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

Let's get started here. Well, last people are piling in. I can read the research disclosures. It's a good use of time. For important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representatives. We're delighted.

I'll [ see you and raise you ] and read a safe harbor. We're going to make today statements about events and trends that affect the company and industry. Our actual results may differ from those forward-looking statements, and we refer you to our filings with the Securities and Exchange Commission for detailed discussions and factors which could cause such a difference.

Got it. And for everybody who doesn't know me, I'm Meta Marshall, I cover the communications software space here at Morgan Stanley. Barry needs no introduction, but we'll take the chance, CFO of Five9, and maybe you want to explain Mike's absence, who was supposed to be here today.

Yes. Mike came down with an extremely severe case of food poisoning. He said to me over the text that he's never been this ailing and sick in his life. And so he's so sad, he really wanted to be here, but he gave me some notes, and hopefully, it will be okay.

All right. So maybe the first question was kind of used to be for Mike. He's come back to the organization. He wasn't far. He was Chairman of the Board. What has -- what have his objectives been? And what have you kind of noticed as kind of any changes that have taken place for the organization with Mike coming back?

Yes. Mike has really come in fully energized. He's done such a lot of major initiatives, projects, if you will, focused on them and has just given a new verve and excitement throughout the company. We recently had a sales kickoff meeting, never had so much excitement with him getting standing ovations and it's all systems go. And where are we going to? Well, if Mike was here, he would say that the 3 main areas that he's focused on has been and will be, first of all, the continued success and march-up market. We've demonstrated our success over there. Some of these mega deals, but also the $1 million plus ARR deals. We're now at 161. We had just 3 when we went public back in 2014. Secondly, the expansion internationally. We've made the investments over the last several years. Most of the agents in the world are outside of the U.S. We've had a very tiny presence. So it's a lot of upside opportunity. Fourth quarter bookings in International grew 87% year-over-year, 2022 revenue was up 44%. And we're just getting started there. And then importantly, is the product. The product is scalable, reliable, fully featured and now with the advent of AI and automation, something that I think you're going to be asking about later on, we've got one of the leading prior portfolios there. So those are the 3 things that the company is focused on under Mike's leadership.

Got it. Contact Center from when Mike stepped away to kind of when Mike came back came into a lot more focus for investors. How much of that do you think of -- and Barry, you've been here the whole time and kind of comment on that, like how much of that is the market finally recognizing the value of the space? And how much of that was just from the product and the channel kind of advancing?

Yes. It's difficult to need to bifurcate between the 2 but there has been a sea change. If you rewind that movie just a few years, the Contact Center was in the basement. It was a [ cost center ], necessary evil almost, how do you reduce the average handle times and not viewed as strategic at all. Now it is looked at central in terms of enhancing customer experience. It is strategic in so many ways. It's no longer just part of the plumbing. And there's a number of reasons for that. Clearly, the product has played a role. Nobody is going to switch from Avaya or any on-prem system until they can be assured of having future parity so they can be assured that they have the reliability because you're going to have all of the features you want. And if the product is not functioning because it's down, it doesn't matter anything. And we've demonstrated, at least in our case and others too, extreme reliability, and then security as well as scalability. And then the cherry on the top, of course, as I alluded to earlier, is the AI and automation, which you can only really do in the cloud. You could theoretically do it on-premise. There's also the channel in light of the on-premise vendors retrenching, the channel has pivoted. They used to sort of quasi embrace us. Now they really are. And we've got a major initiative led by people who know the channel, ex-Cisco people, to really develop that and have a deal -- route to market. And so at the end of the day, it's a lot more promising than it was a few years ago.

Perfect. The Contact Center market has maybe been a laggard in cloud transition. Previously, our survey work would kind of say it's triggered with the CRM upgrade or a cloud transition initiative. That survey is maybe a couple of years old. Have you seen the trigger change? And what is driving kind of this accelerated move towards the cloud?

Yes. Those 2 factors that you mentioned are digital transformation and a very good leading indicator is a CRM transition to the cloud have been and remain really key. I would add to that, the realization that if you on the premise in the world that's working from home, and which is doing the AI and automation and cloud and where it's more economical and [ plannable ] in the cloud. You've got to start thinking, especially when you know that your system is not going to get any major upgrades. It's going to be end of life at a certain point in time and so on. So there's a certain sharpness that wasn't there before to make -- to come -- to make plan B real. Let me just hasten to add that we're not talking about a big land grab over here. This is something that's measured over time and slow.

