Five9 Inc (FIVN) 2016 Q4 法說會逐字稿

Good day and welcome to the Five9 fourth-quarter 2016 earnings call.

Today's conference is being recorded.

At this time, I would like to turn the conference over to Tony Righetti. These 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 2016 results. Today's call is being hosted by Mike Burkland, CEO; and Barry Zwarenstein, CFO.

During the course of this conference call, Five9's Management Team will make projections and other forward-looking statements regarding the future financial performance of the Company, industry trends, Company initiative and other future events. 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 understates no obligation to up date 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. A more detailed discussion 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 this call.

Management believes that this non-GAAP information is useful because it can enhance an understanding of the Company's ongoing performance and Five9 therefore uses non-GAAP financial information internally to evaluate and manage the Company's operations. This non-GAAP financial information should be considered along with, and not as a replacement for, financial information reported under GAAP and could be different from the non-GAAP financial information provided by other companies in our industry. The full reconciliation of the GAAP and non-GAAP financial data can be found in the Company's press release issued earlier this afternoon and is available on the investor relations section of Five9's website.

Now, I would like to turn the call over to Five9's CEO, Mike Burkland.

Thank you, Tony. Welcome, everyone, to our fourth-quarter and full-year 2016 earnings conference call. Our strong fourth-quarter results capped off a record year for Five9. For the year, we grew revenue by 26% to $162.1 million, an acceleration from the 25% achieved in 2015 and the 23% in 2014.

Total revenue for the fourth quarter was $44.2 million, up 8% sequentially and 23% year over year. This revenue growth was again driven by our enterprise business, which delivered 43% growth in LTM enterprise subscription revenue. Furthermore, we continued to enjoy leverage in our business model, resulting in record adjusted EBITDA for the year of $8.4 million, a $13.6 million improvement over 2015 and a $31 million improvement versus 2014.

For the fourth quarter, adjusted EBITDA was a record $2.9 million. The adjusted EBITDA improvements continue to be driven by strong enterprise gains, which are delivering high marginal profitability. We continued to make these improvements and profitability even as we accelerated investments in two areas.

First, in enterprise sales to take advantage of the opportunity to hire talent from cloud competitors that were recently acquired and second, in our professional services capacity in response to the ongoing growth and acceleration in our enterprise bookings. Speaking of bookings, I'm extremely pleased that we set an all-time record for enterprise bookings in the fourth quarter and that the pipeline reached an all-time high. For the full year, our enterprise bookings growth far exceeded the growth in our enterprise quota-bearing sales head count, which I will remind you was between 30% and 40% year over year.

Our exceptional bookings were again driven by continued expansion of our direct Salesforce, coupled with the increasing leverage we are getting from our expanding system of partners. This expanding ecosystem of partners influenced more than 50% of the enterprise deal flow in the fourth quarter, which included a significant increase of joint business with many key partners. As a reminder, Five9 has deep partnerships in areas such as CRM with the likes of Salesforce, Oracle, Zendesk and Microsoft, in WFO with partners like Calabrio, Verint and CallMiner and in unified communications with Microsoft Skype for Business and Cisco.

Each of these partners are industry leaders in their respective market. Five9 shares a common vision with these partners to modernize customer experience in order to keep ahead of the increasing expectations of today's consumer, resulting in a collaboration that is truly one of leaders and innovators.

We now enter a new chapter in these partnerships with the Five9 joint development program. Extending beyond simple integration, the joint development program provides deep access and alignment of road maps and key resources to deliver a differentiated, seamless experience. In fact, we believe that a comprehensive customer experience can only be realized when these products operate together as a fully integrated solution.

An example of the joint development program is our relationship with Salesforce. Working in collaboration, the Salesforce service cloud and Five9 engineering teams have come together to achieve the deepest and most comprehensive omni-channel solution in the industry on Salesforce Lightning.

Another example of our joint development program is our relationship with Zendesk. In December we announced our strategic alliance with Zendesk. As part of that alliance, both companies have come together to provide a state-of-the-art customer experience for enterprises.

The joint solution allows enterprises to have personalized interaction with their customers, helping build strong customer relationships. Five9 was selected as a premier CTI partner by Zendesk based on the number of successful customers we have, the depth of integration with Zendesk support and overall quality of the customer experience.

This recognizes the investment Five9 has made bringing together the Five9 virtual contact center and Zendesk support solutions, which enables a seamless user experience and empowers contact center agents to deliver robust customer care. The joint solution of Five9 and Zendesk delivers a turnkey cloud-based contact center solution.

Our channel program continues to grow nicely and is yielding results beyond our expectations. For example, the number of master agents and resellers more than doubled from a year ago and bookings from these channels also more than doubled, accounting for approximately 15% to 20% of our enterprise bookings in 2016. We continue to invest in our direct sales force and channel program to take advantage of the large underpenetrated enterprise contact center market, which represents a significant and lucrative ongoing opportunity for Five9.

There are 15.8 million contact center agents around the world, representing an estimated TAM of $24 billion in annual recurring revenue and cloud penetration still around 10%. I'm frequently asked about market landscape and competitive dynamics following the bankruptcy filing by Avaya and the acquisition of two of our cloud competitors. While this is not the appropriate forum to go into details, I will make the following overall points.

