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

All right. Perfect. All right. We're going to go ahead and get started. Thanks, everyone, for joining. For those of you that don't know me, my name is Arjun Bhatia. I cover Five9 here at William Blair. For a full list of our disclosures, go to williamblair.com. I'm pleased to have Mike and Barry from Five9 here. Before we get started, Barry, I'm going to hand it off to you to read -- for your disclosures. Yes, there we go.

Hello, everybody. So I want to remind you that the forward-looking statements made during today's discussion regarding future events, trends, expectations, projections, beliefs that may affect our industry or our company's products development, AI and automation and potential growth drivers, statements or predictions and should not be unduly relied upon by investors, actual events or results may differ materially, and Five9 undertakes no obligation to update information of such statements. And lastly, I refer you to our Forms 10-K and 10-Q to understand why those things may be different.

All right. Thanks, Barry. All right. So maybe to start off, Mike, I think it would be helpful if you can just lay out a little bit of background on Five9, where you fit into the broader contact center space. And as you look at your growth over the last couple of years, what are maybe some of the major factors that have been impacting the growth story?

Yes, happy to, Arjun, and thanks again for having us. So at the highest level, we're a software company, a cloud software company, that has been changing the game, quite frankly, in customer experience for some of the largest brands in the world. We've announced some of them recently, as many of you know. But we've been in this game for a long time. We've got what we call our Intelligent CX platform, which is really AI-powered an AI-led solution, but also as a data-driven solution. And it's important to understand AI and data are big part of what we do. And at the end of the day, what we're doing is in the contact center part of CX. We're replacing legacy on-premise solutions like Avaya, Cisco and Genesis on-prem with our cloud contact center solution, our CCaaS platform. Obviously, that will evolve over time. It's becoming more and more of an AI solution like everybody else, but this is real. 17% of our bookings last quarter were AI and automation solutions, in addition to our core contact center. And that's just going to continue to grow as we evolve with this market. Our large enterprise customers, which are, for the most part, it's 88% of our business is large enterprise. They're looking to reimagine their customer experience. They can't get a great CX, all of us are consumers, right? We've all interacted with call centers and contact centers over the years. Those legacy solutions cannot deliver even a good CX. And we're delivering great CX for our Enterprise customers that are looking to take advantage of AI, where think of us almost as a little bit of the platform or the vehicle to help these large enterprises deliver AI at the edge, so to speak, because we've got a portfolio of 9 products now, AI products, starting with IVA and Agent Assist, but I'll talk more about that. But again, a lot of the tailwinds are coming in our business are -- by the way, our subscription revenue grew 20% the last quarter. That is the key metric. It's almost 80% of our revenue. And it's being driven by the end of life of a lot of these legacy solutions, the importance of delivering real CX, good CX, we call it joyful CX, and taking advantage of AI and automation now. So those are the drivers of growth, and it's an exciting time to be in our market. I've been here 16 years as CEO and Chairman of the company, and there's never been a better time to be in cloud, CX and cloud contact center in spite of some of the narratives you're all hearing.

So I certainly want to -- yes, we'll dig in, I think, a lot more to the AI theme. I think before we get there, I want to go back to the last kind of platform shift that happened and tech, which was cloud. And I think the CCaaS space is pretty unique because there is a big installed base of on-prem contact center solutions. And now we have cloud that's been around for a while, and we have generative AI that's taking off. So what are you seeing from that legacy installed base of customers that are at some of your competitors? Is there a greater impetus to move to cloud? Is it kind of steady state? What are you seeing from those customers?

It's a great question. It's absolutely inflecting. The -- and the best indicators I can talk about are -- the growth in our bookings are net new logo bookings. We haven't quantified them exactly but we've told you quarter after quarter after quarter, we keep making records. Our top-of-funnel RFP flow, if you will, went up about 100% year-over-year, 5 quarters ago, and it's kind of maintained that very high watermark. It's an indicator of this market inflecting. Part of it is the end-of-life announcements that some of these on-premise solutions have announced. But again, it's a market that doesn't move quite as quick as many other markets, mainly because contact center is mission critical. It is the touch point for an enterprise brand and their consumers, our customers. And it's literally like heart surgery, to move off of one of these legacy -- actually, they're not usually moving off of 1, they usually have like all 3, both Genesys, Cisco and Avaya, somewhere in their enterprise. They're typically the ones we win, in particular, are moving off multiple legacy ACD systems, and they got to run their business at the same time. So these are transformations. They are long-term projects. They -- this large financial services company that's a large bank that we just announced. It took them several years just to get to the point of selecting us as their vendor. Now we run a multiyear deployment journey of that. And we've got to keep them -- keep their business running the entire time during that migration.

