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

Thanks, everybody. I'm Meta Marshall. I cover the communications software space here at Morgan Stanley. If some of these conversations from the last session can move outside, that would be helpful. As we get started, at first, I'm going to read the disclosures. Please note that all important disclosures, including personal holding disclosures and Morgan Stanley disclosures, appear on the Morgan Stanley public website at morganstanley.com/researchdisclosures or at the registration desk. Again, Rowan, CEO of Five9, thank you for being here today.

Thank you, Meta, nice to be here.

I'm going to start this session with kind of the topic du jour of any potential corona impact that you've seen or just any changes in behavior that you've seen just kind of in the couple of weeks that we've been working through this.

Sure. So at a high level, we know -- I'll just point out, the vast majority, 92% of our business, is U.S., domestic business. So certainly, we're somewhat more insulated than others from international exposure whatever there would be, on that front. Our business is a cloud SaaS business. And I think from a business continuity perspective, there's definitely a perspective amongst the customers that cloud-based software has the flexibility of letting people work from home. I think you've seen that recently with Zoom and some of the UC vendors, UCaaS companies. The same is true of the contact center. So these contact center environments are environments that frankly are like big rooms like this, probably like giant airplanes, in a sense, where you wouldn't necessarily want to have your agents all consolidated in the environment of -- in the event of an outbreak or a pandemic. So some of our -- one of the benefits of Five9 is the ability to have your agents actually work from home. You just bring your laptop home, and you can actually take calls and do your messaging and do everything that you can do in the office at home. So that's a sort of fundamental power of the cloud. We certainly haven't seen anything on the downside or upside candidly with this -- with the more recent news around coronavirus. So it's kind of business as usual for us. And I think the last thing I would say is we're by no means immune to global macro issues. We primarily sell on seats, so seats in the contact center. We do tend to, in our contracts, limit the downside of that, the flex to around 15%. So even if we have customers that are having issues, we are sort of protected on the downside. But 1/3 of our business is usage-based. And so you could certainly see fluctuations. We're not seeing that now. But...

Okay. Got it. Contact center has moved up the awareness stack, even in the time that I have been covering it to kind of the time that you guys have all been around over the past kind of couple of now almost 10 years that Five9 has been around. Where do we think we are in the process of organizations realizing the value that contact center can add to their customer strategy?

Well, of the 2 big drivers of our market demand, customer service transformation is one of them. And your -- you did a great research report last year that showed that the enterprise IT priorities' #1 on that list was customer service. And I think that's in part driven by -- well, there's a number of factors, but one of them certainly is Gen Z and millennials' preference for better service and better contactability and "treat me well, and I like the experience as much as the product" kind of environment. So that's certainly one driver. And we see that as this huge secular tailwind behind every business saying, "Oh, my God, we have got to do a better job with customer service." It's just the way it used to be with crazy IVRs and long hold times. That just doesn't cut it anymore for large enterprises. And then the second really big tailwind for us is just the cloud transformation. The -- we sort of worked through this evangelization of like cloud actually can work, a; b, the infrastructure for doing real-time communications is now at a maturity level where it's relatively easy to put in communications like cloud-based communications software. So that's underlying a lot of the acceleration you've seen with Zoom and Ring, where it used to be sort of the exception that a customer would have enough networking bandwidth overhead and everything else that they needed to do communications over the top to the cloud. Now that's pretty much the standard. And so in fact, many companies have sort of even over-provisioned bandwidth and campus networking to the place where it's quite feasible to put in these over-the-top communications products, so that we're seeing this wave now drive our industry as well.

Got it. And then -- and tied into that and kind of tied into some of the research that we've done, digital transformations tend to kind of be this trigger for customer service or contact center upgrades, or CRM upgrades kind of being the pain point that people are trying to address. Do you still see that being kind of the trigger point as we kind of continue over the next couple of years? And why has the system integrator been such like a critical piece of your business as well as kind of that decision-making process?

