Twilio Inc

NYSE:TWLO

Earnings Call Analysis

Twilio Reports Strong Q3 2024 with Solid Revenue and Profitability Gains

In Q3 2024, Twilio achieved $1.134 billion in revenue, up 10% year-over-year, driven by strong performance in its communications business, particularly messaging. The company generated $182 million in non-GAAP income from operations, reflecting a 34% increase from the previous year. Free cash flow reached $189 million. For Q4, Twilio projects revenue between $1.15 billion and $1.16 billion, indicating 7% to 8% growth, and expects to raise full-year operating income guidance to $700 million to $710 million. Twilio is optimistic about leveraging AI to enhance customer engagement and is tracking ahead of its goal for GAAP operating profitability by 2025.

Strong Quarter Performance

In the third quarter of 2024, Twilio reported revenue of $1.134 billion, reflecting a growth of 10% year-over-year, and exceeding prior guidance. This strong performance was supported by a $182 million non-GAAP income from operations, which represents a 34% increase compared to the previous year. The company also generated $189 million in free cash flow, marking a positive trend in cash generation. The results demonstrate Twilio's commitment to innovation and operational efficiency, as they continue to expand their product offerings.

Strategic Focus on AI and Customer Personalization

Under CEO Khozema Shipchandler, Twilio has intensified its focus on integrating AI and machine learning into their product suite. This strategy aims to enhance customer personalization through contextual data, as evidenced by a successful use case with a global business supplies retailer, which achieved a 592% increase in sales per email campaign through AI-driven recommendations. The emphasis on AI sets Twilio apart from its competitors in the Communications Platform as a Service (CPaaS) market, positioning it well to capture a significant growth opportunity.

Product and Service Highlights

Twilio's communications business generated $1.060 billion in revenue, up 10% year-over-year, with significant growth attributed to messaging and email services. The ongoing migration of the Segment business to new infrastructure aims to improve efficiency and is expected to enhance gross margins post-migration. The company is also realizing positive momentum from its newly released products, such as the messaging deliverability dashboard, which aids customers in optimizing their messaging strategies.

Financial Metrics and Margins

Non-GAAP gross profit reached $600 million, translating to a non-GAAP gross margin of 52.9%. This margin saw slight declines as hosting costs are expected to rise in Q4 due to the holiday season. Despite these challenges, the overall financial picture remains strong with continued improvements in operating margins. Non-GAAP operating margin for the communications unit was reported at 51.8%, flat quarter-over-quarter, while the focus remains on achieving breakeven for the Segment business by Q2 2025.

Future Guidance and Market Outlook

Twilio has provided Q4 revenue guidance of $1.15 billion to $1.16 billion, which equates to a year-over-year growth of approximately 7% to 8%. Additionally, the full-year organic growth guidance has been increased to 7.5% to 8%. For Q4, non-GAAP income from operations is projected to be between $185 million to $195 million, raising the full-year non-GAAP income from operations outlook to $700 million to $710 million. Looking ahead to 2025, Twilio anticipates revenue growth in the same range of 7% to 8%, buoyed by improved volumes in core business segments and a more normalized macroeconomic backdrop.

Commitment to Shareholder Returns

Twilio remains focused on enhancing shareholder value through its ongoing $3 billion share repurchase program. To date, the company has repurchased over $2.7 billion in shares, with plans to complete the remainder by year-end. This proactive approach to capital management reflects Twilio's confidence in its operational strategy and financial health.

Earnings Call Transcript 2024-Q3

[Operator]

Good day, and thank you for standing by. Welcome to Twilio Inc. Third Quarter 2024 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Bryan Vaniman, SVP of Investor Relations. Please go ahead.

[Bryan Vaniman, executive]

Good afternoon, everyone, and thank you for joining us for Twilio's Third Quarter 2024 Earnings Conference Call. Joining me today are Khozema Shipchandler, Chief Executive Officer; and Aidan Viggiano, 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 earnings presentation posted on our IR website at investors.twilio.com.

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-K, in our forthcoming 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 Khozema and Aidan, who will discuss our Q3 results, and then we'll open the call for Q&A.

[Khozema Shipchandler, executive]

Thank you, Bryan. Good afternoon, everyone, and thank you for joining us today. Twilio delivered a strong third quarter. We exceeded our Q3 guidance delivering $1.134 billion in revenue, up 10% year-over-year, and generated $182 million in non-GAAP income from operations.

We also delivered another strong quarter of cash generation with $189 million of free cash flow. I'm encouraged to see the acceleration to double-digit revenue growth this quarter, alongside strong operating leverage and continued product innovation. Our commitment to financial discipline, operating rigor and innovation remain key guideposts for the team, and I'm proud of what we accomplished in Q3.

Since becoming CEO at the start of the year, I've met with hundreds of customers in nearly every industry across the globe. In my conversations with customers, many of the problems they're encountering can be solved by greater personalization vis-a-vis communications plus contextual data plus AI.

Our concerted focus on embedding AI and machine learning throughout the Twilio platform has resulted in a differentiated offering that strategically positions us to capture a massive opportunity as we leverage the strength of our platforms, the leading CPaaS and supported by unmatched data tools, including segment to minimize complexity and create better customer outcomes.

More customers are turning to Twilio because we deliver a stronger ROI, driving demonstrable results that help customers increase their revenue and reduce their costs. By integrating AI with our core product suite, we're able to automate capabilities, boost productivity, and drive personalization at scale.