First, it is unquestionably a benefit to Five9 and other cloud contact center vendors that Avaya filed for Chapter 11. Avaya has been, and will likely continue to be, the legacy solution that we replaced most often and they still have the largest market share amongst the legacy players. The continued uncertainty around their future can only help us, as more and more enterprises are likely to be reluctant to make multi-year investments and commitments to Avaya.

Second, while there are dynamics specific to each of the two cloud competitors that were acquired, the common denominator is the potential distraction and dislocation they face as they attempt to integrate different cultures and operations. We believe Five9 will continue to be the beneficiary of this dislocation by adding partnerships, making key hires and gaining customers. In short, we believe that competing gets two recently acquired businesses may be somewhat easier than competing against two singularly focused independent cloud contact centers competitors.

In summary, we believe that uncertainties facing our two key cloud competitors going these mergers and the leading on-premise vendor going through Chapter 11 may give Five9 a competitive advantage in the marketplace. Now switching back to our highlights, the following metrics demonstrate our ongoing momentum in the enterprise market. First, 43% growth in LTM enterprise subscription revenue, an acceleration from 38% in the fourth quarter of last year.

Second, enterprise revenue has grown to 69% of LTM revenue versus 65% a year ago. Third, we continue to move upmarket as our average enterprise deal size in 2016 was approximately $560,000 in annual revenue, up from $450,000 in 2015. We will continue to provide this metric on an annual basis.

Fourth, from 2012 to 2016, the compound annual growth rate in revenue from enterprise clients generating between $500,000 and $1 million in annual recurring revenue was 41% and for clients generating above $1 million in annual recurring revenue, the CAGR was 60%. Fifth, we estimate our win rate against two key cloud competitors averaged over 70% in the fourth quarter.

Now that I've shared some of the key metrics for our enterprise business, I'd like to remind you of some of the specific reasons why Five9 is being selected by enterprise customers. The first is our end-to-end solution providing the industry's most robust omni-channel solution. Bringing together a keen focus on user experience, the industry's deepest CRM and WFO integrations, guaranteed voice quality with our Agent Connect service, web engagement in predictive proactive analytics, the Five9 suite is designed to deliver the highest level of customer engagement. This solution is built on our Freedom platform, which provides a modern microservices-based open enterprise architecture with over 300 REST APIs and powerful SDKs.

Second, we continue to deliver best-in-class reliability, security, compliance, and scalability that meet the standards of large enterprises, including, for example, some of the leading financial services and healthcare companies. We are extremely proud of our uptime performance, which averaged 99.93% over the past 12 months.

Third, our high-touch, on-site, fixed-step implementation process performed by domain experts as well as our personalized premium support program. Fourth, 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 with you highlights from some of our key fourth-quarter enterprise wins in expansion.

The first example is a global distributor of life-changing health products that have been using Cisco's on-premise solution for its contact centers. As they grew, they were experiencing dropped calls, poor voice quality and had limited CRM integration. After we were introduced through one of our master agent partners, and competing with two other cloud solutions, Five9 was selected.

This customer selected Five9 because of our comprehensive solution, including our chat and email, superior voice quality, including our MPLS Agent Connect service, ability to provide on-site implementation resources, and our robust, proven integration with Salesforce, which they plan to migrate to in the coming months. We estimate that this customer will generate approximately $800,000 in annual recurring revenue to Five9.

The second example is the world's largest car sharing service, which is owned by a leading car rental company. They had outgrown their existing cloud contact center solution and required a global solution to accommodate their own agents as well as outsourced agents. The outsourcers were all on disparate systems, which made it very difficult for this company to control and have visibility of their customer interactions, creating inefficiencies across these sites.

With Five9, all calls interactions are now routed the best agent across all sites worldwide. This creates the efficiencies of one virtual contact center and gives the customer complete visibility, control, and consistent reporting for every single customer interaction.

Our partnership and pre-integrated solution with Zendesk played a big role in this win along with our ability to provide the data protection and security required their operations in various global market. We estimate that this customer will generate approximately $600,000 in annual recurring revenue to the Five9.

Another win was a leading athletic apparel company who takes large volumes of inbound inquiries from its retail outlets and consumers for sales and service. They're an Oracle service cloud customer for CRM and had been using a Cisco on-premise system with limited routing and reporting capabilities. The customer decided to do a bake-off between Five9 and another leading cloud provider.

It became clear within a matter of days that Five9 was a choice. Not only did our solution and support stand out, but mid-process the alternative provider had announced they were being acquired. The customer was very concerned about the uncertainty of what the future would entail with the other provider and that sealed the deal for Five9.

This customer also liked our ability to give them an alternative to their WFO solution. This initial order is estimated to result in approximately $700,000 in annual recurring revenue for Five9.

The next example is a large insurance broker who offers a variety of insurance carriers for auto, life, home and health and had been using three disparate contact center solutions, Cisco for its auto and home divisions, ShoreTel for its life insurance division, and another cloud provider for health insurance division. Because they were operating in such silos, it prevented them from being able to seamlessly guide customers from group to group for a variety of reasons, including selling and servicing umbrella policies, not to mention that they had difficulty dealing with three solutions from three different vendors.

