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

Perfect. Okay. Hello, everyone, and welcome to day 2 of UBS's Tech and AI Conference. My name is Taylor McGinnis, I'm head of the apps and SaaS coverage here at UBS. And in this session, we have Five9. So we have Five9's CEO, Mike, and then we also have Five9's CFO, Barry. So Mike and Barry, thank you so much for joining us today.

Thanks, Taylor. Great to be here.

Yes.

Perfect. And before we get started, Barry, I know you have some very important remarks you would like to share with the group. So go ahead.

Thank you, Taylor. But before we start, we want 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 or our company, also product development, AI, automation and potential growth drivers. Such statements are predictions and should not be unduly relied upon by investors. Actual events or results may differ materially. Five9 undertakes no obligation to update any such information. Please refer to our most recent Forms 10-K and 10-Q and the captioned risk factors and [indiscernible] Five9's annual and quarterly reports filed with the Securities and Exchange Commission. Thank you.

Perfect. Very well executed.

I think we're off to a good -- It gives people a chance to get in from the line, yes.

Exactly, exactly. So perfect. Well, let's dive in. I think a good place to start is you definitely saw an inflection last quarter. So you had growth accelerate a point -- 14% versus the 13% growth that we saw in the first half of the year. So maybe you can just talk about what some of the key drivers were behind that?

Yes. Happy to Taylor. And again, the most important metric is subscription revenue. And subscription revenue growth accelerated from 17% to 20%. So 3 percentage points acceleration in subscription revenue, which is 80% of our revenue mix. And really the most important metric that I want to make sure everybody realizes that is the best metric to really determine how many customers are coming on to our platform and how many products they're purchasing from us. So subscription revenue is the key metric. The other 20% of our revenue, as you know, long distance usage, which is not growing, it won't be a growth vector for us, and that's by design. These are large enterprises that are coming on to our platform. Some of them bring their own carrier and -- many of them bring their own carrier, and that's just fine with us. We'll take the subscription revenue, higher margin and more valuable revenue to us. And professional services is the other component. And that also we're going to continue to offload some of that professional services implementation work to third-party partners. And that's also not a major growth vector for us. So again, subscription revenue, 20% growth. Up from 17%.

Perfect. And then in terms of what drove that? So you guys talked about bookings improving in 3Q, relative to 2Q. I know that helped subscription revenue as well. But what were -- what was the catalyst there compared to some of the challenges or hurdles that you guys saw in 2Q?

Yes. Q3 was a much better quarter from a booking standpoint than Q2. And I would say that it was -- that increase sequentially was really driven by some external factors and some internal factors. And -- the -- first of all, the sequential increase was a nice increase. It was above our internal forecast. And that was in spite of a couple of $1 million plus deals slipping into Q4, which I'm happy to say, closed in early October. Which is always a good sign. So our sales execution was really good in Q3. In terms of external factors, I would say two big things came into play. There was this -- I'd say the peak of AI distraction, if you will, in terms of decision-making. A lot of large enterprise brands were still trying to figure out AI. And they were all instructed -- every CEO is telling every CIO, go figure out AI and don't do anything else. And so we -- in fact, I was talking to an industry analyst just yesterday, and she has been covering our industry for decades. And she said the same thing, that in Q2 seemed to be just the peak of this AI distraction and lack of decision-making. And that really cleared up in Q3. And I would say just the macro backdrop, while we're not declaring victory or anything else, we saw less budget scrutiny in Q3 on deals and -- than we did in Q2.

Yes. Let's unpack that a little bit more. So on the latter, when you're talking about, there was a lot of AI creating noise. People are trying to figure out what their contact center states are going to look like going forward, macro playing into that to some degree. But what was the unlock there? Why, I guess, did you see some customers then start to move forward with their contact center plans. And like what changed, I guess, in that quarter?

Yes. I think there was just a -- again, there were some internal things which I'll talk about as well. But AI, we and our customers are finally getting down to brass tacks in terms of practical AI, understanding where to go first, second and third. And a lot of that is kind of our responsibility as the AI vendor and the experts in AI. We've been in AI for -- 4 years ago, we acquired Inference. We were in AI before that. But really got into the AI market 4 years ago. And it's up to us to help navigate this new world of AI for our customers and our prospects. And I think we're helping them do that. And that was part of the internal changes that we've made to really become -- and enable our sales organization, both sellers and sales engineers to be those trusted AI experts. We rolled out a new program called the AI Blueprint, which is more than just a name. It's our consultative approach to helping large brands. First, diagnose their interactions across their customer experience spectrum, diagnose which of those interactions are high-value interactions, which are most suitable to be AI-powered and really use the technology that we have, AI insights, to diagnose and be essentially prescriptive and helping them define that blueprint around which interactions are best suited to take down the AI path versus continue to handle with human agents.

