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

Thanks for joining us for our next session. I'm really happy to have the management team from Five9 on. Before we go into Q&A, Barry, you had a special statement you wanted to read?

Yes, just a safe harbor statement. So before we start, I just want to remind everybody that our discussion today may include forward-looking statements concerning events and trends, including our acquisition of Inference Technologies, that may affect the industry or the company and its operations. Of course, actual results may be materially different from what we discussed here. Please refer to our most recent forms 10-K and 10-Q and the caption Risk Factors and elsewhere in the reports for detailed information about certain factors that could cause our results to differ materially from those described in such forward-looking statements. Thanks, Raimo.

Okay. Perfect. Thank you. And hey, it's really great to have you on this quarter. It was like you have, like, one of the most amazing third quarters out there. Rowan, maybe talk a little bit about what happened because, like, there was a real -- I mean, you've been accelerating every quarter for a little bit, but Q3 was kind of really where everything seemed to have come together even more. What -- [indiscernible] what were the factors there?

Yes. As you said, Raimo, this has been -- it's been solid execution building for a while. The last few quarters, I've Just been commenting on the team that's been executing like clockwork, and this quarter was no different. We've -- we saw all 4 parts of the business in terms of enterprise and commercial across net new and installed base all kind of hitting at the same time. We've seen that commercial business continue to do better and better as we changed that strategy a couple of years ago. [indiscernible] So you're seeing over the last couple of years that commercial business went from low single digits and has been rising. So that's contributing as well as our enterprise business, which just continues to execute in the mid-30s in terms of subscription growth. So really, really solid execution across the boards, and that's what drove this.

Yes. And then, like, if you look -- what was weird is like -- and we were all thinking, like, who's the COVID winner, who is kind of the COVID loser, not so much, but more who is COVID winner. Like, so you guys, like, people needed to work remotely, so then the idea of cloud came up relatively early. But it was actually more Q3 rather than Q1, Q2 where it showed up even more. Like, do we have to think about sales cycles here? Or what's kind of what's driving the timing?

I would say we saw some puts and takes as a result of COVID. The acceleration in the underlying fundamentals of our business started before COVID. We have seen, and we've been sharing that in our quarterly earnings reports both the pipeline and the book deals. Our book deals tend to take 6-plus months to show up in revenue. So you're definitely seeing that sort of -- a lot of what you're seeing is actually pre-COVID activity. We did see some acceleration from COVID, but we also saw some deceleration. And some of the e-commerce heavy companies or even retail that had to shift to e-commerce, where they were our customers, we saw strong usage throughout the year as their contact centers got more and more load placed upon them. We didn't see as much exposure to the COVID-negative segments of the business that were really affected. We just didn't have a lot of exposure there. So I would say there was a slight tailwind in usage from COVID and in terms of just overall contact center volumes. We haven't really -- so if you add it all up, you could view COVID as a net slight positive for us. But the underlying fundamentals are not slowing down. They're really accelerating. More and more enterprises are moving and recognizing cloud. If anything, the need for all of these enterprises and businesses to send their agents home was sort of like the straw that maybe broke the camel's back of the on-premises legacy. And so we're just continuing to execute, frankly, the same strategy with an additional leg of that strategy now coming in the form of the Inference acquisition.

Yes, yes, yes. And I mean, enterprise is the real story for you, but before I go there, just spend a minute on commercial as well. Like what's driving the research or the higher growth there? Because you think, like, in theory is like more uncertainty, recession-type scenarios in the economy means more attrition. So commercial should suffer, but it's the other way around actually. So help us understand that.

Well, first and foremost, it's a big market. And it hasn't been a huge focus for us, as you know. It's around 20%, just under 20% of our overall business. And what we did in our strategic shift was to actually go and look at different types of buyers. So we shifted the sales funnel and the sales strategy to find smaller businesses who were more focused on customer service transformation and less on sort of either the outbound dialers or the sort of lead gen sort of opportunities. So it was just finding a different vein of buyers in that segment that are, A, stickier, so our net dollar retention rate is benefiting from a lower churn rate in our commercial segment. And shifting -- and that's all sort of on the back of this new leadership team that shifted the focus where, frankly, these small, medium business buyers that we're now tapping into look more like the enterprise buyers in terms of customer service being strategic as opposed to this is just a churn and burn kind of get them in the door, outbound dialer telemarketing kind of situation. So they tend to be more sticky. They're buying more professional services from us, and so that commercial business is just looking stronger as a result.

