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

Great. Welcome, everybody. I'm Meta Marshall. I head up the communications software coverage here at Morgan Stanley. We're delighted today to have Five9 with us virtually. But we have Rowan Trollope, CEO; and Barry Zwarenstein, CFO. I'm going to start with a in disclosure. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Barry, I believe you have a safe harbor you wanted to touch on as well.

Thanks, Meta. So before we start, I just wanted to remind everyone that our discussion today will include forward-looking statements concerning events and trends that may affect our industry or the company and its operations. Our actual results may be materially different from what we discuss, including the risk associated with the ongoing COVID-19 pandemic. Please refer to our most recent forms 10-K and 10-Q under the caption Risk Factors and elsewhere for detailed information of what could cause our results to differ materially from those described in such forward-looking statements. Thanks, Meta.

Great. And just a reminder to anybody in the audience. [Operator Instructions]

Rowan, maybe starting out contact center software maybe came to the forefront of a lot of investors' minds over the last year as digital transformation became a theme and as you guys saw acceleration. Just how do you feel like that changed from a customer awareness standpoint or a customer need standpoint over the last year?

Sure. Well, over the last year, I think it did leapj to the forefront of a lot of customers' minds, given the fact that: a, they had to get all of their agents out of offices and working from home, and that was clearly easier with a cloud solution. And b, when they recognize that they weren't going to have any kind of physical in-person presence, that focused the attention on the contact center as kind of the only front door for their business was to be able to engage with those companies digitally and through their contact centers. So I think both of those together made this a much more important priority for a lot of businesses. We saw definitely some acceleration in terms of customers saying, okay, gosh, I can see where this is more important now. And as we are sort of on the back end of the pandemic, hopefully, what we are also seeing is that customers aren't going to undigitize or they're not going to kind of go backwards and say, well, like thankfully, that pandemic's over. Like, let's go back to that same old crappy customer service we're used to delivering. They're really leaning in now to this trend and recognizing that it's just that much more important. So that's been that's been -- the last year has been a nice, healthy appreciation for the contact center amongst business owners.

Got it. And to the point of customers are having to now deal with a different set of competitive threats. They can't just go back to the way things were. How do you think about what you guys or your ecosystem of partners can do to kind of help them, not just give them tools, but help them figure out how to implement some of these digital transformation initiatives?

Yes. Well, that's where our partner strategy has come into play in a big way for a lot of our large customers. So we talked about -- we've been talking about Deloitte and our systems integrator partners for a while. And Deloitte -- that's an area where you think about the customer needs to do a lot of things. We're a part of an overall ecosystem of technologies that are required to transform a customer experience and implement self-service and be more proactive and be more engaging and all those kinds of things that businesses want to do. And that's where we see the SIs really come in, kind of putting in place a whole end-to-end transformation project. Specifically and notably at the larger end, where the biggest companies really do rely on those consultants to do that work. We've significantly diversified our reliance on kind of the one big partner, Deloitte. We've seen a really nice strength across the boards in the SI category. And we've also seen, for -- in other cases, we've seen other partners move forward, kind of leaning into this transformation. So in the -- in the deal that we announced last quarter, or the largest deal in the company's history, there was a partner involved there, a U.K.-based or a European-based partner who's helping the customer along on that front. And what we discovered when we got into that deal was they really heavily relied on [ partnerships ] to operate the whole organization. So we had to pull in a bunch of partners, and it actually helped us create some new relationships that we can now leverage going forward.

Got it. You mentioned maybe, first, it was just, okay, I need to figure out how to get my employees remote. Now we're talking about a bigger digital transformation initiative. But has the entry point with the customer changed from where it was kind of pre-pandemic?

Well, for us, we are getting engaged at a higher level in the organization. We've always -- one of the sort of the secret sauce powers of Five9 has been that we engage directly with the line of business buyer. And Gartner has recently done some surveys on this and showed that the line of business buyer is becoming more empowered and getting more sort of control in these larger businesses over technology choices. And so that's sort of lining up really well with what our -- one of our key strengths. We speak that language in the -- and so that's really been helping. And I think the pandemic has accelerated that, where you're seeing line of business owners sort of leaning into the transformation and pulling IT along. And so that's what I've noticed even more in the last year than I had seen previously.

Got it. And in terms of kind of referring back to the large deal that you mentioned that you won in Q4, there was a large -- what differentiated Five9 in winning that deal? And what were kind of the differentiating factors there?

