Good day, and welcome to the Five9, Inc. Q2 2016 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Tony Righetti. Please go ahead.

Thank you, operator. Good afternoon, everyone, and thank you for joining us on today’s conference call to discuss Five9’s second quarter 2016 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 this call. Management believes that this non-GAAP information is useful, because it can enhance an 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 than 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 on the Investor Relations section of Five9’s Web site. Now, I’d like to turn over the call to Five9’s CEO, Mike Burkland.

Thank you, Tony. Welcome everyone to our second quarter earnings call. Our second quarter results were truly outstanding with further acceleration on the top line as our revenue growth increased 28% year-over-year, resulting in record revenue of 38.9 million. This revenue growth was driven primarily by the continued acceleration in our enterprise business, which delivered 41% growth in LTM enterprise subscription revenue. Furthermore, we continued to enjoy exceptional leverage in our business model, resulting in record adjusted EBITDA of 2.3 million. Since our IPO eight quarters ago, our adjusted EBITDA margins have increased by nearly 34 percentage points to 6% in the second quarter. This trajectory gives us confidence in our intermediate-term goal of 20% plus adjusted EBITDA margins. Our results continued to be driven by our strong enterprise gains, which deliver high marginal profitability. We are also pleased to report our first quarter of positive non-GAAP operating income, our second consecutive quarter of positive operating cash flow and our third consecutive quarter of positive adjusted EBITDA. We believe we are still in the early days of a massive push towards modernization of customer service and contact center technologies. Given our leadership position in this market and the strong momentum in our business, we are raising 2016 guidance. I’m also extremely pleased that our bookings and pipeline reached new highs for both enterprise and commercial. Our exceptional bookings were again driven by continued sales execution by our direct sales force, coupled with the increasing leverage we are getting from our expanding ecosystem of partners, including CRM vendors, resellers, master agents, referral partners, systems integrators, VARs and ISPs. This expanding ecosystem of partners influenced more than 45% of our enterprise deal flow in Q2. Our recently expanded channel program is yielding significant tangible results and is exceeding our expectations. For example,…

Thank you, Mike. Revenue for the second quarter of 2016 was $38.9 million, up 28% year-over-year. This growth is all organic and reflects the continuing strong growth in our enterprise business that now makes up 66% of LTM revenue. Our commercial business, which represents the other 33% of LTM revenue continued to deliver steady and consistent growth of around 10%, as it has for many years. Recurring revenue accounted for 94% of our revenues in the second quarter of 2016. Recurring revenue is made up of monthly software subscriptions which are based on the number of agencies, plus usage which is based upon minutes. We enjoy a high retention rate on these recurring revenues. We are pleased to report that our annual dollar-based retention rate in the second quarter increased to 100%, our fourth sequential quarterly increase and up from 94% in the second quarter of 2015. The other 6% of our second quarter revenue was comprised of professional services fees generated from assisting clients in implementing and optimizing the Five9 solutions. I will now discuss gross margins and expenses, both of which I will address on a non-GAAP basis. Gross margins of 61.9% were up 50 basis points sequentially, up over 300 basis points versus the second quarter of 2015 and up 1,000 basis points versus the second quarter of 2014. Gross margins on our recurring revenue increased sequentially, mainly due to leverage on the cost of subscription revenue. Professional services margins, while still negative, also improved sequentially, helped by higher revenue which was sufficient to overcome the increased hiring we are doing in this area to build and train a talent pool to meet the demands of our enterprise customers. We expect gross margins to remain at approximately this level in the current quarter and increase modestly in…

Thank you. [Operator Instructions]. We’ll go first to Richard Baldry with ROTH Capital.

Thanks. Given one of your primary competitors was acquired recently, could you talk maybe about any changes to the competitive landscape you’ve seen since then, sort of in head-to-head engagements or the amount of times you’re seeing them in deals versus prior to the acquisition? Thanks.

Yes, sure, Rich. It’s an interesting time in our space and I think the acquisition of one of our competitors recently I think in general shines a nice spotlight on our space. From a competitive standpoint we view this as a very, very positive development. It’s not often that a company’s acquired that doesn’t get distracted and end up losing people and partners and customers through that process. So we’re already seeing the beginning of the benefits of that transaction and I expect most of the benefits to actually be in the future. But we think from a competitive standpoint, this is a very good development.

And then just on the new revolver facility, can you talk about if there is any restrictions on that in terms of your flexibility now, whether it may be improved to do acquisitions and fund it either out of that facility or out of cash, but with no need to hold certain amounts of restricted cash against those balances? Thanks.

Yes. So, Rich, we’re very happy with our new facility. We do have two covenants in there, liquidity coverage ratio and a minimum cash and undrawn portion of the revolver commitment of at least $25 million. We have done these models very carefully and we have more than ample room to meet those covenants. In terms of the specific question with respect to flexibility and acquisitions, that is identical to what it was before.

