Twilio Inc Q1 FY2022 Earnings Call

Good afternoon. My name is Emma, and I will be your conference operator today. At this time, I would like to welcome everyone to the Twilio First Quarter 2022 Earnings Conference Call. Thank you. Bryan Vaniman, SVP, Corporate Development and Investor Relations, you may begin your conference.

Thanks, Emma. Good afternoon, everyone, and thank you for joining us for Twilio’s First Quarter 2022 Earnings Conference Call. Our prepared remarks, earnings press release, investor presentation, SEC filings, and a replay of today’s call will be found on our IR website at investors.twilio.com. Joining me today for Q&A are Jeff Lawson, Co-Founder and CEO; Elena Donio, President of Revenue; 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, our discussion and responses contain forward-looking statements, including our projections and expectations regarding future performance. These forward-looking statements are subject to risks, uncertainties and assumptions. And 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 a remark marked 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. And with that, I’ll hand it over to Jeff for some opening remarks. Then we’ll open the call for Q&A.

Thanks, Bryan. We delivered another strong quarter of results and continue to execute against our long-term strategy to build the world’s leading customer engagement platform. We remain confident in our ability to deliver over 30% annual organic revenue growth through 2024, and we’re committed to delivering annual non-GAAP operating profitability starting in 2023. To achieve this goal, we’ll continue to make the necessary investments in 2022, which will put us on a solid trajectory to deliver against our growth and profitability targets over the coming years. And as you likely saw in our prepared remarks and press release, we are really excited to welcome former Twilio Board member, Elena Donio, as our President of Revenue. Elena is a remarkable executive and a leader with deep knowledge of the Twilio business, our market, our value proposition and our culture, having served on our Board since 2016. Elena has extensive experience leading massive growth and scaling go-to-market activity as the former CEO of Axiom and the former President of SAP Concur. Elena will help Twilio to its next phase of growth, and I’m thrilled to officially welcome her to the team. And of course, I want to thank Marc Boroditsky for his partnership and contributions to Twilio over the last seven years. And lastly, may the Fourth be with you all. With that, let me open the call for questions.

Your first question today comes from the line of Meta Marshall with Morgan Stanley.

Perfect. Just maybe starting on the CRO transition. Could you just give a little bit more background on what the thinking behind that was? And just given recent management changes, any continuity efforts or considerations that you had in making that change? Maybe as a first question, and then I have a follow-up.

Absolutely, Meta. So look, I’ve had continuing and ongoing conversations with Elena throughout the years as she was considering her next operating role and about the opportunity to get her more actively involved in Twilio’s leadership team. And we’re incredibly fortunate that with Marc’s intended departure, we have the perfect person to step into the role and a perfect role for her given her experience. And she was already tremendously familiar with the organization, the team, the people involved, the opportunity, our customers, etc. Look, I always believe when you have an opportunity to bring on a world-class leader of Elena’s caliber, you jump at the chance to do so. In addition to her tremendous insights into our company, the culture and products from her time on the Board, she obviously brings a wealth of direct experience in software, in SaaS, in go-to-market, in products, and scaling organizations while managing costs through a period of rapid growth. Those are all the things that we’re focused on doing. So I’m extremely excited to have Elena join the company as President of Revenue and in the latest forward in our go-to-market efforts. And by the way, I’m incredibly grateful to Marc for his enormous contributions to Twilio over the years.

Got it. Appreciate that. And as a follow-up, I mean, clearly, you guys have noted in the past that there would be quarter-on-quarter kind of volatility in the organic growth rate in that, that growth may not be 30% in any given quarter. But just any trends, Khozema, that you think are worth noting in just the Q2 guidance that may be causing the sequential downtick in growth or in a sequential growth rate?

Meta, not really. I mean, I think the big thing to keep in mind here is that the 30% organic target is obviously on an annual basis, and we’ve been pretty consistent about communicating that. And then last year, in Q2 '21, we had a really, really strong organic growth quarter at 50% year-over-year. So as we look at the second quarter at 36% to 38% reported and then 27% to 29% organically, we feel pretty good about Q2. And then as we look out for the balance of the year, we see a more favorable set of comparisons as we go through the second half. And so we do feel good about 30% for the year, and we also feel pretty good about 30% for 2023 and 2024, as we’ve communicated previously.

