Twilio Inc

NYSE:TWLO

Earnings Call Transcript 2020-Q2

[Operator]

Good afternoon, and welcome to Twilio's Q2 2020 Earnings Conference Call. My name is David, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session.

I will now turn the call over to Andrew Zilli, Vice President of Investor Relations. Mr. Zilli, you may begin.

[Andrew Zilli, Vice President, Investor Relations]

Thanks. Good afternoon, everyone, and thank you for joining us for Twilio's second quarter 2020 earnings conference call.

We are once again conducting our earnings call from separate locations, so we appreciate your understanding if we run into any technical glitches.

Our earnings results press release, SEC filings and a replay of today’s call can be found on our IR website at investors.twilio.com. Joining me virtually today are Jeff Lawson, Co-Founder and CEO; George Hu, COO; and Khozema Shipchandler, CFO.

As a reminder, some of our commentary today will be in non-GAAP terms. Reconciliations between our GAAP and non-GAAP results and guidance can be found in our earnings press release. Additionally, some of our discussion and responses may contain forward-looking statements, which are subject to risks, uncertainties and assumptions. In particular our expectations around the impact of the COVID-19 pandemic on our business, results of operations and financial conditions and that of our customers and partners are subject to change. Should any of these materialize or should our assumptions prove to be incorrect, actual company results could differ materially from our projections are those implied by these forward-looking statements?

A description of these risks, uncertainties and assumptions and other factors that could affect our financial results are included in our SEC filings, including our most recent report on Form 10-K, and our remarks during today's discussion should be considered to incorporate this information by reference.

Forward-looking statements represent our beliefs and assumptions only as of the date such statements are made. We undertake no obligation to update any forward-looking statements made during this call to reflect events or circumstances after today or to reflect new information or the occurrence of unanticipated events, except as required by law.

With that, I’ll hand it over to you, Jeff.

[Jeff Lawson, Founder, Chairman and Chief Executive Officer]

Thank you, Zilli and good afternoon, everyone. Thank you for joining. Before we begin, I'd like to take a knee so to speak. As you all know, the last several months have been very difficult. It started with COVID and the impact that this has had on the world and then we saw the much-needed broader social movement around Black Lives Matter. This year has shown more than ever the important role corporations play in the lives of our employees, our customers and society at large. And we take that role seriously. Racial justice is an area where companies, Twilio included can step up and help drive improvements in multiple areas. It starts by introspecting personally as leaders and people in a position of power and as a company and how we can use our power to instigate change. It begins inside our walls. One of our core values of the Twilio magic is be inclusive and we have a body of work to do in order to truly build the company that's representative of the world around us, where every person knows they belong.

But we are committed to that work and make small strides of progress each day. But we also know the power of coming together as a company to fight systemic injustice as we commit as a company to the principles of anti-racism. And as I've talked with Twilions around the world in the past couple months, I've found that we have a company full of people who support this cause, both the issue of racial injustice facing black Americans and other groups like Latinx and indigenous Americans also similar issues that face communities around the world in EMEA, APJ, LatAm, I found similar desires to engage to do the work and to fight in each one of our communities for the issues of diversity, inclusion and belonging that face every community.

I'm humbled and inspired by all of you especially in a year where people could say, look, we have enough other problems right now. So thank you Twilions for engaging and committing to doing this work. We know our work as individuals, as leaders, as a company is just getting started and we stand in solidarity with the black community and believe equivalently Black Lives Matter. Consider this my taking a knee to begin this earnings call.

Now on to Q2 results. We saw continued broad-based strength in our business in the second quarter as our customers leveraged Twilio to build the future of customer engagement. Over the last several years, we have built a well-diversified customer base across industries, regions and company size that have driven our great results. And now we're seeing the strength of that diversification really play out during COVID, as we've seen new industries, new use cases offset some of the more negatively impacted areas. Companies are adapting quickly to this changing environment. Over the last few months, we've seen years-long digital transformation roadmaps compressed into days and weeks in order to adapt to the new normal as a result of COVID-19.

Our customers in nearly every industry have had to identify new ways to communicate with their customers and stakeholders, from patients to students to shoppers and even employees essentially overnight. In fact, in a recent Twilio global survey of more than 2,500 enterprise decision makers, 97% believe COVID-19 has accelerated their company's digital transformation efforts.

We also found the company's digital communication strategies were accelerated by an average of six years, barriers like lack of clear strategy or getting executive approval or reluctance to replace legacy software and lack of time have broken down and budgets are increasing as companies are seeing new ways of engaging customers. As we remarked on the last call, Twilio was built for this. The things we've always brought to our customers, digital engagement software agility and cloud scale are enabling organizations to innovate now even faster than ever. Messaging, email voice and video are allowing companies to engage with their customers safely while reimagining their digital engagement strategies in ways that will be resilient for years to come. This effort is the focus of every executive team at nearly every company not only are we helping companies’ figure this out now but we are an engagement platform that was built for the future and we believe the solutions being built today will be the standard for digital engagement going forward.

In addition to the traditional use cases we've always powered, we continue to see additional traction in healthcare, education, financial services, retail contactless delivery and e-commerce. In fact, I was recently speaking with the CIO of a major retailer who said they saw their e-commerce adoption experience five years of growth in the second quarter alone. The need to scale every part of the business to meet that demand is substantial and in order to service those customers and meet that surge in demand they turn to Twilio. We're also seeing companies face the same challenge when it comes to their workforces. How do we adapt to this new dynamic of work? Where work and homes are blended and we don't go into the office every day. While it would be nice if we could flip a switch and return to normalcy, I think that the coming years will present a more fluid version of work. Companies who adapt now and prepare to serve the needs of a more agile workforce will be the ones who thrive.

