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

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Hey, good afternoon. Thanks, everyone, for joining us here for day 1 of the Wells Fargo TMT Summit. I'm Michael Turrin, software analyst here at Wells. Pleased to have a company from our coverage universe with us for this next session. We have Barry Zwarenstein, CFO; and Dan Burkland, President of Five9. I'll start off with some questions. If anyone tuned in has questions they'd like for me to ask, you can shoot an e-mail at [email protected]. I'll do my best to sprinkle those into the conversation as well. Before we go too far, I promised Barry I'd give him a moment to step through the safe harbor statement as well. So I turn the floor to you, Barry.

Thank you very much, Michael. Before we start, I just want to remind everybody that our discussion today will include forward-looking statements concerning events and trends that may affect our industry or the company and its operations. Actual results may be materially different from what we discuss here. Please refer to our most recent Forms 10-K, 10-Q under the caption Risk Factors and elsewhere in such reports for detailed information that could cause such results to differ materially from those described in such forward-looking statements. Thanks, Michael.

Yes, happy to. There is a lot to discuss, so I don't know that we'll get through it all in 30 minutes. But I wanted to just start with level setting for investors who haven't paid as close attention to Five9 and the CCaaS market as may be expected. And so before we get into some of the other moving pieces, just in terms of the market backdrop in general, can you just provide some context to characterize what you saw throughout the course of the pandemic, what that did for contact center and where we currently sit from a market perspective based on what you're seeing today?

Sure. Thank you, Michael. I'll take that one. And if you look at the market landscape itself, the pandemic hit right at a time when customers were starting to open up and consider digital transformation was already occurring, move to the cloud was starting to occur mostly in middle -- mid-level enterprises. And what the pandemic did was it woke up a lot of companies, especially upmarket, further upmarket, that you've got to have the flexibility of the cloud to be able to adopt to things like a work-from-home overnight transition or work from anywhere, that flexibility. Because prior to that, most of our value proposition was, "Hey, move to the cloud. You won't have to sacrifice anything." It was basically -- there wasn't this big incremental shift of other than, "Hey, you won't have to maintain the servers. You got one virtual solution. And yes, you'll have security and scale and so forth." But until the last couple of years, that was the case. And then the advent of AI and the automation solutions that we have has now had enterprises upmarket recognize, "Aha, the only way I'm going to differentiate and deliver these automation solutions to my customers and reimagine the customer experience is by moving to the cloud." And so a lot of them have started to accelerate or start a process that they may have otherwise put off for several years because they thought, "Well, okay, move to the cloud. What do I really gain?" A few years ago, there wasn't a gain. It was just move to the cloud. It's easier and more convenient, whereas now it's incrementally extremely different and much more valuable.

Yes. I have a feeling if you had presented the pandemic scenario a few years ago, you would have gotten eye rolls. But apparently, it was a very, very realistic scenario. I mean, the other kind of key topic before we get into more just specific details that you laid out and did a great job with the Analyst Day is Zoom, and there was a potential coupling of the 2. I think investors look at the change there and might have some skepticism around, "Hey, does Five9 still have the same durable positioning on the back of that as they might have prior to?" I know your stance on this well, but I think it's useful to spend some time hearing you step through it. So Five9 as a stand-alone kind of coming out of this, maybe just help reinforce the perspective and level set where you're standing.

Yes. And I'll start and Barry, jump in. But we had been on a trajectory that was accelerating, and you saw us move into the 30s from a growth perspective and even into the 40s as of late. And that was with what we talked about before, 2 amenable trends of digital transformation, the migration to the cloud. And continuing on that path was very important. And doing so, agnostic, playing Switzerland was so key for our success. And so when Zoom came knocking a couple of times to do something, we owe it to our shareholders and owe it to the Board to present that. And it could have given us access to another buying motion, another buyer, if you will, the IT buyer. 90% of our sales occur with the line of business owner. And that's the same person acquiring the CRM and the person who's responsible for that customer care, that leadership. That's who we sell to. Zoom, on the other hand, sells into the infrastructure buyer, the IT buyer. It would have given us incremental additive swim lane, if you will. But without that, we still needed to maintain, even if we were going to become part of Zoom, a stand-alone business where we were selling Contact Center. It's a very different sale, right? When you think about the Zoom applications, you sign up, you download, you start using it. Ours are very much hands-on, custom and professional services, we go in. So we've got different sales forces, different professional services groups. We stayed very focused during that long window that we had before a potential close to stay focused on executing and not miss a beat.