So if we were to just compare today to 5 years ago, let's say, just as an example, like are the -- is the quality of the customers that are coming off of on-prem, are those deployments now getting more complex? And how is that impacting your implementation times for these customers that are saying, "Oh, we want to go to Five9 because we want to go to cloud, and we want to get the benefit of AI," how is that changing?

What's changed from 5 years ago is the size of the enterprises that are moving to the cloud. And with size, with greater size, bigger and larger enterprises comes more complexity usually. Not always but usually there's more complexity, especially in the way of integrations. This large bank we talked about, we talked about on the earnings call. They have integrations. We are now going to integrate as we deploy at this bank, integrations with 20 -- 24 CRM systems. And those are different systems, some homegrown, some departmental, some vertical, and some off-the-shelf classic Salesforce and other CRM. So again, it just goes to show you that these large deployments are complex. They take time not because we can move fast. We turned up the large parcel delivery service. We turned up 10,000 seats in literally weeks. So if we can go as fast as they can go. It's typically that these are multiple business units across global multinational corporations, and it's a separate project for every business unit. So that's really why these take time.

Okay. Is there anything that you -- as you think about what you can control, is there anything that you can do to help them with their business trends? Like is there more Professional Services? Is it getting partners and SIs involved? How do you -- how can you mitigate that pain a little bit of upgrading to a better CX?

Well, Frankly, that is why we win a lot of these business -- these deals because of our Professional Services and implementation team. They've shown time after time with some of the large mega wins that we've had and the referenceability of those, a lot of that reference is around how we help them succeed on our platform. So our expertise is important in this, I call it a heart surgery. I mean it really is open heart surgery on migrating these legacy on-prem to cloud to our cloud or anybody's cloud. But we've also -- we made a key acquisition recently, a company called ACS, which was a company that is very unique. They actually -- we saw them in a lot of these large enterprise deals that we are winning. And they're -- think of them kind of like MuleSoft or an API platform for the contact center CX market. They've got integrations, prebuilt integrations to every CRM back-end billing systems, legacy ACDs and that legacy ACD integration allows us now to be able to normalize all their reporting and analytics while they're in this migration. It's a huge benefit that we have to help these large enterprises make the migration. ACS -- that's why we acquired the company. And that's the reason we won this Fortune 50 deal as well.

I want to go to AI because I know that's certainly on top of everyone's mind, and it's been a big initiative for you as well. I think you've shared some metrics in the past about AI-related bookings. So it's clearly something that customers are investing in. But as you think -- like take a step back and think broadly about the customers that you want to serve and sell AI capabilities to, where do you think they are just in terms of readiness to be able to actually adopt AI capabilities because there's business transformation needs that they need to meet, and there's data readiness, and we hear about a lot of these things. So where are we in that process at this point?

It's a great question. I mentioned data for a reason earlier. While we just had our customer advisory board a few weeks back, and one of our largest customers was talking about data readiness and the fact that there's a sequencing to this. especially when it comes to AI, you can deploy AI without your data, if your data is not ready for that. Now again, AI allows us to access a lot of unstructured data, which is great. But there's still a data readiness element to really taking your CX to the next level. And our customers are focused on that. They're getting there. But again, we're deploying these large enterprise solutions every day, and that's what drives our revenue. And I would say one other thing when it comes to kind of what our customers are thinking. When it comes to AI, they're looking to us as their CCaaS platform player or a vendor to provide those AI solutions. And part of the -- the reason is, it has to be part of a platform. To have a point solution just -- it gives you a tunnel vision, we'd all here about these chatbots that are replacing agents but those are in very unique cases. And again, they're not going to be part of a broader platform that allows cohesive visibility reporting, cross-channel escalation or movements. It's an important part of this is to have the whole platform. But I would say that, again, there's a lot of interest in AI and automation. There is some narrative out there about agent counts and seats disappearing, and IVAs taking over the world. We can debate all day long about how drastic the seat cannibalization might be of AI, but it's important for everybody to understand our customers are not thinking that way in extreme. They're thinking about 5%, maybe 10% labor arbitrage, which is a huge ROI in and of itself. But even if there was a drastic reduction in human agents and contact centers like some people believe might happen. Five9 and CCaaS players in general are winners because we provide AI software solutions at about 2x the revenue per interaction. So our TAM, our available market, the more automation -- the more that automation replaces agents, the larger our TAM becomes. So it's a 2x increase.