By consolidating all of their divisions onto Five9, they are now able to achieve tremendous efficiencies and operate as one company, resulting in a much better experience for the consumer. They are leveraging MPLS Agent Connect for end-to-end solution, managed by Five9 with guaranteed SLAs. We estimate that this customer will generate approximately $1 million in annual recurring revenue to Five9.

Now like to share an example of our customer base continuing to expand their use of Five9. A current customer with over 500 concurrence seats on Five9 recently added several of our enhance services, including omni-channel with customer journey analytics, which provides agents with valuable insight to where the customer has been, whether on the website or in the IVR and gives the agent next-best actions based upon our predictive analytics.

In addition, the customer also added visual IVR and a complete WFO suite with QM, WFM and speech analytics. We estimate that this expansion will result in an increase of over $400,000 in annual subscription revenue to Five9. In closing, I'm extremely pleased with our increasing momentum in the enterprise market, which is demonstrated by our strong enterprise subscription revenue growth of 43% on an LTM basis.

We believe that our powerful differentiated cloud contact center software, combined with our continued execution, puts Five9 in a great position in the customer service market that is still an early day of a massive shift to the cloud. This includes a shift of the cloud for both CRM solution like Salesforce, Oracle, Zendesk and Microsoft as well as contact center solutions like Five9. Our cloud contact center software is tightly integrated with these leading CRM solutions and we are going to market together to help our joint customers modernize their contact centers.

I will now turn the call over to Barry to provide more color on the fourth-quarter and full-year financials.

Thank you, Mike. I will first talk about our fourth-quarter results and then discuss the full year.

Revenue for the fourth quarter of 2016 was $44.2 million, up 23% year over year. This growth is all organic and reflects the continued strong growth in our enterprise business that now make up 69% of our LTM revenue. Our commercial business, which represents the other 31% of LTM revenue, continued to deliver steady and consistent growth of around 10%.

Recurring revenue accounted for 95% of our revenue for the fourth quarter of 2016. Recurring revenue is made up of monthly software subscriptions, which are based upon the number of agent seats, such usage which is based upon minutes. We enjoy a high retention rate on these recurring revenues.

Our annual dollar-based retention rate in the fourth quarter of 2016 was 100%, up from 96% in the fourth quarter of 2015. The other 5% of our revenues in the fourth quarter of 2016 were comprised of professional services fees generated from assisting clients in implementing and optimizing the Five9 solution. 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. GAAP gross margins in the fourth quarter of 2016 were 64.3% and adjusted gross margins were 61.9%. The fourth-quarter 2016 GAAP gross margins were benefited by 7 percentage points due to a $3.1 million reversal of an accrual following a favorable SEC ruling.

Excluding the $3.1 million, GAAP gross margins increased by 0.7 percentage points from the fourth quarter of 2015. Adjusted gross margins, which were not affected by the $3.1 million reversal increased by 0.5 percentage points on the fourth quarter of 2015. We are particularly pleased with the gross margin improvement, given the significant front-loaded investment that we have made and are making expanding our professional services team to implement our software for enterprise customers.

These investments have been accelerated, given a higher-than-expected enterprise bookings growth. Looking ahead, we expect adjusted gross margins to decline in the first quarter due to continued professional services hiring and the impact of the January 1 FICA reset.

Looking further ahead, we continue to expect to close the remaining 5.6 percentage point gap to the midpoint of our intermediate-term model of 65% to 70% adjusted gross margins by three main drivers. First, subscription margins continuing to increase as we continue to scale revenue on fixed and semi-fixed cost; second, professional services margins continuing to improve and turning positive as the investments we are making in the area pay off; third, the gradual shift of 2 to 3 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 decide to utilize their own carriers for usage.

Turning now to expenses, which I will discuss in the order of the remaining [GAAP] to close to reach the intermediate term 20%-plus adjusted EBITDA model. GAAP G&A expenses in the fourth quarter of 2016 were $6.5 million, or 14.7% of revenue, and non-GAAP G&A expenses were $5.3 million, or 12.1% of revenue. Both GAAP and non-GAAP G&A expenses as a percent of revenue declined by approximately 3 percentage points from the fourth quarter of 2015.

The remaining GAAP to the midpoint of our intermediate-term model for non-GAAP G&A is now 5.1 percentage points. GAAP R&D expenses for the fourth quarter 2016 were $6.2 million, or 14.1% of revenue, and non-GAAP R&D expenses were $5.5 million, or 12.4% of revenue. Both GAAP and non-GAAP R&D expenses as a percent of revenues declined by approximately 1.5 percentage points in the fourth quarter of 2015.

The remaining GAAP to the midpoint of our intermediate-term model for non-GAAP R&D is now 2.4 percentage points. GAAP sales and marketing expenses in the fourth quarter of 2016 were $14.5 million, or 32.8% of revenue, a year-over-year increase of 3 percentage points and non-GAAP sales and marketing expenses were $13.7 million, or 30.9% of revenue, a year-over-year increase of 2.3 percentage points. Sequentially, non-GAAP sales and marketing expenses increased by $1.4 million from the third to the fourth quarter of 2016.