Yes. I mean, is there anything you observed -- and maybe this is too optimistic, but is there anything you observed that just long term, the vision with Zoom could have made a lot of sense, but near term, it did introduce some complexity in terms of the conversation? Because Five9 has been able to position agnostically across CRM solutions, across communication stacks. Having that remain the case here in the position of Switzerland, does that just help you kind of reinforce or move those conversations forward maybe with a little bit more ease?

It certainly does, especially if you take the analogy of Microsoft Teams, right? They have a huge installed base, huge market share. It would have been awkward to try to sell stand-alone, "Hey, buy your Contact Center from Zoom after you bought your UC from Microsoft." Awkward there. And so it would have closed us out of potentially a big portion of the market, even though it would have introduced us to have a very high attach rate for a grower but yet a very small market share provider that they have today. They have a very small market share.

Yes. Well, we managed this far before going into long-term targets, Barry, so congratulations. I don't know if I can hold off any longer.

Go for it.

So clearly, a lot of focus on those targets and your confidence in putting those out here currently. I think it obviously just reinforces a lot of trends that you're seeing. But in terms of the thought process and laying those out, talk about you're generally very prudent in terms of framing targets. And so this is a bit of a change. And so what went into that decision process? And just the targets as they stand for investors that don't have them in front of them.

Yes. So I'll start with the very end and then go back. What Michael is referring to is what's in the proxy. And that has us, in 2026, growing to $2.4 billion, which implies a CAGR of 32% from where we are now and an adjusted EBITDA target of 23%. And we've embraced those targets. Let's have a little bit of a history lesson. So before the Zoom transaction, we would go each year to our Board of Directors and present an annual plan, and we would characterize that plan as an 80/20 plan. In other words, 80% probability that we will make it and 20% that we might not. And the Board is fully accepting of that. The reason that we do that is that we want to be able to control our expenses. We want to see the revenue first before we authorize the head count increases, and it worked fine. Along comes the transaction, and we have basically a legal and an ethical obligation to present our shareholders with an A/B type situation, the A being what is Zoom offering and the B being what would Five9 look like on a stand-alone basis and make that comparison. And that needed to be done in a fair way is how we described it to the Board in the middle, 50% chance of making it, 50% chance of not making it. And that's what's in the proxy. Now bear in mind, it is a top-down mechanical, linear-type forecast. There will be reality fluctuations along the way. But we feel comfortable, as we described at the Financial Analyst Day, that those targets are reasonable. They are 50-50, but it's something we'll strive to maintain. And we are a company that has had a pretty good track record of saying what we're going to do and then doing it. I'll focus just on the top line for -- just to be real brief, so I'll give you a chance to ask some other questions. The 3 main reasons that we talked about in terms of that improvement, and this can maybe tee you up for some further questions, are sustained enterprise LTM subscription growth rate in the 30s, something we've been talking about for years; secondly, an increase in the dollar-based retention rate from the 123% with fluctuations up to the high 120s; and international, despite the growth in our domestic business, growing from the current 9% up from 8% to mid- to high teens, bearing in mind that -- well, I'll leave it at that for now.

