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

Welcome, everybody. I'm Meta Marshall. I head up the communications software coverage here at Morgan Stanley. We are delighted to have Barry and Rowan with us here today from Five9. I'm going to start and basically say that if you have any questions about anything you hear on this call, just -- or any disclosures, type in www.morganstanley.com/researchdisclosures. And I'm going to hand it off to Barry to do some quick disclosures on his end, and then we will jump into our discussion.

Thank you, Meta. Before we start, I just want to remind you that we will make forward-looking statements today concerning events and trends that may affect our industry or the company and its operations. Actual results may be materially different. Please refer to our Forms 10-K and 10-Q under the caption Risk Factors and elsewhere in such reports for detailed information about such factors that could cause our results to differ materially. Thanks, Meta.

Great. And so Rowan, maybe starting with you guys, the theme of the last couple of years has certainly been an acceleration of digital transformation, and I think people getting familiar with the fact that it's here to stay. And so if you could just lay out for investors just why Five9 is kind of best able to capitalize on that transition, not only to digital transformation but cloud transformation?

Sure. I think you're absolutely right, that digital transformation has accelerated. Meta, thanks for having us on today. Over the last several years and particularly, of course, through the last 2 years. And cloud, of course, has gone somewhat hand-in-hand with that transformation. I mean that that's -- those are the 2 trends that really drive our business. And what you've seen with the Five9 business is there's been an acceleration, frankly, since we went public, growing in the low 20s, now most recently up to the high 30s. And you can see our projections, going forward, call for our enterprise subscription growth to continue to grow in the 30s. And so I think it's a fair question. Why are we so well positioned and confident in this transformation? And why is it that Five9 is winning over our competition? Because we are growing, in many cases, faster than our competition and taking market share. Fundamentally, it's a couple of reasons. Number one, we were born in the cloud. Customers are today only really looking at cloud software. And so as they go to the incumbents, the on-premises legacy providers, those companies are struggling to catch up, and they really do not have offers that are suitable for the market at this point. We've been in the market for 20 years. We've been well-known now, and we've been selling higher and higher. What we've been seeing over the last, I would say, year or so is that as cloud has, call it, proven itself out, larger and larger enterprises have started to get on board with moving larger and larger contact centers. And for many years of our existence, there has been a need to go out and to explain to customers that the cloud is okay and that the cloud is secure and the cloud is a good way for you to go architecturally. Those days are over. We're no longer having to -- I think this is now a foregone conclusion in most IT departments and most large enterprises that essentially -- I think it was Adam Selipsky, who recently said all workloads are moving to the cloud, and we're absolutely seeing that in the contact center. Investments that we've made over the last 3 years -- and to directly answer your question, Meta, so that was the background. The investments we've made over the last 3 years, in addition to our background, have positioned us really, really well and I would say better than anyone else to capitalize on this growth trend. Number one, we've invested in large enterprise growth. So we now are closing, as you've seen in every quarter, we're closing larger and larger deals, with our largest account now representing a $24 million ARR account for us. We're talking many, many thousands of agents concurrently connecting to our platform. And so we invested in the scale to get there. The second part is that we invested in public cloud to move us internationally. All of these large enterprises are multinational, and they need coverage around the world. And the fact that we went deep on the public cloud investment and rearchitecture, basically has given us the ability to scale anywhere where those businesses are. And every single one of the large deals we've shared with you over the last 2 years, every single one of them have pieces of their business outside of the U.S. So we're really well positioned there. And then the third thing I would say is channels. Our investment in channels -- and this has been a theme for us for 3 years has been really, really important for these large enterprises. Because when they come to us, they are undergoing big digital transformation projects and they need to bring in partners to help them with that transformation. So our channels team, led by Andy Dignan and Jake Butterbaugh, have done a phenomenal job really ramping up. So you've seen our announcements around things like AT&T, Mitel. We've really signed up some significant partners, Conn3ct in the U.K. who can help these large customers actually make these transitions. So those are kind of 3 of the underlying drivers for the growth acceleration.

