Twilio Inc Q4 FY2022 Earnings Call

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

Thanks, Emma. Good afternoon, everyone, and thank you for joining us for Twilio's fourth quarter 2022 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; Elena Donio, President of Revenue; Khozema Shipchandler, COO; and Aidan Viggiano, SVP of FP&A. As announced in our Q4 earnings press release, Elena, Khozema, and Aidan will be transitioning into their new Twilio roles effective March 1. As a reminder, some of our commentary today will include non-GAAP financial measures and key metrics. Reconciliations between our GAAP and non-GAAP results and further information related to guidance, definitions, and key metrics can be found in our earnings press release and the appendix of our prepared remarks, both of which can be found on our IR website. The information provided and discussed today also will include forward-looking statements, including statements about our future outlook and goals. These forward-looking statements are subject to known and unknown risks, uncertainties, assumptions, and other factors that are described in more detail in our most recent periodic reports filed with the SEC, including our most recent report on Form 10-Q and subsequent reports on Form 10-K or Form 10-Q and any amendments to any of the foregoing and are available on our website at sec.gov. Forward-looking statements represent our beliefs and assumptions only as of the date such statements are made. Actual results may vary significantly, and we expressly assume no obligation to update any forward-looking statement except as required by law. With that, I'll hand it over to Jeff for some opening remarks, then we'll open up the call for Q&A.

Thanks, Bryan, and thank you all for joining us today. As you may have seen, we've made a number of significant changes to our business that we believe set Twilio up to perform in both the short, medium, and long term. As I mentioned in my prepared remarks, we are confident that this is the right set of actions and the right path forward for our customers, for our teams and that will enable us to create more value for our shareholders. And I'm sure you have questions, so let's hop right into it.

Great. Thanks. I appreciate it. Maybe a couple of questions for me. Just maybe to start, I know at the Analyst Day, you guys have talked about a lot of changes that you were making to kind of the data and application sales force and just the driver to growth that would be in the future? And just as you have gone through the process of splitting the business units, just where do you think you are on some of those initiatives? And I guess, kind of as a second question to that, where do you feel like there are synergies or dissynergies from kind of splitting the segments as far as kind of getting customers to go from communications customers to kind of those data and applications customers? Thanks.

Thank you for the question. I’ll address the points you've raised and then hand it over to Jeff for additional insights. The first question was about our data and applications business, its current growth state, and our ongoing transformation. In previous quarters, I mentioned our investments and growth in this area, as well as some challenges we faced at the beginning of last year. We feel significantly more optimistic about that business and its trajectory now. We believe that separating our sales forces into distinct business units will further enhance and accelerate our growth. Although revenue growth follows bookings, we are pleased with the performance of our data and applications business in the fourth quarter and are confident in a reacceleration. I've previously discussed the necessary hiring, onboarding, and equipping of new representatives. We are satisfied with our progress in building capable teams, utilizing both internal transfers and external hires with the right expertise. While we continue to encounter some macroeconomic challenges, such as longer sales cycles and delays in decision-making, we remain confident in our controllable factors. We are proud of our investments and our outlook moving forward. We still believe that the separation into two business units does not change the value of working together; our products complement each other well. However, we have recognized that a clear sales focus addressing the unique needs of each buyer is essential.

Thank you, Elena. The second part of your question pertains to synergies and dissynergies. Here's our perspective. Each customer approaching us for communication has a specific use case in mind for engaging with their own customers. They may need voice solutions for a contact center, messaging for identity verification or two-way customer interactions, or email for marketing purposes. These use cases are quite defined and often group together. This gives us the chance to ask customers what they aim to achieve using our platform and to suggest other parts of our offerings that could help them reach their goals more effectively, or even at a lower cost. Our applications provide value by directly addressing customer needs through the communication channels we employ to deliver messages. I believe this is how we will succeed in this space over time, by understanding why customers are sending these messages and communicating with their own clients, alongside providing the messaging infrastructure. It may seem that our two-business unit structure complicates the integration of these areas, and it can feel that way from an experiential standpoint. However, we've learned that lumping everything under a single sales rep does not work effectively. Our current focus is on the distinct needs of different buyers, emphasizing specialization and attention to detail. Simultaneously, we will foster collaboration and leverage our data and insights to discover opportunities that encourage cross-team cooperation, enabling us to identify which customers require specific use cases, making them ideal clients for our applications and data solutions.