I want to spend a little bit more time on the expansion rate because I think if you're -- if someone's asked me a question of what could drive a multiyear 30-plus percent growth profile for Five9, look no further than an expansion rate that continues to trend higher. And that's what we have here. This has historically been somewhat of a land-heavy model. Expansion -- you didn't necessarily have the product portfolio historically that you have today. And so maybe you can just walk through the evolution of the expansion rate and what's driving those numbers and allowed them to expand from 113% to above 120% and is reinforcing your view that, "Hey, don't think about business like peaking here. They can continue to move up based on what we're seeing today."

Yes. So well said. That is key. We've now got a big installed base. We've got more products, et cetera. But the biggest single driver is the fact that we -- Dan and his team are having such a success with $1 million-plus ARR customers. We now have 123 of those. They're growing at an 87% rate. The comparative 2 numbers, if you go back 2 years ago to our last Analyst Day, instead of the 123, there was 49, and the CAGR instead of being 87% was 67%. This is serious, mission-critical sharp point of the spear in terms of interaction with customers that people don't -- they don't get replaced once they're in. And the bigger the customer, the more likely it is to expand because commonsensically, the bigger the customer, when you land, you're not going to land the entire company. You're going to have hedges to expand. And hence, they have a meaningfully higher dollar-based retention rate. So that is the biggest of the 3 drivers. The other 2 drivers are that there are ARPU increases. We can talk about that separately, including notably the labor to technology arbitrage in terms of AI and automation. And then finally, we do have what I'd characterize as this tail breeze from the fact that we have to -- have the enterprise business, you have the commercial business. The commercial business, as you can imagine, has a meaningful lower, sort of high 80s, low 90s type retention rate. And you've got a mix impact as that shifts over towards the enterprise, which has an inherently higher rate.

Yes. [ And I still have been ] getting called out for the 7-figure deal strength. It's always nice to hear from your CFO. Maybe I can ask your perspective on that, too. What are you seeing in the field that's enabling that momentum and the ability to reach the larger customers and inform the metrics that we're talking about?

Yes. In particular, Barry hit spot on the DBRR metric and why that continues to go and is likely to go up is, again, you go into a large, large enterprise, it's not a flash cut with all their users. So you've got that expansion opportunity significantly. The innovative AI and other automation solutions are also going to and are continuing to drive ARPU up. So we can go into our customers, make them even more sticky as well as bringing them more paid-for things. As we move upmarket, and a bigger percentage of our business moves up market, what we see is they tend to take more, meaning they order all the SKUs. They have the full omnichannel, all the integrations, all the extras. So we end up with a higher ARPU, not necessarily as expansion ARPU but just out of the gate, the -- just the average per user is much higher right at the beginning. So we're continuing to see that acceleration as well.

We've also heard good things from your partner community on what you're doing with bundling. And some companies might maybe overstate the impacts of what they're doing with bundling. And in this case, it might be somewhat understated. Can you just talk about what led you to the bundling approach and if that's also just removing some friction in terms of adoption of some of the other products?

Yes. You hit right on. As we've expanded our portfolio and have the plethora of different SKUs, to do à la carte pricing was difficult enough for our salespeople. But as we expand our channel and go international, imagine the complexity on their side, trying to understand which SKUs do I order for these different solutions? And so bundling it together makes it simpler. And it also helps people jump to that next bundle where they might get a little bit more product than what they were going to otherwise purchase, but it gives them a chance to try things and then expand from there. So yes, it's been a great, great success. We probably underestimate or don't talk about enough the value of those bundles and what it's creating for our salespeople as well as our channels.

Barry, it's next growth driver you can highlight in the next year or 2. That's okay. You're doing great. Great work. I've gotten a couple of questions via e-mail that I'm just going to add into the conversation as well. The first one is just around seasonality, and you're talking about the move upmarket. And the question is just, is that changing the seasonal profile of what you're seeing at all? Does that make the market more Q4 seasonal now that some of the customers are larger? Or is that maybe not the case?

