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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day everyone and welcome to the Five9, Incorporated Q4 2017 Earnings Conference. Today’s call is being recorded. And at this time, I would like to turn the conference over to Lisa Laukkanen. Please go ahead.
Thank you, operator. Good afternoon, everyone, and thank you for joining us on today’s conference call to discuss Five9’s fourth quarter and full-year 2017 results. Today’s call is being hosted by Barry Zwarenstein, Interim CEO and CFO and Dan Burkland, President. Mike Burkland, Five9’s Executive Chairman will also be on the call today for the Q&A session.
During the course of this conference call, Five9’s management team will make projections and other forward-looking statements regarding the future financial performance of the Company, industry trends, Company initiatives, other future events and are recently announced management transitions.
You are cautioned that such statements are simply predictions, should not be unduly relied upon by investors, and actual events or results may differ materially, and the company undertakes no obligation to update the information in such statements. These statements are subject to substantial risks and uncertainties that could adversely affects Five9’s future results and cause these forward-looking statements to be inaccurate.
A more-detailed discussion of certain of the risk factors that could cause these forward-looking statements to be inaccurate and that you should consider in evaluating Five9 and its prospects is included under the caption Risk Factors and elsewhere in Five9’s filings with the Securities and Exchange Commission.
In addition, management will make reference to non-GAAP financial measures during the call. Management believes that this non-GAAP financial information is useful, because it can enhance the understanding of the Company’s ongoing performance. And Five9, therefore, uses non-GAAP financial information internally to evaluate and manage the company’s operations. This non-GAAP financial information should be considered along with and not as a replacement for financial information reported under GAAP and could be different from the non-GAAP financial information provided by other companies in our industry.
The full reconciliation of the GAAP to non-GAAP financial data can be found in the Company’s press release issued earlier this afternoon and is also available on the Investor Relations section of Five9’s website.
Now, I would like to turn the call over to Five9’s Interim CEO and CFO, Barry Zwarenstein.
Thank you, Lisa. Welcome everyone to our fourth quarter and full-year 2017 earnings call. I’m very excited to report that our strong fourth quarter results kept over record year for Five9.
For the year, we grew revenue by 24% to a record $200 million. Revenue for the fourth quarter was a record $55.4 million, up 25% year-over-year and 11% sequentially. This revenue growth was again driven by our Enterprise business which delivered 37% growth in LTM Enterprise subscription revenue.
Furthermore, we continue to enjoy leverage in our business model resulting in record adjusted EBITDA for the year of $17.6 million representing an 8.8% EBITDA margin an increase of 3.6 percentage point over 2016.
For the first quarter of 2017 adjusted EBITDA was a record $6.9 million representing a 12.4% EBITDA margin an increase of 5.9 percentage point year-over-year and 40 percentage points since our IPO.
The adjusted EBITDA improvement is continuously driven by two factors. First, a strong growth in our Enterprise business which enjoyed excellent unit economics and is consistently increasing as a proportion of total revenue. And secondly, by the operating leverage we have consistently achieved over the last three years.
I will now turn the call over to Dan to highlight the success we are having in the enterprise market.
Thank you, Barry. I’m extremely pleased to report that we had our best quarter ever for enterprise bookings in Q4 and pipeline reached another all time high. Our exceptional bookings continue to be driven by the massive push towards digital transformation including the modernization of contact center and customer service technologies, the improved market landscape, the growth of our direct sales force and increased leverage from our existing ecosystem of partners.
This ecosystem of partners which includes master agents referral partners and resellers as well as other integration partners influenced more than 55% of our enterprise deal flow in the fourth quarter of 2017.
As a reminder, Five9 has deep partnerships with industry leaders in such areas as CRM, with the likes of Salesforce, Oracle, Zendesk, Microsoft, ServiceNow, in WFO with the likes of Calabrio, Verint, and CSI, and in unified communications with Microsoft teams formerly known Skype for Business as well as Cisco and several others.
The following metrics demonstrate our ongoing momentum in the enterprise market where win rate once again averaged more than 75% against our two key cloud competitors in the fourth quarter of 2017.
First, 37% growth in LTM enterprise subscription revenue. Second, enterprise revenue has grown to 74% of LTM revenue compared to 69% a year ago. Third, our average enterprise deal size in 2017 was approximately $640,000 in annual revenue up from $560,000 in 2016.
This ongoing success in our enterprise business continues to be driven by six key factors. First, a massive market opportunity, estimated at $24 billion in annual recurring revenue, where cloud penetration is still only 10% to 15%. Not only is the market opportunity massive, but it has a number of appealing aspects.
Namely, this is not a land grad, but a steady replacement cycle lasting over a decade or more. The evangelical phase of this replatforming is clearly over. Nowadays, most RFPs include cloud option as a matter of course.
Second, our end-to-end solution providing the industry’s most robust omni-channel solution. Third, our investments in growing our enterprise quota-bearing sales headcount plus strong traction in our channel expansion initiatives.
Fourth, our unique high touch on-site implementation process performed by our professional services team as well as our ongoing personalized premium support service provided by our technical account management team.
Fifth, we continue to deliver best-in-class reliability, security, compliance and scalability to meet the standards of large enterprises. We are extremely proud of our uptime performance which averaged 99.995% over the last 12 months.
And sixth, our customer first culture, which starts with our team of top-tier talent combined with a do whatever it takes mentality and a rigorous focus on cross functional customer success KPIs.
Now I would like to share a few examples of enterprise wins for the quarter. The first is a leading global property and casualty insurer who is using premise based system for their Canadian operations.
