Five9, Inc. (NASDAQ:FIVN) Q4 2022 Earnings Call Transcript

Five9, Inc. (NASDAQ:FIVN) Q4 2022 Earnings Call Transcript February 22, 2023

Unidentified Company Representative: Thank you for joining us today. On the call are Mike Burkland, Chairman and CEO; Dan Burkland, President; and Barry Zwarenstein, CFO. Certain statements made during the course of this conference call that are not historical facts, including those regarding the future financial performance of the company, customer growth, industry size and trends, our expectations regarding macroeconomic conditions, company market position initiatives and expectations, technology and product initiatives, and other future events are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are simply predictions, should not be unduly relied upon by investors.

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 Five9’s future results and cause these forward-looking statements to be inaccurate, including the impact of adverse economic conditions, including macroeconomic deterioration, including increased inflation, increased interest rates, supply chain disruptions, decreased economic output and fluctuations in currency exchange rates, lower growth rates within our installed base of customers, the impact of the Russian-Ukraine conflict, the impact of the COVID-19 pandemic and the other risks discussed under the caption Risk Factors and elsewhere in Five9’s annual and quarterly reports filed with the Securities and Exchange Commission.

In addition, management will make reference to non-GAAP financial measures during this call. A discussion of why we use non-GAAP financial measures and information regarding reconciliation of our GAAP versus non-GAAP results is currently available in our press release issued earlier this afternoon as well as in the appendix of our investor deck and currently available in the Investor Relations section on Five9’s website at investors.five9.com. And now, I’d like to turn the call over to Five9’s Chairman and CEO, Mike Burkland.

Mike Burkland: Thanks, Emily. And thanks everyone for joining our call this afternoon. I’m pleased to share that we closed out the year with strong results for the fourth quarter and 2022. Fourth quarter revenue grew to $208 million, up 20% year-over-year. For the full year 2022, revenue grew to $779 million, an increase of 28% year-over-year. Our enterprise business, which accounts for 86% of total revenue, continues to drive this increase, with LTM subscription revenue growing at 32% year-over-year. Fourth quarter adjusted EBITDA came in at 22% of revenue, helping drive another record quarter for free cash flow of $25 million or 12% of revenue. These results clearly demonstrate that not only do we continue to be a leader in delivering on this massive, underpenetrated opportunity, but we also believe our business model supports a very attractive combination of strong growth and profitability.

Let me illustrate what I mean when I say massive and underpenetrated. Based upon trusted industry sources, there are over 16 million contact center agencies worldwide, with approximately 20% or 3 million of those agencies having already migrated to the cloud. This leaves an opportunity of about 13 million seats. To put this into context, as one of the leaders in the industry, we had approximately 440,000 named seats at the end of 2022. In spite of the current macroeconomic backdrop, we remain very optimistic about our long term opportunity in this market, especially at the upper end, which is the largest and least penetrated part of the market and the fastest growing category of our business. Our confidence in this opportunity is based on three key trends.

First, the viability and desirability of cloud solutions are no longer questions. Legacy vendors are retrenching, forcing enterprises to develop concrete plans with an even greater sense of urgency to replace their on-premise contact center solutions. Second, companies are enthusiastically pursuing digital transformation initiatives to enhance customer experience. According to multiple industry analysts, CX technology budgets will increase in the next 12 months. Enterprises know that the sooner they move to the cloud, the sooner they can take advantage of the benefits that come from game changing technologies to differentiate their customer experience. And third, AI and automation have become front and center in the CX market, providing an attractive and tangible ROI, thus becoming a significant catalyst for enterprises to shift to the cloud.

This labor arbitrage opportunity is especially important in tough economic climates and tight labor markets. Now, I’d like to discuss what we view as the three main growth drivers for our business, namely our platform, our march upmarket, and our continuing international expansion. Let’s begin with platform. As we talked about last quarter, we continue to make investments to enhance our platform with the objective of delivering ongoing reliability, deployment at scale, and continuous innovation. Our recent enhancements fall into two categories, each of which we believe plays a central role in the future of the contact center and customer experience markets. The first category is analytics. Our recently launched Five9 Analytics product marks a turning point for reporting and analytics in the contact center industry.

To truly optimize CX performance, contact center managers need the ability to define unique business metrics for success. Five9 Analytics allows customers to perform deep data discovery, explore trends in their contact center, create their own dashboards and fulfill their custom reporting requirements in a self-service manner like never before. Today, it’s crucial for contact centers to unify and analyze customer interactions across self-service and live channels to transform data into a winning customer experience strategy. Five9 Analytics integrates state-of-the-art business intelligence with operational data to create a contact center intelligence platform. Users can gain performance insights across all channels to identify where workflows can be added or improved.

To help customers gain instant value from this offering, we provide a built-in library of over 250 metrics, modern visualizations, and a robust data analysis engine. The second category is generative AI such as ChatGPT. As you know, we’ve been leading the market with our AI and automation solutions, and we are now further strengthening our portfolio with the inclusion of GPT-3. We are pleased to announce two new product offerings that leverage GPT-3 from OpenAI. The first offering is AI Insights, which uses real-time transcription to automatically interpret interactions and cluster them into categories, which then allows customers to identify opportunities for automation and process improvement without the need for professional services or tuning.