Your next question comes from the line of Kash Rangan with Goldman Sachs.

Jeff, I'm curious if you could give us some thoughts on the broader environment. Obviously, there's been a lot of volatility in rates and customers' propensity to deploy tech or maybe that has not changed. Give us your state-of-the-union perspective on how customers are prioritizing investments in Twilio. And also, secondly, it's laudable to see the company gear more towards operating leverage, etc. What are the things operationally that Twilio has determined that will provide sources of operating leverage in the future? That's it for me.

Yes, this is Khozema. There are a few points to discuss. I'll start, and Jeff can add his thoughts if needed. Regarding the macroeconomic situation, if the economy were to enter a significant recession, we wouldn’t be completely shielded from its effects. However, based on our internal research and external studies, it’s clear that digital transformation remains a high priority for many companies. This trend benefits Twilio as businesses seek to enhance their engagement strategies. We recognize the macro environment, including economic and geopolitical factors, but we believe our business is well-positioned to take advantage of ongoing digital transformation efforts. Despite inflationary pressures such as supply chain issues and rising labor costs, we have accounted for these in our models. Our strong balance sheet also supports us in these challenging times. As mentioned previously, we are confident in our guidance of over 30% revenue growth through 2024, along with projected non-GAAP operating profitability in 2023. Regarding profitability, over the past three years, we’ve made several planned investments that we deemed crucial, particularly in Flex, our go-to-market strategies, and more recently, in Segment, which is vital to our customer engagement framework. We are approaching the peak growth period for these investments. While we will continue to invest, we expect the rate of cost growth for these investments to be lower than in the past. This reduction in cost growth is how we aim to achieve non-GAAP profitability next year.

Your next question comes from the line of Michael Turrin with Wells Fargo.

Gross margin saw a meaningful improvement sequentially. The prepared remarks still referenced just some near-term fluctuation potential. Just in sort of adding some more context around that. I guess the question is just why wouldn't that be at least somewhat bottoming if we're looking at sort of a point in time where U.S. growth is moderating? Some of these 10DLC impacts are playing through. Are you at all comfortable that gross margin can at least remain around a similar ZIP code regardless of how our messaging mix plays through? Or anything else you could just provide to help us think through normalization of what these fluctuations can look like?

Yes. That's a good question. I mean, I think with respect to the gross margins in Q1, we are obviously happy with them improving to 53%. I think, Michael, the thing I'd encourage you to keep in mind is that just the size and scale of our messaging business is what tends to drive it. And so that's why we're kind of signaling some level of fluctuation in gross margins in the near term. I think it'll be in the ZIP code. I mean I'm not going to be prepared to call the bottom or anything like that. But I'd also remind you that we like the messaging business a lot. And while it does carry that lower gross margin, it also generates a lot of gross profits that we reinvest back into the business. And we've spent some time over the last few quarters talking about this 'in and up' strategy, and messaging still serves as that important foot in the door with our customers so that we can execute on that 'in and up'. And obviously, on those deals, we evaluate everyone on those opportunities, looking at whether or not they're going to drive lower gross margins and making sure that there's real strategic value there. I think the flip of all of this is that our emerging software business continues to grow at elevated rates and obviously does carry significantly higher gross margins. And as we think about our long-term targets around 60% plus over time, we continue to see a lot of tailwind there, and we continue to like the software businesses quite a lot. And we just have to continue executing on that up strategy that we've been talking about sort of for the last several quarters.

Yes. That's all really useful. And then I think great to see Elena coming off the board onto the field. Can we just go back to just how you keep continuity in making that change midyear? Are there any near-term changes we should expect? Or how should we assess the transition there? It looked like sales and marketing spend maybe ticked down a touch sequentially. So if you can just kind of hit on those, I think that's also useful.

I will answer a few from the lens of maybe go-to-market results. And then I'd love for Elena to maybe just introduce herself and provide some of her own comments. But I think in short, we don't really expect the transition to have much of an impact certainly on the short term. And I think in the long term, we certainly anticipate that Elena is going to have a very positive impact on the business. Right now, look, we've got a great team in place. That go-to-market leadership team is very strong. We have a clear plan for execution. The results that we've already seen in Q1 are a good setup for the rest of the year. And as I said, I mean, I think with Elena coming on board, I'm very excited personally, and I think she's going to have a really positive impact. I think her track record speaks for itself and to bring a person of her caliber on to the management team is really lucky on our part. But let me maybe just turn it over to her for a moment, and she can tell you a little bit more about how should be thinking about things.