Got it. All right. So it's standing room only in here in part because AI is the topic du jour. And it's certainly applicable within the Contact Center. Can you just outline what your spectrum is of AI solutions and from entry level to advance and just where some of those are your own homegrown solutions and where some of those are kind of partner solutions?

Absolutely. So when you think of the Five9 AI portfolio, think of 8 separate but in some cases, related modules. The first 2 are before the call even starts. That's IVA, Intelligent Voice Assistant, both the voice one and the digital one. And what -- now with the real-time economical, highly accurate, ability to understand and hear what's being said through the bot, the call gets deflected with a massive return to the customer and to, by the way, to Five9, to the customer because instead of paying $4,000 per seat, per month -- per seat, per agent per month, you're paying $400. In our case, we're going from 200 to 400. It is a one-to-one by the way. It's not that the bot speaking faster than a human would. Then -- so that's the first 2. Then during the call, let's assume that the call is not deflected, you then got Agent Assist. So the agent, the live agent is sitting there and chatting to you, he or she is sort of trying to find out what -- how to answer this particular question and is looking at the FAQs and knowledge database. Now Agent Assist comes up and pops us an answer. Whether the agent accepts that answer or not, is training that module, and it can do it much more efficiently and faster. That's the third one. Then after the call is done, we have workflow automation from our Window acquisition, which sends out reminders and send out surveys and the like. So that's as far as the agent is concerned. The last -- the next 4 -- and the last 4 with respect to the running of the Contact Center efficiently and -- the first one is a long-time standard of all the companies have that, which is simply speech analytics. We can listen to calls. You can't listen to 100% of them, but they pick out certain ones and see whether the agent needs coaching and the like. The 3 that were new that were announced on our fourth quarter earnings call a few weeks ago, first of all, analytics, this allows a dive into the data within the Contact Center to look at the trends, prepared dashboards, look at custom reporting and all on a self-service basis. And to help that, we've got over 250 metrics, both old traditional metrics like average handle time and first-call resolution and newer times like how quickly the e-mail matter was resolved or where the conference was set up, a virtualization layer and a very robust data analysis engine. And you need that because you're talking about in Five9 cases, 10 billion, 11 billion minutes a year with different calls that you're trying to analyze it between -- all calls between May 1 and May 31 that had a campaign or such and such a nature. So that's analytics, and that's out with our customers. Many scores of those customers that are evaluating it. The smart money will start getting revenue from that in the second quarter, not material, but it will grow over time. The last 2 are AI Insights and AI Summaries. The first one, automatically in real time, makes a transcription of the call, figures out where the different intents are, what's really happening, trusses them together and comes up with suggestions on way to make improvements, and does so with no professional services. Using that data, then you get into the AI Summaries, which is then automatically uploaded in the CRM system, And it, too, does not require any professional services. Those last 2 -- we've not been a complete discussion with AI without mentioning ChatGPT3. And so those are both powered by ChatGPT. And I do want to make an announcement on that, that this is not just -- let's make a press release type of thing. We've been working closely with OpenAI for quite some quarters. And these products are in beta, they're real. And then not just as simply according to an API. These are real integrated products.

So I mean what is the kind of adoption journey of those like I think a lot of people in this room might be familiar with chatbots and that getting the company to adopt a chatbot may be easier than some of these other products, just what is kind of the customer journey in adopting some of these AI products? Or how do you envision that if they haven't adopted all of them?

Yes. It varies a lot by different products. The IVAs have a natural adoption in the sense that the ROI is just so huge. Chatbot, just say -- just to do the basic function, I think it may be a little bit less so more incremental to the agent. The big difference, though, is more between new orders coming in and the installed base. In terms of the new orders coming in, as you can imagine, everybody is fired up. We're doing this big digital transformation. We're revamping all of our procedures. We're making things more efficient. We've got the persons up, we've got senior management's attention, and we tend to have a pretty high attach rate there. On the other hand, in the installed base, it's a little bit more difficult in the sense that you've got to have a catalyst to have people want to adopt it. And we stick just with IVAs for a moment. The customer says, "Oh, okay, I'd like to get started. I've heard all about this. And then we say, fine. Where do you want to get started? And they say, we don't know and they don't because they haven't had the benefit of doing these analysis to see what are the best work streams to be automated. Now with that, what I just mentioned a moment ago, the IVA Summaries, without any peers, we can go in and diagnose where the most likely areas are and have a start on the IVA. So we're pretty optimistic about that. And we also, frankly, are sharpening ourselves in terms of having more, if you will, hunters in that installed base than basically the farmers that we've had up to now. So we're expecting an increased adoption.

