Five9, Inc. (NASDAQ:FIVN) Q3 2023 Earnings Call Transcript
Five9, Inc. (NASDAQ:FIVN) Q3 2023 Earnings Call Transcript November 2, 2023
Five9, Inc. beats earnings expectations. Reported EPS is $0.52, expectations were $0.43.
Operator: [Abrupt Start ]…certain customers, customer growth, anticipated customer benefits company growth the anticipated benefits, from our recent acquisition of Aceyus, enhancements to and development of our solution, market 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 and uncertainty, 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, achieve the intended benefits from the acquisition of Aceyus, 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 and guidance is currently available in our press release issued earlier this afternoon, as well as in the appendix of our investor deck, and in the Investor Relations section on Five9's website at investors.five9.com. Lastly, a reminder that unless otherwise indicated financial figures discussed are non-GAAP. 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 report strong third quarter results with revenue growth of 16% year-over-year, primarily driven by our LTM enterprise subscription revenue growing 28% year-over-year. Adjusted EBITDA margin for the third quarter was 18% of revenue, helping drive an all-time record for operating cash flow of $37 million, or 16% of revenue. Let me start-off by reminding you of the three continuing trends that drive our confidence in this market. First, enterprises are developing plans in a greater sense of urgency to replace their on-premise contact center solutions as legacy vendors have retrenched and slowed or even stopped development in some cases.
Also a reminder that, in terms of cloud replacing on-premise we believe that the penetration is still less than 20%. Second, companies are enthusiastically pursuing digital transformation initiatives to enhance customer experience cut costs and increase revenue. In this context, remember that contact centers are mission-critical systems, which are a source of brand loyalty and differentiation. And third, AI is becoming an even more important catalyst for enterprises to shift to the cloud. AI automation is clearly an area of focus for enterprises as demonstrated by our greater than 80% attach rate on $1 million-plus ARR deals in the quarter. Now, I'd like to discuss the three main growth drivers for our business namely our platform, our march up market, and our international expansion.
Let me start with our platform. As you recall in August, we closed the Aceyus acquisition. We have experienced significant momentum with the Aceyus solution as the number of Aceyus opportunities in the pipeline has increased over 30% in this very short period of time. As a reminder, Aceyus is a fit for our $1 million-plus ARR customers, giving us continued strength in our march up market. For example, they're opening doors for several Fortune 100 deals, although, it's still early days. A good portion of our innovation continues to be centered around our AI and automation portfolio, and we are seeing significant traction as a result of this innovation. For example, our professional services team worked on more than 250 AI deployments during the quarter.
Additionally, bookings for our Agent Assist product increased 150% year-over-year driven by our AI summaries customer trials. It's clear that, our practical approach to AI continues to deliver real tangible value to our customers. This is directly tied to our core AI tenets, including our beliefs that AI should be available across our platform that, AI should be democratized and available to all customers that AI should remain engine-agnostic, and that AI should be applied in a responsible and ethical manner. And now, I'd like to focus on our march up market and international expansion. I'm pleased to report that we continue to see strong momentum up market and booking $1 million-plus ARR deals. As a reminder, $1 million-plus ARR customers make up more than 50% of our recurring revenue.
I'm also pleased to report that our pipeline for strategic deals doubled, year-over-year in Q3. In addition, we had a record number of enterprise and strategic RFPs in the third quarter which increased 66% year-over-year and 21% sequentially. This march up market and our continued international expansion are increasingly being driven by our ever-growing network of global partners and their dedication to leading with Five9. I'm very pleased to share, that IBM has expanded their relationship with us as a global SI partner reselling Five9 along with their CRM and ITSM offers, and also as a technology partner integrating watsonx with our AI solutions. This is a common model amongst large SIs as we are complementary, and tightly integrated with solutions such as Salesforce, ServiceNow, Microsoft Google and others.
We have now established ourselves as a global brand with the help of key strategic partners like IBM, BT, TELUS International, Deloitte and Accenture to name a few. Our partnership strategy is built not only on recruiting new partners, but also on enabling and empowering partners within our methodology of sell with, deliver with and build with. This approach was one of the key drivers that led to our EMEA bookings growing 57% in Q3. In addition, a US managed service provider who has been our partner for the past three years celebrated their largest quarter, with several new customer logo wins and over $4 million of incremental ACV added in the quarter. Their success is built in part on their ability to implement Five9 solutions integrated with their enterprise management platform and other services.