For example, companies must prepare for customer service agents to work from home rather than a crowded call center. Retailers who rely on the expertise of their in-store sales associates will need to create workflows where those employees can still advise customers digitally. Banks will need to replace their traditional in-person branch processes to online services and the tools and services that keep these agile workforces up and running like Twilio will continue to see demand increase. We are just scratching the surface of this huge opportunity as companies around the world reimagine their customer engagement for the digital world. This is what Twilio has always been focused on and now this opportunity has been supercharged as customers continue to use our customer engagement platform for new use cases brought about by the current environment. While there's a lot of uncertainty in the macro environment, we remain cautiously optimistic about our opportunity for the remainder of this year and we're even more excited about what we can do in the long run.

Before I hand it over to George, I want to highlight a couple of other items. I want to welcome Michelle Grover as Twilio's new Chief Information Officer. Michelle joins us from SAP Concur and will be responsible for the technology systems and processes that drive innovation and growth at Twilio. Ultimately empowering the company to better serve customers. We're thrilled to welcome her to the team. I also want to remind everyone that SIGNAL our customer and developer conference is coming soon from expert speaker sessions product deep dives, speaker panels and more SIGNAL delivers powerful and practical sessions to build legendary customer relationships with Twilio. You'll learn how to unlock the power of a single communications platform to engage with your customers anywhere on any channel. It will be a virtual event from September 30th to October 1st and you can register today at twilio.com/signal.

Finally, I want to thank our employees for their dedication to our customers during this unprecedented time and for delivering these great results. I also want to thank all of those who are on the front lines of this pandemic and continue to fight to keep us healthy and safe. Our food supply is continuing and our store is stocked. Thank you for everything you're doing for the rest of us.

With that I'll hand it over to George.

[George Hu, Chief Operating Officer]

Thanks Jeff. Against the backdrop of a very difficult macro environment and the first full quarter of remote work, our team pulled together to deliver great results in the second quarter Our investments in the enterprise expanding internationally and growing our partner ecosystem continue to drive great outcomes as we are helping companies across industries and around the world with their digital acceleration efforts. Our marketing team transitions several events from in-person to virtual hosting multiple engage everywhere events including industry-specific events focused on health care and retail. Our developer relations team drove great results with more than one million unique visitors to our blog during the quarter. We were able to shift our customer hackathons to virtual experiences from multiple companies. These hackathons help companies reimagine their customer engagement strategy using the Twilio platform. And we continue to see digital transformation projects accelerating at companies and organizations of all sizes and across industries. As Jeff mentioned, COVID is accelerating the digital transformation efforts of companies and organizations everywhere because there is no such thing as routine customer engagement anymore. And our opportunity has been supercharged in light of this driving some great new deals in response to COVID.

Few companies have seen as explosive growth as Zoom as a result of COVID and with that growth they needed an email platform that would scale to match their needs. Already a Twilio customer Zoom added email knowing we offered a platform that would consistently deliver email in a timely fashion at scale with a deliverability and speed to support their customers during this massive growth phase. We expanded our relationship with Peloton, the largest interactive fitness platform in the world with more than 2.6 million members. They needed an email infrastructure that would grow with them. Peloton selected Twilio's email platform for all of their marketing emails to optimize deliverability, allow them to iterate quickly and provide the scale they need for the future.

There's also never been a better time to be in the contact center space. We are happy with the momentum we've seen reflect to date. The flexibility of the platform allows for many different use cases outside of traditional customer service. One area we've seen great traction in is contact tracing, where we've worked with several universities and city and state governments to help them prepare to reopen safely and efficiently. In Q2, we signed more than 25 transactions with these organizations including New York City and New Mexico. Flex also allows companies to cut costs by moving from expensive on-premises implementations to the cloud. Red Ventures, a portfolio of digital companies was looking for ways to cut costs while continuing to provide great service. Having used a legacy on-premises vendor for more than 10 years, Red Ventures chose Twilio Flex to provide a cloud-based solution to drive cost savings while delivering a highly customized sales experience.

We also entered into a new relationship with DGL Group, a leading digital distributor of insurance and household financial services to over 10 million customers. DGL's existing legacy solution did not allow for large-scale remote working and requiring staff to stay in the contact center was not acceptable. DGL turned to Twilio Flex to deploy a remote contact center, enabling several hundred agents to be up and running in two weeks and according to the DGL team drove a straightforward decision to change. Our results also show the power of our diversified go-to-market supporting companies of all sizes across multiple industries and geographies. In the enterprise, we expanded our relationship with a Fortune 50 company serving millions of customers a week. They are seeing a spike in usage of their buy-online pickup-in store option and they needed a solution to verify the customer phone number at checkout or at pickup.

This company is shifting from buying 80% of their software to building 80% of their software and selected Twilio to build a solution using Twilio Verify, lookup, SMS voice and email. We entered into a new relationship with a Fortune 50 multinational company that needed a more efficient and effective way to issue escalation alerts and notifications from their service now command center. They will be implementing service now notify powered by Twilio SMS and voice to seamlessly deliver these critical communications to global employees and executives to ensure fast response times for their customers. We entered into a new relationship with CBRE Spain, a division of the world's largest commercial real estate services firm like many companies CBRE Spain was trying to imagine what a return to the office would look like. Their head of digital and technology stepped up and built a solution in less than 24 hours using Twilio Studio. With Twilio Voice IVR SMS and email employees can now book a desk over the phone, receive an SMS to confirm more information about the reservation. And finally receive a personalized email with authorization to return to the office.

Globally, we've also had tremendous success. We entered a new relationship with Tokopedia, an Indonesian technology company with a mission to democratize commerce through technology, with the exponential increase in traffic due to COVID; Tokopedia needed a secure and reliable solution to support their growth and selected Twilio for SMS notifications. We entered a new relationship with E.ON next, a company that provides electricity and gas to more than 5 million people in the UK. E.ON next is delivering and developing a new customer engagement platform in an effort to become the leading residential energy provider. They are leveraging Twilio voice, messaging and email to build this new engagement platform. And we are excited to support them in their effort to deliver the best customer experience in the industry.