Great. Thanks and congrats on a great quarter.

Thank you.

Thanks.

We’ll go next to Raimo Lenschow with Barclays.

Hi. Congrats on a great quarter. I had a couple of questions. First of all, Mike, could you talk a little bit about the strength in the enterprise business? It seems to keep accelerating here. I’m just wondering was this just a good execution quarter, or are we actually growing even higher on the growth rates than what we’ve seen before?

Yes, Raimo, I’d be happy to comment on that. Our enterprise business is continuing to accelerate and has been accelerating for several quarters as you’ve seen in our subscription revenue metric. A big part of that, as I’ve said before, is just the payoff of our ongoing investments in sales capacity at 30% to 40% year-over-year growth. We’ve been making those investments at that pace since our IPO eight quarters ago. There is a lag in terms of the payoff from those investments but we’re also getting layered benefit on top of that from the channel expansion that we’re beginning to benefit from. So as we do a little bit more and more through channels on top of that, we expect that to be layered growth on top of the growth in enterprise bookings and revenue. So there’s also a market phenomenon here. It’s not just our ability to execute very consistently and scale that sales organization and scale those channels. We’ve also hit a very, very important inflection point in our market of customer experience and adoption of cloud. We’re at the intersection of both of those trends. So if you look at Salesforce and Service Cloud, companies like Zendesk, these are the CRM partners of ours that are helping enterprise customers provide a better customer experience and we’re tightly integrated with them. These enterprises are very, very focused on raising the bar for customer experience. And we’re one of the two major technology components in any customer service equation.

Yes, okay, perfect. That’s very clear. And then can you maybe talk a little bit about the drivers for the dollar-based retention improvement that’s been coming a few quarters now? And like talk a little bit about drivers, but also kind of where that can go or is the 100 that you achieved there is like the level?

Yes. So we’ve seen our annual dollar-based retention rate increase from roughly 94% I believe four quarters ago to 100% this past quarter. That’s a very good increase. Most of that’s coming from our enterprise business. And again, part of it’s the mix shift, right. More and more of our revenue is in the enterprise category. We’ve talked for a long time about the fact that our dollar-based retention rates are significantly higher in enterprise than they are in our commercial business. So part of it is just formulaic but even within that enterprise business, we’ve seen nice increases that are driving that number north. Again, we don’t guide on that number going forward but at the same time the trajectory – the trend in the rearview mirror here has been very, very good.

And then one last question for Barry maybe, if I’m allowed. Obviously, I like the leverage and it’s amazing, it’s really good to see what you do on G&A and R&D. But the other question that comes in obviously with it, and I'm sorry to ask it, is if you look on a dollar basis, you’re declining G&A and R&D but you keep growing the business at a faster rate. Do you expect at some point that that will turn around? Like, in other words, how much leverage can you get out of here with it before this has to start turning? Thank you.

Yes, Raimo, just to clarify, your question is on terms of turning around on G&A and R&D, is that right?

Correct, yes.

So you’re right. We actually have had a very minor in fact reduction in the case of G&A and flat R&D basically. And in terms of G&A we’ll keep those increases in the very low single digits, extremely low. We have the management in place, we’ve got the systems in place and there will only be basically transactional increases. In R&D, it’s much the same although we’ve got a pretty big R&D organization. But there will be some more growth on that side of that equation.

Good. Perfect. Thank you. Well done.

We’ll go next to Mike Latimore with Northland Securities.

Great. Hi, guys. This is Nick Altmann filling in for Mike. Just a couple of quick questions. One, are you guys still on track to grow your enterprise sales headcount by 30% to 40%? And then I guess if you guys could provide any color as to where in that process you guys are, that would be great?

Yes, happy to do it, Nick. Yes, we are on track to continue to grow our quota-bearing sales capacity in enterprise at 30% to 40%. That is our strategy. That is our plan. It’s been the plan since IPO and will continue to be our strategy going forward. Again, we done hire in a perfectly straight line but we’ve been very consistently growing that sales organization at that rate and expect to continue to do so in the future.

Okay. Thanks. And then in terms of bookings on the quarter, what percent of wins were against cloud competitors versus on-prem?

Yes, I track that actually as a percent of opportunities. So we looked at all the opportunities out there that we see in a quarter, and about half of the opportunities we’re in. We see one or two of our key cloud competitors and the other half they’re not there and it’s a great indication of the size of this market. It is, as I’ve said on the prepared remarks, a massive market that is still around 10% penetrated in terms of cloud; 15.8 million contact center agents around world and we are in very, very early days in the first inning of a nine inning ballgame, if you will.

Great. Thanks.

Thanks, Nick.