Thanks, Khozema. Michael, nice to meet you. Having served on the Board for the past six years, which was just really the ride of a lifetime, I have become really familiar with the company. But with all that as a backdrop and knowing our products, our sales motion, our customers, our team from the Board lens is quite different from knowing it from an operating lens. And so I look forward to bringing my own background, skill set and lessons learned to the team but also doing a ton of listening and learning, particularly in the early days. I've spent my whole career driving operations and hopefully, delivering operational excellence, growth and scale. I see a huge opportunity to bring that capability into the company. We start with a fantastic team. I'm really, really proud of everything they've done in the past and the Board role in that, but I think the road ahead is perhaps even more exciting. I'll also say I'm actively engaged with many of our team members, customers, even investors. And so I feel like I have a pretty good perch to sit from, but I'm also really excited about continuing to learn from here, to meet the rest of the team, to congratulate them on all of their accomplishments historically, but also to jump on the ride with them from here and envision a great future as the leader in customer engagement.

Your next question comes from the line of Mark Murphy with JP Morgan.

And forgive me, I joined a minute or two late, in case it's redundant. But last quarter, you had mentioned some domestic friction on the ADP registration side. Could you just describe that a little? And I'm trying to understand if the friction is solely related to the onboarding process versus anything about the fees themselves? And then was there a deadline for customers to get that done during March? And I have a quick follow-up.

Yes. Mark, this is Khozema. Good to hear from you. So the growth slowdown just kind of domestically generally and the friction associated with 10DLC was really to do with the onboarding process for both new and existing customers. And it does create some friction in the short term but over time creates a lot more trust on our platform. As a result of some of the friction that we saw, we have built a number of features to make that registration process more seamless for our customers. The majority of our traffic has now been able to get through that registration process. We believe that that's behind us. With respect to your question about a deadline, there was a deadline, and that was March 1. I think now with that behind us and the majority of our traffic, also having completed that initial process, we do expect domestic messaging to normalize through the balance of the year.

And then just a quick one for Jeff on the topic of 2-way messaging. In the past, I believe you said that it's still early days. And so now you've got another quarter under your belt. You've got the conversation with API and the front-line product developing. Do you see any more activity? Or is there any kind of a backlog building perhaps in terms of 2-way messaging?

Thank you, Mark. I believe there is a significant opportunity in Twilio messaging. Traditionally, one-way messaging has dominated the market, but this sets the stage for transitioning to two-way interactions. It creates a pathway to engage customers who utilize messaging for alerts and notifications. The question companies face is about when to initiate conversations and how to respond to customer inquiries. Many businesses are realizing that customers want engagement, so ignoring them is not an option. Instead, they must find ways to connect with customers who are actively seeking dialogue. For instance, in financial services, we've seen increased scrutiny over non-compliant two-way messaging, prompting the industry to take notice. In retail, companies like Nike use Flex to enable staff to interact with customers both in-store and through digital channels. Our investment in the product roadmap reflects feedback from businesses that view two-way communication as essential for fostering meaningful customer relationships. The API layer facilitates the integration of various conversations across different platforms such as SMS, WhatsApp, and voice, creating a cohesive experience for companies and their customers. From a consumer's perspective, the interaction should feel like a singular conversation with the company rather than a fragmented experience across departments. This is a significant opportunity, and we've been focused on it for some time. More companies are adopting this approach, and I experienced this firsthand with a musical gear retailer who effectively communicated with me after I placed an order. I received a text from my salesperson informing me that my package had shipped. When I replied with questions, he responded promptly with helpful information. This kind of exceptional customer service is noteworthy, and it highlights the benefits of two-way messaging in various scenarios, whether for mortgages, banking products, musical instruments, or other purchases.

Maybe you can play us some music sometime.

Your next question today comes from the line of Derrick Wood with Cowen.

Jeff, I guess for you, first. You guys have seen a lot of leadership change over the last year. It sounds like there is a little bit of increased attrition in the quarter in Q1. We've seen this certainly from many companies that have scaled so quickly and have to evolve into a much larger organization. But just curious, have all these changes had any disruption kind of looking backwards or looking near-term forward? And then as you just look at adding kind of headcount and backfilling some of the attrition in Q1, what are the plans in terms of investments for the rest of the year?

