Five9, Inc. Q3 FY2020 Earnings Call

Good day, everyone and welcome to Five9's Q3 FY2020 Earnings Call. Today's call is being recorded. And at this time, I'd like to turn the conference over to Lisa Laukkanen. Please go ahead.

Thank you for joining us today. On the call are Rowan Trollope, CEO; Dan Burkland, President; and Barry Zwarenstein, CFO. Certain statements made during the course of this conference call are not historical facts, including those regarding the future financial performance of the company, industry trends, company initiatives and the proposed acquisition of Inference and the timing and expected benefits thereof, 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 the COVID-19 pandemic, and the closing of the Inference acquisition is subject to certain closing conditions that the transaction may not close when expected or at all and that the total purchase price is subject to various purchase price adjustments, as well as whether or not certain earn-out metrics are satisfied. 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 the 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 available in the Investor Relations section on Five9's website at five9.com. And now I'd like to turn the call over to Five9's CEO, Rowan Trollope.

Thank you, Lisa, and thanks to everyone for joining our call this afternoon. I'm thrilled to report outstanding performance in the third quarter, driven by continued strong execution, positive industry trends and constant product innovation. We reported record third quarter revenue of $112.1 million, accelerating to 34% year-over-year growth and 12% sequential growth. Both of which are all-time highs as a public company. Enterprise subscription revenue grew 35% on an LTM basis. And on the bottom line, adjusted EBITDA margin was 21.5%, also a Q3 record for Five9. And we continued to experience strong bookings across the boards for both commercial and enterprise with our existing customers and with new logos. In addition to these excellent financial results, we're also very excited to announce a definitive agreement to acquire Inference, a leading provider of Intelligent Virtual Agents and a partner we've been successfully going to market with. Inference accelerates the Five9 AI portfolio to provide effective digital labor, driving a new level of efficiency for contact centers. IVAs use conversational AI, enabling natural dialogue between computers and humans, and are a major evolution from touch-tone or voice-activated IVRs, which depended upon structured, fixed grammar interactions. These more accurate and user-friendly IVAs result in significant savings through increased call deflection rates, better-informed agents, or both. With this proven IVA technology, the Inference acquisition will position Five9 to take advantage of the trend towards increased automation of mundane contact center tasks. Having an IVA is fast becoming a fundamental requirement in enterprise deals as demand continues to increase on contact centers, especially in this COVID-driven environment. And it can no longer be addressed by simply hiring more agents. What customers are requiring is digital labor, as provided by solutions like IVAs to meet the increased demand and enhance their customer experience. A great recent example is the logistics company deal that we talked about last quarter. The company helps state governments and managed healthcare organizations with transportation services. The deal, which was one of our largest ever, started out with an IVA focus through Inference, our partner at the time, and mushroomed into a full contact center solution. With Inference, they're able to trigger automatic booking confirmations, SMS reminders, status of rides, as well as follow-up surveys and more. And Dan in a few moments will provide more examples when he talks about our third quarter deals. We selected Inference for a number of reasons. First, they are a market leader in this emerging category, both from a technology and from a market share perspective, according to industry analyst firm DMG Consulting. Inference is deployed worldwide with customers in Asia-Pacific, Europe and North America. Second, it's disruptive. Most current IVA solutions are either professional services-centric, which are available only to the mega enterprises with huge implementation budgets, or they're developer-centric. The Inference Solution, on the other hand, can be deployed in days with minimal people involved, offering the best of both worlds. Third and finally, we see very considerable go-to-market synergies, a large number of Tier 1, 2 and 3 telecom providers around the world, including AT&T in North America and Telstra in Australia, trust Inference. And we see considerable opportunities to leverage the Inference global presence and introduce them to our partners, including systems integrators, VARs, and other resellers. We've been delighted by customer demand and acceptance of the Inference Solution. And this is one of those moments where new technology is reaching maturity at a time when the market demand is increasing, which creates a great opportunity for Five9 with Inference. We expect to close the Inference acquisition no later than January 5, 2021. And Barry will talk more about the financial impact in his section. Having introduced Inference, I'll now turn to discuss the underlying market drivers for our strong performance. First, the transition to the cloud continues unabated, including for larger enterprises, and we believe will continue for many years to come. Second, it's become imperative to digitize customer experience as part of a company's overall digital transformation. Third, these two megatrends, the move to the cloud and digital transformation, have been accelerated by COVID-19. We see this in the significant increase in demand for