Got it. Maybe you can just kind of outline -- you've talked about AI being something that doubles kind of the ARPU that you can get from a customer. But just how should we think of -- you just laid out 8 categories of AI, just not product by product but just how to think about what is a traditional customer and what is kind of a fully loaded customer for AI? And how many products is that? So an easy question. I guess I'm just asking, when you typically have talked about it doubling the ARPU opportunity is that they've adopted 3 of those products is that they've adopted -- something that contextualize that.

Yes. So in the case of the IVA, it's simply double. We average seat price for a live agent per month is $200. It's -- we've got 3 different categories in terms of IVA. It's $400. To be perfectly candid with respect to the analytics and certainly, the insights and summaries, we still a little bit on a voyage of discovery over there. We're figuring out seat versus usage, bundle versus nonbundled, what exactly the pricing will end up with from Open AI and Microsoft and so on.

Got it. And just how does -- you mentioned in the last quarter that 40% of RFPs now kind of have some sort of AI component to them. Does -- how much do AI considerations slow a sales cycle? And just kind of what have been effective approaches to kind of speeding up the cycle?

Yes. For new logos, it probably does elongated slightly, but not in a period, it varies a lot, but probably measured in days, weeks with an extra demonstration or extra sign off because of the extra expense. I will say though that on the other side, we're pushing on an open door when we talk about the balance because we've established the cloud capability.

Got it. We have another question we've been getting from investors is just what are AI tools -- like you mentioned you have ChatGPT for couple of these tools. But what are the values that you're kind of bringing into some of the AI tools that can't be done by some of these kind of ChatGPT or other generative AI model?

Yes. So the key over here is to fully understand and embrace the fact that these enhanced products like ChatGPT3 are not overlapping or replacing products that we are selling and we and our competitors are selling. These are a core technology that we are using in addition -- in place of some of the other core technologies we were doing before. It's really nothing more than a more powerful NLU engine that we were using anyway before. And so what we do is we bring at the end of the day, something that's unique, something that's important and something that's absolutely essential, and that is the data. The actual conversation with the -- either voice or exchange digital with the customer. And to that, we bring our own voice stream. We bring our own transcription services. We bring our own virtualization. We bring our own clustering algorithms and all within the Five9 administrative console. So very powerful. It's that whole incremental UI is something that is just where we add the value.

Got it. All right. So maybe moving on to Q4 results. You noted seeing some weakness amongst kind of existing retail and health care customers. Just as you look forward to 2023, just how are you seeing conditions versus kind of when you saw them originally or when you saw them maybe 90 days ago in Q3?

Yes. So just to level set so everybody is on the same page. We have a pronounced seasonality in the fourth quarter. The typical overall corporate increase from Q3 to Q4 is [ pre ] this year is between 4% and 12%, primarily in 2 areas that we always talked about health care, people primarily buying insurance and consumers, people just interacting with the Contact Center and in the holiday season and the like. The -- in the fourth quarter of 2021 compared to the fourth -- sorry, fourth quarter 2021. From the third to the fourth quarter of 2021, those 2 categories, which account for roughly about 1/3 of our installed base revenue and which is our first and third biggest verticals, grew 24%. This last quarter, they grew slightly less on that, so around about a [ little 9% to 12% ]. The other 15 that we track, all grew pretty regularly as expected. It was a little bit slower than we would have hoped. We still ended up, frankly, to be blunt. We still ended up beating the guidance by 2%, which in this environment is a pretty respectable beat because it's not very effervescent consumer environment. We then have not taken that into account when we look at 2023. And we've assumed a similar sort of macro environment for the installed base and a similar seasonal uptick in the second half.

Okay. Got it. You've had some very large deals come on board in 2022. What is that market looking like for large deals in 2023?

So our strategic business, as we commented on the call, is doing extremely well. We had some -- so Five9, approximately half comes from an installed base, which we just talked about a moment ago, the other half from new logos being implemented and ramping. That part of the business, we had some mild softness in the mid-market, but the strategic and international are both doing extremely well. And we do not see that changing.

Okay. I mean I think in the past in conversations, you guys have said, there's a long pipeline of customers who are maybe waiting to see these kind of 8-figure deals get implemented, do you think you kind of need to wait for some of those to get implemented for kind of some of this pipeline to make decisions? Or are you seeing them kind of already start making decisions now that there's kind of confidence in elections of some of these things...

Yes. So I mean these sales cycles for these mega deals, the parcel delivery service and the health care company, $55 million, $40 million ACV, respectively. They have a long sales cycle, and we've said repeatedly that it will take -- we will not be in the [ sizable barrels ]. It takes quarters or even years before we have the next one. In the meantime though, the million dollar plus customers are doing very well. We ended up with 161 like I talked about earlier. And those remain robust and in due time, the next mega deal will come along.