Thanks, Derrick. I'll answer the question about the executive. I think it's a fair question. You never like to see executive turnover for sure. And attrition is elevated across the market aside from this at Twilio. It's not just tech. It's actually the entire economy, basically, and you see it probably, especially true in companies that are growing as quickly as Twilio is. In some ways, it's the reality we're all living in every company, but it's also a reality for any fast growth company. But what I really look at is that we have been consistently able to attract incredible leaders to Twilio with highly relevant expertise necessary to take the company to the next level. And that's what we are always doing as we grow the company and are very appreciative of the leaders that have gotten us to where we are but also looking forward to leaders who are going to take us where we go. You can do both those things at the same time. Elena brings a tremendous wealth of direct experience in software, in SaaS, in building go-to-market and in product and in scaling organizations while managing costs through rapid growth. These are all things that we are doing right now and that we are going to be doing for the coming years. Look, I’m incredibly excited to have her driving our go-to-market efforts going forward. It’s always bittersweet, right, when you say goodbye to an executive. You’ve been in the trenches. You work with them closely, but you also look forward to the people coming in or here to bring you where you're going. I’ve been running Twilio for 14 years, so yes, I’ve seen groups of executives come in, help me build the company to where we are today, a $3.5 billion revenue company, growing very quickly. It’s just part of what happens when you grow a company incredibly quickly.

No doubt, you've had incredible growth. That makes a lot of sense. Real quick, Khozema, for you. I know we're not getting specific numbers on application services, but anything to share in terms of how growth trended or how that performed against expectations? And anything to share around the efforts and training the broader sales force around Segment?

Yes. I mean, I'd say, in general, it's kind of a repeat of what we've talked about in the past, which is we feel really, really good about the Segment product. We feel great about the performance of it. Certainly, that team has been really, really additive to the long-term success of Twilio. More specific to your question, that software category more generally has been growing at elevated rates. Obviously, based on the margin profile, we clearly like that a lot. That certainly underscores our faith that we can get to our long-term gross margin targets of 60% plus. Having as many people trained up on the product as we possibly can should obviously accelerate its growth over time. So feel really good about where we are with Segment, and it's going to be really important to us as we build out our customer engagement leadership.

Your next question comes from the line of Samad Samana with Jefferies.

I guess first one for you, Khozema. When I think about the disclosure on Q4, the international versus U.S., and I go and put that mix back in, I'm just curious how we should think about the gross margins. I don't want to re-litigate Q4 necessarily, but usually, the U.S. domestic has higher gross margins than international. So I'm just curious if it was not a mix, maybe was there something else that we should think about for the Q4 gross margin pressure? And then I have a follow-up for Jeff.

Yes. Samad, it’s a fair question. So maybe first off, just to own what happened, there was a discrepancy in the mix of that domestic versus international revenue, and it should have been caught in Q4. Luckily, it was caught as we ran the closing process in Q1, and we noticed the discrepancy then. We have put in place some additional analytics as well as some additional controls to make sure something like that doesn’t transpire. I did want to own it before answering your question. In terms of that split, the way that we provide the disclosure, that split is based on the IP address or the mailing address of a customer at the time that they register with Twilio. So effectively, it’s something that we use for reporting purposes, but it’s not how we manage the business day to day. Samad, you know the business pretty well. Where we focus tends to be on where those messages terminate, and we continue to see very strong growth in messages that terminate outside of the U.S. If you go back to a couple of years' SIGNAL, when we did the Investor Day, we showed them that, that split is about 50-50, and it’s continued to grow from there. That tends to be the much more significant impact on gross margin. Of course, there is some correlation between destination messaging as well as what the customer origin is, and it can deviate obviously from period to period. But that's the gist of why that commentary from Q4 remains true today.

That's really helpful. I appreciate the extra clarity. I believe that has clarified a lot of points. Jeff, I want to follow up on something Khozema mentioned regarding understanding the business. At the end of the day, growth remains very strong with substantial figures. So when I consider the company and its future growth, what market strategies do you foresee being implemented? Are there any anticipated market changes that will support the guidance of over 30%? How should we view it in light of the recent changes to the management team?

Thank you, Samad. Why don't I have Elena answer that question?

