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

Okay. I think we are about to get started here. Please take your seats. Thank you for joining us today at JPMorgan's 50th TMC Conference. My name is Noah Herman. I'm currently a software research analyst here at the firm. We are very thankful to be having Five9 here today, CEO, Rowan Trollope; also CFO, Barry Zwarenstein. And before we begin, I think, Barry, you had a safe harbor?

Yes. Good day, everybody. Just a reminder that before we start, we'll be making forward-looking statements about the company, the industry, operations. The actual results may be materially different. I refer you to our SEC filings, 10-K, 10-Q for the factors that could cause such differences.

Great. Thanks. So just to really set the stage here, can you provide a brief overview of Five9's business, including the markets in which you compete and the customers you have?

Sure. We are a -- thanks for having us today. We're a contact center company. We provide contact center software in the cloud. So we're a SaaS business, pure SaaS. And if you think about just to frame it for folks who don't know our story, any company in the world that needs to talk to their customers, needs -- probably has a contact center, and they're going to be using software to talk to their customers. The legacy of this space is phone systems. As you all know and probably hate dialing up into a legacy business and having to push 1 talk to someone and you end up stuck and you get a hold of someone that doesn't know who you are. That's a result of like legacy on-premises phone systems. And we provide a modern pure cloud offer to those companies. The agents log into a web browser. Much of the traffic comes in over digital channels. So you kind of will probably start with a company that uses our software by going to their website and starting with a messaging or a chat and then maybe escalating to voice and then you get this much more delightful experience. So that's the -- the space that we sell into is a -- there are maybe 16 million or 17 million of these agents around the world. We sell on a per month per agent basis. On average, we sell for about $200 per agent per month. So it's around a $24 billion category. The latest -- just to bring up to speed that side of the background. The latest in this space has been that -- of those 16 million or 20 million -- somewhere between 16 million to 20 million agents in the world, that's a lot of spend on labor and companies are looking to save money. And AI technology and machine learning, more specifically, natural language understanding and natural language processing has advanced to a place now where we're starting to automate a lot of the work that those agents do. And so if you look at the history of the space, it's been one where every business had sort of like somewhere in the company, there was a field of cubicles with people wearing headsets answering the same questions from customers over and over and over again. And we're moving to a world where we can automate a lot of that work and take that burden off of human beings and actually do with technology. That represents a much larger opportunity than the $24 billion category of software because there's $240 billion spent on labor by businesses globally on contact centers. And so that opportunity, we size it somewhere north of $34 billion. And we're just getting started on that. So it's really a shift to an automation -- a software automation story using artificial intelligence. So that's kind of Five9 in a nutshell.

Yes. And so -- I mean great overview and kind of double-clicking on that. How much of the contact center market is still on-prem today? And what is really the opportunity for transitioning agents to the cloud?

There's different estimates about penetration of cloud software. But some -- on average, I think folks would say it's around 15% penetrated today. So 85% of the market is still leveraging on-premises phone systems to do a contact center service and support. And so it's a huge opportunity that's still in the early innings, you could say.

And sort of how has the COVID-19 pandemic impacted that trend? And what were some of maybe the difficulties or opportunities that presented Five9?

Yes, it was mostly opportunity. We had been seeing an uptick -- the business demand environment had been increasing pre-pandemic. And what we are seeing is increasing larger enterprises sort of ask for contact center. Through the pandemic, the biggest impact that we saw was a positive uplift in our existing installed base customers. So these are people who are already using Five9, who's -- who needed to hire more agents because their businesses went from in-person to virtual, and they needed contact center agents. That kind of happened and went away. It seems to have normalized now. But the fundamental demand trend that we had seen which was going up is still there. And so as we come out of the pandemic, we're seeing -- and I think maybe this was even sort of accelerated by the pandemic, but we're seeing more demand from larger enterprises post pandemic. And those companies -- I think if there's one thing that pandemic did is it showed people that trying to send all of your agents home when they're using an on-premises system doesn't work. And a lot of companies struggled. And so now I think a lot of those companies are saying, "Oh, yes, that turns out that cloud things pretty much a good idea, and we should go for it." So we're not having to sell cloud anymore. It's the other benefits that we're selling on, but the basic premise that this stuff can and should be done in the cloud that is now basically an answered question for most large enterprises. And so I think we're on the other side of that at this point, which certainly helps.