We expanded our relationship with car finance 24X7, the UK's number one car finance broker guiding their customers from initial loan application to car purchase. They have been a great customer of ours for years and this quarter added Twilio Flex for their customer support and sales contact center based on the flexibility and scalability of the Flex platform. We're excited to continue to build on this great relationship. Overall, I'm very proud of the entire team for their performance through the first half of this year. Our investments in enterprise go to market; international expansion and our partner ecosystem are paying off and are setting us up for long-term success. We remain focused on supporting our customers through the current environment and helping them build customer engagement solutions for the future. And finally to echo Jeff, I'd encourage everyone to register for SIGNAL to hear all about how you can leverage Twilio for your own customer engagement needs. And with that I'll hand it over to Khozema

[Khozema Shipchandler, Chief Financial Officer]

Thank you, George and good afternoon, everyone. Total revenue for Q2 grew 46% year-over-year to $401 million and dollar based net expansion was 132%. As a reminder, this was the first quarter we fully lapped the SendGrid acquisition, so our reported numbers do not require an organic adjustment. Recall that Q1 organic revenue growth and dollar based net expansion were 48% and 135% respectively after adjusting for the one-month stub period.

During the second quarter, we continue to see a net positive increase in usage during COVID-19 relative to our expectations, while some of the more negatively impacted verticals showed a slight comeback, they are still below their pre-COVID levels. However, use cases within healthcare, education, e-commerce and others continued to offset the headwinds, re-emphasizing Jeff's comments earlier we have a well-diversified and resilient business model. Twilio is built for this and we remain cautiously optimistic about the remainder of the year and as enthusiastic as ever about the long term.

Revenue from our Top 10 active customer accounts represented 15% of revenue which was flat sequentially and up from 13% last year. International revenue was 27% of total revenue in Q2 compared to 28% last quarter and 29% in Q2, 2019. WhatsApp contributed approximately 7% of revenue which was flat sequentially. Verizon's A2P or application to person messaging fee contributed approximately $7 million to revenue. As a reminder, this fee is a direct pass-through to customers and does not impact gross profit dollars.

Second quarter non-GAAP gross margin was 56% and was negatively impacted by 100 basis points from A2P fees. Non-GAAP operating profits came in at $10 million stronger than originally forecasted. There were two primary drivers for this outperformance. One higher revenue than forecasted which was the largest contributor and two, COVID related items including hiring, travel and office expenses among others.

Moving to guidance, we continue to watch the same economic indicators as all of you. And it is clear that the macroeconomic environment remains uncertain. In context, we are only providing Q3 guidance and we expect revenue of $401 million to $406 million including A2P fees for year-over-year growth of 36% to 38%. We expect a third quarter operating loss in the range of $10 million to $15 million. Our focus for investment remains the same continuing to build out an R&D center of excellence in India, hiring and go-to-market and systems infrastructure. Given the inherent difficulties of hiring and infrastructure building, while we are all working from home, we do expect some of these investments to continue next year. We are highly confident in the ROI these investments will produce over the long term and are making them with a strong balance sheet.

One other important note to mention with regards to operating expenses is SIGNAL, our customer and developer conference. SIGNAL will take place virtually September 30th to October 1st incurring expenses in both Q3 and Q4. We originally forecasted SIGNAL expenses to be about $10 million before moving to a virtual event and any cost savings from hosting SIGNAL virtually will be reallocated to other marketing areas. We are still planning to host a Virtual Investor Day on October 1st to coincide with SIGNAL. We are finalizing the logistics and will provide more specifics in the coming weeks.

Finally, I wish everyone well and I hope you are all healthy and safe. Thank you for joining. Operator, please open the line for questions.

[Operator]

[Operator Instructions]

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

[Meta Marshall, Morgan Stanley]

Great. Thanks maybe a first question just on how is COVID informed where you or how you continue to evolve the platform? Are there areas where it's been highlighted by customers that they would like more investment or more capabilities? And then second just how has it changed how ISB or SI community has their interest level in working with you guys and level of engagement with those communities? Thanks.

[Jeff Lawson, Founder, Chairman and Chief Executive Officer]

Thank you, Meta. This is Jeff. I'll take the first part of the question and then maybe I'll have George answer the second part. Well with regard to how we're involved in the platform, yes, I think there's two parts to that answer. First, is one of the neat things about being a platform and being APIs that can be used to build so many different things is that we don't necessarily have to like rebuild our product for new scenarios or new use cases that arise because of COVID. In many ways our platform approach allows us to be adapted very well to changing circumstances. And so that really makes our product very perfectly oriented towards uncertain times like this. I've talked about how the need for software agility is one of the key things that the world has needed during this time to respond to unprecedented events. And so I think our platform is nicely oriented towards helping our customers solve problems that maybe didn't even really exist in the world six months ago.

But as far as how we are adjusting our roadmaps, there are adjustments that have been made for example we are investing quite a bit in our video product to respond to new demand and new use cases that are rising or are accelerating in their demand because of COVID. And so that's an area where we're focusing our energy as well as many of the new use cases that are emerging because of it, because of things like contactless delivery or telehealth or distance learning right. These bring about new use cases or growth of existing use cases that may have existed before but are achieving new levels of interest and scale. And then those things will then help us to adjust a roadmap. But like I said as a platform, I think we're really well positioned already to be able to capture new workloads as they emerge it's not like we have to go reinvent our product or build a brand-new product for these emerging use cases. And that's a pretty good attribute of a platform business like ours. With that let me hand over to George to talk about the ecosystem.