Got it. I mean maybe spending a second on the large customers. You've started to see a lot of traction here. Clearly, you've signed a lot of 7-, 8-figure deals over the last year. Do you think it is a matter of time? Do you think it's -- you have equipped the right partners to have the solutions to kind of put the full suite of solutions around to make those transitions? Or is there something kind of particularly about their needs that has kind of triggered that transition?

I think it's the acceptance of cloud, really, amongst these larger and larger customers. And frankly, nobody really wants to be the one to go first. Some bold companies have those steps. I think the pandemic really was maybe the straw that broke the camel's back though. Because when you had to send your agents home -- and no business, by the way, that we've talked to, is looking to come back post-pandemic into an all on-premises world in terms of their head count, right? So having everyone in offices, they're still looking to leverage and have agents at home and so on for a variety of reasons. And as a result, premises just doesn't work in that world. And we saw this firsthand with customers who really struggled with premises systems, especially hardware-based phone systems, where they just couldn't handle their agents working from home. And so that drove a shift to digital channels, which is where, obviously, we have strength, and also a shift towards cloud technology workforce, we have strength. So I think that's -- that was the straw that broke the camel's back. But fundamentally, I think the overall trend to cloud has just accelerated, and larger and larger enterprises have said, okay, yes, this is finally the way to go.

Is it the same that would go with international as well? Because I think on the telephony side, like international has been a laggard as far as kind of adopting cloud. Is it they've just kind of gotten with the program? Is it that you have the programs targeted there? Is it that you have the data residency that kind of helps support them? What -- is it the same kind of trends on the international side?

Yes. We have seen -- that's been a little bit further behind in terms of adoption just from a customer perspective, a customer and channel partner readiness. Part of that is that our industry, as you point out, is tied to -- we deliver the telco services as part of our business. And that has country-by-country regulations, and some of them are -- we've completely essentially deregulated here in the U.S., and we have one very large market. In Europe, particularly, it's many small markets and, of course, in Asia Pacific as well. So it's about focused investment for us. So we now have over 100 head count in Europe targeting that opportunity. But we are -- we're seeing growth now in Europe that has accelerated faster than the U.S. business, so that's good, but it's still 9% of our overall business. I think the market is catching up though. We're starting to see more interest from channel partners. We're starting to see more interest from large enterprises in EMEA start to consider this transition. And I think you're going to see -- at least if you look at our plan, that our 5-year horizon calls for that international business to grow to high teens for us. And so we're going to see that continue to be probably 1 of, if not the biggest driver of our growth over the next 5 years.

Got it. And I guess I just want to spend a second on -- you've had a lot of success with channel partners and your SI partners. And just as you guys gain more traction, as people know you better, just kind of what part channel still plays in that? Will that still be the biggest inroads just because they can be that services organization? Just how do you kind of continue to build that out even as your brand has kind of grown?

Yes. They get more important for us just purely from a scale perspective. So our ability to hire the numbers of head count that we need to be able to say, deliver services, we now have over 500 people in our services organization, 2,000 people globally. And so we absolutely need to leverage channel partners. And I think what's happened over the last couple of years is that the channel partners have said, okay, we see the shift in the buying behavior of customers, and we know that we can't continue to exist just continuing to serve this premises installed base. And so we really need to get involved in this cloud transformation. And also, it's on our side. We had to make investments, and not just us but the other cloud providers that sort of work with same channel partners, to enable the tooling so that the service providers and the SIs and the other reseller channel partners are able to deliver services on our platform. So for, call it, 3 years ago, it really wasn't possible. But now we have regions internationally as a result of our investments where channel partners are delivering 100% of the services. Now that's not the norm, but that is one example where we have been able to enable channel partners to do that. And that's important because they're no longer rolling trucks. They're not rack and stacking boxes, and that's where they collected most of their money. And I'm speaking specifically about reseller channel partners and sometimes SPs. So you need to give them an alternative way. And the nice thing about the contact center business is there is a ton of services to wrap around these transformations. Systems integrators have been doing this for a while with the CRM partners. But that was invested in by Salesforce over many years to create an ecosystem, to create a platform that the service provider -- or the systems integrators can build on top of. So we've had to take that kind of an approach with the reseller partners to say, here's a platform for you where you can transition from this legacy, premises-based model to a model where you can continue to make money in the cloud world and deliver value to the customer. So that's the transformation that's required investment by us and a recognition by the channel partners that it's time.

