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Five9, Inc. (FIVN)

Q3 2015 Earnings Call· Tue, Nov 3, 2015

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Transcript

Operator

Operator

Good day, ladies and gentlemen. And welcome to the Five9 Incorporated Third Quarter 2015 Earnings Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Mr. Tony Righetti. Please go ahead, sir.

Tony Righetti

Management

Thank you, Operator. Good afternoon, everyone. And thank for joining us on today’s conference call to discuss Five9's third quarter 2015 results. Today's call is being hosted by Mike Burkland, CEO; and Barry Zwarenstein, CFO. During the course of this conference call, Five9's management team will make projections and other forward-looking statements regarding future events or the future financial performance of the company. We caution you that such statements are simply predictions, should not be unduly relied upon by investors and actual events or results may differ materially, and the company undertakes no obligation to update the information in such statements. These statements are subject to substantial risks and uncertainties that could adversely affect our future results and cause these forward-looking statements to be inaccurate. A more detailed discussion of certain of the risk factors that could cause these forward-looking statements to be inaccurate and that you should consider in evaluating Five9 and its prospects is included under the caption Risk Factors and elsewhere in our filings with the Securities and Exchange Commission. In addition, management will make reference to non-GAAP financial measures during the call. Management believes that this non-GAAP information is useful, because it enhances in understanding of the company’s ongoing performance and Five9 therefore uses non-GAAP financial information internally to evaluate and manage the company's operations. This non-GAAP financial information should be considered along with and not as a replacement for financial information reported under GAAP and could be different the non-GAAP financial information provided by other companies in our industry. The full reconciliation of the GAAP to non-GAAP financial data can be found in the company's press release issued earlier this afternoon and available at www.five9.com. Now, I’d like to turn the call over to Five9's CEO, Mike Burkland.

Mike Burkland

Management

Thank you, Tony. Welcome everyone to our third quarter 2015 earnings call. We are very pleased to report results for the third quarter that once again exceeded our expectations across all key metrics. Total revenue for the third quarter was $32.3 million, up 25% year-over-year, the third consecutive quarter of mid 20s growth. This revenue growth is all organic and is a blend of our faster growing enterprise business and our slower but steadily growing SMB business. Our solid topline growth was complemented by a significant improvement in our EBITDA margin of nearly 1,600 basis points from a year ago. Bookings were another key highlight as we set a third quarter record. Given our strong results, we are increasing our revenue and bottomline guidance for the year. In addition, we are pulling in our EBITDA breakeven target from Q4 of 2016 to Q3 of 2016. My focus today will be on our faster growing enterprise business since it is where we are concentrating our investments and generating most of our growth. The enterprise market has significant ongoing growth potential for Five9. Cloud penetration is under 10% and it is a huge market opportunity. Huge in the sense of there are 14.5 million agents around the world with an estimated available market of 22 billion in annual recurring revenue. The vast majority of which is in the enterprise market, which again is our focus. Now let me share with you three key metrics that highlight our increasing traction and success in the enterprise market. Number one, our win rate against two key cloud competitors was once again over 70% in the quarter. Number two, our LTM enterprise subscription revenue growth has grown 35% year-over-year. We believe that this is a key metric that reflects the payoff from our ongoing investment in…

Barry Zwarenstein

Management

Thank you, Mike. Revenue for the third quarter of 2015 was $32.3 million, up 25% from the third quarter of 2014, reflecting the strong growth in our enterprise business. Recurring revenue accounted for 96% of our revenues in the third quarter of 2015. Recurring revenue is made up of monthly software subscriptions, which are based upon the number of agency plus usage which is based upon minutes. Please note that we enjoy a high retention rate on these recurring revenues. In the third quarter of 2015, our annual dollar-based retention rate on recurring revenues was 95%, up from 94% in the second quarter 2015 driven by meaningful increase in the enterprise component of the calculation. As a reminder, this retention rate is a blend of the higher retention rate from enterprise business which is over 100% and a lower retention rate from the SMB business, which is less than 100%. The other 4% of our third quarter revenue was comprised of professional services fees generated from assisting clients in implementing and optimizing the Five9 Solution. Non-GAAP gross margin adjusted to exclude all non-cash charges was 59.4% for the third quarter 2015 compared to 53.3% for the same period of 2014. Adjusted gross margin improvement was driven by both subscription and usage. Subscription margins continue to improve due to the benefit of higher subscription revenue growing against the base of largely fixed or semi fixed cost and usage gross margins continuing to expand from our ongoing success with the implementation of least cost routing. Please note that we have increased gross margin sequentially in 13 out of the last 14 quarters. Building on this trend, we remain confident in our ability to reach our long-term model for gross margins of 65% to 70%. It is important to point out that while…

Operator

Operator

[Operator Instructions] We will take our first question from Michael Huang with Needham and Company. Please go ahead.

