Q3 2023 Twilio Inc Earnings Call
Good afternoon, and welcome to the Twilio third quarter 2023 earnings conference call.
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After the Speakers' remarks, there will be a question and answer session.
To join the queue for questions. Please press star one.
I would now like to turn the call over to Brian Vitamin S. V. P of Investor Relations. Please go ahead Sir.
Good afternoon, everyone and thank you for joining us for Twilio as third quarter of 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 that Twilio dot com joining.
Joining me today are Jeff Lawson co founder and CEO, because they must ship Chandler President Twilio Communications Native Michigan, Chief Financial Officer.
As a reminder, we will disclose non-GAAP financial measures on this call definitions and reconciliations between our GAAP and non-GAAP results can be found in our earnings release and our prepared remarks posted on our IR website.
We will also make forward looking statements on this call, including statements about our future outlook and goals such statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those described many of those risks and uncertainties are described in our SEC filings, including our most recent Form 10-Q forward looking statements.
Represent our beliefs and assumptions only as of the date such statements are made we disclaim any obligation to update any forward looking statements, except as required by law and with that I'll hand, it over to Jeff and the team will discuss our Q3 results and then we'll open the call for Q&A.
Thank you, Brian and thank you everyone for joining us today <unk> delivered a strong third quarter exceeding our revenue and non-GAAP profitability targets and generating another record quarter of non-GAAP income from operations and free cash flow. All told we delivered 1.03 or $4 billion.
$136 million.
non-GAAP income from operations and $195 million of free cash flow on the back of our strong year to date results, we're raising our full year non-GAAP income from operations guidance to 475 million to $485 million.
As you can see the efficiency gains are rapidly showing in our quarterly results, reflecting the fundamental strength of our communications business, which represented 88% of our revenue in Q3.
Our communications business was recently recognized by Gartner as a leader in the first ever Magic quadrant for sea bass.
Terrific recognition indicative of our attractive market position and the strength of our platform.
We continue to focus on opportunities with our communications go to market motion to win new customers improve our self service capabilities and drive more cross sell opportunities across our customer base. We're also forming meaningful partnerships to help us win further market share, including a significant expansion of our softbank.
We expect these efforts to drive durable efficient growth in our communications business moving forward.
But the real story is how over time, we believe we can continue to grow the top line of our communications business, while controlling costs with our more streamlined cost structure and continued innovation. We're proving every day that this business can be a powerful driver of profit and cash flow portfolio.
As our communications business continues to successfully execute in an environment, where usage volumes are stabilizing. We're also focused on driving improvements in our data and applications business. We've been rebuilding our go to market function and have seen some initial green shoots, including a modest uptick in bookings in the third quarter. We also.
Continue to receive external validation for the strengths of our products and segment was once again named the CVP market share leader as of June 2023, and was also named the leader in the IDC CVP market scale for financial services. While these early signals are encouraging there is still more work.
To be done before.
Before I get further into the details of the quarter I'd like to share that Elena Danielle we will be transitioning out of her role as president of Twilio data and applications and into an advisory role.
<unk> and I are partnering closely to decide on the best path forward to Reaccelerate the business, especially in light of the AI opportunity ahead.
With that Elena as an adviser and will run TDMA in the interim period until we recruited a seasoned leader to lead this part of our business.
Thank you Elena for joining the Twilio team at a critical time for our company and leading us through a difficult but necessary transition I respect your partnership as a board member executives and as an adviser.
As I mentioned, the TBA business saw a modest improvement in bookings. This quarter. However, those are not yet where we want them to be while this is a very small portion of our business today only 12% of our revenue in Q3, we believe TD <unk> overall and the foundations for AI in particular are key assets for our future. We are committed to success.
And this business as we work to re accelerate growth drive further progress on our go to market scaling efforts and undertake investments to take advantage of the significant AI opportunity.
We saw a number of exciting customer wins across both flex and segment in the quarter that are encouraging and which I will detail later and spending time with our customers at signal our banks in both San Francisco and London continues to reinforce for me the market demand for and the unmatched capabilities of our software solutions.
A signal in August we revealed customer AI, a set of predictive and generative capabilities that Paris customer data with large language models to give companies AI that truly knows their customers when I talked to our customers. They all know that AI will fundamentally be wider the core.
Their companies.
Workforce will need to change the skills required to deliver their vision will change and importantly, the need for data to power their AI initiatives will grow.
This is the initial set of opportunities working with customers using segment to get their customer data AI ready and then activating on that data with Twilio communications.
This communications and data flywheel will empower brands to enter the AI race steps ahead of their competitors armed with the AI ready data the platform that will allow them to interact with customers informed by that knowledge and enable them to clean more insights from each message call and E mail interaction.
We believe this will improve their customer datasets and in doing so help them deliver more effective personalized customer communications.
Our teams have made immense progress over the course of 2023 in just nine months, we have delivered 316 billion and non-GAAP income from operations and we have begun to generate meaningful levels of free cash flow. We are solidifying our strong foundation that positions us well to drive towards low growth deliver.
<unk> profitability and realize the benefits of our customer AI strategy over the long term I'm excited to work more closely with our data and applications team to deliver a value proposition around customer AI that is truly differentiated to twilio and with that I'll turn it over to Jose Mas to talk about our communications business.
Thanks, Jeff Trillium Communications delivered $907 million in revenue in Q3 up 5% year over year on a reported basis and 8% on an organic basis with a non-GAAP gross margin of 49, 8% as a team we continue to focus on driving efficient growth.
Landing, new logos cross selling across our communications portfolio and generating meaningful non-GAAP profits and we're executing well against all of these objectives.