Yes. It makes sense. And let's dive into the sales changes because I know you guys talked about that on the 2Q call, where there were some execution-related challenges. And I know you made changes off the back of that. So can you provide a little bit more color on the changes made? And what then helped to facilitate some of the deal activity that you...

Yes, absolutely. We brought in a new EVP of sales to be a hands-on leader across our entire sales organization. And I shouldn't say brought in, we promoted from within an individual that's been with us 10 years, has been an absolute rock star, rising star in our sales organization, run multiple parts of our sales organization over the years, including our AI overlay sales team when we acquired Inference 4 years ago. So that leadership change is manifested in some significant changes in terms of just re-sourcer or aligning resources across the various segments of our business. And so what we -- essentially, been netted out is we allocate our quota-bearing reps across the various segments of the market, including the mega deals and the -- we call them the whales and the dolphins. So, we essentially have put more quota-bearing rep capacity against the dolphins. And we had too many folks whale hunting, and it's definitely working.

Perfect. And Barry, one for you. Not to get into the nitty gritty of the financials, but I think it's a question worth asking because there was a lot of investor questions that we fielded. But just when you look at the 4Q revenue guide, I know you guys talked about the Acqueon acquisition in 3Q. You said that it was less than 1 point, right, of growth. When you got that, I think you get roughly $2 million. Everyone did the math on $2 million, 1 month, that could be $6 million of revenue in 4Q. You strip that out, it looks like that you would have reiterated the 4Q guide of closer to 9% growth. Now, since talking to you guys, it sounds like there were some nuances there. So do you just plan on providing some clarity for the group and the puts and takes in the 4Q guide and maybe what's implied with the Acqueon acquisition?

Absolutely, Taylor. Thank you. And one of the hallmarks of your coverage is precision. And I'm glad you said less than 1%. We didn't say how much less. That being said, it's really important to understand, we have been reselling Acqueon for quite some time. And to make this concrete in your mind, I'll just give you the three recent examples. In Q1, a major deal with that financial services company, one of the biggest deals ever featured Acqueon quite prominently. In the second quarter, one of the deals we talked about on the call, this company that helps universities and colleges raise money and recruit and enroll, Acqueon was prominent in that as well. And then the biggest deal that we talked about in the third quarter was an Acqueon company deal as well, PIO Acqueon. So this is a hybrid revenue and we don't plan to continue to give the distinction. It's -- for us all grits to the meal.

Perfect. Appreciate all the clarity and thoughts there. Maybe turning to the growth framework and the growth that you guys are seeing today. I think one question that we get from investors is why's Five9 not growing faster, right? So you obviously felt like a really nice acceleration that you mentioned on the subscription revenue side going from 17% to 20% and I know there's puts and takes, right, with professional services and some of the usage revenue. You guys have had such tremendous deal activities that you've announced in the past. So why is that? Is it a function of the macro? Is AI still maybe creating noise amongst your customers? Is there still improvements to be had on the sales marketing side? Maybe there's less mega deals than before. Is there anything that you would attribute that to? And maybe it's just a matter of time, but would love to get your thoughts there.

Yes. Again, Taylor, as I said, 20% growth in subscription revenue is the key metric to pay attention to. And macro has definitely affected our installed base expansion. Again, in contact center and customer experience, it is a real-time indicator of the macroeconomic conditions relative to discretionary spending and transaction volumes. So we're very tied -- our business is very tied to the macro. But -- and again, if we're assuming kind of steady macro over the near term and long term -- not long term, but near term. And we have said this before. When that macro turns, we're spring-loaded for growth from our installed base. But at the same time, I was so impressed with our ability to continue to knock down a lot of dolphins in the quarter. The whales are going to be -- the pipeline for these mega deals is very, very good. They're going to be intermittent. They're going to be a little lumpy. We've still got a very impressive backlog, that large financial institution that we closed in Q1, we've said will not start to generate subscription revenue until 2025, and that will be a multiyear journey. But the most important thing to focus on from a day in and day out revenue growth standpoint really is -- are the dolphins. And that's what I talked about earlier about our sales quota-bearing reps and the realignment around the dolphins because that is the meat of this market. It's a bell curve like any market. The mega deals are up here on the tail. But that middle of the bell curve are those $1 million to $5 million customers. And again, we've talked about it, 56% of our recurring revenue comes from $1 million plus customers, $1 million plus ARR customers. So -- and that is a very rapidly growing part of our business. So it's becoming a more meaningful portion of the business, and it's growing much more rapidly, did we disclose. . .

