Hello, and welcome to the Twilio First Quarter 2023 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. I will now turn the conference over to Bryan Vaniman, Senior Vice President, Investor Relations. Please go ahead.

Thanks, Sara. Good afternoon, everyone, and thank you for joining us for Twilio's First Quarter 2023 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, Twilio Data Applications; Khozema Shipchandler, President, Twilio Communications; and Aidan Viggiano, Chief Financial Officer. 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 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 annual report on Form 10-K and our forthcoming quarterly report on Form 10-Q, which are available on our website and 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, and then we'll open the call for Q&A.

Thanks, Bryan. Before we begin, I want to highlight three key points today. First, the significant actions we took in Q1 are proving effective, as demonstrated by our strong non-GAAP operating profit results. After just one quarter, we’re beginning to reveal the profit potential of this business. We are also one quarter into our new structure. As indicated in our Q2 guidance, we anticipate ongoing challenges as we develop the sales capacity of our data and apps business in a challenging macro environment. However, I believe we will maintain and even grow our leadership position in this environment, and I don't foresee any issues such as increased churn or loss of market share. We are observing a moderation in consumer usage patterns and are also comparing against last year's peak crypto usage, which are some of the challenges we’ll address. Throughout all of this, I want to express my gratitude to the Twilio team. We have navigated considerable changes in the past quarter, and I see Twilions approaching these transitions with grace, energy, and a clear sense of the tasks at hand. It’s truly inspiring for me and for our leadership team. This is the magic of Twilio in action. Thank you. Second, I know this is on people's minds. The transition to AI platforms is here. Similar to the shift from PCs to the web and then from the web to mobile, this is the next significant technological evolution in our society. Collaborating with customers, we are discovering numerous ways to utilize customer data in Segment throughout the entire customer life cycle with artificial intelligence. We will share more details on this in the coming quarter and at SIGNAL in August regarding products, partnerships, and customer use cases; I'm really looking forward to it. The third point I wanted to address is that I’m ready to take your questions now.

Thank you. Your first question comes from the line of Mark Murphy with JPMorgan. Please go ahead.

Thank you very much. So, a question for Elena. You mentioned being in a strong position to actually reaccelerate bookings later this year. And Khozema, in their prepared remarks, you're mentioning optimism in being able to reaccelerate growth as the year progresses. I'm wondering if you can just shed a little light on what is underpinning that positive thought process? And could it mean that Q2 might mark a bottom actually for the revenue growth rate or a local bottom for the revenue growth rate?

Hey Mark, it's Elena here. I'll start, and then I'll pass it over to Khozema for some commentary on the communications business. First, let me just kind of walk you through the path to here to provide some context and groundwork for what's to come. First of all, I joined the company a year ago, exactly this week. And at the time, Jeff asked me to sort of rearchitect and rebuild our go-to-market muscle and motion. And what that meant was two things. One, more substantively impact the communications; and one, on the data and application space. So, we realigned, rearchitected our sort of resource map and went through some of the big cost-cutting initiatives that you've seen, and you're starting to see the results of that. And that was primarily around our go-to-market muscle in the comm space. At the same time, we were sort of reinvesting in the data and application space. The job has been to rebuild and grow our talent base there. So, we had some turnover, attrition, and changes in how we set up the sales team, which we unwound and began to rebuild from there. That rebuilding effort has taken us the last few quarters, and we're now fully hired for the most part, but we're not fully ramped. Right now, our big focus is on enablement. It's on getting those reps from their first deal to their test deal and really showing what that team is capable of. Having spent time with our people across the last few weeks, I feel really comfortable about the team that we have in place. That's a big reason for optimism as you've asked. I think, we're seeing evidence of that in a couple of areas. We've talked about things like cycle lengths, average selling prices, conversion rates across the funnel and a bit of contraction. We're definitely seeing all of that, at the same time that we're rebuilding, reengaging and reenergizing a field organization. With all that said, the things that give us real optimism include great customer wins amidst all of this. We had a couple in my prepared remarks, Cricket Wireless, a current Twilio customer, became a Segment engaged customer; and Web Health, a large BPO, becoming a sizable Flex customer. We've had other significant wins in the financial services space across this quarter and last. Our product teams are really delivering a lot of new capabilities from Segment Unify to Flex Unify. The enablement journey is in full swing, and we're seeing exciting customer wins. Those are the things that give me faith that we'll begin to see ourselves climbing out of the trough that I think was in part self-inflicted last year and in part driven by the headwinds in the economy. I'll let Khozema talk about the corollary on the comp side.

