Twilio Inc Q4 FY2021 Earnings Call

Good evening. My name is Chantal and I will be your conference operator today. At this time, I would like to welcome everyone to the Twilio Fourth Quarter and Full Year 2021 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Operator Instructions. Andrew Zilli, Vice President of Investor Relations, you may begin your conference.

Thanks, Chantal. Good afternoon, everyone, and thank you for joining us for Twilio's fourth quarter and full year 2021 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 for Q&A are Jeff Lawson, Co-Founder and CEO; Marc Boroditsky, CRO; and Khozema Shipchandler, COO. 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, statements about Twilio's outlook for the quarter ending March 31, 2022, Twilio's goals regarding delivering non-GAAP operating profitability beginning in 2023, and meeting the annual growth rates and long-term non-GAAP gross margin targets, Twilio’s expectations regarding our products and solutions, Twilio's expectations regarding business benefits and financial impacts from acquisitions and our partnerships and investments, including the associated transactions, our expectations regarding the impact of recent and future privacy changes on certain third-party platforms on Twilio and our customers, and Twilio's 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 margins 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. And our remarks today 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 the management circumstances after today or to reflect new information or the occurrence of unanticipated events, except as required by law. With all that out of the way, I'll hand it over to Jeff for some opening remarks, and we'll open the call for Q&A.

Thank you, Zilli. I am very happy with our 2021 results built on some great outcomes for customers that continue to generate the best-in-class growth for investors that you see today. I've never been more excited about the future of the company than I am sitting here right now. We have an awesome leadership team, a combination of our leading cloud communications platform with Twilio Segment's #1 customer data platform gives Twilio an unparalleled view into the customer journey, setting us up as the company that can truly deliver on the customer engagement platform vision. We intend to become the software player that digitally connects every business to their customers to introduce true personalized engagement and relationships in the next chapter of the cloud. We're builders. So our work is never done, and I'm incredibly eager to continue building the company in 2022 and beyond. With that, let's open the call for your questions.

Operator Instructions. Our first question comes from Samad Samana with Jefferies.

Congrats on the strong finish to the year. It's great to see the organic growth. Maybe, Jeff, first for you. And just in reading over the prepared remarks, I think the company really did a good job of expressing moving from just the infrastructure side to more of the solution layer. I'm curious if you could maybe help us understand how the adoption is going for the more solution-based products that the company is rolling out, and how we should think about maybe the traction changing? I know you guys called IDFA, in particular, as a driver. Are we at an inflection where that's accelerating? Or how should we think about the shape of that adoption?

Yes. Thank you, Samad. So I think there's two parts to that question. First of all, I'm really pleased with how the introduction of our software layer is going. If you think about the customers that we're talking about in our earnings calls — not just this time, but every quarter — we've got great companies adopting Flex and Segment. I love the Vertu Motors example that we talked about today, bringing Flex and Segment together to make a contact center better. We've got Stripe adopting Flex for their contact center needs, Flex expanding in a Global 2000 financial services company and a Global 2000 automaker, Nubank, Invisalign putting Flex into their processes, and many others. We can come up with so many customer stories. Our "in and up" strategy is a great one because Twilio is used by so many companies around the world — every industry, every size, every continent. Needs like e-mail and messaging are ubiquitous and developers see there’s so little friction. We're able to use those initial wins and that initial traction to move up the value chain, move up the workflow, and move up the software stack to then address the things our customers are trying to solve, whether it's in the contact center, their sales process, marketing, or inside their products. That is really what the "in and up" strategy is all about: leveraging Twilio's ubiquity across different kinds of companies into building this customer engagement platform. From our conversations, customers need to build great relationships with their customers by understanding them and then engaging with them. Twilio has the leading CDP to understand customers and the leading communications platform to engage with them — a powerful combination. Second, regarding IDFA and the tailwind provided by privacy: I think society is on the right track, investing in privacy, testing regulation and laws, and deprecating tracking tokens. If most consumers knew what had happened on the Internet, they'd be pretty appalled, actually. These changes are forcing our customers' businesses to focus on the fundamentals of business. Think of my grandfather selling paint at our hardware store in Detroit: you know your customer, you talk to them about their needs, and you show how your offering helps. Investing in privacy means companies must use first-party data — how people use their product, website, mobile app, what they buy, what they return — as signals for how to digitally engage customers and make experiences personalized and compelling. That journey is a big trend; it aligns with a larger direct-to-consumer shift where companies invest in building their own customer bases and turning them into repeat, loyal buyers instead of relying solely on ads. This is exactly the space where Segment and our other products help customers succeed.