We increased sales and marketing expenses faster than in prior periods for two reasons. First, we took advantage of the opportunity created by the acquisitions of two cloud competitors to make some key hires. Second, commission expenses came in meaningfully higher as enterprise bookings outperformed.

Looking ahead, we plan to remain within our intermediate-term target for non-GAAP sales and marketing expenses, which remains at 28% to 32%. We are extremely pleased with our fifth consecutive quarter of positive adjusted EBITDA. Despite the increased investments in professional services and stepped-up enterprise go-to-market marketing expenses, we generated record adjusted EBITDA of $2.9 million in the fourth quarter of 2016, or 6.6% of revenue.

Compared to adjusted EBITDA of $1.2 million, or 3.5% of revenue, for the fourth quarter of 2015. This improvement continues to be driven the enterprise revenue growth, strong unit economics and operating leverage, all factors which we expect to persist. GAAP operating income in the fourth quarter 2016 was $1.2 million.

Excluding the $3.1 million reversal referred to above, the GAAP operating loss was $1.9 million. Non-GAAP operating income was $0.9 million, our third consecutive positive quarter on this measure. GAAP net income for the fourth quarter 2016 was $0.4 million, excluding the $3.1 million reversal, the GAAP net loss was $2.7 million.

We are extremely pleased to report that we achieved a key milestone in the fourth quarter, namely our first quarter of non-GAAP net income, which was $148,000. Please keep in mind that our proximity to breakeven will mean that it will take some time to break through to positive non-GAAP net income on a persistent material basis.

Before turning to our full-year performance, I would like to note that our average concurrent seat count for the fourth quarter of 2016 grew to 68,113, a 23% increase from the fourth quarter of 2015. As a reminder, we are providing the seat-count metric only on an annual basis. Now for a closer look at the key full-year 2016 income statement metrics, for the year end of December 31, 2016, revenue was $162.1 million, up 26% year over year, the gain [which is] largely by the growth in enterprise.

GAAP gross margins for 2016 were 58.7%. Excluding the $3.1 million reversal, GAAP gross margins were 56.8%, up from 53.8% in 2015, while adjusted gross margins [improved] to 61.7%, up from 59.1% in 2015. GAAP operating expenses for 2016 were $101.7 million, up 12.3% from 2015, while non-GAAP operating expenses were $91.6 million, up 12.5% from 2015.

Non-GAAP sales and marketing expenses increased year over year by 25%, driven by increased headcount. Specifically, year-end sales and marketing headcount increased by 32% to 173 as of December 31, 2016. As a result of the 26% revenue growth, the improvement in adjusted gross margin and operating leverage, we enjoyed a $13.6 million improvement year over year in adjusted EBITDA from a $5.3 million loss in 2015 to a positive adjusted EBITDA in 2016 of $8.4 million, our first full year of a positive adjusted EBITDA.

GAAP net loss for the year end December 31, 2016, was $11.9 million. Excluding a $3.1 million reversal, GAAP loss was $15 million compared to a GAAP net loss of $25.8 million for the year ended of December 31, 2015. Non-GAAP net loss for the year ended December 31, 2016, was $3.6 million compared to a $16.5 million loss for the year ended December 31, 2015.

Finally, before turning to guidance, some balance sheet and cash flow highlights. Capital spending in the fourth quarter of 2016 was $3 million, of which $2.8 million was financed by our capital leases and the remaining $158,000 was paid for in cash. In the fourth quarter of 2016 we generated $2.8 million in cash flow from operations, our fourth consecutive quarter of positive operating cash flow.

For the full year 2016, operating cash flow was $6.8 million, an improvement of $19.8 million over the $12.9 million operating cash outflow in 2015. In the fourth quarter of 2016, free cash flow, defined as operating cash flow less capital spending paid for in cash, was $2.7 million, our third consecutive quarter of positive free cash flow. For the full year 2016, free cash flow was $5.7 million, which was also an improvement of $19.8 million from the $14.1 million free cash outflow in 2015.

We are also pleased to have achieved another milestone in the quarter, namely that for the first time total cash flow for the quarter was positive as we generated approximately $800,000 in cash in the fourth quarter of 2016. Drivers for the good cash flow performance were the improved adjusted EBITDA and continued strong DSO performance, important given that accounts receivable are our operating assets.

DSOs for the fourth quarter of 2016 were 27 days. This DSO performance is an indication not just of payment terms and their enforcement, but also of the level of customer satisfaction. Looking ahead, DSOs will increase gradually as a mix shift to enterprise from commercial continues.

I'd like to finish today's prepared remarks with a brief discussion of our expectations for the full year of 2017 and for the first quarter. For 2017, we expect revenue to be in the range of $187 million to $190 million.

GAAP net loss a suspended to be in the range of $17.3 million to $20.3 million, or loss of $0.32 to $0.38 per share. Non-GAAP net loss is expected to be in the range of $1.5 million to $4.5 million, or a loss of $0.03 to $0.08 per share. For the first quarter of 2017, we expect revenue to be in the range of $44 million to $45 million.