29%

29% growth in the $1 million-plus category. So lots of goodness.

Perfect. I appreciate all the color. And, Barry, maybe in terms of how that go -- like equates into the guide. So when we think about the 4Q guide, it implies like 1% quarter-over-quarter growth, which I think is a little bit weaker than what we've seen in past 4Qs.If we look at the initial guide for next year, I think you guys have been talking maybe something closer to 10%, which a little bit lower than what we've seen as an initial guide. So in terms of what is being embedded in that, like when will we start to see some of these amazing tailwinds that you guys are talking about really start to offset some of the headwinds? Maybe it's just conservatism. But Barry, can you provide any thoughts on what led to those initial assumptions?

Yes, absolutely, Taylor. So our industry, across the entire U.S. economy, it's a very horizontal industry, very much tied to transactions. And we put a lot of store with the debit and credit card spending because it tracks our internal spending by month as well pretty much. And the evidence is blindingly clear. We -- when you look at JPMorgan, we don't have it UVS, but we have Bank of America. And they show the dividend in credit card spending. And we're talking about basically 2/3 of the economy, most of which is done on credit and debit card spending. And it's in nominal terms, bouncing around the bottom. And for us, we didn't want to have any leaps of faith in terms of what the seasonality might be. We always have some degree of seasonality. We also surveyed our customers, and they came back pretty strongly in saying we're not seeing that bigger seasonal uptick. So given that, we took a muted response and hence, the 1% that is indeed less than we normally have, we haven't got that hockey stick that we customarily had before. And for next year, we're assuming similar macroeconomic conditions. We're busy working on our numbers for next year. We were comfortable with the Street number which did have a 10% increase. And we'll see what happens when we finish our numbers. And we know what the December jump off point is for the rest of 2026 -- 2025.

Perfect. Now let's shift gears because this is an AI conference, let's talk about AI. So there's been a number of software companies that have introduced their own flavor of AI agents. You've had the CRM players do it, obviously, the contact center players, there's private companies. We hear companies doing DIY, right, agents and building it themselves. So in terms of when you look at Five9's IVA offering in terms of who you guys typically go head-to-head with, what does that -- what does that look like?

Yes, great question, Taylor. And again, it's important to understand that -- CRM is a great example, right? The CRM vendors, including Salesforce, Salesforce is a great partner to ours -- to us. And at the end of the day, to run a customer service organization, a contact center, you have to have two critical components. You have to have a CRM system as a system of record and you have to have a contact center routing solution like Five9. And we are in so many joint opportunities with Salesforce, ServiceNow, Zendesk, other CRM vendors. In the end of the day, customers want to purchase their AI solutions predominantly from their CCaaS vendor, predominantly because of the contextual data that becomes available within our platform that is not available in other platforms. So you have to have -- your AI is only as good as the contextual data that powers the AI, including real time interaction data. Our -- for example, our Global Voice Network, right, which powers live communication, real time interactions, in and out of contact centers, in those cases where AI might get purchased by another vendor, whether it's a CRM vendor or a point solution. They still have to connect to our platform. And we monetize that with voice stream and transcript stream, and these are not insignificant revenue opportunities for us. These are expensive solutions, which we're monetizing in a very handsome way, when a third-party AI solution is being used. And that's something I think it was a little confusing to people. It's not like kind of either/or, it's -- look, at the end of the day, we -- as a good partner to Salesforce and other CRM partners, we're going to do whatever is best for the customer. It's usually going to be a hybrid of their AI and our AI. Today, it's predominantly our AI because they're still maturing their solutions and just coming out with them. We've been in this market for a long, long time. But even over the -- as time goes on, most every brand has multiple CRM platforms. They've got Salesforce over here. They've got Dynamics over here. They've got ServiceNow over there and homegrown CRM systems. They want AI to work the same way, consistently, across those heterogeneous CRM environment. And they want the contextual data from our platform, whether it's real-time interaction data or it's all the integration to other back-end systems that come with our platform. So we're in a very good position. And in those cases where a third-party AI solution is purchased or is already in use, they have to connect to our platform, and we monetize that significantly.