agents in general and, in particular, demand for agents working from home, benefiting both businesses and agents. And finally, fourth, as I will elaborate upon in a moment, the demand for AI-driven automation is clearly increasing. In short, as we all know full well, the new front door for many types of businesses, from yoga gear to e-learning, telemedicine to electronics and so on, is the contact center. And we believe that this front door will open wider in the future. I'd now like to discuss our go-to-market approach and highlight our key achievements. For the last few years, our GTM approach has become more balanced with our extremely successful direct approach, being complemented by master agents, VARs, distributors, systems integrators, and finally, service providers. Our investments in these complementary areas are clearly paying dividends. As you can see from the following examples, first, our SI momentum continues; once again this quarter, SI bookings more than doubled compared to last year. And we anticipate our SI bookings to finish 2020 at more than triple what they were in 2019. We're also now significantly more diversified by SI partners than we were last year. Second, we're very pleased with the performance of our AT&T partnership. Following AT&T’s rapid onboarding and the successful launch of AT&T cloud contact center, we're now jointly delivering initial customer deployments and quickly growing our global pipeline together. And finally, third, we continue to enjoy significant international traction. Our product localized for multiple languages has enabled multi-country connectivity to a host of local carriers and is supported by in-region support personnel and partners. Moreover, we successfully migrated our platform to run on Google Cloud Platform and deployed two new instances in Canada, in addition to our data centers in London and Amsterdam. We're experiencing momentum from our international marketing strategy, which includes thought leadership programs, regional programs around awareness and demand generation, as well as partner enablement and amplification. Our growing international presence was also evident at our recent CX Summit, where we saw strong international participation with 54 countries represented. And finally, some metrics; although the numbers are still somewhat small, our international momentum continues with record bookings in EMEA and Latin America, with EMEA growing 3x and Latin America growing 4x year-over-year in Q3. I’ll now turn to focus on our product execution and leadership. Here our emphasis is on portfolio expansion to increase our average revenue per user, which complements our growth via logo addition. The tool of course takes some time to manifest in our financial results, but we're very encouraged by the strong positive feedback from our customers and partners on the capabilities we're delivering. To achieve this ARPU growth, we're focusing both on product evolution and innovation and are making great progress on both fronts. So with respect to evolution, here are three recent highlights. First, our most recent release included over 135 new features with significant focus on digital accounts. Second, our recently acquired BO business is doing extremely well, posting record bookings in Q3. The first version of integration into the Five9 platform has been completed, and further enhancements are underway. Finally, third, we broadened and deepened our CRM and UC integrations. We're especially pleased with our recently GA, Zoom Phone and Microsoft Teams. We're also seeing excellent early traction on the innovation front. So here are some examples. First, VoiceStream. VoiceStream is a media streaming API, enabling the building of apps that access real-time call audio. These apps will enable businesses to do things such as authenticating a caller's identity to voice biometrics, effectively coaching agents while they're on a call, utilizing speech and sentiment analysis, and much more. This will help contact centers improve agent performance while also delivering a better customer experience. With VoiceStream, Five9 is taking a unique approach, implementing it in our own products while also creating a platform capability that makes it easier for our partners to build AI apps for the contact center. Second, we announced the release of Agent Assist, which captures in real-time call transcripts and generates accurate, time-saving call summaries that automatically sync with the CRM platform and greatly improve agent efficiency. Agent Assist uses innovative natural language processing technology developed by Five9 and has already had a remarkable reception for such a pioneering product. Third, as I mentioned earlier, we now also have Inference, which will help us take a meaningful step in meeting industry demands while increasing ARPU. Given a Virtual Agent is priced at up to $400 per virtual seat per month, roughly double our current ARPU per human seat. So stay tuned for much more to come. In conclusion, we believe we are very well positioned for continued strong growth with clockwork-like execution. Our team continues to focus on go-to-market initiatives and capitalize on the significant tailwinds in the market. We have a tremendous market opportunity with only 15% cloud penetration of the $24 billion contact center software market. Moreover, we see the opportunity to potentially more than double our current tab with labor arbitrage through the deployment of automation technologies. Our acquisition of Inference is the first step to realizing the arbitrage opportunity, and given these favorable market trends and the proven ability to execute, we continue to believe that we can maintain 30% level enterprise subscription growth for quite some time. With that, I'd now like to turn it over to our President, Dan Burkland.