We're continuing to push the bounds of innovation highlighted by our recent new product announcements focused on customer AI, including voice intelligence traffic optimization engine branded calling sangre engagement quality and fraud guard, which are already creating new opportunities for our communications customers and prospects.
For example, our customers can assign preferences for high priority messages, such as one time passcodes to be delivered leveraging the most timely route whereas a marketing communication can be delivered via the most cost effective route.
We continued to demonstrate solid traction in our ability to drive growth with a more efficient cost structure.
Good market model has been streamlined and we've had success in expanding our ISG and global technology partnerships. As a result, we are seeing momentum with landing large new logos across our communications product portfolio.
And through focused cross selling efforts in fact, roughly half of our expansion deals in North America, where in non messaging use cases.
Couple of cross sell wins to highlight from Q3 include a longstanding communications customer in the financial services industry.
Verify to replace their legacy solution for identity and security. Additionally.
Additionally, a leading Latin American E Commerce platform, adding Twilio interactive voice response, while also expanding their voice business with us.
Encouraging results in our voice business overall in the quarter.
We also landed several new logos in Q3.
Beginning with one of the largest European Airlines, who chose Twilio programmable messaging based on our reliability and superior compliance standards for <unk>.
Streamline their customer feedback workflows.
Similarly.
Global Hotel brands chose Twilio as accounts security capabilities to serve their millions of App users again, citing our ability to navigate global regulatory and compliance while delivering a seamless customer experience and.
And finally, a leading AI company adopted verify approach, which allows customers to consume verified versus subscription with upfront payments.
We're continuing to broaden our go to market footprint, leveraging our market leadership position to drive wins with Isps and global technology leaders in Q3, we signed a landmark agreement with Softbank and Softbank will offer twilio services through and sales channels in Japan, which have a strong domestic customer.
<unk> to Dropbox.
Softbank will also provide 24 seven support for Japanese customers.
This is an exciting expansion of our partnership with Softbank and we will continue to pursue strategic partnerships to efficiently capture additional market share.
We're also focused on improving our self serve motion and automation efforts, so customers can more easily purchase build and grow with us.
In the near term, we are expecting to bring more purchasing billing and contract management capabilities into the twilio console, where customers can seamlessly adopt new products and expand usage.
In addition, our teams will continue to automate compliance requirements and phone number provisioning that allow new customers to onboard much more quickly.
As a reminder, we previously made a commitment to our carrier partners to only permit registered U S bound 10, DLC SMS and MMS traffic effective August 31 2023.
I am very pleased with our success in executing against our 10, DLC registration deadline and exceeding our initial goals. Thus far we've been able to register virtually all of this traffic, which has enabled us to mitigate much of the revenue risk we had anticipated for the second half of the year.
We now expect the revenue impact in Q4 to be minimal in light of the amount of registered traffic going into the quarter.
This is an improvement from the potential headwind of up to 300 basis points that we previously referenced.
Similar to our efforts in registry and U S bound 10, Youll see SMS and MMS traffic.
We will also be requiring our customers to register U S bound traffic from.
From toll free phone numbers as of today November ish.
We expect the revenue impact in Q4 and beyond to be immaterial.
Our Q3 dollar based net expansion rates for communications was 101% and 104% excluding crypto customers.
Similar to last quarter, new customers are driving a greater portion of the overall growth, while crypto and social and messaging headwinds masks. The success, we're seeing with our cross sell and expansion opportunities.
<unk> continues to remain relatively stable and we are seeing year over year volume growth across many industries.
I am proud of the execution that our team demonstrated in the third quarter, leading the charge on compliance and enacting our 10 DLC registration deadline was no small feat.
We continue to focus on streamlining our go to market, including improving our self serve motion and capitalizing on cross sell opportunities across communications.
We're seeing encouraging results and there is still further opportunity to improve so I'm confident we will be able to make sustained progress over the coming quarters and with that I'll turn it back to Jeff to talk about the <unk> business.
Thanks Suzanne.
Turning to <unk> results, our primary focus continues to be re accelerating growth.
In Q3, this business unit delivered $127 million in revenue up 9% year over year with a non-GAAP gross margin of 79, 8%.
The evolution of our <unk> business is ongoing and while we've seen some initial encouraging signals from our go to market rebuild efforts, we need to translate early proof points to further bookings re acceleration.
This business deserves to grow faster and has all the ingredients to do so I believe that reconstituting our old go to market playbook was necessary, but not enough. We have to continue to evolve it as well given the rapidly changing market now that we have the selling team in place I'll be working with our go to market leadership to accelerate further changed.
As to our Playbooks taking into account recent learnings.
At this stage, we continue to see increased churn and contraction in TDMA, reflecting the current dynamic environment and issues some of our customers are experiencing and growth with their businesses.
Despite this market dynamics, we're still continuing to land exciting new customer deals across both flex and segments.
We saw several flex customers win this quarter, including competitive seven figure deal with a leading insurance company, which was looking to migrate not only agents off of their legacy on premise solution, but also their IV hour and messaging and chat ultimately consolidated all contact center flows onto Twilio we.
We also signed a cross sell deal with Sweetwater, a musical instruments retailer along tend to be a customer of voice messaging and E. Mail Sweetwater is now actively bringing all of their agents on the flex platform from their previous on premises banker.
Sweetwater is a great example of a company who came to <unk>. It was a communications customer looking to deliver a bespoke experience to their customers and has since gone all in on the Twilio platform because of the customize ability of the experience they are able to deliver across our solutions.