Key elements in their selection of Five9 were multilingual self-service IVR, secure pay, collection and storage for PCI, in-country storage of recordings using our Calabrio 1-QM solution and Five9 MTLS Agent Connect for guaranteed voice quality. We estimate the initial order will represent over $5 million in annual recurring revenue to Five9 with additional opportunity to grow globally.
The second example is a Fortune 100 specialty chemical company who had been using several premise based solutions. They had a digital transformation initiative which resulted in an RFP for consolidation and migration to a cloud-based solution for the inbound requirements across several departments.
Key criteria for them choosing Five9 was the summer of 2017 announcement of our global voice offering to serve all the international locations at a lower cost and with lower latency as well as integration to several key systems including Microsoft Dynamics, Service Now and Work Day. We estimate this initial order will result in over $2 million in annual recurring revenue to Five9.
The third example is a premier provider of office products for business consumer and industrial client. They were using a legacy hybrid system hosted by their carrier that was being discontinued. They brought in a consultant to help them with a selection process of the cloud-based solution.
Five9 demonstrated the deepest level of integration with their Oracle service cloud CRM and this along with the Five9 WFO solution from CSI including voice and screen recording further strengthened our ability to win this deal. We estimate this initial order size will result in approximately $1.4 million in annual recurring revenue to Five9.
As you can see from these examples, we continue to see larger and larger enterprises embracing the cloud and Five9 for their mission critical contact center solutions. Our proven track record, validation from third-party trusted sources like Gartner and our strong referenceable customer base allowing Five9 to take advantage of this digital transformation.
Now as we normally do, I would like to share an existing customer who made a significant expansion to the business they do with Five9. One of the largest food delivery services in the country who has been using Five9 since 2012 made an acquisition of a competitor.
They contacted Five9 to ensure that they could expand their Five9 solution to include the acquired company having one front end IVR and self serve all restaurant clients and customers across both companies in a unified fashion while leveraging the entire pool of agents.
Five9 with our expandable cloud platform was readily and rapidly able to accommodate this expansion and bring consistency across the entire operation, while also integrating with the newly acquired companies with CRM. With this expansion, we estimate annual revenue from this customer to Five9 will increase to approximately $2 million.
In summary, I’m extremely pleased with our momentum in the enterprise market demonstrated by our strong enterprise subscription revenue growth of 37% on an LTM basis. Customer experience has become more strategic to enterprises as customers have become more empowered, more mobile and more digital.
The contact center is the frontline when it comes to improving the customer experience and thereby retaining these customers and increasing revenue. Forward-thinking enterprises of today, who were undergoing digital transformation are more focused on enhancing their customer experience rather than reducing cost per interaction.
We believe that our powerful differentiated cloud contact center combined with our continuing execution puts Five9 in a great position in the customer experience market that is still in the early days of a massive shift to the cloud.
This includes a shift to the cloud for both CRM solutions like Salesforce, Oracle, Zendesk, Microsoft and ServiceNow as well as contact center solutions like Five9. Our Cloud Contact Center solutions are tightly integrated with these leading CRM solutions and we are going to market together to help our joint customers modernize their contact centers to drive a better customer experience.
I will now turn the call back over to Barry to provide more color on the fourth quarter and full-year financials.
Thank you, Dan. During today’s call, we will review our fourth quarter of 2017 financial results according to the historical revenue recognition standard of ASC 605. And we will also discuss our financial guidance for the first quarter and the full-year 2018 according to the new standard, ASC 606.
I will first talk about our fourth quarter results and then discuss the full-year. Revenue for the fourth quarter of 2017 was $55.4 million, up 25% year-over-year. This growth is all organic and affects the continued strong growth in our enterprise business that now makes up 74% of our LTM revenue. We also benefited in the quarter from a stronger than anticipated seasonal spike from customers and industries such as retail and healthcare.
Our commercial business, which represents the other 26% of LTM revenue, is growing in the single digits as we focused our investments on the higher ROI enterprise business. Recurring revenue accounted for 95% of our revenue in the fourth quarter of 2017. Recurring revenue is made up of monthly software subscriptions, which are based on the number of agencies plus usage, which are based upon minutes.
We enjoy a high retention rate on these recurring revenues. Our annual dollar-based retention rate in the fourth quarter of 2017 was 98%, the same as in the second and third quarters of 2017. The other 5% of our revenue in the fourth quarter was comprised of professional services fees, generated from assisting our clients in implementing and optimizing the Five9 solutions.
I will now discuss gross margins and expenses; a reconciliation from GAAP to non-GAAP results is included in the appendix of our Investor Presentation in the Investor Relations section of our website. Fourth quarter of 2017 adjusted gross margins were 63.6%, an increase of 174 basis points from the fourth quarter of 2016. Year-over-year adjusted gross margins have now increased each quarter for the last 20 quarters.
We are heartened by this consistent performance as we believe that gross margin is the best indicator of the strength of our market position and the potential for cash flow generation. We expect adjusted gross margins for the first quarter of 2018 to slightly decline sequentially given the FICO reset and the absence of the seasonal revenue benefit enjoyed in the fourth quarter of 2017.
Looking further ahead, we continue to expect to close the remaining 3.9 percentage point gap to the midpoint of our intermediate term model of 65% to 70% adjusted gross margins via three main drivers. First, subscription gross margins continuing to increase as we continued to scale revenue on fixed and semi-fixed costs.
Second, professional services margins improving and turning positive as investments we are making in this area pay off; third, a gradual shift of two to three percentage points per year in the mix between the portion of recurring revenue, which comes from subscriptions, and the portion, which comes from usage.
As we have mentioned before, this mix shift is being driven by two factors. First, we are seeing more add-on subscription products being purchased as we move into larger accounts. And second, a small percentage of new enterprise accounts decided to utilize their own carriers for usage.