Five9 AI Insights is the latest example of what we call practical AI. The second offering is AI Summaries, which is offered as part of our agent assist product line. AI Summaries allows customers to auto summarize call transcripts in seconds and publish them in real time into their CRM. Again, this new offering requires little to no professional services or tuning, meaning the time to value is much quicker. These offerings come to market as we see AI continuing to gain momentum, especially in the enterprise. For example, in the fourth quarter, 41% of RFPs that came into our strategic and enterprise sales organization cited AI as the main or auxiliary reason for issuing an RFP. Our industry-leading AI and automation portfolio of products now has eight distinct modules, including speech analytics, workflow automation, voice IVA, digital IVA, agent assist, and now Five9 Analytics, AI Insights and AI Summaries.

We believe that AI and automation are at the core of the modern contact center. And the generative AI with the large language models is game changing. Overall, our portfolio of omnichannel solutions plus our AI and automation offerings, including these recent additions that I just spoke of, creates a platform to deliver what we refer to as fluid CX. Fluid CX enables consumers to move through the most efficient and personalized path across channels and between virtual and live agents, keeping context and creating a frictionless customer journey. Enabling this is critical as the modern consumer continues to demand an integrated and seamless customer experience from the brands that serve them. Now turning to the next growth driver, our march upmarket.

We continue to see strong momentum upmarket and exited 2022 with 161 customers that are each generating over $1 million in ARR, up from 134 customers a year ago. This cohort now makes up slightly more than 50% of our recurring revenue. Another key factor driving our success upmarket is the growth of our channels and partner ecosystem. The channel, long beholden to the legacy vendors, has pivoted to the cloud. And as a result of our focus and investments, we are executing and gaining leverage with an expanding list of partners. We have a balanced route to market strategy with direct sales being complemented by VARs, distributors, technology solution brokers, global service providers, and importantly, systems integrators. These channel partners love how easy Five9 is to work with and our partners appreciate how their enterprise customers can easily make the migration to Five9, with tools we have developed to replicate and easily transfer their configuration data, routing logic and reporting information from their legacy solutions to Five9.

Before turning to international, I want to mention a factor that I believe is key to our overall success. Not just upmarket, but across all customer categories. And that is the trust we have built up over the years. Due to significant and sustained investments in professional services and customer support, we have consistently delivered exceptional experiences through strategic implementations that help customers accelerate time to value and ongoing worldwide support, designed to optimize and improve efficiencies. As a result, we continue to set the benchmark for the industry with NPS scores in the 80s and 90s. Lastly, I’ll briefly discuss our international expansion. We have been making significant investments internationally and we continue to enter new markets including Germany, Spain and several other countries.

These investments are paying off as our 2022 international revenue grew 44%. Additionally, our partner certifications for sales and implementation services are gaining significant momentum globally, but especially in international regions, where the number of total certified partners more than tripled in 2022. As a result of our broadening global reach, driven by both direct and channel expansions, our international bookings grew 87% year-over-year in Q4. In closing, let me reiterate my enthusiasm and excitement about the opportunity ahead for Five9. I believe we are extremely well positioned with our industry leading platform combined with a best team of people that will enable us to continue executing against this massive, underpenetrated opportunity.

With that, I will turn it over to our President and Chief Revenue officer, Dan Burkland. Dan, go ahead?

Dan Burkland : Thank you, Mike. I’m pleased to report another strong bookings quarter in Q4, driven by our continued momentum in $1 million plus ARR new logo deals and unprecedented leverage from our channels who are now participating in not only sales, but also implementation and ongoing services, particularly in the international markets, as Mike mentioned. Customers are clearly seeing the benefits of transitioning from on-premise to the cloud. And we believe they are more motivated than ever given what we are seeing from legacy providers. As a result, this is driving more opportunities, growing our pipeline to another all-time high. While we are continuing to see macro headwinds at our installed base and in new logos in the mid-market, that softness is being offset by overachievement upmarket in our strategic accounts and strong growth in our international bookings.

And now as I normally do, I would like to share some examples of key wins for the quarter. The first example is a global business process outsourcer or BPO based in Spain, and Latin America serving retail, telecommunications and financial customers. Five9 was chosen to replace many of their Avaya solutions, where they do not have the flexibility and full suite of applications that Five9 can provide, including omnichannel, IVA and automation solutions their clients are demanding. We anticipate this initial order to result in over $4.3 million in ARR to Five9. The second example is a Fortune 500 clinical laboratory providing health care diagnostic testing and services throughout the US. They take inquiries into their contact centers from patients and healthcare providers to schedule tests, check results and collect payments from patients and health insurers.

They were operating primarily on Avaya and could not add the innovation, automation nor analytics they require. After evaluating several CCaaS providers, they chose Five9 for our complete and fluid omnichannel solution with analytics, insights and deep integration to ServiceNow. They will also use our digital IVA, voice IVA and email as additional channels to offer self-service for scheduling appointments, finding locations and requesting test results. We anticipate this initial order to result in over $3.8 million in ARR to Five9. The third example is a global company focused on partnering with physician owned radiology facilities to build and equip them with state-of-the-art high quality imaging systems and related technologies. They were using both Cisco and Avaya as a result of prior acquisitions, and lacked the reporting integrations and omnichannel solutions to effectively serve their customers.

Five9 was chosen due to our end-to-end technology suite, our innovation and AI roadmap and our quality, high touch implementation and ongoing managed services. We also partnered very closely with salesforce, while our key competitor aligned with a different CRM they were considering. With QM, Interaction Analytics and WFM, they can evaluate agent efficiency and recognize areas for improvement. They’re using our advanced IVA to allow self-service for appointment scheduling, appointment confirmation, outbound reminders of appointments, and to process payments. We anticipate this initial order to result in over $2.3 million in ARR to Five9. And now, as I normally do, I’ll share an example of an existing customer who expanded their use of Five9.