Yes, yes. Yes, it was a pretty amazing transformation in these times, actually, yes. It's really good to see. Like -- but the bigger story is kind of really more around, like, you guys kind of getting more and more momentum around enterprise, moving higher up the chain, et cetera. Can you just -- maybe from a bigger picture perspective, like, the CCaaS market still seems very underpenetrated with, like, proper cloud solutions because everyone is like, oh, it's on-premise, I need to customize and that sort of stuff. But you have been able to kind of deliver high and higher up the value chain. Just kind of where do you see penetration and where do you see that going?

Well, it clearly is early innings on the penetration front, somewhere between 10% to 15% penetrated on cloud for a very large market. This is a $24 billion market and just barely penetrated. The enterprises, obviously, as you mentioned, that's why we're -- that's where we're placing a lot of our bets because we're seeing more and more of those enterprises start to get more interested. And our CAC LTV ratio is much stronger on the enterprise side, and they tend to buy more and stick around for longer. So it's been a big part of our strategy. That's the first leg of our strategy. And I mentioned that we added another leg to the strategy. So part 1 is like, get as many on-premises contact center, human seats transition to the cloud. Stage 2 is all about automation. We started sharing this story at our Financial Analyst Day and even beyond that. But we really fleshed it out at Financial Analyst Day last year around what is the opportunity to drive automation and labor arbitrage in the contact center, which is a 10x bigger spend for the contact center. Labor is 10x the cost of technology in the contact center. And with the Inference acquisition, we've now taken a leadership position in the next stage of this journey, which is automation.

Yes, yes, yes. And talk a little bit about, like, say automation angle, but then also from a product angle, you were able to play higher. Because like I remember when Barry and I first met and we were still young -- younger, sorry, we talked about 50 seats and more and where's the kind of enterprise. I think you moved kind of quite a bit higher -- up higher in terms of what you call enterprise and what's kind of a proper market for you there?

Yes. We're selling at 2 orders of magnitude higher than that now. So this has been a slow, steady build. We're regularly pulling down deals with greater than 5,000 seats. And every [indiscernible] we're sort of sharing great progress and bigger and bigger deals, record deals for us in terms of size, and that is continuing. And that's a really important segment of the market that I think is relatively untapped. Clearly, the 50 to 500 is the bread and butter that has really sort of driven a lot of the momentum in cloud. But now we're seeing that 500 to 5,000 and even 5,000 to 10,000 segment really starting to go in on cloud. And part of that is just the traction that ourselves and others have taken down enough of those larger customers that they're able to show those use -- those proof points and those case studies to their peers in the industry, and it's really helping us. And then one other that's reflected, by the way, is in our $1 million deals. So in last -- Q4 of last year, actually it was at our Financial Analyst Day, we shared that we had 49 customers paying us $1 million or more in ARR, and we're going to release an update to that number in Q4 of this year, but it's been a very, very strong growth segment for us.

Yes, well done. Yes. Okay. That sounds very exciting. And then one last kind of bigger picture question was like -- and it's kind of interesting in this conference because you have all different vendors that are coming from the -- in this market from a different angle. Like, how do you see this whole -- like, the way consumers operate with businesses is changing. And we're taking new formats on like messaging, et cetera, How is your thinking evolving there around kind of who you're on, what you are today and in the future?

Absolutely. It's very clearly a digital-first world at this point. I think no matter -- it used to be, I think, an accepted view that was younger generation wants to use modern digital technology, but all people still want to call in. And that's really not the case at this point. And certainly, COVID, if there was a nail in the coffin of that perspective, it was COVID. And people really of all ages and all the segments are saying, look, digital first is the best way to engage with customers And so -- and that's what customers want. So really, we've reflected that in our portfolio mix. We've got a release that we put out earlier this year that was really all focused on digital first. So we have great traction on that front. Voice is still a big component, but digital is growing much faster, and it's much more interest from customers. And part of the Inference acquisition, actually, is really exciting on this front because it's a next-generation platform that ties together all of the channels from an automation perspective. So a text conversation with a customer is treated the same as a voice conversation. The underlying rules that you put in place are independent of the modality, whether it's text or voice. And so you can build out automations and converge what used to be chatbots and, like, the kind of stuff you see from companies out there that were focusing on sort of niche automation spaces for text channels. We're now seeing those all come together, and that's what Inference is doing really well.

Yes, yes. That was actually leading to my next question. If you think about automation, like, there are several aspects to that. But how do you think that mixture between, like, voice and an agent actually talking towards like AI and an automated having bots, like, will change? So what can we do today already from a technology capability perspective? And where do you think this can go?

