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

Five9 fireside chat. My name is Matt Stotler. I'm the analyst here that covers Five9. For a full list of disclosures and potential conflicts of interest, I encourage you to look at our website at williamblair.com. More importantly, today, we have with us, Dan Burkland, President; Barry Zwarenstein, CFO of Five9. Thank you guys for being here.

It's a pleasure. Good afternoon, everybody. Just before we start, we're going to be making forward-looking statements about events and trends that can affect the company, the industry, and actual results will -- could vary materially, and I refer you to our filings with the SEC for factors which could cause such variances. Thank you.

Great. Thank you. I appreciate you guys being here. Maybe we can start out, maybe for some people who aren't as familiar with the story, with just a quick introduction to Five9, the markets you serve and the problems you're trying to solve.

Yes. Thanks, Matt, and thanks for having us here. Good afternoon, all. If you look at Five9 and the markets we serve, we're in the cloud contact center, referred to as CCaaS, Cloud Contact Center as a Service. We went public in 2014, just south of $100 million at the time. We've been growing the business very steadily. You'll see that we have a very balanced approach to our growth, which is top line and bottom line conscious, especially in markets like this, it's important to do so. And so we've put ourselves in a very promising position in the market as one of the largest and growing very healthy and serve enterprises of all sizes as well as small business. But the market for contact center as a service in the cloud has gone from what one day was small, midsized businesses to now the largest of enterprises are starting to take advantage of the new innovative technologies that we deliver. Not only the core traditional capabilities that you see in a contact center, like automatic call distribution, and IVR and others, but now with innovations along the lines of bringing automation for the first time to help either replace the labor in some cases to deliver self-service options in the forms of IVAs, and we'll talk more about those virtual agents, if you will, to infusing AI to help assist the agent to be more productive in a contact center by listening to the conversation, fetching information and bringing it to the agent so they can be more effective in their transaction and then workflow automation to capture those. So that's kind of in a nutshell how the industry is evolving. And as you can imagine, these technologies are appealing to many industries. Anybody who has customers, has to serve those customers. They often do so from a contact center or a call center, as it's been traditionally referred to. And we provide our solutions to help those interactions and matching up every inbound inquiry of a customer to the most appropriate resource or agent, if you will, and then delivering the appropriate data to make that conversation most effective. And again, we serve businesses of all sizes across many different industries and very glad to be here.

Thank you. And so how do you think about the size of that market opportunity, right? Because to your point, you have the kind of traditional call center market that needs to be modernized, but there's a lot more to it and there's a lot more that people are investing in to augment traditional customer engagement experience around the contact center. How do you think about that overall market opportunity?

Yes. We've looked at the size of the market. And if you look at the contact center agents worldwide and the fact that the number that have actually made the migration and moved to the cloud gives us a total available market just on moving agents from their old legacy premises solutions into the cloud solutions creates a $24 billion TAM. And we're seeing that the automation solutions that I just touched on, where we can actually help augment and do labor arbitrage, opens up a $34 million (sic) [ $34 billion ] additional TAM. So a total of $58 million (sic) [ $58 billion ] is what we're looking at from a TAM perspective.

Right. Right. Pretty substantial.

Yes.

And so as you think about the landscape there, there's a number of companies that are trying to solve this problem. What do you see as Five9's key differentiators there that provide you a sustainable competitive advantage in the market?

Yes. And I think I just -- I touched on some of those, which is all of our competitors have the traditional applications that have been around in contact centers for years, which is the greeting a caller/customer, understanding their intent or why they're contacting you as a business, routing them to the most appropriate -- appropriately skilled and available agent and then triggering the data from a CRM or other source to give that agent what they need to interact. The true change that's occurred and the real evolution of the market for us, and it's really helped open up the high end of the market for large, large enterprises has been the automation solutions because traditionally for -- if I go back 4 or 5 years, the message was move to the cloud. You have all the benefits of a subscription model, no servers on your premises. It's just a scalable and secure and reliable, but there wasn't that real super compelling ROI about disrupting a large enterprise to make a shift and move to the cloud until they saw something compellingly new and different that had a return on that investment. And that was really the advent of AI and virtual agents to be able to come to the forefront. And the only way you get those and can take advantage of those is if you're in the cloud. So it's allowed that new market to open up for us in the high end.