Yes. And on the topic of really moving upmarket, well, congrats on the $40 million ARR win you announced last quarter. In your opinion, I guess, kind of following up with that, what was really driving that cloud adoption by the large enterprise? If you can maybe talk a little bit more about that deal, what led to it?

Yes. Most of these large -- most deals, but especially the large deals are driven by their on-premises systems expiring essentially. And the really only option for a lot of these companies is to go buy new hardware and install rack and stack that hardware in their data centers and install new software, on-premises software. So then you're in for another 7 years maintenance cycle and sort of that's the average lifetime that these systems have. So I think with the writing on the wall now around cloud, it's like nobody is going to like in their right mind is going to do that. And so that's currently the state is that -- and that really is something that, that's what drove that big deal. I mean -- and frankly, most of our big deals are we just can't continue with our existing on-prem software. We don't want to upgrade the hardware and put in new phone systems and all this other stuff. We want to move to the cloud. That's the biggest driver. And we, I think, also have sort of differentiated ourselves in a couple of other ways, and why we're winning these larger deals? One is we spent 3 years rearchitecting our platform. So we did this somewhat quietly in the background. We did tell The Street we were spending more in R&D. We modestly increased R&D spend to 12% of revenue, which is where it is today. But as a result of this consistent investment, we now have a platform that can scale to the largest companies in the world. We were not there 3 years ago. We are there today. That is good timing because those companies are now coming to our platform. So we're able to scale to the tens of thousands of seats. We just couldn't do that 3 years ago. We also think that we're uniquely positioned in this way versus our other public company competitor who is, I think, quite far behind us in terms of scale. So we're ready for the largest customers and scaling with the largest customers. And then the second big differentiator is our investment in AI and automation. Because these large companies are coming with huge labor budgets in a tight labor market and saying, "Okay, we know there has to be a better way than just hiring more people to do more manual work, and we have a market-leading solution there, and it's been really taking off in the last couple of quarters." Last quarter, in Q4, it was 10% of our enterprise net new bookings was our AI and automation solutions. So that is really getting traction and probably at a good time also as we head into this economic downturn because companies are looking for ways to save money. And a huge -- like people spend -- in the contact center, you spend 10x more on people than you do on technology. So that's, I think, a play that's going to have legs here for a while.

And sort of following up on that, is there a specific customer size or vertical that is demanding automation more than another?

Definitely at the larger end of the customer sort of segmentation because that's where the numbers really start to just add up. So when you have 1,000 agents, if you can do 10% savings, that's 100 heads. That's a lot of people. On average, those agents cost you $2,000 a month fully loaded cost. So you're talking about very substantial savings. And the investment that it takes still from a machine learning and training perspective with our technology, there's still some upfront investment. And so it needs to be at a certain scale. So we kind of look towards those like 500-seat contact centers and greater is where it's getting the most traction. They have the most to gain, and they have the willingness to invest upfront to get the results.

Got it. And to what extent do your competitors offer similar automation capabilities? And how do you -- your solutions really compare to theirs at this point?

We should ask them that. But I think we are leading the market in this space. We made some key organic investment starting 3 years ago. We hired our Head of AI and machine learning is a MIT PhD. He actually is here in the city in Boston. He's been building that team up for 3 years. We also partnered heavily with Amazon and Google. So we are leveraging both of their platforms under the covers, and we made a key strategic acquisition of who we thought was the market leader, Inference. And that company is now part of our portfolio as well. So we've sort of assembled some best-in-class pieces and also done this organic investment over the last few years. And we think that it's a real strategic advantage for us right now. The analysts at least the kind of couple that cover this in a more dedicated way, put our technology in the leader's quadrant for AI and automation. So we hear from customers that we have a better portfolio and better technology on this front.

