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

Thanks, everyone, for joining us. I'm Rishi Jaluria. I cover software here at RBC. I'm delighted to have with me Mike Burkland, who's the CEO; and Barry Zwarenstein, who is the CFO of Five9. Before we get started, Barry, I know you wanted to say the safe harbor.

Yes. So before we start, I wold like to remind you that today's discussion will contain forward-looking statements, including those regarding future events, trends, expectations, projections and beliefs that may affect our industry, our company, product development, AI, automation and potential growth drivers. Such statements are predictions and should not be unduly not be unduly relied upon by investors. Actual events or results may differ materially. Five9 undertakes no obligation to update the information of such statements. Please refer to our most recent Forms 10-K and 10-Q, under the caption Risk Factors and elsewhere in the financial -- in Five9's quarterly filings with the SEC. Thank you.

All right. Perfect. Maybe let's just start with a little bit of an overview of Five9 for people who are generally new to the story. And maybe we can segue into that. You obviously had a pretty nice bounce back quarter. Stock was up nicely in Q3. Maybe talk a little bit about what you got out of that.

Sure, Rishi. Yes. So we provide software for large enterprises, actually in midsized and small enterprises as well, to essentially power their customer experience. And this is an AI-powered platform that we have. And we're about $1 billion in revenue, and we'll talk about some of the metrics. I would say for the third quarter highlights, subscription revenue accelerating to 20% year-over-year growth, and that makes up 80% of our revenue mix. So we really want to encourage investors to look at subscription revenue as opposed to the other 20% of our revenue stream that essentially is not really -- they're not growth vectors for us, and we can get into that. I would say another highlight was our AI revenue growth as well as bookings. Our AI revenue growth was 40% year-over-year in the quarter. AI bookings on the net new side made up 20% of ACV bookings for the quarter, and that's a really important number. I think that's actually the most important number that I see. 20% of our ACV bookings mix on new customers, that's a big number. And there were other AI highlights in terms of metrics as well. We talked about installed base bookings into our installed base. Our AI upsell, cross-sell into our customer base grew 50% year-over-year. So lots of momentum in AI. Speaking of AI, we also announced our AI agents, which are, again, the next-generation of what we call IVA and DVA, but we're going to start calling these AI agents. They're both digital and voice for self-service and front-end interactions, really exciting. We're just -- as an industry, we're moving towards more autonomous AI agents. It's really exciting, and our customers are excited about it. And last but not least, Acqueon. We closed the Acqueon acquisition and announced a $4 million deal that was led by the Acqueon product, a $4 million ARR. So it was nice to get off to a great start with a recent acquisition. I'll stop there.

No, I think that's super helpful. A lot of things to go on there. So maybe let's start on the AI front. As you can imagine, that's -- one of the biggest debates on the stock today is really understanding the puts and takes of AI. So maybe let's spend a couple of minutes on that. Starting first with, why should we not worry about decompression as a result of AI?

Yes. And this is a great question, Rishi. It's top of mind for everyone. And understand we have an end-to-end platform that powers interactions between a brand and their consumers. And we're all consumers, right? And we all want to interact with a brand in different ways, different channels, including, in some cases, self-service powered by AI or even with a human agent, which has AI kind of helping them do a better job. So that's at a high level. And we have software for powering all those interactions, whether they're AI handled, through self-service, fully contained digital or voice, or they're handled by a human agent with our AI assistant and Copilot technology. There's a lot of other AI products that we deliver to these brands, but it's really important to understand that the more automation and the more AI, the more interactions that are handled by true self-service and less by human agents, that's actually a TAM expansion for us. We get more revenue per interaction for our AI software than we do for our software for human agents. So we're a net winner in this equation. The more automation and the more self-service through AI, that's actually better for us. A lot of people are kind of misunderstanding that thinking that's a bad thing for us because the risk of agent counts going down. And again, we'll see how this all plays out. We're, again, as I said, a winner with more automation through AI.

Yes. Okay. So let's follow up on that now because I think the second question becomes, why do you have a right to win when it comes to AI? And two, that I hear a lot is, Salesforce with Agentforce and then with Microsoft with Copilot for Service. Obviously, admitting both are very new products. But maybe walk us what gives you the right to win versus those larger brands?