Yes. This is something that we picked up in our own work, and I would agree. I think this is something that's gotten lost in the shuffle that's really -- that's a really interesting opportunity for you guys. So could you maybe elaborate a little bit more on that? So, for instance, is there some level of seat compression that, let's say, you could see that you guys would be comfortable with because the opportunity maybe with some of this data ingestion or your other AI offerings would be enough to offset any of that pressure? And I don't know if you've given anything on pricing or what that could look like, how that might compare to the opportunity that you have with your own IVA offering. Just anything to help provide more color on that.

Yes. I would just say this, that the voice stream, transcript stream opportunity for revenue for us is actually a very significant offset to any of the AI software that might be coming from another vendor. And at the same time, look, it's a TAM expansion for us. All this is a TAM expansion. And look, there's a business case that most brands are using to talk about labor arbitrage and the deflection to AI and self-service. In the end of the day, our customers are telling us that they want to do this on the margin. They're not trying to replace a large percentage of agents. They're trying to take the right percentage of interactions and have them be powered via self-service, predominantly our IVA or our DVA. AI agents as we're calling them now. But even in those cases where it might be done by a third-party point solution or a CRM AI solution, that monetization of voice stream and transcript stream, we're not quantifying it, but we -- it's a very significant offset.

That's helpful. And then a two-part question for you would be, one, I know historically, you guys have had a really good relationship with Salesforce. And there's a lot of focus amongst the investment community on agent force. So just in terms of what that means for your partnership going forward, does that mean you guys might cross paths more? Is it actually a bigger opportunity for you guys? I would love for you to unpack that. And then this is the second part. I think also, too, what sometimes gets lost in the shuffle is that AI doesn't just mean agents, right? There's a lot of opportunity with sentiment analysis and intelligent routing. So in terms of those other AI offerings, like what are you seeing on adoption from those?

Yes. So first off, this opportunity for us to partner with Salesforce. And let's say, again -- I mean, look, they made it very clear agent force is very front and center for them. And that's a great thing for us. We are -- they're leaning into our partnership more heavily since that announcement. They know that we -- they need to work with us to really achieve that vision. And it's -- not just because they're just getting started in AI, but they know that from the customer's perspective, that customer wants a full AI offering and a full solution across all interaction types, not just digital, but voice AI agents as well. Which they're not quite there yet, and they will be there over time. But there's all these other SKUs that we talk about. We've got more than just IVA and DVA. We've got eight other SKUs, whether it would be workflow automation, AI Insights, which is this kind of diagnostic solution, AI Knowledge, AI Summaries. There's agent assist. There's just a lot of other AI solutions that we're monetizing and are a huge TAM for us besides just AI agents. So I think it's important for people not to over-rotate on just AI agents. It's an important part of self-service. But in the end of the day, customer interactions are going to be handled across a spectrum, there's going to be some percentage that are truly fully contained self-service? Our customers are still telling us that they want that to be a marginal percentage, let's put it that way, not a majority or anything close to it. And there's in-between where you might start in a voice spot or a digital bot and then have to escalate the voice. And then there are human agent handled transactions or interactions that are actually helped by AI, and we provide solutions across that entire spectrum. And the best way to think about Five9 is we provide software for interaction management whether it's AI handled, a hybrid or a human handled. So we're kind of benefiting in all of the above.

Perfect. And last AI question for you. I know it's the one that you guys get asked all the time, but I'm going to ask it anyway, which is just on seats, right, and the risk there. So I know you guys have said multiple times that you aren't seeing -- seat compression with -- driven by AI. But I guess how could you be certain, right, of that? And when you speak with your customers, is there a risk of that going forward? And what gives you guys the comfort that there's enough opportunity in what you're seeing to have an offset to that?

Yes. Yes, that's a really good question, and I know it's top of mind. And I think it's important to understand that, look, we talk to our customers, we've said this before. Every year -- just about every year, we talk to our. . . .

Yes.