This is a leading financial services company for consumers and they’ve been a customer of Five9 for over two years, and are currently utilizing a full suite of solutions on our platform and had been piloting our IVAs. Due to the success experience with our initial IVA use cases, they are now expanding to include a broader, more advanced set of use cases. This additional IVA order is expected to add an incremental $1.8 million in ARR, bringing their total annual spend with Five9 to over $6.7 million. As we’ve demonstrated, Five9, along with our partners, continue to bring comprehensive end-to-end CCaaS solutions to our customers with the analytics and insights to improve their contact center operations, while giving them the flexibility to deliver exceptional customer experiences to their end users.

And now, I’ll hand it over to Barry to cover the financials. Barry?

Barry Zwarenstein: Thank you, Dan. Before going into specifics, reminder that unless otherwise indicated financial figures I will discuss are non-GAAP. Reconciliations from GAAP to non-GAAP results are included in the appendix of our investor presentation on our website. As Mike mentioned, we had a strong quarter despite ongoing macro headwinds, with the fourth quarter revenue growing 20% year-over-year and LTM enterprise subscription revenue growing 32% year-over-year. In terms of revenue composition for the fourth quarter, enterprise made up 86% of LTM revenue and our commercial business represented the remaining 14%. The commercial business grew in the teens on an LTM basis, and we expect this to continue. Also, recurring revenue accounted for 92% of our total revenue in the fourth quarter and the other 8% was comprised of professional services.

I will now give more color on revenue. In doing so, I will again provide more details that we customarily do. Please, though, bear in mind that we do not intend to routinely continue making these more detailed disclosures. Let’s start with the installed base where changes in demand show up promptly in revenue. Q4 is typically our strongest seasonal quarter, with non-pandemic sequential growth rates ranging between 8% and 12% historically. Last year, we reported sequential growth of 5% in the fourth quarter. This solid growth is primarily due to our installed base continuing to face headwinds, particularly in healthcare and consumer, which are typically our two strongest seasonal variables in the fourth quarter. For instance, in the fourth quarter of 2021, these two industry verticals, in aggregate, increased 24% sequentially, while in the fourth quarter of 2022, it grew at slightly less than half this rate.

If, in the fourth quarter of 2022, these two verticals had matched last year’s growth rate, the sequential growth in total revenue would have been within the historical range of 8% to 12%. Turning now to our other source of revenue growth, namely from new logos. New logo seat in the fourth quarter continued to be strong and slightly exceeded our expectations. With respect to the deployment profile of the two new logo mega deals that we’ve discussed in recent calls, we continue to expect that the international operation of the parcel delivery company will be substantially deployed by the end of 2023, and the healthcare conglomerate to continue ramping throughout 2023 with full deployment in early 2024. To summarize on the new logo side of the business, we have good visibility into 2023 revenue due to our continuing success in going upmarket and international expansion, as well as from a substantial backlog of booked seats that are not yet generating revenue.

Our LTM dollar-based retention rate was 115%, a decline of 3 percentage points sequentially, mainly due to macroeconomic headwinds causing our customers to add fewer seats than normal. Longer term, we continue to expect our retention rate to trend towards the high 120s by 2027 due to higher mix of enterprise customers, especially larger ones, which have demonstratively higher retention rate and high ARPU from the automation and other offering. Fourth quarter adjusted gross margins were 62.3%, a decrease of approximately 50 basis points year-over-year, but a quarter-over-quarter improvement of approximately 90 basis points. As we have been communicating, the sequential improvement is driven by the moderation of our previously accelerated investments in professional services and public cloud.

Fourth quarter adjusted EBITDA was $46.2 million, representing a 22.2% margin, an increase of approximately 90 basis points year-over-year. Fourth quarter non-GAAP EPS was $0.34 per diluted share, a year-over-year increase of $0.12 per diluted share. Before getting to our full-year performance, I would like to report that our average concurrent seat count for the fourth quarter grew to 293,430 seats, up 19% year-over-year. Note that we estimate our concurrency to be equivalent to approximately 440,000 seats on a named seat basis, a unit of measure that the others in the industry cite. As a reminder, we provide this seat count metric only on an annual basis. And now for a closer look at key full-year 2022 income statement metrics. 2022 revenue was $779 million, up 28% year-over-year.

2022 gross margin was 61.3%, a decrease of approximately 220 basis points year-over-year, but above the 61% outlook we had provided, driven by the sequential improvement in the last few quarters due to the moderation of our accelerated investments in professional services and public cloud. 2022 adjusted EBITDA margin was 18%, a decrease of approximately 10 basis points year-over-year. 2022 non-GAAP EPS was $1.50 per diluted share, a year-over-year increase of $0.34 per diluted share. Finally, before turning to guidance, some balance sheet and cash flow highlights. I’m pleased to report that, in the fourth quarter, we achieved another set of record highs for both operating and free cash flows of $32.7 million and $25 million, respectively, driven in part by continued strength in DSO performance, which came in at 35 days and moderated capital spending.