Well, this was a deal that we've been chasing for years. So it wasn't it just happened all of a sudden. It was heavily contested. So there was -- all the competitors you could think of were in that deal, and so we had to compete against everyone to win it. What differentiated us, I think, first and foremost, was our reputation and reference customers that we could bring to the table for this particular customer that were meaningful to them. In other words, like in their particular industry vertical and in their geo. So those 2 things really helped us. Second was the strength of our portfolio. So over the last 2 years, we've been -- we've made a few strategic acquisitions around contact center automation. And the first one was a company called Whendu, which is a no-code, low-code automation platform. And the last one was Inference, which is a digital virtual agent and intelligent virtual agent technology that's all about automating those manual tasks, the high-volume, low-value tasks that most large enterprises have human beings doing. Our perspective and our technology now is in place to solve this really takes the perspective that, hey, we can help you save money. There's a very clear ROI case for this customer, in particular, around reducing their reliance on human capital to solve all of these problems. And so I think the fact that we acquired the market-leading technology in that area, complemented by our market-leading sort of core platform that does all the things that they were expecting a CCaaS platform to do really helped this tip the scales in our favor. And this customer basically bought all of those technologies for their environment.

Got it. I mean you just mentioned AI being a differentiator there. Clearly, it's an area where people are looking to not only kind of provide better customer service but maybe reduce some of the human capital within their organizations. Where do you see where Five9 can offer the value? Where do you see where enabling ecosystem partners with the voice data can -- and can kind of enable other people. And just how do you think about the equation of higher-priced seats versus maybe lower number of seats?

Yes, I'm glad you asked that question, Meta, because it's a key part of the model that we've sort of put together to think about how this is going to unfold. So first and foremost, I'll start out with sort of a fictional 1,000 seat customers, so a larger enterprise that has 1,000 agent seats. The way we talk about this with the customers, we say, listen, you've got 1,000 people sort of picking up phones or answering messages or text messaging with customers or whatever, but engaging fundamentally with customers over different channels. A big chunk of what they do in every company is very high volume like -- but low-value tasks and they're very repetitive. So we started with a very conservative number. We say, what if we could automate 10% of those tasks? And you then do the math. And you say, well, we don't need to have 1,000 people. We could have 900 people instead. What would that 1,000 people -- what would that represent in terms of savings to us on a monthly basis. And the number is big. It's $2 million a year -- $2 million a month, if you could save on people. Because they're on average, globally, about $2,000 per head in labor costs. So with those savings, you then say, look, the technology you're going to buy from Five9, instead of buying the human seat, which we typically monetize at about $200 per human agent, we're going to sell you a digital seat. And the digital seat is going to cost more, cost $400, but net, the savings to you are very significant. So for us, it's a value creation and capture opportunity that could potentially double our TAM, double our -- the size of the market we can go after. And from a customer's perspective, there's significant savings on their side, which they need in order to reinvest in their operations. So not only would they -- some of them may drop that to the bottom line, but many of the folks we're talking to are not buying this technology to drive savings to the bottom line. They're buying the technology to improve the customer service. So they can take the remaining people and say, go focus -- they may not reallocate, by the way, those 100 people. They may slow down their growth. They may take the 100 people, they may not lay them off. They may put them on to delivering a better customer service for their customers overall. So they're looking at it in different ways, but this is kind of fundamentally how we're helping them deliver on that imperative of improving customer service.

And I mean, just in terms of where you can add value versus general ecosystem partners, where they might provide more analytics than you could.

Yes. So our strategy -- it's a big world. And what we've recognized is that we can solve a bunch of the problems with our own sort of AI-powered technology. But we also have a bunch of customers, and there is a very large sort of at least start-up ecosystem at this point, building sort of vertical technologies to solve specific problems. I'll give you an example. In health care, there's a big compliance use case, where you want to sort of listen to the call in real time, and identify those moments when you -- when the agent needs to say something specific in order to have the compliance. Maybe it's reading the privacy disclosure or checking for some drug interaction, whatever it is. So what we're doing is we've also -- in addition to offering our own tech, we are opening up our platform through an API called VoiceStream that allows for a cloud company to consume the real-time voice for one of our customers and then in real time, react and prompt the agent to do different things. So we are opening up [indiscernible] with open platform, and we're also building our own automation technology on top of that platform. And we think that's going to be the way of the future. It's going to be a combination of us and others solving this problem.

Got it. And maybe turning over to Barry; and, Rowan, obviously, any input you have here as well. But you guys have accelerated growth over the last couple of years. You've remained very profitable kind of over that time period. You set out aggressive, or versus your competitor set, profitability targets over the next kind of 4-year horizon. Just how do you think about the calculus of growth versus profitability? And what kind of informs where you are on that dial in any given quarter/year?