Thank you, Rowan. We continued to set records in bookings and contributions from our channel partners and systems integrators. Our enterprise net new team booked a record for any Q3, nearly eclipsing Q2, which you will recall was an all-time record. Over 60% of our deals continue to be influenced by partners, and our pipeline continues to grow to an all-time high once again, reaching more than double what it was just a year ago. As Rowan mentioned, our go-to-market machine, along with our key investments in channels and international are providing us accelerated momentum, as you can see from our results. Now I'd like to share some key wins from the quarter. The first is a technology company which provides software to financial and healthcare organizations for IT, HR, and accounting. They had been using Amazon Connect for about six months when they determined the path to delivering their CX vision would require extensive investment, additional resources, and an elongated timeframe. So they decided to abandon the project and start fresh with a more complete cloud solution. They selected Five9 due to our end-to-end CX offering, including first, our deep integration to their ServiceNow CRM; second, our IVA powered by Inference to replace an outdated speech-enabled IVR, where callers can receive intelligent self-service; third, if opting out to speak to an agent, all the IVA journey data is passed to the agent for personalization, never requiring the caller to repeat information; fourth, we are providing real-time speech analytics from our Virtual Observer acquisition to alert supervisors of calls in flight, which are in need of assistance to immediately improve the customer experience. As a result, this customer expects to save over 70 seconds in handle time per call on to more than 30,000 calls they process each day. We anticipate this initial order will result in approximately $2.7 million in annual recurring revenue to Five9. The second key win is an automobile insurance company for specialty and collectible vehicles. They had been using an on-premises Genesis system, which lacks the deep integration to their Salesforce CRM and had no integration to their Zoom phone UC solutions. This is also an excellent example of a customer looking for an end-to-end solution to truly transform their CX vision. This customer is implementing the following key features. First, our Five9 AI product Agent Assist for transcription and summarization of calls to be inserted into their various CRM systems, including Salesforce, ServiceNow, Insuresoft, and a homegrown solution; second, our IVA solution powered by Inference for intelligent self-service; third, our secure pay for PCI compliance; fourth, our engagement workflow and routing of Salesforce chat and email; fifth, visual IVR for customers to interact from any mobile device; sixth, the Five9 Virtual Observer QM and speech analytics; and last, our Zoom phone integration, where agents can have a shared directory, see the status of Zoom users, and perform seamless consultative transfers. We anticipate this initial order will result in over $1.9 million in annual recurring revenue to Five9. The third example is one of the nation's leading providers of credit and lending programs for consumers. They too found that adding legacy point solutions over the years had created islands of technology and silos of data with little or no integration between them. So they embarked on a process to find a complete CX solution. Five9 was selected from all the typical competitors for the completeness of our offering, along with our modern SaaS microservices architecture, which gives them hundreds of APIs to ensure integration and the ability to share data across many disparate systems. This customer is leveraging performance dashboards, QM, speech analytics, and WFM from our Virtual Observer WFO suite. They also found Five9 was the only provider who could truly blend inbound and outbound calling, allowing the system to dynamically pace their outbound campaign dialing based on observing the rate of inbound call traffic. This is designed to maximize the utilization of their agents while also minimizing wait times for inbound callers. We anticipate this initial order will build in approximately $2.8 million in annual recurring revenue to Five9. And now, as I normally do, I'd like to share an example of an existing customer who is expanding their use of Five9. This healthcare company providing patient journey and decision-making data to pharmaceutical, biotech, and medical device companies became a Five9 customer in 2019, and we served a single department's contact center needs. Not only did they recognize the benefits of moving to a single technology platform, but they also found a significant difference in the support they received from Five9. They are now moving the rest of their departments and agents from competing solutions over to Five9, where they will also get the benefit of a technical account manager, responsible for continuous optimization of the solution across all of their departments. This customer will go from just under $500,000 in annual spend to over $1 million in annual recurring revenue, and join our growing list of $1 million ARR customers. As you can see, more than ever, Five9 is delivering a comprehensive next-generation CX platform that is helping enterprises transform how they, in turn, deliver a more intelligent, personalized, and agile experience to their customers. And now I'd like to hand it over to Barry to share our financials.

