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

Hey, good afternoon, everyone. Thanks for sticking with us for day 1 of the Wells Fargo TMT Summit. Looking forward to our next session with Five9. With us today, we have CFO, Barry Zwarenstein; and President, Dan Burkland. I'll start off with some questions. If anyone in the audience has anything you'd like to ask, you can shoot me an e-mail at [email protected]. I'll do my best to layer those in as well. Barry, Dan, thanks for joining us here today. Most importantly, before I head into questions, I promised I'd allow Barry some time just to read off the safe harbor statement. So Barry, go right ahead.

Thank you, Michael, and good day to everybody. Before we start, I just want to remind everyone that our discussion today will include forward-looking statements concerning events and trends, including our acquisition of Inference Technologies Group, that may affect our industry, the company and its operations. Of course, our result may be materially different from what you -- from what we discuss here today. Please refer to our most recent Forms 10-K and 10-Q for information about certain factors, among others, that could cause our results to differ materially from those described in such forward-looking statements. Thanks, Michael.

Yes, absolutely. So let's dig in. It's been an atypical year for many businesses, but a very good one for Five9. Maybe highest level for those investors who are less familiar and haven't spent as much time as they maybe should have, we could start with just the value proposition around cloud contact center, sort of the genesis of where Five9 started. And any thumbnails that you have on just cloud penetration and state of the market today just in setting the stage, I think, is helpful.

Sure. So Michael, thank you. This is Dan Burkland, President of Five9. Just to level set, the cloud contact center has been around, and we really moved upmarket about 10 years ago from SMB business up into enterprise. And all the while moving into a single virtual contact center in the cloud made a lot of sense for businesses. If you just strictly look at the fact that on the premises, you had silos of technology servers sitting within these locations that could serve that location and the agents associated with that location very well. But the economies of scale were all lost. And by moving that technology into a single instance in the cloud allows organizations to treat all their agents across all their different locations as though they're sitting under one roof. You can have one -- all the economies of scale. You can have skilled agents in any location, anywhere. They're all logged in to one system. So the interactions can get routed to the agents wherever they might reside. That was kind of the early days value proposition of cloud over premise. Then came the world of how do we move upmarket and how do we get to really larger enterprises. And we had to cross a few thresholds of prerequisites to do that. We had to prove scale. We had to prove more reliability than they could achieve on their own at the premise. We had to prove that we could secure and protect their customer data. We had to get on par from a feature functionality perspective and then provide them with a platform for innovation. We checked all those boxes about 5 years ago and then some. And then the innovation started taking place because we had now a platform where you could bring to the market really innovations along the lines of automating different functions. And that can only be done in a cloud-based solution. And when we talk about automation that can be done, innovation, it can be done in a variety of ways. If you think about the sequence, I'd like to position this kind of in a chronological order of a typical transaction. When you reach out to a contact center, whether it be e-mail, chat or voice -- let's use voice as the first example, most commonly, you reach out, you're typically identifying yourself, giving your intent for your inquiry and then you're being intelligently routed to an agent that could serve your needs. And historically, that's really been the contact center solutions like Five9. That's it, right? We come in, we identify a caller through an IVR, we route them, and we get them to the right agent. We pop a CRM screen, and we're done. Well, today, we can infuse technology that allows us to automate at the front end, whether it's a full self-service IVA through our acquisition of Inference recently, industry leader in IVA technology. It takes IVR to a whole new level. Rather than use touch tones or a very select set of voice commands, it now can be open-ended and interpret English language. Just like Siri or Alexa that we're used to in the consumer at home, we now have that same technology available to us to understand spoken English, fetch answers and give -- or fetch answers and then speak them back to the customer for complete self-service. Second area we infuse automation is during the call. We're transcribing and listening in on the call. We can then apply natural language understanding. We can go fetch information, deliver it back to the agent, and the agent can deliver the best response. We also can do a post call wrap-up with automation. I can now -- if I'm transcribing the whole call, we have technology that will pull out the summary data, insert it straight into the CRM. And suddenly, we don't have to have 2 or 3 minutes at the end of every call to do wrap-up. And then another final area in technology is really workflow automation. Being able to then follow up with you, as an example, Michael. If you place a transaction with us, I can now follow up and send you a text message that thanks you for your order, confirms when it's going to ship, sends you a survey after it does ship and so forth. So what we're finding now is consumers are expecting that whole level of choices and automations throughout their experience. And we're now, for the first time as an industry, able to deliver those.

That is a great overview. So you're laying out the value proposition. I think it's -- stand-alone is compelling and then something like 2020 happens. And all of a sudden, there is an even more demonstrable need for what you're enabling, right? There's a shift towards e-commerce. There's the move and the need for remote contact center agents. And that all follows directly within the purview of what you're describing. And so maybe you can just help us understand more recent customer conversations. Has that awareness picked up in what was a more patient market and still is, to some extent, right?