Got it. One of the things that we've heard more from resellers of late is, you certainly hit upon, there's a comfort with cloud. They need to have remote solutions. But what we're really hearing now is a need for a virtual kind of assistance or virtual solutions, whether they be chatbots, whether it be smart or voice assistants, and that's been an area where you guys have really led. And so just give me an idea on like how that's changed the landscape and some of your differentiated solutions that you guys have there to really exploit that need from customers?

I'm really glad you asked because it's a big investment for us, and it's been very successful. 2 years, 2-ish years ago, Barry, at our Financial Analyst Day, we rolled out our thesis around automation. And what we said was the opportunity in contact center is not just to sell software. For the last 15 years, we've been sharing with our investors and then The Street that there's this huge $24 billion category of software transformation to move to the cloud. That's still there. It's still moving. It's still early. It's still only 15% penetrated. But what we saw emerging a couple of years ago is the need to drive more efficiency with the head count. And the head count spend in the contact center is well north of $200 billion a year. So it's a 10x almost in order of magnitude larger spend on head count than on software. And what we saw happening was software to drive efficiency and fundamentally enabled by AI. So we made some key investments. We acquired 2 companies -- actually 3 companies in this space: Virtual Observer, which is really about optimizing your labor and workforce. We bought a company called workforce -- workflow automation that -- or it's called Whendu, that is really about automation. And then we bought just a pure automation company. And then we bought a company called Inference Solutions, which is a conversational AI company. When you put those 3 together, what we've created is a portfolio to help customers, end-to-end, optimize their workforce and begin to shift importantly, not just to make their people more efficient, but to replace their human employees with digital employees, the digital agents. And those digital agents, we sell for twice as much as we sell the software for the human agents. So the simple math here is that -- or it's a simple value proposition to the customer is there's some kinds of work that your human beings are doing that can be automated. And we're replacing -- and the main way that we're getting traction on this automation story today is with the IVA, the Intelligent Virtual Agent. Again, we sell it on a per virtual agent basis. It's $400 per virtual agent per month. And this talks to a customer, has a conversation, answers their questions. So think Alexa, Google Assistant, using the same technology underneath the covers. And businesses can build workflows and tooling on top. It's all visual point and click. We even have a library of tasks where it's very, very easy to get started to set up a virtual agent to handle some of the simple calls. Just a really simple example would be retail customers may get a lot of phone calls, e-commerce saying, where is my product, I'm waiting for it, when is it going to be here? And you can handle that call in an automated way with a virtual agent as opposed to having to talk to a human being. So this kind of hit at a time when we had this perfect storm. Because the technology had reached a level of maturity, thanks to Google, Amazon, Microsoft having invested in these conversational AI technologies and making them available through their platforms through APIs. So we sit on top of that. And at a time when businesses are unable to hire new head count. You've got this great resignation and you've got the labor shortages. So companies are coming to us saying, we actually -- it's not even about efficiency at this point, it's about growth. We can't hire people fast enough. How can you help us deal with the load, the increased load on our business and use virtual agents so we can use our human beings more efficiently and not have to go and get all the head count. So it's been growing like gangbusters. It's now up to over 10% of our portfolio, so it's in the double digits, just the overall category of labor optimization. And we see this now as our TAM, having moved from -- we shared on our last Financial Analyst Day, which was a month ago, our TAM that we're now saying is not the $24 billion of software at the contact center. It's actually $58 billion. This is the total spend. This is the addressable amount of the labor we think that can be automated over the next 5 to 10 years with this technology. So we've seen a massive expansion in our TAM, and it's just a lot of upside and room to grow for us as a business. And this is particularly working with our larger enterprise buyers who have these big growth needs from a head count perspective. So I think, I think, Barry, I don't remember the exact number, but the penetration of this technology on our new, large enterprise sales is really high. Is it 100%, Barry? Or what is it?