Hey, Mark, what I would say is, first of all, I totally echo Elena's enthusiasm about the path ahead here. I think there's a lot to be excited about. Our sales kickoff was at the same time. We kind of did them together. And so there's a lot of energy among the sales rep force. Sales rep productivity remains quite high. As Elena mentioned, we did a lot of work on cost structure. But even in spite of that, I think we feel very, very good about rep productivity. Second, we are maintaining share in what continues to be a tough macro environment. We're very excited about our most recent customer wins. We talked about two deals in the script specifically where they were our largest ever on e-mail and selling network authentication. So I think those are indicators that we’re continuing to win with our customers, albeit at slower rates than where they were. And third, especially as you look at our financials, we have a really tough comp relative to last year. Crypto was really outsized in the way that that part of the impact in our business grew, and we're kind of hitting the peak points as we're lapping that. So, naturally, as we come out of the next couple of quarters, you're going to see some natural acceleration in the growth rate as a result of that. I would hesitate to call it bottom. I think it's dynamic, obviously, and we’re not necessarily prepared to say that, but we're very, very excited about the setup for the back half of the year and our energy with customers.

Wonderful. Thank you so much.

Thanks, Mark.

Your next question comes from the line of Meta Marshall with Morgan Stanley. Please go ahead.

Thank you for the insights. I wanted to ask about the peak crypto anniversary. Could you share which areas are experiencing the most challenges? Additionally, regarding the Communications segment, what does a reduction in marketing budgets imply? Are we cutting back on specific use cases, reducing the number of emails sent, or is it more about fewer transactions? As we consider how to forecast a recovery, I’m curious about how use cases might evolve and what the potential bounce-back could look like. Thank you.

Hi, Meta, this is Aidan. I'll start, and I'll hand it over to Khozema. So just to talk about some of the industry headwinds. We've called some of them out in the past, and we continue to see headwinds persist on the social side, consumer on-demand, e-commerce and in particular, crypto. So those continued in the quarter. As it relates to crypto, as Khozema said, we saw volume peak on our platform kind of in the Q2, Q3 timeframe last year, and that's creating a few hundred basis points headwind year-over-year on the growth. Khozema, I'll hand it over to you.

Yes. I would largely echo what Aidan said. I think as she mentioned, crypto was significant last year. And so as we lap that, I think we feel pretty good about our ability to come out of that. The marketing spend that we referred to was much more on the customer side, not necessarily on our side. Obviously, some of our products serve use cases that are marketing-related. As customer marketing volumes have come down a little bit, frankly, that impacts both sides of our business to a degree. It impacts probably communications a bit more significantly upfront. We talked about the dynamics, and Meta, you know the company really well. On the way up, we react very quickly; on the way down, we react very quickly. As things kind of moderate, I'm optimistic that we'll be able to come out of it pretty fast. Otherwise, it's kind of business as usual. We continue winning, expanding and maintaining our share. We're not seeing any pricing pressure out there either, so we feel pretty good otherwise.

Great. Thanks.

Your next question comes from the line of Michael Turrin with Wells Fargo Securities. Please go ahead.