[George Hu, Chief Operating Officer]

Thanks Jeff. I think that what we're seeing the ecosystem mirrors a lot of what you said certainly on the ISD side, we've seen traction with companies that are developing new disruptive business models to try and address COVID scenarios. So we've seen growth in ICS that are focused on changing education through remote proctoring. We've talked about our relationship with EPIC and we're definitely seeing more companies in the telehealth space, ISVS want to work with Twilio and then on the SI side, it's also been a catalyst for us to build relationships with SIs, a good example that would be what we're seeing on the contact tracing side that a lot of these contact tracking use cases with state local government. They're bringing in SI to help them do the work and these SIs are being introduced to Twilio and in some cases deepening their relationship with Twilio because of this and as they learn more about us and see what's going on with our technology, they're more and more excited about it because it's such a great fit for this time and place. So overall, I would say we've definitely seen it as a catalyst for improved growth and relationships in some of these specific areas great.

[Operator]

Your next question comes from the line of Alex Zukin with RBC Capital. Your line is open.

[Alex Zukin, RBC Capital]

Hey, guys. Thanks for taking my question and congrats on a great quarter, maybe just two for me. The first maybe just help us understand a little bit around the magnitude of the headwinds and how much they've improved and whether you're seeing some of these new tailwinds as a structural change to the way that your product is even perceived in the marketplace? And then there's a follow-up just to maybe comment on dollar based net expansion expectations for 3Q and anything we should keep in mind of as we model that metric for the rest of the year.

[Khozema Shipchandler, Chief Financial Officer]

Yes. Hey, Alex, this is Khozema. Thanks for the question. Around dollar based net expansion, I mean that's not a metric that we guide to, and so I would say we feel good about the broad-based strength of the business. Generally we feel great about the 132 that we put up in the quarter and we do and we've said this for a long time, we anticipate that that metric over some period of time will fade out. I mean it's just law of large numbers at some point but we feel great about kind of where we're headed right now and the performance of our customers.

In terms of some of the impacted industries, I think that was the first part of the question. The impacted industries that we called out there they're still a little bit down. I will say that we are starting to see some green shoots, we physically called out in the past rideshare, hospitality, travel and we are starting to see a modest rebound. I wouldn't say that they're anywhere near the levels that they've been at historically. But we are starting to see a little bit there. And then I think on the plus side some of the other areas that Jeff had called out previously around education, health care, e-commerce even philanthropy, I think these are now becoming kind of secular tailwinds for us. And so I think we're starting to see structural changes and consumer behavior which are going to drive some ongoing and long-term strength in those industries for us.

[Alex Zukin, RBC Capital]

Perfect and maybe just if I could sneak one more in. Anything you guys can talk about with respect to election related spend and kind of where you've seen that trend either in the first half and what's the right way to think about that in the next quarter?

[Khozema Shipchandler, Chief Financial Officer]

Yes. We're not we're not really breaking it out, Alex, in terms of the revenue impacts of that traffic. What I will say is that in Q2 we did see a healthy amount of political use cases in the quarter and I think as you can probably imagine that with a lot of the events and rallies being canceled staying in touch with constituents via the products that we offer email, messaging, voice becomes really important. But we haven't really changed our assumptions around political traffic for the remainder of the year, but we are starting to see some activity there.

[Operator]

Your next question comes from the line of Ittai Kidron with Oppenheimer & Co. Your line is open.

[Ittai Kidron, Oppenheimer & Co. Inc]

Thanks. Hi, guys. Congrats. Fantastic quarter. I guess I wanted to have a couple of questions. First of all, George on the international front. I piloted a few activities there but it seems like the growth over there on a year-over-year basis decelerated quite substantially. So help me understand how much of that was business activity or is there anything unique to the international markets maybe because --maybe there's event effects impact here, would love to get an insight on that and then Khozema, I just want to make sure I understand your comments on the OpEx and I certainly understand the higher revenue as a driver for higher operating margins, but last quarter you've kind of detailed the plan to aggressively higher this year and pull higher from next year into this year. Are you basically saying you're not able to run at the pace that you were planning to do?

[George Hu, Chief Operating Officer]

Why don't I start and then because Khozema can go into the hiring pieces? This is George. So in terms of the international mix certainly it's changed marginally as Khozema talked about in the numbers in terms of our percent of revenue from international, largely we attribute that to relative COVID impact honestly so it's like a slight difference there in terms of what we're seeing in other markets relative to North America. In North America, we've definitely seen, I would say maybe globally there's been similar impact in certain industries but we've definitely seen some of the counter balancing forces and certain industries I've picked up to be a little bit more active in North America. And that's it's probably also a little bit about the fact that our distribution's a little bit more mature in North America. But it's nothing like these are small deltas so we're not concerned about it; it's just something that we think is largely temporal as we all go through this pandemic impact together. I'll turn it over Khozema.

[Khozema Shipchandler, Chief Financial Officer]

Great, Ittai. Part of your question George was also around FX, I wouldn't say that FX was a material impact for us in Q2. Obviously, rates have moved a little bit around and we'll watch that for future quarters. In terms of your question around operating expense, you're right that in part slower hiring was part of the goodness that we saw in Q2. I would say the preponderance of it honestly was driven by our revenue beat. So I just want to kind of put those in proportion to one another, but what we saw in Q2 and it was a little bit of a continuation of what we saw in Q1 is that we continue hiring, we continue making investments in infrastructure we called out a few of the specifics around the R&D center of excellence, our investments in go-to-market systems and infrastructure. The reality is it's just harder to do these things at the rate that we'd anticipated when we started the year and we keep updating that as we go through the year. We're hoping to catch up some of that in Q3 but I think there's going to be a little bit more spend associated with that as we go.

