Twilio Inc. (NYSE:TWLO) Barclays 2022 Global Technology, Media and Telecommunications Conference December 7, 2022 4:20 PM ET

Company Participants

Jeff Lawson - CEO

Conference Call Participants

Ryan MacWilliams - Barclays

Ryan MacWilliams

Okay. Good. We'll get started. Same thing. How about the Eagles, how about those birds. So guys, thanks for joining us today. Ryan MacWilliams, mid-cap Software Analyst here at Barclays. Welcome to Twilio, it's Jeff Lawson, Founder and CEO. Jeff, just had to say we talked about the Eagles, but I'm glad for your Michigan Wolverine…

Jeff Lawson

I know nothing about the NFL, but I'm a Michigan fan, and this is the best year in my recent recollections.

Ryan MacWilliams

I'm a Penn State guy. So -- but I was rooting for you guys, for Ohio State…

Jeff Lawson

Why just you didn’t say Ohio State…

Ryan MacWilliams

Yes, good luck from there. So we'll be taking questions directly from the audience today. But if you do have questions, please e-mail me at ryan.macwilliams@barclays and get those in.

Question-and-Answer Session

Q - Ryan MacWilliams

So Jeff, I want to talk today about the tough macro environment. But I think an interesting story from your early years when you sold some wedding gifts in order to fund their early days in Twilio. How can we think about how it's looking to get back to that scrapping mindset in like the current present situation?

Jeff Lawson

Thanks. Yes. I mean I think that's a lot of what the current situation is about. Being frugal is one of our values. And at times, it's -- you think about frugality versus enterprise software and those things don't tend to think of those two together, right? And so that's been a little bit of a conflict. But for us, let me define what frugality mean, because a lot of people think, I mean don't spend money. Obviously, we need to spend money to make money. But frugality means really focusing on the ROI and making sure that all of your investments are actually worthwhile and being pretty rigorous about that. The example that I gave about frugality to employees from the early days of the company was when we had, I don't know, $100,000 in the bank, we're doing our first run of T-shirts for developers. And we had a choice between Hanes T-shirts, Hanes BCTs or like the American Apparel soft stuff, right? And Hanes costs $3 and the American Apparel cost $9 or whatever, or we did the American Apparel shirts and to me, that was frugal. Why? Those shirts got worn everywhere, every day, developers are asking, can I get another one? I’ve worn mine out. I would rather spend $9 and have something to get a huge ROI out of and $3 like that get sort of the trash.

And so I give that example, which is to say frugality is about measuring the ROI. And to be frank, I think we grew pretty fast. And when you're growing as fast as we were, it is hard to have as much focus on ROI. And so now we've curtailed hiring, you saw that we did a risk back in September. And this is a period of time now where we're getting back to the fundamentals, not just like values and culture and things like that, but actually of the dollars and cents and measuring ROI of all those investments and the ones that don't make sense cutting and the ones that are making sense, we obviously keep doing. And that's the financial discipline that you want. I think we've been good stewards of capital. Historically, I do think the last couple of years, the growth did get pretty accelerated, but now we're really pulling it back and looking at those fundamentals every single day.

Ryan MacWilliams

Yes. I think you've seen definitely a pull forward in some of the growth in the messaging business. And I'm most surprised by the scale, right, in size and the momentum you've seen even as you doubled and tripled volumes there. So what -- about this business, particularly the unit economics make the core SMS business like so compelling?

Jeff Lawson

Yes. We have a communications business. We have a software business, we're building on top of the communications business. And the conversation with investors over the past several years has always been about like the size and scale of the communications business, how sticky that is, the gross margin of it and then the software business, which is how big is that, how fast can we grow it, et cetera. And at our Analyst Day last month, we did open up a bit more about the details of the communications business. And in particular, the conversation with investors over the past two years where we have seen a gross margin decline because of the rapid growth of our messaging business, in particular, our international messaging business. And investors have been concerned at the decline in gross margin. And so what we wanted to do is unpack it a little bit and talk about the unit economics, because the unit economics, we believe, matter here. And it's not an excuse to say we are not focused on building the software business. We are. But the challenge is when you just look at the gross margin of the company and you try to solve for like a monotonically increase in gross margin. In the quarter, where we have a $3.1 billion communications business and a $400 million software business. And the communications business keeps growing.