Turning to segment and signal London last week, we announced that we have processed more than 12 trillion data events in the last 12 months and resolve those data points into over $100 billion customer profiles on behalf of brands and we can do all of that in <unk>. This is the basis of our <unk>.
<unk> share leadership recognition and underscores the need for a real time CDP in the markets, which segment delivers in Q3. The segment teams starting to deal with a leading Fintech company and longstanding communications customer who is driving a product led growth initiatives. Their first use case is leveraging.
Segment to process real time transactional data across all of their data systems in order to identify cross sell opportunities all in real time, we also established a new relationship with a software company in the construction space as the company has been very acquisitive historically, they needed to consolidate data for multiple <unk>.
Spirit systems to build a 360 degree view of the customer to inform their marketing journeys.
We also inked a deal with a leading global toy company that will be using segments reversed <unk> capabilities with data breaks to offer their millions of customers real time personalization across their most popular apps and games. What's most exciting is that segment will give hundreds of employees access to advanced.
Customer data models and insights to help improve the customer experience for a globally recognized brand. This exciting deal was one with a great GSI partners as well. We think this is a repeatable partner model and look forward to continuing to invest in our partner ecosystem around segment.
Segments capabilities are foundational to customer AI, we've already announced the general availability of our first <unk> product predictions, which allows customers to create hyper targeted audiences based on predictive trades like lifetime value likelihood to churn, where the propensity to take an action such.
Making a purchase subscribing et cetera.
We have more than 100 customers using predictions already and they are quickly seeing results. One company has seen their cost of customer acquisition, Paul by 85% with more targeted advertising based on propensity to convert to predictions. Another company saw a two X improvement across all funnel metrics for that.
E mail campaigns, including opens click throughs et cetera based on product recommendation predictions.
Our early customers show that engagement is multiplying and costs are rapidly declining Matt is just the first of several customer AI capabilities that we're working on bringing to market. Our short term goal is to help customers see how the coming nine use cases require better customer data something that segment can.
Provide today.
Our long term goal is to provide unprecedented automation cost savings and better customer relationships. Thanks to AI.
We are seeing significant customer wins within TDMA and our investments in AI products are generating significant customer interest we have more work to do and I intend to get closer to our field teams and our product teams and most importantly, our customers to build on our foundation and deliver on the incredible potential of this business I will now turn it over to Adrian to walk through.
The financials in more detail.
Thank you, Jeff we continue to build a strong financial foundation for Twilio.
We exceeded our Q3 revenue guidance and delivered another record quarter of non-GAAP income from operations and free cash flow.
We came into the year targeting $250 million to $350 million of non-GAAP income from operations and have exceeded that goal and three quarters delivering $360 million year to date.
Our results demonstrate our ability and commitment to drive meaningful levels of profitability in our business over time.
Third quarter revenue was $1.034 billion up 5% and 8% year over year on a reported and organic basis, respectively.
As a reminder, this compares to second quarter revenue of $1 $13 million after adjusting for the $25 million of revenue from our divested value first and Iot businesses.
Communications revenue was $907 million up 5% year over year on a reported basis and 8% on an organic basis.
Data and applications revenue was $127 million up 9% year over year.
We continue to see stabilization in volumes across our usage based products throughout the quarter. We also executed well against our <unk> registration volume mitigating revenue risk.
Both of these factors helped drive our revenue would be great.
As we referenced during our Q2 earnings call. Our Q3 revenue growth rate was negatively impacted by headwinds from customers in the crypto industry.
Total Q3 organic revenue growth, excluding crypto customers was 11% year over year.
While the impact has started to moderate we still expect about 200 basis points of crypto related revenue headwinds in Q4 down from 370 basis points in Q2, and 290 basis points in Q3.
Our Q3 dollar based net expansion rate was 101%.
<unk> mentioned dollar based net expansion for communications was 101% or 104%, excluding crypto customers dollar based net expansion for data and applications with 96% driven primarily by instances of higher contraction in churn among segment customers.
We continue to see some customers experiencing growth slowdown and facing cost cutting initiatives in their own businesses given the current macro environment.
We delivered non-GAAP gross profit in Q3 of $553 million growing 11% year over year, and representing a non-GAAP gross margin up 53, 5%.
That was up 270 basis points year over year, and up 120 basis points quarter over quarter, driven by messaging termination Mexican product mix within communications.
Gross margins also benefited from our recent divestitures.
non-GAAP gross margin for our communications and data and applications segments were 49, 8% and 79, 8% respectively.
Q3, non-GAAP income from operations came in meaningfully ahead of expectations at $136 million, representing a non-GAAP operating margin of 13, 2%.
This was due to our revenue and our continued focus on driving more efficiencies across the business.
Q3, GAAP loss from operations was 109 billion, which includes $7 million of expenses associated with restructuring in real estate impairment charges.
Stock based compensation as a percentage of revenue was 17, 9% in Q3, excluding approximately half a million dollars of restructuring costs of 320 basis points quarter over quarter.
Down 180 basis points year over year.
The sequential increase was primarily driven by the timing of employee refresh, France, which occurred later than in prior years, we expect stock based compensation as a percentage of revenue to decline modestly in Q4.
In Q3, we generated free cash flow of $195 million driven in part by heightened collections, while we do not expect this level III occur each quarter free cash flow remains a focus for us as we drive greater profitability in the business.
Lastly, we continue to execute against our $1 billion share repurchase program that we announced in February and have now completed approximately $620 million of repurchases to date.
Moving on to guidance for Q4 were initiating a revenue target of $1 3 billion, one 4 billion representing year over year growth of 1% to 2% on a reported basis and 4% to 5% on an organic basis, which accounts for a recent value first in Iot divestitures.