Great. Thank you.

Hi, thank you so much and congratulations to all the new folks who have been promoted. My first question is regarding the $250 million to $350 million non-GAAP operating profit that you expect this year. Should we assume that all of that is being generated by the Communications business? Or perhaps more than 100% of that, if we were to assume that the data and applications business is unprofitable this year?

Hi, Mark, this is Khozema. I'll take that question. It's really the latter part of what you said. It's more than 100%, and that's kind of intentional on our part. We do think that we can be very efficient in the way that we bring the communications business to market and that it can generate a lot of profitability, while at the same time, the data and applications business, they're in the middle of an investment cycle, and we're early stages in that. And so, we do think it's appropriate so long as we're making judicious investments to be able to grow the top line of that business.

Okay. Understood. And then as a follow-up, I looked at the prepared remarks, and it says that some of the macro headwinds that you had mentioned still persist. So, I'm wondering if you could just clarify whether the buyer behavior feels any better out there. I mean, in terms of the bookings cadence in recent months? Or would you say that, that is still continuing to degrade somehow?

It's Elena. I'll take that one. Those factors are still present. I wouldn't say everything has been cleared from the system, but we are improving in how we manage the situation. We are comfortable with our Q4 bookings in our data and application segment. We believe our products are crucial during challenging economic periods, and we are doing our best to navigate those challenges in the market. We've refined our messaging to clearly communicate why it's essential to allocate budget to these products right now. We feel that our message is resonating. However, from an economic standpoint, I don't believe we've fully overcome the difficulties yet. I'll pass it to Kho for further comments.

Mark, just one other thing I wanted to add is that importantly, we do intend to drive profitability through whatever the cycle ends up being. We provided a relatively large range on the non-GAAP operating profit in light of the current macro conditions, which are pretty dynamic, but we do think we can be profitable through whatever the cycle is, and we intend to be.

Good afternoon. Thank you for taking my question. I would like to follow up on the operating income guidance since it indeed stands out compared to expectations. Can you provide any insights on what would lead to an operating income of $250 million versus $350 million? Also, how should we view gross margin in relation to that discussion and the potential growth scenarios that could account for the difference?

Yes, a lot there, Michael. So, let me just try to unpack it a little bit. So, in terms of, I think the way that we planned for it, is that irrespective of kind of the gross margin outcomes, we're going to be able to deliver operating profitability within that range. I think the difference will be basically that if revenue kind of performs in line or kind of within a range of our expectations, then we'll be at the higher end of the range. And if it doesn't, then we'll be at the lower end of the range. Given how dynamic the macro is, we did want to provide a little bit of a cushion. We wanted to kind of plan and run the place a bit more conservatively in light of things that we've seen. Certainly, a lot of companies have reported similar. But irrespective, we'll be profitable, but that's kind of the color behind why that range. In terms of gross margins, as I said, I don't think that they'll really have an impact on the way that this plays out. We're really trying to orient the business much more towards gross profit generation.

Very helpful. It's a substantial answer to a substantial question. Just a quick follow-up, if I may. On the expansion rates, we're seeing compression in a number of different vendors across software. Can you just walk through what's driving the expansion rate headwinds you're seeing currently and how that informs the 1Q guide? Thank you.

Yes. I think the expansion rate basically kind of follows some of the revenue growth rate deceleration that you've seen. One of the things about our business is that as macroeconomic factors kind of take the economy and other businesses down, given the usage-based nature of our business, we tend to feel those a little bit more acutely. Kind of in the same way that we felt them a bit more acutely on the way up, right? If you kind of go back a couple of cycles or even the most recent cycle to COVID, we turned up very, very quickly as different macro factors kind of pulled markets up. And so, I think we're starting to see that come down a little bit. In terms of the Q1 guide, I mean, we still feel quite good about our ability to generate revenue growth in spite of a very difficult macroeconomic environment on a year-on-year basis, and we'll just continue to monitor it.

This is Param Singh on for Ittai Kidron. So firstly, I want to understand what are the areas within communications you were able to cut back on overhead? Was it because of excessive hiring in '21? And how much of that cutback are, you would say, some international, which has a significantly lower gross margin profile?