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

Hi. This is Joyce Yang for Nikolay. Congratulations on the great quarter guys. I wanted to ask a quick question, Mike, on how you’re thinking about the go-to-market mix going forward? And you’re obviously ramping up on the sales team as well as the channel seems like it’s doing very well as well. So where are your investment priorities among those pieces?

Yes, Joyce, I’ll give you a little insight here. Again, enterprise versus commercial is the first breakdown I should give you. And as we’ve been doing for several quarters in a row, enterprise is the area of investment. Our commercial business has been growing in and around the 10% rate for quite some time. It’s now 33% of our revenue. And we will continue to invest in and around 10% sales capacity growth for that commercial business. On the enterprise side, our direct sales force will continue to grow at 30% to 40% year-over-year and will layer on those additional channel partners. An individual by the name of Wendell Black joined us a few quarters ago and he is absolutely hitting it out of the park. He is doing a great job of signing new master agents and resellers into the equation. I talked on the prepared remarks about some of the growth in that channel as well as the bookings in that channel. Again, it’s early, early days but we’re making significant investments there. The good news is, there’s leverage in those investments. And the ROI we’re getting in that channel is pretty significant.

Got it, sounds good. And just one more please. Can you give us an update on your international growth strategy there and if you’re seeing any impact from Brexit from the recent quarters?

Yes, happy to Joyce. International continues to be a great opportunity for us. We’ve made the initial steps to go into Europe. We’ve also made some initial steps in Latin America. Those are both performing very, very well. And again, it will be a game of small numbers for quite some time here. But I really like what I see in terms of our traction to-date.

Great. Thank you.

[Operator Instructions]. We’ll go next to David Hynes with Canaccord Genuity.

Hi, guys. Good quarter. Mike, I wanted to ask you about the change in WFO partners with NICE buying in contact folks. How material is that to your business? How does it affect kind of the go-to-market strategy? Just kind of any color, how easy was that to do? Help us think about that.

Yes. As you saw, DJ, we announced a partnership with Calabrio. We’ve already had partnerships with companies like and Authority and CallMiner. And you’ll continue to see further announcements from us in terms of partnering with additional WFO solutions. The good news for us is that we are the contact center of choice in the cloud to some extent for most of these WFO solutions. Now that NICE and inContact have paired up, it actually creates a great opportunity for us to be the partner of choice amongst many WFO companies. And they’re leaning in hard and we will continue to sign more and more of them as partners.

Okay. And then maybe one on the professional services side of the business. It’s increasing a bit as a percent of revenues, which tells me the new deal flow is obviously healthy, but also maybe suggests you’re seeing some pricing leverage as you sign larger customers. And I know you have a relatively new leader in that team, so just curious kind of what you’re seeing on the professional services side? And then the follow up to Barry would be at what percent of revenue does the professional services business become profitable?

Yes, I’ll take the first part, DJ. So, yes, you’re right. The deal flow – that PS revenue growth is a good indicator of our deal flow and the increase in our bookings. But again, part of that is volume driven, part of it’s just pricing driven. So as I think I’ve mentioned in the past, not only have we increased our implied or imputed hourly rate for our professional services, we’ve also increased the number of hours that we’re bidding including in SOWs with enterprise customers. So we’ve seen the percentage of our bookings that our PS go up dramatically over the last, I’d say, six quarters and that’s really what’s behind a majority of that growth in PS revenue.

And in terms of the attainment of profitability, let me both answer the question that you asked and the timing. So it’s good progress that we’re making. It’s actually, as you referred to, we doubled our percent of revenue in the last couple of years from 3% to 6%. And the profitability has improved despite making very considerable investments. We will take some time to get that to breakeven and then into the single digits of profitability. And that period is measured in quarters and years, not months. And in terms of the percent of total revenue, it’s never going to be a very material part, maybe a high single digit, at best low double digits.

Got it. Okay, great. Thanks guys. I’ll pass the line.

We’ll go next to Jeff Van Rhee with Craig-Hallum.

Hi. Good evening, guys. This is Ryan sitting in for Jeff. Just a couple of questions and first to start with, can you just comment on the trend and the price per seat? I know before it was around 200. Have you seen any changes in that price in the recent quarter?

Yes, in general that price per seat or the revenue per seat as we talk about it, Ryan, has gone up about I think around 5% in the last four quarters. Is that accurate, Barry?

That’s absolutely right. And continues to remain firm as we add – remember we’re talking here about revenue per seat. And as our enterprise sales team adds a host of different products, we see that revenue per seat remaining firm and increasing.

Great. Thanks. And then just on deal count, any commentary you can give there about how deal count – the absolute number of deals has trended?

Yes, that number continues to go up into the right, Ryan. Again, as we grow our sales force for enterprise we continue to do more and more transactions every quarter. They are growing in size and those are dual benefits, so to speak, in terms of what’s driving our bookings growth.