And so in order to actually kind of predictably say like, yes, every quarter, the gross margin of the company is going to march upward, we would have to say, okay, we're done. We're not selling communications anymore. Like we just have to like zero out the new customers or not allow customers to grow and all that and you're like, well, in what universe does that make sense? Well, it will make sense if we don't make gross profit on those customers, once we want to open up and say like, look, this is a good business. So we opened up the unit economics. Domestically, in the United States, we make about quarter of a penny per message sent, that's the gross profit. Internationally, we make about half of penny per message, twice as much. And importantly, over the last two years, domestically, we've increased that gross profit by 10% and internationally, we've increased it by 25%. So there's been a lot of concern like, if gross margins are declining are you guys -- are your gross profit compressing, are you making less, is competition eating your lunch, like those kinds of questions. We want to show like, no, actually, we make half a penny in every message we send internationally, and that's actually increased by 25% over the last two years. So we don't see a reason to artificially curtail this business.

But what we do need to do, while we continue to grow that, we do need to make that business profitable and grow that profit, get leverage on it, make it more and more and more profitable because it's a scale business and because it is one with a lower gross margin profile, there's even more scrutiny on the profitability of that business, great, like we are going to relentlessly focus on the profitability of the communications business, but we're not going to apologize for like adding yet another international SMS to the mix where we just made another half penny. Like, we think that's fine as long as we do that profitably. Flip side is we're going to put a lot of that growth energy of the company into the software business. And we already have -- we've been doing that for multiple years. $400 million software business is good. We think it can be a lot better. We'd like it to be growing faster. And so we talked about a number of changes that we're making in order to drive an acceleration of the software business while really focusing relentlessly on the profitability and the continued leverage growth of the communications business.

Ryan MacWilliams

Perfect. And I definitely want to get to the software side. But just sticking with the Communications business. I'm more surprised even in your early days how quickly you spread internationally, and how many customers you had and like all the different people in the world that were using Twilio. But from your perspective, like as you try to drive more profit out of that business, right, we're talking about growing in a healthier way, right? What can you do to maybe like more streamlined go-to-market there or just be able to better invest in so far?

Jeff Lawson

You know it's interesting, the roots of the company were really in product-led growth and in a very efficient distribution of our products. And in recent years, we did see an ROI of adding more sales capacity and of growing the sales cost, and so we did. Now I think that what we're looking at now is the way we are getting more efficient is really turning our energy of the company back towards product-led growth for communications. Really -- like, I think we are probably applying sales resources where they may not be needed to get the growth, because I think we see so much demand for the product. I mean you talk to sales reps that flies off the shelf. Like, great. What am I paying you for? Like just to be a little flippant. Obviously, our sales team does a lot of great work with customers. But when you've got a product that is flying off the shelf, really lead on that product-led growth. While the distribution calories in the company are really put towards that software stack, contact center, CDP, our engagement products like those are software products, they're sold to C suite members, and those are more what you traditionally think of as a B2B SaaS sales cycle. Great. Let's put our sales calories more there and lets -- let the Communications business lean on what are really the roots of the company anyway, product led growth, very efficient distribution, and that's the way that we're progressing the go-to-market function of the company. And Elena, our President of Revenue, talked about this transition at our Analyst Day last month.

Ryan MacWilliams

So you guys had price increases this year. And one thing I've thought about a lot is how you have this long tail of customers, right, that rely on Twilio and never think about going anywhere else. But do you think there's an opportunity there to maybe monetize the long tail customers better or improve margins there?

Jeff Lawson

You know I think there is. I think the energy of the company right now is probably more focused on the software selling and pulling the software products through. We've got the leading CDP product in the market, and the market is red hot for CDPs. We've got Flex, the contact center, which, from my perspective, four years in, is doing really well. It's at $100 million basically of ARR and for a SaaS product four years in, I think that's pretty good. I think it can be better. But I'd say the energy of the company is a little more into driving the software growth of the business. I think there are opportunities. I think we can get better. I think when we focused a lot of our energy on making the sales team successful in communications, there were product investments that we forgo because we're investing in actually sales. And I think now with a more product led growth focus, we can put those calories back towards some product improvements that can drive margin from long tail that can do a better job of cross selling the long tail in ways that when we put those calories towards sales, we may not have focused as much on.