GAAP net loss is expected to be in the range of $5.3 million to $6.3 million, or a loss of $0.10 to $0.12 per share. Non-GAAP net loss is expected to be in the range of $1.7 million to $2.7 million, or a loss of $0.03 to $0.05 per share. This net loss guidance includes the impact of higher costs and expenses related to the hires we have been making and continue to make to support our enterprise revenue growth as well as the material impact of the annual restart of FICA and unemployment obligation.

With respect to the profile of revenue by quarter for the remainder 2017, consistent with the guidance in past years, we do not expect a sequential growth in the second quarter. We expect revenue to increase sequentially in the third and particularly in the fourth quarter, following the seasonal pattern that has been evidenced in the last few years. Given the shape of this revenue curve and the fact that we ramped expenses in a somewhat linear fashion, we expect increased losses in the second quarter, a smaller loss in the third quarter and positive non-GAAP net income in the fourth quarter.

For modeling purposes, we would like to provide the following additional information. For calculating EPS, we expect our shares to be 53.5 million for the first quarter and 53.8 million for the full year 2017. We expect our taxes, which relate mainly to our foreign subsidiaries, to be approximately $35,000 in the first quarter and $140,000 for the year.

Our capital expenditures for the first quarter are expected total approximately $3 million to $4 million. For the full year, we expect capital expenditures to be between $10 million and $12 million. In summary, we are very pleased with our fourth-quarter and full-year performance.

We'll continue to be focused on driving solid revenue growth while progressing towards our intermediate-term and long-term adjusted EBITDA target of 20%-plus and 25%-plus, respectfully. Lastly, before we turn to your questions, I would like to announce our upcoming presentations at the following conferences, the Pacific Crest Fourth Annual Emerging Technology Summit in San Francisco on March 1 and the 29th Annual ROTH Conference in Laguna Niguel between March 12 and 15. Additional details on these events will be made available by a forthcoming press release.

Now we would like to open the call for questions. Operator, please go ahead.

(Operator Instructions)

Our first question from Sterling Auty from JPMorgan.

Thanks. Hi, guys.

Hey, Sterling.

A couple questions. Let's start with you mentioned some key hires on the sales side, you mentioned some investment in professional services, can you give us a little bit more quantification of how much your capacity in the sales area and how much your capacity in the professional services area has increased of late with these investments?

Yes, let me give you a little insight here, Sterling. As you know, we have been making some opportunistic hires in both enterprise sales as well as our professional services organizations, partially because of the competitors that have been acquired and the talent available to us and we picked off some of the best and brightest. We continue to expand our enterprise quota-bearing sales capacity at 30% to 40% year over year in general. But again, we were, I'll just say, at the top end of that range, if not a little above it in recent months and quarters and again expect that the kind of bleed into Q1.

From a professional services standpoint, again, because of the bookings out performance that Barry mentioned, we want to make sure we are front loading that investment in professional services talent. It's really, really an important differentiator for us to enable our enterprise customers to deploy on our solution and be successful right out of the gates. It something that our competitors have not been able to keep up with and we're going to continue to front load that investment, make sure people are trained up on our team to be able to implement those enterprise customers with great expertise.

Sterling, let me just add for the avoidance of doubt since you asked about quantification. On the PS side, that too was above -- at the high end or above the 30% to 40% range.

Got you. Looking to 2017, coming off of 2016 with a great enterprise growth and 10% growth in the mid-market, what kind of underlies your assumptions for 2017? In other words, are you thinking the mid-market will continue to grow 10%? What have you factored in, in terms of your thought around enterprise growth?

Yes, I think the best prediction of the future, Sterling, is what we've seen in the rear view mirror. We've been very, very consistently delivering enterprise subscription revenue growth in the low to mid 40%s, as you've seen, and if you look at our commercial business, it's been very, very consistently growing in and around 10%. I'd say those are the best proxies for you to do your modeling.

Okay. Last question, seasonality, you made the comments around the second quarter. Is that centered around, okay, we have an administration change, as we think about Affordable Care Act and possible changes that maybe you don't get the lift in the second quarter there versus the typical holiday retail surge you get at the end of the year?

Yes, I would say it's really all of the above, but not anything specific to the administration, if you will, Sterling. We've seen this pattern for several years now in terms of our seasonal revenue curve. Again, it has more to do with the growth in Q4 and the hockey stick we see every year in Q4 that bleeds into Q1 that drives that relatively flat sequential growth in Q2. So very consistent with what we've seen in the past.

Got it. Thank you.

Thank you.

We'll take our next question from Scott Berg with Needham.

Hey, Mike and Barry. Congrats on a great quarter. I have two quick questions. First of all, Mike, can you talk about your assumptions around general productivity in your 2017 guidance? Your productivity the last year to two years seems to be increasing, but given the competitive dynamic out there, are you expecting any real changes or is it pretty much in line with how you answered Sterling's questions?

It's -- we've definitely have seen increases in productivity, but at the same time, our philosophy around guidance in general is very conservative, Scott, as you know. We never really like to take any leaps of faith when it comes to the future even though it may have occurred in the past.

Sure. Fair enough. Then a question on last year's average deal size, which was up nicely, 24% year over year. Can you give us a little color what drove the average deal size higher? I know you've talked about larger deals in more modules, non-usage related components being part of the sale as well. I'm trying to get an understanding of that mix that drove that? How much did the partners contribute to that ASP going up?