Yes. Well, that's where, I think, people have been quite surprised. And one of the reasons why we moved so quickly on the Inference acquisition is that we saw customer demand just spiking in the mid -- early to mid-part of this year. We signed a partnership with Inference. So what Inference builds and delivers an AI-powered interactive virtual agent technology that is in the modality. It's both a chatbot and also a voice chatbot essentially. And we saw in some of our largest deals, customers saying, look, we're seeing volumes go out the roof. We can't just go hire more agents. Is there an automation technology you guys can help sell us here? And the answer was, yes, of course, there is. It's an IVA. And we got the best technology, the market-leading technology with Inference. We're bringing that technology to bear with these customers. So for example, in our last earnings call, we shared a large logistics company. One of the biggest deals in our history was actually led by an IVA. In fact, 2 out of the last 3 biggest deals that we've done as a company, have involved IVA as a core part of the technology. So what is happening here is the technology maturity has reached a place where enterprises are saying, I got to get in on this. I have to get access to this technology to deal with increased load. So where that leads in the future, it is independent of what channel the customer chooses to use. Really, the dynamic here is more about whether it's a human or a virtual agent that's servicing that request on the back end. And what IVA technology has -- what Inference has done with this technology that I think is so special and magical is that anyone can implement it. It's drag and drop. There's a huge library of pre-built use cases across many industry verticals so you can look at retail and you can pick all the different kinds of use cases you might see in retail and very, very quickly in hours or days, build up a very, very complex IVA. And it's abstracting the underlying AI technology. The complexity that you have with the Google or an Amazon or an IBM, all is taken away and presented through a visual tool. What all this sort of adds up to in terms of long-term opportunity for us is extremely interesting. We shared the numbers that are fab that when you break down the spend in the contact center globally, it's around $24 billion being spent on technology and north of $200 billion a year being spent on labor. So it's a labor automation opportunity that is in order of package larger. How do we go after that? Well, we go after it with AI-powered automation and Inference is the market leader. In the next 10 years, Mackenzie thinks 16% of that labor can be automated, the tasks that labor does. And it's usually the high volume, low-value kinds of tasks that the humans are doing today. When you do the math, it's about 2.5 million, 8 million agents' worth of work that can be automated. Inference sells this digital agent technology for $450 per agent. So you can do the math, and what you quickly see is that this is a very large opportunity. The opportunity in terms of the 16% of the labor spend is $34 billion. How much of that we can capture? Well, it's about 2.5 million agents at about [ $450 ] per agent. So in other words, it's a massive new opportunity for Five9.

Yes, yes, yes. That was really exciting, yes. And then, like, in theory, in terms of the quality of the automation depends a little bit in terms of like, how good -- how many data you have to train the systems and how good the AI is on the data. But you're sitting on like a crazy [ leader. ]

Yes. The competitive moat that we have that is substantial around -- is around data primarily, and that's about 5 billion minutes of transactions per year recorded on our servers in the cloud. And so that's all accessible to us to use from a training perspective. And because of the fact that we've been expanding our enterprise subscription business in the mid-30s, and we look at that continuing for a long time, that's a significant expansion of our top-of-funnel ability to capture data. And then we monetize it at the back end with Inference automation.

Yes, yes. I mean how do you think about the -- and to me, it looks more -- if I look out for someone that I would worry for you would be the hyperscalers, like, how do you compare? It's like they are doing a lot of work around that as well. There's like Amazon Connect, I guess, doing something. Like, how do you kind of think about working with them or working with [indiscernible]

We view them really as partners. And in fact, we -- within -- Inference has a really interesting approach here, which is that they ride out of the layer above hyperscalers and AI providers. So within Inference, you can build out your business flow and your automation flow, and you can choose underneath the covers Google, Amazon, IBM, LuminBox, any of the AI vendors, Microsoft, Azure and so forth, you can actually pick and choose those. You can even mix and match them in a single flow. You could use Amazon AW -- automatic speech recognition, you could use Google text to speech, you could use Azure natural language processing. And that's really important. Essentially, what we're doing here is we're commoditizing that lower layer of the stack. We're making it really, really easy for customers to access any of those technologies. And we have an open platform so that as other vendors come to market with these technologies, we can just plug them in and underneath the covers. And so it's a really simple solution for customers to deal with without having to go -- if you look at those underlying vendors, much of their technology is essentially developer oriented. You have to sort of be a developer programming on GCP or AWS to get access to that technology. We have a visual layer that basically lets you wire them together and capture the business process and then marry that with our data. And that's the other key is that it's married with our data. And without our platform, you really don't have the data to be able to go train those technologies to make them effective.

Yes, yes, yes. And that would be -- if I think about it applicable for your whole customer like the mid-market -- the commercial segment, it doesn't happen because as also we even think about it. So the kind of longer-term key solution from you and then enterprises kind of, well, yes.