Thank you, Meta. And I'm going to start out and then come back in. When I say out, I mean when we had our Analyst Day in New York back in November of '19, it seems like an age ago, we said that we would have 4 years from now, approximately a 27% plus adjusted EBITDA. And it's very difficult to be confident about things in business, but we are pretty confident about that. Because the 2 big drivers, gross margin expansion, which we've done 29 out of the last 31 quarters each of the last 7 years, will continue. The unit economics on these mission-critical systems is extremely high. And then the other one is the G&A where we've done that now for 26 quarters in a row. Now so getting there, we feel very confident about. However, in the near term, we are going to take, as we mentioned in our prepared remarks on the earnings call, a detour. And it would be irresponsible for us not to. The market is extremely strong, and we are awash with opportunities to make some investments. So we are going to soften the emphasis we've put on the bottom line. We'll still be very respectable, but we want to make those investments in the near term and then resume that trajectory towards that 27% plus.

Got it. And then...

If I can just add one last thing. Sorry, Meta. We likely will, at some point, see some strength in 2021 in terms of revenue. Time will tell. It depends on the seasonality. But to the extent that we do, we plan fully to invest those incremental revenue -- the margins from those revenues in what I've just been talking about. And so investors should not expect to see a big improvement in the bottom line as revenue improves.

Got it. And maybe to that point, with contact center becoming -- coming to the forefront of everybody's mind, there's kind of more participants kind of talking about their positioning within that market. Just where do you consider kind of Five9's moat? How do you consider the landscape evolving of the different pieces of the contact center market?

Rowan, do you want to go?

I do. Yes. Thanks, Barry. Our moat, number one, and this is on the strategic -- this is more of a strategic moat around automation. So the big opportunity over the next 10 years. So start out with the wallet spend in the contact center, right? For every dollar of technology that is spent, $9 is spent on labor. So we start with that. And the moat to -- how do you go after the $9 of labor is really with automation, and that's powered by AI. AI is powered by data. What is the data? Conversations. We have over 7 billion -- as of last year, 7 billion minutes of recorded minutes of conversations on our platform. We've got more recorded conversations than almost anyone in the world and certainly more than the on-prem vendors who have 0. So this is a big, strategic asset for us, and we are only beginning to unlock the power of that data. So over a long period of time, that's something that's going to help us. And if you watched any of the other industries that have started to leverage AI, probably more on the consumer side, it ends up being a winner take most because there's the sort of a flywheel effect and a feedback that comes from having the most and the best data. So we think we have a really incredible source of data, and we want to leverage that to drive automation into the contact center. So that's one. I would say the second one is we are a leading cloud -- sort of born in the cloud company with a full and complete portfolio now. So there are very few companies, certainly, that are stand alone, very few companies that have the breadth and the scale of the technology platform that we've built, candidly, over 20 years with all of the parts that are necessary to deliver that globally. Now this is not easy to deliver real-time voice globally in all these different countries. It requires that we establish relationships with service providers and build that out. Now we're really getting started internationally, but we've got, I think, a leg up over our competition given our architecture. So combination of sort of technology strength and portfolio breadth along with data powering our AI strategy, I think, gives us a really differentiated place in the market over the coming 5-plus years.

Got it. Maybe turning back to Barry. Rowan just mentioned sort of the international opportunity. International has maybe been a laggard with a lot of cloud communications, technologies, but we're now kind of seeing some loosening of that. Just what type of investments do you need to make internationally as that piece of the puzzle kind of becomes a bigger growth driver?

Yes. So one of the biggest sets of investments we've already made, which is containerizing our solutions so they can run in the public cloud, in our case, Google Cloud platform -- Google Cloud. And we have already got it up and running successfully in Canada. And in a period measured in days or weeks, we will have it also in continental Europe. And so that investment is behind us, although we, of course, got the initial ramping costs in terms of the actual production. We also are investing pretty aggressively in terms of headcount across all different functions. We mentioned on the call that, albeit from a small base, we've increased by 70%, primarily focused on Europe. We've also now got a springboard following our acquisition of Inference, which is Australian-based. So Australia is a pretty big market and also, as I alluded to, a way to jump off into the rest of Southeast Asia. And so we'll be making some investments there. So more than something like 9.X million of the seats of say, the 16 million seats are abroad, and we are aggressively going after those.

Got it. Channel has clearly been a strength of your -- of you guys with 65% of deals kind of influenced by channel in Q4. Rowan, you maybe mentioned that you needed to expand beyond kind of just the Deloitte relationship. But just as that buyer changes, are there different types of SIs? Are there different types of partners that you would grow relationships with in the future that might influence or kind of create a differentiated deal pipeline?