Yes, great question, Scott. Again, in terms of average deal size, it's really a combination of seats, more seats as well as more products. It's a blend of two-thirds, one-third, two-thirds in seats and one-third in additional products. We're really pleased to see that kind of ability to fire on both of those cylinders in terms of average deal size growth. What was your second question, sorry?

Just partner impact to the deal size of that. As partners continue to impact more and more of the businesses, are they driving higher average deals than I guess than what you are seeing in your own direct sales, what you source completely yourself or maybe are they doing something less than that? Just trying to understand their impact on how that number's moving.

Yes, as I said in the past, Scott, deal size in and of itself is not extremely different between our direct business and our partner led business, or our channel business. I will say this, though, in terms of those channels. As I said in the script, I will reiterate, we are seeing tremendous growth in the master agent and reseller category. Again, it still logged fairly small numbers, right? As I said earlier on the call, resellers and master agents drove between 15% and 20% of our enterprise bookings for the year, but that's up significantly over the prior year. It's becoming more and more a meaningful part of our bookings engine and a big part of our future growth.

That's all I have. I'll jump back in the queue. Thank you.

We'll take our next question from Richard Baldry with ROTH Capital.

Thanks. If you look at the full year 2016, it looks like about 40% of your incremental revenue was dropped into the adjusted EBITDA line or the pro forma line. Can you talk going forward now that you've demonstrated pro forma profitability, sort of philosophically how much you think is more appropriate to try to drive from the top line into the bottom line given the large market opportunity you are facing? Thanks.

Yes. The trajectory that we saw in 2016 in terms of top to the bottom will be somewhat more muted in 2017. Starting at the top of the income statement, we are front loading some of the investment in PS in order to get ahead of the bookings growth, the enterprise bookings growth. In addition to that, in 2016 we still saw some benefit, Rich, from the sharp increases in usage in terms of the gross margins there and inevitably that will tend to flatten out. We'll still get gross margin improvements in the other two areas, as I alluded to in the script.

Moving down in terms of the sales and marketing, pretty much similar year upon year. We'll maintain roughly 30%, plus or minus. R&D, we didn't have very much growth in R&D in 2016. We do, as we have been saying now for some time, going to, not accelerate but to at least tap the accelerator a tad and increase the investment there. Then in G&A, you've seen nominal growth in G&A in 2015 and 2016 on a full-year basis. You're going to see more growth in 2017. And a number of special factors but the two that I will draw your attention to is that this year we need to become SOX 404(b) compliant and that inevitably, despite the preparations we've been doing the last several years, requires considerable more expense now that it's real.

Second of all, like many other companies, with ASC 606 coming down the pike, that is a nontrivial expense and even though like other SaaS companies the impact is minor, there's still a tremendous amount of work that needs to be done tracking literally thousands of allocations with new software that, even though they don't have to be -- they're going to be a big impact in the revenue, probably, there still needs to be demonstrated and recorded.

Great. Thanks and congrats on a great quarter.

We will take our next question from David Hynes with Canaccord.

Thanks, guys. I wanted to piggyback on Scott's earlier question around average deal sizes. Mike, you spoke to kind of two components of it, which is higher number of agents at land and more functionality per seat. I'm curious, the third, which you didn't touch on, is pricing. What are you seeing on pricing with new deals? Is that a lever that is driving this increase we're seeing in average deal sizes?

I would say that pricing continues to be very steady in terms of our base product, DJ. Again, we're -- over the years we've discounted less and less as we get and gain competitive advantage against our direct competitors, but at the same time, we're moving upstream. We're doing larger deals. We're doing deals that are much, much larger from a seat count perspective and obviously there's a volume discount element to that. These are offsetting factors that really result in flat pricing from a base price perspective, but again, we're getting increased products in the mix, which drives that number up, and we're getting increased seats, which also drives it up.

Yes, okay. Barry, on the gross margin side, a two-part question. I understand the need to ramp professional services hiring. Any way to quantify what -- you talked about a goal to get that business back to breakeven. Is there way to quantify how much of a drag that is on margins? That's question one. Part two, gross margins, we've been kind of stuck in neutral for the four or five quarters in that kind of 61.5% to 62% range. Any thoughts on linearity of how that progresses in 2017 as we reach towards those intermediate-term targets?

Yes, talking first about the professional services, let me begin by saying that we've made tremendous progress in terms of improving, or narrowing, rather, the losses that we have on that business. That's both the revenue curve, which, if you do the calculations you will see that, that PS business grew in the 70%s in 2016 and that comes from the success that our sales team had in terms of increasing proportional ACV with the enterprise customers who expect and demand that. Now, we will take quite an extended period, I'm not talking quarters, I'm talking a year or two, before that gets -- those negative gross margins get to breakeven and positive. In the meantime, it's an overall drag of between one to potentially to two, two and-a-half percentage points on our overall gross margins.