So right now, it's 5 -- potentially 5%, 10% labor reduction but you're seeing...

By the way, that's over 3 years by most of our customers. That's what they're telling us, if they're going to reduce it all.

But you're seeing a 2x uplift on price. So your revenue is increasing at a rate that's greater than whatever the seat reduction might even be...

There's a factor -- by a factor of 2:1.

Okay interesting.

Yes. So if there's a 10% automation reduction in agents, there's a corresponding 10% increasing our TAM because it was the 10, but then we get 20 back.

And is your pricing model for your AI capabilities already adjusted such that it's -- if it's an IVA that it's usage-based, and there's a consumption elements to it?

So we're doing both kind of port-based and usage-based or consumption-based pricing for our IVA and other solutions now. In the end of the day, it all comes down to ROI. So remember, the labor arbitrage, if they're successful in doing this, they're going to get a 10:1 labor arbitrage savings. So we're -- so the ROI being so significant for our customers allows us to get that 2x, and it might even be 3x in some cases. I'm being conservative with that.

Okay. I think one of the other debates that investors have about the CCaaS market is this element of build it yourself and you talked about this a little bit, but I think there's been some early examples thus far of businesses saying, we'll build, bought ourselves and deploy it with an open integration or whatnot, whatever it is? And what are the challenges that kind of a deployment might be overlooking? And what might they not be able to address [indiscernible] the Five9?

Yes. We talked about this a year ago, the airplane analogy, airplanes and engines. And in order to -- you don't -- the analogy I'll use it really quickly. You don't fly across the country on an engine. That engine has to be part of an aircraft. Where are the aircraft? The LLMs, the Deepgram, all these language -- these large language models and other engines, foundational engines, we just plug them into our platform. So they in and of themselves are not a product. You can build, yes, a great chatbot, but it's just a chatbot. It's not the end-to-end platform. And what you need to deliver true personalized, CX not just in the chat, but across all of your channels. You have to have the platform that has visibility into all the channels, whether it's voice, whether it's other digital channels, whether it's self-service, IVA. We've got one platform, that allows an enterprise brand to have full visibility across all those channels and have them -- again, if you're on a phone call as an agent or if you're an even in an e-mail interaction as an agent, you have to have visibility to what's happening in those other channels. Otherwise, you're not going to deliver personalized CX. It's that simple. So again, most companies, all of our count stores, they have no desire to do a build-your-own chatbot because it's going to be a siloed solution, give it that way. They want the platform, they want it from us or another CCaaS vendor and the other element that you have to have to deliver real personalized CX as contextual data. And that's also -- we have integrations with CRM systems, billing systems, now legacy ACD systems. We have an ability to infuse knowledge from the enterprise brands, FAQ website, white papers, the list goes on and on, all of the content specific to the products and services that they provide as well as real-time data about the consumer. On the other end of that interaction, real-time transcription of either a voice interaction, a digital interaction, an IVA interaction, that's all happening with RAI. So we know that, the system knows, the brain, if you will, in our AI, knows exactly what you just said 10 seconds ago. You have to have -- not to mention all the stuff you did last year. So you have to have that full visibility. You've got to have all the data. And again, the large enterprises that are doing business with us, they understand what they really need. That's why they're doing business with us.

Can you -- on the ROI side of the equation, can you talk about when you're going to market with your AI capabilities, is the ROI pitch today more about cost savings from a labor perspective because we do see sometimes tens of thousands of seats deployed in contact centers is it better CX. Like which one resonates more with customers that they're looking to?