Turning now to expenses, which I will again discuss in the order of the remaining GAAP to close to reach the intermediate-term adjusted EBITDA model in the second half of 2019. Non-GAAP G&A expenses in the fourth quarter of 2017 were $6.4 million or 11.5% of revenue, a decline of just 60 basis points from the fourth quarter of 2016.
The reasons for the smaller than normal decline are due to the expenses associated with the implementation of ASC 606 and the enhancement of our Sarbanes-Oxley compliance in preparation for attestation by our auditors. We expect these expenses particularly those associated with ASC 606 to continue in the first half of this year and then to anniversary out.
Non-GAAP G&A expense as a percent of revenue has now declined year-over-year for 13 consecutive quarters. The remaining gap to the midpoint of our intermediate-term model for non-GAAP G&A is 4.6 percentage points. We plan to continue to close this remaining GAAP via operating leverage while there may not be a linear process due to the temporary expense associated with ASC 606 and Sarbanes-Oxley.
Non-GAAP R&D expenses in the fourth quarter 2017 were $5.8 million or 10.4% of revenue, a decline of 194 basis points from the fourth quarter of 2016. The remaining gap to the midpoint of our intermediate-term model for non-GAAP R&D is now at just 0.4 percentage points. We also plan to close this remaining gap by operating leverage, although this may not be a linear process.
Non-GAAP sales and marketing expenses were $16.2 million or 29.2% of revenue, a decrease of 167 basis points from the fourth quarter of 2016 when we ramped up sales and marketing expense faster than usual in order to take advantage of the opportunity created by the acquisitions of our two cloud competitors at the time.
Typically, sales and marketing expense as a percent of revenue is the lowest in the fourth quarter this year, a seasonally strongest revenue quarter, which is what helped offset the higher commissions related to our all-time enterprise bookings record in the fourth quarter of 2017.
Looking ahead in most quarters, we are planning to remain within our intermediate term target or non-GAAP sales and marketing expenses. We are extremely pleased with our 9th consecutive quarter positive adjusted EBITDA.
We generated record adjusted EBITDA of $6.9 million in the fourth quarter of 2017 or 12.4% of revenue, compared to $2.9 million or 6.6% of revenue in the fourth quarter of 2016, reflecting the strong unit economics of our rapidly growing enterprise business and continued operating leverage.
This quarter also marked out 17th consecutive quarter of year-over-year adjusted EBITDA margin expansion. Looking ahead, we maintained our conviction that we can steadily increase year-over-year adjusted EBITDA margin into the 20s through continued revenue growth and strong execution.
Non-GAAP operating income was $4.9 million or 8.9% of revenue in the fourth quarter of 2017, an increase of 6.8 percentage points from the fourth quarter of 2016. Non-GAAP net income was $4 million or 7.2% of revenue in the fourth quarter of 2017, an increase of 6.9 percentage points from the fourth quarter of 2016.
Before turning to our full-year performance, I would like to note that our average concurrent seat count for the fourth quarter of 2017 grew to 82,097 seats, a 21% increase from the fourth quarter of 2016. We estimate that this equates to approximately 123,000 seats on a named seat basis. As a reminder, we are providing the seat count metrics only on an annual basis.
And now, we closely look at key full-year 2017 income statement metrics. For the year ended December 31, 2017, revenue was $200 million, up 24% year-over-year driven largely by the growth in enterprise. Adjusted EBITDA margin for the year ended December 31, 2017, increased by 3.6 percentage points year-over-year just to 8.8%. Non-GAAP net income for the year ended December 31, 2017, was $6.3 million, compared to $3.6 million non-GAAP net loss for the year ended December 31, 2016.
Finally before turning to guidance, some balance sheet and cash flow highlights. Capital spending in the fourth quarter of 2017 was $3.7 million of which $2.9 million was financed by capital leases and the remaining $0.8 million was paid for in-cash. For the full-year of 2017, capital spending was $12.9 million or 6.4% of revenue similar to the 5.8% of revenue in 2016.
In the fourth quarter of 2017, we generated $2.9 million in cash flow from operations, our eighth consecutive quarter positive operating cash flow. For the full-year of 2017, operating cash flow was $11.1 million, an improvement of $4.3 million over 2016.
We are particularly pleased with an operating cash flow performance since it illustrates a strong unit economics and the operating leverage inherent in our business model as well as our low working capital intensity driven by a low DSO. Specifically, DSOs for the fourth quarter of 2017 were 28 days.
As I’ve remarked before, the DSO performance is an indication not just a payment terms and the mission criticality of our solution, but also of the level of customer satisfaction. Looking ahead, we expect DSOs increased gradually as a mix shift to enterprise from commercial continues.
I would like to finish today’s prepared remarks with a brief discussion of our expectations for the full-year and the first quarter of 2018. Before doing so however, I would like to highlight the impact of ASC 606 on our results, our guidance and our financial models.
First, I remind you that we have elected use the Modify with respective approach, which we estimate will have an impact on the January 1, 2018 retained earnings of between $18 million and $28 million. Second, there is no material difference in revenue between ASC 606 and ASC 605.
Third, we estimate that 2017 non-GAAP net income would have been between $5 million to $7 million on ASC 606 due to lower commission expense on capitalizing and amortizing advertising a significant portion commission expense rather than expensing all such expenses upfront. Fourth, our intermediate term model now as a target of 22% plus for adjusted EBITDA for the second half of 2019 with the previous 20% plus reflecting the lower commission expenses.
Similarly, our long-term model now has a target of 27% plus with the adjusted EBITDA margin or approximately four years from now versus of the adjusted 25% plus a gain reflecting lower commission expenses. Correspondingly, our intermediate and long-term targets with sales and marketing expense are now 26% to 30% of revenue versus previous 28% to 32% of revenue. The new model are in the Investor Day.