I don't think we entirely heard your question. So, I'm just going to try to play it back for a second. What I understood the question is being that in what areas were we able to cut back in the communications business? And what proportion of that was international relative to other markets? Is that right?

Yes. That was the main point, but I also wanted to know if the changes were due to over-hiring in 2021 in communications leading to a return to more normalized levels, or if there are other aspects of streamlining the communications business that were previously unrecognized. I'm looking to understand the factors behind the restructuring we announced since September.

Yes. I mean, I guess what I would say is that there's a couple of parts to it. So, if you go back to the fall and the restructuring that we did at that time, I would call that like kind of more cost cutting. Obviously, it had the unfortunate impact of us having to part ways with about 11% of our workforce at the time. And that obviously is something that we feel bad about, but that was more kind of in the cost-cutting vein. And I would say this time around, it was more a restructuring around two different businesses that we think can drive better outcomes, both for our customers as well as our shareholders just given the different buying cycles that have economic aspects of the two different businesses. In terms of where the costs came from, I would say it was pretty much across the board. Like I wouldn't necessarily point out that it was heavier international necessarily relative to the way that it played out domestically. A lot of our roles are kind of global facing.

Absolutely. Thank you for that. And then if I could really quick. I want to understand the level of investments you're making in software, considering this past quarter is only 22% growth and I just want to understand the impact of your operating headwind that you're going to have in the near term while you build this business to hopefully $1 billion-plus business.

Yes. I mean, we're not going to break out that number specifically. What we did do is say in our prepared remarks that we're guiding in the current year to about $250 million to $350 million of non-GAAP operating profit. Offsetting that or included in that number is about $150 million of incremental OpEx. And there's two dimensions of that, that we specifically broke out. One was an increase in the way that we're going to compensate employees vis-a-vis bonuses to help us offset some stock-based compensation headwinds that we've seen over the last few years that would otherwise continue. And then the balance of that will really be predominantly investments in Segment and Flex. We think those are smart investments because we think those can accelerate the growth of those products.

Hi. Thanks so much for taking my question. So, lots of great incremental color on the call. But one area that you didn't discuss was the 15% to 25% revenue outlook you provided at the Analyst Day. I would imagine here, given some of the changes that, that outlook might be a little bit stale. But any color you could provide on how you're thinking about the revenue potential now? And then as a second part to that question, just looking at the 1Q guide, could you maybe talk a little bit more about what's embedded in that rev guide? And particularly how it might relate to some of the changes you made in any risk of disruption?

Taylor, this is Khozema. I'll take that question. So, the 15% to 25% is really a medium-term guide. We both provided a revenue guide on the overall business of 15% to 25% in the medium term, which we labeled as three to five years during our Investor Day as well as 30% plus in the software business. And those aren't changed. Beyond that, what we have said a few times now is that just given the dynamicism in the macro environment, that we're going to continue guiding quarter-to-quarter on the top line for now until we see the macroeconomic picture kind of clear up. We haven't seen that play out really. In fact, we've seen it kind of get a little bit more rocky over the last couple of months. And so, we just want to be smart about the way that we guide things. I think that the 14% to 15% that we called out in Q1 is kind of reflective of that. It is a tougher macroeconomic environment. I think in spite of that, we're going to be able to put up pretty good growth numbers on a year-on-year basis. But I think it's basically macro signals that we're seeing that are kind of making us think about the business in light of a number of different things that could play out, and it just seems prudent to us to kind of plan and run the business conservatively in light of that. Yes. I mean, I guess the way that I would say it is that you got a couple of factors in the mix. So, first is that we gave you $250 million to $350 million in the current year. That gives you some sense of kind of how we're anchoring 2023 to give us a base off of which to grow. As we look out over the next several years, we're obviously taking into account our medium-term revenue guide with some appreciation in software, given that we've called that at 30% plus. And so, if you kind of run the math out over the next several years and assume a few different things around gross margins and the gross profit dollars that each of those two businesses will kick out, that kind of gives us a sense of how profitable a business that this can become. And then I think some discipline on the OpEx side, which I think we've shown over the last couple of periods and certainly the most recent actions, really give us a sense of just how simplified and efficient we can run the business, that kind of gives us the confidence to say, as we look out, we can drive additional op margin accretion, which ultimately will yield GAAP profitability in 2027.