Thank you, Dan. Before going into specifics, a reminder that unless otherwise indicated, all financial figures that we'll discuss are non-GAAP; reconciliation from GAAP to non-GAAP results are included in the appendix around this presentation on our website. We are very pleased with the top and bottom line results, which far exceeded our expectations. As Rowan mentioned earlier, revenue grew 34% year-over-year and 12% sequentially, both all-time highs for any quarter as a public company. This record growth was driven primarily by our Enterprise business, where subscription revenue increased 35% year-over-year on an LTM basis. Enterprise makes up 82% of LTM revenue, and our commercial business represents the remaining 18%. Note that our commercial business continues to be resilient, growing year-over-year in the team. Recurring revenue accounted for 92% of our revenue, and the other 7% of our revenue was comprised of Professional Services. LTM database retention rate increased to 107% from 105% last quarter. As a reminder, our continued success in winning larger and larger enterprise customers is expected to continue causing fluctuations in our dollar-based retention rate and in our enterprise subscription growth rates that come onto the platform at different times and ramp at different rates. Third quarter adjusted gross margins were 65.4%, an increase of approximately 140 basis points year-over-year. Third quarter adjusted EBITDA was $24.1 million, representing a 21.5% margin, also a Q3 record. This is an increase of approximately 350 basis points year-over-year. Third quarter non-GAAP net income was $18.5 million, an increase of $5.7 million year-over-year. Non-GAAP EPS for the third quarter was $0.27 per diluted share, up $0.07 cents year over year. With regard to the balance sheet and cash flow highlights, DSO was 31 days in the third quarter. Third quarter operating cash flow was an all-time record of $22.8 million, maintaining high LTM operating cash flow margin in the team over the last 10 consecutive quarters. We remain optimistic about our potential for continuing cash flow generation, given that long-term model, our substantial NOLs and our low DSOs. And now, some specifics about the Inference acquisition. Five9 has agreed to apply Inference while having $48 million in cash, subject to certain purchase price adjustment with additional cash payments of about $24 million upon certain earn-out provisions being met. I'd like to finish today's prepared remarks with a brief discussion of our expectation for the fourth quarter and the full year 2020, which do not include any impact from Inference, as the transaction works to close in the fourth quarter, rather than in the first days of January. I will also provide some initial comments on 2021, in particular about the financial impact of acquiring Inference and especially the COVID profile of the bottom line. First, fourth quarter in 2020, we are guiding fourth quarter revenue to a midpoint of $115 million, which represents a 3% sequential increase over a particularly strong third quarter and 25% year-over-year growth. For 2020, we are raising the midpoint of our annual revenues guidance from $400 million to $522 million, which represents an increase in the year-over-year growth rate from 22% to 29%. As for the bottom line, we are guiding fourth quarter non-GAAP net income to a midpoint of $16.5 million, which represents a $2 million quarter-over-quarter decrease that is within the range of sequential decline that we have guided to in prior fourth quarters. This sequential decline is primarily driven by a substantial ongoing investment in key strategic areas, particularly in go-to-market and R&D. With five of these investments, we are raising the midpoint of our annual non-GAAP net income guidance from $53.7 million to $60.2 million. Taking into account these investments and other items that are detailed in a GAAP to non-GAAP reconciliation, we are guiding GAAP net loss to a midpoint of $40 million in Q4 and $48.9 million in 2020. I'd now like to provide insight into our current thinking for 2021. While we are not providing formal guidance at this stage, we can provide some high-level commentary. While those of you who have been following Five9 for some time know that we have in the past always started the 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 on our business. For 2021, we currently estimate a higher than typical year-over-year growth rate of 18% on the midpoint of our 2020 revenue guidance, primarily due to the additional revenue contribution we are estimating from Inference. Driving total revenue for the year to reach approximately $500 million. We also expect revenue to continue following a typical pattern, with slightly more than 50% of our annual revenue being generated in the seasonally stronger second half of 2021. With respect to 2021 non-GAAP net income, please note that Inference will be diluted to our bottom line. In addition, we are trying to continue investing in go-to-market and R&D issues to maintain the momentum of our core business in this COVID-driven environment. As a result, we expect non-GAAP net income in 2021 to be approximately the same as a midpoint of our 2020 guidance at $60.2 million. In addition, we would like to provide a more extended outlook on the COVID profile of our bottom line. We currently expect non-GAAP net income to be approximately $8 million in Q1, flat in Q2, progressively better in Q3 and especially strong in Q4, which is always our strongest quarter. We'd like to remind you that we remain committed to achieving our long-term EBITDA margin target of 27% in approximately four years. Finally, here are the customary estimates for modeling purposes. For calculating EPS, we expect our diluted shares to be $72.2 million and basic shares to be $67.8 million for the fourth quarter of 2020 and $58.6 million and $54.6 respectively for the full year of 2020. We expect our taxes, which relate mainly to target subsidiaries, could be approximately $120,000 for the first quarter of 2020 and $570,000 for the full year 2020. Our capital expenditures for the fourth quarter of 2020 are expected to total approximately $10 million to $11 million. For the full year 2020, we expect our capital expenditures to be between $31.5 million and $32.5 million. At the midpoint, this represents approximately 7.5% of our guided revenue for the year, which is higher than our historical average of 6%, primarily driven by international expansion and the build-out of our new headquarters. In summary, we are very pleased with our third quarter performance, achieving all-time records of multiple metrics. We are also excited to expand our already matured TAM by acquiring Inference to capitalize on the opportunity of automating the mundane tasks in the contact center. And we remain laser-focused on making strategic investments to guide momentum in our business.