Michael Huang

Analyst

Thanks very much. Good afternoon, guys. Good afternoon. Just a couple questions for you. Just in terms of the record Q3 bookings, great to see that. I was wondering, I mean, what ultimately is driving that? Is that just the ramp of kind of enterprise sales, or were there any kind of elephant size deals out there that help contribute to this?

Mike Burkland

Management

Hey, Mike, great questions. So yeah, we had a record Q3 from a booking standpoint and it is being driven by enterprise bookings. And I highlighted earlier on the call a couple of large wins we had that were over $1 million in annual recurring revenue. So we continued our move upstream, up market and doing larger and larger transactions with very large enterprises. And I also mentioned, those employee counts for a reason to help people really understand the size of these enterprise accounts we’re closing.

Michael Huang

Analyst

So I guess I can confer from the commentary that the average deal size, maybe the average count for some of your enterprise deals is continued to grow. Just for help trying to quantify, is there any way that you can help us compare from just kind of seek count standpoint average or deal size average, what is it now versus kind of what it was a year ago?

Mike Burkland

Management

Yeah, I would point back to the metric we gave at the end of 2014, Mike, which was our average deal size for all of 2014, which was $350,000 in annual recurring revenue. We will release that metric on an annual basis.

Michael Huang

Analyst

Okay. Got you. Great. I will turn it over. Thanks.

Operator

Operator

We will take our next question from Sterling Auty with JPMorgan.

Sterling Auty

Analyst · JPMorgan.

Thanks. Hi, guys. Drilling further in on that enterprise piece, you mentioned the win rates in terms of cloud providers. But just any sense of you know has there been a change in the competitive dynamic, maybe some of the traditional on-premise players not faring as well and some of the new RFPs etcetera that’s allowing you to have a better hit rate or just the cloud providers as a whole may be picking up incremental traction in the opportunities that are out there each year?

Mike Burkland

Management

Yeah, Sterling, great questions. So yeah, I would characterize the competitive landscape a couple ways. First of all, premise vendors are actually doing less than we expected them to do at this point. The Avayas and Genesys of the world have had a really, really hard time moving to the cloud quite frankly. They're just not there yet and it's showing in our new wins against those guys and our ability to rip them out and replace them in large enterprise deals, which for the most part are majority of the enterprise wins that we have. I would also say that on the cloud side, we continue to extend our leadership position. We've got a couple of key competitors in the cloud that quite frankly have stumbled from an execution standpoint. And if you look at how they’ve stumbled, it really comes in a couple of flavors in terms of not being able to deliver latest technologies and also tripping up in terms of the implementation and support. And we've won a lot of deals recently because of those two elements against those key cloud competitors. As I noted earlier, win rates against them, against each of them was north of 70% in the quarter and we feel great about where we are competitively.

Sterling Auty

Analyst · JPMorgan.

And when you look at the -- you mentioned you had the total opportunity, the $14 million, when you think about the number of agents that each year see their systems come up for renewal, upgrade etcetera, how would you characterize kind of where we are in terms of, what percentage of that installed infrastructure has at least made a decision within the last year or two to either continue with on-premise or move to the cloud and what might be there in front of us for the next year or two in terms of the opportunity?

Mike Burkland

Management

Yeah, really helpful questions certainly for everybody to understand the size of this market, 14.5 million agents around the world. Analysts estimate that the cloud penetration is still under 10%. There is a technology refresh cycle that’s underway that is typically seeing most of these on-premise solutions turnover about every 8 to 10 years. But quite frankly, it's just a huge, huge opportunity and most of it’s still ahead of us. We view ourselves in the first inning of a nine inning ball game.

Sterling Auty

Analyst · JPMorgan.

And then last question when you talk about the seasonality for the fourth quarter, the retail higher education etcetera, is there some additional color you can give us in terms of what part or what percentage of the business is represented by those types of industries that will have the seasonal uptick so we also frame the right expectations for the March quarter as you go off of that seasonal high?