Yes. So if you bifurcate it between the AI, it's -- the IVA, should I say, 88% on the big accounts. And then on the WFO side, it's 100%.

So we're getting great traction, and it's definitely helping us with the acceleration of growth, Meta.

Is that an area where -- you noted having made 3 kind of tuck-in acquisitions to advance that. Is that at a point where you're always going to be opportunistic on areas where there might be complementary technologies? Or do you kind of feel like you have that portfolio as it needs to be for the next couple of years?

Yes. It's still early days in the -- on this in the sense that we're starting to see the traction from buyers. We now have enough of a base, frankly, of engineering talent and capability and, frankly, market leadership where we can afford to hire and do much more organically. So we see more of an organic future for us here. One of the things that we did -- and I think this is important relating to acquisitions, is we also said we're going to be very focused on this IVA opportunity, and we're going to open up and create an AI platform for other AI companies to get in on this game. And this is unique to Five9. So the platform we've created allows third parties to plug in. What we have seen in the start-up world is most -- actually, almost entirely in the start-up world, nonpublic companies, where there's all kinds of vertical solutions springing up using AI in live conversations and bots and so on. And what all of our competitors are doing is they're basically saying, we have everything you need, you can buy it all from us. We saw this massive expansion happening. And we said, let's say laser focused and open up the platform so that other vendors can plug in. So we're allowing other vendors to plug in. And these are some of the hottest start-ups out there, conversational AI start-ups. They're plugging into our platform. It's called VoiceStream is our AI platform. And that's enabling us to basically go to the customer and say, look, you can buy anything from us, right? We've got every solution out there in the market. And in terms of your question around organic versus inorganic, there's definitely going to be more inorganic here because as we start to see some of these other, call it, small private companies start to get traction -- and we can now see that because they're building on our platform, we can be smart about what we do there. And that's really important. So we're going to make organic investments, but we're also keeping a close eye on what's getting traction in the market on our platform, and those could be very targeted acquisitions. Of course, maybe not right away. The challenge there is valuations are completely insane. So I'm not going to overpay for technologies at this point. But we do see that there's going to be opportunities down the road for us to move in this direction. And again, adding more than $20 billion of TAM means there's going to be a lot of investment in this category.

Got it. That's helpful. Maybe just a second on the competitive landscape. Certainly, you guys talked about or you opened and talked about kind of differentiation against the incumbents, whether it be a Cisco or an Avaya. But just there's a lot of vendors in the space trying to do a cloud approach. Like what -- is it segment of the market? Is it approach to the market? Like what do you think kind of helps you differentiate versus maybe other cloud players?