Hey great, thanks. Appreciate you taking the question. Just on guidance and what's assumed, given there are a number of moving pieces you mentioned in the prepared remarks. Can you just walk through what you're assuming in terms of the macro and what you're seeing in expansion rates? Is this a consistent environment assumed? And also thinking through the progression of some of the go-to-market improvements that you're making, is there a way for us to think about the timeline and progression of where expected benefits from those might start to play through? Thanks.

Yes, I'll start with a bit on the second quarter and then go a little bit into some of the traction for the year. So, it's largely macro as we think about the second quarter. The market continues to be pretty dynamic, and we're feeling the impacts of a broader slowdown. You see that reflected in our guide. The majority of our revenue comes from our communications business, about 85%. As Khozema mentioned, that's a consumption model tied to consumer activity. So in that business, we're dealing with a combination of macro, as well as tough comparisons that we talked about regarding crypto. Again, that's creating a headwind year-over-year as it relates to the second quarter growth rate. On the data and application side, as Elena has also talked about, we are rebuilding...and really enabled the team further. We're also doing that in a tougher macro cycle. So, on the communications side, it's a combination of macro combined with tough comparisons in software. We've factored all of this into our guide. Beginning with some choppiness on growth in the short term, we’re focused on delivering profit in any environment.

Appreciate the detailed answer. Thank you.

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

Thanks for taking the question. Just one housekeeping piece. How much essentially is the potential sale of your IoT business possibly impacting the second quarter guidance? Are there any products or geographies where you're currently deemphasizing revenue as part of these go-to-market changes? Thanks.

So as it relates to the sale of our IoT business, it's a relatively small contributor on revenue in kind of the mid to high single-digit millions. We'll provide more information as we go forward. It will be adjusted out of our organic calculations in the future, so you'll get an apples-to-apples comparison on revenue growth, but it's a relatively small contributor overall. As it relates to any specific regions, we have no plans to deemphasize revenue in certain geographies.

Your next question comes from the line of Ittai Kidron with Oppenheimer & Company. Please go ahead.

Thanks. My question is for Elena. I was wondering if you can kind of delve into the data and application business. More specifically, when you look at the growth of the unit this quarter, help us understand what products are growing faster versus below the average segment Engage Flex marketing. Which ones are growing faster than the 19% you delivered versus lower? And then since we don't have the historical data on this, could you talk about what deteriorated the most over the last two to three quarters? And what part could recover the fastest over the next two to three quarters? Thank you.

Sure. So we don't break out product by product. Just as a reminder, many of these products are new. The Unify product, Engage, like a lot of those things have only been in market for months to a handful of quarters. We're excited about the momentum and progress, but we shouldn't expect them to meaningfully impact the Twilio data and applications business unit’s revenue in the near term. I would reiterate that the real path to reacceleration comes down to two things. First, ensuring that our team is in place and enabled. We're putting a lot of emphasis on that. And second, is playing through the tough macro environment while ensuring customers that even during a time of belt-tightening, this is a valuable investment. That's what we're focusing on right now. But overall, we see themes hitting our Flex and Segment products, and we're working on ramping and building the team to work through these.

When you look into the next quarter guide, is there another significant step-down assumed in this business from a year-over-year growth standpoint? This business was not impacted by crypto. So I'm just trying to understand the drag on the next quarter. How much of that is from the communication business versus the data and applications business?

Hi Ittai, this is Aidan. I'll take that. So, we don't provide guidance by business unit on revenue. But generally, as you think about the second quarter, you can assume that the slower growth is attributable to both businesses. Given the much larger size of communications, it obviously has a bigger impact on our consolidated growth.

Thank you.

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

Yes, hi. Thanks for taking my question. Just looking at the 1Q revenue, the 1Q revenue declined sequentially and the 2Q guidance, I think even if you strip out IoT, assumes something similar. I know you mentioned that there hasn't been much change in churn. So, can you just provide more color on the drivers there? It seems like it might be some seasonality. But if that's the case, as we look throughout the rest of the year, are there any other seasonal patterns to keep in mind?