Right. Right. And I think in addition to being able to do more advanced things in terms of automating customer engagement or augmenting optimizing agent performance, obviously, in the eventful last couple of years, we've had, I think, COVID has also served to kind of highlight the need for that transition to happen. Would love to maybe just go over what you guys saw in terms of demand trends during COVID? What customers were buying? And now that we're kind of getting into -- lapping that, how is that playing out?

Yes. So Matt, that's a great question because it oftentimes gets a little bit mislabeled that COVID caused everyone to run out and get a cloud contact center. It caused people to take notice of the importance of cloud because it was so much easier for our customers and other cloud companies, customers of theirs, to send agents home. If they can log-in from a PC and a headset from anywhere, it made it very easy to transition agents to home. Now very few companies ran out and changed their contact center solution in that very short period. They kind of made do with what they had, and it was more painful for some than others. But it did remind folks of, hey, next time, if something like this was to happen, we want to be prepared for business continuity and so on. We started introducing the AI and automation solutions just prior to the pandemic. What we're finding now is businesses are recognizing that that's a true differentiator. And today, in the tight labor market, it's becoming even more compelling because they're looking at finding agents is very difficult. Though there's some added flexibility because they can hire them and have them work from home, which is another reason why moving to the cloud makes a lot of sense for them now to consider this. It's much easier for them to have agents at home that they can still observe and monitor and watch their actions, and that's important. But it also allows customer or companies to look at that transition and move to the cloud because they now can look at the automation solutions where they don't perhaps need as many agents. If you have highly repetitive questions that are occurring on a regular basis, offering a self-service option as an example, I may not want to wait on 20 minutes on hold in queue, so I can ask a very straightforward simple question. Where's my package? I'd rather just speak to an automated system that can answer that question for me. So there's lots of use cases that we can use to deflect or move some of the their -- some percentage of traffic over to the automated agents as opposed to the human agents. When we sell our software into the human agents, it's $200 to do what it does to help that agent be more effective. When we serve an automated agent, we're actually providing that service for $400 for the agent. Very compelling when you look at the fact that most contact centers are going to spend about $2,000 per month for the human agent for the wage, for the labor, for the -- of that person. And if you can automate that and not use a human to have that interaction, we can take that cost from what is roughly $2,200 a month down to $400 a month, and that's the real compelling ROI that's making this of more and more interest upmarket.

Right. And so I think that -- I think probably is well into the obligatory macro question, right? We're looking at a lot of different factors here. There's -- you mentioned the tight labor market, increasing input cost inflation. How do you balance the realities of what that means for the global economy, for the potential for a recession with the fact that in that environment, what you provide has a very -- or is very attractive and provides high value for customers that we also serve?

Right. The other thing it is -- and those are all true statements. The other thing is this is not a nice to have technology. Some of the automation solutions are nice to have. But every business that has customers has to have a contact center solution. It's not just one of those, "Oh, well, I want this new tool or I want this new application, that's going to help my business." It's a required solution. And as those legacy on-prem systems get end of life or come near need massive upgrade dollars to get to the next level. It's also the impetus for companies to take a look and look at transitioning to the cloud. So that's helping. The other thing is when you look at the market itself and if we were to face headwinds in the market, which we haven't seen yet in our business. But if we were to see them, we feel very comfortable about not only is our installed base very diversified across many different industries and we rely about 50% of our revenue coming from the installed base and about 50% from net new logos, we feel very good about the fact that, that high end of the market that's just opening up for the first time is doing so -- for us, that's a tailwind because we're coming off of 0 from a revenue perspective and it's meaningful. Could it be higher in a thriving market? Perhaps, but it's still a tailwind. Same goes for our international expansion. So we're expanding into new countries. When we go into a country, that's business coming off of 0, even if they're facing like in Western Europe, some macro headwinds, we're not seeing it because for us, it's a tailwind because it's incremental growth. So we feel very good about those growth markets helping offset any potential slowdown.

Yes. I think it's an interesting topic to think through because especially upmarket, these contact center modernization projects aren't a couple of quarters in terms of duration, these are very long-term projects. But to your point, require a lot of buy-in and dedication. And once you start moving that forward, you're not going to pull back because there's some kind of fluctuations. So that's also been a kind of a key area of focus for you, as you mentioned, is traditionally you played in this 50 to 500 seat kind of segment of the market, but you moved well above that recently and you've got customers in the 5-digit seats range. Maybe we can start with just kind of talking about when you look at that enterprise segment of the market, why is that so attractive for Five9? And what are some of the characteristics that make that really attractive business for you?