Thank you. So first of all, I’d say a lot is going well. We really like our long-term growth trajectory, and I tend to continue along that trajectory. When I think about how I spent my first couple of months, first and foremost, it’s obviously about getting to know the team and customers more deeply so that I can internalize their aspirations and really get to know them as we have our plans. I would say there are a couple of really important short-term priorities that go along with that. Number one is accelerating software growth, especially Segment and Engage once launched. Number two is calibrating our resource model explicitly towards the greatest efficacy possible. So that means nurturing our product-led growth engine that we’ve built over time in messaging but also amping up our direct and channel sales capabilities in software. Lastly, doing both of those things while driving additional operating leverage and go-to-market overall so that we’re ultimately paying off the investments we’ve made over the past number of years.

Your next question comes from the line of Ittai Kidron with Oppenheimer.

Maybe, Jeff, I'll start with you on Twilio Engage. Can you be, first, perhaps a little bit more specific on timing? When is that finally going to be available? And any color you can share with regards to the trial activity with customers? How should we think about traction and adoption here once it's out?

Thanks, Ittai. First, regarding timing, we're looking to launch GA and Engage in the second half of the year. As for what we're learning from our early customers, when introducing a new product to the market, we initially deploy it in a beta phase with a select group of early users who help shape the product roadmap and highlight key focus areas. We've received excellent feedback from the early customers of Engage, and interestingly, we have more requests for data access than we can currently accommodate, which is a positive indicator. The feedback from these pilot customers has been invaluable as we respond to their input and gain a deeper understanding of the issues they wish to address with Engage. Our aim is to create a product that uniquely solves their challenges. Engage is positioned to fill a significant gap in the market by providing a platform designed to aid B2C companies in understanding their customers through data and leveraging that insight to personalize every aspect of the customer journey while empowering employees with the Engage applications we are developing. Engage adopts a data-first approach to marketing, which is essential in today's privacy-conscious landscape where relying on third-party anonymous cookies and IDFA is no longer viable. Modern marketers are focused on truly understanding their customers, personalizing their experiences, and cultivating loyalty to turn them into happy, repeat buyers. Early adopters in our pilot program are expressing the need for our solution as they find existing tools inadequate. Twilio is addressing this need, and I believe that eventually, all marketing will trend in this direction. Marketers will prioritize spending on acquiring quality data and will need a platform that activates that data, moving beyond the outdated methods of blindly sending out campaigns and merely tracking subscriptions. Those times are behind us. Moreover, using data as the foundation for marketing tools allows for optimizing outcomes that matter to businesses. Since Segment can track data flows from various systems, it enables marketers to see not just engagement metrics, but actual sales results from campaigns. Companies succeed through significant sales, not just opens and clicks. Segment can provide insights like how much revenue a specific campaign generated, which is incredible. This demonstrates the value we can offer to companies, allowing marketers to justify their investment in our tools by showing that they are generating revenue from it. While we are still in the early stages of this product, we expect to roll it out to GA in the second half of the year.

That's great to hear. I have a follow-up question for you, Khozema, regarding the gross margin. It's encouraging to see the progress. I'm trying to connect that to the registration date of March 1, where you mentioned that you expect messaging to normalize. I assume that means messaging was somewhat low around that date because some customers were not registered. Is that influencing the political activities aspect of your adjusted gross margin, which should see higher volume in the second half of the year? Additionally, with messaging volumes expected to normalize in the latter half, should we not anticipate any further gross margin improvements between now and the end of the year due to these two factors inflating messaging volumes? Is that the correct way to look at the situation?

Yes, Ittai. If everything aligned in our favor, it could be possible, but we are not making any forecasts about that. We do not provide guidance on gross margins. What will primarily influence it are the fluctuations in the messaging business. The size and scale of this sector mean it is often the main factor. Considering what I mentioned earlier, the way messages conclude, who manages that traffic, and how everything unfolds is quite complex. While I believe we will be close to a certain range, we are not offering guidance on it today.

Your next question comes from the line of Joe Goodwin with JMP.

Great. I think that might be me, Pat. Elena, I have a question for you. Just I would love to hear any sort of learnings that you have from your time at Concur or some of the other boards you're on or other companies that you think might be relevant and might be things you can apply at Twilio.