I think we already -- so we've established a really good starting point. We've expanded over the last couple of years. We initially were, I would say, made an investment in SIs early. That really helped us. And then we invested in our Master Agent channel. What's evolved over the last really 2 years since we started investing heavily in our channel go-to-market is service provider acceleration. So we've added service provider, most notably with AT&T recently. And then also resellers. We added CDW as well. We also view the UC companies as a channel partner, and so Microsoft and Zoom have been particularly strong for us. And so those are 3. We've also on the SI front, we have diversified away. We got a really good start in -- over the last year, I think we tripled the bookings for our SI channel partner program. And we're looking to -- and we have diversified away from our biggest partner and started to get -- sign up some more there. We've had really good success on the sales front, Salesforce side. There was a lot of questions around Salesforce and their Amazon strategy when they launched it and announced it. We leaned into that because we knew and felt comfortable and confident in the quality and basis of the quality of our product and our service. And since they'd launched with Amazon, our sales have accelerated with Salesforce. And so we continue to do well there. And by the way, much of that is driven by the partner channel. So Salesforce-specific call them, SIs like Slalom, for example, have done really well for Five9.

Okay. Got it. You just mentioned Inference kind of as a -- I guess, I'm just trying to figure out, with some of the acquisitions that you guys have made over the past couple of years, where they -- where do they pull in additional deals? Where do they kind of act? Or where do you decide where to position them in the sales cycle?

Yes. We're beginning to lead. We're leading now in many large enterprises with Inference. So the conversation starts there, where we say, hey, we got to -- we've got something to help you with. And of course, we have the full CCaaS platform to pull along with it. But what we've been finding over the last, I would say, 6 months is that, that's become more and more of an important part of the conversation, particularly for the larger enterprises who are looking for those cost savings opportunities to reinvest and do other things with. So yes, we've actually begun to lead with it in this year. We also can sell that technology somewhat as a Trojan horse because we can put it in front of your existing on-premises system without having to take out your on-premises system. And that is very much how Inference was being sold previously alongside Cisco and other partners. And so that is an opportunity for us to get our foot in the door in a very lightweight way for some of these larger enterprise customers. So they can put that technology in and bring on the CCaaS piece afterwards.

Okay. Perfect. On the topic of acquisitions, you guys have done a couple of smaller acquisitions. Just how do you think about M&A? Where do you think about kind of tuck-ins versus portfolio additions and just kind of current strategy or thinking?

Yes. So the -- I'm a software developer, so I like to build stuff generally. We made the decision to build our own AI-based agent assistant. So that's been going very well, coming along strongly. But our strategy, of course, is to leverage our position to look at both buying and building. And so on that buildings -- on that buying side, we made 3 small acquisitions. The strategy really very much is around contact -- a number -- 2 things: 1, expanding the portfolio, as you mentioned. So we added Virtual Observer. There are more products in the ecosystem that could be bundled with the CCaaS offer to make for a more complete portfolio. So that's one area we might look. And then secondly, but I think more importantly, is the automation opportunity and with Inference as the sort of the anchor tenant on that front. There could be other things that we would do in that direction. But it's an emerging field. There's no large companies out there today, not at the significant scale with modern technology because the technology is so new. So it's not -- there are some very expensive assets out there in the start-up front that they're going to want a lot of money for. And that makes it a little more difficult for us to make moves on that front. But I think we've got a great start with what we have, and we'll continue to look at these other opportunities as they come out.

Got it. And maybe just last question for me. It's a frequent maybe informational question that we get from investors. But just how often is the UC and CC decision kind of coupled? And is that changing with what you're seeing with customers?

Yes. It's been decreasing, the UC plus CC sort of joint sale. And I would say there's a couple of dynamics that are important to point out. The first one is if you work at a CC company -- sorry, if you work at a UC company, then you're speaking to the IT buyer, right. Like business buyers are not buying telephony in UC. If you are -- if you're in a contact center company like us, we -- because we don't have a UC system, we have a contact center platform only, we actually sell to the line of business buyer, so that's the significant difference. And what's been happening is that money has been shifting out of IT and towards the line of business buyer, at least from an influence perspective globally. Gartner reported on this fact recently in one of their studies, where they showed that LOB's sort of budgets in the contact center are on the rise. And that's where we sell to. So they're both valid sales. They're both sort of valid. From my perspective, they're like -- they're interesting buying centers. And so we want to go out both. So on the UC side, we've been attaching ourselves to Microsoft with their Teams [ use ]. We've been attaching ourselves to Zoom and trying to build out those partnerships. And then on the contact center direct side, we just go direct to that contact center buyer. So that's the dynamic, and I think it's shifting more and more in our favor.

Okay. Perfect. Well Rowan, Barry, thank you so much for being here today. One of these days we'll do this in person again. And -- but I appreciate you guys being here. And if anybody has any follow-up questions, either filter them through me, and I'll get them to Five9. Great.

Thanks, Meta.

Thanks very much, Meta. Thank you.