Got it. I mean kind of noted on Q4 that it really isn't a new customer pipeline issue, it's largely just your kind of existing customers and even narrowing that further to kind of your retail and health care customers. Just -- are there any changes at all that you're seeing in kind of RFP activity, whether kind of a smaller piece upfront or just any changes you're seeing there?

No, in terms of the RFP and the new logo side, stay strong. We're seeing a strong interest in AI and automation, like 41% was either the main or auxiliary reason to go out to RFP. We talked about earlier the retrenchment in terms of the legacy providers. And yes, that remains robust on the new logo side.

And a bunch more questions here. But are there any questions from the audience?

I was wondering, so you talked about the slight differences in customer segment by segment a second ago. One thing I noticed clearly was your enterprise revenue growth, which is the vast majority of your revenue still had a pretty healthy clip even in the last couple of quarters despite the macro stuff. Your non-Enterprise business, which I know you had been thinking about moving away from or flowing down through deprioritization versus enterprise anyway. I noticed that actually ticked down quite a bit in the last couple of quarters. So can you help us just think through how to think about that? Like is that sort of customer macro demand thing? Is that your focused thing? Would love to just put that in context.

Yes. Thank you. So just real quick so everybody is on the same page. 86% of the business is enterprise, which is growing very healthy. We've committed to having 3 handle on the LTM Enterprise growth rate on the subscription part of it, which is 60% of our total revenue. That may dip into high 120s because of the macro environment. What's -- what the other 14% (sic) [ 40% ] is our commercial business that was growing in the 20s, now growing in the teens. Frankly, we're putting less investment in it. It is a meaningfully lower LTV to CAC on a truncated 5-year basis. Enterprise is 6x. Commercial is half that. But we are seeing a pretty good response from the channel. They don't distinguish whether the customer has got 40 seats or 100 seats, they come to us. But we feel comfortable with the LTM inside growth on the commercial side. And the investment mainly is going on enterprise.

I mean there's a lot of new big logos talking about kind of offerings in the Contact Center space. Just how do you see the Contact Center or competitive landscape within the Contact Center?

Yes. So that's a big question. There's 3 of us at the call and have been likely will be for a long time. There's been no new entrant of scale. That's NICE, Genesys and Five9. In terms of the shared donors that remains Cisco, but especially Avaya, and then Genesys store base, which, by the way, if they -- if a Genesys installed base customer decides to change, they might as well go out to RFP given that it's a very different environment to go to the Genesys Cloud from the Genesys premise. The -- there's also -- I'm getting -- I don't want to cause any serious problems here. Let me say -- let me rephrase it. They've got Amazon, which is a company always be respected, but they don't have a product. What they have is a suite of packages that can be assembled by an SI and internal IT department over a period measured in years, and you get a highly customized ideal for that particular organization. That's not what Avaya company -- Avaya customer is looking to go to. They want a complete package solution to implement it in a few quarters typically. Twilio Flex is out there, although that's probably more of a point solution. Zoom has got an embryonic. I think that would describe it themselves in that way. It's got a fair amount of feature enhancement that still has to come in the future -- in the fullness of time. And we also might -- I don't want to [ elect anybody ]. Microsoft also has announced a few quarters ago -- a few years ago now actually, a product, but we frankly haven't yet seen it in field, but they've got a lot of resources. They've also got nuance. They've got dynamics for the CRM because there's always a close connection between the Contact Center and the CRM system. And they may become serious down the road, that's what I can think of at the moment.

Okay. You've made a number of investments over the past couple of years, whether it be international expansion or professional services. Just how do you see some of those investments ramping and just kind of margin profile of the business over the next couple of years?

Yes. So what we referred to here is we made a massive investment in professional services where you had these mega customers coming to us to go global. Our head count in professional services went from the 30s up to 58% in the second quarter of 2022, back down to 24% now. That's largely behind us. We also put a massive amount into cloud operations also to be able to send out our GCP instances across the world. So we're now in Canada, Frankfurt, Amsterdam, India coming, South Africa coming, et cetera. And so those are largely behind us, and we go back on the resumption of leveraging into the fixed and semi-fixed costs, a path [ well trudging ] by Five9 in the past before we have to do those investments.

All right. Perfect. Well, we hope Mike feels better. But Barry, thank you so much for being here today. And I think that wraps us tonight.

Thank you very much, Meta.