And can you sort of outline the pricing dynamic of customers buying human seats versus virtual seats? And how will shift towards automation impact the revenue per seats over time?

Sure. Our go-to-market strategy has been to go -- we sell to -- [ let's take a step ] back up. We sell to the contact center operations leader or head of customer service. And when we look at the budget that those buyers have, again, 10% is technology, that's often an allocation back from IT and then 90% or 90-plus percent is labor. And so our strategy has been to go after that labor spend and to make a very simple translation for the customer in terms of ROI. And we sell -- so the way we sell this is a per virtual agent basis. So if you have a 1,000 agents, that's a 1,000 people you're paying $2,000 a month. Our play as we go and we make a -- we look at the data, we talk to the customer, and we look at the high-volume, low-value contacts, often things that are like people calling up to say where is my food or check their bank balances, I mean like kind of really rudimentary stuff like that. And those are relatively easy to automate. And we start out by looking at -- we shared an example in this last quarterly earnings. One of our health care customers who identified around 10% of the calls that could be automated. And they had 360 agents. They were able to save 36 agents' worth of work by automating 10% of the calls using our AI and machine learning technology, and that resulted in significant savings. Now for us, that's less human beings to sell software to. But each human being, we sell software at $200 a month or each agent gets monetized at $200 a month. Each virtual agent, and it's a one-for-one replacement, sells for $400 per month. So for every human beings worth of labor we can automate, we double our monetization opportunity. So that's the current math, and the savings are significant for the business because think about it, instead of spending $2,000 a month, they're spending $400 a month. So it's an arbitrage of labor spend is really what's happening.

And when do those customers typically start seeing those savings really kick in, like you mentioned?

Immediately. So once it gets deployed, so the deployment process takes months. We have to first put the system and train. We have to figure out the shape of the conversations. We have to actually train and label the data. But once the technology goes in, it starts delivering on savings immediately, so it can be very fast. And these technologies, by the way, like this approach has been around for a long time, but it was just -- it required generally like hundreds -- like dozens or hundreds of engineers, and it was an order of magnitude more expensive. With machine learning and the latest technologies and the stuff that we've been investing in, it's an order of magnitude cheaper and faster to get sort of better results than you could get before. That's really where we are. And so it's making it more accessible to more companies.

So kind of switching gears here. I kind of wanted to focus a little bit more on the international and channel expansion. So you are targeting international to represent a mid- to high-teens percentage of last 12 months revenue by 2026. What areas of the platform are driving that expansion?

Well, really, it's the whole portfolio, but we did make some investments over the last couple of years. As part of the rearchitecture of our platform and refactoring of the platform, we invested in moving towards public cloud and that's allowed us to expand faster. So we deployed 2 new data centers using GCP. We actually use a mix of GCP and Amazon. But GCP in Canada, and then 2 new public cloud instances on the European continent that we just launched. And so we've got 2 in U.K., 2 in the continent in the European -- on the main continent, mainland and then we've got 2 in Canada. And then we have a whole bunch of points of presence that are just voice points of presence for telco connections. So that's opened up -- the new European data centers is really opening up that market for us. And it is a fast-growing part of our business. It's a small part today. It's less -- it's just about 10% of revenue, is that right?

Just slightly under, yes.

Just slightly under 10%. But it's growing faster than our U.S. business. And we also just recently opened a new R&D center in Portugal, low-cost R&D center there. So we're really ramping up the investments in Europe in -- to go after the opportunity that's there.

And I think you sort of mentioned before that you wouldn't have been able to win some of these mega global deals without the increased international footprint. Can you maybe touch on how moving upmarket and international expansion are really intertwined?