[Operator]

Your next question comes from the line of Nikolay Beliov with Bank of America. Your line is open.

[Nikolay Beliov, Bank of America]

HI. Thanks for taking my questions and thank you so much to the team for making it easier for all of us to dial into this call. And I'm just curious is that the Twilio interface you're using for the first time this quarter?

[Jeff Lawson, Founder, Chairman and Chief Executive Officer]

It is not Twilio interface for this quarter.

[Nikolay Beliov, Bank of America]

Okay. Look forward to the new interface in the future. My question is around the Flex, clearly great traction consistent with our field checks and one thing that we heard from your Flex partners which tend to of course sell the small Flex deals is that well Flex is more of a framework rather than actual products. It takes on average one to three months to install Flex. And you guys in your prepared remarks you were talking about the two-week implementation cycle which is amazing. So this still seems to be some lingering perception that Flex is more of a framework rather than an actual product. Is that an issue in your sales cycles and how you guys addressing that, if that's the case?

[George Hu, Chief Operating Officer]

Well, this is George. I mean certainly like the value proposition of Flex is around the word flexibility right. The product can be highly tailored to the needs of a customer which is one of the great selling propositions of the product. Obviously to do that tailoring that customization requires some amount of time and it really depends on the complexity of the use case. So we definitely can get customers up and running for to get started within a couple weeks and get a lot of value out of it. Then usually those customers over time want to do more and more. So I really, I think depends on the nature of the use case just moving agents’ home or setting up an IVR can be relatively quick to do a full rip and replace of a complex contact center is realistically not going to happen in two weeks. I don't care what product in the world you're looking at but Flex definitely is a fantastic product. You're right. It is getting traction in the marketplace, the value proposition is resonating and I think those field checks you're doing are on in terms of the demand and I think as people get more educated about the platform and the value proposition, I think people should realize that this model is actually the future. So we're excited about it and we're seeing excitement in our partner community as well.

[Nikolay Beliov, Bank of America]

And a quick follow-up to Khozema, what was the linearity in the quarter April versus May versus June and what trends are you seeing in the month of July? That's it for me. Thank you.

[Khozema Shipchandler, Chief Financial Officer]

Yes. I'm not going to comment on the current quarter. I would say I mean it's been pretty steady. I mean we don't typically break out linearity in terms of our performance, but we're seeing pretty consistent results through the balance of the quarter.

[Operator]

Your next question comes from the line of William Power from Baird. Your line is open.

[William Power, Robert W. Baird & Co]

Okay. Great. Thanks, yes, a couple of questions. I guess probably first for Khozema as we think about Q3 guidance, the revenues up a bit sequentially but not to the degree that we've seen in past years. So I guess I just wonder if you can comment on the broader trends you're seeing in the business. Are you seeing any kind of meaningful slowdown in traffic and to what degree perhaps is conservatism part of that just given some of the ongoing uncertainties? And then I'd love to come back to Jeff, some of the comments on new use cases. I wonder if you could expand perhaps would you be with some of the more innovative use cases and how you're thinking about the staying power of some of those use cases as we kind of move past this pandemic at some point.

[Khozema Shipchandler, Chief Financial Officer]

Yes. Hey, well this is Khozema. I'll go first and then I'll turn it over to Jeff. I wouldn't call out anything specific in terms of our Q3 guidance. I mean we've delivered great results in Q2 and we continue to see broad-based strength across a very diversified business. As I mentioned on the call, we continue to see all the same economic indicators that you do and I think there are still some questions around the macro environment. So we're definitely cautiously optimistic about Q3 and the second half of the year more broadly. We're extremely optimistic about the longer term, but we're having a kind of a hard time predicting the future in the very near term. And so I think our Q3 guidance putting aside in sequential certainly shows continued strong growth on a year-over-year basis and we're very comfortable with the range we provided today. With that maybe I'll give it over to Jeff.

[Jeff Lawson, Founder, Chairman and Chief Executive Officer]

Great. Thanks, Will for the question. Yes, so I think we've seen so much innovation go on in the last say six months in related to COVID and I look at this as acceleration. I think that's how our customers do too. We mentioned that survey that we did which essentially COVID is accelerating plans and things they might have dabbled in or maybe taken their time with have been really accelerated because of the necessity of COVID and so I look at some of these really innovative use cases. Like one of them that I love is the curbside pickup and like I've been a customer of these curbside pickup workflows at retail businesses where you order online and then basically you drive by and it's a very streamlined workflow where they basically throw your bag into the backseat of your car and you keep driving. And it's like if you're going to the store to pick up, I don't know like a bag of marshmallows and like would you want to walk into the store and have to go find the right aisle or do you want to like use a great convenient interface on your phone and then basically drive up text something like I'm here and have them put in your car.

And I think that even after COVID is over these workflows are going to be really powerful way for bricks-and mortar retailers to provide a great customer experience leveraging their online presence as well as their offline and bridge and water presence. What are some of the other use cases that I think are great? I think telemedicine again is a fantastic set of use cases. I'm very happy that we invested in HIPAA compliance across many of our products early starting like 18-months ago. So that we could deliver that functionality earlier this year to our customers because you think about the convenience of a telemedicine visit, for a lot of visits I think doctors are finding that the convenience level for a patient to not have to take half a day off of work and drive sometimes to a whole other city to get to the medical center where they've got the specialist with the expertise but rather just fire up your camera almost like just a meeting that you might have in your calendar for half an hour be able to see a doctor and get the same level of care for a substantial number of the medical visits that go on in our country. That's pretty game changing for people's ability to get care and so I think organizations that do a really good job of delivering video care is going to essentially have an advantage in the market with patients.