In terms of the trajectory of gross margin increases overall, we have, yes, only somewhat slower increases in 2016 as usage improvement slowed. It's heavily dependent upon revenue growth because we do always get improvements on the subscription side. Not every single quarter, but most quarters, and that's a simple function of the revenue growing faster than the cost of the co-location, the data centers, the tech ops and so on, customer support. That will continue at a slow, steady improvement on two-thirds of our revenue and we have a high degree of confidence on that. We've got another two years, two to two and-a-half years to go to get to the midpoint of our 65% to 70% and our models are comfortably getting us there.

Got it. Okay, great. Thanks for the color, guys.

We will take our next question from Jeff Van Rhee with Craig Hallum.

Great, thank you. I'll add my congratulations. The numbers look very nice. Couple pieces for me here.

First, I guess start high level. In terms of contact center and the environments you're selling into, could you just give a little color on what you're seeing trend wise? Which particular channels of contact are driving urgency within the call center to address in terms of this omni-channel experience? Obviously, messaging, chat, voice, a lot of different channels that folks are trying to deal with. I'm just curious if you could call out any of the higher level trends that are leading the urgency in terms of a purchase decision in the call center right now?

Happy to, Jeff. You hit it right on the head. I mean, the omni-channel experience is really what we're seeing most of our enterprise customers strategically focused on. Again, our partnerships with the likes of Salesforce and Zendesk and Oracle and bringing it together, our omni-channel solution with their CRM solutions and being able to do things like customer journey analytics across those multi-channel environments whether, again, it's a website visitor, an IVR visitor, a chat, we have some very unique capabilities and we're uniquely positioned with those CRM partners to add value to their solutions to intelligently route omni-channel interactions and arm the agents with what they need, very visually and very analytics driven so that those agents can really help customers through whatever issue they are facing.

The overall trend is to have a truly integrated omni-channel solution and we're way out ahead of the competition in terms of true omni-channel as opposed to siloed multi-channel. There's a big difference between those two.

Absolutely. Okay, then. Appreciate that. Two others for me, then. On the professional services side, talk to me about how you work through the trade-off between control versus passing, control versus margin drag, obviously. A lot of partners, a lot of pretty good channel partners out there do a lot in the space. You've got to find the right balance between controlling engagement and the experience versus taking on lesser margin. Talk through how you think about that trade-off.

Yes, happy to, Jeff. We've been at this a long time. We do, from time to time, use third parties to do implementations but it's the exception, not the rule, and we're very careful to make sure that we only use third parties that are as good as we are at implementing Five9 in an enterprise contact center. We've seen competitors, and I know you're familiar with some of them, that have actually solved for margins instead of customer satisfaction and it backfired on them. What it resulted in was customer churn on their side and quite frankly, customers coming to our platform off of theirs.

In the end of the day, we need to be solving for customer satisfaction and customer experience amongst our enterprise customers as a first priority. Even with that control of doing it ourselves, we're talking about a multi-quarter to potentially multi-year cycle to get that professional services business profitable. But even with that, the most important element of our business is bringing on new enterprise customers and satisfying them through that process and having them have a successful experience on our product and our platform.

It's working extremely well. You see it in our retention numbers, the customer satisfaction levels of our customers compared to our competitors that try to outsource professional services. It just is, it's a different equation. I think in the end of the day, it's a big reason we've delivered the bottom-line leverage that you've seen over the past two and-a-half, three years since we went public. Again, 35 percentage points in EBITDA margin expansion; a big part of that is just profitable revenue growth in enterprise and that six-to-one CAC LTV we talk about and being able to just continue to sell that next customer with the positive reference customers we've got that have been through our implementation process.

I know it's a long answer, but it's a really, really important strategic element of our business.

Great. I appreciate that. The last for me, then. In terms of the midpoint of the guide, if that's the right way to approach it, you talked about a couple different factors, some driving your recurring subscription and some influencing usage. Can you narrow it down to what the point differential is on growth, if subscriptions is growing X, usage is growing a couple points less than that, because I think you called out obviously some customers are coming up with their own usage solutions and other reasons where the attach rate might not be steady. I'm just trying to understand how that varies in forward guide.

The best way to think about this, Jeff, is as follows. We have mentioned two reasons that subscription revenue growth will outpace usage revenue growth. Those two reasons are that when we sell more products, more solutions, to every seat that's out there, we're going to have subscription revenue growing much faster than usage revenue, which is, if an agent's an agent's an agent, they are going to be on the phone, so to speak, and using our platform X number of minutes out of every day. That doesn't really change, so subscription will outgrow usage for that reason.

The other reason is from time to time, enterprise customers choose not to purchase usage from us but just our software on a subscription basis and stick with their carrier to buy their long distance services. The best way to quantify the impact of that, or the spread in growth rates, is actually to look at the revenue mix. As Barry said, I believe in his prepared remarks, there's about a 2% to 3% shift annually in that mix of subscription revenue and usage revenue. It's about a two-thirds, one-third mix today, so you can kind of do the math yourself, I believe.

Got it. Okay, thank you. Appreciate it.

You got it.

We'll take our next question from Brent Bracelin with Pacific Crest Securities.