As an example, a longtime customer that is a global business supplies retailer, has been using our AI recommendations product, which leverages machine learning to automatically determine a specific product, brand or category, a customer is most likely to purchase. The company recently ran an e-mail campaign targeting customers most likely to purchase Apple products and saw a 592% increase in sales per e-mail, this is just one of the many examples of the unique value that Twilio offers, helping brands create better engagement, deliver greater value and build more trusted customer experiences.

AI presents a huge opportunity to improve and expand the impact of CPaaS solutions to truly enhance the customer experience. We are well positioned to win in the age of AI because unlike other CPaaS players, our true value comes from the integration of communications with data. Twilio uniquely combines communications and customer data to help brands drive deeper customer engagement.

What sets Twilio apart is our ability to unify this valuable contextual data, whether it's real-time triggered by customer interactions or stored in a data warehouse or a system of record and help brands to activate it. With our platform, we're already powering these intelligent interactions at scale, whether it's personalized engagement via unified profiles on IVR and Flex or fraud prevention with our security products.

We're powering over 8 trillion e-mails and billions of messages annually and ingesting hundreds of thousands of events per second. We recently announced our integration with OpenAI's new real-time API, making it easier for Twilio's customers and developers to build powerful conversational virtual agents.

As the world of conversational AI evolves rapidly, this is an exciting milestone. It enables customers to take advantage of OpenAI's flagship multilingual and multimodal GPT 4.0 model to create solutions and build virtual agents for IVRs that feel more human making these advanced tools accessible for businesses of all sizes.

Now let's turn to our business highlights. Our Twilio communications business had a strong third quarter with revenue of $1.060 billion, up 10% year-over-year. Our quarter-over-quarter growth acceleration was driven predominantly by strength in both messaging and e-mail. As we've referenced on previous calls, our near-term growth will be fueled by our ISV customers, self-service enhancements, and cross-sell opportunities.

We're seeing good performance in each of these areas and a continued bright spot is our ability to deliver increased value through software capabilities built on top of Twilio's core channels. Verify, SMS pumping protection, engagement suite and voice intelligence, leverage AI and machine learning to drive better outcomes which include things like combating fraud and providing better data analytics in real time.

These products are designed to deliver smarter and more trusted communications which is key to unlocking more value for our customers. Furthermore, as we focused on integrating our communications products with segments products and contextual data, I've been excited to see how products like personalized virtual agent leverage Twilio's unified profiles to help brands better understand their customers, and make incremental changes to improve the customer experience through every interaction.

Another area driving improved messaging volumes is our platform feature updates that now give customers greater transparency into communications deliverability and engagement. Within our console, messaging customers now receive a deliverability score with personalized actionable instructions from our AI agent so that they can immediately take action to remediate messaging deliverability errors.

By providing analytics we're radically simplifying the messaging experience for developers, leading to better engagement and ensuring that the message they intend to send are delivered error free. In addition to enhancing our current products, in Q3, we released new innovations to support branded communications.

RCS Business Messaging went into public beta, which is key for brands who want to deliver a more custom personalized experience. In a recent Twilio survey, we found that 75% of consumers who received a branded text set to increase their trust in the communication. Our CS business messaging improves the branded experience through rich content and interactive messaging features, including carousels, high-quality media, content cards and location sharing.

Customers like Fresia have deployed RCS capabilities to build brand trust and increase message open rates and one of our ISV partners, Hive, will leverage RCS to enhance marketing campaigns for their customers in the live events industry, driving greater fan engagement and boosting ticket sale conversion rates.

We also saw exciting wins with branded calling, which allows brands to display their name, logo and call reason when placing calls to customers. Care Signal light beams deviceless remote patient monitoring company needed a cost-effective way to improve patient pickup rates and achieve health outcomes in the process. With Twilio branded calling, they've been able to improve call pickup rates by 6% to 7% in just 3 months. In the future, we expect this type of incremental value will accelerate as we continue to help brands use their contextual data to unlock smarter and more personalized experiences.

Turning to our Twilio segment business. Segment delivered revenue of $73 million flat year-over-year as we continue to focus on and make progress against the priorities we outlined in the operational review earlier this year. We ended the quarter with an increase in our win rate both quarter-over-quarter and year-over-year and a reduction in churn and contraction.

While there is more work to be done, we're encouraged by the progress that we're making and segment remains part of our long-term strategy, enabling us to differentiate our communications products by infusing contextual data while we continue to innovate for stand-alone CDP buyers.

With respect to product innovation, we continue to enhance our data warehouse interoperability capabilities and improve customer time to value by graduating many features to GA. For example, with segment products like Data Graph and Linked Audiences, we are addressing key pain points that our customers are trying to solve such as removing data silos and disjointed customer profiles.

We have advanced our data warehouse integrations with Databricks, Snowflake, Google BigQuery and Amazon Redshift so that customers can activate their data in meaningful ways to drive more personalized touch points with consumers. This is an important step in our unified profiles offering as we're making it easier for customers to leverage through existing data from websites and mobile apps and combining it with data in their warehouse from systems of record like CRM, contact centers or ERP to deliver personalized e-mails and communications.

We are seeing promising results, and we're excited to add additional integrations with other major data warehouses moving forward. Our new features and integrations for advertisers to create targeted campaigns began delivering promising results. First, our generative audiences feature that uses generative AI to create audiences with natural language prompts is significantly reducing the time and resources required to build targeted audiences for customer engagement campaigns.

Over 25% of our segment CDP customers have already started taking advantage of this new capability in the few weeks it's been made globally available. Second, we've expanded and created new integrations with Amazon, Google, LinkedIn and Meta, giving marketers the ability to activate their data in campaigns across these platforms and reduce their customer acquisition costs.