Great. That's very helpful. Maybe just a quick follow-up for Khozema. First, appreciate the additional disclosures and the numbers around organic growth. That was very helpful by you and the IR team. Maybe if I just — the outlook for getting to profitability in 2023, I know we're still a ways out from that. But can you maybe help us understand what the assumptions are around — is that going to come on the gross margin line? Or is that mainly because of OpEx leverage or revenue mix? How should we think about what allows the company to get to that profitability and what you're assuming in that?

Yes. Thanks, Samad. Appreciate the question. I think it's a combination of things, some that will play out in the short term and others that will play out in the medium to long term. In the short term, improvements are really going to come from operating expenses. As I mentioned in my prepared remarks, we haven't been investing in a number of areas over the last several years, and historically we've called out Flex, enterprise go-to-market, international go-to-market and core infrastructure. We expect the rate of cost growth in those areas to moderate basically in the second half of the year. For example, our ERP project goes live in the middle of the year. It's not that we won't continue to invest in these areas, but the rate of growth in those investments will be lower than what we've seen historically. Up to this point, we prioritized growth in scaling the company. Growth remains a priority, and we actively made that trade-off historically. We're at the point now where we've got enough scale that we can start reaping the benefits of that scale and become more efficient in our cloud operations. We see a real efficiency opportunity and we're confident in our ability to deliver non-GAAP operating profitability in 2023. Over the medium to long term, we also expect improvements in our gross margin line. That number can bounce around period to period in the short term as we onboard customers and have opportunities to grow with them, but consistent with what Jeff said, as we bring customers into higher levels of the software stack through our "in and up" strategy, we can provide more value and see margin improvement. That's why we stand by our 60%-plus gross margin target over time.

Our next question comes from Derrick Wood with Cowen.

Nice to see a strong quarter. Congrats. Jeff or Marc, you guys have been on this journey to build out this kind of CRM suite of applications. You referenced this in-and-up motion, and the product portfolio has certainly matured quite a bit. So from a go-to-market perspective, looking in 2022, how are you planning to be more aggressive in this up stack, the up part of the motion? And what would you like to see kick into a new gear in 2022?

Derrick. Thanks. Great questions. It is front and center in the way we are going to market in 2022. We are in the final days of our sales kickoff this week, and the primary objectives we're enabling the team on are the in-and-up strategy — leveraging our installed base and access to customers efficiently through e-mail and messaging to sell them more broadly on the vision of the customer engagement platform. We announced the customer engagement platform at SIGNAL this past quarter and it's resonating with customers of all sizes, driven by their desire to take more control over their digital engagement. We're hearing interest across the entire arc — from top-of-funnel engagement all the way through long-term loyalty. The training we're doing now is supporting our sales team to ensure they are ready and able to approach the significant opportunity we see in the market today.

Great. Great to hear. One for Khozema. Could you double-click on the change in your guidance philosophy? How has your approach changed versus what it was before? And I guess what kinds of new insights have you gained or are more comfortable with in order to better predict consumption behavior here?

Yes. Great question, Derrick. As you know, we run a usage-based business model with some elements of subscription. Each year we gain more insight into how customers use our platform and we fine-tune our forecasting model. Our FP&A team continually refines that forecasting model, and as we collect additional information, we become more granular in our predictions. For Q1, we refined our guidance philosophy to provide guidance that is more consistent with actuals and to give investors a better approximation of our expected performance. As you saw in our Q1 guide, we're showing continued growth of 45% to 47% on a reported basis and 32% to 34% organically. That includes Segment. We have a lot of confidence in our ability to deliver 30%-plus growth over the next several years. We also get a lot of good feedback from our investors and analysts and we take that into account, which helps provide a more consistent setup over time.

Our next question comes from Michael Turrin with Wells Fargo Securities.

Maybe my least glamorous question on the call but feels worth asking is on gross margin. Clearly the growth is outstanding. The gross margins are stepping back here. It's clear international messaging strength is gearing forward. But how should we think about the tradeoffs and when those can help flatten that trajectory? And maybe secondarily, we saw the Syniverse transaction ended this morning. Is there still a chance you can partner there or comment to improve the core gross margins? Or is that no longer the right way to think about that relationship?