Right.

But I think, in general, this need would seem to become, I think, even more critical given the prior few months.

Right. So the phenomenon that customer experience can be a differentiator for organizations was happening for the last 2 to 3 years, where instead of a call center, instead of trying to just do more with less and get people on the next call, what companies found was they could actually differentiate on the service they delivered and more so than their product even in many cases. And so investing and having it be a strategic investment was important for a lot of businesses. And so that was happening pre-COVID. When COVID hit, it required -- it forced everybody to a work-from-home model as we know. And they kind of had to do that with whatever they had. If they had a cloud-based solution like Five9, it was very easy. Your agents tomorrow log in from home instead of from the office. Well, you got a built-in soft phone. They use that Internet connection to have their conversation, and it was business as usual. For the premises-based solutions, it was more cumbersome, right? I got to get through the firewall, and I got to log in to those servers that are at one of those locations that I described earlier, so very cumbersome. So a lot of companies did look at it and say, we need -- we weren't going to look at cloud contact center for total -- our current systems were fully depreciated, we wanted to sweat those assets as much as possible. Now I think there's been an acceleration of interest for 2 reasons. One is for that one, the work-at-home flexibility and the work-from-anywhere flexibility, but also for these -- the innovations that I described. Okay. Yes, let's go ahead. This is accelerating. People want options. They want to have innovation and automation. Let's move forward in a quicker fashion. So they started that process. So we've seen customer demand increase slightly, but it wasn't a runout. It's not like this Zoom call we're on, where everybody was able to run out and install it and use it tomorrow because there's quite a sales cycle involved in enterprises revamping their contact center infrastructure, and then there's an implementation cycle. So what we found is the interest is there. The pipeline is growing, not only from a customer demand, but then Five9 has also made strategic investments in our channels, into our international presence and footprint around the world and then also into some of the big global SIs. We enjoyed a partnership with Deloitte for several years, and we invested in the beginning of 2019 with EY, Accenture, Slalom and IBM, which is now paying off nicely with results. So that's been the drivers.

That's great. Barry, I'm going to bring you into the conversation here. Q3 was a set of impressive results. I think maybe just to start off with from your perspective, can you talk through what took shape there and hit on some of the key highlights for investors from your vantage point?

Yes. The quarter was really firing on all cylinders. One of our key metrics is LTM subscription revenue -- enterprise subscription revenue growth. And that comprises now more than half of our total revenue, and that accelerated from 33% to 35%. And it's a good indication of where the business is going. And the -- one of the drivers was the fact that we turned up more seats ever than we did -- than ever before in the quarter. And these were seats that were there prior to COVID because, as Dan mentioned, it takes a while for the sales cycles to manifest itself. And with that, then also came strong usage revenue because, obviously, if you have the seats, you got the agents in the seats making the phone calls. We were especially pleased then that our commercial business also was delivering good results, growing in the mid- to high teens. And we ended up in with 34% year-upon-year growth, something that we haven't done for quite some time. It's a record. The sequential growth is also a record. And we belong to that subset of companies that also believe in the bottom line, and we had 21% EBITDA and, again, strong operating cash flow. So a good market and a good execution.

That's great. And one of the questions we get often lately is just around temporary versus durable phenomenons. I think we've talked a lot about the patient process of selling in contact center. And so it certainly wouldn't seem like, to Dan's earlier point, this is Zoom where you just turn it on, and you're up and running. And we know this is generally a land-heavy model as well. But when you think about the durability of what you're seeing, maybe you can add some context around generally the cadence of sales cycles and how you think about just the general progression of this migration to cloud that is still taking shape.

Yes. It's not only still taking shape, it's just getting started. I mean when you really look at the 10% to 15% penetrated, even that can be looked at as an exaggeration because that includes some of the hosted solutions that wouldn't necessarily be classified as cloud, but somebody that's just hosting a solution for a customer and then charging them a subscription fee. But when you look at true cloud, yes, this migration, we don't see it slowing down. If anything, people have looked at it and said, time to move faster towards that so that they can innovate and deliver better experiences. But as far as working through it, yes, there's been a slight increase in some industries. As you mentioned, with e-commerce increasing, we've got more transactions taking place in the contact center, especially among retailers. They've had to migrate and move that business over. We talk about the contact center being kind of the new front door of many businesses. And what we mean there is that's typically, in many cases, the only conduit that companies have to their customers. So they've got to create a great customer experience in order to do that. And they only have one place to do that, and that's from their contact center. So it's become more and more important, especially even for those retailers that have storefronts where they could create an image and an impression and a brand before through a combination. Now it's almost exclusively through the contact center. So that's one thing. We see the other is upmarket. More and more larger enterprises are seeing a need and the ability to leverage cloud to deliver what they want to deliver. And it took years for the industry to get to the point where we can prove out those points I made earlier about security and scale and reliability. And we've done that. So it's opened up a whole new world and a whole new set of customers. And the SIs are helping us establish that trust.