As an example, the Motley Fool needed an out-of-the-box integration to help build, manage and activate audiences. With Segment, the Motley Fool was able to increase its operational efficiencies by automating processes, accurately target paid ad campaigns to decrease its cost per acquisition, and make the experience more relevant for its premium members, helping with retention and lifetime value.

I am incredibly energized about the opportunities ahead. The solid quarter that we delivered and significant progress we made against our financial goals is a testament to the hard work and focus of our team. As we look to create a world in which every digital interaction between businesses and consumers is amazing.

I firmly believe that Twilio has the right strategy, leaders and innovative platform to unleash the full potential of communications plus contextual data plus AI. And with that, I'll turn it over to Aidan.

[Aidan Viggiano, executive]

Thank you, Khozema, and good afternoon, everyone. We're pleased with our performance in the third quarter, delivering record revenue, non-GAAP gross profit and non-GAAP income from operations. Revenue of $1.134 billion was up 10% year-over-year. Communications revenue was $1.06 billion, up 10% year-over-year, and segment revenue was $73 million, flat year-over-year. .

We saw encouraging volume trends in our communications business with growth acceleration and messaging and strong performance in e-mail. Our efforts with ISVs and on self-serve and cross-sell initiatives continue to yield good results. We also implemented several new features, including the messaging deliverability dashboard that Khozema mentioned that helped drive volume and revenue in the quarter.

In addition, our new AI-enabled products and features such as VERIFI and SMS pumping protection are helping to drive faster growth. While we had higher political revenue in the quarter, those contributions were fairly immaterial and contributed roughly 90 basis points to our reported revenue growth rate. This was offset by a 90 basis point headwind associated with sunsetting the software component of our Zipwhip business.

Our Q3 dollar-based net expansion rate was 105% and representing our best performance since Q1 of 2023 and reflecting the improved growth trends we've seen in our communications business over the last several quarters. Our dollar-based net expansion rate for communications was 106% and the dollar-based net expansion rate for segment was 91%.

As Khozema mentioned, while we're encouraged by the early progress that we've made with segment since the operational review in March, there is more work to be done, and it will take time to improve dollar-based net expansion given it's a trailing metric. We delivered record non-GAAP gross profit of $600 million, up 9% year-over-year. This represented a non-GAAP gross margin of 52.9%, down 50 basis points year-over-year, and 40 basis points quarter-over-quarter, both driven by our segment infrastructure migration efforts.

Non-GAAP gross margin for our Communications business unit was 51.8%, flat both sequentially and year-over-year. As in previous years, we expect higher hosting costs in the fourth quarter associated with the holiday shopping season. And as a result, we would expect a modest sequential decline in communications and consolidated gross margins in Q4. Non-GAAP gross margin for our segment business unit was 69.8%, down 350 basis points sequentially.

As we noted in Q1, we are migrating part of segment architecture to new infrastructure providers this year to recognize greater efficiencies. We are continuing to make progress on this project, and we expect to complete the migration during the fourth quarter, after which we expect segment gross margins will begin to improve.

Non-GAAP income from operations came in ahead of expectations at a record $182 million, up 34% year-over-year, driven by strong revenue growth and ongoing cost discipline. Our non-GAAP operating margin of 16.1% was up 290 basis points year-over-year and down 10 basis points sequentially.

Our Q3 results reflect an additional $18 million in expenses for our company-wide performance-based cash bonus program, representing roughly $6 million of expense for each of the first 3 quarters of the year. This increase reflects a higher anticipated bonus payout as a result of our year-to-date outperformance on non-GAAP operating income and increased outlook for the year.

We are proud of the operating margin improvement we've achieved over the last 2 years, and we continue to see opportunities for additional operating leverage over the next several years. Non-GAAP income from operations for our communications business was $268 million and non-GAAP loss from operations for our segment business was $60 million.

Segment operating losses were flat sequentially, primarily as a result of the incremental bonus expenses I referenced. We remain committed to segment achieving breakeven on a non-GAAP operating income basis by Q2 of 2025.

GAAP loss from operations was $5 million. We continue to make solid progress on our path towards GAAP operating profitability, and we are tracking ahead of our previous target to achieve GAAP operating profitability by Q4 of 2025. Stock-based compensation as a percentage of revenue was 13.6%, excluding restructuring costs, which was flat quarter-over-quarter and down 430 basis points year-over-year as we continue our efforts to reduce equity compensation.

We generated free cash flow of $189 million in the quarter and over the last 12 months we generated free cash flow of $775 million. We remain focused on driving strong free cash flow margins going forward. Finally, we're continuing to execute on our $3 billion share repurchase program. Since initiating the programs, we've repurchased more than $2.7 billion of shares and we intend to complete the remaining balance of the authorized repurchases by year-end.

Our total shares outstanding as of September 30 was $155 million, down 15% year-to-date. Moving to guidance. We're encouraged by the trends we're seeing across the business, and we're continuing to plan prudently given our usage-based revenue model and the dynamic market backdrop. For Q4, we're initiating a revenue target of $1.15 billion to $1.16 billion, representing year-over-year growth of 7% to 8% on both a reported and organic basis.

Based on our year-to-date performance and Q4 outlook, we're increasing our full year organic growth guidance range to 7.5% to 8%. Turning to our profit outlook. For Q4, we expect non-GAAP income from operations of $185 million to $195 million, and we're raising our full year non-GAAP income from operations guidance to $700 million to $710 million.

As it relates to free cash flow, year-to-date, we've generated $564 million, which has outpaced our non-GAAP income from operations. However, we are anticipating higher prepayments in the fourth quarter, which we expect will drive a sequential decline in free cash flow. As we said previously, we periodically pay certain vendors early to secure favorable terms and pricing. As a result, for the full year 2024, we expect free cash flow in the range of $650 million to $675 million.

