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

All right. Great. Thank you, everybody, for joining us. We have with us Dan Burkland and Barry Zwarenstein from Five9. Thank you both for joining us today. I know there's a lot going on, and its exciting times, and we appreciate you carving out some for us. So with that, I know, Barry, you wanted to make the safe harbor statements. I'll let you kick it off there.

Thanks, Samad, and hello, everybody. Just want to say that today, we're going to be making forward-looking statements, our events and trends that could affect the company, the industry. Actual results may be materially different due to our filings with the SEC, 10-Q, 10-K for things that could cause such a difference. Thanks.

Great. So Guys, I want to rip the Band-Aid off a little bit just because everybody has asked me what I'm seeing in the macro environment for the companies that I cover, and therefore, I have to ask you the same question. So there's a lot of cross currents that we're seeing in terms of though it's being tough to hire. The economy appears strong. On the other side, there's people concerned about a slowdown and what's going to happen and what you're seeing in Europe as well. So Dan, why don't we get off with you as somebody who's seeing it day to day with the sales organization on the operational side, what are you seeing with customers or what feedback are you getting in your everyday conversations?

Yes. Thanks, Samad, and thanks for having us. Glad to be here. I'll start with -- and that's the question we get most often obviously, in these times is, what are you seeing from a macro headwinds perspective? And what I'll say is we have a pretty significant sales cycle to most, especially upmarket in enterprise and larger enterprises. And so we haven't really seen an impact from that yet. We're not immune to a slowdown or potential recession that may hit certainly. But the good news is we have a very horizontal application. The contact centers come in all sizes. They also come across all industries and companies still need to maintain that touch with their customers. And so it's -- what we sell and what we provide is not an elective optional software solution. It's required. You've got to have it to communicate with your customers. And having said that, we're a cloud provider, and the trends that we see in the growth in the industry continue. The legacy on-premises systems are going to continue to be end of life and get long in the tooth and the advent of AI and some of the more advanced solutions, not only are they being adopted faster than ever because of the compelling ROI that they deliver, but also because of the cost savings that they bring about. So as long as we're able to demonstrate and deliver strong ROI that we aren't seeing a slowdown in the business. Now having said that, if you look at -- you mentioned the European market, and we get oftentimes asked, how is that -- how are you handling that? Is that a headwind for you? And I'll say even though it may be a headwind overall for companies, what Five9 in many of the markets, we're brand new. I've shared the example today with several of you that we just put sellers into Spain for the first time just in the last week, and that's incremental business. So it's a headwind. In a thriving market, could we have added more heads into that market and done even better perhaps, but it's still a headwind. I mean, it's still a tailwind for us.

Great. That's helpful. And then maybe, Barry, I think one for you. Let's -- it's funny. We're all worried about things slowing down, but we haven't seen it in the business, right? The business is doing great. But how do you think about maybe the playbook that you would have if we were to see something like that? And I guess, where would we see it in the KPIs if we were looking out for that? How do you think about that?

Yes. So we're constantly vigilant. We're not seeing, as Dan just mentioned, signs of a slowdown. By the way, we look at it both on the new -- separately for the new logo versus the installed base, which each contribute approximately 50% of the annual revenue growth. And the installed base has -- excuse me, the new logos continue very strong, especially at the higher end. The installed base is the same thing. We have customers -- it's very -- as Dan said, it's very horizontal, mission-critical. We see pockets of strength, including pharmaceutical company. We see pockets of weakness, a company making loans to smaller -- that make loans to smaller companies who sells insurance through them, telemedicine. But overall, pretty strong. We -- in terms of KPIs, the pipeline is key. The sales cycle is the key, and Dan has been telling investors that those are both -- that remain at both -- healthy levels. And yes. That's it.

Great. Maybe let's switch gears and Dan, the last couple of years have been great for -- I want to say the contact center industry in general, at least the companies that are well positioned, such as Five9, and you guys have certainly seen an acceleration in growth. And a question we often get is, you -- we've all seen good growth over the last few years. How far along are we in this cycle, right? Are we still very early days in terms of both conversion from on-prem to the cloud, but also maybe just in what's called the overall modernization of the contact center?