And now for the guidance on the ASC 606. For 2018, we expect revenue to be in the range of $231 million to $234 million. GAAP net loss is expected to be in the range of $13.4 million to $10.4 million or $0.23 to $0.18 of basic share.
Non-GAAP net income is expected to be in the range of $12.6 million to $15.6 million or $0.20 to $0.25 per diluted share. Note that this guidance includes $6 million addition to the bottom-line due to lower commission expenses under ASC 606, which is the midpoint out of $5 million to $7 million range for 2018 we are expecting for this accounting change.
For the first quarter of 2018, we expect revenue in the range of $54.5 million to $55.5 million. This reflects a typical seasonality of our business and includes the impact of the expected total from the strong seasonal tailwind in the fourth quarter. GAAP net loss is expected to be in the range of $4.5 to $3.5 million or $0.08 to $0.06 per basic share.
Non-GAAP net income is expected to be in the range of $1.3 million to $2.3 million of $0.02 to $0.04 per diluted share. This guidance for the current quarter includes the impact of the higher cuts and expenses related to online hires we have been making and continue to go after this massive market opportunity.
The Impact of the annual restart of FICA obligation and the expense is being incurred for ASC 606 and Sarbanes Oxley. Note that this guidance include a $1 million acquisition to the bottom-line due to the lower commission expenses under ASC 606, which is a midpoint of the $0.5 million to $1.5 million range for the current quarter, we are expecting from this accounting change.
With respect to expected revenue trend by quarter for the remainder of 2018. Consistent with the guidance in past years, we do not expect sequential growth in the second quarter. However, following seasonal business patterns, we expect revenue to increase sequentially in the third and particularly fourth quarters.
Given the shape of the revenue curve and the fact that we ramp expenses in somewhat linear fashion during the year, investors should expect a bottom-line profile similar to that experienced in 2017, with somewhat weaker sequential second quarter bottom-line performance and strong results in the second half. In short, our bottom-line will not increase linearly during the year. Most of the year-upon-year improvement will again occur in the second half.
To illustrate this point in a different way, consider that for each of the last three years, 53% of our revenue had been recognized in the second half of the year and that we enjoyed a very high margin profitability on incremental revenue. In other words, we have a natural lift in adjusted EBITDA margins in the second half of the year.
For modeling purposes, we would also like to provide the following additional information. For calculating EPS, we expect our diluted shares to be 61.5 million and basic shares to be 57.5 million for the first quarter of 2018 and 63 million and 58.5 million respectively for the full-year 2018.
We expect our taxes which relate mainly to foreign subsidiaries to be approximately $60,000 for the first quarter of 2018 and $240,000 for the full-year 2018. Our capital expenditures for the first quarter of 2018 are expected to be approximately $3 million to $4 million. For the full-year 2018, we expect total capital expenditures to be between $13 million and $15 million.
In summary, we are very pleased with our fourth quarter and full-year performance. Our customers, our partners, our employees place a high value on our consistent execution in all key areas of the business. We have a hardened reputation for showing up and delivering.
It manifests itself in our financials, which reflect consistent 20% plus year-over-year revenue growth, over 10 years of increasing revenues sequentially each quarter except one which was flat, five years of increasing year-over-year gross margins each quarter, and over four years of increasing year-over-year adjusted EBITDA margin each quarter.
Going forward, we will continue to drive solid revenue growth while progressing towards ASC 606 based intermediate term and long-term adjusted EBITDA margins of 22% plus and 27% plus respectively.
Our confidence in meeting these targets is based upon the persistence of the factors which have driven year-over-year improvements up until now, a massive underpenetrated market, strong unit economics of our Enterprise business, which is constantly increasing as a proportion of total revenue, and the operating leverage in G&A and R&D.
Lastly, before turning to your questions, I would like to announce our upcoming conference participation. We will be presenting at the Morgan Stanley Technology, Media and Telecom Conference in San Francisco on February 26th, the 13th Annual KeyBanc Emerging Technology Summit in San Francisco on February 27th, and the 30th Annual ROTH Conference in Laguna Niguel on March 12th. Additional details will be available in upcoming press releases.
And now, we will open the call for questions. Operator, please go ahead.
Thank you. [Operator Instructions] And we will go first to Sterling Auty at JPMorgan.
Hey, hi guys. This is actually Ugam Kamat on for Sterling. So nice results across the Board. I was just thinking about additional drivers that can give lift to your revenues in 2018 or 2019. What are you thinking about the international opportunities from here and how are you investing to actually take advantage from that?
Yes, this is Dan, glad to take that. Looking at international expansion, we are very careful due to the upfront investment that it take in order to really establish a brand and establish the personnel necessary to succeed in international markets and that’s why we have been very conservative as we have expanded into Europe, expanded into Latin America and so we look at each of those very carefully before we do so.
As far as expansion to answer the question as far as how we can get further leverage in 2018 and moving forward I think it comes primarily from continuing to scale here in what is a massive market opportunity as we talked about before it’s only 10% to 15% penetrated to cloud and so there is a great deal of opportunity domestically, so that we plan to take advantage of with today’s products as well as ambitions that we planned to release later this year.
Got you. That was helpful. And just a follow-up, your dollar base retention has been fairly consistent for the last three quarters just to go a level deeper, how much amount of that has stayed consistent because you are driving better up sales versus reduction in churn or is it the other way around where you are seeing higher churn, but more up sells so?