Ryan MacWilliams

I think you guys did a great job in your Investor Day about explaining that shift, right, about focus on the go-to-market from communications to software, and how maybe it's better if you kind of separate that go-to-market and have dedicated resources. Can you talk about where we are in that shift and how you think that can really drive growth in the software business?

Jeff Lawson

Yes. Well, I'll talk about why I made the decision to change the go-to-market motion there. Because prior to midyear of this year, we had generalist reps who had everything in the bag and then we had overlay salespeople who could help with expertise in a contact center or the CDP or one of these other areas, but primarily, you had a generalist to own the sales cycle end to end and they had a lot of flexibility in terms of what products they were going to sell into in particular accounts. And the philosophy there is a rational economic engine to close deals and so they will pursue the opportunity inside of each account that makes the most sense for the company to grow revenue, grow the customer base. It's a good philosophy. But the thing it didn't account enough for was that we value software more than we value communications, just to be blunt, right? And our growth and our strategic objectives are in software and we did not torque the incentive plan enough to account for the fact that the communications products were basically flying off the shelf. And so -- and you also look at it, though, and you're like, well, the skills required to sell a contact center and a communications or sell a CDP, there is a lot of training. And there's only so much training a rep can have on different products. And while we did do that enablement and while we did torque the comp plans, we just realized it wasn't enough. We weren't getting the outcome that we wanted.

And so what I decided to do midyear was to, first of all, make some changes in the sales leadership and second of all, was to go to a model where you've got reps who all they can do is sell Flex, the contact center. All they can do is sell segments in Twilio Engage, which is the CDP and our marketing automation platform and then you've got reps who can sell communications. And they can create leads for the others. But the reps who sell Flex and the reps who sell Segment, all they can do is close those numbers, they run those cycles from beginning to end. And we can control the outcome of how much Segment we sell and how much Flex we sell by how many AEs we put into those groups as opposed to the reps having more control over deciding which product they're going to sell to make their number. And that's a big change for the go-to-market and I think it's the right change after we analyze the dynamics that are happening in the field. I mean reps are excited about these products, but then push came to shove, if I've got a number to make and I can make that number with a large SMS deal, maybe I'll just do that and that's the dynamic we're running into.

Ryan MacWilliams

In 2021, we can't say it was a normal year for Twilio, right? All that inbound coming in…

Jeff Lawson

Yes, right. In 2021 was a year of a lot of growth. The pandemic saw a lot of demand for communications and our software products, by the way. But it's just like the messaging products we're selling quickly, the sales cycles are short, the ASPs are high and there's a lot of demand. And if I'm a rep, what am I going to do, right? It makes sense. And we thought we were accounting for that. And one of the things was -- I'm a software developer, right? So when I think about what is core to software world, it's agility, it's the ability to move on the fly, right? Sprint after sprint. And one of the frustrating things I found about sales compensation models is you can't change it on the fly. I kind of wish you could, I go, yes, that's not working. Let's change it next week. No, there's stability in those models. I get it, it is people's compensation and deal cycles take a while. So you can't just torque those things. And so we would continue torquing them year-over-year more towards software and do enablement, and all that kind of stuff, but we just realized it wasn't happening fast enough for our liking. So we made a structural change to saying, look, we have a dedicated team, a dedicated team. And now we can size and we actually move our sales capacity over to these products to continue to grow the capacity to sell them. And that is our mechanism to be able to control the -- and accelerate the growth of software and control that growth, which I think is much better than what we had before. And so that's why I made the decision.

Ryan MacWilliams

Yes. And I think people were surprised to see just 300 upsells of your core communications you've had based into things like Flex or things like Segment. But it also kind of works the opposite. Like if you attach Segment and Flex, you can get usage on the back…

Jeff Lawson

Yes, of course. So that 300 number was just the last couple of quarters. It's not like all time. But the other thing I will say is when you've got a big denominator of almost 300,000 customers, you're like, oh, my god. Well, when do we get to 200,000 contact center customers? I'm like, look, it's not a quantity game for like selling contact center or CDP, it's a quality game. And I look at some of the deals that we have announced on earnings the last few quarters. Fortune 100 insurance company, eight figure contact center deal, 20,000 agents, Fortune 100 retailer, eight figure Flex deal. I mean these are enormous ones. Fortune 100 Bank, these are substantial contact center deals, right? And so when you talk about 300 out of 300,000, you're like, oh my god, what's going on. And I'm like, what matters is that we're selling the right deals, the large deals, strategic deals into the right kind of customers and that's what I see happening.

