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

All right. Welcome, everybody, to the fourth day, the afternoon, we're winding down. But I'm very excited to have Five9 with us here today. For any important disclosures, please see the Morgan Stanley website at morganstanley.com/researchdisclosures or talk to your sales representative. I'm Meta Marshall for those who don't know me, I cover the communication software space here at Morgan Stanley. We're delighted to have Barry Zwarenstein, CFO of Five9 here with us today. Barry, I think you need to start with your own safe harbor. So I'll hand it off to you to start before we get to questions.

Great. Dueling safe harbors. Before we start, we'd like to remind you that the forward-looking statements made during today's discussion, including those regarding future events, expectations, projections, beliefs, et cetera, of our company, product developments, AI and automation and potential growth drivers are -- such statements or predictions should not be unduly relied upon by investors, it may differ materially. And please refer to our most recent Forms 10-K and 10-Q for factors that could cause such a change. And just one thing, if I could just interject, some of you may be wondering why I'm sitting up here alone rather than with Mike and/or Dan, it's not that they've lost interest, far from it. It's just that we have a long-planned Customer Advisory Board and Analyst Relations Meeting down in Mexico, and I left early to come here and they stayed on. So that's why they are not here.

I'm sorry about that. All right. So from an investor perspective, we saw multiple swings in sentiment around -- sorry, Five9 and Contact Center throughout 2023, as to whether or not kind of CCaaS players would be winners or losers as AI is adopted. How have your conversations with investors changed relative to the time -- this time last year? And what do you think is still the most misunderstood piece of the Five9 story today?

Yes. That was a very hectic time towards the end of 2022 and the first part of 2023, when -- the thing that we have been beating the drum on and expounding upon namely the benefits of AI and automation, all of a sudden, we were a loser. Despite the fact that our Head of AI, Jonathan Rosenberg, a luminary in the area, had the title, Head of AI, and CTO for a number of years, despite the fact that we shelled out serious money to buy the leader in IVAs back in November of '20. So all of a sudden, we are a loser. Somebody must have pulled a Moses on us. So suddenly, we can't go into this promised land of automation. And so fortunately, on June 5, 2023, we believe we've flipped this -- the team flipped the script. We flipped the script by having this webinar, which had 3 of our key customers there who said, agents are not going to go away. In fact, we continue hiring. If there is a diminution it's not going to be that material. And we're really excited about the benefits that you can get from AI and automation. And our two internal experts, namely Jonathan Rosenberg, who I just referred to, our CTO/Head of AI; and Callan Schebella, the guy who founded the IVA business and was the CEO before we bought it. He -- the two of them explained very clearly to the investors the importance of our platform. The platform that has the integrations into all the back office systems, the platform that has all that reporting, so consolidated across all the multichannels that has the security, that has the compliance. You don't just put in a little point solution and expect that that's going to work in an environment that people want to have omnichannel at the end of the day. So right now, the AI and automation is on the march. Real results, real revenue, it's beyond the hype. So just quickly to throw out some pointers and some of these will come back to later on, I'm sure. On the IVAs, if you look at the chart of the IVA ports, in Five9, it looks like a hockey stick. If you look at Agent Assist, that's our fastest-growing bookings SKU in Five9, admittedly from a small base but still the fastest growing. If you look at Agent Assist, one person sitting next to me at our Customer Advisory Board, exact verbatim quote, it was like night and day, the difference after we implemented its summaries in terms of the improvement. So we're seeing a really good traction. In terms of misunderstood, I think post that event, we've been pretty clear, consistent and steady in our communication. So I don't really have anything to add to that.

Okay. So I mean in terms of -- maybe given you already had ahead of AI, you had hired somebody who had a lot of experience in this space. Maybe the answer to this is it hasn't. But it seems as if the market has changed in their perception on how big this opportunity could be over the last 12 to 18 months. And so just maybe contextualize in terms of ARPU or cloud penetration or overall seat count. Just how you see AI impacting kind of your opportunity set?