I'll start here, and if Elena and Khozema want to add, they can. You're right, churn overall has been relatively consistent. Where we are seeing some impact is, we are seeing a bit higher contraction, again, due to lower spending on the part of our customers, which we attribute to the macro environment. On the expansion side, we are seeing that at a lower rate than where we've been historically. Again, we think that's customers being budget-conscious and scrutinizing their spend due to the macro. On the data and application side, we expect to gain traction there over the year as we ramp our sales force, resulting in bookings reaccelerating toward year-end. That gives you color on how to think about revenue for the rest of the year; we'll continue to guide quarter-to-quarter given how dynamic the macro is. We’ve acknowledged we have tough comparisons in the second quarter.

I would add more color on contraction for Twilio Data and Applications. The good news is that, when we see contraction, it is not that we're seeing competitive loss or takeouts. It's primarily customers tightening their belts, cutting back on their marketing spend or reducing transaction usage, for example, on Segment or utilization of Segment. So, we believe the product is extremely valuable; however, seeing a contraction happening that is a newer dynamic over the past few quarters.

Appreciate the extra color. Thanks.

Your next question comes from the line of Derrick Wood with Cowen. Please go ahead.

Great. Thanks. This is for Khozema. One of the questions we had was whether growth in consumption from the base would be impacted by the sales restructuring since you were taking so many reps out of that business. Given the net revenue retention rate down at 106, how much of that pressure is coming from the macro versus how much is kind of the pullback in your own growth investments? And as you look at a few months into your new low-touch structure, what's working well, and what would you like to see some improvements on?

Yeah, that's a good question, Derrick. I would say, in general, I would attribute it almost all to macro. The reduction in investments we made on the sales and marketing side were difficult decisions, but I think, with the hindsight, it was absolutely the right thing to do, and we're seeing benefits of the efficiency. You can see those flow through to the bottom line. In terms of any impact in DB&E and/or overall growth, we're not seeing it right now. I think having reps aligned to specific products tightly aligned to an economic buyer on the other side has been impactful for our business. We've tilted more towards a self-service, product-led, growth-oriented go-to-market motion, and we’re definitely seeing early successes there. There are various aspects of the experience like onboarding, compliance, cross-selling, and making it easier for customers to adopt Twilio, and that has been quite good. We probably shifted toward marketing dollars versus rep-oriented dollars, which worked pretty well. I feel good about where things are heading and I'm cautiously optimistic about where they're going for the back half of the year.

Got it. Thanks for the color.

Thanks.

Your next question comes from the line of Nick Altmann with Scotiabank. Please go ahead.

Yeah. Thanks, guys. Just building on Derrick's question, it sounds like you haven't seen much pressure on the growth side of the equation from the communication side from the headcount reduction and some of the go-to-market changes. And so I'm just wondering, can you maybe parse out for us how significant those changes were on the communication side? Is there any way to give more granularity around what's the split of quota-carrying reps focusing on data apps versus communications? Also, how do you measure that impact and make changes? If the communication side sees further growth deceleration, will you allocate more reps to that side of the business? Just any more granularity around that would be super helpful. Thanks.

Sure. This is Khozema. As we went through the restructuring over the last six to eight months, it largely impacted the communications business. The costs that came out of the business were primarily tied to communications. Conversely, our data and applications team is investing because we see a big opportunity going forward. We're trying to optimize for profit on the communications side while continuing to invest for growth on data applications. We did make reductions in rep count related to communications and retained reps on strategic accounts. We continue to grow our rep count in data and applications. Hopefully, that provides some additional clarity, although I can't specify the exact split of reps.

We looked at the ROI of each cohort of sellers and supporting roles within the go-to-market organization. We took a close look at where we were yielding discontinuous growth and cut out wherever it wasn't. This effort aims to ensure that we inject human capital effectively to achieve returns. This fitness level we've created across go-to-market now in both communications and data and applications should yield significant improvements moving forward.