We expect Q4 non-GAAP income from operations of $115 million to a $125 million and we're raising our full year non-GAAP income from operations guidance to 475 million to $485 million.
I am pleased with the progress we've made on our profitability targets to date. The teams are executing well, which provides a good setup as we look to deliver a strong finish to the year and enter 2024 with momentum.
And with that let's open it up for questions.
Thank you at this time I would like to remind everyone in order to ask a question. Please press star one.
In the interest of time, we kindly ask that you limit to one question.
Your first question comes from Taylor Mcguinness with UBS. Please go ahead.
Hey, everyone. This is Jeff <unk> on for Taylor. Thank you so much for taking the question congrats on the quarter on that data and apps business.
Retention following the 96% from 99.
Like things continue to soften a bit there what are you seeing in terms of trends when we could maybe hit a bottom and.
It's gross churn something that could be impacting the gross margins of that segment currently.
Thanks.
Thanks, Jeff I'll take the first part of the question and maybe at this gross margin aspect of the question then I'll, let <unk> take it.
We noted we've been working through some of the churn and contraction headwinds, particularly as customers are realizing lower growth in their own businesses. They are focused on cost cutting efforts as you would expect and this results in reduced deal sizes at renewal and in some cases outright churn.
Several initiatives, we have in place to try to mitigate the churn and contraction, we're making a concerted push with our post sales teams to drive faster and easier implementations with customers as well as mandated professional services in certain instances to make sure customers can successfully we're also ensuring our sales incentives are aligned to not just driving the bookings, but also mitigating churn and <unk>.
<unk> as well.
And ultimately we need to drive bookings improvements and continue to deliver on the value of our products to those customers in order to approve GBA and I think we did see modest improvements in bookings in Q3 relative to Q2, and we have an ambitious product roadmap for <unk> around customer AI as well, which is driving a lot of early interest in meetings, given we announced it.
Over a month ago, but most importantly, we're not seeing an increase in competitive churn and I think that's the most important part of what we are seeing in the churn and contraction.
Adam is there anything you would add about gross margin, yes, sure. So I don't think the churn if not.
Gross margins for data and application. So they are down year over year in their GAAP quarter over quarter. So a couple of dynamics just you understand there. So first as we mentioned last quarter, we continue to invest in innovation in this business and Thats driven an increase in capitalized software expenses, which is flowing through our P&L and.
And obviously these innovations are focused around things like customer AI in our next next gen products and features.
We're also seeing and expect to continue to see higher infrastructure and hosting costs and data and application.
We're continuing to invest in AI capabilities across the portfolio as I said and to ensure efficient scaling of these products are migrating certain backend functionality and infrastructure type functionality to new vendors in 2024 and that will optimize our spend over that over the longer term. So there will be a period of time, where we have OS.
We're lapping or double expenses and youll see that in the margin rate on the back end, obviously, we expect to reap the benefits of these investments.
Our next question comes from meta Marshall with Morgan Stanley. Please go ahead.
Great. Thanks, maybe sticking with the data and applications business Jeff.
Just what do you see as the keys to the Reacceleration of this business maybe outside of overall macro is it still room to go on go to market or product advancements and just kind of what are you looking for as you look for new leadership for this business.
Yes. Thanks.
There's two things that really speak to the growth trajectory of of G&A number one is arresting churn and contraction and number two new bookings right. So that's what we've been focused on all year, we just talked a bit about churn and contraction.
In terms of what other things we can do to make sure customers are successful makes for customers. When it comes time for renewal are most likely to renew and those are the things in our control customers on business not a lot.
You can do or so like that but that's really not the majority of it really allows us is in our control.
The second thing of course is new bookings.
So we are very focused as you know on the reconstitution of the sales team, which is something we've spent the greater part of last year doing so hiring up the sales reps, enabling them training them building pipeline et cetera, and like I said, we've been seeing bookings growth throughout the year, we'd love to see it continue to grow and grow even more aggressively than it has but we are seeing that.
Bookings growth happen and meaningful logos expansions cross sells I mean, we talked about all those things on the call. Today. So those are all the positive signals that we're looking for especially as we go into the fourth quarter and it's also worth noting that we see win rates and enterprise Asps are remaining healthy and stable.
Leadership kind of what you are looking for or is it somebody with more sales of our product focus.
Yes, that's a great question, we're looking for a leader to.
I think with a good go to market background, but also obviously some degree of technology given that AI is becoming increasingly important especially for the segment business the contact center business as well as.
Our big customer AI initiatives. So we're looking for someone who primarily I would say has go to market really good product market fit understandings both with the current products, we have as well as we bring new products to market in the form of customer AI.
Great. Thanks.
Next question comes from Mark Murphy with Jpmorgan. Please go ahead.
Thank you very much.
Jeff I'll take it back to the signal conference you spoke with Sam Altman and he brought up this idea that the cost of intelligence could fall by a factor of a million dollars.
And so I'm wondering if if it even if it moves in that direction. If <unk> ends up being the mechanism that allows Bob to understand who they are talking to and who the customer is how much do you think that could amplify.
<unk> value.
To the typical customer as all of these generative AI projects gathers team I mean I'm just wondering.
As you can see cases, where where customers the customer spend until you would really kind of ratchet up pretty materially.
Well thanks, Marc obviously, it's very early in this game. So it's hard to tell exactly how things are going to play out.
We set out our vision for customer AI for what we think is going to happen I kind of said that not only is this going to become possible I think it will become inevitable and the key to a lot if not all of those things I talked about is company is having a really good handle on all the data about their customers right. So if you've got your data spread across all of it.