Mike Burkland

Management

Yeah, Barry, correct me where I'm wrong here if I misquote this, but I would -- we’ve talked about this in the past, Sterling, in terms of the percentage of healthcare, for example that's -- the percentage of our business that comes from that industry, it’s typically in the mid to high single digits as a percentage of our overall revenue. And when we talk about seasonal patterns in our business, I would say healthcare is one of the bigger drivers of that. And that's pretty much the majority of seasonal fluctuations in our business. I hope that you captures it.

Sterling Auty

Analyst · JPMorgan.

Yeah, that’s pretty much spot on. All right. Great. Thank you, guys.

Mike Burkland

Management

Thank you.

Operator

Operator

We’ll take our next question from Raimo Lenschow with Barclays.

Harry Heyer

Analyst · Barclays.

Hey, guys. This is Harry Heyer on for Raimo. Thanks for taking the question and congrats on the quarter. So just thinking a little bit more into the enterprise, which obviously is a focus for this quarter, some solid results there. You talked a little bit about better results but from kind of putting competition aside, would you say that you've seen a palpable improvement in the broader demand environment for cloud contact software in that segment? Is there just better acceptance? And on the flipside, you talked a little bit more about the enterprise sales effort being more efficient, actually when you're talking about expenses. But would you say that may be you're just doing a better job of penetrating the existing kind of willing enterprise customers for lack of a better term?

Mike Burkland

Management

Yeah. Good question, Harry. So we are definitely seeing acceleration in just overall demand for cloud by large enterprises. The best evidence of that is the size of a couple of those deals that I mentioned earlier on the call. We have climbed the ladder over the years and are just doing larger and larger transactions. And to me, those were all additives. So as the higher seat count opportunities open up the cloud, that just accelerates the adoption of cloud in the enterprise market overall. So all-in-all, we see a great trend. We see an evergreen opportunity ahead of us for multiple years, but it's getting better and better each quarter, which is great to see.

Harry Heyer

Analyst · Barclays.

Great. Thanks.

Operator

Operator

We’ll go next to Nikolay Beliov with Bank of America.

Nikolay Beliov

Analyst

Hi. Thanks for taking my question. Barry, nice to see an uptick in the retention rate, historically used to be 95% now, historically used to be 100% plus, what would take to get it back to those historical levels?

Barry Zwarenstein

Management

Yes. So as we’ve explained in the past Nikolay, the deep climate we did report in previous quarters on the dollar-based retention rate to simplify it was largely due to two factors. The first one is we had this large customer, who is still a great customer of ours, who took the international revenue elsewhere and technical the Affordable Care Act, which is now become considerably muted and so both of those are out of the base. And you’ve seen an inflection point this quarter. And given that our dollar-based retention rate is a blend of the enterprise as I mentioned in this prepared remarks of over a 100%, solidly other a 100% and SMB, which is below a 100%, you over time and not maybe every single quarter are going to see dollar-based retention rate start to increase and then get back over a 100%.

Nikolay Beliov

Analyst

Thank you. And Mike, can you please talk about the Freedom release, why this release is important, give us more specific about increasing functionality and how that is helping your competitiveness in the marketplace?

Mike Burkland

Management

Yeah. Nikolay, Freedom has been a great milestone for us. It really is centered around the agent experience and our core belief is that the customers, the end customers experience is driven by the agent experience. And our Freedom release allows agents using our system to really have one single application, one single desktop instead of swivel chairing between different applications with all the information they need at their fingertips, contextually at their fingertips through all the, sorry, all the communication channels that gives them a full view of the customer's entire history. So we also guide the agent through these solutions to help that customer resolve issues. And in end of the world, end of the day, excuse me, what we deliver is a better customer experience for our customer’s customer and the Freedom release is all about delivering on that promise. So it's been a very innovative release for us and a big milestone for the company.

Nikolay Beliov

Analyst

Okay. Thank you.

Mike Burkland

Management

Thank you.

Operator

Operator

[Operator Instructions] We’ll take our next question from Brendan Barnicle with Pacific Crest Securities. Please go ahead.

Brendan Barnicle

Analyst · Pacific Crest Securities. Please go ahead.

Thanks so much, guys. Mike, you mentioned that one of the big new enterprise customers were still going to go direct to their carrier? Is that a trend that you guys are seeing more and will that remove some of that variability out of those enterprise contracts?