Ryan MacWilliams

And greater than $10 million CapEx under deal, I mean that was a big take away for me for the Investor Day. I mean as a contact center guy, I can say nothing happens fast there, right…

Jeff Lawson

Yes, right. It takes -- and by the way, the revenue from those deals is basically unrealized because you close the deal, they implement, they go live. So that's not even represented in revenue numbers yet.

Ryan MacWilliams

Yes, and the usage that comes from along that. Just sticking with the Investor Day, I think people were surprised that there weren't targets for next year, they're expecting. And I understand what's the usage based model into a macro. But can you talk through that decision maybe not to provide those? And if there's anything today that's like unexpected about the macro at the back of your business?

Jeff Lawson

You know, we've talked about with the usage based model, there are some industries that have seen usage slow, these are the ones that have seen usage grow, right? And so like a classic trade off that we see in our business is we've got crypto customers, we also have traditional financial services customers. The crypto customers, usage is not looking so good but the financial services customers, usage is looking great. Why? Because in a dynamic market environment, people are checking their stocks a lot more, they're making trades a lot more, they're moving money a lot more, they're worried about this stuff, right? And so there's more usage of traditional financing, less usage of crypto, good for you all. I probably -- or maybe not, maybe you guys are doing crypto. But that's like a classic trade off that we're seeing. Retail, we were seeing a little bit of softness in, in terms of consumer buying. So we have some visibility into that. We've got some impact of the usage patterns.

What we've generally seen, though, is that they often offset each other, right? Because when changes go out in the economy, it's usually not everything is down, it's like some things are down, some things are up. We saw this early in COVID, right? Early in COVID, ridesharing, not looking so hot, right? But then deliveries went through the roof, an offset, right? And so this is what we're seeing in our customer base today. We've talked about it, we talked about now for two quarters, and we'll keep updating investors on the trends that we're seeing sector-by-sector. And I think that just gives us pause like give big bold 12-month guidance when we are in a dynamic economy, it's just that doesn't feel like the right time to start giving longer term guidance, that would seem like we'd fill the IQ test if that was what we did. However, we have definitely heard, I just want to acknowledge this. We've definitely heard the feedback from investors that you want firmer targets on our profitability goals. So I just want to let you know, like we've heard the message and understand why you want more visibility and firmness on that. Like you want a number, not just the greater than zero profitability target. So understand the ask.

Ryan MacWilliams

So during COVID, I think that's a good example of like there are pockets of weakness, pockets of strength, but the overall digital economy search for in that period. I guess that would be helpful for investors now, like you're not seeing anything from the digital economy side of like kind of like the hangover effect from that or like broad weakness there.

Jeff Lawson

What I think we're seeing, investors have asked like, like was this just a pull forward of revenue, but like you're going to see -- and I'm like I don't think that COVID represented a pull forward. Like when I think about digital transformation projects that got accelerated by the pandemic, it's not like those projects go away. We have a usage based model. So once you've built these capabilities, whether it's more e-commerce, more delivery, more herbicide hiccup workflows, more telemedicine, all these kind of stuff. The grand scheme of things is like those use cases, the building of them got accelerated but now they're live. And then people keep building on top of them, right? What's next in these workflows, what's next in these things? And so I don't think the notion of -- like instead of a software sale, where you have a onetime sale, like think about on-prem software. I sold it today, therefore, I can't sell it to that same customer again for five years. In a usage based model, if we pulled forward them implementing a use case, well, great. Now we get that in perpetuity as long as that use case is still running. And now with the foot in the door, we get to go sell the next use case and the next and the next.

And this is where our progress in becoming a more strategic partner of our customers, growing these accounts over the last two years, I think, is really important because, look, we talked about it at our Analyst Day, we've grown the number of customers that spend $1 million or more a year on Twilio. Two years ago, that was about 125 customers. Now it's more than 425 -- or 150 and now it's 425. $5 million or more. That was 17, now it's $65 million. $10 million or more. That was 7. 10 years ago, we had seven customers spending $10 million more. Today, 27 customers, right? So all of these metrics of large customer adoption of Twilio have grown substantially in the last year. And so to me, that's the benefit that the pandemic provided, not that there's benefits to a pandemic. But getting us in front of our customers in a time when building these things was incredibly strategically important.