We have now delivered 26 consecutive quarters of positive LTM operating cash flow and we expect it to increase meaningfully in the longer term, given our ability to expand adjusted EBITDA margin, our substantial and our low DSO. I’d like to finish today’s prepared remarks with a discussion of full-year 2023 and first quarter 2023 guidance. As a reminder, for six years through 2020, we started each new year with prudent revenue guidance of 16% year-over-year growth at the midpoint, mainly due to the uncertainties around the magnitude of the seasonal impact of our business. Now, post pandemic, for 2023, we are returning to provide full-year guidance at a midpoint of 16% year-over-year growth or $901.5 million in revenue, in line with the high level outlook we provided last quarter.

Please note that our guidance takes into account a prudent view of the uncertainties around the magnitude of the second half seasonal uptick, along with our assumption that macroeconomic headwinds will persist throughout the year. Ultimately, the 16% year-over-year growth is a starting point. And we will update our outlook as the year progresses. Also, a reminder that, as we stated last quarter, given the installed base typically contributes approximately half of the annual revenue growth, we may see a drop in the LTM enterprise subscription revenue growth rate into the high 20s due to the macroeconomic challenges. We believe that this will be temporary and will improve as macroeconomic conditions improve. Note that the enterprise subscription revenue currently makes up over 60% of our total revenue.

With regards to the bottom line, we are guiding 2023 non-GAAP EPS to a midpoint of $1.69 per diluted share, well above the $1.58 outlook we provided for 2023 during our last earnings call. Additionally, the $1.69 non-GAAP EPS implies a non-GAAP net income margin of 14% at the midpoint, which is in line with our 2022 net margin. As for the first quarter, we’re guiding revenue to a midpoint of $207.5 million, which represents a slight sequential decline, but better than the 1% to 4% quarter-over-quarter decrease we have been guiding for Q1 in the past five years. Despite the macro headwinds, we are guiding to a smaller sequential decline than prior Q1 due to a lower-than-normal seasonal uptick in Q4, which we expect to result in less seasonal downtick in Q1.

As for the remainder of the year, we expect a very small sequential growth in the second quarter and larger sequential increases in the second half, primarily driven by the ramp up of our large customers and seasonal patterns. As a result, we anticipate slightly more than 30% of our annual revenue being generated in the second half of 2023. We expect first quarter non-GAAP EPS to come in at $0.24 per diluted share at the midpoint, a decline of $0.30 per diluted share sequentially. I would like to point out that the first quarter non-GAAP EPS is always the weakest of the year and that the $0.30 per diluted share sequential decline is relatively in line with the $0.29 per diluted share decrease we guided to Q1 of last year. For the remainder of the year, we expect non-GAAP EPS to increase to approximately $0.32 per diluted share in Q2 and further improve in the second half.

Please refer to the presentation posted on our investor relations website for additional estimates, including share count, taxes, and capital expenditures. In summary, we are pleased with our fourth quarter performance. We will continue our disciplined approach of driving balanced growth as we navigate through the macro uncertainties and invest in key strategic areas to reach our 2027 financial targets of $2.4 billion in revenue and 23% adjusted EBITDA margin. Operator, please go ahead.

Q&A Session

Operator: . We will take our first question from DJ Hynes at Canaccord.

David Hynes Jr.: Dan, I want to ask you a competitive question, but not the one that I think you get often. I’d love to get your thoughts on how you see Microsoft positioned in the CCaaS space over the next several years. I think traditionally we’ve kind of positioned this market as a three horse race. Totally makes sense today. But with Microsoft’s addition of Nuance, their alignment with OpenAI, the growth of Teams, like, do you see them being a viable player in this space longer term? Or any thoughts would be helpful.

Dan Burkland: You don’t want to underestimate a Microsoft. And while they’ve done those acquisitions and made a move to enter the space, as we talked about over the years, it takes many years to really perfect a solution and be able to deliver the reliability, scalability. The voice portion is so complex to be able to deliver that in real time across the world in a very highly quality way. For instance, if you’re running data applications and software gets scaled across the world regularly, packet loss for the data is overcome very easily by the individual user. You hit your key twice, you wait a couple seconds, and on you go. If you have that same packet loss with a voice conversation, it’s disaster. And it’s disaster across hundreds or thousands of agent conversations.

So, it’s very hard to get that right. And there are very few companies, like we’ve mentioned, us and two others that have really mastered that. And it does create natural barriers to entry. A lot of folks believe they can enter the space very quickly, and it takes them a lot longer than they anticipate. But we’re always going to keep our eye on Microsoft and some of the other large hyperscalers that have mentioned their interest to enter this space. And we’ll see where it leads. Some of them enter and realize how difficult it is and exit and other stick with it.

Operator: We’ll take our next question from Ryan MacWilliams at Barclays.

Ryan MacWilliams: Love to hear about the AI Summaries. Separately, just the challenges you mentioned in the healthcare and consumer verticals, is that simply a product of the macro? And would you expect the seasonal agent ramps to normalize if the macro improves? And have you seen broader company layoffs impact contact center agents at this point?

Dan Burkland: Again, in terms of those impacts on a couple of verticals, we believe it was macro. And again, you heard various comments about kind of what we expect in Q1 relative to kind of the seasonality of Q4 typically versus that macro impact on that seasonality that just occurred. So, again, we’re pretty certain of that. Again, we get a lot of insight into our customers and what’s impacting their businesses. Again, we always talk about the long-term opportunity that we have in this market and how attractive it is, in spite of those macro headwinds,

Barry Zwarenstein: In terms of the layoffs, I have a list of the companies that grew less than we would have expected both in healthcare and in consumer. And there’s none of the usual suspects in terms of layoffs in any of those names at all. We’re just not overly dependent on that part. So, in our view, it truly is transitory. It’s on the installed base. They’re adding seats, they’re just adding them at a lower pace. And one day, the economy is going to come back, and it’ll be a case where it helps us.