Yes, great question. And I think if you look overall, we're still in the early innings, if you will. And I say that every study you see will benchmark somewhere around the 20 to very low-20s as far as the percentage that have made the conversion to the cloud. That trend, along with digital transformation and the modernization is key. And I think what's helped us see that acceleration, it's easy to point to the pandemic and say, oh, contact centers move to the cloud more rapidly because of that. And while there may have been a little bit of that, typically at the lower end where they could make quick decisions, we saw the acceleration occurring before the pandemic due to the introduction of AI and automation into the contact center. So if you take kind of the 3 key areas that we describe as automation for contact centers, IVAs where you can do self-service to a spoken interface from a machine without human interaction. Deflecting that traffic over to the automated agents is key. It helps save the customer a cost reduction in their labor force as far as the agents. Using AI to listen into the conversation, what we call Agent Assist to be able to listen in and provide coaching to the agent or fetch answers for the agent, makes them more efficient and can reduce their handle times. And then the follow-up that companies used to spend, lots of time and effort with humans doing follow-up to confirm their order to confirm when it's being shipped and do a survey that can all be automated now. So those automation layers for the first time are now available to the contact center. And that's what's really opening up the true upmarket, large, large enterprises for us as an industry for the very first time. For many years, large enterprise would look at it and say, well, IT is taking care of it. I've got it under control, it's not broke, don't fix it. And there was not a real compelling incremental value that was being delivered other than the typical cloud benefits. And so now we do have that compelling argument to say, hey, wait, you've got to get on the bandwagon with these automations. And so that's what's opening up those, I guess, centers for us for the first time.

So you're talking about big megas, you guys signed a massive deal last quarter, biggest in the company's history by some size. And so I know you mentioned some of the things that are making you more attractive to large enterprise. But if I remember correctly, that was actually just a core routing deal, right? And so how should we think about how even the core product has changed? And what's making it where you guys can serve a company with tens of thousands of agents, not just for the add-on features, but with the actual core scalability of the platform itself?

Yes. So I appreciate that one. So architecturally, we weren't ready for the large mega enterprise, and they weren't ready for CCaaS. And I think simultaneously, when the advent of AI came about, that was one element that could help us position something incremental to the business. But we also had to make sure we had scale and reliability. And we brought in engineering lead from Cisco to really help take the platform and scale it infinitely. We basically built a 10x increase in our capacity on a per tenant basis. So rather than be at the 1,000 or 2,000 range, we're well north of 10,000. And we don't know where that ceiling will reside partly because of the architectural enhancements we've made. That's on the infrastructure side. And we did so while concurrently increasing the reliability of the platform to reach the Five9's of reliability that we have in our name. And so those 2 things allowed us to be able to go into enterprises. The $40 million mega deal that you spoke of, that's just for the software for the core capabilities, it doesn't include telco. It doesn't include the automation solutions that I described earlier, and that's because they decided, hey, let's take 1.5 years or so and get everybody on to your cloud. And at that time, the AI solutions will be even more advanced. We'll purchase them then when we don't have to just purchase and set them on the shelf and have them become obsolete over the next 2 years. So we're excited for that to actually increase the ARPU that we get from that deal.

Great. And I know Barry touched on pipeline for a moment. But just, Dan, I guess, when you signed a deal like that, I know we all right about it, and we all jotted down in our notes. But does that -- how much attention does that draw with customers, right? Are you seeing the pipeline benefit for talking about that and I'm sure with your industry analysts, you've given them the name of the company, but we don't know it. So just -- how much attention does that draw? And how much of a reinforcing loop is that?

Yes. It draws a lot of attention because our category, CCaaS hadn't really sold into and have been successful in those tens of thousands of seats before. Now there's only a few of those. So it's not going to be the steady diet of $40 million deals. But what it does do is it's a very small world. The CIOs in Fortune 50 talk to one another. You only get one chance to succeed or fail. And so we invested heavily in not only the infrastructure, as I mentioned earlier, but also in our professional services teams to make sure we could truly help implement and extract the value that we positioned for the client. And that first client, the U.S. parcel delivery service that's global in nature. Having them endorse us unsolicited by us to say, hey, they did it for us. They leaned in, they helped us solve our problems that we had, in many cases, without them even knowing they had them or asking for them, helped us validate to the health care conglomerate. That's so important to the pipeline growth that we're seeing because, again, a lot of folks, because it's mission-critical because seconds of downtime are impactful to their business, nobody wanted to go first. It was a big chess game, and it was about -- now that they've seen a couple go, that should open things up for others, and we're seeing that in the pipeline growth.

Great. And Barry, maybe to piggyback on to that. How should we think about, as you do larger and larger deals, let's just say that the average deal is larger? How that impacts the visibility and maybe the time from bookings to revenue is as we think about the model? And then I have a couple of follow-ups in that regard.