Yes. So every one of these mega customers, these [ whales ] are -- have -- are pretty much multinational and need coverage outside the U.S. And so we've been -- we signed a large insurance company that originally they had a -- we signed their Canadian offices and then we moved over to the European operations 2 years ago. And they needed the data center. They needed everything from a GDPR perspective to be resident in country. So we made those investments for them. But now we have that investment done, we've been able to land other large -- recently other large customers, including our shipping company that we won last year. The start out is a $14 million ARR deal. That's now a $30 million ARR account for us because their European operations are moving on to our platform. So they've more than doubled their spend with us and expanding globally. And the coverage globally and our ability to service them, not just with data centers, but also people in region and partnerships and other investments is really paying off. And you do need that coverage to win these strategic deals.

I think I'll take a quick pause here to see if anyone has any questions, you could just raise your hand and someone with a microphone will come and assist. Does anyone have any questions? I think in the back over there.

Just a quick question on something we mentioned just on going into this economic environment. We mentioned that the cost savings could be actually a benefit for some of our customers. So as I think maybe some of the trade-offs of potentially we have large deals as well that could have implementation cycles that customers need to think of, but then also it could be revenue generated, but also cost savings opportunities. So how do you guys think of that balance? And how are customers really thinking about this transition with those 2 things in mind? And then I have a follow-up.

Yes, especially on the strategic side, it's a critical part of every deal. And like in the big deal that we just announced, I mean, they made this an important part of their decision criteria, the $44 million ARR deal. They said, "Hey, we want to get there, and we need to evaluate all of your AI and automation portfolio to make sure that you have the best technology there because that's where we want to get to." So essentially, it's become the -- 1 of the top 3 reasons where we're winning these accounts is the investments we've made there, in addition to scale and maturity and reliability that kind of standard stuff that we've had. So it's increasingly just over the last 6 months, and maybe it was like everyone thinking about the labor shortage problem or what have you, but it's really popped up to the forefront in terms of customers' mind share and driving decisions. And I think that is likely to continue in a cost-constrained environment, right, in a recession that we're in and that who knows how long it will go on for, companies need to find ways to spend to save money. And we represent now with that part of our portfolio, that's a very clear-cut ROI case that we can make to those customers. And so yes, we plan on obviously leveraging that.

I see. And then on the comment on refresh cycles driving a lot of people moving from prem. Would there be -- just because the last 2 years have been -- many companies have been thinking about deals or thinking about focusing on just getting their business to survive. And so in the last, do you have any of those deals may be pushed out in terms of refresh cycles where this year has maybe caught a bunch of those, and it's almost had like a new refresh cycle? Is that a [ way thing ]? Or is that just a little too hard to tell?

We have not seen any pushes. And again, because the biggest driver in this space -- it's not an optional purchase, they're generally forced to make this change. Most companies, especially on the strategic side, are very conservative in their contact center. Their contact center buyers are very conservative. They wait until these systems are on the very last legs before they kind of make the -- until they really have to make the move. So it hasn't really been an optional move for most customers. And so I don't think that's going to really change. But we certainly could see other effects. I mean we're not immune, as Barry will point out, to economic downturns and companies going out of business and so on and so forth. But I like our hand on that front, relatively speaking, better than I think others in the enterprise B2B space.

A quick question. On Concentrix, right, players like that, is that a competition, coopetition? What's...

Concentrix?

Yes.

I don't know who they are.

They are outsourced call centers.

They would be a customer-ish. But we really sell to enterprises who use -- so BPOs like -- the BPOs like those guys, if that's what they are, BPO, they're in the value chain, but they tend to sit behind the enterprise. So the enterprise makes the decision and then they outsource...

Could that be another channel for you guys?

Yes, it has been actually. So we have a number of BPOs that have chosen the Five9 platform. And where they can, they push that to their enterprise clients. But most of the time, the enterprise clients are doing the pushing and saying, I want to go on to your platform. I want you to use my platform not the other way around. So it's a smallish part of our business. Could be bigger in the future, we'll see.