Yes so Ugam, this is Barry. The normally frankly you would expect solely for that dollar base retention rate to increase. The retention is extremely high in our enterprise business which is a growing proportion of our revenue, longer term it should increase. The reason that it’s been somewhat steady as you alluded to is that we had a major customer, our biggest customer in fact that was ramping very strongly in 2016 and that is making the comparison somewhat tougher. So that is I think what is happening.
Awesome. Thank so very much.
You are welcome.
And we will go next to Terry Solomon at SunTrust Robinson Humphrey.
Hey good afternoon, gentleman. Can you hear me okay?
Yes.
Okay. Well first I hope Mike you are doing well and hi Barry and Dan. Just a couple of questions from me. First I don’t know if this is for you Dan, I’ll just throw it out there to everyone to answer, please do. But in terms of some of these metrics the ASP up to 640,000 that’s good to see, total seat count 123,000 but I’m just curious as it relates to that enterprise business in terms of the growth and momentum, are you seeing a more in terms of the contribution coming from just bigger seat count from these deals or they are going bigger earlier with the number of seats and committed contact center site or is it more skews and there is just a lot more attach of all of these add capabilities. So that’s the first question.
Yes, so Terry this is Dan and I think you hit on a number of factors that are contributing to that. A couple of things are play here. One is, we continue to go further and further up market as enterprises get more and more confident in the cloud and they understand the ability for us to scale provide reliability, provide security of their and protection of their customer data.
And those factors along with just customer seeing others of the same size and complexity moving to the cloud and moving to the Five9. So that’s just a phenomenon of that just discontinues each and every quarter.
You hear from our narrative larger and larger wins. That doesn’t take the place of that really strong mid-market. When you look at the lower end of the enterprise, we continue to do more and more volume as we expand our footprint, expand our sales force and leverage channels at the same time.
And then just the follow-up question relates to in the prepared remarks talking about increased leverage from your ecosystem. And I think over 55% of the business influenced by partners of various types. I’m curious as it relates, thinking about your sales capacity growth in 2018 and I think historically, you talked about sales capacity growth in enterprise kind of in line with the type of top-line growth.
But does it change any of the investment cadence or maybe you get incremental leverage, because of this ecosystem really ramping or are you still going to be growing that sales capacity in enterprise at the same rate? Thank you, Dan and congrats.
You bet. Thanks, Terry. Yes, I think to answer the question, it is going to continue, we are going to continue to grow our sales capacity of 30% to 40% and I think you will see and continue to see the enterprise subscription revenue rate grow within that range as well. As far as leverage from the partners, we continue to get like we said greater than 55% influence from the variety of ecosystem partners that we have not modeled in any additional leverage from those partners. Today, they’re primarily used to give us access and endorsement into accounts, but we still do the primary of bulk of the selling with that direct sales force.
And we will go next to Scott Berg at Needham & Company.
This is actually Peter Levine in for Scott. So two questions, the first question I guess is, I guess are ask around Avaya. I know in the first quarter, you announced the number of new partnerships, but also kind of winning a number of Avaya VARs especially, I think it was two to three top partners. Can you talk about how those relationships that played out to 2017 and expectations for 2018, and I guess the number of VARs still available up for grabs that you are kind of potentially going after here in 2018?
Yes. This is Dan. Thanks Peter. Great question. We continue and this is not anything new, anything we see changing dramatically. But we continue to see the Avaya install base, which as you know was 25% to 40% by most estimates of the market share of context centers.
And we continue to see that base really earning for moving to the cloud, some customers go direct to us and other cloud providers to make that transition to the cloud, others turn to their VAR and they turn to the Avaya VAR and one have a cloud solution. And that just hasn’t been able to them through Avaya.
So they have turned to Five9 and we have signed up as we said last year over a dozen. We handpicked those, they have the best appetite, they have the strongest basis that were again earning for the cloud. And we are being very careful not to just go widespread with all of the Avaya VARs out there.
We want to make sure that we are spending the time and effort to enable them, educate them and really be able leverage them by bringing them up to speed on Five9 and our cloud offering. So that’s what we have done on the Avaya front. As far as the impact to 2017, it’s been primarily introduction education and access to key accounts and building a significant pipeline and I think we will see the results occur over the next year.
To piggyback off the last question with Terry, I know you talked about ramping your sales force, but can you talk about expectations for your professional services team, I know you ramped it up pretty big here in 2017, but expectations for 2018 on the professional service front?
Yes, great question. And as we continue to as we said, expand the sales force and the capacity there by 30% to 40%. We actually are at the luxury of not having to scale the professional services or CS team quite at that same rate.
We are starting to get leverage and efficiencies I should say from those teams, things along the lines of being able to templatize some of the call flows being able to build tools to migrate databases of users over from a customer CRM system into ours.
So, we get greater efficiencies as well as just when we did that massive hiring previously, those folks have really come up to speed and then trained, and they are much more proficient than they were before.
Okay. Thank you very much.
Yes.
And we will go next to Meta Marshall with Morgan Stanley.
Hi, this is Yuuji Anderson on for Meta. Thanks for taking my question. Can you speak more towards the opportunity leveraging partners like Salesforce and Oracle versus say developing more of the traditional channel types or do you use like entirely new opportunities, do they tend to be bigger or smaller, just any color there I think would be pretty helpful?
Yes. They won the gamut, right. They sell to customers of all sizes. So when you look at Salesforce and Oracle in particular, they are the primary CRM providers, along with the others that we discussed Microsoft as well as ServiceNow and Zendesk. Partnering with all of them is very, very important, because we don’t want to dictate what a customer is using.
They typically have that already in place. Oftentimes we are selling into their base, it’s very important for us to get the endorsement of those CRM players and we do that in several ways. One is alignment in the field with resources. The other is really tight alignment and often times joint development from our product teams working with their R&D teams to take things beyond just traditionally what we have termed as integration.