Yes. Great question, Michael. Let me take the second one first, then I'll address gross margin more fully. With respect to Syniverse, there was press suggesting we might buy Syniverse. We're not doing that. What you saw in the announcement this morning was that the merger agreement between M3 and Syniverse came to termination by mutual agreement, largely reflecting market conditions. That agreement also provided for an alternative path — a minority investment in Syniverse — and that's now the path we will pursue. The commercial wholesale agreement that we've referenced historically remains in place. We have a longstanding relationship with Syniverse, and we intend to continue that. That partnership gives us a valuable product to leverage in the United States, so I don't see a significant near- or medium-term impact from that change. As for gross margins more broadly: we have a very high-growth messaging business that performed exceptionally well in Q4 with a big uptick in international volumes. International messaging tends to carry a lower gross margin structurally relative to some other products, but the messaging business generates significant gross profits that we like and that we want to reinvest. Most importantly, as Marc alluded to, it creates an installed base that we can execute our in-and-up strategy against. As disclosed, our application services category is growing at a faster rate. We have the good problem that messaging grew 52% organically last year while application services grew even faster. Over time, as we grow application services and Segment and continue the in-and-up motion, we believe we can reach the 60%-plus gross margin target. In the short term, you'll see some volatility quarter to quarter, but we feel confident in our long-term trajectory.

Our next question comes from Mark Murphy with JPMorgan.

Khozema, I'm wondering if you can shed any light on any specific products that are growing materially above or materially below this organic growth level of about 39%. I would imagine Flex, Video, Segment are outpacing. I'm less certain about voice, e-mail, Authy, some of these products. Just curious if you're able to comment on any of the major outliers there?

Mark, appreciate you asking the question. I'm not going to go through every single product, but here's the answer. If you look at our growth rates over the prior year, our messaging business grew at incredibly high rates — 52% organically — which is tremendous. In spite of that, our application services category, which includes many pre-Segment and pre-SendGrid non-telephony-based products, is growing at a faster rate. The messaging business is large in revenue contribution, so it will take time for the in-and-up to play out in our financial statements even though it's playing out in the life of our customers. Segment had a fantastic quarter sequentially; year over year we don't break that out because it was inorganic in the prior period, but sequential growth was really strong. Now that it's in our numbers, we have confidence in the 30%-plus target over the next three years, especially given the stronger base since the acquisition.

That's very helpful. And as a quick follow-up for Jeff, you had mentioned the in-and-up strategy. I'm just wondering how rapidly perhaps your R&D investment is shifting toward products that might be sold more to a marketer rather than a developer. For instance, the customer journey insights, the Engage product and orchestrating messages rather than the delivery of messages.

Yes. You can see we've invested in products in Segment and in the core customer data platform as well as new products we're building above those layers. Developers assist the sale for communications APIs — they can pick up a lot of the work. For a marketer or a contact center buyer, there will be a line-of-business buyer making a purchase, but with Twilio they get the support of their internal technical teams at the table. Developers and technical people are proponents of Twilio; they can prototype and say, 'Yes, we can do this with Twilio.' In years past, salespeople might have sold to a line-of-business owner who would then turn to IT and the IT team would make the decision. The magical thing about Twilio is we get proponents both on the technical side and, increasingly, on the line-of-business side as we invest in application products. The application products we're building are developer-centric in customizability and flexibility: they do a lot out of the box but give ample room to customize and become the company's long-term solution. We're not trying to be merely turnkey and impossible to customize; we're building for flexibility as markets evolve, and that approach has been proven by adoption across a wide variety of customers, from digital disruptors to Global 2000 companies.

Our next question comes from Meta Marshall with Morgan Stanley.

Congrats. A couple of questions. One, you noted disclosure of having about 36% of the Global 2000. I just wanted to get a sense: is some of your confidence about the 30% growth rate for the next couple of years driven by room within this core customer set, or is it from the opportunity to win more of the Global 2000? How much do you feel you've already landed that gives you confidence in the 30% growth rate? Second, building on what you just said, Jeff, you made a compelling argument at SIGNAL about why Twilio is best enabled to help customers on their customer journey versus some competitors. Are you finding that you still have to do evangelism about why you versus others, or are customers generally happy to have a solution you provide?

Thanks for the question. On the 30%-plus dynamic, our confidence isn't just because we have relatively low concentration in the G2K. We've also done significant business with digital disruptors. Since the IPO our top 10 concentration has shrunk, and while there are large companies in that bucket, the rest of our customer base is very wide, so we're not overly concentrated in any one customer or industry, which helps scale. Second, beyond messaging, we sell many other products into customers, so our ability to go up-stack with application services, Segment and e-mail allows for upsell and cross-sell. Third, investments in international go-to-market are starting to pay off — you saw a lot of momentum in the most recent quarter. There are many customers globally we are eager to serve. Marc, do you want to add?