Great. And just lastly, have you seen any changes in time to go live on, say, a 100 seat deal?

No. We actually have had very, very consistent – in fact I looked at a dashboard yesterday that my PS team gave me that showed time to go live and we’ve had very, very consistent number of days to go live across our enterprise customers in general.

Okay, great. Thanks, guys.

Thank you.

We’ll go next to Brendan Barnicle with Pacific Crest Securities.

Thanks so much. Mike, in your prepared comments you talked a little bit about the legacy vendors that are still out there. Clearly you guys are taking share from them pretty dramatically. What are they doing? We saw NICE do an acquisition, that’s maybe one response. What are some of the other responses you’re seeing out of some of the legacy vendors right now?

Yes, I think the number one legacy vendor is Avaya and they continue to go through just a huge transition as I’m sure you know have retained some bankers to figure out their strategic alternatives. They’ve got 6 billion in debt and they’re going in the wrong direction from my perspective. And again, that’s good for us, it’s very good for us. They’re not moving to the cloud. Genesys is really the next in line and they have made a number of acquisitions that are still trying to be put together into a cloud platform that delivers scale and reliability. From our perspective we don’t think they’re making very good progress. And if you look at Cisco, they continue to focus on other parts of their business. So again, it continues to be a very, very good time because most of the legacy players, the ones that really matter, the ones that have large share, are really underinvesting in terms of shifting to the cloud.

And the other thing, Mike, we’ve seen people like Zendesk and some of your other partners investing in bots and machine learning and looking at some of the ways that that will apply on some of the CRM side. Do you envision a role for some of those technologies in some of the call center things that you’re building out now?

Yes, we definitely do. In fact, we see an integration opportunity with all those technologies. In some respects we view our job in the contact center/customer service market as the routing engine. And we can route really any type of interaction whether it’s a phone call, an email, a chat, a message, for example. But we also when you talk about artificial intelligence and bots and machine learning, again we have an opportunity to leverage our predictive analytics, our natural language processing engine. We’re doing that for a lot of enterprise customers these days and helping them really predict next best actions, for example, for live agents. And so we do see an increasing role for bots and artificial intelligence in the contact center.

Terrific. Thanks a lot, guys.

Thank you.

Thank you.

We’ll go next to Scott Berg with Needham & Company.

Hi, Mike and Barry. Two quick ones for me. First of all, Mike, if you look operationally at the business and how you’re trying to go into Europe, with all the changes that will happen with regards to the Brexit, what do you have to do operationally different there? My first assumption is there’s probably a mainland data center that’s got to come online. But outside of that, would there be any other changes to pursue over the next 12 to 18 months?

Yes, Scott, if you don’t mind, I’m going to take that one. So currently we do have a mainland backup data center in Amsterdam, the primary one in Europe is in Slough, outside of London. To be perfectly candid, we don’t see any major impact in the near term. First of all, Article 50 has not yet been triggered, so it’s going to be quite some time before anything concrete happens. Our focus was always in the UK and the Nordics. At least one of the Nordics – excuse me, two of the Nordics would not be affected. And in the fullness of time, as that business grows both in terms of direct and then channel, we will establish further presence as we always plan to in the continent probably in Germany.

Okay, great. And a follow-up question. Sales capacity, I certainly understand the 30% to 40% growth and your sales results recently speak to your effectiveness there. But Barry, just trying to understand why your sales and marketing expense on a non-GAAP basis for the second quarter was actually sequentially lower than Q1? Just didn't know if there’s some abnormality in that quarter. I would have expected it to be sequentially higher at least.

Q1 is overall, not just in sales and marketing, has the headwind of the recalibration of FICA and other employment taxes and it’s pretty material for a company of our size. That is the biggest single factor in the sequential decline.

And I’ll layer on one more comment here which is the timing of sales hires, that is a significant impact on our sequential sales and marketing expense. And again, as I said earlier on the call, it’s not a straight line. And if we have compensation expense for enterprise reps that start in the very first day of a quarter versus towards the end of the year, that’s going to impact the sequential numbers. And I would say the other impact is marketing. Marketing’s also not growing in a straight line.

Great. That’s all I had. Thanks for taking my questions.

You got it, thank you.

We have no more questions at this time. I’ll turn the call back to management for any additional or closing remarks.

All right. Well, thank you everyone for joining the call today and for the opportunity to share our optimism around Five9’s future. The market appears to be genuinely inflecting, as I said before, as contact centers modernize and as legacy vendors continue to underinvest and struggle to some extent. With our fully featured and trusted solution, Five9 is increasingly viewed as the safe choice by enterprises. We look forward to continuing to update you on our progress in the future. Thanks for joining us.

That does conclude today’s conference. We thank you for your participation.