Thank you. We'll take the first question today from Sterling Auty with JP Morgan. Please go ahead.

Yes, thanks. Hi guys. So Rowan, are you in the same room with Barry?

No, we’re not. We're at our respective homes.

You need to check in on him, as every quarter since the IPO, the guidance for the next quarter has typically been around $600,000. So, witnessing a roughly $3 million increase in guidance that doesn't include the Inference acquisition suggests that something significant has changed. Clearly, we are experiencing the benefits from COVID and other factors, but am I interpreting this correctly? Is there a real shift in the business momentum? Considering all the information you've provided, what has changed the most since our discussion 90 days ago during the June quarter call?

So certainly I’ll assure you Sterling, I’m feeling very well, but thank you for your concern. So we’re seeing – we’re seeing very strong momentum in the enterprise business on all fronts, not just the new logo that we typically in the past talked about, but also in the install base and on the commercial side, which Dan can talk about more if you want. The seat turn-ups were a record during the quarter, our PS organization performed flawlessly and churn declined post-COVID, and things just went extremely well pretty much across the board.

Got it. Thank you.

And we'll take our next question from Meta Marshall with Morgan Stanley. Please go ahead.

Hi, this is Karan Juvekar on for Meta. Thanks for the question. Just a quick question on Inference, are there any particular workflows that the solution is best for today? And who would be responsible for creating those vertical-specific solutions? Would it be you guys or them? Thank you.

Yes. So I think first thing to point out about Inference is that it’s really built for mass deployment; it’s unlike really anything else out there. The legacy in this space requires professional services, and this is a tool that finally allows just about any company to get the power of IVAs. I'll let Dan comment on. We've actually been developing this product and had a partnership with them previously, so we've already got some experience with it. We shared it on the earnings call, the logistics example there, and others. But Dan, any comments on industry verticals where you think this might be more or less complete?

Yes, I think – and thank you. All the typical verticals that we see for contact center, which is really a very horizontal application that goes into just about any type of business, one that receives calls from its customers. So when you look at consumer products, whether it's healthcare, financial services, retail, technology, what IVA has accomplished and what they're there for is really to handle customers that don't need to speak to a human that want to get self-service but still have an open-ended number of questions they may be asking. So they're going to have to think of it as a conversation, not with a human, but with the system, and the system team will fetch the answer and come back and provide the answer. What's unique here is if you think about historically where IVR has placed, they were replaced across all industries. IVR has started out with touch-tone choices, then they evolved into some very limited speech recognition, where you were listening for a very succinct list of grammars or questions. Now it's very conversational and open-ended. It can be applied just about as widespread as we apply our other contact center solutions. That's one of the reasons we're so busy, have to think about this acquisition.

Thank you, that makes sense. Appreciate the answer.

Thank you. We'll now go to David Hynes with Canaccord.

Hey, thanks guys. Congrats on the strong results. I don't know if this is better for Rowan or Dan, but I'm curious what a fully loaded ARPU looks like these days. I may have my numbers off, so correct me, but I think we've talked about in the past, like the typical sales 200 to 250 with a max that goes all the way up to 400. You guys have added a ton of products. So I'm curious how we should think about that now, and I realize it probably gets a little bit messy with that labor arbitrage opportunity that you talked about. But any kind of framework would be helpful.

Yes, I'll take that one. It's pretty clean here, and the numbers haven't changed much from what we shared last time, but I think our average is in the 200s, around 204, 205. For fully-loaded ARPU, which is the original question, if you bought everything in our portfolio, you're talking around $400 per month per agent. To put things into context to deploy an on-premises solution with the same level of redundancy and availability and scale, the capability that we can deliver in our portfolio costs more than $400 – $400, $500, $600, and so on. So, where we are on that is, as you point out, we've been expanding our portfolio, bringing in virtual observers and so on. Those are really owned by Five9, but we were already selling those products on Five9 paper. And so you're not seeing a drift up in the ARPU number from us at this point. Inference is a different story. Inference is actually very simple; instead of selling per human seat, we sell per digital seat and sort of concurrent digital seat. Those will sell for up to $400 per digital agent per month, which is roughly double what we could get from our traditional software sold for the human agents. From a customer's perspective, the benefit is, of course, they're not paying the labor costs and the salary or labor cost for the employee. So they actually see some pretty significant savings by moving to digital seats.

Yes. Okay. That makes perfect sense. Helpful. Thanks, Rowan.

We’ll now go to Terry Tillman with Truist Securities.

From a customer's perspective, the benefit is that they're not paying the labor costs and salaries for the employees. They actually see significant savings by switching to digital seats.

Hey, Terry. Terry, this is Dan, you’re cutting out; if you wouldn’t mind either starting over or we can come back to you.

Is it better?

Much better. Thank you.

Well, I was going to have a great kind of preamble there. I'm going to be hopefully witty about varying the guidance for 2021, but I'll just move ahead with my question. But in terms of the international business, I think when Barry was talking about the guidance and strategic investments into 2021, I'd love to learn a little bit more about maybe is there a greater lead into the international side? And the second part of that one question is just maybe Rowan or Dan just consumption and what you're seeing with the international business: do they bond more strategic or piecemeal? So just would like to hear more about international and the opportunity. Thank you.

Sure. Yes. A key part of our growth strategy, we have been investing particularly in Latin America, Canada, and Western Europe. We're starting to see that pay off, as we shared the pipeline is up 3 times and 4 times in Western Europe and Latin America respectively. So we're seeing tremendous interest. We've also signed some really exciting new partners over there with the market leaders and have been hiring, opening offices. As you know, we've been primarily U.S.-based, but a couple of years ago, we began to make those expansion moves and investments. They have taken some time to really kick in, but I'm starting to see it now as it feeds into the overall top line. And we'll see that continue. In terms of the differences in Europe and elsewhere, we do see very similar situations in Western Europe to the U.S. There’s slightly more complexity from a backend perspective because of local country telco regulation and data residency. We've chosen GCP as I think we said in the earnings script earlier that we'd selected GCP and deployed that now in Canada, and then we're moving next to Amsterdam. So that's an important part of the strategy as well. But the dynamics in Western Europe are very similar; Latin America is very similar as well, and we've seen very, very strong growth there. Our growth playbook is working equally well in both those regions.