Ryan MacWilliams

And doubled your penetration within the Global 2000 on time as well…

Jeff Lawson

Yes, and doubled the penetration of Global 2000, but the number of substantial accounts we have has just grown tremendously over the past two years, and that is a great resource. Now in a period of time, you might see a little fluctuations. And Elena did talk about that in the current economy, we are seeing some slowdown in buying cycles in some of the software categories as I think a lot of software companies are seeing. So that's probably not unexpected in an economy and economic environment like this. But at the same time, what we are doing is pivoting our message to those customers of look, Twilio is going to save you money. Like this isn't a luxury item, this is actually a necessity in an environment like this, and we've correlated the use of our products with lowering customer acquisition costs and increasing lifetime value. And we have data point after data point after data point from our customer base to show how using customer data really well with the CDP allows you to actually lower your customer acquisition costs. We have amazing stories, Domino's Pizza, lowered their cost of customer acquisition and increased the return on ad spend. The ROAS went up by 700% after they put in a segment. So those are the stories we're leading with now, right?

Ryan MacWilliams

Yes, that makes a lot of sense. And just look, covering Twilio from a stock perspective for many years, right? It's always like what could political traffic be this year, and then like how bad is the comp the year after, right? But for this quarter, it seemed like there was a decision to step away from the nonopt in political traffic. Can you just kind of like talk about like what went behind that decision?

Jeff Lawson

Absolutely. So I made that decision after the 2020 election. Look, I was a big fan of this use case actually at Twilio for a long time. I saw -- Twilio was board in 2008, a presidential election year, we saw as a younger person, I was very involved in like phone banking and knocking on doors. And it's just like, to me, that's part of democracy. Reaching out to your neighbor and saying, this is what I believe, and like trying to convince people of ways that we can change our society through free and fair election. I mean that's just like fundamental. And when I saw customers starting to use Twilio, first for phone banking in like 2010 and then messaging starting in 2012, I was like, this is a great digital extension of democracy. I'm proud that Twilio being used in this way. Unfortunately, it works too well. And so in 2014 and then in 2016 and then in 2018, every year, the amount of traffic that political campaigns we’re sending with Twilio was growing and growing and growing. And the problem is they got to carve out when the laws were passed like TCPA that said politicians, candidates, they aren't subject to that law, kind of like that's an interesting carve out for you. And then they use that then as the excuse to say, we don't need to get opt in to text messages, we can just buy voter list that have a phone number and just go spray text messages. And unfortunately, the medium works too well, they were getting an ROI in terms of like outcomes, boats, donations, things like that.

And as a customer -- as a consumer, I don't know about you all, my phone is blowing up now every two years, ask me to give money to candidates that are like running for things 4,000 miles from where I live. I'm like, what's going on here. We’re just buying this list. Consumers hate it and carriers have it. So creative friction with our carrier partners. It created friction with consumers. If consumers start saying, you know what, I don't want to text messaging anymore. I'm going to move it all of it like Facebook or WhatsApp or signal or one of those, like, well, that will be net negative for our business, right? And so in some ways we just made this decision that we want to help preserve the integrity of the channel by curtailing this activity, and we want to improve our relationships with our carrier partners. Because like the CEOs of carriers were getting these messages and sending it to their team has been like WTF, make the stop. And then they would just say, well, Twilio come on, and we'd say, the law is what it is, and we're kind of stuck in the middle. And we just said, you know what, we can get out of it. So despite the fact that I was actually proud of this use case for a while after 2020 change for mine and said, look, unless they prove to us that they're getting opt in, that's a different story. If you say I want to engage with this campaign, I want to give money to this cause, I want to do this, like, great." But the idea that you can just spray and pray to try to raise money or to get people to vote, that's not okay. And I think it was the right decision, still a lot of it went on in the recent election, they just switched to some other companies. And I'm kind of like, well, you know what, let those companies now go pick fights with carriers and consumers and all that, while we actually build a better platform as a result.