Yes. Well, it helps considerably. Internally, we talk about the mega deals as whales and continuing with that aquatic theme, there's a lot of dolphins out there. And it wasn't too long ago that $3 million, $4 million, $5 million deal was a big deal at least for Five9. And now Dan and the go-to-market team turn those out like hot cross buns. And so we see a lot of visibility enhancements. We've got a huge backlog gives us a lot of confidence. In addition to that, these bigger companies tend to have dollar-based retention rates that are way above the 120% that we reported this last quarter. And they're the fastest-growing part of our overall business. As we reported in our Analyst Day in November for the $134 million plus deals, up from 3 when we're public 8 years ago. The expansion rate from the time they came on to the platform to December 31, 2021, was 93%. I don't have the -- we don't share the current number. I didn't even have it frankly. But I can almost certainly say that there's not materially different. And it makes sense, big company, you landed one spot, and to the others, whether it's through just organically or through acquisitions that they make. So visibility-wise, we can't see around corners, but we feel very comfortable in being able to predict the business. If there is -- just going back to one of the earlier questions, if there were to be a serious economic slowdown, it would hit the installed base part of our business because we cannot be immune to it. People are not going to have empty seats. But at the end of the day, taking everything together and the mission criticality, it's pretty -- a lot of visibility.

Great. That's helpful. And then maybe switching to another one of the growth vectors that's in focus is the international side, right? So I know first the company did a really admirable job getting your employees that were in the Ukraine out and I know you're opening up a new office, if I remember correctly, Portugal. So I would love to host a site visit there. I can't wait whenever you guys are ready for that. But just maybe help us understand the investments and some of the decisions you made in Europe and how that's driving the international traction as well?

Yes, I'll start with kind of the go-to-market piece and let Barry elaborate. But if you look at the go-to-market, we've seen the international market is one of our biggest growth drivers just because we haven't had a significant presence. We've been around 9% of our revenue from companies headquartered outside the U.S. We have lots of multinational conglomerates that have agents all over the world, but putting local resources in and going after the businesses that are headquartered, there has been a new motion for us, and it is quite an investment. We've had the luxury of being able to take our growth domestically and help subsidize some of those early investments because there is a year or 2 of investing before you start to really collect revenue in those markets. And we've been able to do that very judiciously. And it's not only been from a people perspective and the compliance and language and localization and telco and so forth, but it's also the infrastructure, having the right data centers in the right countries to be able to give them data solvency. We had our primary data centers in Europe located in the U.K. Obviously, for EU purposes, they were wanting their data to be stored outside in many countries. And so we've opened our data centers in Amsterdam and Frankfurt to handle those customers. So I think we're in a great position now to pick the hot spots and be able to go after them with more go-to-market focus as opposed to infrastructure focus.

Yes. You've said it well, Dan. Very little I can add. The international has been a major area of investment for us. Over the last several years across the board, the infrastructure now we've in Frankfurt and Amsterdam data residency there. The new innovation center in Portugal. And by the way, it might have given us a good idea have people fly over for the next Financial Analyst Day from New York rather to Portugal than to come out to the West Coast, brand awareness, triple their headcount. And this is so important because there are more agents outside of the United States than they are inside. And we're not even really scratching the surface. Our international growth, international business is 9% of the total, the dividends that we're getting from that investment is resulting in the revenue growing consistently in the 40s on an LTM basis. And that is part of the key along with 2 or 3 other things to get to the $2.4 billion in 2026 that we talked about at our Financial Analyst Day last November.

Great. And maybe, Barry, just -- we've talked about large enterprises. We've talked about international. I know we're going to get to some of the -- Dan touched on earlier with IVAs and virtual agents. I think a big part of what we're trying to figure out is how all of those different dynamics factor into ARPU trends, right? And so I guess, if we look at ARPU based on the annual disclosure of seats, I think it's continued to kind of melt up slightly. But how should we think about that maybe like-for-like compare, just how do you -- how are you thinking about ARPU with all of these different changes going on at once?

That's a great question, melt up slightly, and that's true. And the numbers we give you every in the fourth quarter show that. We have an upside optionality with the AI products in general. Why? We don't know. We know that it's going to happen. We just don't know the gradient of the curve and the exact timing of when that inflection happens. So we've assumed very slight ARPU increases because of that particular SKU. The other SKUs will certainly -- that have been manifested in the annual increases in ARPU will continue to happen. But we've got some small amounts baked in, and we'll see exactly what happens.

Great. And then, Dan, on the competitive side, you guys have done a great job. I think you have some peers that I'm sure even you guys admire. Just what are you seeing on the competitive side both on that pricing question? And then maybe more broadly, what you're seeing as well in terms of what continues to differentiate you when you go into a deal and why you win?