Before we open up the call for questions, given the various tailwinds and headwinds that have influenced the business over the past several quarters, we also want to provide a preliminary outlook on how we would expect a more normalized fiscal 2025 to play out.

We are encouraged by the volume and growth stabilization we have seen in our communications business over the last several quarters, and we continue to make progress on the operational goals and segment. Based on the trends in the business and assuming a neutral macro environment, we would expect full year 2025 revenue growth in a range of 7% to 8%. We also expect to generate meaningful non-GAAP operating margin expansion over the course of the full year.

Finally, we would expect to achieve GAAP operating profitability for the full year. We will provide more commentary on both our fiscal 2025 and longer-term outlook at our upcoming Investor Day, which we're currently targeting for late January. I'm very pleased with the accelerated revenue growth we delivered in the third quarter as well as our ongoing cost discipline that is driving strong profitability and free cash flow.

I'm also encouraged by the innovation we are delivering and the impact new products and features are having both for our customers and on our revenue growth. We are tracking well ahead of our target to reach GAAP operating profitability and we are confident in our plans to drive durable growth, continued margin expansion and free cash flow growth over the next several years.

I'm looking forward to finishing 2024 strong and seeing you all at our Investor Day in Q1. And with that, we'll now open it up to questions.

[Operator]

[Operator Instructions]

Our first question comes from the line of Arjun Bhatia from William Blair.

[Arjun Bhatia, analyst]

Congrats on the nice quarter here. I wanted to maybe start with just the OpenAI partnership. Can you just touch a little bit on what exactly that entails and how that might play out across your customer base? Like are these agents going to be built largely on the voice side? Do you see this expanding into the messaging front as well. And then I'd be curious to hear just about timing of how long this might take to play out across your customer base?

[Khozema Shipchandler, executive]

Yes. Good question. Thanks, Arjun. So I would say maybe to start with, it's built off of the voice side of things, but I would anticipate whether it's with OpenAI or one of the other partners that we have out there that you should expect to see it across all channels over time. That's probably not a surprise to you. Like the way that we would want to approach it ultimately is in more of a multichannel way. I think that's the most optimal way to end up reaching consumers vis-a-vis the customers that we serve. .

As it relates specifically to the partnership, it is voice based, as I said, basically, what it allows for is for us to use OpenAI's capabilities as it relates to their large language models and then apply them using a Twilio API vis-a-vis our voice capabilities. And I think where it gets really interesting and as we kind of alluded to in our earlier remarks, if you compare that with some of the contextual data that we would have about our customers' consumers, like you end up with a really personalized lively and very easy to implement interaction between one of our customers and the consumer.

In terms of time frame around revenue, I mean, obviously, AI is all happening very rapidly. Like I wouldn't anticipate that it shows up materially in our revenues for a little while still. That said, like we are very excited about the partnership. We're very excited about what's going on with AI. And in particular, I would really point to the combination of communications and contextual data when paired with AI is a really, really valuable combination.

[Arjun Bhatia, analyst]

Perfect. That's very helpful. And then Aidan, if I can ask one, I'm sure we'll hear more about this at Investor Day. But since you gave the initial guidance on the initial outlook on fiscal '25, I think you mentioned you were assuming a neutral macro for the 7% to 8% growth target. Is that neutral compared to what we're in right now in 2024? Or is it like a headwind right now in '24 and that goes to neutral in 2025, implying slight improvement? Just would be curious how you're thinking about that. .

[Aidan Viggiano, executive]

Yes. I'd say, Arjun, it's kind of in line with what we're seeing right now. So I'd say neutral to kind of what we're experiencing today.

[Operator]

Our next question comes from the line of Jim Fish from Piper Sandler. .

[James Fish, analyst]

Great quarter. Just in terms of the go-to-market side, is there any color you guys can provide as to how big the ISV channel is for Twilio at this point and what that is growing relative to the overall business?

[Khozema Shipchandler, executive]

We haven't -- Jim, this is Khozema. I can start and then Aidan can provide some additional commentary. So we've never broken out the kind of the quantum of how much business that we're doing with ISVs. Obviously, it's a meaningful contributor to us. But I will give you 2 data points. One is that it does grow faster than the consolidated revenue base, which is obviously very exciting for us. .

And it also carries higher gross margins than the consolidated revenue base. And so that's actually pretty encouraging as well. And just given our ability to get leverage distribution in the way that we end up serving these fees, I think it's just a very important channel and ultimately, a very important partnership, and we want to be able to help these guys grow, and that will help us grow.

[James Fish, analyst]

Got it. And on the RCS side of that major airline win, is there a way to understand how this will potentially change volumes for that customer, be it on the SMS side versus RCS and what that sort of gross margin profile looks like for RCS relative to SMS at this point?

[Khozema Shipchandler, executive]

I think it's really difficult on a unique customer basis or more broadly to really extrapolate like what's happening with a particular usage inside of a channel and obviously, in this channel being messaging, I think I would imagine that fundamentally you'll probably see something relatively consistent with where we are now. Like our expectation is not necessarily that RCS will end up supplanting a bunch of the other activities.

I think it works really, really well for an airline use case. And so with respect to airlines, I think my expectation would be that given that it's something where we each tend to have apps where it's something that we tend to use in sort of a repeat basis, I would imagine that, that's a category more broadly that ends up using RCS.