Yes. I think the impetus to improve customer service sort of -- that's like the tip of the pyramid. It has a lot of stuff underneath it. And so you kind of have to start out with, like, "Well, we need to know more about our customer." And when the agent is engaging with the customer, they need to have a complete view of that customer transaction because it's really bad service when you know you just returned the product, then you call the company and have -- they try to up-sell you on something, and they don't apologize for whatever problem you had. So you want to give them that insight and visibility into the customer, and that starts with CRM. So CRM and contact center and all these things are all quite tightly tied into this overall picture, and that's where the SIs have been really important. So as you -- I think we've mentioned to you before, Meta, the -- Deloitte is one of our front-runners on that front, doing over $10 million business with us. They've built contact center into their digitization practice. The other SIs are certainly, I think, not far behind on that front, and in their own ways are doing a lot of business both with Salesforce and others. So I think we'll see continued upside on that front. So we're really investing heavily in the SIs. And frankly, I think that what is also underlying this is a bit of the consumerization of IT that you've seen over the years, where sort of tech-savvy line of business leaders have become much more empowered to make decisions and drive sort of business systems choices with the cloud. And that has resulted somewhat in a hollowing out of IT and not only from a budget perspective but also from a skill set and influence perspective, where the LOB buyer has a lot more influence. So this is just sort of a factor of what a modern company looks like. Not to say that IT is less important, but the lines of business have become much more important and influential. That's our primary selling motion, is to that line of business buyer, actually not primarily to the IT buyer.

So you would say probably, at this point, 50% or more of sales are kind of determined by the outline of business?

For us, more than 50%. Yes, it's our primary buying motion. Now that's quite different than the UC and meetings company, sort of software buyer, who is really is still the IT buyer. It is influenced increasingly by LOB, meetings probably more than UC. But that's another valid and, I think, very interesting go-to-market for us is through the UCaaS phone cycle upgrade. So big partnership on that front for us recently has been with Zoom. Zoom's emerged as like the real, I think, longer-term, strategic competitive challenger to Ring, who has really run away and done a great job with the market. But we can sell into that motion as well, and they actually need us. They need to have a contact center to go along with their phones.

Got it. And you just mentioned Deloitte kind of being $10 million worth of business or kind of contributing upwards of $10 million worth of business. You've also announced relationships with IBM or E&Y. Can they be as big? So we think of those relationships as being as large as Deloitte has been?

Longer term, absolutely. I think we're just at the real front end of this transition. So it's globally a $24 billion category. It's south of 15% cloud penetrated at this point. So you've got another -- something just shy of a decade worth of upgrades, of moving these premise-based contact centers to the cloud. And so I definitely think the SIs are going to be a leading figure in that transition. But you're also -- we are now starting to see the traditional UC and meetings VARs start to get into this game because they're actually seeing their customers attrit to the cloud contact center companies, and they're saying, "Well, we need to get into that game." And they haven't been able to get offers from their sort of legacy incumbent providers. And so they're coming to the table now as well as the service providers. And globally, the service providers are, I'd say, much more influential and important. So we're seeing sort of much more increased interests from the VAR channel and the SP channel, not that's -- nothing that's probably material this year for us, but it's something that we're investing in.

Okay. Got it. You mentioned international markets kind of being more tied to maybe a service provider being the trigger for that. But just where are we in international adoption of kind of cloud contact centers? It's been a laggard on the UC front. How do you see it on the cloud -- okay.

It's the same on CCaaS for a few reasons. One is, I think, bandwidth deployment is one of those issues. I think also, there's more complexity on the regulations side globally. And that's even been ramping up, and it's still a moving target with regards to GDPR and so on. So we're in the midst of investing in a public cloud infrastructure investment starting actually in Canada. So we've had quite a bit of interest in the Canadian market, and they want data centers in Canada. So we're giving it to them. But we're not doing that by our -- sort of deploying our own data centers. We're leveraging public cloud. And in this case, we're using GCP. So that's -- we're making an upfront investment around Kubernetes and other infrastructure transitions from a technology perspective so that we can rapidly deploy to new regions and geos around the world, so that we can keep up with the expansion there.