Fair enough. So you mentioned the word contextualized and let me maybe just click it up before we go into AI, in particular, because it goes together. So there are three drivers now as to why the shift is taking -- from premise to cloud is taking place. And in fact, it's probably at an inflection point, and it's still early days. The first of the 3 is the fact that we've got the legacy vendors no longer coming up with -- in most cases, with new on-prem platform. So the people who've got these mission-critical systems, they interact with consumers have to do something or pay a tax in terms of becoming increasingly obsolete. The second is the importance of customer experience. The metrics that -- things like customer satisfaction and propensity to leave and NPS scores. People are valuing those, even if it means a higher cost in the traditional metrics like average handle time, first call resolution and so on. And then the third one is, importantly, is the AI and automation, which you can -- seriously you can do some aspects of it in the cloud, but you really need to -- on-premise, but you really need to be in the cloud to be able to do it. So in terms of the traction that we're seeing, in terms of seats and -- I'll come to seats at the end, but in terms of the metrics that we shared on our last quarter earnings call, 17% of our Enterprise bookings came from separately priced SKUs in the AI and automation. And by the way, virtually every single, if not every single Enterprise deal had some discussion about AI and automation in it. I mentioned Agent Assist. Each quarter in 2023, it was doubling, growing progressively and by the end of the year, in the fourth quarter, it was 6x what it was in the prior quarter, Q4 2022. I mentioned already that summaries is the fastest-growing booking SKU within Five9. So we're getting a lot of traction. The ARPU on this is pretty high. Commonly, we would sell just the subscription part of a regular non-AI seat at about maybe $130 per seat per month and then the usage will be on top of that. Here, we're seeing regular handles of $300, $400, even $500 per seat with the AI automation included in there.

Okay. Perfect. And so how are you thinking about end market demand in 2024 in the context of these AI tailwinds and then lingering pressures with consumer discretionary customers? Within your kind of 16% revenue growth guidance, just what are the -- some of the key areas that could either drive upside or downside to your expectations?

Important question, Meta, and it's very topical. So in order to answer that, this level set in terms of Five9 in having two parts of the business, the installed base part of the business and the net new part of the business. In terms of the installed base part of the business, it's been a reasonably good situation with 16 of the 17 verticals that we track. This Q3 to Q4 growth rate in 2023 was similar to what it was in 2022, although that was subdued versus some of the prior year history, given the macro. There is, however, the consumer, which is a big part of our overall mix, the third biggest vertical. It's the most -- by far the most seasonal in the fourth quarter. And we saw headwinds there, pockets of weakness. We're not like some of our other competitors in the industry who live in this world where they're impervious to what's happening in the macro. We saw consumer discretionary -- subset of the consumer for the first time since coming on to the platform, the bigger accounts, actually contracting from Q3 to Q4. It never happened before. So we had some heavy sailing there. The good news, just by the way, before I come to the net new side of it, is that the logo retention has been excellent, in the mid-90s for the Enterprise part of the business. And so when inevitably, the American economy turns around, we're going to take -- we're going to benefit from that in a serious way. On the net new side, a much brighter story currently. We -- currently was reference to not net new, it's the reference to what's happening in the installed base. In terms of the net new, the numbers speak for themselves, RFPs doubling year-over-year in the fourth quarter. Pipeline for the Enterprise and strategic at record levels. The best quarter ever for Enterprise bookings. So clearly, something really positive is happening there. And it is this backlog that we've built up because these things on the commercial side, they're going pretty quickly. But on the Enterprise side, it can take -- 7 months is what we model, but it could take much longer if it's an international deal, a big deal. And so we have this backlog plus some, what we call go-gets, that will be orders that will be imminent, and that will be delivered before the end of the year that allow us to have high visibility into what's going to happen later in the year and which gives us the confidence that allowed us to give the guidance we did for the 16% growth, which implies given the H1 guidance that we gave, is revenue reacceleration in the second half of 2024. If you would indulge me just a moment longer, there's another way of looking at it, just to simplify it arithmetically. With installed base, we'll talk about dollar-based retention rate, I'm sure later on. But for ease of communication arithmetic, if you assume that it's 110%, that 10% growth versus 2023 equates to about $83 million based on the recurring revenue, which is what the dollar-based retention rate is calculated upon. The other $62 million comes from that backlog I was just talking about. And between those two, that gives us the $145 million -- $155 million -- $145 million that is the year-to-year growth implied by the 16%.

Okay. That's helpful. And so maybe on that DB&E question for a minute. You just -- in your previous answer spoke a lot about new adds traction is incredibly strong, but you have some kind of headwinds within the installed base, which makes a lot of sense. But you've called for DB&E to inflect positively in the second half of the year. And so just what is it that kind of gives you that confidence all the installed base, can kind of come back in that second half? Or is it kind of layering in some of this pipeline?