Yes. It's very attractive for us, and it's very attractive for them. So I want to be in the market for the reasons I mentioned earlier. But it wasn't always the case. As I mentioned earlier, that business case wasn't there to really make the compelling ROI. That's part of it, but we had to be ready as well. So as a company, we had to look at, can we serve the massive scale, the tens of thousands of agents in a single instance or a single tenant, if you will, on our multi-tenant platform and that wasn't always the case. We looked and brought in senior leadership on the engineering and product development side to take our architecture and more than 10x expand the capacity for a single tenant. At the same time, improving the reliability and uptime and making sure that it was an always-on platform that enterprises would now say, I can't get that kind of reliability from my own IT group servicing my systems. So we had to demonstrate and show that we can handle the largest of enterprises. The examples we've used recently for those who have listened to our earnings report, a $40 million annual recurring revenue customer just for the software -- recurring subscription software alone and tens of thousands of agents that that's going to be rolled out to. We're talking about a very -- one of the largest companies in the world. There's not a lot of those, but our ability to demonstrate success into that company and another Fortune 50 company that has tens of thousands of agents gives the credibility and the assurance to those customers that are below that, that we can serve them for sure, if we can serve the large guys. So that should be very comforting, and we're seeing that come out from the next year down, which is really that we have 134 customers at year-end that were contributing more than $1 million in annual recurring revenue. That number continues to accelerate and get larger. And part of it is because of the comfort level and the trust they have in us.

Right. Right. Yes, I mean, clearly seems to be some strong momentum in that segment of the business that move upmarket. I think that's one of the things you guys have cited behind these 2026 targets that you've put out. We'd love maybe, Barry, if you could just walk through, I guess, the targets themselves, how you're thinking about the path to get there and then how this move upmarket and other factors and kind of strategic growth initiatives gets you there.

Absolutely, Matt. Thank you. So what Matt's referring to is last November at our Financial Analyst Day, we put out a -- or reaffirmed really a number that had been in a proxy that we were filed at the time of the proposed acquisition of Five9 by Zoom last summer. That call for revenue in 2026 of $2.4 billion and an adjusted EBITDA margin of 23% plus. And this is an objective we embrace. On the top line, we've got various initiatives. Most notably is our dollar-based retention rate, we've got a growing and big installed base. The -- currently, it's at 120. We see over time they're going -- that not -- net dollar-based retention rate going up into the high 120s. Big driver of that $2.4 billion. Another is what Dan was talking about a moment ago is international. There are many more agents outside of the United States than they are inside, yet only 9% of our revenue comes from the United States based upon bill to address, and we've been very successful in growing that business. We've made the investments in infrastructure to switch up mostly here in the U.S., hosted multi-tenant, hosted colocated contact centers here in the U.S. to the Google Cloud Platform internationally. We just announced that we've established on the continent in Frankfurt and in -- in the European continent of Frankfurt and Amsterdam. We spend money on brand awareness, et cetera. And all of this is showing up in growth rates in the international that, on an LTM basis, have been more than 46%. So that's on the revenue side. In terms of the bottom line, currently, we're in the teens in terms of adjusted EBITDA margin. So we're looking for an extra approximately 10 percentage points. Two, there are a number of drivers, but the main 2, which we feel very confident about, first of all, is approximately 70% or 75% of our revenue that's recurring subscription revenue, that grows pretty much consistently as we've been talking about overall with something like a 3 handle. And our cost of that semi-fixed and fixed costs don't grow anything like that. So we had a steady increase. Currently, it's in the 70s, on its way to the 80s. And then the second of the 2 items on the gross margin is because of these big deals that Dan is talking about, we've ramped up, starting in the second half of last year and continuing through the first half of this year, a professional services organization. It's a distinguishing feature for Five9. We get NPS scores in the 90s, makes a great first impression, makes that customer really sticky, leading to those high net dollar-based retention rates. And so -- but that's a transitory investment. And we've told The Street that this second quarter is a trough for our gross margins and that it is going to start improving. And part of it is professional services investment that's causing us to have an overall headwind to our corporate margins of mid-single digits. Even though it's only 9% of revenue, it's negative. And we feel very confident that we can return to it being profitable once we worked our way through these initial mega deals and get to a profitable number. So between those 2 and a few others, we'll get to a 70% plus gross margin from the 61% we reported this past quarter. And then coming up to the rear, a little bit also of assistance, though, is that for 30 consecutive quarters, we've had G&A grow as a percent of revenue lower than the prior year and that will continue and will get us from the current 7% closer to 5% or 6%.