What's great is it's both, and it really is both. It's a great business case. You can make an easy, easy business case. In fact, we had one of our large enterprise wins that we've talked about, a business case that justified the entire $40 million ARR contract with Five9 was the labor arbitrage savings. But at the same time, they're not solving just for cost. They're solving for a better CX. And by the way, AI and automation is part of better CX for the stuff that -- for these stuff, the interactions that can be handled by AI. The consumer loves that. But what you don't want to do as an enterprise brand is force automation on to the consumer when they don't want to be automated. This gets back to the old days of the IVR hell. We've all experienced that, right? You're trying to get to an operator, operator zero out. All of our customers are fearful of doing that again with AI. They don't want hallucinations. They don't want inaccurate information. AI still has to -- it has to go through a maturity curve like everything. And again, our customers are very conscious of their customer experience as well as their cost savings. It's both.

Okay. Can we -- if we can talk about competition for a second because certainly, I think the AI use case is pretty compelling in the CCaaS market, but you have competitors in the market that have similar AI capabilities. When you think about maybe you'll debate that. But the -- what is the differentiation? And what is the competitive advantage that Five9 has over others in the CCaaS market especially relative to AI?

Ye, our AI leadership is well known. If you look at surveys by some of the other firms, I don't want to name your competition, but there are surveys of channel partners out there. They talk about who's got the best AI. Five9 is not just like a little bit ahead. We're viewed as well ahead. There's a reason we're winning these large enterprise deals because our AI is ahead. It's partially because we made an acquisition over 4 years ago of a company called Inference, which had the leading IVA in the market. We've built 8 new products on top of that and integrated it into the Five9 platform. So our strategy was also, I would say, differentiated. In addition to the acquisition and the AI solutions that we've built, being kind of ahead, that's one element of this, but our strategy of being engine agnostic from the very beginning. It was the perfect strategy that this gen AI revolution and GPT-4o now and whatever is next plays right into our strategy. We never invested a single R&D dollar to build our own engines, and our competitors did. So they've had to kind of pivot, and we focused on building the application set. And those 9 SKUs, and our competitors are -- they've spent a lot of their R&D dollars, building their own engines. Those are obviously not going to -- they're going to toss those and evolve.

Barry, maybe I want to bring you into this. I think it's been an interesting time, I think, in tech and software in general. We've seen some choppiness in the demand environment from other companies that have reported. I think you've called out some verticals that have been more challenged than others as well. Can you talk about just what you're seeing now in terms of getting deals across the finish line, is it getting harder? Is it -- are you still able to close deals on time? What's happening with sales cycles? Just give us some sense of what the demand environment looks like?

Yes. When you look first at the net new business, we did see some elongation of sales cycle in part because of what Mike was talking about with the AI, what's happening to my data, who is going to see, it private, et cetera. But that is returned to normal. And for the reasons Mike also gave, we've seen very strong bookings momentum on the net new side. These are mission-critical systems. They're not being enhanced aside maybe for security patches or bug in fixes -- or bug fixes or whatever. And you want to do AI and automation. And where do you do AI and automation, you do it in the cloud, not on-prem. And so we see very considerable momentum. On the other side, to which you began your question with, Arjun, which is the installed base. We track 17 different verticals, the one that -- however, that has got the most variability is our consumer vertical, our third biggest vertical. It has a seasonal strong second half typically and last year was no exception but more muted. But it also is suffering from the macro economy. If the transactions are not there, then we're not going to have agents sitting in the seats sitting idle because they can flex a number of agents seats. So we started seeing that weakness in the course of last year. It certainly continued into the first quarter as predicted in -- of 2024. And by the way, one way to look at it from the external world is looking at debit and credit card spending, for example, JPMorgan puts out data. And for January, February and March of this past year, it was basically negative real growth. Normal growth was negative and plus 1% or 2%. So after inflation was negative real transactions. And that's what we've assumed in our case, for the rest of the year. We're noticing any downtick -- further material downtick in the economy nor any uptick. Where an uptick to happen? At some point, it will happen. We're feeling very, very happy about that because our logo retention has been very strong. You don't switch out these systems as Mike called it, these are heart transplants. Our logo retention on our Enterprise business, which is 88% of the total, is mid-90s. And when that tick up, and you'll see it, it will be both virtuous from the revenue point of view, but also from the margin point of view because deleveraging fixed and semi-fixed costs.