Absolutely. Picking up where Khozema left off: the opportunity is massive beyond our existing footprint. Landing new logos remains important — landing them with SMS or e-mail and then building a trustworthy relationship is a true opportunity across market segments. We also have the white space within accounts to expand footprint. There are many enablers helping us: we power independent ISVs that sell packaged solutions, we have partners, system integrators, BPOs. For example, the relationship with HGS shows significant progress with over 20 of their customers moving to Flex. These are accounts brought through a channel strategy, and we'll pursue growth across all these dimensions. The opportunity is still in front of us.

Meta, I'll answer the evangelism part. Customers come with specific business challenges and market dynamics. Executives increasingly realize they need direct relationships with customers: understanding them, building profiles, and acting on that data to improve business outcomes — spend less on ads, increase retention, decrease acquisition costs, increase lifetime value. Often, there's a bottom-up motion where frontline people bring Twilio in to solve immediate problems and then we follow up with top-down education about the broader approach. I'll share a quick story: I was talking to the CEO of one of our customers — a large education company — and he shared a report that said the old way was monolithic apps and the new way is composable APIs. He asked, 'Jeff, you're not getting rid of APIs, are you?' I said of course not — we're building with APIs and making it possible to integrate these experiences together. The idea of APIs and composability is now widespread; developers and companies see that APIs are the building blocks to innovate rapidly. That is why customers come to Twilio: we provide the building blocks plus higher-level products, and there's always some education when moving technologies forward, but the market is ready.

Our next question comes from Alex Zukin with Wolfe Research.

I want to ask maybe two questions. First, when you think about the major differences in the demand drivers between Q3 and Q4, obviously those were two very different quarters. Khozema, you mentioned it's a consumption-based business and inherent in that is some volatility. But just help us understand what were the biggest differences — what made Q4 such a great quarter relative to Q3? Second, with Segment going into the organic bucket, what's the right way for us to think about modeling dollar-based net expansion going forward? I know you're not guiding to that metric, but any help would set the right framework to better understand the components.

Alex, good questions. On demand drivers, there's nothing materially different other than the nature of a usage-based business — you'll see variability period to period. In the most recent period international really took off, which reflects multi-quarter investments and is something we feel good about. It's not that one dramatic structural change happened between quarters; rather, we saw broad-based strength across the business in Q4. Regarding Segment: we provided separate disclosures for Segment on a year-over-year basis and we broke out some of that detail. I won't dive deeper here, but we feel really good about the growth prospects for that business. The sequential growth was strong and the combination with messaging and other Twilio products, including interesting opportunities with partners like Stripe, gives us strong growth prospects going forward.

Our next question comes from Will Power with Robert W. Baird.

A couple of questions. First, international growth clearly accelerated. It sounds like messaging was a big piece of that. Any other color as to what drivers behind that surge in international messaging might have been and what else you might have seen internationally that drove some of that acceleration? Second, building on other commentary: looking at your strategic position around first-party data and the in-and-up strategy, what pieces could bolster that further? And more broadly, how do we think about the M&A pipeline and appetite here?

Thanks, Will. Two dynamics. First, our international market investments and Marc's international team are starting to show returns; we've seen that over multiple quarters. Second, there was one large customer in particular whose volumes really took off in Q4, and that contributed meaningfully. That happens from time to time and can affect gross margins, but we feel great about how international is trending and we expect that to continue.

Okay, great. And then maybe for Jeff, building on some of the other commentary, what are the pieces that could further solidify your position around first-party data and in-and-up? And how should we think about M&A appetite?

When I think about what bolsters our position, it's continued execution. We have best-in-class products — messaging, e-mail, Segment — and we're bringing those pieces together. We have three pillars: Engage for marketers, Frontline for frontline workers, and Flex for the contact center. There's a lot of TAM and a lot of buyers, and we are continuing to bring these products to more customers. On M&A, we'll always survey the landscape. Acquisitions can accelerate our roadmap and we should consider them when they make strategic sense with a high bar for culture and product fit. But today we're very focused on our organic growth rate. In the current market there may be attractive opportunities, and we'll be on the lookout, but our primary focus is growing the business organically and executing on our strategy.

I'll just add that while there may be attractive opportunities in the market, we're very focused on our organic growth rates right now and don't see anything necessary to do immediately from an M&A standpoint.

Our next question comes from Ryan MacWilliams with Barclays.

Looks like Twilio’s presence in the Global 2000 doubled since the end of 2020. Congrats. Jeff, I know it's early, but love to hear about the strategy and expectations behind Engage and how customers are responding to the idea of using Twilio as a unified customer engagement platform.

