Five9, Inc. (FIVN) Earnings Call Transcript & Summary

All right. We can get started. Thanks, everyone this morning for joining us. For those less familiar with myself, my name is Scott Berg. I lead the enterprise software efforts here at Needham. Today with us we have Five9. We have the company's CEO, Rowan Trollope with us and the company's CFO, Barry Zwarenstein. Barry, I think you want to start off by saying a couple of quick words. And this is not an opening prayer, but it's close.

Good morning, everybody. Today, we'll be making forward-looking statements about events and trends that could affect our company and the industry. Obviously, real results may be different from that. I refer you to our SEC filings to see what the factors are that cause such a difference.

All right. Why don't -- Rowan, why don't you give a quick overview of the company for those that might be less familiar.

Sure. So we're -- Five9 is a cloud contact center company. [ We're a ] contact center with people in every business who engage with the business' customers. So either through phone or text messaging or e-mail, if you are a business that talks to your customers, you need software from Five9. The market is around a $24 billion market of contact center software. And there are around 16 million agents globally in businesses who engage with customers. Most of them are -- about 80% of those are telephone-based engagements. And the cloud contact center, which is what we are, is a radical new departure from what came before, which was legacy PBXs, literally phone systems that sat in closets. Our system is in the cloud. It's a completely multitenant and global and agents don't need to have phones on their desks. They just log into web browsers and put in USB headsets and then they can start to talk to their customers or to message through e-mail. And so we tightly integrate into Salesforce and Oracle and other CRM platforms. Zendesk is another one. So as companies are thinking about how do they deliver a better service to their customers, they're typically moving to cloud-based CRM technologies and running digitization initiatives, and we get dragged along into that refresh. The penetration of cloud into this market, this $24 billion market today, is probably around 10%. So it's probably another 10 years of transitioning this market to this new wave of technology.

Great. 2019, I think, was kind of an exciting year for Five9. Lots of changes on the product side, successes on the go-to-market side. But maybe from your viewpoint, Rowan, quick recap, what was the most exciting kind of thing that happened to the company in 2019.

I think we expanded our leadership team was a big step for us. So we brought in Anand Chandrasekaran from Facebook. We brought in Dave Pickering, from Intuit, Jonathan Rosenberg from Cisco. And we doubled the number of developers at the company. So we've hired a lot of engineers. And that investment -- it's really the leadership investment in the company is about this long-term opportunity to transition this market to the cloud. The engineering investment is we're -- because we're continuing to hear from larger and larger enterprises that they need more capabilities in the platform, and so we've been investing in that to keep servicing our customers. Our Net Promoter Scores on our products remain really, really good. So that's big. And then finally, I would say, partnerships. We've kicked off some cool partnerships, some good partnerships. Google is one of them. We made more announcements about our AI strategy. And we've made progress there with some of our larger customers. So overall, a really good year building on this long-term opportunity.

So moving to the competitive market a little bit. Lots of changes in the contact center space in 2019, a couple of large announcements. Many of you are familiar with them. Ring and Avaya might be the largest one that's out there. But how do you view all -- whether it's those announcements or others because there's plenty of them. Salesforce, certainly announced a kind of a solution. But how do you view those announcements or changes relative to your business competitively?

So first, I'd say there's a broad recognition as you see these bigger names expressing interest in this space that, oh, this actually an interesting space. For a long time, I think it was ignored. And when you saw it, for example, at Dreamforce Salesforce, essentially you say, okay, we think voice is an important part of the contact center. That was the first time they had actually said that. Before then, it was a story which was all contact centers are going to move to digital engagement with SMS and e-mail, and that's going to be the way of the future. And so I think there was a shift towards, okay, we actually think voice is very interesting now. So that is, I would say, number one, it's a good recognition that the category is really critically important. I think from an Avaya Ring, I think that was an interesting admission that they're losing a war on 2 fronts, and maybe they should get focused just on the contact center. And so we're still waiting for them to release a cloud contact center, as are their customers. But so far, so good for us.