And that has taken things to where we can provide unique offerings with the combination of Five9 and that particular CRM solution. And so it wins the gamut, each partner wants to do something a little bit differently with us and we maintain those relationships very strongly and they make a big difference in our success.
Great. And my follow-up, that was actually a good segway to my follow-up. On the R&D side of the expense, when we look at 2018 should we – qualitatively, should we be thinking about what kind of features and functionalities you are kind looking to launch, any color there also would be helpful? Thanks so much.
Sure. Yes, thank you. If you look at the R&D, a part of that R&D certainly goes into partner integrations and just continuing to make those deeper and deeper, so that we can bring more and more value generally to our customers in working with them.
And then secondly, if you look at the innovation with others and that may be through partnering and it may be through things that are developed here directly at Five9, but things along the lines of using artificial intelligence, machine learning, Chatbots, the buzzwords that are out there of late.
And the key there is applying them in a fashion that is usable and consumable, and brings value to our customers contact center. We hear the AI, Chatbots extensively throughout the industry and the key is finding the applications that we can readily deploy while also giving them a vision towards the future.
And we will take our next question from Raimo Lenschow at Barclays.
Hey, thanks for taking my question. Quick one for you, Dan. If you look at the competitive environment, can you talk to what you mentioned a wire and that’s I don’t know first of all, yes, is there a change now that they are out of Chapter 11? But then also talk a little bit about the 2 cloud competitors, but also then talk a little bit about the broader field, so someone that is in the UCI space like RingCentral is trying to make more noise around you. I doubt that they have the competitive offering, but just talk a little bit to what you see in the market there? And then I have one follow-up for Barry please.
Sure. So I’ll break it down into those three sections you just did which is if you look at the traditional premise folks, it’s not only a wire, its Cisco, its Genesis and several others, the aspects of the world that we replace on a regular basis and really, that’s because they struggled with getting to the cloud.
We don’t see or anticipate any change with them exiting Chapter 11 and I don’t think that was surprised it, they were going to do so and they have a large install base, but it’s yet to be seen that they can deliver a true cloud solution and we will see from that point. But we continue to replace all of the primary space systems.
As far as our cloud competitors interactive in any contact the acquisition that interactive or that Genesis made an interactive intelligence. Those are more overlapping similar application products slightly different size of the market that they went after, but those are competing products.
So it’s still yet to be seen, which products will survive, which ones they will lead with, which sales team will survive and become the controlling interest there and customers are still having uncertainty until they have that mapped out they either want to take the chance on trying themselves to something that’s going to get perhaps discontinued.
So, that bodes well for us in contact its part of nice seems to do very well. They’ve continued to keep them I think somewhat as a separate entity and also I think nice as being the large enterprise player that they are bringing in contact up market into some of those larger and larger opportunities, which I think only, bodes well for our industry it helps validate cloud even further up market.
And then the third part of your question about that you see you raised example of RingCentral. RingCentral has OEM agreement with another cloud provider and they continue to package that together when a customer does want single solution from a single provider that typically happens in the low to mid market for them.
Okay. Perfect. Thank you. And then for Barry, if I look at your EPS guidance and then back into the EBITDA numbers that I kind of need to have to kind of get to those numbers. I’m seeing about 250 basis points expansion a lot of that is 606 from the sales commission. Can you talk a little so that looks underlying about flat to slightly better? Can you talk a little bit to about the investment areas for 2018 that you want to be focusing on? Thank you.
Yes. Sure. So yes, on the percentage basis the implied EBITDA in our guidance is similar as it has been in the past at this stage of the year. The investments continue in all areas from top to bottom, professional services, customer support. Obviously sales and marketing in general R&D, G&A.
What is driving fundamentally that initial flatness as we have done in the prior years is the revenue. At this stage of the year, we are being prudent in terms of how much revenue seasonally, we will enjoy in the second half of the year. We know full well August is going to follow summer and winter will follow August, we just don’t know how cold that particular winter will be or how warm it will be.
But what we do know is that as the year unfolds when we start to see exactly what that is likely to be, we will be happy to do the same as we have done in the past and raise the guidance and we know also with a very high degree of assurance that those incremental revenues enjoy a very high marginal profitability. So much more are the same in terms of investments in various areas that we have talked about repeatedly and the year will unfold where the year will unfold.
And we will go next to Jeff Van Rhee at Craig-Hallum.
Hey guys thank you for taking my question. Several for me. If you would circle back to the $5 million ARR deal, I mean that’s really impressive numbers there. Can you just expand a bit more about that deal, I would love to hear a bit more about kind of how you found it, how it was sourced, what the cycle was, some color on landscape. Just kind of how the deal evolved and there are some where that sort of suggest maybe there is an incremental opportunity from here. How large could that be, just fill in some of those gaps if you would?
Sure. This is Dan. Thanks Jeff. Regarding that, that’s a global insurance provider and they are Canadian operations, again we are setup with several premise based systems and they needed secure IVR self-service. They wanted to make sure, they had secure pay for PCI compliance to make sure they could collect credit card information and not have it an even be visible to their agents.
They needed to make sure, because of the Patriot Act that they kept call recording and screen recordings in country and stored in Canada that they never left Canada. So we were actually partner with Calabrio, one of our WFO partners.
They brought us into the opportunity, shared with us what the customer was looking for and we teamed up with them and delivered a solution that like we said is schedule to resulting over $5 million in revenue this first year and that’s just the initial order and as we mentioned there is potential to grow globally after that.