That's right. What's so significant about this is IVA technology has been in a nascent form out there in the market for many years. But it always -- and frankly, for all of our competitors, it involves a multimillion dollar, very large engagement that takes a long time. It's the services led, it's a large amount of custom coding and language -- system modeling of the language and dialect and all this sort of pre-deep learning stuff. That's what our competitors have. We have harnessed the power of the modern advancements in deep learning, powered by AWS and Google and Amazon and Microsoft, and we're just sort of bringing those to market. What that means is in minutes or hours, you can build out from a starting place of a template an IVA that is way, way more real time and a much more slick experience than you would have gotten with the legacy technologies. And every company of every size can now afford to do this.

Yes, yes, yes. Democratizing -- I can't pronounce it, but I know. Yes. Okay. I wanted to touch on another subject. Now that you're a bigger, more important vendor, it also seems like partners are more interested. Like so talk a little bit about like AT&T and the other partner programs and what it means to you?

Yes. AT&T was a big and meaningful deal for us. They have selected Five9 as their exclusive partner to provide AT&T Cloud Contact Center, a white label version of Five9 that they are selling to their customers, integrated with their UCaaS offer, which is powered by RingCentral. So on the back end, we have arranged marriage with RingCentral from an integration perspective through AT&T. So that is going well. These deals -- and with AT&T and the larger service providers, they take quite a bit of time to start to really get into their full -- get the flywheel effect going. It's going well within AT&T. And then I would think -- I would also say, look, as we continue to sell up market in these deals that are greater than 5,000 seats, we're running into the telcos more and more because they own those accounts often. And when those customers ultimately end up going direct, the telcos are taking note of that, right? Because it's ultimately pulling business away from them. So we are going back in and reengaging with them on the back of these large deals and actually bringing them very large deals from an enterprise perspective. And that's getting their attention. It's hard to get their attention with onesie-twosie smaller deals. But when you're taking multimillion dollar ARR deals, taking those down in the enterprise segment, that's something that the service providers really can grasp onto and care about. So we're actually seeing more interest. And then finally, I'll say, Inference also brings us a very, very nice asset here and a head start in the SP market because they were 100% service provider led. They were partner channel-led techno. So they were partner with AT&T and Telstra in Australia and a bunch of other service providers throughout Europe and Middle East and Africa, And so that is in their DNA. So we actually now have a set of service provider relationships, courtesy of Inference that we can leverage for the broader CCaS opportunity over time.

Yes. That sounds exciting. It's like they have a lot of muscle in the market as well. Yes, yes. okay. Yes, that sounds really good. Last question for me is, like, because my times almost up, like -- and let's move on for Barry now, and it's the same question every year. Gross margins.

Yes. So what's the question?

Well, the question is like, look, you're picking on a nice journey to increase gross margins, and we're at much higher levels than when the IPO like years and years ago. What's the next stage of the journey? And what are drivers that you kind of need to think about?

Yes. So as you said, it's been a wonderful journey out for us, 31 quarters. We've increased our gross margins year-over-year, 29 out of those 31, including 140 basis points as last quarter. Going forward, we also have a full year plan from now. It was 5 years when we had our Analyst Day to get our current mid-60 style margin up to above 70%. And we take a lot of encouragement from the fact that the key drivers of getting there is what's happened in the past or continuing what we've done before, which is growing our subscription revenue, in particular, our enterprise subscription revenue in the 30s, while growing our cost of that revenue at a lower pace. There are other attendant factors, but that's the biggest one. Now I want to hasten to add, though, it is not going to be a straight line. There will be a detour, primarily driven by the fact that we have been investing, are investing and will be continue investing to hybridize our solution. We've made great progress moving it from our own data centers to GCP as well. And that costs a lot of money. And until you can really ramp it and get over those bubble costs to headwind to margins, of course, lower capital spending in the meantime.

Okay. Yes, it makes sense. It's not -- I mean, well done, though, Barry. Like you've kind of promised that, and we were all like how can you do it, but, like, you've been delivering really nicely.

Yes. It's a very profitable business overall. As Rowan alluded to, it's a on the enterprise side of the business, which is over 80% of the total. The LTV to CAC is 6. And by the way, it's a big 6. So we have difficulty rounding it down to 6. And -- so the tremendous explosion that we've had since we went public when the adjusted EBITDA was negative 28 to the last quarter, positive 21. So 49 points, that is driven in part by this -- you don't even get to all of that from revenue acceleration, which we've also enjoyed and the associated operating [indiscernible] Its inherently profitable.

Yes. No, well done, Barry.

Yes, that's it.

And it's a nice -- Barry, that was a nice closing statement as well, so I'll leave it there. Guys, great to have you back on. Congratulations. It's -- momentum is clearly visible. Great to see you again. And hopefully, next year, we'll do it in person.

Very good. Thanks a lot, Raimo.

Take care.

Take care. Bye.

Bye.