So on the competitive stream, your enterprise business continues a multiyear run on a -- growing on a trailing 12-month basis of greater than 35% is -- but your recent Analyst Day in November, you highlighted your goals to maintain a 30% or better growth rate in that area. Is -- why do you believe the company continued to grow at that rate at a much larger scale for a long period of time, or at least long enough period of time, when the rest of the space is not appearing to grow that fast?

Well, it's really just the -- it's just the math of the number of seats that are currently on-premise's technology and with around 10% penetration. Those systems are -- they're getting old and they can't be serviced anymore and they have to be replaced. So we're just -- this is a -- the beginning of the wave of the transformation of this segment of the market, and they have to go to cloud. I mean, essentially, there is no other option. And we're really well positioned in the enterprise. What we said is the segment of our business that is enterprise subscriptions will continue to grow in the 30s. And that's -- it's done that for many years. And we don't see any end in sight to that. And certainly, we have leading indicators there around bookings and orders that we have visibility to, and we see increased traction from larger and larger customers and also from partners that haven't been involved in this before either. So we just think that we're at the beginning of this wave, and it's going to go for a while.

Got it. The company also announced a small acquisition in the fourth quarter, a company called Whendu. How does that platform help your sales efforts, in particular? And then from the product side, why should that integrate fairly equally with the existing Five9 platform?

Sure. So Whendu is an integration platform-as-a-service. Which is a low-code no-code workflow technology for wiring back-end systems together, similar to some of the technology that Salesforce acquired with MuleSoft. And actually Google just yesterday, acquired a technology in this space. And this whole category really is serving an important need, which is -- and I'll make it specific to contact center. In the contact center, you have lots of very complex business processes that these legacy PBXs are tied into. And when you go to shift that technology -- underlying technology to the cloud, you have to rewire a lot of that stuff and that takes developers today. If you're using MuleSoft, it's an API platform, it takes developers. So what we saw as the opportunity with Whendu is that our contact center buyers don't have access to a lot of developers where they can't get up in the IT priority list high enough in order to sort of get the allocation from a development perspective, and we see this global shortfall. I mean, I think Satya Nadella recently commented that there will be a 500,000 -- there will be a shortfall of 500,000 developers over the next 5 to 10 years. And so Whendu helps us solve that problem. For our largest enterprises, what it gives us is a platform to get to them to say, hey, here's a way for you to recreate all of those business processes without having to hire developers. Your business analysts can just drag and drop and connect them. So Whendu had built 55 specific connectors, back-end system connectors, specific for the contact center category. So the founder of Whendu actually was originally the founder of Five9. And so he has rejoined Five9. He saw this big opportunity in this emerging category of low-code, no-code integration stuff. And so he's gone up and done that. So we brought him back together with the Five9 family. Excited to have him back. And our largest customers are very excited about it because it allows them to very, very quickly take either their legacy processes, or more importantly, the new things that they'd like to do and to really accelerate building those workflows and those particular business processes that they can't do today without getting developer time.

Got it. Lastly, on market drivers is -- it's interesting your enterprise business has grown relatively fast the last 4 or 5 years since you've been public, as I commented earlier. But why does it seem the enterprise is just starting to crack today? And maybe that means Barry can have more minecraft charts going forward. For those at the Analyst Day, it's an inside joke. Sorry.

So I think enterprises have been skeptical about the scale of the cloud platforms. And we've been proving that we can increase our scale every quarter, and we've been showing them more referenced customers who have demonstrated this. So we have -- our largest customer now has a contact center with well over 5,000 seats on our platform. So we continue to take down larger and larger contact centers. But there's been a hesitancy among large enterprise. And there's been a lot of FUD, by the way, amongst the incumbents who have been saying, no, no, no, cloud is not ready. And that is the same -- and you know, we've seen this movie before when CRM moved to the cloud. If I go back 15 years, it was oh, no, no, no, CRM is great in the cloud for small businesses, but you really can't trust your business to move on to a Salesforce or one of these other companies. And so that's the same thing that's been going on. But increasingly, that story is not holding water as IT is saying, well, we think, actually, maybe this is the way to go. And look, there are some other customers that have done it. So we just continue to plug away at it. We've made great progress. And again, if you -- if we look at the size of customers that are now coming to us and asking to -- for us to engage and fill out RFPs, it's much bigger than we'd ever seen before. So we're just seeing all the signs that this is going to happen and that it is happening.