Our leadership in the channel is further validated by the three leading technology solution distributors in our industry: Telarus, Avant and Intelisys, ScanSource each recognizing Five9 as their number one CCaaS supplier. Furthermore, a recent channel survey by Baird ranked Five9 number one for top CCaaS solutions sold by the channel and number one in easiest to do business with. These partners along with many others are helping place us in a prominent position, within the global channel community. In closing, I'm very excited about our continued momentum out market globally and with the success we are having with our AI automation offerings. The opportunity ahead for Five9 has never been better, and I want to thank all of our employees who bring passion and purpose to their work every day to make this a reality.
And with that, I will turn it over to our President and CRO, Dan Burkland. Dan, go ahead.
Dan Burkland: Thanks, Mike and good afternoon, everyone. I'm pleased to report that we had a strong bookings quarter. Our pipeline reached another all-time high with our strategic accounts pipeline doubling year-over-year. And our sales of AI and automation solutions are seeing unprecedented momentum. As you know, the very high end of our market is lumpy, with regards to the timing of bookings. However, I'd like to remind you that the large enterprise category of $1 million to $5 million of ARR is the bread and butter of our business, and in aggregate is a larger contributor to our revenue growth than the mega deals. Now, as I usually do, I'd like to share some examples of new logo wins during the quarter. The first example is a health care insurance company, that was moving away from an Avaya on-premise version that was being end of lifed.
They chose Five9 along with one of our leading UC partners, with deep integration in order to gain visibility and provide seamless transfers between contact center workers and back-office employees, all from a single UI. We will also include our chat e-mail, SMS, QM and interaction analytics and we anticipate this initial order to result in approximately $2.3 million in ARR to Five9. The second example, is a hospital billing and collections company. They were using Cisco that was being managed by a third-party making moves adds and changes, cumbersome and also long lead times. They evaluated the major CCaaS providers and chose Five9. We are including the full omnichannel solution with e-mail, chat, SMS as well as both voice and digital IVAs. We are also providing them with QM, interaction analytics, WFM and Agent Assist where they expect to reduce call handle times by up to 50%.
We anticipate this initial order to result in approximately $2.3 million in ARR to Five9. The third example, is a utility company serving many markets in North America. They were using a hosted Cisco solution that was nearing its end of life. They chose Five9 from all the major CCaaS providers. And we'll be implementing our core offerings along with the advanced solutions including chat, e-mail, Agent Assist, our complete WFO suite powered by Verint performance management and gamification. This customer will also be deploying our voice and digital IVAs for self-service to pay invoices, check account balances, and canceling or moving service. We anticipate this insurer to result in over $2.2 million in ARR to Five9. And now as I normally do I'd like to share two examples of existing customers who have expanded their use of Five9.
This first example is a global pest control company who had been using our system for several years and was recently acquired by a European company who is using an on-prem legacy solution. The North America operations team was able to do a side-by-side comparison with real production traffic to compare performance over several months. They chose us for our superior reliability as well as our AI and automation portfolio. We anticipate their spend to increase from approximately $2.1 million in ARR to approximately $4.2 million in ARR. This last example is a leading global ticket sales and distribution company where we began providing our solution throughout Europe more than five years ago. In early 2022, we used the strong success we established with them in Europe to parlay this into their US operations where they saw increased call volumes.
We now continue to expand as we replace their legacy on-prem solution. This recent order increases their spend with us from approximately $1.2 million in ARR to over $2.2 million in ARR. So, as you can see, we are executing extremely well in landing some of the largest brands in the world as well as helping our existing customers expand and reimagine how they deliver CX to their customers. And with that, I'll hand it over to Barry to cover the financials. Barry?
Barry Zwarenstein: Thank you, Dan. Third quarter revenue exceeded our expectations, growing 16% year-over-year, primarily driven by the 28% growth in our LTM enterprise subscription revenue. As a reminder, we believe we are well-positioned to resume historic levels of growth in the 30s with enterprise subscription once the macroeconomic headwinds on our installed base subside. Our enterprise business made up 87% of LTM revenue and our commercial business, which represented the remaining 13%, grew again in the single-digits on an LTM basis. Now, I would like to provide color on our recurring versus total revenue. Third quarter recurring revenue, which made up 92% of total revenue, grew 18% year-over-year, the same year-over-year rate as in the second quarter.
Third quarter recurring revenue grew 4% quarter-over-quarter the same sequential rate as in Q3 of last year as new logo deployments offset slower installed base growth. Speaking of new logo deployments note that the international rollout of the parcel delivery company and the deployment of the health care conglomerate remain largely on track, considering the inevitable ebbs and flows of implementations across multiple divisions. Total revenue however grew sequentially at a slower rate of 3% in the third quarter versus 5% in the third quarter of 2022, primarily driven by the lumpiness of our professional services revenue, which declined 3% sequentially coming off of a record high PS revenue in the second quarter of 2023. This type of fluctuation is typical for our professional services revenue, which has experienced negative sequential growth in at least one quarter in nine of the last 10 years.