Ryan MacWilliams

As a [indiscernible] surprise but as a consumer with the PA phone number of Purple States, and I was getting like 10 a day, I was like this makes a whole lot of sense…

Jeff Lawson

And we've actually had an infrastructural later, started to put up more ways to ensure that there's only that good traffic. So that even if someone goes to another vendor, like we've got the exclusive toll free channel in the US. So if you want to use a toll free phone number, you have to go through Twilio. And so we can actually set the rules of engagement there along with our carrier partners. And so I think that corralling this into a more sensible world is a really good idea.

Ryan MacWilliams

It makes sense for the SMS channel on the health of that. Just you've talked -- you're pretty early coming out about SBC and how that was going to change in software. But with $4 billion in cash and cash equivalents on your balance sheet, like any thoughts there about strategic actions you guys can do or maybe help offset some of that dilution. Like how are you thinking about your strategic position here?

Jeff Lawson

Well, look, we raised the money primarily for M&A opportunities. Now I would be -- I think I would fail the IQ test if I didn't say if we went out and did some big M&A activity right now, our investors will be super excited about that, right? So look, I think we're realistic that we've got a lot to chew on. We're still integrating Segment in SendGrid even. And look, this isn't the environment for large M&A. So with that amount of cash, the question is what do you do with it. I think all options are on the table.

Ryan MacWilliams

Excellent. And we'd love to hear about some of your like signs of early momentum around Engage, right? And what are kind of your expectations for that for the next year?

Jeff Lawson

Yes. Well, we just launched the TGA a month and half ago, great early customers already. I was just out yesterday in the field, meeting with a big insurance company talking with them about Engage and Segments. And look, I think that we've got a great product here and the reason why Engage for anyone who doesn't know, Engage is our marketing life-cycle automation product. So basically, it takes in everything a company knows about a customer and designs a customized marketing journey for you using all the real time signals that a company can see about you and then using all the channels that they have to engage with you. Whether that's on the Web site personalization, mobile, text messaging, e-mail, advertising, every channel available brings it all into one tool. And the reason why this is so killer is that it starts with the data. There's been no shortage of software out there in the world that is like let's you design a marketing campaign and hits that. Obviously, that's been around for a long time. But as those solutions get more sophisticated and the buyers get more demanding, what do they need, they need more understanding of the customer. So people try to bolt on like data about customers. And they do these batch, then all we can batch upload your customer data once a week or we can ingest data with an API, but it takes us nine hours to make sense of the data.

And Segment is this real time global Internet scale data ingestion and profile building engine. We have one customer, FOX Sports, who uses a Segment during the Super Bowl to understand those customers. They ingest 1 million events a second for FOX Sports. That's just one example. That's the scale. And then resolve those data points about each one of us, what we're clicking on, what we're viewing when we had paused when we -- whatever and turn that into a profile of us. We likely a sport channel. We are not a sports channel. We should -- we sold an upgrade to be a subscriber for the next 12 months or whatever else. That's the whole goal of taking those data points, turning them into profile insights about each one of us in real time that while I'm still on the site, still in the mobile app, you can take actions to personalize and try to make me a better customer. That's what Segment does. So the actual step of them saying -- and now take an action once you have one of those profiles changed with a new attribute, that's what Engage does.

So Engage is so powerful because it started with the data, right, and a real-time Internet scale data ingestion and profile building engines and then buy an ad, send a text message, send an e-mail, right, do a personalization. That's the easy part. The hard part is adjusting that quantity of data at scale and driving insights from it. That's what we already had solved. And so that's why we're so excited about this product, because we've solved the hard problem. Now, the relatively easy part of like design e-mail and have get triggered, that's what we added with Engage. So really excited to bring this product to market. We'll say it's only six weeks into its GA. So we are still at the very early stages, but I think both our large Segment customer base can drive adoption of Engage because you've already got these customers with the data -- of the data there and the profile is there, so adding the next step is relatively easy. I also think Engage will then draw a lot of Segment purchase. Because you have to have a Segment to use Engage. So it's another vehicle and another buyer to go get to go pull in CDP in the company. So I think it's -- we're heading that from two sides.

Ryan MacWilliams

Yes. And another great product to move into more enterprise customers. right? So guys, we’re over time but appreciate Twilio being here. Jeff, thanks so much.

Jeff Lawson

Absolutely. Thank you. Thanks, everybody.