All right. Let's talk product. It's my favorite area. You and I have actually sat down a couple of times in your 2 years to talk product. But at your Analyst Day, my biggest takeaway is, I think, a small shift in the product strategy. And maybe it's a large long-term shift. But you highlighted this new kind of $34 billion TAM for automating contact center labor. Not new necessarily because there's other vendors in the space doing different items. But why is this category attractive to you guys in Five9? And why do you have a competitive differentiation do you think in the areas you're targeting today?

It's attractive because we're -- so just to refresh on the -- what we shared at our financial Analyst Day, you're referring to the $34 billion number. That is our estimation, and I won't get into the details. But it's our estimation of the potential labor savings that are available in the contact center over the next 5 years. And so if you look at a typical contact center for every dollar of spend on technology, there's $10 spent on labor. And if we look at virtually every other industry, particularly where AI has really gotten hold, what you're seeing is this opportunity to take routine rote tasks and automate them using AI. And we've seen that same capability in the contact center. So that was one of the things that interested me 2 years ago coming into this space was, I think we could do a much better job at helping automate a lot of the workflows in the contact center now that AI has gotten to this level of maturity that it has over the last several years. So that's the big opportunity. And it's a major selling point for customers. We've got a handful of our largest customers now in alpha trials, as we mentioned on our AI technology. And what they see as the opportunity as well, if I can make my agents 10% more efficient, if I could give them really good, precise recommendations on what to say to the customer that will make the call shorter and have a better outcome, if I could shorten that by 10%, there's huge savings back to the business. And that's the basic value proposition that couldn't be an easier story to tell. It's something that the contact center has been doing for a really long time. But what they haven't had is the level of innovation coming out of the -- from artificial intelligence that we've seen recently. That's why we partner with Google because we don't want to spend any time doing the basics, like speech recognition and so on. So the solution that we're building is one that makes agents more efficient by providing recommendations and predictions to the agents in real-time and also automating the work that they do every day. So that's kind of part one. Second part of your question was, what's our competitive differentiation there? From my perspective, the biggest answer to that question is data. When you're talking about the vast majority of contact center businesses, there's still voice calls. 85% of the contacts into businesses are voice calls. That data -- the voice data and specifically what customers are saying or how they say certain things, that's the grit for the mill of AI. You need to have that data, and it has to be not just voice recordings but translated into text and then annotated and tagged, so that you have the tagged data, what are all these customers saying and what do these utterances mean so that you can then do -- go and do machine learning and predictions? We've got over 5 billion minutes of customer voice conversations being recorded on our cloud servers every year. And so that is the source of data that is a competitive differentiation for us. And again, because we've gotten an early lead in Contact Center as a Service, even though we're not as big as Avaya or Cisco, they're running legacy premises systems that actually don't have access to any data. And because we're a multitenant system, and we're recording all of the calls by default in the cloud, that's the source of data that we have to operate from. So it's a -- I think it's a huge competitive differentiator for us.

So how do you think about monetizing that? Because I think the [ media ] correction is, if you're going to save 10% on labor, that means 10% less seats maybe over time.

Well, we're going to make customers pay for that or allow them to pay for it. We -- it's a win-win, really. If we can reduce the number of agencies, but capture a part of that back -- capture part of the savings that we've created for the customer, and the math that we have run, sort of back-of-the-envelope math, suggests it will be in that significant positive for us, just because there's 10x more money being spent on labor than there is on technology today. So when you run the math, it basically says, we will probably, at least be able to double what we're doing today from a wallet share perspective over time.