<unk> systems and sitting in all these different places.
Find its very dirty.
It's really hard to actually put AI to use solving some of the really big things I think AI will be able to solve for companies and so the first order of business here is getting customer data in order. So that as these AI use cases come to maturity. They have the raw information that they need to understand who they are talking to and how you can start going about opt.
<unk> these customer interactions customer relationships and overall like the business.
Office of every company.
And so that's how we're thinking about it today now the other thing I think that's super interesting in the world of generative AI in particular.
I think that SaaS businesses. The license per seat has the opportunity to be very much disrupted and thats coming world because I think companies will need fewer seats I think that.
The things that AI is going to need to latch onto is essentially data sitting in systems and that data is going to be really used in a usage type models and so I think our business is generally speaking well set up for a world where companies may need fewer seats. They may contract the number of seats they are using.
They may not grow with the same number of seats, but the data the backend systems. The processes. The workflows that are triggered by AI, that's what really matters in this coming world and so I'm very happy that Twilio is not in a position to largely be monetizing our service on a per seat basis, but rather we have a usage based model based on our.
<unk> business and even the data business as well.
Yes. Thank you, Jim very insightful and I think that's a super important point really appreciate it.
Thank you Mark.
Our next question comes from Nick Altmann with Scotiabank. Please go ahead.
Okay.
Thanks, guys.
First can you just talk about the communications usage trends you guys are sort of seeing in October and November and then just given there is some seasonality in Q4 for messaging.
Can you maybe just speak to how much the guidance is sort of onetime in nature or more due to sort of seasonal factors versus sort of underlying stabilization.
I just think people are trying to understand the extent and what youre seeing stabilization on the communication side.
But the seasonal trends in Q4 player that a bit so any way you can kind of parse out those two it would be helpful. Thanks.
Yes. So I'll start this is data and talk a little bit about the guide and then I'll hand, it over to Sam I'd add any comments.
So we're guiding to 1 billion, one 3 billion and $1 four.
$1 billion of revenue in the quarter, which is roughly flat compared to the third quarter and so what I'd say overall, we're really encouraged by the performance and the volume stabilization that we saw in both the second quarter and the third quarter in communications and we are optimistic that volumes will remain stable, but we know that the environment remains uncertain.
Some customers really seeing variability in their revenue lines and with many cutting costs and therefore, we are continuing to plan prudently, particularly given the usage base nature of that business, which is nearly 90% of our revenues.
With that I'll hand it.
Yeah.
Yes, I wouldn't really add anything additional to what Hayden said I mean, I think we obviously can't comment on October and November those thing in quarter periods, but we are encouraged by what transpired in Q3, and I would just echo what he said that volumes remained stable.
And we're kind of cautiously optimistic heading into Q4 and certainly into 2024.
Okay.
Our next question comes from Kash Rangan with Goldman Sachs. Please go ahead.
Hi, Thank you very much for taking my question, Jeff I'm curious to get your thoughts on the interplay of AI and data.
It looks like there is.
Some logical conclusion that if your system of record.
Full blown CRM system, then it passed all of the data and the AI will be able to work with the data to create actionable campaigns and there's a closed feedback loop I'm curious, how you think about trillium assets.
Science that system of record, which which you don't have but how are you.
Planning to add value to that what seems to be the closed loop, where you have a system of record data AI and the whole AI look and function within that application ecosystem versus you bring a slightly different perspective I'm just curious to get your thoughts on how you take advantage of your assets in the world. The way we laid out thank you so much.
Yeah. Thanks, Kash, there's a reason why we bought segment when we did which is <unk>.
I think that you've been looking at company is trying to solve this problem of having a single view of their customer for give or take 20 years.
And CRM has been the thing that oftentimes customers have turned to instead like this will be the answer this will be how we're going to have that system of record. The single view of our customer and if that were working then I don't think companies would also be turning to data warehouses to try to solve this problem as well. So I think gives us ample proof when you talk to customers that CRM is not solving.
This problem it is actually a bunch of systems of record.
By the way none of that speaks to all the event data streaming data of clicks and scrolls in page views and mobile App opens all that kind of stuff.
That is going on in the world of <unk>.
Specialty consumer scale data and consumer scale companies and so CRM as a part of the story. So is the click stream data so as all the data that's in other systems of record so as the customer service data so as the and the list goes on and Thats. Why this is such a hard problem to solve and that's why 20 years into the world of CRM at least in the cloud.
As an unsolved problems still and segment is a solution that solves that problem and so that's really where we're starting we're not trying to create another.
System of record, we are trying to bring to market the solution to the problem of companies already have too many systems of record and in fact, they need to make sense of it all and that's what customers are coming to Toyota Ford.
Super Thank you so much Jeff.
Our next question comes from Michael <unk> with Wells Fargo Securities. Please go ahead.
Hey, great. Thanks appreciate you taking the question.
On margin net operating income target continues to move up fairly significantly but.
We're also seeing some of the growth rates in core metrics in the data segment in particular show. Some decay. So just wondering if you're reaching a point, where you need to dial back the margin expansion just drive some investment in reinforcing the foundation I appreciate theres. Some just general transition happening there and maybe just help level set how we should think about.
Margin trajectory from here given the significant improvements youre shying. Thanks.
Yes.
<unk> guided to this year in terms of.
Our profit we haven't given a guide for 2024 this.
This year, obviously played out better than what we laid out coming into the year. So we're really pleased with our profit performance to date, when you think about that profit.
Think about that.
The relative.
The two different business units.
Yes.