Maybe 2 quick ones. I wanted to ask your view on -- we've seen a recent DDoS attack on one of your peers kind of in the CCaaS space. Your brand has been built in part on reliability, as you mentioned. Can you just speak to kind of any change in committed dynamic there? And then I had a quick follow-up.

Yes. I spent 20 years of my life in the cybersecurity space. We have made very substantial investments in the security of our platform. And we -- so we've got -- and we've got now an operations leader who's driving this for us and [indiscernible] reports to him, who has done, I'd say, a fantastic job at protecting our infrastructure. So we have not had any kind of impacts from that. So it's something that I think drives a lot of our sales, frankly, is the reliability of the platform and the uptime that we have had, which has been at record highs over the last few quarter -- over the last few quarters. And again, that's something that especially for the largest companies in the world, that's the kind of safety and security that they need to trust the platform. Sometimes it's less about features, and it's more about like, "Please give me the basics and don't go down." And it turns out that's harder to do than you would think, especially when you have an active opponent trying to take you down. And so we have a very -- we have an excellent security team who sort of takes care of that.

And then just a quick unrelated follow-up. Certain competitors like a Twilio and messaging talk about in and up, meaning a modularity of a solution where they can kind of attack the CCaaS space over time. You're doing a lot with natural legging those processing AI/ML, trying to kind of verticalize the service offering. Can you speak to modularity of market at the enterprise level? Do these different solutions play in the -- integrate and play in the sandbox together? Or are enterprises really looking for the one hand to shake, as it were?

Yes. Actually, A lot of our customers use Twilio in -- for specific use cases. So when they want to automate like an outbound text campaign to say, like, "Hey, we know that our Internet is down, please don't call right now" or something like that. They haven't really -- they haven't penetrated the contact center sort of core space at all, it's more been around the edges. So I'd say they are more partners. Same thing with Amazon. Even though Amazon has Connect, we don't tend to compete against them because the solutions are apples and oranges. They have a contact center platform and a set of APIs upon which you can build a contact center product, which is what we offer. So they -- I think it's kind of played out in the market where there's a niche buyer who has engineers and wants to build a contact center platform with a set of APIs. The vast majority of the market, we don't know exactly how it breaks down. I think are still buying contact center products, and that's what they want. What we've done is moved in a direction that is what I would call composability. It's less -- we have an API surface area of about 400 APIs on our product. So you can customize the [indiscernible] side of our product. You can do a lot with our technology. But we also have invested in the low-code, no-code platform because what we found from our customers is that getting the attention of the developers in IT for the contact center person, they're competing against the marketing people and the salespeople who generally win the resources and the budgets. So they are left with like -- basically, they're left out in the cold with no ability to get the resources assigned to their projects. That's basically what most of our customers face. So we've given them a platform that's low-code, no-code where you don't have to be a developer. And that's what's selling like hot cakes. They absolutely love the fact that they can go in and configure their business workflows and basically drag and drop and click to do what used to take like dozens of engineers can now be done by the actual business professionals, and you can mix and match these things. And you still can program them with developers. We have some companies that have lots of developers on our platform. But most of the buyers don't get that kind of access and resource. So they're actually looking for something that enables them and that's where this low-code/no-code platform comes in. So that's our IVA product does that as well as it's called workflow automation, which is a low-code, no-code sort of integration platform. So that's our approach to this, slightly different than our competitors, and it's working out well.

As we sort of think about the go-to-market, to what extent does Five9 really rely on the channel partners? And can you just talk to the productivity of that go-to-market strategy?