Got it. Well, it kind of makes sense. Your average agency is, call it, $1,500 a year and the average cost per agent is somewhere between, depending on where they're located, $25,000 or $50,000 or $100,000. There's a savings to capture there. Another kind of new semi-area of focus on the product side is an emphasis in the omnichannel in supporting customers in a more seamless method across interaction points. I guess, first, how often do you believe customers actually move from channel to channel that were, I guess, end customers where your company customers really want this functionality. And then secondly, kind of what does that product strategy actually mean?

So our product strategy is really -- and as we talk to customers and counsel them on best practices for customer service, it's a digital-first strategy. So what that says is, hey, customers are -- generally want to be able to contact you either by sending you a message or hitting your website and chatting with someone potentially or through e-mail, not by launching a call first. And so our platform, and a lot of the investments we've made -- and we've made, have been to make that very, very seamless. And we're -- we've been creating an experience for our customers where you can seamlessly jump between channels, and that is something that is important to consumers. If you think about how consumer behavior and business typically follows consumer-to-consumer behavior, which is typically, if you think about a communication that you might have with a friend, you're usually today starting with a message, whether it's via Messenger or SMS or WhatsApp. "Hey, are you there?" "Hey, what's the plan tonight?" Or what have you. You might -- if that conversation becomes more complex, actually tap a button to jump into a phone call. But you'll seamlessly go between messaging and e-mail and voice conversations. The same thing is true between consumers and businesses in terms of what they want. And that's one of the things that our platform makes possible. Of course doing the voice piece is a big chunk of what we do. But we're seeing increasingly this blended real-time ability to switch back and forth between messaging and voice is actually what customers and businesses want. So that's something that we do today, and we're investing more in.

Lastly, on product, and it's more an architectural question is, the company started moving some of its infrastructure over to the public cloud. You mentioned Google earlier. I assume that's to use some of the NLP technologies that you talked about. But it's not 100% moving to the public cloud. So why that kind of mixed architecture?

Yes. So the decision is to have a multicloud approach. We're today deployed in our own data centers, and we're also deployed in Amazon for some pieces of our infrastructure. We're looking to deploy more into Google Cloud. And there's a couple of reasons for it. One is geographic expansion. It's faster, it's -- actually it's nimbleness and speed. We can get -- we can build out faster using Google and without as much upfront CapEx investment to go global. So Canada is the first area where we've been looking at, where there are pretty strong regulations that are being -- that really affect the financial institutions in Canada. They can't have their data offshore. And I guess offshore includes the United States. So we have to have data centers physically located in Canada for that. So it's much faster for us to be able to spin those up on Google or Amazon or just any public cloud provider without the big upfront CapEx investment that it would take. So as we think about our international expansion plans, public cloud is the investment choice that we've made there. But there's also a -- behind the scenes, there is some complexity where we're also continuing to build out our voice infrastructure and our network, our core backbone. Just from a cost perspective and a gross margin perspective, we think that we can have a better gross margin profile by using our own network than by leveraging public cloud. So it will be a combination of both, is the plan.

Moving into the go-to-market side, there's going to be a small change at least as it appears in your go-to-market this year, is you're putting a -- placing a greater emphasis on partners. Now partners have always influenced a lot of deals in different capacities. And that percentage has increased, I believe, 60% or more of transactions the last couple of quarters. But the emphasis is not just in a referral relationship or an influencer, it's actually to have them sell. What does that strategy specifically mean to Five9 maybe over the next couple of years?