Operator: Moving on now to a question from Scott Berg at Needham.

Scott Berg: Congrats on the quarter. Dan, I wanted to follow up on your commentary on the sales environment. Sounds like the million dollar deal traction was, again, pretty positive for you all. But can you help us understand how your bookings in the quarter stacked up relative to maybe your expectations going into the quarter? And maybe relative to your third quarter comment where I believe third quarter had the most record number of new million dollar ARR signings ever?

Dan Burkland: As we move upmarket, the sales €“ naturally, the bookings become rather lumpy, especially as we have those mega deals enter into the bookings equation. So we’ve got some tough compares that we’re coming past and getting through right now. But we continue to see great momentum. And the $1 million plus ARR deals, remember, that market is very much at its infancy. It’s just opened up over the last couple of years. And we continue to see that as our highest growth segment of the business. Both that and our international bookings, which grew 78% year-over-year in Q4. So the momentum is there. It’s very strong. And as we said, the activities of the legacy providers and what they’ve mentioned to their marketplace and to their own customers sets up very well for the migration from on-premise to cloud as well as the AI and automation solutions where we can give truly tangible ROIs to those customers.

So we’re seeing absolutely no slowdown in the million dollar plus market. It’s just the ebb and flow of those large deals and the happenstance of when they when they close is what happened in Q4.

Scott Berg: Just a small follow up on that because it’s a continuation of the question. Did you see any deals kind of move in or out of the quarter more than a normal fourth quarter seasonal trend?

Dan Burkland: No. There was still the flurry. At the end, there always is. When you do a lot of transactions, you’re always going to have a handful that for whatever reason can’t get across the line. But we also have others that we pull forward. So it was no different than any other quarter and no different than any other Q4, if you look at that.

Operator: We’ll continue with a question from Meta Marshall at Morgan Stanley.

Meta Marshall: Dan, I think it was you kind of gave the 41% of RFPs having kind of AI as part of that RFP. And, clearly, like, the revenue versus seat count adds kind of shows the attach rate that you’re seeing there. I guess just where are you on installed base and kind of going into the installed base and doing some of that AI upsell? And just does the introduction of some of these new €“ whether it be GPT-3 or OpenAI integration kind of slow that sales process?

Dan Burkland: If you look at what you mentioned about the installed base and penetrating that with the new products, the AI insights, our new web admin and other applications that we can sell into that base are just getting rolled out. So those aren’t entering the equation yet. So we don’t have those in the bookings totals and in the revenue item, for sure. But look for those to be additive, probably the latter half of 2023. But we’re making a concerted effort. Our customers are very interested in adding those and we are seeing quite a lot of growth in attaching the previously announced AI and automation solutions, agent assist, our IVA solutions, as always, are very appealing to the installed base. And that’s going just great.

Operator: Now we’ll go to UBS and Taylor McGinnis.

Taylor McGinnis: I know we’re well into the quarter and 4Q was a little bit softer, but the 1Q guide on a sequential basis is stronger than I think what you’ve done in the past 1Qs. And I think the full year guidance range on a dollar basis was a little bit softer than what we’ve seen in the past. So two parts here. The first would be, can you bridge some of that? And then, when you talk about the softer verticals like healthcare and consumer, what does the guide assume in terms of seat adds versus trend? And then the second part is, you reiterated the high 20s enterprise subscription revenue guide for this year, but on a trailing 12 month basis only grow at 32%. So can you talk about what gives you comfort in that outlook?

Barry Zwarenstein: I want to be sure that I understand the question crisply. The first question is regarding seat adds in healthcare and consumer. Is that correct? And what are we assuming on that?

Taylor McGinnis: Yes.

Barry Zwarenstein: For the rest of the year, we’re assuming that the macro remains similar to what it was in the second half of 2022. And for those two verticals, in particular, the first three quarters of the year are pretty normal, but they both take off, in the past, quite dramatically in the fourth quarter. We’ve assumed a much more moderate take off in the fourth quarter and to some extent in the third quarter as well. If the consumers are less challenged than they were this past year, inflation maybe is a little bit less or the interest rates will be lower, they feel a little less pinched overall, that could be upside to that. But that’s the position that we’ve taken. The second question was with respect to the LTM enterprise subscription growth rate. Is that correct?

Taylor McGinnis: Yeah.

Barry Zwarenstein: We were crystal clear on that. In the last quarter, we said, because half of our business comes from the installed base basically, and if that’s facing headwinds because of the macroenvironment in general, not just in those two verticals, you’re going to see moderation in that growth rate. And we cautioned that it may dip into the high 120s in the course of this year. And that remains our position. And you may wonder, well, if that does happen, when in the year might it happen. It could happen in the first quarter. Obviously, we’re doing our best not to have that happen. But it’s certainly possible. And when it would recover depends entirely upon the macro. One thing we do feel very comfortable about is that this is inherently, in those businesses, the degree to which they expand. They’re not expanding as they once did, and that’s showing up in that metric.

Operator: Moving on now to Matt Stotler at William Blair.

Matt Stotler: Just one on WFO and specifically Virtual Observer. Let’s just get an update on the contribution there. What you guys are seeing? And then in terms of expanding that product, have you seen that move up market at all versus typical focus on SMB or big market. Any color there be helpful.