Got it. I mean you mentioned like the competitive landscape has been very dynamic, whether service providers want to get involved, whether you see guys are trying to get involved, whether CPaaS vendors are trying to get involved. How do you see the competitive landscape transforming over what has been kind of a point product space to everybody trying to come at it with a platform approach?

I think the 2 major factors here are the traditional buying motion of communication software products and then the new buying motion of the LOB-driven sort of business priority of customer service and, like, "Well, we'll just take whatever cloud products we want to do that." And so both of those are happening. Salesforce, I think, most recently made a big acknowledgment of that when they announced Service Cloud Voice, which is a sort of a new interface for them to engage with the contact center vendors like ourselves even more deeply. So we've leaned into that Salesforce relationship even more in the last 6 months or 3 months since the last Dreamforce and see a big opportunity just because that is a -- I mean, they are the 800-pound gorilla driving digitization in most of these companies. But we're seeing equal interest from the other CRM vendors out there, including Microsoft, who we have recently struck up a new partnership with their Dynamics business and then also with their Teams UC business. So Microsoft has sort of -- shouldn't be counted out on the teams you see on the UC side. I think they've taken a detour into competing and trying to take slack out with their messaging initiative with Teams, but I wouldn't count them out on the UC front. So I think you're going to see a continued movement of and even an acceleration of premise-based calling and meetings to the cloud, and that just has to drag contact center along with it. So we want to leverage those incremental partnerships to us, so Zoom and Microsoft being the 2 most important. And then on the sort of digitization front and that motion, it's really all about Salesforce; Oracle; Microsoft with Dynamics; Zendesk, who we have a big partnership with; and the attendant SI community that go around that. So E&Y, you mentioned. Slalom is another one, who is a big Salesforce-dedicated partner. So we're seeing a lot of traction there. For us, it's like we want to go both, go hard on both, really.

And so I mean, that helps fill out kind of the people that are ancillary touching it. But as far as the UC vendor is kind of introducing their own contact center solutions at the low end, maybe a Twilio or such names kind of came in at the -- at what you would consider more of the higher end of the market, just how do you see your space and being able to kind of defend it/grow it?

Yes. So I frame out the competitive landscape in the following way. At the -- on the communication side of the go-to-market, you have the UC companies, again, led primarily by Ring, with their own contact center offers or in Ring's case, notably with inContact bundled. But 8x8, Vonage and these others have sort of built their own lightweight contact centers. We don't, by and large, see the UC vendors playing in our space. That's for a couple of reasons. One, they're actually in the much smaller contact center deployments today. And they're sort of picking up into our space, but we're much more high end in terms of the size of the enterprises that we're selling to. That's one reason. The second reason is that our buying motion is actually quite different. So when our buyers -- our buying motion is this other main motion, which is the digitization motion, and that's not a UC refresh. So we don't bump into them that much, candidly. Our strategy on that front is, look, we got to compete with them as they move upmarket, that's clear. To do that, we need those partnerships around Zoom and Microsoft and these other vendors. So we sort of have an open-for-business with all UC partners approach. On the higher end of the market, you have these new platform players, call them Amazon and Twilio, who have had a lot of noise that we mainly hear at these conferences and actually not really in the customer base. So we're not really seeing them yet. The fundamental thesis behind the Amazon and Twilio move into this space is that contact center is interesting and important, A; B, some customers are underserved and need a platform with APIs that they can sort of code to, and they'll probably have developers who will want to do that. And we estimate that, that's something south of 10% of the market where there's an opportunity. It's a big market, as I said, $24 billion. So I think there's a segment that if they're successful both on a product platform and a go-to-market side, they could sort of carve out a piece of the market for themselves. But that remains to be seen. They're really not there yet. We made an acquisition recently along this line. So the -- again, the thesis that -- of these platform players is that it's really hard to take a off-the-shelf SaaS product and make it work for your large enterprise. Therefore, what you need is a platform with APIs, and that's what Amazon and Twilio are good at. They are platform companies. We acquired a company called Whendu because what we were seeing with our -- which is an integration Platform-as-a-Service that we're embedding into Five9. And what that does is allow for all that customization without writing any code. So it's a low-code, no-code visual workflow editor that the contact center operations people can use to customize their products. And so we're seeing a lot of success initially with that product and before we acquired them, actually, at helping larger enterprises deal with these corner case integration cases, where the only sort of alternative was to go to the code and to use APIs and so on. So this is somewhat of our sort of competitive reaction to that. So that's kind of how it breaks down. And then in the core segment of the market, our main competitor is inContact. It's largely a duopoly. The third place in that competition is Genesys, but they're quite far behind. And so we really see sort of inContact and us in a head-to-head race for this market in the main part of this enterprise segment. And what both of us are doing, but I think we're probably getting more acceleration on this front, is actually moving up into these even larger enterprise accounts. So that's the race right now is to transition this space up into the larger and larger enterprise.