I would certainly hope they avail themselves of some of the features and capabilities there. But I don't necessarily expect that it's going to change the dynamics of our underlying business. And then more broadly, we're not anticipating at least sitting here today that RCS really has an impact on either revenues or margins in terms of the dynamics in our business.

[Operator]

Our next question comes from the line of Ryan Koontz from Needham & Co. .

[Ryan Koontz, analyst]

Great quarter there, certainly. Khozema can you outline kind of where you are in your self-service journey? I really -- it sounds like that's a nice growth driver. I'm sure it's an operating margin expansion with your lower sales and marketing expense. But can you maybe explain kind of where you are from kind of a milestone perspective and where you might be headed in the future?

[Khozema Shipchandler, executive]

Yes. I mean, look, not to be kind of cliche about it. I would say at some level, like it's always like sort of a day 1 style approach that we're trying to take to self-serve. I mean I think, as you know, like being sort of a long-term follower of us, like the developer's attraction to the platform, to the tools and capabilities that we offer has always been sort of a hallmark of the company.

And I think over the last several years, like to ensure that there's additional trust and compliance and things of that nature on the platform. We've almost on purpose had to introduce certain levels of friction in the sign-up process to be able to onboard new customers. And so in sort of that landscape, what we want to be able to do is that for every new developer, for every new startup, for a super established company that's just getting started, we want to make it fundamentally as easy as possible as can possibly be for a developer to attach themselves to the platform to be able to get up and running with a use case.

And then to start promulgating that inside of their consumer base. And so I would say like we're never done. I mean, our milestone list is actually quite long. We're very, very happy with the progress that we've made to date. But I think we will constantly look for ways in which we can continue to improve the experience for developers. And in that spirit, I would say it's kind of still day 1.

[Ryan Koontz, analyst]

When you talk about that friction, you're talking about malicious use. Do you want to make sure you want to qualify these folks? Or is that the reason for it?

[Khozema Shipchandler, executive]

Yes. I mean, that's definitely one reason. I think you're also familiar with like I think it was last summer, if memory serves me correctly, where we went through like the 10 DLC onboarding process where we had to kind of put customers through that, right? We obviously got through the other side of it without any real impact to the business. But ultimately, like you're a consumer of the stuff, right? Like you don't want to be receiving stuff. You certainly don't want your children to be receiving stuff that they shouldn't be.

And trust has kind of always been one of the #1 things that we sell around here. And I think, creating a platform in which there's both trust as well as ease of use has always been a hallmark at Twilio.

[Operator]

Our next question comes from the line of Alex Zukin from Wolfe Research. .

[Unknown Analyst]

Rich Magnus on for Alex. A question on free cash flow. Should we expect free cash flow margin expansion to outpace operating margin expansion next year given the prepayments affecting free cash flow in the fourth quarter, can you help sort of quantify that headwind in 4Q? .

[Aidan Viggiano, executive]

Rich, thanks for the question. So we're not yet providing explicit free cash flow guidance or commentary for 2025. I'd say, in general, the way to think about it is it tracks fairly closely with our non-GAAP operating income over time. Like within quarters, there might be some variability, but over time, an annual cycle or something like that, they track fairly closely.

And as we said in our prepared remarks, as it relates to Q4, as we've said previously, we do have these episodic kind of prepayments from time to time. We will experience some of them in Q4 but as we think about free cash flow going forward, I'd kind of think about them generally in line. And then we'll talk about more as it relates to 2025 specifically at our Investor Day.

[Unknown Analyst]

And then one more on, is there anything you should think about regarding political traffic in 4Q from these final election pushes? And how does that sort of compare to the prior cycles?

[Aidan Viggiano, executive]

Yes. So as we called out in the prepared remarks, in the third quarter, we did have some political traffic. It contributed about 90 basis points to our growth rate. It was offset by a product that we are sunsetting on the Zipwhip software business. So it really didn't contribute to the revenue growth.

I'd expect Q4 to be similar immaterial. There will be some political traffic, but we don't expect it to contribute much. If you go back several years, we did have more political traffic on the platform, but we made a decision a couple of years ago to limit that just based on our acceptable use policy and what we're willing to carry on the platform. .

[Operator]

Our next question comes from the line of Taylor McGinnis from UBS.

[Taylor McGinnis, analyst]

The first one is just given like the acceleration that we saw in revenue in the quarter and it sounded like particularly the messaging business. Anything in particular, I guess, you would flag as really driving that? And then as we look into 4Q, it seems like you guys only raised the guide modestly. So anything that was maybe specific to 3Q with the messaging business? Or anything we should keep in mind seasonality as we look into 4Q? .

[Aidan Viggiano, executive]

Yes. Why don't I cover a little bit on Q3, then talk a little bit about the guide. So we're really pleased with the acceleration that we saw. So maybe first, just to be clear, reported and organic are now equal, just we lapped all the acquisitions. So the 10% is both our reported and organic growth number. And we saw really a combination of strength across the business.

Messaging, as you highlighted, it accelerated in the quarter from a growth perspective, e-mail continued to be strong from a growth perspective. We also saw strength in our ISV platform Khozema kind of talked about that on one of the previous questions as well as self-serve, and then when you think about it by industry, we saw pretty good healthy volumes, I'd say, revenue growth kind of in our largest industry, that's tech, health care, financial services, retail, e-commerce, I would say, social and messaging kind of continued to be softer for us, but that's a relatively smaller portion of our revenue nowadays.