Got it, okay that’s good thanks. And then with respect to sales. Just any changes certainly you have been very, very steady consistent about the pace of hiring and it certainly seems like the productivity has ramped remarkably consistent. But with respect to how you are finding the talent. Has there been any pivots with respect to method source, kind of skill sets you are hiring 10-year or any pivot at all or is this continuing to stamp out exactly as you have done over the last few years?
Yes. Certainly no pivots, I think what happened is it’s allowed us to be far more selective and bringing in top tier talent, Five9 with our success over the last several years. We have got a brand, we have got a reputation, Barry mentioned it on the call, which is we have absolutely strive and pride ourselves on executing and people recognize that. And I think we are becoming a very, very attractive place to want to work. And so we get a lot more interest of top tier talent coming towards us and it just gives us a greater flexibility to be selective.
Okay. And then just two other brief if I could. The seasonality emphasis this quarter seems more than I recall from prior seasons, obviously strong Christmas holiday season this year. Outside of that, is there anything in particular this quarter that drove the seasonality may be in a little more intense fashion that prior year’s?
Yes, we have always mentioned that we have tailwinds in Q4 resulting from the seasonality from certainly retail contributed this year significantly, and then we have also mentioned ACA or healthcare and open enrollment. And that was actually condensed, the Affordable Care Act enrollment period was condensed into about half of the period as it normally has been, you have to have the same call volume overall. So it was pushed into Q4 and it created an even further uptick for Q4.
Got it. Okay. And then last just on the omni-channel side. I’m just curious sort of the attach rates of the incremental capabilities, what is changed in the last say 12 months in terms of the omni-channel capabilities that you are seeing particularly notable increases in demand, or higher attach and the inverse of that things you might be seeing lesser attached?
Yes, so omni-channel for sure is becoming more of a stable. I will say and also caveat it with however. And the however is there are still a lot of companies that will primarily provide voice and use their chat and e-mail and other digital channels as certainly less volume, but often times specialists.
It’s really hard to find a universal - an agent that is highly skilled in being able to have professional voice conversations while also being expert at chat, doing multiple chats and also responding to e-mails. So a fair amount of companies still segregate those agents on occasion and it works very well with the Five9 solution to do either.
So we find everyone find everyone - universal agent that will do both, but in some cases they segregate. So it runs the gamut, some are high volume using lots of chat and e-mail depending on again their industry and how their consumers or customers want to interact with them, and then you have got some that are almost primarily voice. But every year we have seen an increase in the attach rate of omni-channel.
Yes, okay, great. Well congrats again, just outstanding performance.
Thank you.
And we will go next to Nikolay Beliov at Bank of America.
Hi, guys. Thanks for taking my questions. Barry I had a couple of questions for you. number one, during the prepared remarks you talked about Q4 benefiting from even though business in healthcare and retail, was that usage that came in more than you guys expected?
No, Nikolay, it’s both. Usage and subscription benefited from the seasonal strength in retail and healthcare as Dan mentioned.
Okay. And professional services came in at 5% revenue lower than the previous quarters. Is that the new trend in professional service and kind of like what do you expect professional service to be in 2018 as a percentage of revenues, are we talking about mid single-digits, may be high single-digits?
So it is a little bit more lumpy than our recurring revenue. If you rewind the move back to when went public, it was just 3%. It increased on an annual basis by one, two percentage points and for this year it’s difficult to predict exactly probably go up maybe another one and two percentage points. Longer term, we would see like many other service companies that it will get to a high single-digit and low double-digit.
Got it, thank you. And then I got a couple of questions for you. That $5 million that was fantastic and is broadly for partner, but specific to your sales organization, do you need to build a special team that can go after these larger opportunities that you mentioned like you are getting some success there and the upper end of the market is opening up. do you need that’s something different?
Yes, great question. Thank you again, it was a great win for us and what I will say is myself along with the vast majority of our enterprise sales team are used to selling into much higher end of the market. So we have been jumping at the bit waiting for years to finally get where our comfort zone is. So I don’t think we have to get any different skill set. We have been anticipating and waiting for the market to open up so that we could sell.
The reverse is sometimes true where we hire folks that are used to whale hunting and used to selling into the multi-thousand seat environment and we have to temper their enthusiasm to stay focused where the cloud has been most successful in that mid-market and we are now reaping the benefits of being able to sell into the larger end.
Thank you Dan. and then one more for you. Over the last three to six months, we picked up increasing conversations around digital transformation broadly speaking and that type of conversation with customers seems to be inflecting. What do you guys need to do incrementally going forward to kind of like benefit from inflection if it indeed capital in 2018 in terms of like both the product, we heard it first from you, talk about analytics recently. What you guys do in that area so?
Yes, you are exactly right. Yes, the digital transformation messages out there and that’s being broadcast by lots of industries and we play very nicely into that and contribute to that as IT organizations with large enterprise want to move their contacts or their data center footprint off premise and move it to the cloud were a natural fit to go right with that.
And the way we do that is we are always focused on personalized customer experience and that something that helps as consumers have a variety of ways they want to interact with companies. We need to build solutions and build applications that allow them to do so in a very seamless fashion and the way that they want to communicate.
All the studies are out there that say if a consumer and customer aren’t happy with the way they are being treated in that customer experience, and they will defect to an alternator competing solution. That’s why that comment I made earlier was about there is a less concern or focus on cost cutting for interaction and more focus on making that customer experience what that consumer wants and needs.
Second area is cloud innovation. We have got to continue to innovate; the cloud gives us that advantage. We can bring new applications, we can bring AI, we can bring things like chat box and other things to market much easier and quicker and make them available to all of our customers because we are subscription cloud based service. All of our customers stay on the current release.