Yes. Thanks for the question very much. I hope there's a lot of learnings. I started at Concur when my Bellevue startup was acquired in 1998. I saw some amazing years from the early 2000s of the dot-com boom and bust through to 2008 and all of the product and market transitions that went along with that. Moving the company from on-premise shipping CDs to a SaaS company from a company focused on a web front end to mobile, from a company that sold one product that's reporting to one that sold travel invoice management and a whole host of others and ultimately became a platform company while growing overseas, growing into the U.S. federal government, growing downmarket. I’ve certainly seen a lot of different transitions and taken a lot of lessons away from that, including moving into the President role when we were acquired by SAP in 2014, and all of it came with a period of intense change for our people. Maybe those are some of the things that I think I pride myself on the most is navigating a period of fantastic growth, but equally embracing our people, making sure we're thinking about careers and growth and the human side of leadership. I’m excited to bring as much of that as I can to the process. In terms of other boards, Twilio was a great learning ride for me over the last six years, and I think it's given me an interesting unique lens into the business. But that lens will shift as I move into this new operating role. Lastly, I’d say I think board work in general, I do still sit on a number of other private boards. I think that board work in general just keeps me in the mix, hearing from other boards, other investors, other leadership teams, building other products that I think are both interesting as opportunities to learn from. So I’m excited about that. I'm excited to continue to do that work and bring the best set of learnings into Twilio, but also vice versa, I hope to still be a mouthpiece in the industry as I learn here from all of the wonderful talent that will be around me here in this building virtually.

Your next question comes from the line of Frank Havemeyer with Macquarie.

I wanted to start by asking about the recent executive changes at Twilio. I've noticed you've made some significant hires related to privacy and trust. Can you explain how important privacy and trust are to Twilio as you expand globally and navigate the trust-based environment of 10DLC policies?

Yes.

Go ahead, Jeff.

Fred, this is Jeff. I'll respond to that. Privacy and trust are some of the most crucial concepts of our time, and it's essential for companies to invest in these areas to gain the confidence of their customers. When I think about privacy specifically, we've discussed how it's influencing the way businesses acquire, serve, and foster relationships with customers. The privacy landscape is transforming revenue streams for advertising firms, and we're seeing evidence of that in earnings reports. The approach companies take to build their customer bases is evolving. Every time I visit a website, I'm prompted to decide whether I want to share my personal information. This environment is altering how companies interact with their customers; it's not solely dictated by the government. Consumers desire a reality in which their privacy is honored. Companies are actively seeking ways to adapt to these changes for success. At Twilio, we are not only addressing this for our own customers and employees but also developing products to aid our customers in navigating this transition, such as Segment. Segment enhances companies' understanding of their customers, eliminating reliance on third-party data and cookies. This shift is one of the most significant developments since the Internet started serving businesses. It's crucial for Twilio to navigate this change effectively and to assist our customers in doing the same. Amy will lead the team tasked with managing this intricate compliance and privacy regulations amid the vast changes in how the Internet operates.

And now I suppose it'd be the analysts round up with the M&A question, but you have solid positioning on your balance sheet. Just wanted to ask with valuations having compressed in this market, generally, how is Twilio thinking about its M&A appetite? And then as a kind of related question, could you give any update on where or how the Syniverse relationship is progressing?

Fred, this is Khozema. Let me take the second part first. In terms of Syniverse, subject to the closing conditions of the agreement, we do anticipate closing that transaction by the end of May. I think that's probably what you're getting at. The relationship with that organization remains great, and we think that will be an important part of how we go forward certainly in the messaging business. Relative to M&A more broadly, you’re right that we do have a very strong balance sheet. We're certainly going to remain opportunistic. We look and evaluate different opportunities all the time and maintain a game board. I think if something comes along and we feel like it's a good fit we will certainly take a look, but there's nothing necessarily imminent planned at this time. And that's really all that I can say about it.

Your next question comes from the line of Matt Stotler with William Blair.

I guess just one. Kind of looking at your application services, specifically Flex and Segment. It seems like we're setting up for a pretty interesting year for Flex in terms of opportunities, right? Obviously, it's been growing quickly. But it seems like we're in a particularly advantageous position right now. So I’d like to maybe get some color or just expand thoughts on how that pipeline is developing. Any thoughts on kind of the year for that? Obviously, I'm not asking for product guidance but more qualitative. And then in terms of how it relates to the CDP, what kind of interest you're seeing in bundling there? If the addition of Segment is kind of having a pull-through effect as you’re looking at the ramp of Flex over the course of this year.