Well, there's really only 2 companies out there today that we compete with for business, and that is NICE inContact and then Genesis. And really, for a long time, it was a duopoly, as I think you've said even before, it was kind us, NICE and Five9. They're -- they've been the main competitor. They have slowed down. So our -- I think we've been taking share. If you look at their just pure cloud growth numbers versus ours, it's clear in the numbers that we've been taking share from NICE. And we've been bringing the fight to Genesis. Genesis has got a largely legacy premises business. Most of their business is premises, and they have had a stronghold in the large enterprise. We have been penetrating that large enterprise like crazy. And so we've been taking their partners, and we've been taking their large customers. So we've been on the offense here. And that's what we've been seeing more recently. So those are the 2. I would tell you, look, we don't really see any other vendors in these large deals competing at this scale: A, because the products aren't ready, so the incumbent products that they have are not ready to actually service these larger and larger customers. And then there's really nobody else at scale who's playing in these large deals, except Amazon and sometimes rarely Twilio. But they have taken a fundamentally different approach. So you could kind of segment the market at this point. And that segmentation would basically show you that there's a buyer for sort of packaged SaaS products. They're coming to get Five9, Genesis and NICE. Then you've got a buyer who's saying, I've got an engineering team, and I actually want to build a contact center. And that's where you're seeing traction on the Amazon front, Amazon Connect. Twilio, we haven't seen much recently. And -- but we don't see them in the same deals, right? If the customer is evaluating us in the final steps of an RFP, something wrong -- something has gone wrong. We just don't see that. They tend to segment themselves out earlier in the process. And so while there is a segment for the DIY kind of customer, who wants to build their own, using a platform and APIs, they're going to go to Amazon, Twilio route. We're really laser focused on that packaged SaaS space, and those are the competitors.

Got it. A question I get frequently -- and I'm very secure in the answer that I give, but you're much more equipped to give this answer is why -- a question we get is like, well, why can't Salesforce or Microsoft or somebody just enter into this market? And like why shouldn't we be concerned about them as a vendor? And obviously, I'm not asking you to dismiss them, but just like the -- kind of what are the moats or what are the reasons why you don't kind of see new enterprise players as a potential threat in this market?

Yes. I think, first and foremost, I'll take Salesforce as one for example. I won't say them specifically. But any of the CRM vendors, there is a very big difference between real-time and nonreal time. Doing a real-time SaaS service -- and of course, you know this well, Meta, covering the comm sector, that's not easy. And it's sort of famously -- like a lot of companies have tried and not been able to do that. There's a big difference between delivering a real-time SaaS service that has latency requirements because it's a different architecture fundamentally. You have to be at the -- you have to be close to the edge, a different data center deployment model. You have to have relationships with telcos that has a whole set of implications around regulations and compliancy that, I would say, some of these companies don't want to get in, and even margin implications, just being very candid. So I think you're not -- you haven't seen -- that's -- those are some of the reasons why even though they've tried, they haven't really been able to penetrate this market, some of the CRM vendors. Just very complex to do, very different than traditional SaaS, and also with these other sort of overhead reasons around telco, regulations and all that kind of stuff and the margin implications. So that's one reason. Microsoft is a different story. And Microsoft is -- you could say that they, in a way, look more like Amazon than they do like Salesforce, even though they've got a Dynamics business when they recently announced that they have some kind of a contact center offering built on their Azure platform. But we don't know exactly which direction they're going to go yet, whether it's going to be more -- it looks today like it's going to be more of the Amazon route, which is here's a set of APIs you can use to integrate sort of real-time voice with Dynamics, so on their CRM platform. But they're not -- that really is something that's very new, and we don't know exactly where that's going to go. Salesforce has been dabbling in that for quite some time, trying to pull in additional capabilities into their CRM platform. But fundamentally, I think they eventually said, look, we've got a partner for this, and we're one of their leading partners, along with Amazon, actually. So it's Amazon and Five9, I think, are the 2 biggest or 2 most quickly growing partners for Salesforce. And we continue to invest alongside Salesforce, by the way, as a great partner in this space.

Got it. And maybe a question -- not to dismiss Barry altogether, we'll bring you into the conversation. Post the dissolution of the merger agreement with Zoom, there's been a lot of focus on kind of the proxy targets. And clearly, you guys addressed those at the Analyst Day and kind of on your fiscal Q3 call. But just what makes you like -- I think there's just a level of discretion that people need to have on estimates that are 5 years out. But just like how are you kind of explaining what are the keys to success or cautions around those proxy targets. I think we got you on mute, Barry.