Sure, sure. And again, our customers -- and we've surveyed our customers, and there's been other surveys out there. Look, these large brands want to purchase their AI technology from their CCaaS CX platform vendor like Five9. And part of the reason is that we are this end-to-end platform for handling all of their interactions, again, whether they're digital or their voice or whatnot. And it's so important to have the visibility across all those interaction types to power, say, a chatbot. If you have a stand-alone chatbot, and it's not connected to a platform like ours, it's basically like tunnel vision. You don't have that chatbot or if it's a live human on the other end of that interaction, the bot will not have visibility into prior interaction. Rishi was in touch with the contact center a week ago or 2 weeks ago, and this was their problem, right? They have to actually start from scratch, and they don't have any of the contextual data to power that AI. So AI, just like humans, are dependent on contextual data about you, the customer, about the brand and their offerings and about all the information and back-end systems. Our platform has all that visibility. All the CRM data, all the billing information data, we integrate with about 20 to 24 back-end enterprise systems in most of our deployments. So we get that visibility of the contextual data. And again, a stand-alone AI solution doesn't have that visibility to provide a true, personalized customer experience, and our brand -- our customers know that. And by the way, if one our customers does want to purchase AI from Salesforce, they usually get a blend of our AI and Salesforce AI, and we monetize the connector, we call it voice stream or transcript stream, which allows them to essentially have that visibility into our platform, but we monetize that on a volume basis, and it's very lucrative for us. So either way, we -- again, we're going to participate in that revenue opportunity, whether or not it's through a partner solution or through our solutions and our platform. But at the end of the day, the most important thing is we win the platform, the CCaaS platform. That is the majority of the revenue, and we're having a lot of success with partners like Salesforce and others.

Yes. Maybe let's stick on the partner side. Can you talk a little bit about what you've done to build out that partner ecosystem? And you talked -- you started by talking about how you, at the enterprise, used to be known as more of an SMB mid-market player. Obviously, you closed some very large deals over the past couple of years, not reflecting this change. Maybe can you kind of read both of those together?

Yes, absolutely. And again, our marchup market, as we talked about, is -- has been -- frankly, a lot of people have said this, it's just amazing the marchup market. We went public. And again, Barry -- and I've been with the company for 17 years and Barry's been here for, like, 13. And we went public 10 years ago. At that time, we had -- when we looked at how many million-dollar ARR customers we have when we went public, it was 3. And today, we have been closed at the end of the year with 183 customers delivering to us more than 1 million ARR. So it's been a dramatic marchup market. And it's been, in large part, driven by as well as our international expansion. International expansion and marchup market are 2 of our growth vectors over the last several quarters. And our multiple routes to market, as we call it, if you think about partners, and we look at this as, again, one of our strengths is the multiple routes to market, multiple categories, it's the ISVs. These are technology partnerships with ServiceNow, Salesforce, Zendesk and other CRM vendors, some WEM partnerships that we have with the likes of Verint and Calabrio, and the list goes on. So there's an ISV partnership ecosystem, which brings us into a lot of deals. They are the classic VARs and resellers and SIs that are part of our ecosystem. And there are even referral partners that are part of this world of communications as many of us know. So -- and then obviously, we have a very strong direct sales organization. So it's a diversified route-to-market strategy that we've taken. And internationally, we actually get a ton of our deal flow, and the deals are written on partner paper. So it's a big part of the leverage in our go-to-market.

Yes. So helpful. Maybe let's pivot then to talking about competition. Maybe first, I want to think about your core competitors, so the other proper CCaaS because clearly, everyone knows Cisco and Avaya are losing share.

I like when you said that, proper.

So then if we really think about you, NICE, Genesys, maybe walk us through how you think about that? What's your differentiation? And any changes from that?

Yes. Again, we're -- all 3 of us are in a great position. And I think the markets are going to realize that over time here. This is a 3-horse race when it comes to even midsized enterprise and above. There are -- there's a lot of noise in kind of the SMB part of the market. But again, I think NICE, Genesys and Five9 are all positioned extremely well. We all have, what I talked about earlier, it's the power of the platform, right? We're providing AI-powered CX, but we're also providing that core platform, which is so valuable and so important. NICE is a public company, so you can see their numbers. If you look at kind of organic growth, we're growing faster. They're a little more profitable. But again, we're all going to do well in this market. And it's an exciting time, and I do think investors are starting to figure it out, especially if you look at subscription revenue growth because as I said, accelerating as a $1 billion company growing 20% year-over-year on subscription revenue growth. It's dilutive.