Thank you, Matt. This is Jeff. I'm happy to respond to the question. We are very enthusiastic about the ongoing progress with Flex. We're experiencing strong traction with our customers, particularly those we highlight during our earnings calls. You can see a diverse array of companies across various industries and sizes, ranging from digital innovators to large Fortune 500 and Fortune 100 legacy businesses. We've built a solid customer base adopting Flex. Many companies have informed us that traditional solutions do not offer the flexibility or channels necessary to meet customer demands in today’s digital environment. This is why we are optimistic about the interest we've garnered with Flex and the opportunities that lie ahead. We're seeing new customers like Compass adopting Flex for the first time, as well as existing customers, such as a Global 2000 financial services firm and a Global 2000 automaker, expanding their use cases. This reinforces the strong traction we are experiencing. We believe we are only beginning to explore the potential within our partner ecosystem. We’ve mentioned the partners we've engaged to enhance our go-to-market strategy and penetrate various verticals and market segments. We are excited about the market we are targeting and the incredible opportunity for our partner ecosystem and direct customers. It’s great to see a mix of digital disruptors, enterprises, and everything in between around the globe utilizing Twilio and Flex specifically. These trends suggest that we are addressing a broad market need, with a strong roster of customers validating our approach. That’s our perspective.

Your next question comes from the line of Taylor McGinnis with UBS.

Regarding gross margin, can you provide insight into the recent sequential increase in Q1? Specifically, how much of this was influenced by a recovery in domestic growth compared to the growth of high-margin segments? Additionally, as we look ahead, based on current observations, what are your thoughts on the relationship between messaging and customer engagement in revenue? How might this evolve considering the challenging comparisons in Q2 and the easier comparisons later in the year, and how could this impact your expectations for gross margins?

Yes. Taylor, this is Khozema. A couple of questions in there, so let me just try to unpack it a bit. In terms of just the comp set for Q2 and then the second half of the year, I mean, I was really alluding to the business in total, not any specific pieces, Q2 relative to last year. Last year was a 50% organic growth quarter. And therefore, that’s why we guide the way that we did for Q2 this year, whereas the second half of next year provides a more favorable setup for the back half of this year. We continue to feel great about our 30% plus guidance for the year. In terms of the margins themselves that are kind of underneath that, looking at sequential Q4 to Q1, obviously, we’re happy with what inspired. But in our business, just given the relative size of messaging, most things are driven by various fluctuations in the way that different accounts are behaving in that part of the business regarding their margins. Therefore, the mix of messaging tends to drive the mix of Twilio more broadly. As I alluded to earlier, we're comfortable with the gross margins of that business. We love the gross profit that it throws off. We reinvest those profits back into the business. Probably most importantly is that messaging provides a very interesting entry point for us into customers. We just make sure those deals hurdle in a meaningful way that the margins they provide are not just accretive but also have real strategic relationships. In terms of the software components of the business, as I said, we still feel really good about Segment. You heard Jeff's comments a moment ago about Flex and the excitement we have around that product. That part of the business and other application services continue to grow at elevated rates that do carry higher gross margins, as you said. As we go over time, we feel great about our longer-term gross margin guidance of 60% plus. It’ll take some time, given the size of messaging, but we do anticipate that mix shift to happen over time. We gave you some indication of that in our disclosures in the prior quarter.

Your next question comes from the line of Ryan MacWilliams with Barclays.

So we heard from some customers that there could be a price increase this month on Twilio U.S. SMS. If this is the case, like this looks like the first price increase in recent memory in the U.S. How should we think about maybe the thought process behind that, if that's true? And maybe what this can mean for U.S. revenue growth?

I didn't hear the last part of your question, Ryan. What could it mean for what?

U.S. revenue growth?

Yes, yes. It is true. We did update SMS pricing in both the U.S. and Canada to reflect our underlying costs as well as continuous improvements to our infrastructure and software to provide trusted and reliable global messaging. The price changes that we put through will take effect on the 11th of May. It doesn't affect our customers who were locked into a fixed price, and we don't necessarily expect a material impact on our results in the short term. We’re still evaluating if additional price increases make sense in other products, but we obviously are in an inflationary environment. It made sense to us given the value that we offer to customers, the technology and just the current environment.