The communications business today generates 88% of our revenue 82% of our non-GAAP gross profit so that business is really the profit generator for the.
The company and then our data and application side, we're investing so I would say that for the foreseeable future you could assume that the efficiencies that we're generating on the communications side of the house.
Really what's enabling the investment in data and applications. So I think that we have opportunity going forward to continue to see leverage I would I'd expect both of those are that leverage to come from two areas largely the communications business as we move to self serve as we shift to lower cost regions, and we leverage automation as well as the G&A functions.
Where automation and shifts to lower cost regions are also.
Or is that we're pursuing.
But we're not going to give a specific.
Outlook in terms of a range right now.
Okay understood. Thanks, very much I appreciate the color.
Our next question comes from Alex Zukin with Wolfe Research. Please go ahead.
Hey, guys. Thanks for taking my question I guess.
Maybe just the kind of 101 be for me would be.
If you think about the applications business.
When we're talking about Reacceleration I guess, maybe I just wanted to better understand when do we expect the net retention rate the trough and then if I calculate just the change in deferred revenue plus the applications revenue I think I get to about a 5% billings growth number for that business is that the right way to think about.
The kind of the range of the future growth rate kind of ex meaningful.
Improvement and then maybe for Jeff.
You guys have made such great progress on the operating efficiency side.
But.
If we think about the reconstituted.
I would say re <unk>.
<unk> activating some of the sales motion on the upside do you need is that where you actually need to put in a greater investment on the sales and marketing side.
And versus kind of where we've been seeing some of the savings.
Why don't I start and then I'll hand, it over to Jeff. So there was a lot in there so starting with the data and applications.
TVN and where Theres a traffic, we don't guide to that metric and I'm not going to give an outlook there, but maybe just some thoughts on that data and applications growth rate. So we grew 9% in the quarter that was compared to 12% last quarter or so.
So down a bit quarter over quarter.
Sure.
So yes.
That's the focus we saw a number of solid wins in the quarter and we're really working to build on the uptick in bookings we saw in the third quarter.
The second question was with regards to deferred revenue so deferred revenue trends. So I wouldn't take this the change in the deferred revenue balance.
I wouldn't over index to it I guess, it was driven by data and applications in the quarter.
There is always timing and lumpiness of payments and things like that but the trend was driven by data and applications, but I wouldn't over indexed to that number.
So let me hand, it over to Jeff to take the next part of the question. Thank.
Thank you Alex for your question was essentially do we need to invest more in the sales efforts for <unk> and the short answer is no I don't believe we do we have hired.
A good number of reps, we have enabled them and we're starting to see that productivity and obviously, we want the whole thing to be happening faster, but in general I don't think that spending more money on that effort is is the answer it's not a matter of us under investing I think it's a matter of productivity and I think it's a matter of.
Continuing to evolve our presence in the market.
A number of things that we're doing in order to make that team.
Ideally growing and their productivity IGF the numbers that we want to hit so I don't think its a matter of us having to invest more I think we got enough waffles on the plate and I wish I had some sooner.
Excellent. Thank you.
Okay.
Hey, guys. Thanks for the question.
Building actually off of Michael's prior question around margin actually wondering if its statement of cash flow.
You actually talk about stronger collections can you just walk us through the linearity of what you saw this quarter overall, we should expect more of these upfront.
Deals to happen in the coming year or so to help drive these better collections. Overall. Additionally is there any way to think about long term free cash flow conversion relative to net income year over the next couple of years. Thanks.
Yes, So let me just touch on free cash flow. So this is a record quarter for us $195 million of free cash flow in the third quarter second quarter of solid free cash flow generation. So a couple of things to consider there obviously as we become more and more profitable our free cash flow.
Metrics should generally correlate with non-GAAP profit, we're not going to give a guide right now on what the free cash flow margin should be but as profitability improved free cash flow will improve now what tends to happen on free cash flow is there is some variability quarter to quarter with working capital.
Capital in this quarter, we ended up.
With higher collections are heightened collections relative to prior periods, we had about a three day three day improvement in DSO, We just don't expect that to happen every period.
I will say is even excluding that unusual heightened collections, our free cash flow was better in the quarter than the second quarter. So we did see improvement quarter over quarter, but youll always have some of that lumpiness, whether its collections or there's a prepayment in the quarter going the other way and so it's never perfect. It's never linear but like over time.
We should see free cash flow improve as we see profitability improve.
Right.
Can you talk about linearity within the quarter itself. What are you guys kind of thought later on versus if I go to execute here.
No, we're not going to break it down within the quarter.
Our next question comes from Derrick Wood with TD Cowen. Please go ahead.
Thanks, I wanted to touch on the.
On the continued pressure in net new customers at thinking about 2000 in the quarter.
And I guess that's it.
How are you guys balancing the investments in new customers versus cross selling the base and how are you feeling about the effectiveness of the <unk> motion and driving new customers on the on the comp side.
Could you just touch on the metric quickly and then I'll, let <unk> talk more about the business just one.
One thing to note is that Youre right the communications customer our customer count first of all is up 10% year over year up 1% quarter over quarter. There was a smaller tractor and they're driven by the dispositions so that what it would've been up slightly more if we did dispose of the value first fitness in the quarter I think importantly in that business churn continues to.
Well until we don't see churn as a concern within the communications business. So let me hand, it over to because then you can talk more about what's going on.
Yes, I mean, I think just to provide a little additional color on the self serve side of it to answer your question outright I mean, I feel quite good about some of the progress that we've been making there. We've obviously focused a lot of our efforts on streamlining it I would say in the very recent past the 10 DLC registration process that we went through certainly.