Yes. So we have a balanced go-to-market. I think we have invested a lot in our channel partners' programs over the last few years. And it's increasingly been a bigger sort of driver of deal and especially -- deals and especially as we move internationally, just the reach that we wouldn't have just with our own resources. So I think we've done a great job there. Our biggest partners by far are the ISV partners, #1 is Salesforce. #2 is Microsoft because they are selling products that need contact center integrations. So in the case of Microsoft, it's Dynamics and Teams and in the case of Salesforce, it's Salesforce Service Cloud, that's #1 and #2. And so that's been going really well. And we're also -- we've seen -- probably from the reseller and SI perspective, we've seen a tremendous amount of traction with the SIs, especially on these strategic deals. I mean the $44 million deal we had last quarter had 2 SIs as part of the implementation projects signed up on that one. And we've been landing increasingly larger VARs and resellers from the more traditional on-prem world, they are now starting to make the move to the cloud. Just this last week, we had -- we're getting very well. It's not actually done yet, is it? Not done yet. Another very large partner deciding to move over and choose Five9 for their contact center platform. So yes, channel expansion has been a big part of our strategy and especially with the SIs and the ISV partners has been hugely helpful to our growth. From a productivity perspective, just to finish out the thought -- sorry, to cut you off. If you look at our sales productivity, we have -- I think we're at a -- at the top of the -- all the companies that we measure from a revenue to expense metric. And so I think it's working really well.

And sort of following up on that, how is your partnership with AT&T helping you successfully target larger enterprises?

Yes, AT&T is strong at the very high end. In fact, the very large deal that we signed and announced in the last quarter, AT&T had a part of that. They had the usage piece of it. And then they're very strong at the very low end, and we don't have any traction there because that's not really our focus. So I would say the partnership is going well. It's on track to where we had wanted it to be. There has been some turnover in the group at AT&T, which is pretty normal. And these things, I think, generally take a while to kind of ramp up anyways. So still ramping, but we still see them as a very good partner.

Got it. I sort of want to pivot over to just the long-term business model. What are some of the main drivers to the long-term model at this point? And how do they really differ between enterprise and commercial?

Do you want to take that one, Barry?

Yes, absolutely. So we have at our Analyst -- Financial Analyst Day meeting in last November, said a $2.4 billion target for 2026. That would imply a 32% annual CAGR to get there. And frankly, given the size of the market and the low penetration, Rowan has been able to say for the last several years, that we expect to grow our LTM enterprise subscription in the 30s, and that makes up alone 60% of our revenue and we've got a number of other levers, including improving further our dollar-based retention rate and more international growth because there's more agents outside of the United States than they are inside. And we have, as we mentioned just a few moments ago, less than 10% of our revenue from international. Moving down the income statement. The -- we expect to get to a 23% adjusted EBITDA in 2026. And the 2 main drivers for that are ones that we've demonstrated repeatedly in our past that we can achieve. The first of the 2 is further gross margin expansion. We have taken a detour very deliberately and very clearly planned in advance and communicated as such to The Street to increase our professional services, precisely to handle all of these big deals that we saw coming down the pike. And also to be able to move to the public cloud which enables in no small part, the international expansion we've just been talking about. That trough this quarter, and then you'll see it beginning to slowly but steadily increase from the 64% we reported up until 70%-plus in 2026, mainly the several factors, but the biggest one is on that approximately 70% of our recurring revenue that comes from subscription leveraging against fixed and semi-fixed costs. And there's a number of other things as well. And then finally, and not as importantly but still helpful. Our G&A expenses have declined now for 30 consecutive quarters year-over-year, and we expect that to give another modest improvement.

And sort of as we kind of look towards that 2026 target, how should we sort of think about the growth from now through then? Just any clarity on that would be helpful.

Yes. So I mentioned the 32% CAGR, that is basically sort of road map. It will be bigger or stronger in any given year, but that's what the average will be.

Okay. Got it. I think we maybe have time for just one more question if anyone has one. Okay. I think that's -- that does it for today. But thank you so much for being here. We really appreciate it. Thank you.

Thank you, Noah.

Thank you.

Thank you. Thank you all.