And then from a geographic perspective, I'd say the U.S. continued to be strong. And we did see international volumes and revenue trends improve for the second straight quarter. So I guess, pulling it up, not one thing, a number of different things that kind of drove the strength in the quarter. And then as it relates to the guide, we guided 7% to 8%. That's actually 2 points higher than what we guided in Q3. So you are seeing some of that favorability flow through to our forecast. And then I guess, last thing is that we are usage-based. That is a dynamic that we deal with. So we just continue to guide prudently just given that's our revenue model.

[Taylor McGinnis, analyst]

Perfect. And then last one for me would just be on the margin outlook. So you guys have had pretty amazing upside to margins over the last several quarters, but it looks like the pace of that expansion on a year-over-year basis, I think we're starting to see that come down a bit. So as we think into next year, and I think you made a comment about continuing to expect expansion, anything you can share at a high level, like how to think about that maybe versus what we've seen? I know segment reaching breakeven is one of the drivers. But as we look across the model, any other areas of potential efficiency that you guys are looking at? .

[Aidan Viggiano, executive]

Yes. I'm not going to give a specific number for next year, but I do want to call out a couple of things. So in Q3 the reason you didn't see as much leverage quarter-over-quarter is we did have additional bonus accrual that we did in the quarter was $18 million. It was a catch-up for Q1, Q2, Q3, just based on where our forecast is now for profit for the year.

So with that forecast being higher, we had to accrue some additional expenses. So that did impact the quarter, and you should factor that in, in terms of thinking about the underlying operating margin expansion. As it relates to leverage going forward, we're pretty confident in our ability to continue to get leverage. We've proved it now consistently. I'd say next year, some of the levers are, as you called out segment, right? We lost $16 million in the quarter on segment. So if you annualize that, that's $64 million and then the other 2 areas where we're intently focused is, first, automation, and then second, what we're calling kind of workforce planning and just optimizing the org structures as well as the geographic locations of each of our teams. And those are the 2, I'd say, big efforts we have underway to continue to drive margin expansion.

[Operator]

Our next question comes from the line of Ryan MacWilliams from Barclays.

[Ryan MacWilliams, analyst]

I appreciate the color on the 2025 numbers. Are there any trends in your business that's given you more visibility to provide this out year guidance at this point? Like are your customers feeling better about their own messaging volumes. I just love to hear more detail on your build up to that 2025 revenue guidance.

[Khozema Shipchandler, executive]

Yes. I don't -- I'll give you a couple of things. I think, first of all, I mean, we've been working on a number of efforts inside the business. We've kind of characterized those in 3 different buckets, right, disciplined, rigor, and focus. That kind of ranges from a series of financial things that we're doing as well as the number of investments that we're making on the innovation side. .

And what I would say is, is that what used to be kind of a stabilization in trends that's transpired really over the last several quarters has now kind of started to albeit modestly, started to kind of reaccelerate into slightly better growth, obviously, in Q3. You heard Aidan's color a moment ago in terms of Q4 and our ability to kind of consistently raise the guide over several quarters. So all of that feels pretty good.

And as we kind of look out into 2025, it's not just an extrapolation of trends, obviously. It's also a lot of conversations that we're having with our customers as well. Again, in a kind of a neutral macro, what I would say is self-serve has been particularly strong, and that's been a bright spot. I think the volumes that we've seen from our ISV partners that certainly seems like it's quite sustainable. And then that's kind of on a channel basis, if you kind of then break it down by product, the products have generally been performing well.

Obviously, even beyond kind of messaging and e-mail, we called out a number of products from which we have seen a certain amount of strength over the last couple of quarters. We've seen some new innovations take hold as well, like the kind of messaging deliverability dynamics that we talked about earlier.

We obviously have a number of innovations that we're also planning on. And then I guess, finally, I would add to kind of everything that I've said, like there's some things around AI, especially as it relates to contextual data and communications that we're also pretty excited about. One of those was referenced on the call today in terms of our partnership.

We're clearly working on a number of other areas in which we believe that we're extraordinarily well positioned to deliver on personalization at scale. And so I guess, Ryan, when you add all that up, yes, I mean, we have some level of visibility given that we are a usage-based business. It's always tough. But that totality of things feels like a pretty solid setup in terms of the guidance that -- preliminary guidance that we provided for 2025. .

[Ryan MacWilliams, analyst]

Excellent, just on RCS, for Twilio, this has kind of always been the catalyst that's like 2 years away from being 2 years away. But now it does seem more realistic with Apple rolling it out on iPhones. So how do you think about just the time line for RCS adoption in the U.S.? Like are the carriers ready for RCS at this point? And I know it's super early, but do you think it's possible Generative AI does move the needle here for RCS adoption as 2-way messaging use cases at scale was like very hard to service like over hundreds of thousands of messages but could become easier with a more sophisticated bot or with AI?

[Khozema Shipchandler, executive]

Those are all great questions. I think it's really unclear honestly, what exactly happens with RCS in the near term. I mean we're obviously excited to support the technology. I think if you've used it yourself with certain use cases, it's really cool, and it really does deliver kind of the rich content that's always been promised. I'm not really sure how it's going to play out kind of longer term. And the reason that I say that is, is that I think it's really, really well suited for certain companies and certain use cases.

So for example, the airline example that we cited, I think that's an industry that's perfect for it because these are frequent purchases. These are repeat buys in which you probably do want to be able to interact with the message in that way, and you want to have the content displayed in a certain fashion. I think when it's just a simple but traditional notification, it's not necessary, right? And so I think that would be kind of one maybe obvious example or certainly 2-factor authentication would be another obvious example in which it's not necessary.

But even beyond that, like when it gets into kind of more onetime purchases or when you want to do a lot of things inside of the application itself versus necessarily through the channel. But then on the other side, of course, you have to have an e-mail and SMS confirm it. I think all of that makes the picture, to be honest, like fairly confusing.