Another particularly innovative use case that we've seen with bank branches, many of them closed being able to open accounts all done via video. That's an emerging use case to replace that in person having to fulfill on know your customer be able to have to go into a bank branch open an account that can now be done virtually and then I thought the customer that we talked about on the call actually CBRE in Spain, if you think about that solution like they need people to go back to work but work is going forward is not going to be like work used to be. Like I think a lot of companies are not just going to have liked one desk per person and the big conference rooms that everyone used to have liked the nature of what office environments are going to be like is going to change. And CBRE in the real estate space is kind of ahead of the game here, if you will, in that they are deploying these workflows for like do you want to go in basically essentially submit your desire here you get notified, if you're allowed to go in you get assigned a desk, you get everything digitally reassigned your phone for that day like those are the types of new workflows emerging that will enable offices to be open safely, conveniently and using all this digital technology to manage a workflow that basically didn't exist six months ago. Organizations like CBRE are really on the leading edge and I think that's and again I think a lot of those office environments are going to be changed permanently not just temporarily because of hostelling and people working more remotely that'll probably go on long into the future.

[Operator]

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

[Michael Turrin, Wells Fargo]

Hey, there. Thanks. Good afternoon, all. Two questions for me. I'll ask both up front, net customer ads the pace there continues to impress, you're now at 200,000 active customers. Is there anything happening there more recently with some of the new use cases that is pulling some potential new customers forward or can that trend persist maybe not at the pace we've seen but given where penetrations are versus the total opportunity? Just would be curious to hear your view there. And then George, I know it's relatively still early in the go-to-market evolution for Twilio, but is there anything you're seeing that could lead to more verticalization of the sales force and a few focus industries like healthcare, financial services or education? Thanks.

[George Hu, Chief Operating Officer]

This is Georgia. Thanks for the question. I'll take a crack at both of those and then certainly anyone else can chime in. In terms of the net, the net customer ads I mean definitely what we've seen consistently across our funnel is a lot more experimentation happening as people trying to figure out how to adapt to changing circumstances. I think that's all part of this digital acceleration trend that just talking about. It's not certainly confined to one use case or one specific subject matter. And what's interesting is as we look at our numbers, we kind of document or classify all of our inbounds by use cases they come in. And it's not like they're all focused on one thing or even as certain early COVID use cases have come back a little bit. They've been replaced by other things. So I think it's a very diversified interest in digital acceleration across different industries and geography. So I think that's what's healing that.

In terms of the verticalization, we, I do think there is an opportunity for that for us to do more of that in the future. We have some great specialist resources right now already in areas like health care and financial services, as well as in the -- we're seeing opportunities in local, state local government for example contact tracing. So we're certainly today still mostly a geo and segment-based distribution organization, but I do see an opportunity for us as kind of the normal course and speed of things over time to do more vertical things. And we're really excited about something we're seeing in healthcare for example after our HIPAA capability announcement earlier this year. It's really, I think open the door for us to be able to have more and more of those conversations which is really, really exciting for us.

[Operator]

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

[Derrick Wood, Cowen]

Thanks and congrats on a great quarter. Jeff your survey was pretty astonishing particularly around finding that the average enterprise is pulling forward their communication engagement strategy by six years. And I'm just wondering if you could give us a flavor of how the scope of engagements is changing for you guys particularly with larger enterprises? And I guess I'm looking at -- are companies looking to do bigger overhaul of their communication technologies at once or take on bigger pieces or are you seeing kind of an acceleration of replacing legacy or seeing more executive level involvement? Just would be great to hear how you're seeing the engagements evolve.

[Jeff Lawson, Founder, Chairman and Chief Executive Officer]

Yes, absolutely, Derrick. So I think what we're seeing is a like a broad set of use cases at a broad set of companies. And so it's differing a bit by company, obviously, many companies are focused on the short-term needs first right. When you had to send all of your workforce home and they weren't able to do their jobs anymore well that's the top priority for a company. And that's kind of what we were looking at early in COVID and but as like as I would call COVID response version one which was like scramble to get stuff done basically over the course of like a weekend or a few days, as that stabilized a lot of organizations, a lot of industries I think have started to think about okay what does version two of this look like. What do we really want? And I think that's where you're starting to see like our deal with EPIC in the healthcare space, which is hospitals wanting to put in a vertically specific solution for healthcare that will serve them long into the future as opposed to a more horizontal solution that was maybe version one of that solution.

And so I think that's sort of a trend that you're seeing play out which is like first there's the kind of initial response and then playing out where people are building more integrated, more use case or vertically specific answers to how they're building. And I think the other thing is given the urgency of these use cases the importance of solving these digital transformation problems quickly during COVID, well that is accelerating many of the introductions to new businesses that we're seeing. I'm sure George has examples of that as well as just the strategic importance of the work that companies are doing with Twilio. We, our importance as a strategic partner to companies has grown quite a bit this year because in many cases the use cases and the workloads that we're seeing have direct line of sight to CEO visibility and c-suite importance, where maybe before COVID they weren't quite there yet and now they are definitely in the line of sight for key decisions and key strategic initiatives are going on at these companies. I don't know George is there anything you would add?

[George Hu, Chief Operating Officer]

I think that's spot on and I think we've already talked about in our kind of core script some of the logos that we've been able to bring in some new some existing. But I think the common thread is that if you look at all of these customers we talked about, we're talking to and we're selling to a higher level than before. The decision is moving quicker and oftentimes what we're seeing is that these projects are either a phase one to something bigger, so there's more on the plate whereas before maybe it was just an isolated transaction and/ or these are expansions of existing relationships which just shows that we're continuing to go grow in our depth and quality of relationship with customers. And I'm very excited about SIGNAL. I think we're going to have our best showing yet for example for our creator summit which is our executive track. I think every year we see the titles get a little bit higher, the conversation's a little bit more strategic and I certainly anticipate this year at SIGNAL we'll have more of that even as a virtual event.