Yes. So I want to drill a little bit into the numbers and give Barry a lot to talk about. But maybe just rounding out competition. You did kind of allude to some of the SMB competitors. So you've seen some of the UCaaS vendors get into the space, Zoom with Zoom Contact Center. RingCentral kind of announced their own rather than they white label NICE. Have you seen any changes in that with the UCaaS vendors even at the low end of the market?

Yes. I mean, again, they have got to figure out kind of their next play. And if I were in their shoes, I would do the exact same thing. We do know the barrier to entry in our space is just significant. We've talked about it in the past and we talked about it at dinner last night with some of our visitors. And the best data point is Interactive Intelligence. And this is still a few years ago, but it took them 8 years. They were an on-prem CCaaS -- on-prem contact center vendor. And they basically started a project, fenced off an investment, a very large engineering effort. They know the space. They know what features they have to deliver, and it took them about 8 years. Eventually, Genesys acquired them, and that's Genesys Cloud solution. It's -- it takes a long time to be able to -- and the bar is very simple. The bar to compete in our market is very, very simple. Can you replace on-premise Avaya, Cisco or on-prem Genesys at scale, with reliability, with all the features necessary and nowadays, with all the AI function requirements customers are looking for? So it's a high bar. It's -- there's a reason that it's been a 3-horse race for quite some time. And again, we do expect more competition down at the low end of the market. By the way, 88% of our revenue is in the enterprise market and 12% is in the SMB market. So again, it's a pretty small part of our business, and we do still do very well against them, partially because, again, most customers are looking for full functionality as opposed to the best [ product ].

That makes a lot of sense. All right. Maybe let's walk through that acceleration. So as you pointed out, you accelerated growth at scale. What were some of the key drivers that to led to that?

Barry, do you want to talk about that?

So we went from 17% growth to 20% in Q2 to Q3. And remember, as Mike said earlier, this represents 80% of our total revenue. And we'll continue to go up, given that the other 2 parts of our revenue component, namely usage, 13% of the total, and Professional Services, for the reasons we can go into separately, which accounts for the other 7%, are not growing, in fact, contracting in the case of usage. So the acceleration came in the subscription, and there were 3 main drivers for that. First of all, we had a record turn up from our backlog, Q3 record. Secondly, the key part of our business are the bigger customers have led to very big customer wins, but we're just talking now for a moment about $1 million plus. That's 55% or 56% of our total revenue. And that's -- the last quarter was growing at 29%, so that also helps. And the third and final factor was the shift in AI. As Mike said, grew 40%, paid in part by the fact that Agent Assistant, what we called -- people also referred to as Copilot, grew [ 152% ]. So very strong growth there.

All right. Wonderful. Maybe let's talk margins for a second now. So you saw this big improvement in gross margin, about 130 basis points, 190 basis points improvement on the operating line. Can you talk a little bit about what were the drivers of margin expansion? And then how we should be thinking about overall margin growing?

Absolutely. So we've been investing a lot over the last few years, marching up market, growing international, and we're now on the downward slope on that. If you take about Q3 in particular, where there was a 190 -- sorry, about 320 year-over-year, 190 sequentially. There were 3 drivers there. The first one, and the most important one, is the scaling against fixed and semi-fixed costs. And if our revenues go up, our margins go up. We see it in the last 10 years in the fourth quarter when our revenue is typically stronger, that subscription margins are the highest. The second reason over here, in terms of gross margin, is that we did have a risk in August, and that's continued in part as well. And then finally, there's a mixed shift, mix away from usage to subscription. And let me just spend actually a little bit of time on this. When we went public 10 years ago, the usage is -- the long-distance telecom limit was 35% of our total revenue. Now it's down, as I mentioned earlier, to 13%. There are 3 drivers for that, but the main one is with bigger customers that we're landing, they bring their own telephony. And so every year with our trail, there's 1 to 2 percentage points from -- in the total revenue from usage. We got lower margins towards subscription, which have margins in the 70s. [indiscernible]. And that has a consistent -- small, but consistent benefit to gross margin. Looking forward, we would see continued improvement. We've indicated that for Q4 and further down the road as well. Our gross margins on the subscription part are in the 70s, which was very comparable to the outcome.