Thank you.

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

Hey, congrats from me as well. I actually checked back; I think it was like Q2 2014 when you last grew 34%, 35%, so well done. Congratulations on that as well. The – can I go back to the partners? Like you mentioned on the European side of partners, but can I also see in terms of your partnerships? It seems to me, because the partnerships are not that old, that we should actually only be at the beginning of a journey rather than like in the middle of it. Can you just talk to me a little bit about how that whole partner relationship is evolving at the moment? Thank you.

Yes, this is Dan. Thanks, Raimo. Great question. As Rowan mentioned, the market's pretty similar to the U.S. We went there and kind of put a flag in the ground a few years ago and embarked on a direct focus really to establish ourselves in the Western European market. Once doing so, we brought on additional management with the experience of building out a channels organization. I think as we've mentioned before, Brian Atkinson joined our team over a year ago. He's been building that team out, and he has the experience and the relationships to build out a channels group. Depending on the country and depending on the region, there's a strong propensity for buyers to turn to local channels, local organizations or their carriers in that space. So we're working very closely with some of the large carriers and service providers, as well as signing up lots of our and regional distributors like Connect. Connect is one of the distributors that's been carrying our product there in Western Europe and doing a great job with us. We're seeing great momentum across the board; the percentages of growth are significant compared to what we're seeing here, but we are working off of smaller numbers. So in the 30s and 40s, as far as the growth rates in those markets, we're very pleased with our progress there and we'll continue to invest as the opportunity presents itself.

Congrats. Okay, thank you. Congrats.

Please go ahead.

Thank you.

We’ll now go to Matt VanVliet with BTIG. Please go ahead.

Yes, hi. Thanks for taking the question, and congrats on another solid quarter here. I guess looking at the partnership from a different angle; you highlighted a lot of early success on the AT&T front. Maybe just help us think about kind of what those typical opportunities are looking like in – with that partnership and how maybe additional conversations are going with some of their rivals as they've seen this gain momentum so quickly?

Yes, so that's great. Thanks, Matt. This is Dan. The AT&T partnership is flowing extremely well. Not only building up pipeline, but as we talked about at the beginning of the year, we started onboarding their staff, training them, getting the pipeline built, and we're starting to see the fruits of that labor come through from a revenue perspective. As we talked, it's going to move the needle significantly more in 2021 than it will here in 2020. But we're seeing significant growth there, and the pipeline is exceeding our expectations. When we look at the deals themselves, it runs the gamut; they don't discriminate from very large enterprises that they work with and have control over to smaller commercial-sized businesses. So we're seeing contributions into our bookings pretty much across the board, including our commercial business.

And we'll go to Alex Kurtz, KeyBanc.

Hi, is this Mike on for Alex, and congrats on the deal. Now, considering the deal will increase your competitive positioning, I wanted to ask about the opportunity with Cisco; they are introducing a new pricing framework for collaboration early next year called Flex 3.0, and that’ll move over time and customers to subscription. Do you see this as an opportunity for Five9? And can you create programs around this event as customers most doubted solutions? Thanks.

Yes, this is Rowan, thanks for the question. Cisco has been doing a great job of evolving that flex pricing strategy and making it easy to switch customers to a subscription-based offer. But the reality is that they still don't have a CCaaS offer, and that's what customers really want. We've been steadily helping those customers move on to our platform, and they've been very happy to do that. I think that's going to continue, but I would never count Cisco out; I'm sure they've got more tricks up their sleeve down the road.

And our next question will come from Michael Turrin with Wells Fargo Securities.

Hey there. Thanks. Good afternoon. I want to talk more about the move up market, given we're finding more proof points around your success there. I know it's probably tough to quantify, but can you maybe share thoughts around how much of that is driven by the shift towards cloud and some of the partner relationships you established versus some of the capabilities you've been adding, things like workforce optimization, AI soon to be influenced, which can help explain that. Any further color on the market is useful. Thank you.

It's been pretty consistently moving up market as you've seen. Part of that is companies getting more comfortable with cloud and sort of seeing their peers go first, their colleagues prove out that cloud can work for larger and larger customers. We have been one of the leaders in helping bigger and bigger customers move to the cloud. Second, I think work from home is here to stay with COVID, which is really turbocharging the cloud transition. There's been a lot of sticky tape and bubblegum to get your on-prem solution working in a work-from-home mode. This has been another factor that's driven awareness to all-time highs amongst enterprise buyers that cloud is the future. We are still less than 15% penetrated, and I think you can see this quarter that our enterprise subscription is growing at 35% LTM now. We think that's going to continue; we continue to see larger deals in our pipe and bigger customers throwing in the towel on-prem and moving to the cloud.

Thanks. Nice job to the team on results.

Thank you.

Our next question comes from Ryan MacWilliams with Stephens, Inc.