<unk> some friction in terms of new customer sign ups and stuff like that but absolutely. It was the right thing to do and we feel really really good about the trust that we've been able to create the ecosystem as a result of that.
I think beyond that.
We do feel like a that there'll be ongoing efficiencies that we'll be able to drive into the self serve side of things, but I don't think it's going to end up coming at the expense of growth I think importantly, we're not seeing any pressure on pricing for example.
We highlighted a number of really interesting wins in the quarter that actually came from products that were beyond messaging.
That also feels pretty good and kind of alluded to the fact that it is a bit of a volatile macro I think in spite of that the business continues to perform quite well and I think probably the most important dynamic in the whole thing is that we are seeing a stabilization in volumes.
But we don't necessarily see an inflection yet I think we do have a fair amount of optimism about Q4, and how things look heading into 2024.
Thank you.
Okay.
Our next question comes from Samad Samana with Jefferies. Please go ahead.
Everyone. This is Billy Fitzsimmons on for some odd Savannah, I wanted to dig a little deeper into the macro impacts in the prepared remarks and build on some of the questions that were already.
But I think kind of digging into the incremental macro impacts in the third quarter. It sounds like churn remained stable and you called out growth slowdowns and cost cutting measures for some of your customers, but curious if you could dig in a little more down the business metrics tracked over the course of the third quarter when compared to the second and Twilio was pretty upfront about the macro.
<unk> in the first half of the year and you talked about business trends a little bit in the answers to some of the other questions, but what I'm trying to get at here is that we're midway through earning season and we've heard from a couple of software companies. This quarter that specifically called out that headwind Scott that got incrementally worse in the third quarter.
<unk> and some software companies called out that there was a material drop in spending from certain customer verticals, others called out diverting spending trends in enterprise versus SMB customers noted that S&P got got incrementally weaker over the course of the quarter. So curious to hear a little bit more about how twilio business compares to that commentary from some other.
Ill start and then Mark Jeff jump in as well so as it.
Relates to let's talk about communications Thats, the vast majority of the business. So we continue to see volumes remained stable in the quarter. So that's been two quarters in a row second quarter and third quarter, we've seen volume stabilize and that played out through the third quarter and when you look at it at an industry level, we do see some verticals presenting a headwind we talked about crystal.
Crypto and social and messaging, but when you look at the other kind of larger industry vertical we are seeing growth in those and so our overall growth rate is somewhat masked by the headwinds that we're seeing on crypto and social media as well. So did you feel good about where the business is I'd also say as you think about the dollar based net expansion rate for that business.
So it's lower than it historically has been at 101% in the quarter.
And it's an 8% growth rate overall right. So the vast majority of the growth is coming from the customer base. The other thing to consider on the dollar based net expansion rate is what we're seeing is churn has been historically low and continues to be low we're seeing really higher contraction in lower expansion relative to historical levels and this is where.
Something like Crypto comes into play so it's a good example in terms of understanding what we're seeing so obviously when theres less crypto volumes our customers platforms. It results in my clarification messages on our platform. So we are seeing some specific industry headwinds, but overall feel pretty good about how the business is performing from a stabilization.
Dave and across most of the industry.
Yes.
Basically agree with me and said I mean, I think you specifically asked about headwinds and part of your question and I think the one that we pointed out a number of times now is crypto.
We've also historically kind of talks about social and messaging and some of the headwinds associated with those categories, but I think if you look at.
Several of the other industries in which we participate we are seeing pretty good growth.
I think that generally makes us feel pretty good as David alluded to volumes.
Have been stable that certainly feels pretty encouraging and I think the way that we've dialed the business in the way that we've addressed our cost structure I think in spite of whatever it is that kind of comes at us for the foreseeable future we feel pretty good about the way that the business is sized and so I think now we're.
We're prepared to kind of execute or whatever that environment is.
Perfect. Thank you.
The difference in spending for enterprise versus SMB is at this point.
Nothing specific that I would really point to there I mean, we give you a little bit of additional color on self serve earlier I mean, I think there were some short term dynamics that tend to Youll see for example that created some friction at the time, we're past that now so I wouldn't really expect that to persist.
I wouldn't call out anything specific with enterprises.
Perfect. Thank you very much I appreciate it.
Thanks.
Our next question comes from Ryan Koontz with Needham <unk> Company. Please go ahead.
Thanks for the question I wanted to drill down on kind of where we are on the.
The cost out journey for the comps business, obviously, a lot of great work there in terms of expanding profitability. How much room is there to go either through the self service efforts or other programs that are still in place and we are working on thank you.
Yes.
Obviously, we've come quite a long way in a short period of time I do think that there is some additional opportunity in terms of driving efficiency I think that as <unk> seen in the published results. Our business has responded quite well as a result of some of the structural changes that we've made.
We did two right that we've kind of talked about over the last year or so and as a result, we've been able to take out quite a lot of cost I think we've also driven a lot more disciplined focus simplicity and all of that has created greater efficiency.
In terms of additional areas I mean, I think we talked about self serve a little bit I think thats always an area that will allow us to drive ongoing efficiencies.
I think in that category in particular, what we've really been focused on is simplifying the onboarding experience the user experience the kind of product journey. So that a lot of the kind of high touch human interactions that would have happened historically.
That those have waned and that will help us reduce our cost of sale I don't think we have to really add any material incremental head count as the communications business.
After growth so that feels pretty good as well.
AI is obviously an area that you can imagine both externally and many of the remarks that Jeff shared an agent shared earlier in terms of what customer AI, but we definitely see that being a growth accelerate at some point, but I think too. We're also looking at some internal opportunities in which we can we can drive efficiencies there as well so.