Great. Thanks guys. Just a follow-up on the prior question. Just given how significant of a level of restructuring you guys have done and you look at sort of the 1Q guide, how much of the headwind to growth is coming from the restructuring and having less quota-carrying reps versus some of these macro factors and the shift of focus to data and applications?

Yes. Nick, this is Khozema. I'll take that one. Not much, to be honest. I mean, the reality is, is that in the short term, there may be some impact, so I don't want to suggest that they're going to be zero. But I think, by and large, the Q1 guide is not informed by some of the restructuring actions, either that we undertook in the last half of last year nor the ones that we took just a few days ago.

I'm going to add one bit of context to that, if you will. So, this is Jeff. I want to underscore something that was said earlier that I think bears repeating, which is that we have a usage-based pricing model. And in a usage-based pricing model, we see an accelerated headwind in a macro environment like this. And I think that's what you're seeing in our recent results and in our guidance. What we're not seeing, though, is a real change in, for example, our competitive situation, right? I think what you're seeing is a representation of just consumer activity and the general economic activity being slightly muted during this period of time. But I think this also can play to our strength as you see economic recovery occur because that can be an accelerated tailwind for us as well. And that's also the nature of a usage-based pricing model. As we mentioned earlier, like we saw in the early days of the pandemic when people were using our product for many new use cases. And so, I think we are an accelerated view into the macro economy based on the usage-based model. And as we do move towards the economic recovery, I think you'll see a company that is in a really good position because we are more streamlined. We are more focused. And we've got a great customer base to enable us to see the tailwind from that recovery, including the business model. And I just think it's worth again pointing out the nature of the usage model, which is, generally speaking, a great benefit to us during these times, feels like a little bit of a headwind for us. But I think in the long term, it's still the right model.

Great. And then just as a follow-up. Earlier, you had said that the $250 million to $350 million operating profit outlook does not embed any gross margin expansion on the communications side of the business. But now that you're sort of managing the business in two separate units, can you maybe just walk us through the margin implications for the communications side? I mean, would you guys ever sort of disclose that business unit as a separate entity in reporting? Do you have plans to pay a little bit more attention to the gross margin profile there and maybe be a little bit more disciplined on discounting on that part of the business?

Yes, there are a couple of points to address. First, we're disciplined in how we price the product, and I feel confident about our pricing mechanisms. The unit economics are quite strong, whether for domestic or international markets, and we generally set our prices higher than our competitors. As Jeff mentioned earlier, we're not losing market share, so we are very satisfied with our pricing strategy and, more importantly, the value our customers receive from our product. Regarding the disclosures, which is another aspect of your question, we committed during our Investor Day to enhance transparency concerning what we now refer to as communications, as well as our data and applications businesses. We will continue to provide this transparency as we have done in the current quarter.

Hi, thank you. I have a question for Jeff and Khozema. It's great to see you returning to the focus on the product-led growth narrative. With this shift back from a sales-led approach to a more product-oriented strategy, should we expect any changes in the quarterly revenue patterns within the Communications segment compared to previous years? Additionally, since you're guiding for fiscal '23 on non-GAAP operating profitability, should we consider revenue less crucial as a key metric for the company, focusing instead on how it affects your operating margin and profitability outlook?

Fred, this is Jeff. I'll address the first part of your question, and then I'll pass it to Kho for the second part. Regarding your question, I believe you're inquiring about how our shift to a product-led growth strategy will impact revenue. The goal is that once we acquire a customer, a significant portion of the growth in that account stems from their expansion in the market. This involves taking something they've developed from prototype testing to beta testing, followed by a full rollout to their entire customer base, which in turn leads to the growth of their business and customer base. And so really, it's about getting that kind of design win. And that's where developers are often very influential in the life cycle of adopting some of these communications products. And so, by moving back towards more product-led growth, what I think you're seeing is we're going to be investing in the things that make those developers and the companies that are in the early stages of adopting Twilio really successful in onboarding. And I think we see a lot of opportunities to go streamline the product, make it easier to get up and running, but also to scale these products as customers scale globally. And the product can do a lot more heavy lifting in areas where I think we've relied on people to actually help our customers over the line in recent periods. And you're right, this is a return to the roots of Twilio, which is to make the product enable our customers to find success quickly and easily with a really powerful product. And so, that's what we're focused on. So, I think it will help us enable bringing on new customers as well as continuing to scale our existing customers in a way that customers will actually appreciate because it's going to be easier and faster for them to do so.