And then the third area is really just being the trusted partner and having the professional services group that can go in and help optimize the solution and help bring the digital transformation to reality in the way that that customer need to and then truly our integration to the digital partners, primarily the CRM and WFO partners really helps us bring digital transformation to reality.
And we will go next to Mike Larimore at Northland Capital Markets.
This is actually Nick Altmann on for Mike.
We can hardly hear you. If you could speak up a bit, that will be great.
Can you guys hear me now?
Yes. That’s fair.
Yes. Sorry about that. Just to clarify were the bookings an all-time record or just a record for the fourth quarter?
It was an all-time record for enterprise bookings, yes.
Okay, okay. Got it. And then just another quick one. Do you guys see your commercial segment growing this year again?
We do, it’s growing in single-digits as we mentioned before and our investments are being quick into the enterprise area, because that’s where we get the strongest unit economics and we get a lot of pull-through of customers of all sizes due to that.
Got it. Thanks guys.
Thank you.
Thank you.
And next to KeyBanc Capital Markets, Brent Bracelin. Please go ahead.
This is Steve Anderson on for Brent. I was just wondering what your expectations are for 2018 with regard to the Avaya partners the U.S. signed up in 2017?
Yes. I think they are not anticipating any earth-shattering change from what they’re going to get from Avaya. They’ve indicated that to us, customers don’t want to rate out and in hopes of getting a cloud solution, a true cloud solution from Avaya they’ve waited many years already.
So, I think there is an appetite there for the VARs to continue with their base, continue with the Avaya solutions for those that want to stick it out for a few more years. But certainly, they need to have the cloud option; lots of customers don’t want to wait that longer period of time, especially the ones that are on older releases that don’t want to pay the millions of dollars to upgrade.
And we will go next to Richard Baldry at Roth Capital.
Thanks. It’s to mix it up, it’s Rich Baldry on for [Rich Baldry] (Ph) this time. Just quick overall strategic side, your market caps changed pretty dramatically over the past 12 to 18 months. I’m so curious how your thoughts are maybe changing or evolving around M&A. You have obviously much more weight to throw around whether you think that, you haven’t been very active maybe without a change in the size of the thing you might be interested in what types of things you will be willing to look at as of the company grows up? Thanks.
Yes. Hey, Rich, this is Mike. I’ll take that one, because I haven’t said much on the call, but does good talk to you guys again. From a downstream M&A appetite, we are always looking at interesting acquisition target, so especially in some areas like AI and other highly innovative market spaces if you will.
Our currency is clearly better today that it was a year ago or two years ago in terms of making some of those moves. But I’ll be honest Rich; I mean our organic growth in enterprise is so strong as you just heard 37% year-over-year growth in enterprise subscription revenue.
We do not have to look for inorganic growth in terms of acquiring revenue streams or customer basis. But we may do some technology tuck-ins we are always looking for interesting opportunities we have done one in our history as you know and we will see how it plays out.
All right. Thanks for taking my question. Hope you are doing well.
Thanks, Rich.
And next we will hear from David Hynes at Canaccord.
Hey. Thanks guys. Good to see the whole team together. I want to ask about how you are thinking about the channel, I guess in regard – in terms of leveraging those folks for implementation work as the business scales. I mean you talked in prepared remarks around kind of the Five9 controlled high touch services models is the competitive advantage. How does that evolve overtime, what is kind of the thinking around timeline for that, what is involved in the process, any color along those lines would be helpful?
Yes. Great. Thanks DJ. Looking at the channel leverage, as I mentioned earlier, we are primarily relying on channel to open up opportunities even in the large Canadian one we got access. Our direct sales teams went in and sold. And so from a sales perspective, we still want to control that sales effort representing a product that is complex in many ways, is not something that you just hand off to a channel especially in the enterprise. So, I think you will see us continue to have a direct emphasis and a direct focus.
As far as getting third-parties and some of those channel partners to leverage for implementation services and professional services, certainly open to it, but we are very cautious. We have seen others in our space take the approach where they’re pushing out implementations and perhaps even first line support.
And it’s caused them to suffer in customer sat and increased churn rates and we have been the beneficiary of many of those, where customers just say they can’t get a hold of the expertise that they need in order to optimize and make the system do what they’ve purchased it for.
And so we have seen a lot of defections come over to Five9 simply, because they didn’t get that attention that they need and deserve. And so we are very careful not to extend that too much, but we are working with several, doing training and shadowing, and helping them get up to speed, so that some day we will get leverage and we will model that in when it comes.
Yes. Makes sense. And then to the extent you can say anything about the CEO search process, what is the latest there, is there any timeline you could share us to when you hope to have a permanent solution for that thing?
Yes. Hey DJ. This is Mike. I’ll take that one. We are in the midst of the search. It’s going extremely well, but I’ll tell you this, the Board and I are keeping the bar very, very high when it comes to the CEO search.
This is as you guys know a very unique CEO opportunity right where $200 million cloud software company growing very, very nicely with a huge tam ahead of us and as we have talked about this is the top of the second inning of a 9-inning ball game. So again, we are keeping the bar extremely high and we will update you guys when it’s appropriate. But as you can imagine, there’s a lot of interest.
Yes. That’s a good problem to have. Okay. Thanks guys. Appreciate it.
Thanks DJ.
And that does conclude our question-and-answer session. I would like to turn the program back over to the management team for any additional remarks.
Well, thank you for joining the call today. 2017 was another record year for Five9. We believe that we have demonstrated the ability to execute and continue to generate momentum in the enormous enterprise market opportunity and this sets us up well with 2018. We look forward to seeing you at the year-end calls. Thank you.
And ladies and gentleman, once again, that does conclude today’s conference and again, I would like to thank everyone for joining us today.