Thanks for taking the question. Rowan, just on those upmarket deals, have you seen a sense of urgency this year to get those deals done given COVID? And then just since the start of COVID, any significant changes to the customer journey to adopting cloud contact center solutions? What I'm trying to get is, are you seeing more demand coming from collaboration platforms like Zoom or Microsoft Teams than before? Thanks.

Yes, Ryan. This is Dan. I'll take that one, but great question. What I'll say is partly because of COVID, and Rowan has talked about the contact center really being the new front door to business, that's the only conduit and the only way to communicate with your customers. More and more companies are recognizing that they've got to be able to deliver a customer experience across whatever medium the consumer chooses. They want to be able to deliver IVAs and chatbots; that’s why we looked at Inference and brought them on board. Companies want to help. They want to self-serve for many things. They also want to interact digitally; they want to use chat or email to communicate. You've got to deliver a consistent experience there, and there are cases where people want to talk to a human being. They want to have a detailed conversation, an intimate conversation with empathy and the human experience. So you've got to be able to build and cater your solutions to all of those. So, when you say, has it accelerated the decision process? I think in some cases it has; it certainly has brought more decisions to the table. We're seeing that in our pipeline generation and the fact that our pipeline has accelerated. But you're seeing, if you look back at those examples I shared in the opening remarks, the list of applications they've purchased from us crosses the board in all those different areas. It's not just an ACD or just an IVR or just voice; it’s really saying, hey, we’ve got to have IVAs and chatbots and workforce optimization, Agent Assist with AI. They're looking at the broader portfolio more so than they had in the past. Part of that’s due to the technology now being available and part of it’s due to the consumer requiring that companies build more flexible solutions.

Our next question will come from Scott Berg with Needham.

Hi, everyone. Thanks for taking my questions and congrats on the continued strong momentum. I think the one question I'll probably get most tomorrow, that's probably on everyone's mind is how do you accelerate revenue growth, roughly five points quarter-over-quarter on a year-over-year basis? If you look at all the drivers in the business, was there one area, enterprise, commercial, international partners. I don’t know maybe usage that drops to make extra revenue that caused such a sudden spike in the business, or was it just well-balanced execution from all the different areas? Thank you.

Barry will take that, thanks Scott.

Thanks Rowan. Scott, it was very broad-based. When you look at it first, enterprise commercial posted very, very strong results, and we give enough data there for you to calculate what the growth rate is. And you'll see that growth is very well. If you look at it through the lens of subscription usage and PS, PS was actually quite lower than normal this particular quarter, but I wouldn't read anything into that because there's huge lumpiness there; if you look over the last three years, the ratio between the highest quarter and the lowest quarter ranges between 2x and 3.5x. It comes up and down. But when you look at subscription and the related usage, because the usage tracks the subscription, subscription is very strong across the company; I will share with you that our growth rate on subscription in the quarter was an all-time record. With that, the usage that tracks it, especially there's more enterprises, there's a more efficient rate, also hit record levels and is a reflection of a very strong market overall that the comment from Rowan about the new front door was real. We see it all in our personal lines and not doing the brick and mortar ingredient as much as we used to. The center of gravity shifts to online, and you need contact centers.

Well said, Barry.

Very helpful. Thank you. Congrats again.

We’ll now take our next question from James Fish with Piper Sandler.

Hi, guys. Congrats on the quarter. Rowan, you talked about this at the Analyst Day a little bit, but you highlighted that demand for AI is increasing in your prepared remarks. Any update on the penetration of just one AI solution across your installed base at this point? How are you thinking about the large contact centers that have 5,000 seats or more in the pipeline after this quarter?

Sure. We have had two launches essentially. The first was the IVA product that was an OEM in partnership with Inference. We’ve been selling that, and that’s been a key component, a handful of very, very large strategic deals as we shared previously. I think that is really ready for takeoff, I would say; we haven't hit our stride on selling that into our customer base yet, and now that they’re part of Five9, buckle up. The second is our organically developed Agent Assist, which we did launch last quarter and it's getting very good traction. We're initially focused on driving efficiency through call summarization, which typically takes several minutes for agents, but when you’ve got thousands of agents, there’s significant savings. We’re seeing tremendous interest. The pipeline is growing, but it's just launched, so early days on that one. Those are the two that we're betting on right now, and again both of these are really ready for takeoff. As far as the greater than 5,000 seats part of your question, it's an increasing part of our pipe. We've been executing successfully with our largest customers who have over 5,000 seats and getting good references from them and demonstrating that success. We’re seeing more and more interest in that sort of 5,000 to 10,000 seat segment, and that’s going to continue to be a driver, and you'll see the 35% LTM growth rate on our enterprise subscription. I think that greater than 5,000 segment will continue to be a bigger portion of that as we go along here. So thank you.

Thank you.

We’ll go to Catharine Trebnick with Colliers Securities.

Great quarter. Thanks for taking my question. Could you parse the competitive landscape? It seems like it's shifted quite a bit with all your new products. Where do you see how you stack up against like an 8x8 and maybe Vonage and then obviously in contact? Where do you think you're getting the most share from? Thank you.