That's very helpful. And the other piece I want to touch on is, I think, just as I've looked at the shape of your guidance for the remainder of the year, it seems like there is an inflection ramp kind of baked into the back half of the year. And you've talked about backlog. There is some deals that you've won that you're just getting implemented and live. What is your sense now just on timing of those go-lives, are those implementations still on track? How do you feel about that back half ramp that's kind of implied in the guide?

Yes. So I'm going to talk about the remainder of the year, including Q2 because that's how we've guided. If you compare the last 3 quarters of '24 versus '23, it's $116 million of incremental revenue. Bifurcate that in your mind between the installed base business, which is $64 million of that $116 million and then the new business, the backlog implementations and so on is a complementary $52 million. So I'm going to start with the $52 million, first. Because that's where we have the greater visibility. Most of that, not 100%, but the vast majority of it is ready and backlog. And we've got -- and this is a segment of fact, not an assertion, the best professional service 500 people in the industry, and they have joint commitments with our customers to make the deals go live. Then we've both got interest in not wasting resources. And so those are very predictable. Switching -- and there are some go-lives that are also needed in order to start recognizing revenue before the end of the year but we feel very confident around that as well. Switch over now to the installed base, where we've had this sort of study -- or study type macro environment that's hampered the consumer vertical. There, we've got -- we've said that we would expect an inflection in our dollar-based retention rate in the second half with sort of around 109, 110 right now. If we use just the flat 110 partly for the ease of mathematic and apply it to our recurring revenue a year before you get to that $64 million I talked about. Lastly, where can we have the confidence to the extent we can on the dollar-based retain to rate inflecting? Well, first of all, we have the actual spot numbers. But more importantly, there are -- the bigger customers take more than the health care company, for example, take more than 12 months to ramp, and they're really in the equation. And we know pretty much, as I alluded to a moment ago, their ramp schedules. And so that gives us the confidence that these bigger companies that take more than 12 months will help us reflect the dollar base retention rate in the second half.

Okay. Perfect. Mike, maybe I want to -- actually, this might be for both of you. But if we now just think about, if we fast forward 3 years, let's say, and your AI bookings are a bigger portion of your business, AI is a bigger portion of your revenue, there's a lot more demand, what does that mean for margins for Five9? Is that margin accretive to your business?

It is. And Barry, I'll let you kind of comment if you have further comment but the best data point for us is when we acquired Inference, which is just an AI solution company. They had gross margins significantly higher than our current blended gross margins. So again, we're running that part of the platform in a very similar fashion. So the margins are higher.

Okay. Is there any sort of does the usage component, is that the mechanism that ensures your margins stay higher?

So we should be really clear about usage. When we say usage, if you think about our revenue total as having 3 components: subscription, usage, as we call it but that's pretty much long-distance minute usage and it's not consumption-based AI solutions. Consumption-based AI solutions will be in the subscription. Usage revenue grows significantly slower, and that's a good thing. Subscription, usage, professional services. Usage and professional services are growing significantly slower than subscription, and that's by design. We're actually not attaching long distance usage to a lot of our large enterprise deals, including that big Fortune 50 bank, that is because they either have their own carrier or long distance telephony or it's sold with or through a partner of ours, AT&T, BT, they bring the usage that their business. That's -- we don't want to take that. It's low margin. It's low growth, it's not something you should pay attention to. And by the way, subscription is nearly 80% of our revenue, and it'll continue to take more and more of the mix as usage doesn't grow very fast. Professional Services, we talked about project pull-through, that is enabling these SIs and third parties to do the implementations for us. We don't want to grow our Professional Services organization. It's really important as a differentiator. We're going to continue to do it. for some of the larger and more important deployments, but expect PS -- by the way, PS is a negative gross margin part of our business. That's only 7% of revenue. So again, I would encourage everybody not to really look at usage or Professional Services revenue as a meaningful metric. Subscription revenue grew 20% in the quarter, in this last quarter, 20% year-over-year growth, and that's where people should kind of focus on. That's AI software as well as software that powers human agents but again, it will always be a mix at this point.

All right. Perfect. Well, that's all the time we have today. Mike, Barry, thanks so much for joining us. Really appreciate it. For anybody that has follow-up questions, we are doing a breakout upstairs in Jenny B. So please feel free to join us.

Thanks, everybody.

Thank you.

Thank you. That's great.