All right. Really helpful. Maybe sticking with some of the metrics. Let's talk NRR, right? So you've seen an improvement in subscription growth, as you've both talked about, but your NRR stayed relatively flat. When can we expect that to maybe inflect positive upwards and maybe even move better then?

Yes. So it stayed flat at 108, as you indicated, on an LTM basis. It's not impacting us at the moment due to the fact that we have a seasonal customer who is somewhat more muted and better that we thought it would be in Q3, but it's still not likely to move again. It's not going to reflect in Q4. In fact, as Mike and I have been saying, there can be a slight decline. But we are in the knowledge that long term, it's going to go up. And why do I say that? So going back to that bigger customers, those customers with $1 million-plus revenue, which is 46% of the total, they have dollar-based retention rates that are meaningfully higher than that 108, and they're growing much faster [indiscernible], say, 100%.

So you mentioned long term, maybe let's go to that. You provided some long-term outlook on the call. What drove the decision to provide that, especially ahead of the Analyst Day rather than waiting for the Analyst Day to provide it?

Yes. I made that comment a few times. And again, we do see a long-term opportunity for very durable 20% to 30% growth in subscription revenue, right? And we just talked about subscription revenue in the quarter was 20%. So we're not talking about a massive leap of faith, but we are talking about that in particular because, again, I think it's important for investors to know how we view this market, whether it's our AI products or our CX platform. We talked about it earlier in terms of -- we're a net winner with this AI-powered customer experience revolution that we're going through. And we think it's important for customers -- for investors to understand that, long term, we're very, very bullish on our growth outlook. This is a massive TAM, still very underpenetrated in terms of cloud replacing on-premise in the core contact center part of the market. AI just adds an additional TAM. On top of that, with our platform, our people, I do believe we're well positioned to take advantage of a great opportunity for many years to come. And again, in a healthy macro, yes, we're doing what we're doing in a pretty choppy macro still. And so that's why we made it happen.

Yes. No, that's helpful. Maybe can you drill a little bit down into some of the macro pressures that you've seen? And when you think about the long-term outlook, are you relying on macro improving? Or is it more you can grow that rate in spite of macro pressure?

Go ahead.

Let me start on that. Yes, it's really very straightforward We all know the fact that the consumer is the bulk of the U.S. economy. We all know the fact that they are using debit and credit cards to moving products again. And you can look at different -- I'm sure RBC has -- they are as well, the one we refer to Bank of America, crystal clear. The transactions are going on a nominal basis, flat to down, depending upon whether you're talking about year-over-year or quarter-over-quarter. And in an environment where transactions are real term, post-inflation, are meaningfully down, you're not going to get a lot of agents. However, when the economy inevitably, at some point, will come back, we are spring-loaded to take advantage of that. Our dollar base -- excuse me, are globally sanctioned and the enterprise is mid-90s. People don't want to do a hard transfer. And they stick around, especially when you got a quality product with a high reliability likewise. And so that will come back at some point. We don't know exactly when. For Q4, which is typically sort of like a hockey stick in the old days when the economy is booming, will go up 8%, 12% sequentially. We are assuming basically a muted seasonality without that hockey stick with time, and we'll see what happens in terms of the actual sentiment. We did survey our customers 2 months ago. We stayed very close to them. And universally, they've taken caution in respect to that.

So now maybe let's bring the growth algorithm and the margins now together. So we used to be a Rule of 40-plus company. I guess, number one, what's your confidence in getting back to that on a long-term sustainable basis? And number two, given investors are increasingly trying to figure out the right way to balance that, how should we be thinking about maybe free cash flow per share growth as being a KPI for you going forward?

Can I start and you back me up on this? But -- so again, Rule of 40, we're, I think, at 35%, right, using EBITDA margin, right? So it's 15% total revenue growth for the quarter. Last quarter, 20% EBITDA margin. We're at 35%. We've been above 40%, as you know, quite frankly. Significantly above 40% during COVID. And we are very confident in the long run to getting back above the Rule of 40. Again, part of this is driven by just unit economics, right? We have very strong unit economics. Our business model has proven that over the years. We've always had a lot of leverage through growth periods. So again, we're pretty confident in that leverage that we're going to get. We've already talked about in our guidance even about profitability the next year increasing. And we're -- again, if you think about what I said before, we have subscription revenue growth, 20% this last quarter in a really choppy environment. We do think, long term, there's upside to that, and it ought to put us well above that threshold in the long run.