Despite the changes in communications, we've maintained share, customers are sustained on the platform, we haven’t seen any elevated churn, and we continue winning with significant accounts. Starting off the year with strong profitability is crucial, and now the rest of it is execution.

Great. Thank you.

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

Hi, good evening. Thank you for answering my questions. I wanted to ask about the software aspect of the business. Considering your investments in representation, how should we interpret the booking trends, especially if customers begin to reduce their marketing spending? How is this affecting the flow of leads into the pipeline and what types of discussions are you having? Is there a shift in how customers perceive you beyond just the immediate financial results, which have been influenced by recent changes? I also have a follow-up question.

Great. I'll take that. So we don't disclose our booking metrics, but we have seen headwinds across the board. Of the work we're doing to rebuild, reorient, and specialize the organization, that's still in progress. While we're making strides, we’re attempting to ensure our sales team ramps effectively. We expect to hit that stride in the next couple of quarters, but we're also navigating this during a tough macro period. Your point on marketing spend is key; we need to demonstrate that these investments yield higher returns, especially now. We are seeing headwinds from a macro perspective. Customers adding people to the sales cycle and approval levels elongates these cycles.

Great. And then just a follow-up. There have been talks about Google rolling out something called Passkeys, which limits the need for 2FA and changes the nature of passwords. What do you see as the opportunity for Twilio? I know 2FA has been a revenue driver in the past. How are you thinking about that as authentication evolves over time?

Absolutely, Samad. The way I think about authentication these days is there are typically multiple forms. There's something you know, and there's something you have. Passkeys are evolving the notion of passwords; they’re easier to use and more secure. However, it doesn’t provide an identity component. How do I know who they are? Traditionally, things like an email address or a phone number provide that. That's where our Verify product comes into play. It verifies identity while also giving us the contact information. So these things work well together. Our Verify product is selling very well.

Great, Jeff. That's very helpful. Thank you so much.

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

Hey, guys, this is Alex on for Matt. Thanks for taking my question. I wanted to ask about the partner channel. If you could talk about any updates you might have there, especially with the GSIs and regional SIs. How are you enabling those partners? Do you have any thoughts on expanding partner contributions going forward?

It’s Elena here. We see a crucial role for partners today and going forward. We have a robust ecosystem, particularly on the SI side, involving regional players. We're seeing good performance with the SI community and have a couple of notable partners. We also see positive traction with Segment and partners within the AWS IV Accelerate program, connecting AWS sellers and our sales process. Overall, this is an area of focus and investment for us, and we’re seeing good signs of growth.

Your next question comes from the line of Fred Havemeyer with Macquarie Capital. Please go ahead.

Hi. Thank you. I wanted to ask about some of the segment wins that you were talking about there. Could you talk about perhaps some use cases these companies are using Segment for? Where are those companies finding value right now with Segment?

Segments are super interesting. We discuss B2C, with fantastic brands focused on direct-to-consumer relationships, but we also have a percentage of our Segment customer population that’s B2B. Customers are using Segment to manage channels and customer identities integrating data effectively. They're utilizing Segment for customer data governance, personalization, and tracking customers across multiple acquisitions. This capability becomes especially valuable in M&A cases, enabling effective cross-selling and retention. We see customers adding on capabilities like Engage and our new Unify feature. This sets CDP at the center for powerful functionality across the customer lifecycle.

Thank you. And as a follow-up question, I noticed the top 10 customer accounts now account for about 10% of total revenue. Is that due to diversification of Twilio's revenue base, or is there anything to interpret regarding how your top customers are trending their own usage?

This is Aidan. Yes, it's largely a function of continued diversification. We're well diversified across industries and customers. Lower usage has been observed across the communications and data applications business, primarily due to macro factors, but as it relates to the top ten, it’s mainly continued diversification.