[Operator]

You next question comes from the line of Alex Kurtz with KeyBanc Capital Markets. Your line is open.

[Alex Kurtz, KeyBanc Capital Markets]

Thanks. Can you guys hear me, okay? Great, just thanks just back to Flex now that you have more time looking at deals in the pipeline and seeing how customers are interacting with the platform, how would you say it's materializing as far as deal size now that you've gotten a couple more quarters in it, it's just staying roughly the same kind of landing size and the first couple of iterations of how people are using it? Then I guess the sales cycles, it's a little bit different than the core platform and how it's deployed. So I just need a little bit more context as you guys have taken a little bit more time to look at the pipeline and how it's progressed so far.

[George Hu, Chief Operating Officer]

I think it's hard to generalize it because if you just look at like the raw average dollar value per opportunity. I think it'd be misleading in the sense that we are seeing, yes, some large transactions in the pipeline that we're working on but I think a lot of these like what COVID has done is it's really triggered a lot of these shorter term, I shouldn't say shorter term but like initial deployments that people are in a kind of as Jeff called it phase one COVID getting, people getting something to get it done and contact recent is a great example where even if eventually they want to get the thousands of contact tracers, the starting point typically is a much smaller number than that. So if you look at the initial deal size, I think it's kind of misleading.

What we are seeing is faster engagement for certain projects that are more time sensitive and also the beginning of what we hope to be larger and larger projects as some examples I mentioned plus DGL is a good example where we think there's an opportunity to do even more with them over time. So I think some of these initial deal sites are precursor to bigger opportunities for us down the line. And I think that's what we're excited about is we're planting a lot of seeds during this period. And we're getting the word out about Flex and people are really liking what they're seeing which is really great.

[Operator]

Your next question comes from the line of Heather Bellini with Goldman Sachs. Your line is open.

[Heather Bellini, Goldman Sachs]

Great. Hi. Most of mine have been answered but I just had two quick ones from Khozema, just on the A2P for the third quarter is it should we be assuming just as a baseline roughly the same as the $7 million you got in this past quarter? And then I had a question, Jeff, just if you go back to January 1st pre-COVID being on anyone's mind. Can you kind of think about what your three-year outlook was for Flex and adoption and you compare it to how you feel now? How would you characterize the difference and how you're feeling about just kind of the trajectory of that business? And that's it. Thanks.

[Khozema Shipchandler, Chief Financial Officer]

Hey, Heather. This is Khozema. I'll take it first and then turn it over to Jeff. In terms of A2P, I would say roughly order of magnitude the same, it's obviously going to vary a little bit with volume, but you're in the ballpark for sure. Jeff?

[Jeff Lawson, Founder, Chairman and Chief Executive Officer]

Hey, Heather. This is Jeff. So, yes, as far as Flex goes, I mean I think that the Flex is already off to a fantastic start as a product. I think it's an extraordinarily compelling value proposition for customers to be able to finally move these workloads into the cloud right. And as we've talked about in the past, it's -- we talked to analysts it was something like 85% of contact center was still on prem. Despite the fact that customers wanted to move these workloads into the cloud and Flex was a product that it was allowing them to do that. And I think COVID has only accelerated the adoption of that idea. We talked to customers. There are a lot of customers who had plans to move their contact centers into the cloud and these were multi-year roadmaps and those roadmaps have just been getting compressed. Now we've talked about some of the more extreme examples of like, oh, they got it done in a weekend and those are great examples to talk about. But I think the reality is that the majority of these ones they're not going to get done in a weekend obviously, but those roadmaps have been compressed from years probably down to quarters.

And I'm really excited by the conversations that we're having with a wide range of companies about the long-term plans for their contact centers. And how COVID in some ways has been an accelerant to make decisions, to invest resources and to really modernize how they engage with customers using these digital channels and part of the driver of that as we've talked about the past is work from home agents, the flexibility that the cloud enables for those employees to work from anywhere, which I think is really important given the agile workforce that everybody is planning for now not knowing exactly where those employees are going to reside when they do their work, but also because new channels are enabling new ways to flexibly and at scale be able to communicate with customers things like messaging. And one of the things we hear pretty consistently from customers on Flex is that messaging so SMS or WhatsApp or Facebook messenger using these messaging channels to be able to engage with customers in many ways is game changing. And I think Flex is the best messaging-oriented contact center out there.

And so I think that's another driver that was existing before COVID and now because scaling up these digital channels is getting even more important. Flex is an even more valuable -- value proposition for customers because of it. So I think there are multiple reasons why Flex is a great product for the market before COVID and not because of COVID that's even accelerated.

[Operator]

Your next question comes from the line of Mark Murphy with JPMorgan. Your line is open.

[Mark Murphy, JPMorgan Chase & Co]

Yes. Thank you, I'll add my congrats. So, Jeff, we've heard some commentary from your peer group that the increased usage that was driven by COVID-19 peaked back in April and then it has dissipated month over month but it's remained at an elevated level.

Some of that might have related a little more to the video conferencing scenarios. I'm just curious did you sense that to any extent or are your use cases broader to such an extent that it doesn't apply or that it's kind of getting counteracted by the other scenarios that are newly emerging?

[Jeff Lawson, Founder, Chairman and Chief Executive Officer]

Well, given that we have an almost entirely usage-based revenue model by the magnitude of our performance, our beats this quarter. I think you would say that usage continued to grow. And when you look at the factors as Khozema talked about in early in the prepared remarks, there are some headwinds to certain industries and we support those customers helping them to build through the crisis, but they have seen decreases in usage for certain of those key travel, hospitality type industries. But that's been more than offset by increases across the board in a number of other industries as so many different kinds of companies in so many different verticals have had to invest in, digital accelerate those digital plans and really build great digital customer engagement to be able to serve their customers during this time. And long beyond because this is clearly the trend that the world's been on and so those plans that have been accelerated per survey companies took their plans and accelerated them by an average six years. And that's a pretty powerful tailwind for us.