Yes, we definitely want to get deeper with partners. And so we've been hiring more and we've been building out, I would say, a more robust and mature channel partner program. We are seeing the traditional Cisco and Avaya VARs start to come knocking on our door to say, "Hey, can we resell Five9?" And so we want to be able to let them do that when they're ready. And so there are definitely investments that they have to make on the professional services and billing and some other infrastructure things they need to go do to resell SaaS as opposed to reselling hardware. But many of them are making that -- those investments for other reasons. And so we want to be right there with them. So we've seen just -- we're actually -- we feel like we're being pulled into the VAR channel. The service provider channel has already been there. But they're seeing it as increasingly important. They -- in many cases, the service providers have made investments in contact center that they're now recognizing but none of them have a cloud contact center per se. And so they're all -- and many of them are recognizing, okay, we need to go look at a proper CCaaS offer. So we're starting to see the SPs. And then for us, the systems integrators are another big and very, very important channel because our primary sales motion is along digitalization and digitalization is being heavily touched and influenced by the systems integrators. So like Deloitte, for example, are huge partners. So yes, it's a big investment for us in channel to get scale. And particularly as we go global, that's going to be important as the service providers will be important there, too. So see us continue to invest there.

So I remember sitting down with Dan Burkland, Company's President, probably is roughly 2 years ago -- we'll go with that at least, and we were talking about hiring reps in the space, and it was really easy back then, given easy is maybe a relative word, given the trajectory of the business, at least out of other contact center peers. Is that kind of still the case today? Is hiring sales reps still pretty easy?

Yes. We get our pick of the litter. We're getting great reps. We're about to go into our sales kickoff next 2 weeks. And we've done the hiring that we needed to do in Q4 to ramp into 2020. And no, we just -- we've been on a roll with getting great, great sales reps. And Dan has done a phenomenal job building and maintaining that culture. That's one of the big reasons why these reps -- I mean, A, is the growth and the opportunity, I would think everyone sees that. But they also -- it's pretty well-known in the industry that the Five9 culture is something that is very attractive to their -- to these sales reps. We're getting good reps.

Good. Lastly, on go to market. At your Analyst Day, you talked about splitting up your enterprise reps into 2 different segments. Kind of why that change? What are you seeing there that's driving it?

Yes, just the increased traction in enterprise that we've been seeing, and we didn't previously have that segmented out amongst our enterprise sales -- amongst our sales force. And so what we've done is we've just created enterprise sales, which are the very large deals, and then what we would now call midmarket, the lower end of that. And that's just to help us attract the right kind of talent. We've been hiring folks into those high-end enterprise sales jobs. And what we were seeing is that our -- there was a natural, sort of, segmentation happening amongst our field where some reps are really, really good at the large relationship selling and some are not. Some are much better at the 100 to 200 seat contact centers and 1, 2, 3 month sales cycles getting those done. And so we were already seeing better success from some reps with the very large accounts. And so this is, I think -- this is pretty normal at the playbook that I think every company goes through. So we've just taken that next logical step to create that enterprise segment and we've staffed it with some of the most successful reps at Five9, and then we've also begun to hire externally. So we've got some good external talent coming in.

All right, moving on to a couple of financial questions before opening it up to Q&A for everyone because we have the CFO here, and you have to say more than the safe harbor statement. Long-term profitability is probably the one financial question I get most frequently about Five9 partially because you've had a cloud competitor that was public. Obviously, not public anymore, but their model is substantially less profitable and also growing at a slower rate than Five9 is today. But any comments on what the profitability of your model looks like, maybe from a time duration standpoint or maybe at a $500 million or even $1 billion revenue range relative to where you are today.

So before we go forward, let's go a little bit back. I'll remind everybody in the audience who haven't followed us closely that we went public a little over 5 years ago. And at that time, we said that about now, we would be in the 22% adjusted EBITDA profitability. And we actually got there a year early. And it was quite a serious improvement. When we went public, we were negative 6. Now this last quarter in terms of EBITDA -- excuse me, negative about 20. And just last quarter, we reported positive 18. So a pretty dramatic improvement. And that's come across all the areas, both the gross margin where we've had, over the last 5 years, about a 12 percentage points improvement. Slow but steady, and then also considerable operating leverage. Going forward, we've told The Street that we have a 27% adjusted EBITDA target in about 5 years from Analyst Day, which was in November. And we feel pretty confident in the 2 main areas that would drive that. The first one is continued gross margin expansion. There's going to be detours. This last quarter was the first quarter in over 5 years where we didn't improve our gross margins year-over-year because of some investments we're making, including going to the public cloud. But the main single driver there is that our subscription revenue, which is about 70% of our recurring revenue. That always grows somewhere in the 20s, a blend between subscription -- enterprise in the 30s and commercial in the single digits. And the cost of that subscription revenue grows less than that. And that gives us a steady expansion. And then further operating leverage, particularly in G&A. We've gone now 5 years where every single quarter our G&A percentage has gone down year-over-year. And those are the 2 big drivers. We're not expecting much from either sales and marketing and R&D. So that is our main focus going forward, is that 27% in 5 years with, obviously, not a straight line. There's going to be detours along the way.