Fred, you asked about segment use cases and it’s worth sharing that customers find multiple benefits from having customer data centralized. For example, a global Fortune 100 shared five use cases with us: personalized tracking across multiple acquisitions, cross-selling capabilities utilizing clean data, and improving customer interactions through service use cases. Segment allows for seamless usability, fostering better customer relationships and marketing effectiveness, indicating its growing importance in the current landscape.

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

Hey, guys, thanks for taking the question. The gross margins in the quarter were better than expected and the best performance since Q1 of last year. Notably, the international didn’t decline as a percentage of total revenue. Can you provide insights into whether there were changes to business that had lower gross margins in the quarter? How should we think about trends going forward?

Yes, so it was 52.3% in the quarter, up sequentially about 170 basis points. It’s largely tied to the mix of products and the mix of geography where traffic terminates. A different mix in traffic termination relative to last quarter drove the improved gross margin. Going forward, we’re orienting the business more towards gross profit dollars rather than gross margin rates because those unit economics are strong, particularly in the messaging biz. As long as we ensure the right cost structure, we're committed to generating gross profit dollars.

Got it. And Jeff, one for you. You touched on AI and generative AI in relation to Segment and CDP. There’s been increased interest in bidirectional messaging and conversational messaging lately. Can you discuss the potential tailwinds to the communications side of the business from generative AI and what you're seeing in customer conversations surrounding this opportunity?

Certainly, Alex. Generative AI marks a major technological shift, reminiscent of the evolution from PC to web, and web to mobile. Customers are trying to define enterprise use cases for these technologies and determine how to maintain relevancy in the customer dialogue. For example, a large financial services company shared insights about their years-long investment into bot technology, highlighting how they were able to achieve a 40% containment rate. While they intend to maintain that investment, they also recognize that generative AI could help them optimize these processes. Our discussions around how to harness large language models alongside Segment’s customer data are quite promising, and we're seeing significant opportunities emerge for businesses that use Twilio to streamline their customer engagement. It's a fascinating intersection of various technologies that enhance business operations. We plan to elaborate more as we move towards SIGNAL in August.

Perfect. Thank you, guys.

Your next question comes from the line of Siti Panigrahi with Mizuho. Please go ahead.

Hey, guys, it's Phil on for Siti. Thanks for taking my question. In your prepared remarks, you noted a Flex win with a major financial services company. Could you elaborate on this win and whether it was sourced through an SI partner? How well is Flex positioned to compete with other CCaaS vendors?

We don’t believe that one was partner sourced. It's a deal we've been working on for a few quarters. This is a legacy takeout and a contact center-specific use case. Flex is performing well across several key use cases. We see direct-to-consumer brands leveraging Flex for in-app digital communication and contextual sales with large retailers and financial institutions. This example resides within the core contact center space.

Okay. Thanks.

Your final question comes from the line of Michael Funk with Bank of America. Please go ahead.

Yeah, thanks for squeezing me in. Two quickly, if I could. Aidan, one for you if I could. The operating margin guidance for Q2 indicated several factors pressuring that sequentially. However, I thought a full quarter of headcount reduction and maybe a positive mix shift would offset other issues you called out. Are there other factors influencing this?

Thanks for the question, Michael. We aimed to be transparent in the prepared remarks, anticipating profit to decline quarter-over-quarter. The first quarter benefited from a $12 million one-time accrual reversal tied to our employee sabbatical program, which won’t repeat in subsequent quarters. We’ve guided to lower quarter-over-quarter revenues, which directly impacts our gross and operating profits. Several cost items will exert pressure on the next quarter. Merit increases will take effect in Q2, and some employees are transitioning from equity-based awards to cash bonus arrangements, creating modest operational expense pressure. We anticipate more normalized spending levels in marketing and travel in Q2 compared to Q1. These elements offset the full quarter benefit derived from our restructuring decisions in February. Still, we’re tracking well and raised the lower end of our guidance for the year.

That’s very helpful color. I appreciate it. Thank you.

This concludes the conference call. Thank you for participating. You may now disconnect your lines.