Right. Super helpful. And I think the point on dollar-based net expansion going from 120 to 126, I think you mentioned a couple of drivers there, but one of them is, as you move upmarket, these are really large opportunities, but they're typically land and expand and how they roll out. So I know it would be helpful to walk through...

Matt, we should switch seats because that's an excellent point. What Matt's referring to is exactly right. It's logical, you land and you expand. If you look at our $134 million -- as Dan mentioned, $134 million-plus customers as of December 31, their growth rate, if you take just a simple average of the compound annual growth rate to each of the $134 million, it is 93%. And they have dollar-based retention rates that are massively higher than the 120 that we reported, and that's a bigger part -- excuse me, is the fastest-growing part and the largest single part of our overall business. So we feel very confident about that.

Right. Right. And so in addition to the move upmarket and user expansion, and you touched on AI being a kind of core area of innovation and expansion, the IVR specifically. Can you just double-click a little bit on the AI portfolio, the product road map for that? And then how meaningful you expect that to be in terms of how it drives or contributes to revenue over time?

Yes. So the AI, we hear about it everywhere in many different industries. If you think about the contact center, when you bring AI into the fold, what we're able to do, and I'll step back historically and when you think about transactions that have occurred in contact centers for decades, it was about getting that call routed to the right resource, complete the transaction, either complete it within the ticketing system or the CRM system. And that was really the customer record database. And whatever the agent put in there, that's what was in there, period. End of story. We now have a massive amount of data. If you think about -- if I'm an agent and I spend 8 hours of my day on the phone talking to customers, I'm probably going to input into that database about 5%, if I'm lucky, of the information that was conversed on the phone all day. But now with AI, we can listen in and not only record the calls for historic purposes, but we can, during that session in real time, be able to apply natural language understanding. You transcribe it, you apply NLU just like Google does with a Google search, it looks at what's being asked. It goes to the various data sources within that company and gives back that information to the agent to be that much more productive and informative to the client on the other end. It can shorten the time frame so the agent doesn't have to go search for information, the system will go fetch it for them. That's one of the compelling arguments. If you just take it 1 step further, the recording of the voice itself, we now have the intelligence to be able to interrogate that recording, okay, with automation. So before you had a QA department that would go back and try to listen to 1% of the calls and just try to pick up on trends that are happening for training purposes and others. Now we can listen, the system can listen and analyze every call and not only put the transcription -- the full transcription of that call into the CRM, but it can pull out valuable insights and be able to put a few key nuggets. And the reason that might be helpful is the next day, that customer -- if I didn't complete their transaction as an agent, and they call in and Barry is the agent they get sent to. Barry pulls up and says, "Oh, I see you talked to Dan yesterday, and these were the results." Boom. Boom. Boom. Yes. Yes. Dan offered me a 10% discount, and Barry could say no, 5% discount, you can see it right there. So you have valuable data for that agent to be that much more effective. And those are the kinds of innovations that we're finding. Customers can really take advantage and change how they deliver an experience to their customers.

Right. So changing gears a little bit, so you mentioned a couple of minutes ago in terms of additional growth opportunities. International has been a big focus. I think at this point, it's still less than 10% of revenue, but obviously, there's been a lot of expansion there in recent years. Could you touch on what you're seeing in terms of adoption trends there? How it's similar or different to how you saw things start to roll out in the U.S. and then thoughts on how meaningful that is over time? Obviously...