Dan Burkland: We continue to see WFO, especially our VO product, be attached to €“ and it’s not just SMB. It’s absolutely in that mid-market and even enterprise. We have the Verint relationship, which is excellent for those customers that have a history. Typically, upmarket in this very large strategic accounts and the million dollar plus accounts, we still sell VO into several million dollar plus accounts. It’s just there’s oftentimes a history that someone has and they’ve collected years and years of data on their existing Verint platform and they want to be able to transfer that data over and continue using the interface they’re comfortable and used to. So, it’s important for us to have both. And whichever one’s the right fit is what we’re going to move forward with.

Operator: We’ll take our next question from Sterling Auty at Moffett.

Sterling Auty: Given the commentary about the installed base, it would seem like the new logo wins are going to be even more important to the revenue targets for 2023. So with that as the context, have you guys done anything different in terms of the way that you’ve scrubbed the pipeline? Or maybe increased coverage ratios or something else to give you an improved sense of being able to deliver that new logo close?

Mike Burkland: Yeah, certainly. I’ll start and let Dan finish. But I want to make one point really clear. 2023 revenue is going to be impacted by our installed base. And quite frankly, mostly from our backlog of net new business we’ve already booked. It gives us extreme visibility into what’s going into revenue in 2023, especially in the large enterprise part of our business, right, where, again, those bookings take quite a while to turn into revenue. So again, as we go through the year, our bookings, especially in the second half of 2023, on the net new enterprise side are going to impact 2024 revenue, just to be clear.

Dan Burkland: On what Mike just mentioned, the visibility of that backlog and the scheduled rollout gives us predictability to that revenue growth in that half of the growth portion. And then the other half of the growth, as Barry mentioned, comes from the net new logos. That’s all the way up and down the scale from the very smallest, which tend to turn to revenue very quickly, 30 to 60 days to when they start generating full revenue, to some of the larger ones that can take three to six months or even longer. So, yeah, we have very close insights. How we’re approaching it on the sales side is absolutely placing more scrutiny on the sales organization and how we go through and qualify opportunities, making sure people have true budgets to make decisions, and really working more closely with all the partners that are now bringing us more and more deals.

Our expansion of our partner ecosystem is so important to the long term, not only to our long term growth, but really making sure that we’re in the pole position for those partners to turn to Five9 first. There’s been recent studies out, channel checks to make sure how we’re doing compared to our competitors, which we love to see from third parties, to validate that we’re doing the right things and that they love working with us. And that’s working very well. We’ve got a couple projects that we’re very focused on with the higher end of the market with some very select partners to really certify and enable them to deliver not only sales leverage, but as I mentioned in the prepared remarks, services and implementation, and managed services work for us.

So, we’ve been careful over the years not to sacrifice the quality because we’re delivering in the 80s and 90s from an NPS score. But there are certain partners who are willing to make the investment on their side to keep that level very high. And we’re investing in them to be able to do that for us.

Operator: Next from Jefferies, Samad Samana.

Samad Samana: Maybe just first question. Barry, just thinking about the EPS guidance, it’s slightly slower than the overall revenue growth. Just maybe how should we think about margins and maybe what the margin framework for 2023 will look like based on kind of different growth outcomes? And to that end, OpEx actually looks like it was down quarter-over-quarter in 4Q and OpEx growth slowed quite considerably. So, how should we think about maybe OpEx and then the same question around margins just for 2023?

Barry Zwarenstein: It’s going to be classic Five9. We’re going to increase our OpEx in line with what we see the revenue to be. You mentioned the bottom line guide and mentioned that it was €“ I believe you said it was slightly down, and that’s a function of the 2.5% increase in outstanding shares. But for that, it would have been completely flat. So, we will continue to increase our OpEx. And with respect to the direct part of your question, namely what do we expect the EBITDA and gross margin to be, we’re not at this stage giving guidance on that. Just remind you, though, of the following. We’ve given 2027 guidance to get to EBITDA of 23%, which is 1 percentage point more than we got in the fourth quarter. We got 22.2%.

And to get to gross margins of 70%. And we feel €“ for reasons we can go in separately €“ very comfortable in getting to those numbers. Now, obviously, it’s easier to get to those numbers when your revenue trajectory is at the high end. To get to that $2.4 billion in 2027, you need a 25% CAGR off the 2022 revenue number. And in this particular environment, it’s not particularly in terms of our ability to grow revenue, given the macro.

Samad Samana: Dan, maybe one for you. Just as I think about some of the newer offerings, you just talked about that leverage, ChatGPT, and then as I just think generally as you get more AI and automation into the product, how should we think about maybe the evolution of the revenue model there, the pricing model? And are you seeing that yield gains? And as you think about €“ the value that you’re adding and monetizing that versus just kind of that traditional fee based model?

Dan Burkland: We’ve talked about the headwinds that the install base is facing from a seat add perspective, that caused us to really get €“ I think we’d referred to in a couple quarters ago about getting scrappy and going into the base and selling more applications. And it’s great because now we have a whole suite of applications that are new to those installed base customers. So we’re seeing an increase in the percentage of bookings that comes from those new applications. That’s continuing to gain momentum. And as we come out with the GPT-3 and other capabilities for insights and analytics, those are products that can appeal to a vast majority of our installed base. Yeah, some of the very small customers don’t need it. But once you get up into the mid-market and above, it’s hard to say that they won’t benefit from those applications.