Yes. So it's the layering in the pipeline that is the major thing, not the upsell so much. So let's real quick go to it. We gave guidance and we gave the third quarter call that the dollar-based retention rate in the fourth quarter would be flat or very slightly down, and that's what happened, despite the somewhat weaker installed base. And the reason is that we have great visibility into the spot rates and into the stratification in terms of big, medium, small businesses. And we knew that our second biggest customer, which was basically 0 a year ago. It's a health care industry company, would be ramping. And that's indeed what happened and allowed us to come in at 110 just as we guided to. We expect in Q1 to be lower slightly. And for H2, we've said explicitly, we expect an inflection point based upon what we know is in the backlog for -- to go up. Before we leave this, the key thing to keep in mind over here is the bigger the company, our data shows is the higher the dollar-based retention rate and the bigger companies are growing faster. And this also gives us the idea or the plan to have the dollar-based retention rate go up in the high 120s by 2027.

Okay. Perfect. We just kind of talked about you're seeing AI in almost all of your new deals. And I think we can understand that. Just what are some of the efforts or initiatives to kind of upsell your installed base?

Yes. So we've not had, frankly, as much success here as we initially would have expected. We've done two key things, which we believe will make that be much better in 2024. The first of the two, and I can't help but smiling when I think about it is that we brought in a new head of this business, who is tested and proven and done huge things for us in the past. So he's back now and doing this, and we've infused into his organization, not just the farmers, if you will, but people who wake up each morning with a quota mindset, the hunters, if you will, and working together into that organization. The second of the two things is we have something called try and buy type program. The try and buy type program is we go into -- well, you can imagine what it is. We've come out with three different trials. The first one was Five9 Analytics, which is focused upon the operational side of the business, somebody who is trying to see what handle times are, resolution times are, et cetera, and what can be done to improve it. So it helps with the analysis of that. The second one is post-call summaries to increase the quality of those summaries and reduce the time needed to do that. Very strong results there. And the third one is something called Five9 Insights using LLMs to address the more business-oriented part of the company -- management, where they want to be able to see where -- which are our longest calls and persistent -- where was the most numerous calls to see how we can improve that. Now all three of these products require only minimal PS or maybe no PS, which means they can go in pretty quickly. So we're kind of hopeful that we'll see some results on that.

Okay. Is there -- you just broke down kind of the multiple different products. You gave that 7% of subscription revenue and 17% of Enterprise bookings is attributable to AI. Is there just a way to kind of break down or contextually kind of give a sense of how much of it is -- some of these kind of IVAs versus Agent Assist technologies and any margin impact we should be mindful of as these products grow as a percentage of revenue?

Yes. So the leader in terms of revenue, Meta, is the IVAs. It was the company we acquired. We had the leading product and so on. The Agent Assist is gaining ground very rapidly. It's becoming more and more important. When you think about it, if you're going to be offloading the more mundane repetitive inquiries offering to the IVA or into the chatbot, what's left? What's left is for the agent, is the more difficult and challenging cases. So they need more assistance. So Agent Assist is really showing some really solid traction. It's things like real-time transcriptions. Think about maybe an agent who is hard of hearing, real-time guidance to do the coaching and the training in the post-call summaries that I mentioned a moment ago. And those are all seeing pretty good traction.

Okay. And then, how are you seeing the conversation around pricing evolve in this market? A lot of your competitors are doing a kind of combination of fee-based and transactional models. I know there's also some customers who want something that's where they know what the price of it is going to be. Just how are you seeing kind of that conversation evolve with customers?

Yes. So we try and accommodate and be responsive to what the customer wants, wherever we can. Right now, we have three different basic structures. In terms of for -- the AI and automation products, for the IVA products and the chatbot, it's based upon ports, essentially capacity type pricing. For Agent Assist, which goes to the agent, it's therefore, linked to the number of seats, it's more uplift to the seat price. And for WFA, workforce automation, the automatic surveys and so on is based upon usage. Now having said all of that, we've got an active program to bring in some more options. It could be more usage based, although we would end up backsolving to get to a similar situation to what we now have. Bundles, if a new company is starting out, say a mid-market company, which ones do I buy, where we can give you a collective. But all of these will take some time to go through all the legal and educational and systems-type [ advances ] to...

And any margin impact to kind of win-win?

No. The key thing is the one there about, if we're selling it on a usage basis or a per seat basis, we would backsolve to come up with a similar thing.

All right. Perfect. On past earnings calls, Dan has noted that kind of Virtual Agent Solutions have about a 50% completion rate. And most recently, kind of noted that there's a lot of volatility to that number based on kind of what [ TAS ] customers are giving kind of these AI agents. What has the past year and kind of the boom of AI tools taught you about how to guide customers as to where AI can be most effective?