Yes, sorry. Thank you, Meta. So big picture, 2026, $2.4 billion in revenue, which we characterized as being a 50-50 type situation down the fairway and equal chance of making it or not making it. But do remember that this is a management team, Meta, that has repeatedly demonstrated its commitment and ability to meet the targets that we've set out there for ourselves since we've gone public. The confidence around the $2.4 billion in revenue comes from 3 drivers. The first one is the enterprise LTM subscription growth growing in the 30s, as Rowan mentioned earlier on. We take a tremendous amount of confidence in that. Rowan has been saying that as a public company CEO for several years now, because the market is huge, it's underpenetrated, a new front door is open, we've got over 2,000 people that are just laser focused on execution, and we can execute. That's the first of the 3. The second one then is our dollar-based retention rate going from the current 123%, up into the high 120s. And there, there's also 3 factors that are driving that. The biggest one, though, by far, is the fact that we're having such success in going with this million-plus ARR customers. 2019, 2 years ago at our Analyst Day, 123%, that was million-plus ARR customers now. And those customers tend to have meaningfully higher dollar-based retention rate, which simplistically makes sense. If you're landing a bigger customer, the bigger it is, the less likely they are to have a -- to penetrate the entire organization. There's no flash cuts in those types of organizations. Then in addition to that, we have ARPU increases coming over time, particularly around AI and automation. We also have a slight benefit from the fact that our Enterprise business is growing meaningfully faster than our commercial business, and there's a disparity there with the dollar-based retention rates. The third and final one is what we talked about earlier here as well, is international. There's more agents outside of the U.S. We only have 9% of our revenue in the U.S. We've made tremendous investments both in, for example, public cloud in terms of being able to step out GCP instances across the world and in our Professional Services for the bigger customers that are global. And we feel pretty darn confident about being able to take that 9% and growing into, as Rowan mentioned earlier, to the mid- to high teens. It would be more, but of course, the domestic business is much bigger and is growing at a healthy clip.

Got it. And maybe in our last minute, Rowan, just any changes to strategy kind of post dissolution of merger? Or is it really -- that we should be mindful of? Or it's just the same strategy you have beforehand and just continuing to execute because you would have been kind of an independent arm within any potential merger partner.

I hate to say, if it ain't broke, don't fix it, Meta. But in this case, we are on a rocket ship. We were not looking to sell the company. Zoom approached us. That didn't work out. We were -- we had the confidence in our own business and, frankly, in where we're heading, which is perhaps different than some of the rest of vendors in our sectors. We're absolutely on the rise on this front. So we said, look, we feel that we had a great strategy. So we continued to execute on it. And nobody in the company missed a beat on execution through the conversations that we had. So we've really hit the ground running again or it never actually left the ground. We kept on running through that whole process, you could say. And as we head out, I mean, clearly, we're looking at this -- I'd say that the one shift has been doubling down on the AI and automation opportunity. I mean if there's one thing that's really different right now than it was a year ago is you're seeing the traction by -- with large enterprises. We're also seeing, by the way, very large enterprise traction that we weren't seeing a year ago. We are now -- and we have a clear technology advantage against our competitors, both Genesis and NICE, on scale. We're now able to serve companies larger than they are in the cloud. And so that is giving us an ability, and Dan shared some of the pipeline numbers there where we're seeing just huge expansion. We're signing some of the -- we are signing the largest contact centers in the world now. And so that's going to be a key feature of our growth. So large enterprise expansion, a technology advantage there and doubling down on the automation opportunity given what's happened in the market and the labor market and so on. So those are the real, I would say, tweaks to the strategy on top of a strategy that was already working well.

Got it. Well, with that, we're out of time. I could ask a million questions. So Rowan, Barry, thank you so much for being with us today, and I look forward to catching up soon.

Thank you. Thank you, Meta.

Sure. Thank you.