're still targeting 60% to 65%. We're not focused on short-term fluctuations; there's some noise. Messaging has had a strong performance but the mix pulls margins down a bit. International increased from 29% to 32%, and then the fees clipped us a little. But our long-term outlook and how we're thinking about gross margins remains unchanged.

Your next question comes from Siti Panigrahi with Mizuho.

I want to dig into Flex adoption in contact centers. How are you looking at the cloud contact center opportunity given UCaaS vendors and convergence of UCaaS and CCaaS vendors with recent consolidation? How are you looking at that opportunity?

With Flex, we're really happy with how it's going. If you looked at Flex independently, you'd see it's one of the fastest-growing SaaS products on the market. We have broad adoption from digital disruptors like Shopify, Lyft and Robinhood to Fortune 500 incumbents like major banks, Allianz and international airlines. The market is still early in moving to cloud — only around 15% is in the cloud, so 85% is still on-prem legacy solutions. The contact center is evolving from an IT cost center to something closer to revenue and customer experience. Digital channels and serving customers digitally are making the contact center a driver of top line. That shift aligns with where we sit and who we sell to in companies.

Your next question comes from Ryan Koontz with Needham.

Regarding international revenue strength, how do you characterize adoption of digital customer engagement across customer sets? How do you view international markets relative to the U.S. in terms of adoption — are some more advanced or are they catching up?

It really depends on the technology. For SMS and e-mail, North America is at parity or ahead of other places. For platforms like WhatsApp, we've seen more advanced adoption in some international markets. It just depends on the part of the portfolio.

Your last question comes from Mark Murphy with JPMorgan.

Congrats on a strong quarter. Jeff, I wanted to ask about Frontline. We're intrigued by the potential for an app that connects frontline workers with consumers. There are more non-desk workers than desk workers. How do you see Frontline progressing and have you been able to build good pipeline there?

We launched Frontline with the observation that there are more non-desk workers than desk workers. There are two types of people who interact with customers: those who sit in a place and primarily interact with customers full-time (contact center agents) and those who have many responsibilities but need to drop what they're doing to help a customer. Frontline targets the latter: mobile, easy-to-use, native-feeling tools that empower workers with CRM information and allow companies to track and ensure compliance rather than employees using personal phones. We've seen interesting use cases in sales communications and have a major Fortune 500 health care company deploying Frontline even before GA, indicating broad use cases. We're scratching the surface and excited to bring Frontline to GA.

Quick one for Khozema on the A2P fees. Do you think carriers who increased fees are one-and-done, or is there a chance for ongoing lifts in the future? It seems customers are absorbing the cost because the ROI remains high. Is that fair?

I think the ROI is incredibly high for the use cases we're enabling. It's hard to say whether carriers are one-and-done. Based on what we know today, we don't see anything additional in the future, but it doesn't preclude them from taking other actions. All our financial modeling is not based on any additional fees at this time.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.