I do think it's impressive going forward the next couple of years. You're still committed to having some margin expansion, yet the R&D investments on a relative basis seem like they're stepping up, and you can see that in the model a little bit, a good trade-off. Lastly for me, Barry, not quite 2 years ago, you raised some money from a convertible debt offering. You spent a little of it recently on the Whendu acquisition. But hindsight being 2020, that seemed to be a shrewd move, not necessarily to fund some acquisitions. For those that are less familiar with the model, the company had historically undertook a number of operating leases for some of this CapEx. Now you're spending, obviously, out of cash. But can you help us kind of understand maybe what the annual interest savings are through that change or that shift in strategy?

Yes. So basically, we were very low on cash. We didn't do a follow-on offering as many other companies did. We were amongst the lowest in the SaaS universe. And when this convertible came along, we resisted it until the interest rates got down to 1.8%. And if we include the amortization of [ the capital ], which doubled the stock price, we're still approximately what we were earning on surplus cash, which we didn't really need but we wanted to get rid of this higher cost debt from the leases that Scott referred to. So we're saving about $1.5 million in net interest payments between those not having capital leases and also not having a revolver that we had at the time.

So I am happy to open it up to anyone.

In the past, I've always thought of you as being really strong in the -- sort of the routing in the back end and partnering on WFO and other things. Now we've moved more to automation, omnichannel. Did that model shift a bit? It seems like you're moving sort of closer to the agent and maybe -- and does that disrupt any of your relationships with the partners?

We -- Verint is a really big partner in WFO and another company called CSI, so -- that you might not have heard of, that we kind of sell for the high end and the low end of the market, respectively. A lot of the technology, you're right, that I referred to in -- when I was talking about AI and automation, it does sort of -- it's a new take on what you might have considered classic WFO. And so from some -- from that perspective, I think you see there's a lot of attention in that space, not just from us but from others. So we are definitely moving into that space. And our partners certainly understand that, that's an area where we have some competitive advantage because we've got the data that we have. And so yes, we're going to continue to move in that direction, but I don't expect any disruption of our partnerships as a result. There's just a lot of value to be created here, and I think everyone is excited about it, but we're not seeing any negative effect from our partners as we've been announcing our plans.

Could you share your thoughts on Twilio Flex and [ call inventory ]?

Yes, well we haven't seen them very much at all. We see traditional Twilio in some of our customers as they use their SMS APIs to do automated messaging. But Flex, not at all.

Could you talk about the channel strategy that relates to Europe [ and U.K. ]?

Yes, channel strategy? Yes. I think the service providers will be an important part of our strategy in Europe, particularly in the U.K. just because of the complexity of telco regulations in all the various countries that you'll go into. And so -- whereas in the U.S., you have a single, very, very large market, and we've been able to do what we've been able to do essentially without the service providers, globally, we think we're definitely going to want to leverage the service providers more.

Probably time for 1, maybe 2 more, if you want.

I know you mentioned you have the 75% or higher win rate versus competitors in RFP. Can you talk about the [ view ] for that number as being the upper market and then lower market customer wins?

Yes. So the question is, what about our win rate, which has consistently been over 75% versus our 2 main competitors. Well, especially inContact, which is the main competitor. That's in our enterprise business overall. And frankly, we don't measure that at all between -- whether it's a 1,000 seat customer or a 500 seat customer.

Great. With that, we'll let everyone get to the next meeting. Thank you.

Thank you.