Got it. I think for people searching for what that AI use case is, contact center is kind of that perfect AI use case. Can you just give a sense of what you've been trialing with customers over the past couple of years? And what you've finally just gone GA with on some?

Yes. We're not GA yet, so that's a this-year thing. But the AI opportunity in the contact center is very easy to understand. For every $1 of technology spend in the contact center, you have $10 of labor spend. And so people are very expensive, and it's a people-heavy operation. What the people do, contact center reps, is largely rote and repetitive tasks. Some big chunk of their tasks are relatively repetitive and rote and so, therefore, are sort of open to automation and particularly now open to automation with AI. So at the advent of deep learning is opening up a lot of doors for much more effective automation of the routine tasks those agents are doing. So our longer-term game plan with AI is to say, "Look, without having to think about transforming anything about the service you deliver to your customers or anything else, let's talk about how we can make your agents more efficient." I'll give you a very simple example. A big chunk of an agent's daily time, it's about 10% of the time that an agent spends, if it's a 10-minute phone call, they typically tend to spend about 1 minute doing postcall wrap-up, which is they open up your customer record, they type in the note, "So Joe called about this, na, na," and clicking on a few fields so that they can have some data about that call. That is sort of perfect for AI. So you can imagine, translate the cost in real-time using automated speech recognition into text, do use NLP to do text summarization and inject into the record the automated call wrap-up. So that's one simple use case we've been working on with one of our customers. Another customer in the health care space that we shared at our Financial Analyst Day, McKesson, are looking at a much more advanced use case that's around compliance. So they've got a lot of human beings that sit around manually listening to phone calls, spot-checking agents, and their agents need to comply with a lot of regulations around issuing proper disclosure to customers. So they'll listen in on these calls. And when they find an agent every once in a while not doing the right thing, they have to pull them in and train them and blah, blah, blah. They want to use the technology to automatically recognize those scenarios, so in real time, figure out the customer is talking about this drug and that drug. We know that when that happens, we need to ask these certain questions, so that technology recognizes that in real-time and pops up a compliance form for the agent. And they can say, "Ask this, ask this. Check, check, check." So that'll actually save McKesson lots of money in their quality management function. They've got dozens and dozens of people, that's all they do. So that's a second example of AI. The long-term opportunity, again, here is huge. It's $250 billion of very inefficient spend that's being spent on people that are delivering a service that basically no one likes. I mean customer service globally is not like on the top list of things that people love about dealing with companies. And it's almost like a nightmare. Call in, go through the runaround, you can't talk to an agent. That's not the future. And the technology is what's going to enable the surplus of spend to make that experience better, and it's going to have to come from making those agents more efficient. We sit on 6 billion minutes of recorded phone calls per year. And that's the sort of the grist for the mill of AI, machine learning training data. So this huge as I said I think unprecedented data set that we can use to train these models to do the 2 simple examples I gave you earlier. So there's big upside, but it's a long-term horizon.