Yes, we don't see 8x8 and Vonage till last week but what we do see is NICE inContact first and foremost. Genesys has begun to get more attention to the cloud part of their portfolio. So we haven’t seen Genesys more, and there are a handful of other ankle-biters, startups, and other companies that are making noise, but nobody who's getting traction in these important segments of the market, which is where the growth is the sort of mid-market and enterprise business in the thousands of seats, which is where you're seeing a lot of our growth there. And on the UC front, I mentioned – you mentioned 8x8, but RingCentral is clearly there with our inContact partnership. We are seeing lots of introductions through our Zoom partnership and through our recently launched Microsoft Teams connector. So there are a lot of competition in the UC space. The fact that we have a Switzerland play here; we can integrate with any of them equally well actually sets us up well to be able to serve the market. Customers ultimately have a choice. They can choose their phone system; they can choose their contact center independently, and we guarantee we'll make those work together, and that’s something that's gone over very, very well in the marketplace.

Great, thank you.

Thanks, Catharine.

We’ll take the next question from Will Power with Baird.

Hey, this is Charlie Erlikh on for Will. Thanks for taking the question. Great to see the pipeline continuing to be strong. I'm wondering if you can talk a little bit about the makeup of the prospects in the pipeline. Are they perhaps a little bit larger than your average customer size, or they may be more inclined to take some of your AI products? And I'm hoping you can talk a little bit about maybe your confidence in closing the deals in the pipeline as well?

Yes, thanks Charlie. This is Dan. We absolutely are seeing an increase in the pipeline, and it really runs the gamut as far as the number of applications and the types of applications as I've talked to earlier. More organizations are looking to provide a unique experience to their customers, and they need to do that in a variety of ways, whether it's self-service, digital channels, workflow to do follow-up and outreach proactively via SMS. The more we can deliver the different applications, the stronger the adoption rate for this whole industry is. If you look at our pipeline in general, we're seeing it across the board, but the significant growth as you mentioned is at the higher end of the market. Companies are recognizing that this is the future; this is what the market is moving to. So we feel very good about the pipeline in general; it's hitting on all cylinders, and we get that pipeline now from more sources than ever. It used to be generated, if I look back three to five years, primarily by us through our digital marketing efforts and by our brand and word of mouth. Now it's being generated by thousands of sellers and large companies that are touting Five9. When you look at the number of systems integrators that we work with globally now, the number of distribution organizations, and the thousands of sales personnel we've trained and on-boarded to understand Five9 and at least be knowledgeable enough to recognize the opportunities to speak to it intelligently, and then bring us to apply our sales expertise. We’re getting more opportunities now from more channels than ever.

Thanks Dan.

And our last question will come from Peter Levine with Evercore ISI.

Hi, this is Peter Levine calling. Congratulations on a great quarter, and thank you for accommodating my question. How do you anticipate messaging and trends in conversational commerce will develop over the next 12 to 24 months? With the Inference acquisition, it seems the messaging landscape is shifting. Could you discuss what your customers are seeking in terms of messaging and how partners might utilize Inference in the future? Thank you.

Yes, great question. Messaging and what I would call sort of like near real-time channels, so SMS and any sort of text-based communications are clearly on the rise in our customer base. Inference brings us two things: one is a way to automate those conversations using AI; that's very exciting as a chatbot capability that we can bring to our customers natively as part of the product. But more importantly, I think, is the voice-based IVA to replace the IVR. Many customers have tried to implement that in the past with older technologies and have struggled with it. What's changed now is it's now possible to implement this for even the smallest companies in the world. Nobody likes IVRs; they're generally frustrating to your end customer. This is an opportunity to see the whole industry move towards new technologies driving more automation and more self-service. All of that can be done either by voice, so if you call the customer, what we really want is to make the experience great no matter what channel you're connecting in on. You can also do that via texting or messaging on a website, sending an SMS, or what have you. We can apply that technology across multiple channels, and I think it’s ready for takeoff in the industry. It's a good time for us to make this move.

Thank you.

I’d like to close out by saying thank you all for your questions and joining our call today. Thanks to my leadership team and the finance group and all the support folks who helped us to create this earnings call; we really appreciate it. Five9 is clearly on a roll. We have been executing like clockwork now for many, many quarters and doing so in the face of unprecedented disruption with COVID. My hats off, and I have to really thank from the bottom of my heart, our employees who have been at the front-lines of making everything that you've heard today happen. So thank you to the Five9 employees. And secondly, thank you to our partners, who have been a huge part of our growth story here; we couldn't have done it without them. And finally, of course, thanks to all of our customers. It's been an incredible nine months, I guess, you could say since COVID hit or perhaps a little less than that. You've given us your business and your trust, and we're honored to be able to serve you. So thank you very much and appreciate your time today. Thanks everyone.

That does conclude our conference for today. I'd like to thank everyone for your participation, and you may now disconnect.