Barry, you provided an initial outlook for 2021 in line with the Q3 call. Some may call it prudent, given the market backdrop we're describing, but can you help set the stage for what's assumed in guidance and where sources of upside have come from historically? And what could cause those to come up again here potentially next year?

Yes. Thank you, Michael. So you are alluding to our prudent guidance philosophy, which is a reflection of that philosophy, not of the strength of the business. We adopt this. We -- for the last 6 years, we've adopted this policy where we give initial guidance with a 16% year-upon-year growth. And the reason we do that is we have seasonality in our business. The H1-H2 split is typically 47-53 in terms of annual revenue. And we have extremely high, extremely high margin profitability, and we don't know the degree of seasonality. We know that there's going to be a winter, we just don't know if it's moderate or strong. And so we don't want to play havoc with our bottom line, and we take this prudent approach and then are happy to increase it as the year unfolds. This year, unusually, instead of giving the classic 16%, we gave 18%. And the incremental 2% is entirely attributable to a very exciting new acquisition of Inference Group Technologies, which we can talk about more, but a really stunning leadership type acquisition in the IVA, the intelligent voice assistant market, which is now becoming standard in the enterprise. And that inorganic 2% is why we went from 16% to 18%.

That's helpful. I think I'd like to spend some time. Inference ties into this, but just in thinking about ways that you can drive the per agent price point higher, I think there's always been good appetite for spend just given labor cost and the customer focus within contact center. But there are potential opportunities just to drive that agent price point higher. Dan alluded to some in the beginning, in the opener, just around some of the new technologies, some of the new features and functionality that Five9 has enabled, that I think demonstrates more value, helps provide more efficiency and can capture potentially higher spend profile. But when you look at this market and some of the things that you're seeing, what are your sort of highest probability use cases for what drives that agent pricing higher? And how does Five9 differentiate in that conversation? We've seen a lot of innovation. We've seen the acquisition of Inference. And I know there's a lot there, but those are, I think, things that are top of mind that are helpful for investors in helping understand Five9's differentiation in this market as well.

Yes. I'll take that one. And if you look at the whole portfolio, right, I did mention the Inference and Whendu acquisitions give us some increase, and AI gives us another. If I look at AI and the use cases there and workflow and the use cases there, those are -- we're evangelizing those and creating demand for the first time in the industry. They're not pre-budgeted, already established solutions. If I take 2 more solutions that are budgeted. If you take IVA and think of it as the next-generation of IVR, I'm just taking my -- what was some very rudimentary speech-enabled IVR and now fully automating it more accurately, that's something that I think can be a big game changer as we look -- as we move forward into incorporating that into just about every customer as some sort of an IVR. And this is a way to replace that with the next-generation of IVR. The other is workforce optimization, WFO. We acquired a company, Virtual Observer, that gave us the ability to take that. And that's really where you can -- we can sell everything from workforce management to quality management to speech analytics. And so those 2 areas are probably the most -- that move the needle the furthest from an ARPU and increasing that ARPU that we sell into our installed base. Today, we get $200, just north of $200 per seat per month across our user base. If a customer goes all in and buys those 4 application sets I just described plus chat and e-mail, you can get upwards of around $400 per user a month. So there's a range there that gives us pretty much quite a lot of upside as the years progress and as those other applications become more mainstream.

Is there a sweet spot there in terms of industry or size of contact center that those technologies are more appropriately suited for today or...

It's a little bit counterintuitive because the larger -- people are like, oh, you get volume discount, you'll get a better price per seat as you move upmarket. But as you move upmarket, they want more of what you do also, so we end up selling more SKUs and more applications. And so we actually are kind of very consistent per user. We get -- there's a little volume discount they get on the core seat, but then they end up adding more options, if you will. But the upmarket deals that we've sold of late do fetch a better ARPU across the board just in general because they're buying so much more from us.

Got it. The dollar-based net expansion rate has been consistent. We know this is a land-heavy model. So Barry, maybe you can provide some context for software investors that might not have the full background. It has been picking up more recently. What could drive that metric higher? Is some of this functionality? Does it hold that potential? Or is it more likely still a land-heavy model with some of these added features and functionality adopted from newer contact center customers?

And you're on mute, Barry.

Dan got you quickly.

Can you hear me now?

Yes.

Yes. Go ahead.