I think that from our perspective, all of that, no matter how it plays out, will ultimately be accretive to Twilio. And then lastly, relating to kind of Gen AI and the way that you posed it, I think in all scenarios, whether it's 2-way, whether it's RCS, whether it's some of the voice things that we talked about, we're quite bullish on Generative AI. I think it really works well when paired with contextual data, which is really where we're hanging our hat, especially as it relates to the combination of what we can do with segment and communications and that we're very bullish on. .

[Operator]

Our next question comes from the line of Meta Marshall from Morgan Stanley.

[Meta Marshall, analyst]

Echoing by congrats. Maybe just on the DB&E pickup on the communications side of the business, understanding ISV's kind of helped bring in a lot of new customers. But just wondering do you think that part of the messaging gains or part of the DB&E improvement is kind of gaining share within your customers of their share of wallet with some of the Verify products and some of the other enhancements you've made to the portfolio or just kind of marketing budgets have gotten better and that overall led to more volumes?

And then, just as a second question. Just where do you guys think you are on kind of go-to-market improvements within the segment business now kind of being 9 months into some of those changes?

[Khozema Shipchandler, executive]

Yes. Meta, this is Khozema. I'll start, and then if Aidan wants to add some additional color, she certainly can. I think, let me start with the second question actually first in terms of segment and go-to-market. So I would say we've actually made a number of improvements on the go-to-market side. We do feel better about kind of where we are relative to where we've been. I think improvements in churn and contraction, improvements in contract life cycle improvements and our ability to get customers faster time to value.

That said, I mean, there's a lot of work left here, right? And obviously, it's not quite shown up in certainly the reported numbers and you still see it weighing on our net retention rates. And so I think it's going to take some time, but I do feel like the milestones that we set out for ourselves we're meeting those, if not exceeding some of those. But for that to bleed into revenue, it's just going to take some time.

I will say just one other thing related to segment before I get to the other part of your question, is the one thing that I think has gone quite well is the pairing of communications with segment. So there were some use cases that we talked about where we rolled out products earlier in the year, both with Flex as well as with voice. And those have proven to gain a certain amount of customer traction to the extent that now, especially as we kind of contemplate a future in which Generative AI is going to be present, it's on us now to really deliver what we're referring to as a unified profile that doesn't just serve those 2 products that actually serves every single one of our products right out of the box.

So as the customer gets up and running, they can avail themselves of the inherent data capabilities that segment offers. And I think you've followed us, obviously, for a long time, that's always sort of been the promise of having segment with Twilio. And I think we're starting to make that a reality. And in a Generative AI world, having contextual data is really going to matter. And so we think we're well positioned there.

Back to DB&E for a second. You're right. Like there are some of these areas in which we are picking up new customers. But I wouldn't say it's per se macro related, like that's not the trend that we're necessarily seeing. I think what we've seen really for the balance of the year is kind of a neutral macro and Aidan kind of alluded to that in terms of the way that we're planning for the business next year.

I don't think we're seeing share loss within the business or cannibalization maybe a different way of saying that. I think instead, what we're seeing is customers starting to implement additional products in conjunction with ones that they were already using. I mean we made a modest improvement in DB&E from period to period. So I don't want to like read too much into it necessarily. But we're obviously encouraged by what we're seeing. It's not necessarily a metric that we guide to. But so far, so good, and we're going to continue our efforts in a number of these areas with probably a concentrated effort as we always do on self-serve.

[Operator]

Our next question comes from the line of Michael Turrin from Wells Fargo.

[Unknown Analyst]

This is Rich Poland on for Michael. So just one on the ISV side of things. So I think you had mentioned at one point that you walked away from Engage Premier and that kind of helped avoid directly competing with some of those ISV partners. I just wanted to, I guess, get some insight on, are there any areas where you could look to do that further? Or how is kind of that played out into the ISV strength that you're seeing? Any context there would be helpful.

[Khozema Shipchandler, executive]

Yes. You're -- to maybe start with your kind of correcting the assertion there. We did decide that we wanted to sunset Engage Premier. I think that was the right decision, that was kind of paired with 2 things. I'd say, we've talked about ongoing operating rigor and discipline. And I think part of that is just focusing on the right things. And so it made sense through that lens.

But I think the other side of it was the partnerships, in particular, as it relates to Premier at least that we have with other leading marketing automation companies it allowed us to really focus on those partnerships in a different way versus kind of ending up in competition with them, instead allowing us to grow and thrive together.

And so I'd say many of those companies have for a long time been great customers of ours. And we're engaging across the board, whether it's Airship or Bloom Ridge or Brakes, or Insider or Clavio.like there's a number of these that we have lined up currently. We've got really strong technology integrations with each of them, and we're excited about not just the business that's kind of link to our platform but our ability to grow with those companies together, to partner together to be able to solve customers' needs.

[Unknown Analyst]

That's very helpful. And then I guess just as a follow-up on the AI side of that. It's really interesting to hear about the real-time API integration and being kind of the feature partner there. When we think about, I guess, like other areas in the core comms or API side of things where Twilio can kind of serve as that building block. Are there any use cases out there that you're starting to see kind of really pick up or see meaningful traction aside from that partnership there?

[Khozema Shipchandler, executive]

Yes. I would position it slightly differently as it relates to AI. Like I don't think it's just about communications, and I don't think it's actually just about segment, but I think it's really the combination of contextual data with communications. And I think for the companies that we serve and the ones that we aspire to serve, it's that combination that really activates AI, the reason being that a lot of the most interesting interactions, like when we talk about personalization at scale, like it happens because we have contextual data about our customers' consumers. And that's an incredibly, incredibly important form of IP.