Our LTM dollar-based retention rate was 110%, a decline of two percentage points sequentially mainly due to the ongoing macro headwinds quoting subdued growth in our installed base. We expect fourth quarter LTM dollar-based retention rate to be either flat or slightly down and we expect a positive inflection in 2024, assuming no major changes in the economy. Longer term we continue to expect our retention rate to trend towards the high 120s by 2027 due to a higher mix of enterprise customers, especially, larger ones which have higher retention rates and higher ARPU from our AI and automation and other offerings. Third quarter adjusted gross margins were 16.6%, a decrease of approximately 80 basis points year-over-year. As we mentioned last quarter, we are making upfront incremental investments to support our new logo momentum, which is hindering our ability to report year-over-year growth in adjusted gross margin in the near-term.
Third quarter adjusted EBITDA was $41.3 million representing a 17.9% margin a decrease of approximately 60 basis points year-over-year. Third quarter non-GAAP EPS was $0.52 per diluted share a year-over-year increase of $0.13 per diluted share. Turning now to cash flow. We generated operating cash flow of $37 million a record driven in part by continued strength in ESO performance, which came in at 32 days. We have now delivered 29 consecutive quarters of positive LTM operating cash flow. Third quarter free cash flow of $31.5 million was also an all-time high. We remain optimistic about our potential for continuing cash flow generation given our long-term model, our substantial NOLs and our low DSO. And now I'd like to discuss our guidance for the remainder of 2023 as well as provide high-level commentary regarding 2024.
We closely track numerous indicators with a focus on consumer discretionary spend given that it directly impacts our seasonally strongest vertical in the second half namely consumer. Based on JPMorgan Chase data, the nominal year-over-year growth in discretionary credit and debit card spending deteriorated progressively throughout the third quarter from 5% in July down to 1% in September, which was the lowest growth of the year. Importantly, also note that what matters to Five9 is not normal spending growth, but rather transaction volume growth, which drives contact center inquiry volume. In this regard, the 1% nominal growth in spend in September of this year represented negative transaction volume growth. Given this trend, we are adopting a prudent approach to the fourth quarter and are assuming weaker seasonality in our consumer vertical.
Therefore, we are guiding fourth quarter revenue to a midpoint of $237.6 million which implies a quarter-over-quarter growth rate of 3%. This 3% sequential increase is in line with our typical guidance spend heading into the fourth quarter despite the weaker seasonality expected in our consumer vertical due to the offset from the ongoing strength of our new logo appointments. Accordingly we are maintaining the midpoint of our annual revenue guidance at $909 million or 17% year-over-year growth. As for the bottom-line, we are guiding fourth quarter non-GAAP EPS to a midpoint of $0.28 per diluted share and we are raising the midpoint of the full year to $1.92 per diluted share which represents a year-over-year increase of 28%. I would now like to provide some preliminary high-level commentary on our current thinking for 2024.
For those of you who have been following Five9 for some time, you know that for the six years through 2020 and again in 2023, we started each New Year with prudent revenue guidance of 16% year-over-year growth at the midpoint. For 2024, our outlook we gain here for a 16% year-over-year growth or approximately $1.05 billion in revenue based upon the ongoing strength in our new logo business and less challenging compares in our store base on the assumption that the economy does not deteriorate further next year. This as usual is a starting point and we will update our outlook as the year progresses. We expect revenue to continue following our typical pattern with slightly more than 50% of the annual revenue being generated in the seasonally stronger second half of 2024.
In terms of non-GAAP EPS, we are comfortable with the current street consensus of $2.16 per diluted share for the full year in 2024. In addition, we'd like to provide an outlook on the quarterly profile of our bottom-line. If you look at our historical financials, non-GAAP EPS is typically amongst the lowest of the year in the first quarter and we expect this to be the case again in 2024. Therefore, we anticipate non-GAAP EPS in Q1, 2024 to be in the high-20s per diluted share, which we expect bottom line to improve slightly in the second quarter and more meaningfully in the second half especially in the fourth quarter. 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 third quarter results. And while we remain prudent with our outlook, we continue to execute consistently against this massive market and we believe we are well positioned to accelerate our business once macroeconomic conditions improve. Operator please go ahead.
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