So, it’s too early to tell what the traction rate will be across the board. But on the sales side, I’ve got great optimism that the base is going to really take to a lot of those. And like I said earlier on Meta’s question, it probably won’t find its way into the numbers until the second half of this year.

Operator: We’ll take our next question from Fred Lee at Credit Suisse.

Fred Lee: Dan, all of the three key wins that you highlighted, they were all Avaya displacements. And I was just wondering if you could talk about the opportunity in 2023 versus 2022 as it relates to legacy Avaya seats and whether Avaya’s restructuring has accelerated customer’s decision to leave, perhaps resulting in some pull forward in the opportunity?

Dan Burkland: I’m glad you mentioned that because, on the surface, you’d think that. We’ve had Avaya and Cisco as one and two as far as the systems we most commonly displace and replace. And it’s just coincidence that the three happened to be all Avaya this quarter. If you go back over the previous quarters, it was pretty much a mix. It was one and two, Avaya, Cisco, because of Genesys announcements. A lot of their customer base are issuing RFPs. And so, we’re seeing more Genesys become part of those three. It’s now two €“ it was two. It’s now three that we replaced. One and two being Avaya, Cisco and Genesys with a distant third. Those are becoming neck and neck now between all three. And then just to answer your Avaya question about their recent announcement, everyone saw that coming for a long time.

They’ve been having their financial struggles on and off for the better part of a decade. And so, I don’t think it’s seen a dramatic, all of a sudden everyone is jumping into the fray and putting out RFPs. Most folks saw that coming for several years.

Operator: Moving on now to Matthew Niknam at Deutsche Bank.

Matthew Niknam: Congrats on the quarter. Mine is on new logo growth. I’m just wondering if you’re seeing any sort of lengthening sales cycles or smaller initial deal sizes for new logos? And more broadly, is that something that maybe could slow the pace of new logo growth in upcoming quarters?

Dan Burkland: A small lengthening of sales cycles has occurred, part of that as a function of moving upmarket because the larger and more complex the deals €“ and when you add things like AI, automation, IVAs, you tend to get some new audiences that need to approve those or get them convinced on the ROI. There are, like all software business we hear about now, there’s oftentimes a few more people that want to put eyes on a contract to get approval. So we’ve seen days to close increase slightly, but not enough to make a significant impact to say, oh, new logo growth is going to suddenly slow down. It’s not. And so, like we’ve talked about, there’s drivers that make this purchase, it’s mission critical, it’s bringing a tangible ROI, and customers know that they need to move to the cloud to take advantage of the AI and automation.

And the larger customers realize that that may be a two-plus year process to go through an evaluation, issue an RFP, make a decision and then get fully implemented. So, they’re seeing an urgency to want to enter that process very quickly.

Operator: Matt VanVliet from BTIG has our next question.

Matt VanVliet: Wanted to dig in a little bit on the international side. Obviously, you said it’s pretty much your best bookings quarter ever there, very strong revenue growth as well. Anything you would particularly point to that’s really driving that and how much of sort of expanding the R&D team and having a few more kind of boots on the ground is helping you in that environment?

Dan Burkland: A few things on the international front and I’ll let Mike continue. We took some very strong leadership that really managed our largest enterprise sales here in the US, relocated them over to Europe, built out the teams. A big function of it is people. I think you’ve got to have the scale of just people in the right places in the right countries, and have the infrastructure prior to that. It’s not about just dropping some sales people in and watching productivity occur. You’ve got to build the infrastructure, you’ve got to get all the approvals, make sure you’ve got the compliancy requirements and data sovereignty requirements in certain countries. We’ve done all that hard work to set ourselves up. Now, it’s just more execution of drop sales people in and let them go execute.

And our multinational customers that we’ve sold here in the US oftentimes have operations in many of these countries. And so, we have references we can point to that are local that may have been in place for years, even though we didn’t have a presence in that local country.

Mike Burkland: Dan, I would just add to that. The additional channels that we’ve established internationally are a big part of our footprint internationally. It’s not just direct sellers. It’s folks to support the channel. And it’s basically signing up the right channel partners to drive business in a region.

Operator: Next from Truist, Terry Tillman.

Terry Tillman: I’m going to ask my multipart single question and then go on the mute. Congrats with more of the innovation on the AI and automation side. It sounds like a base of solutions now. Do you have to start thinking about the pricing and packaging whereby instead of this ala carte, I like all these things, but, wow, it’s a sticker shop with six solutions, is there potentially almost like an ELA or a platform sale for AI and automation? And then secondly, is it attaching more and more traction in strategic or enterprise?

Dan Burkland: I’ll answer the last part first. We’re absolutely seeing a greater level of interest in the larger and larger accounts. They have the ability to really pilot these solutions, have professional services in place where they’re needed, and be able to recognize the ROIs. The greater the span of that application, the greater the ROI in most cases. But now to your first question about bundling. We absolutely bundle several of these. In fact, when you look at our agent assist solution, agent assist historically has been where it will listen into a conversation, fetch data, deliver it back, next best action or suggested answers to the agent to give to the customer. Now we’re including, if you go to that level, you’ll get transcriptions as kind of step one, if you just want pure transcriptions of the call and insert those into your CRM, you get summaries as kind of a step two, you can bundle that in with transcriptions.

And then thirdly, you can bundle in the agent assist with what I just described with those first two. So we’re doing some very creative bundling in ways that our customers and our channel partners can more easily propose those and have them consumed by the customer. So it’s not entirely ala carte.