They want -- our customers want that to not travel over into an LLM but instead, to be stored into data warehouse to be secure in a data warehouse, but then to be combined with the other things that we're doing. And so I think the way that you'll hear us talk about it going forward, Rich, is really through the lens of like this unified profile which allows us to see exactly what it is that's most interesting about a consumer on behalf of our customers that we can then go and activate against.

And I think whether it's in a voice contact with a virtual agent, whether it's in an IVR, whether it's in Flex, whether it's in a security product, whether it's in the fraud prevention things that we've done, and then ultimately, even e-mail, like I think it's going to really run the gamut of every single one of our products. And I think we'll start to probably talk less about them through the lens of like just products, but really this combined interaction of communications with contextual data.

[Operator]

Our next question comes from the line of Nick Altmann from Scotiabank .

[Nicholas Altmann, analyst]

Awesome. In your prepared remarks, you guys noted an 8-figure ISV deal that was consolidating some volume from 3 different vendors on Twilio on the SMS side. Can you maybe just talk about what the unlock there for that particular customer for them to consolidate? And then when you look at your installed base, whether it's large customers or ISVs who are multisourcing CPaaS or SMS, how much of an opportunity is that? And how much of a focus is it on a go-forward basis?

[Khozema Shipchandler, executive]

Let's take the second question first maybe. So as it relates to consolidation or kind of multi-sourcing, I think that's the word you used. I think that -- it happens from time to time, and we certainly see customers experiment with it from time to time. But I think the reality is, is that the way that the platform is built and the way that we've kind of always prided ourselves is, is that we fundamentally offer a superior product relative to the other partners in the marketplace.

And so I think, in particular, like we're very, very strong in terms of upfront availing yourself of use on the platform in the first place, like getting up and running, getting activated, getting started using our tooling, using our documentation like that's a really, really easy go. And then I think the other side of it is, is that we're also quite strong in terms of our ability to ensure that our customers are able to deliver what need to be delivered on the other side.

And so these are mission-critical workloads for a lot of our customers. And so our ability to do that for them, especially in a way in a world in which most people don't realize this actually that supply is constrained to be able to moderate between messages that have to get across at one specific moment versus others that can wait just a handful of seconds even like that's a really important differentiator for us.

We deliver that through our engagement suite, and that's pretty impactful. So that's kind of that part of the question, and I think that a lot of that volume ends up coming back to us. In terms of the ISV question that you asked specifically, the 3 vendor consolidation. So I think all of what I said a moment ago remains true, right? Like we have stronger deliverability, we have better quality, we have high trust and getting up and running on Twilio in the first place is very attractive.

In addition to all of those things, I think what's very exciting in this example, and I think what's exciting more generally is that this customer was struggling to scale internationally in particular, they found Twilio very easy as a means to do that. I think in addition to that, what a lot of our ISVs and I'd say customers are at large, this is not just limited find is that being able to engage their customers, especially through multiple channels and then using them kind of off and on to engage with customers on the other side has been really powerful. And I wouldn't be surprised if we see more of that over time.

[Operator]

Our next question comes from the line of Samad Samana from Jefferies.

[William Fitzsimmons, analyst]

This is Billy Fitzsimmons on for Samad. Khozema, in the prepared remarks, you highlighted the AI opportunity with Flex and highlighted the potential for customers to create intelligent IVRs and more broadly, AI agents, the contact center seems like an area of focus for the traditional comms vendors given turnover, high volumes, there's an opportunity to kind of layer in AI to make things easier for customers.

But increasingly, it seems like vendors who maybe traditionally didn't address the contact center are kind of targeting the market, whether other large cap software vendors, hyperscalers, just be curious how Flex has performed in recent quarters, early customer feedback and the integration of AI solutions in Flex and then how you're thinking about pricing and differentiation as you add in those AI features to the solution?

[Khozema Shipchandler, executive]

Yes. That's a good question. So I guess, Billy, the way that I would kind of characterize it is, is that it's not per se about Flex as such. I mean, I think the way that this is going to play out is that whatever the channel and in this case, since we're kind of talking about voice in a way, I think it's going to be driven on the one hand, it's going to be very outcome-oriented in terms of like what you're able to deliver for a customer on the other side. I think that probably ends up breaking some of the seat dynamics in terms of SaaS and licenses and stuff like that.

I think the second thing is, is that a lot of the -- while I'm certainly aware of what you're talking about in terms of various entrants in the market, I think your ability to be able to drive differentiated value actually happens through having contextual data. So having a generic model that happens to use a virtual agent like without any underlying understanding of what's happening with that customer in the first place, like it's really, really difficult to end up solving their problem. Like it's easy for like kind of the basic stuff. But like as soon as you bore down into like an actual purchase or an actual promotion or a renewal or a customer care problem, like you've got to start knowing something about that customer.

And certainly, something that we believe is that, that contextual data is highly proprietary to the customers that we serve. I cannot imagine a scenario in which they start turning over that proprietary data to the large LLMs and helping them train up their models. And so I think that advantage is crucial to use, our ability to use the communications capabilities that we already have, which includes Flex, obviously, but also pair that with contextual data that we deliver vis-a-vis segments and then use AI as a means to then solve customer problems, that's really how we see it playing out. Certainly could happen with Flex, could happen with an IVR, could happen through simple -- more simple interfaces depending on how complex the problem is through any one of the channels that we offer. And since we offer most of them, I think that positions us quite well.

[Operator]

This concludes today's conference call. Thank you for participating. You may now disconnect.