Fred, in terms of the second part of the question, I guess the way that I would think about it is just maybe take a step back and then I'll drill down for a second, is that one of the things that we thought a lot about as a company and as a management team is, is that we've become a really big business, but we also want to become a really profitable business. And so, paired with becoming a large revenue generator, we also wanted to make sure that, that revenue threw off a lot of profit. And so that's why you've seen some of the restructuring that we've done into these two business units. We do think we have an opportunity to better focus in that way and generate a lot more profitability, for example, in the communications business while fueling what we believe can be a tremendous amount of future growth in the Data and Applications business. With that said, we certainly haven't given up on growth in the communications business. We still think there's a ton more growth for us to go get. What's fortunate for us is that we're operating in end markets that are still growing at very, very rapid rates. Our share is maintaining. And if anything, the pie is growing. And so that kind of bodes well in terms of a great growth setup going forward.

Okay. Great. A couple of questions. Let me start, I guess, on the Communications segment. I'm just trying to think through go-to-market and potential impacts to growth there. I think you suggested earlier you didn't expect limited growth, but a little bit of an impact. I'm just trying to understand, just given the magnitude of the changes taking place there, how you get comfort that there's not a more meaningful impact to revenue growth? And any framework you could maybe provide around what you expect for growth in that Communications segment, whether this year or next couple of years?

I'll address that. In my previous role focusing on go-to-market strategies, it's Elena speaking, and Khozema can add anything if needed. I acknowledge the concern. We have indeed implemented significant cost reductions. There are a couple of important aspects to consider that we've begun discussing over the past few quarters. It was essential for us to demand more from our products, tools, and processes as we evaluate the appropriate go-to-market strategy for communications. We believe there are significant efficiencies to be realized in this area. We're making progress against all three of those dimensions now and plan to even make more improvement in how we create efficiency across the team going forward by increasing our capabilities in product-led growth and in self-service. I think when you actually really sort of peel the layers back in how we were servicing our customers historically, we had a number of people involved in any kind of customer experience. And we believe we were a bit over-levered there. And that when you kind of get underneath where our efficiency was great and where it wasn't, we think we can provide those fantastic customer experiences and really benefit from our customers' usage of Twilio without having people involved at every stage of the process and really reserving that human capital for the times when our customers really and truly need us.

Thank you.

Great. Thank you. And congratulations on all the progress. Jeff, this is a very big picture. But Twilio has this unusual situation where you have a dual class of stock that collapses to a single class seven years after the IPO. So, in June. And as the founder, I would just love to hear your thoughts and sort of the history on why you guys originally structured it that way. And now that we've hit the milestone, how do you feel about the decision and how things might be going forward?

Yes. Thanks, Pat. I mean, look, all along, we run this business as owners and for the benefit of all of our shareholders. And we're focused on driving attractive growth, lowering OpEx, increasing profitability. And we've extensively engaged with our shareholders over the last several months and over the whole time we've been public. Help inform the actions that we take as management in terms of balancing growth, balancing our customers' needs, our employees' needs, our shareholders' needs. And our goal is to create value for our shareholders, and we believe the strategy that we're executing is going to do that. And when I think about it from the perspective of a newly public company, when we put this in place just prior to our IPO, I think the idea is for a young company to get its feet as a public company. And that's why we thought of it with an expiration that was seven years in the future. Now at that time, that felt like a long ways off. And here we are. I believe that it served its purpose in helping us establish ourselves as a public company. Throughout that period, we were able to engage with our shareholders and make decisions typical for a young public entity. Now, after seven years in the public market, that dynamic is evolving. The scheduled expiration of our dual class structure will not alter how we operate the company. This is my perspective as a founder, CEO, and fiduciary of the company.

Thank you all for joining us today, and we will speak again soon.

Thank you for attending. You may now disconnect.