Operator: Question now from Jim Fish at Piper.

Quinton Gabrielli: This is Quinton on for Jim Fish. For IVA adaption, it seems like in this environment, if a cloud customer hasn’t adopted or fully rolled out kind of AI or automation at this point, they might hold off until macro maybe improved slightly. Is that what you’re hearing from customers? Or is the pace of AI adoption kind of sustaining in the hopes that the ROI can save you in a tougher labor market? And a quick follow up for Barry is just, is it fair to assume health care and commercial are the largest verticals for Five9 or any other spaces that we should be watching?

Dan Burkland: The first part, I’ll take that. This is Dan. The AI automation, I have not heard that whatsoever about folks waiting until macro improves to put those solutions in place. In fact, more just the opposite, where customers are realizing, hey, we’ve got to do labor arbitrage, we’ve got to get some solutions in here that can save us money. And we’ve got the boat anchor legacy on-prem system that really isn’t delivering the efficiencies nor the compelling ROIs. So, the issue is more of a what we talked about before, which is if you make that decision to move to the cloud in a larger account, it oftentimes can be two years before you actually have the system fully in place and reaping those benefits. So customers are moving to start the process, I think, more than ever right now because they recognize and they’ve seen other customers that have experienced that value.

Instead of just a promise, it’s now we have referenceability to customers that are achieving those ROIs.

Dan Burkland: And I would just add that the popularity and the press that ChatGPT and GPT-3 are getting from OpenAI and RAI and automation solutions, quite frankly, are becoming a bit of a catalyst for those RFPs, which I mentioned, but also just a catalyst for making the move to the cloud, quite frankly, because the cloud is the only place that enterprises are going to be able to reap the benefits of that AI and automation opportunity and the labor arbitrage opportunities. So, Barry, do you want to talk about

Barry Zwarenstein: The order of ranking of the top five verticals based upon Q4 revenue is, number one, healthcare; two, financials; three, consumer; four, technology; five, industrials.

Operator: Next up, we’ll go to Michael Turrin at Wells Fargo.

Michael Turrin: Barry, I know there’s seasonality there. But the Q4 EBITDA margin is very close to the longer term targets that you have out there. We’re hearing lots of focus across software on efficiency. Can you just walk through how you’re evaluating the gross margin trade-offs there? Any change in your approach to headcount addition entering this year versus prior? Just on the other side of it, how do you make sure you’re positioned for growth, given there’s an assumed growth rebound? We’re talking about macro headwinds, but obviously, the bigger picture in CCaaS is still much cleaner. So, can you just walk through your evaluation in the current environment on both of those sides?

Mike Burkland: Michael, if I could start. And, Barry, please chime in. But we’re fortunate, in that we have a business model we’ve been approaching this with balanced growth for a long, long time, right? In terms of investing €“ I always say investing on the curve. We’re not ahead of the curve in terms of the revenue curve. We’re not behind the revenue curve. We’re very instrumented. We understand where our business is coming in. And we tend to hire right on top of that curve. So we’re able to manage the bottom line based on what we see from a visibility standpoint on the top line. We’ll continue to take a very balanced approach. I think the balanced approach that we’ve taken has always put us in a pretty good situation relative to other tech companies in general.

That said, we’re always investing. And this opportunity is setting the track, so to speak, for the long-term growth opportunity that we see. And that’s, again, we reiterate, we always talk about the $2.4 billion revenue target in 2027. And, again, as soon as this macroeconomic backdrop clears, we do have just so much optimism around the future growth opportunities. But at the same time, we’re going to be cautious and thoughtful in the near run relative to the economic backdrop.

Barry Zwarenstein: Anything I would say would be just saying what Mike said in different words.

Operator: And with that, we’ll take our last question from Michael Funk at BofA.

Michael Funk: One if I could. I want to hear your thoughts on elasticity of demand and if you are seeing a more competitive price environment. And then, I guess related to that just in terms of demand, the weakness you called out in 4Q where you expected more seasonality, had seen more seasonality from health care consumer, how much of that is macro that you mentioned versus maybe a post pandemic pullback or resizing of those customer bases?

Barry Zwarenstein: On price, no, we’re not. There’s always some discounting, but it’s nothing at all different than what we’ve had in the past. Our prices have held up very firmly and are likely to go up gently, as they have in the past. Point one. Point two, in terms of electricity, people aren’t buying these systems based on price. This is all about mission criticality and the sharp point of the spear in terms of customer experience. In terms of seasonality, no, we can’t be 100% certain that is all macro. Sometimes our customers don’t even know. It would be arrogant for us to say we know exactly. However, we do get a lot of data in terms of the utilization of the seats, the number of seats, the past patterns, how they are different, et cetera, et cetera. And we come away convinced, Michael, that €“ particularly on those two light vehicles, that is healthcare and consumer, that it is mainly macro related.

Operator: And with that, I’ll hand things back over to Mike Burkland for any additional or closing remarks.

Mike Burkland: Yeah. In summary, I’ll just say I’m so proud of the entire Five9 team for the commitment, the dedication, the execution that drove our record results in 2022. We are making tremendous progress on our market, our expansion internationally, and innovating on our platform. I thank all of the Five9 team. We look forward to keeping you all up to date as the year unfolds. And thanks again for joining us today.

Operator: With that, we will conclude today’s meeting. Again, thanks for joining us, everyone. Have a good evening.