So let me first describe the seasonality, then I'll quantify it and then I'll talk about whether it's changing. And I think the numbers will indicate that. So the seasonality begins a bit in the third quarter when this back-to-school education type situation and also the beginnings of retail. Q4 is a big one with retail, which is a big part of the business. And then on top of that, medical open enrollment, which used to be bigger but is still quite large. And then it tails off into Q1. And then by Q2, it's completely gone aside from a little bit around tax. And hence, Q2 is typically sequentially one of our weaker quarters. In terms of the quantification, if you look at our historic numbers and our guidance for this year, you'll see that the H1-H2 split has been steadily increasing in favor of H2, growing 52%, 53%, 54%. And these are quite meaningful numbers, even though it doesn't sound like that. And going further upmarket doesn't really change it because there's no pronounced difference between a bigger and a smaller company in terms of these seasonal impacts.

Yes. Okay. Another question, this is someone who's clearly doing their homework. They asked, there's a delta between the long-term EBITDA margin and the long-term unlevered free cash flow margin in some of the proxy numbers. What is that driving that difference?

Yes. So the question, just to be crystal clear, is the...

Just the delta between EBITDA and unlevered free cash flow on some of the longer-term numbers that are in the proxy model.

Right. So the delta, which is about 10%, 11%, is what we always typically had and through 2026. I'm going to talk about 2031 because that's also in the proxy. So I'm not sure which of the 2 it was really, so I'll address both. And that's primarily, obviously, the change in the working capital, various aspects of it. We are a little bit different from other companies in that we don't typically have multiyear transactions and hence, don't have a big deferred revenue that gives us some of that tailwind. But if you look at 2026, we have a 12% unlevered free cash flow, the spread from the 23%, so about 11 percentage points, accounting for that -- primarily that working capital and fixed asset additions. The -- if you go out to 2031, that actually improves quite a lot. The spread, instead of being 11%, goes closer to something like 18%, speaking from memory, I believe that to be correct. And that's despite beginning to pay taxes of about 6 percentage points by that stage.

Okay. I want to go back to some of the growth drivers and talk about international. I think you split that out at the Analyst Day as well, and the implied targets there are well beyond some of the growth rates we're talking about. You've had some just history with industry analysts, an ability to reach the broader international markets, but you've clearly found increasing success. And then we've heard some of the large deal metrics and deal specifics that you've highlighted that are supportive of your ability to expand internationally. Can you just add some more context around what is driving the international strength and what keeps that going from a fuel perspective?

Sure, yes. We've expanded significantly internationally, both with our infrastructure build-out as well as our personnel and putting people in the local markets, both in EMEA and in LatAm. If you saw in the Financial Analyst Day presentation, 128% CAGR in LatAm, 167% in EMEA, coming off of small numbers. So when you look at the filings, you'll see 8% having grown to 9% of our international business. Now bear in mind, if you saw the Financial Analyst Day, we had 3 customers on there, all global and major contact centers all over the world, in fact, way more agents outside the U.S. than inside the U.S. Yet if you look at our financials, every -- 100% of that revenue from those 3 customers show up as U.S. revenue because we measure it on a bill-to. We send them one bill for their global agents and so forth. If we set the bills where the agents are located for our global customers, we'd have over 30% international. That's -- yes. So that gives you a feel.

That's interesting.

We're continuing to invest. There are more agents internationally than there are in the U.S., and we're continuing to invest in those markets where we feel that we can get the best return.

One of the other elements of Five9 and the contact center market that we have come to appreciate is there's a true need state for AI. I think we hear a lot of vendors talk about AI because it's a compelling value proposition, but it might not be as direct as is the case in the contact center market. You've been adding products to help crystallize that AI opportunity and handle some of the, "Hey, how many agents are there in the future? What does efficiency mean?" and all of those nuances of the conversation with customers. But can you just talk about what you're seeing from an AI perspective and the attach rates for some of the products that you laid out? We're probably further ahead than I would have expected. And so I'd just love to hear more around that conversation that you're having with customers.