I just follow up really quickly. Just on the first quarter revenue line. The $10 million beat to the high end of your guidance revenue, is this kind of in line with your commentary on what you were thinking last quarter about like a new guidance philosophy going forward around guidance?

Yes, pretty much. I mean, as we mentioned, we did refine our guidance approach. We wanted to provide guidance more consistent to actual to just give investors a better approximation of where things are headed, and that's basically the way that Q1 played out.

Your next question comes from the line of Alex Zukin with Wolfe Research.

I want to follow up on pricing first. So if we think about it, was this driven more by kind of the inflationary environment? If you think about it, is there an opportunity to do this globally? Is there a way to tie this to a more strategic interaction with the customer around the application services? Just walk through is pricing a strategic lever here or was this more of a one-time kind of adjustment that you haven't really exercised over the course of the company's life?

Yes, I think it's a lever. However, I wouldn’t say we have grand plans to implement it globally or across all our products. We're still assessing such options. To give some context, we have previously implemented price increases, particularly in the email business, and even in SMS before, although it's been a while. Other areas, especially Segment, have seen similar adjustments. This isn't something we haven't considered or done before at Twilio. I want to clarify that. We are currently observing sufficient inflation in the market, driven by our variable costs as well as labor inflation, which made it appropriate to introduce a price increase. Although these adjustments will take effect on the 11th, many customers are still tied to fixed-price contracts. I don't expect this to have a significant impact in the short term, but we will continue to evaluate as the year progresses and see how things develop.

Perfect. And then, I guess, with respect to the second half, you called out the more favorable comparables from the prior year. This maybe goes back to Kash's question about just the macro environment. Is there any adjustment or anything you're doing in your models at all to take into account any impacts from Europe or revenue in Russia and Ukraine? Are there any verticals that you're starting to see where use cases bouncing back stronger than others?

Okay. There's a lot there. Let me take them one at a time. On Russia, Ukraine, I wouldn't say there has been really much of an impact at all. Volume in that region is a pretty small piece of our global traffic, and we haven't seen a material impact in our business to date. What I can tell you is that for any new business in Russia, we've suspended doing any. To the extent that we had any traffic with state-owned customers, we've terminated that. We’ve seen a little bit around the fringes with some isolated customers who might pause their traffic to Russia. But it's a pretty de minimis impact on our business. Yes, we have modeled it to the extent that it would even impact us. In terms of broader macro, we’re watching all the same factors that you all do. I think what I would go back to is that what we’re finding based on our conversations with customers, what we’re seeing in our revenue line, what we’re seeing in some research and what others have done is that digital transformation continues to remain a top boardroom priority. We see that as a very secular trend, not one that’s cyclical. That continues to happen over a long period of time, we feel like there’s a lot of tailwind here for Twilio. Of course, there are economic factors, geopolitics, supply chain, labor, etc., but all that stuff is largely built into our models. Our 30% plus growth confidence as well as being profitable next year has a lot of those impacts baked in, and we obviously have a strong balance sheet as well. I’d say there's one other part of your question Alex, I can't remember that.

The verticals that are coming back are stronger than others?

Yes. What we saw transpiring going into the pandemic, obviously, ride-sharing, travel, hospitality were significantly impacted. Based on reports you've seen recently, those industries are coming back pretty nicely. Obviously, that drives some additional volume for us. I think the thing to bear in mind is that we’re very, very diversified now in terms of our customer base. No one industry necessarily drives an outsized impact on our revenue line. The things we saw during COVID that we expect to be quite durable are, for example, e-commerce, health care, financial services. A lot of the use cases in those categories became elevated. Our customers in those verticals now that they've gone down the path of digital transformation and have seen significant ROI want to keep going. We’ve just gotten started with those verticals, and I think there's a lot more that now Elena and her team are going to be able to do in helping customers solve their different problems in those areas. We stand ready to do that with them. A bit of tailwind in some of those industries and then a bit of tailwind in those that I referenced earlier that were down in the early part of COVID.

I think with that, we're going to wrap it up as far as questions and answers. Thank you, everybody, who joined the call. Certainly, the IR team is available subsequently, and we welcome your questions afterward. Thank you very much, and we'll talk to you soon. Thank you for attending today's conference call. You may now disconnect.