And maybe just on the free cash flow per share.

Sorry, with operating cash flow, we had a record. I believe it was around about $41 million. The free cash flow was also a record $22-something million. And on a per share basis, we are pointing to the dilution, which has, overall, been pretty carefully managed by our Board Compensation committee, and was 2.2%, so a very respectable dilution. And then we take a moment to [indiscernible] to talk about the stock-based compensation revenue because there are some people who are not going to invest until we get to a GAAP profitability. Well, the stock-based compensation has come down 8 percentage points from a year ago, 23 to 15. Part of that is the legacy of a transaction that didn't happen and there was a stock award that was not flagged, and there'll be continued responsibility on that. And if we look at the 2 onetime items, the cost of the work and the tax benefit regarding the acquisition, we would slightly be GAAP profitable in Q3 and pointing towards GAAP profitability in our guidance for [ Q4 ].

Okay. Really helpful. I do have a bunch more questions, but I do want to give -- if there's any questions in the field before jumping back in. All right. I'll jump back in then. Maybe I want to go back to talk about AI. So you talked that -- about monetization and there's uplift that you can get from it. How do you think about what that uplift looks like over the long term?

Yes. At the highest level, and we actually put this on our -- in our investor deck. So feel free to look at that. It's on our website, in terms of the TAM expansion related to AI and automation. And it's very simple math. And again, it really comes down to our -- the revenue we get per interaction -- per AI-powered interactions with true self-service versus helping a human engine with more knowledge. So again, if you look, we have actually 10 different AI SKUs across the CX spectrum in our platform. And we're developing additional innovative products, like AI knowledge and AI insights, which are really to help large brands figure out how to go down this AI journey. We also introduced, I should talk about this a little bit, a new program we call the AI blueprint program. And it's really -- our AI experts, we have deployed a lot of AI for some very large brands to help power their CX. And we're leveraging that expertise in a program called AI blueprint, where we're helping our customers and prospects figure out how to navigate this new world of AI. It is very complicated. I think the learning has actually really increased. I think, in Q2, there was a lot of fear in the headlight kind of looks from customers kind of figuring -- trying to figure out how they're going to leverage AI in a practical, high ROI business outcome-driven value proposition at the end of the day. And our AI experts are helping a lot of these customers kind of figure out where to go first, second and third on this AI journey. And it's a big part of our job as a software provider, especially Software-as-a-Service. That as a service is an important component of what we do. We don't just throw technology at our customers, we actually help them figure out how to leverage our platform to deliver better CX, better customer experience for their consumers. Again, whether it's AI-powered or it's human-assisted, their goal is to deliver great CX, but we're all helping them do it at higher efficiency and lower cost. So the ROI, the financial ROI is actually a big part of, to me, what makes this such an exciting period. Because if you look back 5, 6 years ago, our value proposition to a lot of these large brands was, "Well, let's take you off these legacy on-prem solutions and we'll move you to the cloud in a kind of a like-for-like feature set." And it's like, "Okay, well, you're getting rid of some headaches for me. And yes, there's ROI in that." But now with the AI labor arbitrage opportunities and the efficiency gains, there's such a great financial argument to do this and do it quickly. It's becoming a catalyst for new customers for us, and it's playing out great.

All right. Maybe in the minute we have left, how should we be thinking about how AI is going to change the way that you price and the way you sell?

Yes. I think all -- the entire world right now is trying to figure out kind of pricing models for AI. We have -- all of our AI SKUs are available on consumption-based pricing with, in many cases, pre-committed consumption blocks, if you will. And again -- but we've also introduced an opportunity for new prospects as well as our customers to essentially dip their toe in the water with some of our AI solutions and kind of pay as they go in pilots and so forth. So having that consumption-based model, pricing model is really important for them to be able to not have to go look for a bunch of budget upfront, but get started with our AI, even if it's on a small scale, figure out the use cases and the ROI. Prove it. I always say, pilot prove scale. We're helping our customers do that with AI.

Awesome. I think it's a great place to jump off. Mike, Barry, thank you so much.

Thank you.

Thank you, Rishi.