Yes. Thanks, Michael. I'll broaden it a little bit and include all the automation solutions. So if you think about the customer interaction life cycle, if I'm interacting with a business, we're applying automation throughout that interaction. At the very beginning, if a customer chooses and wants to self-serve in voice or via chat, they can self-serve, meaning that I may want to talk to an agent, but I may want to just get a quick answer to my question. And we're all becoming more prevalent and comfortable with voice interfaces: Siri, Alexa, et cetera, in our homes. They're becoming more accurate at understanding what I'm saying. We can apply natural language understanding to it, go fetch an answer and speak it back to the customer. So for all those mundane, repetitive questions, it's a great way to deflect calls to the machines as opposed to the humans, which are 10x more expensive. So having said that, that's at the front end, self-service, seeing a great adoption rate, to your point, at FAD. We talked about the adoption rate in our -- of 88% of our net new enterprise or strategic customers that we're selling into or opting in for that. The second area of automation is in the Agent Assist. We're listening to the conversation, applying that same natural language understanding, fetching answers but then displaying them to the agent. So the agent doesn't have to go fetch and look for answers. It makes them far more efficient with their time, and they can focus on the customer as opposed to hunting for answers in a knowledge database. And then the third area of automation is in the workflow. Let me trigger an event. Let me -- you placed an order. I send an SMS message out or a text message, "Thanks for your order, Michael. Inventory system says it's shipping on Tuesday. I'll send you a survey on Wednesday." Off we go. So applying automation across the board is key. And that's what's really resonating with large enterprises because, again, they know they can only get those solutions by moving to the cloud.

So Barry, does that change your appetite for M&A at all? Or I mean, is it still fairly consistent, given some of the success you're seeing with things like WFO and automation, the market opportunity that you have in front of you? Is it still fairly consistent? Or have some of the initial proof points you've seen in success at all changed your view around the attractiveness of M&A in this environment?

Yes. So Rowan has been pretty clear right from the very beginning that there's a strong preference for organic growth. And he is a technologist, a software maven. And so he'd like to build things. That being said, we have a fabulous corporate development department. They've made 3 really stunning acquisitions: the Whendu; the Virtual Observer, which is turning out to be extremely good; and then a leading IVA solution. So the short answer is we will continue with the preference for organic. But along the way, there could be adjacencies or likely will be adjacencies where we would have tuck-ins or similar.

I think we have time for just one more, and I'll leave it to you just as the closer. You've already presented some compelling long-term financial projections. But just what the metrics that will enable success with the focus areas are for yourselves and for Five9 over the coming year? What are the things that you would point towards and what will enable that success for the business?

Do you want to go, Dan, or do you want me to?

Yes. I'll start and I'll let you close this up there, Barry. But I would focus on 3 key areas. One is continuing to expand our swim lanes, if you will, or our segmenting of our sales force so that we have the right experts working the right deals, strategic folks who know how to sell strategically. We get much higher win rates for that. Second will be on -- I'm actually going to go 4 areas. Second is on products. Continuing to innovate, continuing to further automate. We'll augment the labor force and make the ROI super compelling. And then -- so maybe 3 and 4 together is our channel expansion, which feeds right into our international expansion. Getting thousands of people on the street representing Five9 is key.

Yes. Great.

And then if I could just complement that with that ultimate go-to-market machine, with the product and the services behind, it will manifest itself in 3 key financial metrics. The first one is that the enterprise LTM subscription growth rate has a 3 handle; the second one, that increase in the dollar-based retention rate; and finally -- well, almost finally, the international growth rate going up into the mid- to high teens. The only other thing I would also add is that in terms of the bottom line, we are committed to that 23%, but there are going to be fluctuations obviously along the way.

Sure. Makes sense, given the opportunity out in front of you. This is great. Barry, Dan, I appreciate the time as always. I know your time is valuable, so I appreciate you spending it with us. And thanks, everyone, for joining as well.

Thanks a lot.

Thank you, Michael.

Thank you.

Thanks all.