Mike Burkland

Management

Yeah, Brendan. We don't see it as a large trend but it’s the exception not the rule so to speak. Our attach rate for long-distance service or usage revenue as we call it with our subscription or software revenues is approximately 90%. But as we continue to do large enterprise deals, sometimes those enterprises are going to opt to continue to buy long-distance service from their existing carrier. And there's a little bit of a silver lining here in that. Our gross margins on subscription are obviously, well higher than the gross margins we get on usage revenue. So we do see it. We don't see it in a large percentage of deals. But assuming it happens as more as we move upstream into larger and larger enterprise deals. That will gradually shift the mix more towards subscription and less toward usage.

Brendan Barnicle

Analyst · Pacific Crest Securities. Please go ahead.

Great. And then, Mike, can I -- we also had a bunch of other test companies report, everybody had good numbers, might be raises variety of different sectors and verticals. Is there anything you guys have been seeing just more broadly around apps purchasing or recent applications beyond just typical seasonality that might explain this kind of real resurgence of strength we’re seeing across everybody tonight?

Mike Burkland

Management

Yeah. We agree. We see the same thing and I think, again, if you look at our ecosystem of partners, the CRM vendors like Oracle and Salesforce, most specifically, their momentum in the market in terms of taking enterprises off of legacy solutions and moving their CRM to the cloud. As you know, our contact center solution is tightly integrated with those CRM solutions. It’s a great driver of business for us. We’re just seeing an up-tick in activity in cloud CRM adoption and we’re getting pulled into more and more opportunities by those ecosystem partners like Oracle, Salesforce, Zendesk. So, I think, overall, the cloud and SaaS, the traction in the industry is really, really good and we’re benefiting along with everybody else.

Brendan Barnicle

Analyst · Pacific Crest Securities. Please go ahead.

Terrific. Thanks a lot guys.

Mike Burkland

Management

Thank you.

Operator

Operator

We’ll take our next question from DJ Hynes with Canaccord. Please go ahead.

DJ Hynes

Analyst · Canaccord. Please go ahead.

Hey, thanks guys. Mike, I wonder if you could talk a little bit about what you’re seeing in terms of implementation in timeframes, I mean time to live is obviously a strength for you guys. I think historically you’ve talked about less than 90 days getting customers up and running. We’ve had a string of quarters here with record bookings. So have you been able to keep up with that strength? And then maybe specifically, you can talk about this Fortune 500 final win. What the expectations are on that front with them?

Mike Burkland

Management

Yeah. Happy to do so, DJ. So our implementation times, we monitored very, very closely. They have continued to be in the 60 to 90 days range, which as you pointed out is a key strength of ours compared to some of our competitors, even our key cloud competitors. When you look at the Gartner Magic Quadrant that recently came out for contact center as a service was the first report by Gartner on our space if you will on the cloud contact center space. We were positioned as a leader but not only that, we were positioned as the highest vendor on ability to execute. A big part of there -- they’re recognizing us for our ability to execute is just that our ability to implement and support large enterprise customers, not just from a timing standpoint and time to revenue but just doing it successfully. We thought executed the competition in this regard and I think it's a great validation of that track record.

DJ Hynes

Analyst · Canaccord. Please go ahead.

Yeah. Got it. And then I guess maybe on how you’re thinking about international expansion? I guess, it's been coming up in a year since you guys figured data centre in the U.K. I mean where are we in terms of putting kind of sales feet on the street in Europe and how you’re thinking about that as ‘16 comes in the view?

Mike Burkland

Management

Yeah. Internationally, we've now put our first part if you will, of sales folks and supporting cash into the U.K. office and it’s going very, very well. I will say this, if you look back at the prepared remarks that I commented on earlier couple of those large deals, lot of our deal traction is for multinational presence by enterprises that are even based in the U.S. So that international presence is really geared to our two things, one, which is penetrating that local European market and two, supporting our multinational U.S. based enterprise customers. And I would say, we’re executing very, very well on both those fronts.

DJ Hynes

Analyst · Canaccord. Please go ahead.

Got it. Great. Thanks for the color.

Mike Burkland

Management

Thank you.

Operator

Operator

Ladies and gentlemen, we have no further questions in the queue at this time. I’d like to turn the conference back to management for any additional or closing remarks.

Mike Burkland

Management

Well, thanks everyone for joining us. Another exciting quarter for us and we really appreciate you being with us today. We’re extremely enthusiastic about our continued momentum in the enterprise market as we march into ‘16 here. So thanks for the time today and we’ll be in touch shortly.

Operator

Operator

Ladies and gentlemen, this concludes today's conference. We appreciate your participation.