Yes. Each of the international markets or theaters are very different from one another. Some are close behind the U.S. and others are a lot further behind. But what you do find is there's patterns, and they're very eerily similar to what we saw here in the U.S., which is you got to start with the basics and you got to be able to move upmarket. But a lot of times, they wait and see what's been proven on the technology front. They're not cutting their teeth on the technology for the first time because the U.S. has kind of already done that and hardened the platform so that you bring solutions to market differently. Our key is really looking at where are the best return on the investments for the markets, and you can -- and that's what we're very careful about is you don't want to go early. We saw some people try to bring CCaaS into some of the Western European markets 5 years ago, 6 years ago, far too early. The market wasn't ready and it failed. What we've done is really been mindful of wait until the market is ready so that we can make that impact. And there's -- the strategy around distribution, around leveraging channels, having the infrastructure in and around the correct countries that you need to be, the data residency laws and regulations that they have and making sure that you adhere to that, the telco connectivity and network requirements, the compliance and regulatory compliance -- requirements, you've got to look at all that. And so that all goes in and then you've got price pressures in different markets. And when we've looked at that, we've been able to place our bets in a pretty good prioritized order to make sure that we're getting. Right now, Western Europe and Lat Am are our 2 biggest international markets besides Canada. And that's been very, very lucrative for us. And the next frontier, obviously, would be Asia Pac for us to expand into.

Right. And so maybe we'd like to touch on, we got a few minutes left here. Touch on the competitive environment here. We get a lot of questions around competition, around pricing. I would love to just get an overview, both from differentiating between the opportunity that you and some of your competitors are going after as well as kind of the head-to-head and then kind of the behaviors that you're seeing around pricing and how that's trended over time?

Yes. So we compete with 2 main competitors in the CCaaS market, and that's Genesys and NICE inContact or NICE CXone as they're now calling themselves. And really we're replacing the legacy solutions of Avaya, Cisco, Genesys and others. And really, it comes down to delivering that value to ROI on the newer technologies that they need to make the shift to the cloud for. And competitively, while on the surface, we may all check a lot of the boxes and have similar solutions. The key is differentiating and staying ahead. I would say we differentiate on 2 key areas. One is the automation solutions that I described earlier. Throughout the life of that interaction, we're able to deliver automation that makes a difference, whether it's straight to the consumer making the difference or helping the agent make a difference or back to the consumer on the post-call side. That's 1 big differentiator. And the other one that Barry alluded to earlier was our services, especially -- and it shows itself tremendously in the upmarket success we've had and our ability. You only get 1 opportunity to succeed or fail in those large, large enterprises. And we leaned in and invested ahead of time, enhancing our professional services, enhancing our ability to deliver, investing -- I'll say maybe this is a third area, investing in the platform itself and the infrastructure to be able to scale and deliver the reliability. And when you combine those, the feedback we get from our large enterprises that do business with us is nobody else can scale to where you are. Nobody else can deliver for all of our different business requirements that you can and they've inspected that, and you're delivering us the best and better reliability than we could ever achieve on our own. And those kind of are the things that set us apart. As far as pricing, we're not seeing any pressures going down. If anything, we've seen pricing and our revenue per user, or ARPU, go up. And it's because we're delivering more value. So as value goes up, pricing moves up and their willingness to invest more wallet share in Five9 is increasing. So we feel like we're hitting on all cylinders there.

Right. And so obviously, all that speaks to buy-in from customers. Maybe we got a minute or so left. Buy-in from partners, right? It's been an area you've really invested in over the past few years. obviously, a market multiplier, but it does seem like we're seeing that buy-in from across the partner ecosystem. I'd love to get an overview of what your initiatives are there and where you see the biggest opportunity?

Yes. So thanks for asking because that's one of our strategics -- upmarket, international and then the partner ecosystem and channels. The key with channels is we have a variety of routes to market. Everything from the big SIs that help large companies with their digital transformation and helping them migrate to the cloud for a variety of different solutions. The Deloittes, the Accentures, the UIs, the Slaloms, work very, very closely with them and embrace and give them the content they need to be credible to their clients. They oftentimes stand in front of the client and endorse us. We now have the strong reference ability of these large mega deals. But before we had those, we had relied on the SIs to kind of go in front of them and validate for us. So there's the SIs, then there's VARs, we're leveraging them more than ever for resell. Some of the traditional folks that sold the on-premise solution can now take that base of customers and flip them to cloud with us. We've got referral partners, referred to as master agents or now technology solution brokers, that are referring business to us. And yes, so our ability to get more reach. There's still complexity here that requires our resources to sell and to design for the customer, but we're getting more reach and getting more at bats because of that expanded ecosystem of partners.

Great. Well, that's it for us. Thank you again, Barry, Dan, for being here, and thank you all for tuning in.

Thank you, Matt, and thanks, all.

Thanks.