[Operator]

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

[Matt Stotler, William Blair]

Hey, guys. Thanks for taking my questions. First one just another question on Flex. There have been some positive headlines around Flex adoption, a lot of interesting use cases and ways it's being leveraged in this current environment. We'd love to touch base on where we are in terms of feature functionality. I know this is a year that you guys have positioned as kind of reaching that critical feature functionality for broader adoption plus an update there and any compelling opportunities that you see to add further capabilities from here.

[George Hu, Chief Operating Officer]

This is George. I'll comment from the field perspective and then maybe if Jeff wants to comment from a product perspective. Certainly, we are executing our plan. So we're definitely seeing the product velocity be on pace and so we are delivering more and more capabilities as you would expect so and we're seeing that play out in terms of our success in the field. So overall, I think we feel good about our product velocity always more to do with the nature of software and this is a critical year for us but overall we're happy with the progress. I don't know Jeff if you want to add more color.

[Jeff Lawson, Founder, Chairman and Chief Executive Officer]

Yes, absolutely. There are always more features of functionality to add based on customer need. I think that the key thing that we have done with Flex is get the sort of the bones of the product right. The architecture, the core value proposition, the programmability model that allows customers to go build on top of it. Those are things the industry hadn't seen before and we introduced in a way that enables companies to move really sophisticated workloads to the cloud in a pretty unprecedented way. And so when it -- while there is the feature roadmap that we're always investing in. I think the hard things to get done really that architecture that that core foundation to build upon is so good.

As it relates to the sort of foundational features that we keep building, absolutely. We've been knocking those out, probably the biggest requested one was outbound dialing. We knocked that one out in Q1 and we continue going down the list to finer and finer grained kind of foundational features for our customers. We have re-prioritized some of those in favor of COVID related features of functionality that customers have needed to scale those COVID related workloads in this year. But we feel great about the progress we're making around those features and the customer adoption and customer feedback that we're getting as it relates to both the kind of foundational elements, the architecture and the core value proposition, as well as the roadmap for building out those features that help customers along.

[Matt Stotler, William Blair]

Right, got it. That's super helpful. And then just one quick follow-up as somebody watching before I mean the pace of customer adoption has really picked up through the last four quarters, 10,000 plus net ads, but obviously still a lot of revenue coming from existing customers and net dollar retention rate's very positive so what does the land expand motion look like it's been a big part of your business historically. What does that look like in this COVID environment? And are you seeing any trends towards a larger initial contracts or initial usage? Thank you.

[George Hu, Chief Operating Officer]

I would say we haven't seen dramatic trends in that. I would say as I've said before that we're seeing a lot of interest in terms of signups, experimentation. So again I think if you just look at raw count of dollar per new signup or things like that, I don't think that's the story here. I think the story is we are seeing just more interest on top of the funnel and we are seeing some of the use cases drive significant growth for us even as other industries are being impacted. So I think that's been consistent. We are doing very well with our top customers as you alluded to and definitely what we're seeing in the world in general is that this pandemic is creating certain companies that are, it's a headwind for some; it's a tailwind for others. And for the ones who it's a tailwind for we're definitely growing along with them and doing very well.

So I think that's kind of behind some of the numbers and trends we're seeing.

[Operator]

Your final question comes from the line of Rishi Jaluria with D.A. Davidson. Your line is open.

[Rishi Jaluria, D.A. Davidson]

Hey, guys. Thank you so much for squeezing me in and nice to see continued strong results in this environment. Just two questions for me. First in the discussion on these new verticals and new use cases. I understand your platform people are going to always find new ways to use the Twilio platform and that's I think a really exciting part of the story. Is there potential that one of these kinds of newer verticals or newer use cases can be smart productized in the same way that you're doing with Flex in the contact center. And then I want to ask talking about gross margins, even if we control for A2P right, it looks like gross margins declined about 70 basis points sequentially at 260 basis points year-over-year. Just any color you can provide on this because I know there are a ton of moving pieces and what drives gross margins. Thanks a lot.

[Jeff Lawson, Founder, Chairman and Chief Executive Officer]

Yes. This is Jeff. I'll answer the first part of the question. Then I'll hand it over to Khozema. So as far as the like new use cases that are emerging because of COVID. I think that one of the things I've talked about in the past is the great things about being a platform business is that we deliver these building blocks to the developers of the world and to all of our customers. And they build solutions to the big problems that they have in their business. And by the very fact that customers are taking our building blocks and are building solutions to big unsolved problems like the fact that they're taking their time, their precious developer resources to go build on our platform indicates that there is probably an opportunity. And when we see areas where many customers are going and essentially inventing the same thing, we see that as an opportunity to go and essentially assess whether this is a big broad need by the market. And whether by us building products there we can accelerate all of our customers' ability to adopt that kind of use case and that's exactly what led us to the opportunity with Flex.

And I think we do continue to see opportunities that arise that have been maybe not created because of COVID but accelerated like greater macro trends that have been accelerated because of COVID that our opportunities for us to go address with future products. And with that I'll hand it over to Khozema.

[Khozema Shipchandler, Chief Financial Officer]

Thanks Jeff. Hey, Rishi. There's nothing really specific that I would call out around gross margins. We pointed to the A2P impact and as we've said in the past the gross margins can bounce around a little bit due to a variety of factors. We've in the past talked about customer mix or geographic mix products, FX what have you, there's really no change to our model. We still see gross margins in the mid to high 50s for the foreseeable future. So no real thing to call out there.

[Operator]

There are no further questions at this time. Thank you for participating. You may now disconnect.