Sorry about that. Yes. So at the highest level, there is an upward bias in our dollar-based retention rate, which is last quarter was 107%. I say that because the 107% itself is a blend between the 82% of our business that's enterprise and the 18% of our business that's commercial, where the dollar-based retention rate is somewhere in the 80s, like many other commercial businesses. And the proportion is moving towards enterprise, which gives us an uplift over the upcoming years. Our dollar-based expansion rate has been improving in the enterprise. Look no further, if you go back to our financial analyst days, we took our 49 largest customers with more than $1 million in ARR, and we showed what it was called the Minecraft slide, which showed how every quarter they were buying with a compound annual growth rate, including some that weren't growing that much, of 67%, so very strong. I would hasten to add, though, that the most recent improvement sequentially from 105% to 107% was due, in fact, to 2 big orders in the second half of '18, beginning of '19, which are now out of the year-to-year comparison. And given the big orders that Dan and his team have succeeded in landing, you'll get some more of that volatility in the future. But the trend in our mind is -- over the upcoming years is that upward bias that I talked about.

Okay. Okay. Q3 provided good margin uplift, too. I think, look, some of that is likely a function of the top line outperformance. When you think about the balance between growth and margin going forward, is there anything that's providing more of a temporary uplift given the current environment and maybe a lighter expense profile for us to be mindful of? And then going forward, given it certainly seems like there's plenty of opportunity to invest for the future, how are you appropriately calibrating between those 2 dials, Barry?

Yes. So if we look back first to look forward with some information, since we're in public a little over in April of 2014, we've grown our revenue from 22% to 34%, so 12 percentage point improvement; and our bottom line and adjusted EBITDA base from negative 28% to positive 21%, so an improvement of 49 percentage points. So -- and for us, it is not -- it clearly helps that the revenue is growing that allows us to get the operating leverage. And -- but it also helps the fact that we've got exceptional unit economics on our enterprise business. It's a big 6:1. It's a big -- it's got an upward bias as well. It's difficult to round down to the 6, let me put it that way. And that allows us as we get the revenue to improve. Now you've mentioned Q3 in particular. And they -- it was clearly due to the fact that, as I mentioned in my opening comments, the higher revenue, margin profitability, certainly over 80%, more likely over 90%. Looking forward, we are making investments in our -- taking our product solution from our own data centers to the Google Cloud platform, that's actually been successful, and it's in -- already in Canada going to Europe, which is going to enable, even more strongly, our European growth, which is a major focus area for us and where we have a lot of potential. And then also, in the near term, our Inference acquisition is dilutive on the bottom line. And that's actually the main reason that we gave the guidance we did in the bottom line. But long term, by that, we mean about 4 years from now, we believe that we can get to 27%-plus adjusted EBITDA, which is pretty respectable. And the confidence arise from the fact that the 2 drivers of gross margins were, out of the last 31 quarters, 29 of them we've improved year-over-year and including 140 basis points on the last quarter. And in G&A, this last quarter marked the sixth year where every single one of those 24 quarters, there was year-over-year decline in G&A as a percent of revenue. And we believe that those 2 drivers will get us to that 27% in 4 years.

So pretty good track record, just worth highlighting. Just a few minutes left. I think I'd like to turn the time over to each of you. Just any parting thoughts for investors as we're wrapping up 2020 and heading towards 2021. Focus areas that you're focused on maybe, Barry, on the financial side; and Dan, on the go-to-market side. Just turning it over to you for closing thoughts here.

Dan, I defer to you first.

Sure. On the go-to-market side, because we're seeing demand from customers of all sizes and globally, we're investing heavily in the go-to-market, on all the different routes to market in giving us reach. We know when we get to the plate, we're going to be highly successful and have a great win rate, not only because of the technology and the innovation but also because of the service and support and success we help create with our customers. That's a different model than just being a technology provider. It's a partnership. And we really do allow them to extract the most value out of the technology stack we deliver. So really making sure we're focused on large SIs that bring us upmarket; the large distributors like AT&T, CDW and the likes; and then all the distributors, resellers and master agents that we also bring to the table. So getting our reach out there has been important. It's what's allowing us to continue to accelerate our pipeline and therefore our ultimate success in market. Barry, on the financial front?

Yes, a very straightforward situation. We've got a great market. We've got a team that's got this cultural glue that is unique in the industry, and our mission on the financial side is to try and be a boring company. And to the extent that there's excitement, to provide upside to whatever The Street is expecting.

That's as good a point as any to leave it on, Barry. Well, you can leave it to us to sprinkle on the excitement. We enjoy covering the story quite a bit, but certainly insightful from both of you, Barry, Dan. Appreciate the time. Have a good rest of your week.

Thank you, Michael.

Thanks a lot, Michael, for this opportunity. Take care.

Thanks, everyone.

Bye.