And so how do we think of the interplay between, clearly, you guys have the data, you have the customer interaction, along with kind of some of the more AI partners like Google or anybody else kind of playing more on the analytics side of it?

So our strategy has been to leave the primitives to the cloud vendors. So what you're seeing evolve right now amongst the hyperscale cloud vendors, so Microsoft with Azure and Google and Amazon, is, number one, voice is becoming a native capability of all computing, right? We see that starting with Amazon and Google Home assistant and now Siri. And so essentially, what's happening is all the vendors, and Apple included, have to make voice a native part of computing. So what's that -- what that's making is real-time, high-quality transcription technology easily accessible and at a low cost. So the cost curve is coming way down, and it's now achieved human levels of accuracy, 95%. And if you look at Google's, who has the best today, if you've used Google Home or Google Assistant, it's shockingly good and shockingly fast. So that's why we partner with Google, and it starts with getting the -- that, what that does is very important. It turns a voice channel from an analog stream into a digital channel. Once it's a digital channel, you can compute it. What does it mean you can compute it? Well, we can also leverage in Google's NLP technology, natural language processing, make sense of a real-time stream of conversation data. So we're also leveraging that technology stack from Google, but it's a very competitive field right now. Amazon has Lex and Poly underneath the covers. Microsoft has their own. IBM even are doing their own thing. There's a whole host of start-ups. So I would say there's a very long sort of Chinese menu that's available to us to choose from around which primitives we can bring to bear. Our job is not to do that core work but actually to do the assembling and the deployment of that, apply it to specific contact center use cases.

Okay. I have a whole list of questions. But given that we're kind of getting closer to time, you've noted that you have a long tail to kind of be able to grow in the high teens or into the 20s, as you have been growing for the past couple of, call it, 5 years. You've also been remarkably profitable. So where do you think of kind of the trade-off of investing for growth but also kind of continuing along the trade, where you've been? And what is the biggest contributor to that growth going forward? Is it expanding into some of these AI use cases? Is it just cloud adoption? Or is it kind of channel -- exploiting the channels available to you?

Sort of all of the above. I mean over the last 2 years, you've seen our top line growth accelerate into the high 20s, with last year coming in at the high 20s. And so that acceleration is partially a function of the fact that our Enterprise business is growing -- is 81% of our business now and is -- our enterprise subscriptions are growing in the 30s. And what we forecast to The Street is that, that enterprise subscription, which is half of our business today, is going to continue with the 3-handle for the foreseeable future, which is really just based on the underlying market dynamics of demand and our ability to execute. So we're going to continue to see that grow. And then just mathematically, you're going to see that sort of flow through. We are taking a prudent approach to how we manage the business. We want an all-weather kind of company that has both top and bottom line strengths. And I think that's especially relevant given the scenarios that we're sort of seeing around coronavirus, that type of disruption. Much harder to navigate those kind of waters when it's a growth-at-all-costs scenario. So we're not a growth-at-all-costs. We're a balanced, digestible growth story. We think growing in the high 20s is a great place to be, especially with the 18% EBITDA, which is what we had last year, and we'll continue that going into this year. We're also seeing continued, monotonic almost, expansion of our gross margins, which is sort of just being driven by the underlying factors of growth in the business. So mathematically, that just continues to increase. So we have software in the 60s and 70s going to the 80s, which makes sense for the business as we get to scale. And we have, on the usage part of our business, margins solidly in the 50s. So we have a very nice story in terms of our ability to increase leverage in the business and drive that growth over a long, long period of time.

Got it. Well, we're out of time. But again, Five9 is a great story if you're looking for a market at early innings of cloud adoption and early use cases of AI. So...

Awesome. Thank you, Meta.

Thanks very much.

Thank you, everyone.