Dan must have had 2 Red Bulls that day with a 50% because that's pretty high. But it would be delightful because we make more money the more we automate. It varies tremendously by customer. The customer comes to us and says, we would like to -- we'd like to have one of your bright shiny IVAs. So how much are we going to save? And the answer is, we don't know. We need to go in and figure out what the best applications are and build heuristically better and better solutions for them. So -- it varies so widely. I mean if I was pinned down to what I've heard anecdotally, it would be more in the single digits rather than it would be in the 20s or 30s, or even 50s.

But do you feel like you guys are now kind of getting a context of, if a customer asks you to automate a certain use case to say, hey, that's not the best use case or they're willing to try it?

Oh, no, they all want to try it. It's just what they -- how -- which particular products and what the expectations are in terms of the return upfront.

Okay. So you can better guide them to what the return might be. All right. So Professional Services has been a bottleneck to customer onboarding. It's also been kind of a, choke hold on kind of margin accretion. Just how has thinking evolved on keeping Professional Services in-house versus leveraging partners?

Yes, there's been a definite evolution. We used to do virtually -- well, we did 100% of our installations in-house. And part of the reason for doing that is that we believe passionately that, you only make that first impression once. And we want to make sure that we have those NPS scores in the 80s and 90s, where we know that some of the others in the industry on the 20s and 30s and -- because we're building trust and combine that consistency of implementation. But under Mike's leadership and the project pull-through, we've aggressively gone in and worked on certifications, maintaining the quality through the certification and just especially internationally, outsourcing some of that implementation to outside parties. And the metrics speak for themselves. This last year certifications tripled year-over-year and a number of implementations worldwide doubled. And obviously, we currently have high single-digits, low double-digits losses on Professional Services. We don't mind too much on that because we will get the software quicker because we'll have the ability to do it well and quickly. But at the end of the day, to the extent that it's done more by outside will be less of a drag on the margins. In terms of our own improvements. As we scale up, we've had some really big -- some of the biggest [ contact tuck-on ] extended deals out there and some of the ones that are almost the biggest. And it just takes a lot of scaling to be able to get past that. This acquisition we made of Aceyus, which at its core is helping to move efficiently disparate systems on-prem to the cloud. And so that the client doesn't even know that there's a change taking place. That too, is going to help us improve our professional services efficiency.

Okay. Now that you're bringing in these partners to kind of help with professionals or help with the implementations, just -- is the makeup of some of those deals different than -- or are they bringing you different kind of customer types than you had access to previously?

The partners -- anything that would jump out there is the increasing importance of systems integrators in terms of these bigger deals. They tend to be involved in a lot more.

Okay. Got it. And then just how do you see the competitive environment today, both just from CCaaS vendors, but from just the number of new entrants in this space, both from larger platform vendors to kind of smaller conversational AI specialists?

Yes, it's become very popular to become a Contact Center as a Service -- Cloud Contact Center provider. I mean the market is big, it's attractive on the top and bottom line, it responds to the CX focus of companies. But let me go into the more specifics of -- I'll start with the main landscape, the donors and the competitors. In terms of the donors, traditionally, it was Cisco and Avaya. The top position within Five9 would be changing year-on-year depending upon that particular year. Genesys now with their End of Life of their product as of October of 2022, November 2022 is now also a donor. The competitors are NICE, Genesys and ourselves. We're not involved in all of their deals because some of those are involved in conversion of their base, which sometimes we don't see those deals at all. When we do see them, it's best we can tell and we track it very closely and report it to our Board name by name, where win rates are over 75% in the deals that we are in with either or both of them in. The -- off on the side is Amazon, which doesn't have a customized ready -- it doesn't have a product as per se. What they do is they involve an SI or down resources to help customers come up with a highly customized solution over a period measured in 2 or 3 years. The way we talk about it is that if we and Amazon are on the same deal beyond the first, at the most second round, one of us is making a mistake because we're offering a different type of solution. But they're a very credible competitor. Then if you think about prospective new entrants in a traditional sense, not a point solution, but a kind of end-to-end contact center, Microsoft makes -- has made announcements about wanting to get into it. They have two of the key elements, both the -- to the extent that it's linked with UC, they've got Teams and they've also got the dynamic side of it with the CRM. In the meantime, though, we don't see any -- there's no product that we're competing against, though that might come later. In the meantime, our relationship with them, both on the Teams side and the dynamic side is excellent, really excellent. You've got Zoom as well. Zoom has got a lot of talent, a lot of resources, a lot of determination. But doing what we do is not -- it's pretty difficult. There's been no new entrant of scale into the industry in the last 15, 20 years. And that's one reason, it requires a very, very challenging development, both on the voice side and the data side and on the software side. So -- but time will tell. And then finally, on the point solutions. At the end of the day, we offer our own chatbot. It's got all the advantage of being integrated with IVA because it's built on the same studio platform. But if nevertheless, somebody wanted to go with a point solution they will do so, but they're going to need to come to us if they want to be part of that platform. And at the end of the day, most people want to have an omnichannel solution.