Yes. So there's always competitive pricing issues that's been around forever. I don't think it's any different than it has been in the past. One thing when you look at our space, there's a handful of competitors. And that number hasn't really changed. There's some significant barriers to entry. And so companies that have tried to enter this space recognize that it takes years. You've heard some people -- some companies announced that they're going to get into our space. And then 3 years later, you go, where are they? And they realize the complexity to be able to deliver -- an always on platform that's got the scale and the feature set. It takes quite a long time to mature that. Even companies that are in the contact center space that didn't have a cloud solution, have had trouble trying to build a cloud solution from the ground up just because they know the features that are required to put into it, but it takes an extensive amount of development to get there. That's part of it. So if you look competitively, the dynamics are there. with our main competitors being Genesis and NICE, inContact. And yes, I don't think -- even though there's some day-to-day pricing pressures that we've always seen, the number of applications that we're now delivering and the automation that we're delivering into the contact center have allowed the ARPU to continue to increase. We don't see that slowing down because of these new applications.

Great. I think this is a toss-up. So either one of you can -- whichever one of you wants to take it can. But Five9 did a good job of tuck-in acquisitions, right? And Inference is a good example of Virtual Observer. And I think you really rounded out the portfolio well. So I guess, how should we think about maybe the M&A strategy in that vein? Is that something we should continue to think through and expect and particularly in this environment where multiples have come in. Is that something that's top of mind for the company?

We're always going to be looking for technologies that are immediate adjacencies that would make sense to own versus partner. So we're always going to look for technology tuck-ins. It's a rather difficult market right now with currencies being what they are. But we'll always take a look at that. We -- like you said, we were -- we're very methodical and very careful. You see many failures and acquisitions that occur. And we've been very specific and pointed to making sure that the acquisitions we've made, like Virtual Observer and Inference have been successful, and we'll continue to look at those, make the right decisions.

I could add just one thing. And as we all know, with the acquisitions as much as an art as it is a science. And we're very lucky that we've got some Picassos in the company, graduates from Cisco. And this is a very well-developed muscle and its evidence of that is that while we've only made 3 acquisitions, they've all been frankly, a very good one.

Great. And Barry, one of the things you mentioned, you brought up the proxy target and the company has marched toward that. I think everybody ends up focusing on the revenue number, but I think that the EBITDA margin side is probably just as important. And I think you guys have always tried to take a balanced approach, even being a growth company. So how should we think about maybe the progression towards the EBITDA side of that long term? And especially as we think about this year being an investment year?

Yes, absolutely. That's an important thing for us to be balanced. We've been balanced through thick and turn even when the long -- Harold demise of the Rule of 40 was there and it was growth at all cost, we stuck to the balance approach. And we're sticking to the 23% for 2026. It's not in sales and marketing. We write -- start bank in the middle of the 26% to 28%. It might be 1% headwind in R&D because we're at 12% versus the up the end of 11%. But where it will be is in gross margins. We're making investments right now. successful investments in professional services and cloud operations in anticipation of going worldwide and bringing in these big customers. We knew that we're coming with. That's why we did those investments. We'll have a trough this quarter in Q2 and then end the year at 60.5% for the year, and then continue, as we have in the past, to expand to 70% plus. And that's where the main improvements for the current 13% up to 23% is anticipated to come from. And that comes not from any magic. It comes simply from the leveraging against fixed and semi-fixed costs in our cloud operations, they are auxiliary assistances, but that's a big one.

Great. I think I have time for one more question. So maybe, again, I'll leave this as a tossup. But what would you say, just maybe for either the rest of the year or the next 12 months is kind of the main 1 or 2 priorities that you're thinking both with everything we talked about from a macro standpoint versus all of the initiatives and objectives that are on Five9's plate that you guys are executing on?

Off to you.

I'll start with go-to-market and really that is making sure we keep a close eye on the macro trends and seeing if we're getting impacted by it. So far, we see strong signs of continued growth. We're very confident that we'll continue to grow our enterprise subscription revenue well into the 30s for the foreseeable future. The good news for us is we have some of these mega deals that have been contracted that are in the backlog that have yet to show any revenue, and that's actually comforting because we have sites over the next several quarters as to how that will grow. And so that's comforting that we have a long, long side ahead that we can see where revenue is coming from.

Yes, nothing much to add beyond that.

Great. Well, thank you both for joining us. It's good to have you, and I'm sure the crowd appreciate it, and look forward to touching very soon.

Thank you.

Thank you, Samad.