. . . and how much capacity they need to add to their contact center because of their seasonal businesses. And they give us the reasons why they're either growing faster or slower than last year. And the ones that we're growing that are planning to grow slower in terms of their expansion with us, are -- they've told us flat out what the reasons are, and there weren't any that said, well, we're replacing humans with AI. It was all macro, macro, macro. And -- but at the same time, we should be clear. There is a very good business case here. And it's part of the way we're positioning our AI solutions as a labor arbitrage opportunity to grow your agent population less on the margin by deflecting a certain percentage of interactions to self-service. And that's a win-win. It's -- we call it the new CX. It's the best of all worlds for these enterprises because they can deliver a great customer experience, but also get the cost savings and that ROI of deploying our AI software instead of an extra agent. The labor savings, it's about a 10:1 cost equation. So in other words, 10 times as much for the labor as it will be for the AI software to handle those interactions. Now the question is still how many interactions can be handled by AI? And the more -- actually, the more interactions that can be handled by AI, that's actually good for us. Believe it or not because, again, we've got software to power those AI interactions as well as the human interactions.

Perfect. Appreciate the color. Now let's spend a few minutes on margins. So margins have been roughly -- at least on adjusted EBITDA has been roughly flattish in the past couple of years, but that seemed to -- there seemed to be a turn this last quarter. Yes?

It's just 320 basis points.

Yes. This last quarter, it just seemed to inflect. So maybe let's start top to bottom. So when we think about the gross margin. So there was a 130 basis point sequential improvement. Barry, can you unpack what were the drivers of that? And how do you think about that momentum going forward?

Yes. So in terms of Q3 in particular, three drivers. The first one is stronger revenue, it always works against fixed [indiscernible] fixed costs. You get higher margins. If you look at the last 10 years when the fourth quarter subscription margins, one exception, a special case. It's always highest in the fourth quarter when the subscription revenue is the highest. The second thing is we did do a RIF in August. It impacted people in that -- get charged to cost of revenue, and that was the second factor. The third one is interesting, and we haven't emphasized this enough. We've mentioned it, but we haven't explained. The third factor is the mix shift away from that usage revenue that Mike talked about earlier at the outset to subscription. So every year without fail, between 1 to 3 percentage points will shift up into subscription because these bigger customers, they bring their own telephony. They don't need out. And given the margin differential for -- in the 50%'s usage in the 70%'s for subscription, it gives you a little bit of a lift there as that progression takes place in Q3, that was the third factor. Looking longer term, we've got a number of things going. There's -- we've broken the back of some of the international investments that we've had to do to go quickly abroad, now it becomes more of optimization. We still have Asia ahead of us. But the main item, including, in particular, India is now behind us. We've also got some initiatives in professional services, only 8% -- 7% of our revenue. But we can do better change order management, lower cost in areas and express deployment. So we're pretty optimistic overall about being able to continue to do what we said we would do, which is higher gross margins even in Q4 and then higher still next year.

Perfect. And then in terms of OpEx, can you maybe talk about some of the drivers there? So you had 190 basis points of sequential improvement on operating leverage. So what does that look like?

Yes. So the 190 bps was driven by sales and marketing, which was actually 220 basis points better. Part of that was clearly also the impact of the RIF. And it will be lumpy because there are events and so on. But at the end of the day what that comes down to is not so much reducing the amount of spending. But as Mike likes to point out, getting the dividends from the concrete changes that have been made in go-to-market execution, we're going to see the results of that. We already are, and we expect to continue to see that further next year. Let me just touch on the other important part, which is R&D. There, we were basically zero sequential. Here, we have the benefit of the lower cost geographies, in particular, in Porto -- our European Innovation Center, we basically doubled our headcount there in the last year, tripled over a little bit longer period. And now, through our Acqueon acquisition, the sort of cherry on the top is that we can also now do India as well. So moving to a lot of cost geographies for R&D.

Perfect. And last one for you, Barry. But what does this all mean for cash flow? So when you think about the leverage that you're seeing on adjusted EBITDA and how that can -- how that translates to cash flow, any last minute thoughts you'd like to share there?

Yes, absolutely. Real quick. We were very pleased with the operating cash flow record we had in Q3, $41 million, free cash flow, $21 million. We're going to be focusing more and more on that. We currently -- if you look on an LTM basis, around about $1 per share in free cash flow. We're not where we would like to be, but we're getting there.

Perfect. Awesome. Well, that's all we have time for. So thanks, everyone, and on for listening in, and let's give Mike and Barry around of applause.

Thanks a lot. Thank you, Taylor.

Thank you.