Thank you. I have two questions, if I could here. Mike, I want to start with you. I also wanted to drill down on the enterprise business. My question is more on the enterprise sales cycle. On one hand, you get the benefit of larger deals, obviously $450,000 going to $560,000, good lift there, but I would imagine larger deals take longer to close. On the other hand, you are also seeing increasing contribution from some of your partners. As you think about the benefit of partners selling large deals and then the drawback of longer sales cycle process, what's that -- are you seeing a lengthening of sales cycles on the enterprise side or are the partners helping accelerate the sales cycle for you for large enterprise deals?

Brent, I will tell you this; the partners definitely accelerate the sales cycle. It really helps when Salesforce or Oracle or Zendesk walk us into one of their prospects as the CTI partner, or the contact center infrastructure partner of choice. It also really helps when we're working through master agents and resellers that are putting our solution in front of their prospect.

Just to quantify this, sales cycles have gotten longer as we've climbed up into the larger enterprise market over the years, but I'm talking about at IPO, our sales cycle was 90 to 120 days. That was three years ago and these days it's about 120 to 150 days. So we're still talking about a pretty minor increase in average sales cycle in enterprise. This is just for enterprise I'm talking about. Obviously, our commercial business is much shorter than that.

I expect that overall trend to continue, but we're still very much in a land-and-expand, go-to-market strategy. We're not elephant hunting, even though a lot of these deals we're doing are close $1 million. I talked about a few deals today of $700,000 and $800,000 and $1 million deal. They're large deals, but there is still a division or a subset of a large enterprise contact center opportunity that we're going after and because of that, we're not having to go through protracted enterprise-wide decisions where you see some software companies focused on the enterprise market having to be up against.

Very helpful color. Barry, a couple follow-ups for you, if I could. Wanted to start with, just the midpoint of the guide, 16% growth. Just given the increasing mix on the enterprise side and the growth there, obviously that would imply if that growth were to continue, the guide is pretty -- very conservative, let's put it that way, just given the mix shift to enterprise. Is the assumption that pro services starts to slow as you rely more on partners? What's the delta that we should think about, the guide versus the increasing mix on enterprise side?

Brent, I'm going to be brief for a change. It really comes down to a philosophy of being prudent. You will see that this has been a pretty consistent pattern and I'm just going to leave it at that.

Got it. So a lot of conservatism is in there. My last question for you is just on the CapEx. I heard a $10 million number for this year and that's obviously would be bigger than you done the past. So one, correct me if I'm wrong and I heard the wrong number. Two, if not, walk through what the plans are for the investment you're planning this year.

Thank you for that question. Your numbers are right. We ended up 2016 with $9.4 million and our guide for the coming year -- and that's been increasing in the second half of the year. Our guide for the coming year is $10 million to $12 million. There's one simple straightforward reason for that. We've got a lot of enterprise bookings. We have to get the additional capacity in terms of the hardware in the data centers. Our top-flight tech ops team is doing that. By the way, that has also been a little bit of a headwind because that new hardware that we're accelerating comes with additional maintenance expense, which we've allowed for in our guidance.

Very helpful. Thank you.

Thank you, Brent.

We'll take our next question from Mike Latimore with Northland Capital Markets.

Great, thanks. Nice quarter. Just a question on the bookings commentary. Just want to clarify, is the bookings a record for the fourth quarter specifically, or any quarter? Secondly, did you say bookings grew faster than sales headcounts, meaning that they were over 40%?

Yes, thanks for clarifying, Mike. Q4 was an all-time record regardless of what quarter you look at. It was any-quarter record, which is great news for us and again, something that just gives us a lot of bullishness around the future, obviously. I would add that I did say in my prepared remarks that the bookings for 2016, I did not comment on the Q4 number but -- in this regard, but I did say that the bookings for the full year 2016 far exceeded the growth in our sales capacity of 30% to 40%.

Okay, great. Thanks. On the master agent and reseller growth, you said it had doubled in 2016. I guess what is the thought going forward? Are you going to allow the ones that you've added to mature or do you expect to continue to add a lot more master agents and resellers this year?

We're going to continue to add. This is still very, very early days, especially in the reseller side, Mike. We have just begun to scratch the surface. As you probably imagine, with Avaya's filing for Chapter 11, there are a number of Avaya VARs out there that are very sizable companies that have actually been making a living for decades reselling these legacy on-premise solutions.

They are at a point which, as you'd expect, given the downward trend for Avaya's business, they are looking for alternatives very aggressively and they're very aggressively embracing cloud and we're increasingly becoming the choice. So there's just a tremendous opportunity for us in the reseller channel that is just in the very, very beginnings in terms of what's in the rear view mirror versus what's in the future opportunity for us.

Great. Last one, in your enterprise deal, what percent of the time are you actually competing against a cloud company versus an on-premise company?

Yes, been pretty consistent over the past several quarters, Mike, that we see one of the leading cloud competitors, or both of them, in about half of our enterprise opportunities.

Okay, thanks.

You got it.

That concludes today's question-and-answer session. At this time I will turn the conference back to Management for closing remarks.

Well, thank you, everyone, for joining the call today. 2016 was another record year for Five9. We believe our increasing momentum in the enterprise market, combined with some recent shifts in the market landscape that I've talked about today, puts Five9 in a very unique position to strengthen our leadership position in 2017. Very excited about the year to come and thanks again for joining us today.

This concludes today's call. Thank you for your participation. You may now disconnect.