Just put a wrapper on the whole thing we feel like that.
We can continue driving incremental growth without really any sort of meaningful increase in the operating expense profile and that's how we're running the business.
Super helpful. Thank you.
Our next question comes from Pat Walraven with JMP Securities. Please go ahead.
Oh, great. Thank you, it's really great to see the success of the communications business.
Nearly $1 billion.
The quarterly run rate.
My question, Jeff is.
Yeah.
I mean, even with new leadership.
<unk> business.
Performance doesn't improve.
You think twilio to drive sustained long term shareholder value.
Just with the communications business and without the <unk> business.
Yes. Thank you Matt for the question. So look I'm really proud of what the communications business is driven as well I think we've shown that business at scale can drive.
However, I do think that even better business that we're building over the long term is a business that fuses communications and data together why because with an understanding of who those communications are going to we can drive better communications not just more communications and Thats. The strategy that we're pursuing and so if we are able to take the data.
FX and segment and bring them together with our communications assets, what we have.
The opportunity to do is add a lot more value to our customers drive a lot more software value to the company and really competitively differentiate.
Where this is what customers want customers want more effective communication I love. These stories about how for example, I talked earlier in the prepared remarks about.
The customers are using segment using predictive trades, we're able to bring down the cost of customer acquisition by 85%.
Like those are the types of stories and business results. So I think we can drive when we bring together data, which allows companies to be a lot smarter and communications, which is the vehicle to actually drive a lot of those outcomes in terms of how you talk to a customer and so when I think about the opportunity ahead look so far of the conversation has been pretty much focused on the the <unk>.
Standalone nature of the segment business and obviously, we've been focused on making sure that we drive growth as a standalone, but what we have.
The next step for US is to really start talking about what we kind of mock together and thats the better not more story and I'm really looking forward to.
Using especially AI and all the things we talked about with customer AI as the vehicle to fuse communications and data together in a way that's extremely differentiated and honestly as emerging like Theres no theres no one in that market today and so the gift of the Renaissance of AI whats going on right. Now is the idea that you can get out there with a new value proposition.
That is truly differentiate it and that's what we're pursuing.
Alright, Thats really helpful. Thank you.
Okay.
Our next question comes from Ryan Macwilliams with Barclays. Please go ahead.
Hey, Thanks for taking the question any early insight into how your customers are thinking about holiday season traffic this year.
Over the last year.
And then just we've seen a pickup in M&A recently from a number of software companies just checking to see if there's been any incremental changes on your strategy there. Thanks.
I can talk about maybe holiday seasonality and then maybe you could talk about capital allocation or Jeff.
In terms of.
The holidays I mean, there is there is some seasonality obviously we.
We would certainly anticipate that as with any prior periods, especially around.
The kind of Thanksgiving period that we will see an uptick in certain traffic certainly heading into the Christmas season, but I wouldn't call out anything unusual relative to prior years, I think it'll be kind of the normal seasonality that we see in the business and it will more or less lineup with what.
<unk> provided in the guidance.
This is Jeff I'll talk about M&A.
A matter of good corporate hygiene, we always are keeping inactive gameboard of.
Opportunities that are out there in the market that said I don't think M&A is our top priority right. Now obviously, we're digesting a lot of change and we're really proud of the results that we've shown in terms of turning the corner on non-GAAP operating profit.
And really growing the business and organic way and so that's really where the management team's focus is right now but that said, we always do keep an active gameboard and obviously, we've got a pretty good words, yes.
Great color. Thank you.
Hey, Thank you very much.
I think I fundamentally agree about data as one of the key differentiators in the generative AI application rates and I think just.
Closing out the call I guess the question at a high level here Big picture longer term opening high at the start of the week I think you hinted that a longer term trend that we might see more autonomous agents in the AI space, where they carry out tasks without human intervention and so just thinking about that were perhaps more is done via AI automatic.
Without human communication, how do you see twilio over the next.
And I don't know.
When we might see this exactly but over the next coming years, where trulia would feel it fit into that value chain. Thank you.
Thank you Brad Yes look this AI world is rapidly evolving and I think what we've set out as our vision for our role in it which is to help companies to use predictive and generative AI to really automate and improved all of their customer interactions by taking a really good understanding of their customers the story thats.
Told by the data that those customers give us their clicks their skulls when they sign up for whether they are not signed up for all everything that they've done tremendous understanding of the customer that is the segment profile take that profile and now injected into every touch point. The company has using AI to improve every one of those touch points I think youre going to see a tremendous amount of automation in terms of.
Customer service in terms of pre sales in terms of marketing.
And we showed this vision at signal, which basically says look I agree there has to be a tremendous amount of automation of one hertz part of that is this idea of like agents that are taking actions on behalf of people and I absolutely think that's true when you look at what else is going to happen right. Those agents are going to be taking actions on behalf of companies.
The raw ingredients for how those agents are going to operate as number one we have to have access knowledge with companies number two they have to have access to tools to operate within those companies number three they're going to need access to guardrails about what they are allowed to do it in number four then your access to information about the customer that they are serving and that's the kind of framework that we've thought about as we've gone about.
Thinking how is customer AI going to change how companies operate every customer facing function and we believe there's a tremendous amount of automation that is going to come to play and the result of that automation I think companies are going to get 10 times more productive and serving their customers. They can do it at 110th of the cost that they probably would have to spend otherwise and we're here to.
Power that future for our customers.
Thank you.
This will conclude Twilio third quarter 2023 earnings conference call. Thank you for joining US today you may now disconnect.
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