Okay. Before I keep going with questions, are there any questions from the audience? The quiet crew is after lunch, we've lulled them into silence. So Five9 has been active in the M&A market with a lot of smaller tuck-in acquisitions. Can you just walk through some of the skill sets the last few brought you? And just how you think about organic and inorganic development, particularly kind of at a time of inflection within the space?

So let me start with the second part first. We've got a preference for organic. But as we've demonstrated, as you alluded to, we've made several tuck-ins. We've got a really high stepping corporate developments function headed up by Jim Doran from Cisco, who they know how to do acquisitions. And -- so that's our mindset, organic, but we'll do -- we will continue to do tuck-ins. We've made 4 and arguably, each one has been more successful than the prior one. The first one is we made a company -- bought a company called Whendu. What they did was workflow automation. And that, as I mentioned earlier, is now one of our 8 key products in the AI and automation front. The second one in was a company called Virtual Observer. This is our internal WEM, workforce engagement and management solution that we're constantly improving and is doing very well. And then potentially the star, up until recently of the show would be the IVA acquisition, which was a company called Inference that we bought in November of '20. And that sort of demonstrated our commitment to this AI and automation going all the way back to that, and it remains one of the leaders. And then finally, most recently, last August, I think it was, we purchased a company called Aceyus, which I made reference to. And at its core, they help companies make the migration. These are major companies, and as we reached out and got to know them as we're doing some of these big deals, made the migration seamlessly from -- in terms of data visibility and non-siloing from the on-prem to the cloud.

Maybe something that I find when I talk to investors kind of gets misunderstood is kind of the usage piece of Five9. And just -- I know that, that was kind of a headwind to growth over last year. And so maybe just kind of give me some contextualization of how you see it and how it fits into Five9.

Yes. So it's important to be very clear when we're talking about something that we understand, what we're saying to each other. And no, no, I was -- I just want to be sure that everybody understood. When we talk about usage within Five9, we're talking about the long distance charges. And just to make it crisp, if you look at Q4 2023, the breakout between subscription, recurring subscription services were 77% of the total. Those long-distance charges plus some other small charges was 15% and the complementary 8% from Professional Services. Now as you alluded to, Meta, that usage component declines. When we went public some 10 years ago, it was 36% of the total. Now, it's under 15% and will continue going down, look by 2 to 3 percentage points per year. That's proportion of the total. Now there's a number of smaller reasons why this is happening, which I'm not going to take the liberty of going through with you right now. But there's one big one. And that is that some of these bigger companies that we're landing bring the -- either come to us through partners like AT&T or British Telecom or major corporations that have their own unexpired contracts with the Verizons of the world or whomever. For example, again, that health care company, our second biggest company, we don't get any of these -- of that company's usage. So that they will continue to go down over time.

Okay. Perfect. And then just maybe as a last question, just how you're kind of thinking about operating leverage within this business and just kind of what you're holding yourself to in terms of kind of threshold for investment?

Yes. So we've got so many really, really good opportunities, but particularly in R&D. Going in no particular order, further innovations on AI and automation, more -- going more globally. It's been a real bear in terms of India, but we're pretty close. But there's other parts, other localizations and other advances. FedRAMP, a massive investment, going to take a couple of years before we can really see the fruits of that. But it's a big market. Think of all the hundreds of millions of social security recipients and veterans and so on. But at the end of the day, so we want to make those investments. In 2024, I wouldn't see very much leverage at all. We are trying really hard not to beat the $2.16 of EPS guidance that we gave for 2024. We've tried it in the past, but we're always beaten in the bottom line. We don't want to. We've got too many good opportunities. Longer term, 2027, our model out there, which has become increasingly aspirational because of the macro, but it's out there. We want to be at 22% EBITDA, which we've been at -- flirted with in the past.

Well, Barry, I'm excited to keep following this story, and thank you so much for being here today. Sorry to pull you out of Mexico.

All right. Thank you very much.