Absolutely. On Engage: historically marketing automation products focused on running campaigns — send an email, track opens — and were designed 15–20 years ago. Modern marketing is driven by data: a rich set of data about every customer to determine what message will resonate. Marketers care about whether campaigns drive purchases, increase lifetime value, and improve retention. Great marketers use complex, data-driven approaches that legacy marketing software isn't built to handle. We're going after a data-centric approach to marketing. Segment — the CDP — is critical because it brings data together for marketers. Adding marketing execution with Engage is the next step, and because Segment handles the data, bringing execution on top is relatively straightforward. We're excited by customer feedback and believe we have a novel, attractive approach to go after the marketing budgets of legacy vendors.

No, that was great. One quick follow-up for Khozema on non-GAAP operating profitability in fiscal '23: as we think about the path forward from here, can we think about gross margin being higher on a yearly basis going forward, given the elevated growth in the higher-margin application services business?

Fair question. We're not going to guide year to year on gross margins, but we feel very good about the progress in application services — the non-telephony cross-product offerings — which are growing faster than messaging. As that trajectory continues, we feel confident in the 60%-plus over time target. In the interim, messaging will produce high gross profits and there will be quarter-to-quarter volatility. Over time, given application services growth and products like Engage, we have high confidence in reaching 60%-plus.

Our next question comes from Fred Havemeyer with Macquarie.

Jeff, Twilio's products and platforms certainly expanded a lot since its heritage as an infrastructure and communications API provider back in the early days. As Founder, whenever you put on your coding gloves and you're thinking about what's exciting on Twilio's platform — what are the products that are disruptive or interesting that you would use to build the next iteration of startups and growth businesses? What gets you most excited about what is happening with Twilio here?

That's a fantastic question. It goes back to our mission: unlocking the imagination of the world's builders and developers. People can now build products that, if they get it right, can reach millions or billions of users. That scale of execution is extraordinary. Developers, startups, and companies can innovate rapidly using APIs and composable building blocks. What excites me is enabling customers to say 'yes' — giving them a path to implement what they imagine. We're delivering building blocks via APIs and higher-level products like Flex, Frontline, Engage, and Segment to unlock developers' imagination. For so long companies stitched together monolithic apps; now they can compose modern solutions. Twilio's platform approach empowers builders across marketing, contact centers, messaging, and product experiences. That breadth and composability is what excites me most.

Our next question comes from Matt VanVliet with BTIG.

When you look at Segment and the rate of adoption across the enterprise, it seems like for very large companies the idea is compelling. But how many of the companies you're talking to are ready to implement Segment? How much customer education and maturity is out in the market? And is there potential for adoption to accelerate dramatically over the next couple of years as companies modernize?

Great question. The opportunity cuts across the entire market — from small customers to the largest enterprises. We see use cases where you need to connect a few real-time data sources to understand a customer and provide the right interaction in the customer's chosen channel. Those use cases can expand into more strategic, full customer lifecycle requirements. For example, Vertu Motors implemented Segment to identify callers who bought previously and prepare the agent with the right information to increase conversion and upsell opportunities. We're seeing opportunities to move from point use cases to broader strategic adoption, which positions a CDP as a strategic part of how customers build relationships.

And then on the Flex side, are you still primarily replacing legacy on-prem solutions, or are you increasingly seeing customers who adopted quick cloud solutions during the pandemic now coming back and realizing limitations and choosing Flex as a longer-term platform?

In smaller customers, Flex can be their first real contact center implementation. As you move into larger organizations, there is more legacy installed base. We have a healthy amount of augmentation — customers adding channels and capabilities in parallel with legacy systems — and we're also winning more and more replacements of legacy implementations. The Align example we shared is a digital-oriented business that replaced a legacy supplier with a Twilio implementation that is now their standard. We show up to help customers recognize the next generation of engagement; we don't wait for people to fail. We have examples across Fortune 100 banks and Global 2000 automakers that have successfully moved to Twilio for full requirements.

I'll add that when we acquired Segment I was struck by its penetration into the enterprise. We have enterprise customers like Procter & Gamble, Intuit, and a large financial services company that signed this quarter. The need in complex businesses with many subsidiaries and brands for a CDP to make sense of data has been clear, and the acquisition's traction in market surprised me in how early enterprises recognized that need.

Great, we are out of time. I know there's a lot of folks that still have questions in the queue. We will catch up with you this afternoon. Otherwise, thank you everybody for joining and for catching up over the rest of the quarter.

This concludes today's conference call. You may now disconnect.