Five9 Inc (FIVN) 2017 Q4 法說會逐字稿

Good day, everyone, and welcome to the Five9, Inc.

Q4 2017 Earnings Conference.

Today's call is being recorded.

And at this time, I'd like to turn the conference over to Lisa Laukkanen.

Please go ahead.

Thank you, 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 our 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 affect 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 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'd 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 capped off a 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 points over 2016.

For the fourth quarter of 2017, adjusted EBITDA was a record $6.9 million, representing a 12.4% EBITDA margin, an increase of 5.9 percentage points year-over-year and 40 percentage points since our IPO.

The adjusted EBITDA improvements continued to be driven by 2 factors: first, the 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 3 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 continued 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; and WFO with the likes of Calabrio, Verint and CSI and the Unified Communications with Microsoft Teams, formerly known as Skype for Business, as well as Cisco and several others.

The following metrics demonstrate our ongoing momentum in the enterprise market where our win rate once again averaged more than 75% against our 2 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 6 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 grab but a steady replacement cycle, lasting over a decade or more.

The evangelical phase of this replatforming is clearly over.

Nowadays, most RFPs include a cloud option as a matter of course.

Second, our end-to-end solution providing the industry's most robust omnichannel 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'd like to share a few examples of enterprise wins for the quarter.

The first is a leading global property and casualty insurer who was 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 MPLS 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 their 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 their international locations at a lower cost and with lower latency as well as integration to several key systems, including Microsoft Dynamics, ServiceNow and Workday.

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 clients.

They were using a legacy hybrid system hosted by their carrier that was being discontinued.

They brought in a consultant to help them with the selection process of a 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 additional 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 are 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 company's 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 are 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 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 2017 was $55.4 million, up 25% year-over-year.

This growth is all organic and reflects 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 in industries such as retail and health care.

Our commercial business, which represents the other 26% of LTM revenue, is growing in the single digits as we focus 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 agent seats 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 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.

Fourth quarter 2017 adjusted gross margins were 63.6%, an increase of 174 basis points from the fourth quarter of 2016.

Year-over-year adjusted gross margin has now increased each quarter for the last 20 quarters.

We are heartened by this consistent performance since 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 2018 to slightly decline sequentially given the FICA 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 margin via 3 main drivers: first, subscription gross margins continuing to increase as we continue 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 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 2 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 again discuss in the order of the remaining gap to close and 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 gap by operating leverage, although it 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 via 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 2 cloud competitors at the time.

Separately, sales and marketing expense as a percent of revenue is the lowest in the fourth quarter of each year, our seasonally strongest revenue quarter, which is what helped to offset the high commissions related to our all-time enterprise bookings record in the fourth quarter of 2017.

Looking ahead, for most quarters, we plan to remain within our intermediate-term target for non-GAAP sales and marketing expenses.

We are extremely pleased with our ninth consecutive quarter of 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 marks our 17th consecutive quarter of year-over-year adjusted EBITDA margin expansion.

Looking ahead, we maintain 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 this seat count metric only on an annual basis.

And now for a closer 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 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 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 of positive operating cash flow.

For the full year 2017, operating cash flow was $11.1 million, an improvement of $4.3 million over 2016.

We are particularly pleased with this operating cash flow performance since it illustrates the strong unit economics and the operating leverage inherent in our business model as well as our low working capital intensity driven by our low DSOs.

Specifically, DSOs for the fourth quarter of 2017 were 28 days.

As I've remarked before, this DSO performance is an indication not just of payment terms and the mission criticality of our solution but also of the level of customer satisfaction.

Looking ahead, we expect DSO to increase gradually as the 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 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 model.

First, I remind you that we have elected to use the modified retrospective 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 higher on ASC 606 due to lower commission expense on capitalizing and amortizing a significant portion of commission expense rather than expensing all such expenses upfront.

Fourth, our intermediate-term model now has a target of 22%-plus for adjusted EBITDA for the second half of 2019 versus previous 20%-plus, reflecting the lower commission expenses.

Similarly, our long-term model now has a target of 27%-plus for the adjusted EBITDA margin or approximately 4 years from now versus the adjusted 25%-plus, again, reflecting lower commission expenses.

Correspondingly, our intermediate- and long-term targets for sales and marketing expense are now 26% to 30% of revenue versus the previous 28% to 32% of revenue.

The new models are in the investor deck.

And now for the guidance under 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 per 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 a $6 million addition to the bottom line due to lower commission expenses under ASC 606, which is the midpoint of the $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 the typical seasonality of our business and includes the impact of the expected falloff from the strong seasonal tailwind in the fourth quarter.

GAAP net loss is expected to be in the range of $4.5 million 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 or $0.02 to $0.04 per diluted share.

This guidance for the current quarter includes the impact of the higher cost and expenses related to ongoing hires we have been making and continuing to make to go after this massive market opportunity, the impact of the annual restart of FICA obligation and the expenses being incurred for ASC 606 and Sarbanes-Oxley.

Note that this guidance includes a $1 million addition to the bottom line due to the lower commission expenses under ASC 606, which is the midpoint of the $0.5 million to $1.5 million range for the current quarter we're expecting from this accounting change.

With respect to our 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 a 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 stronger 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 3 years, 53% of our revenues have been recognized in the second half of the year, and that we enjoy a very high margin profitability on incremental revenue.

In other words, we have a natural lift in adjusted EBITDA margin 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 hard-earned reputation for showing up and delivering.

This 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; 5 years of increasing year-over-year gross margins each quarter; and over 4 years of increasing year-over-year adjusted EBITDA margin each quarter.

Going forward, we will continue to drive solid revenue growth while progressing towards our ASC 606-based intermediate-term and long-term adjusted EBITDA margin 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 & Telecom Conference in San Francisco on February 26, the 13th Annual KeyBanc Emerging Technology Summit in San Francisco on February 27 and the 30th Annual ROTH Conference in Laguna Niguel on March 12.

Additional details will be available in upcoming press releases.

And now we will open the call for questions.

Operator, please go ahead.

(Operator Instructions) And we'll go first to Sterling Auty at JPMorgan.

This is actually Ugam Kamat, on for Sterling.

I was just thinking about additional drivers that can give lift to your revenues, say, 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're very careful due to the upfront investment that it takes in order to really establish a brand and establish the personnel necessary to succeed in international markets.

And that's why we've been very conservative as we've 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's a massive market opportunity.

And as we've talked about before, it's only 10% to 15% penetrated to cloud.

And so there's a great deal of opportunity domestically that we plan to take advantage of with today's products as well as innovations that we plan to release later this year.

Got you.

That was helpful.

And just a follow-up, your dollar-based retention had stayed fairly consistent for the last 3 quarters.

Just to go a level deeper, how much amount of that had stayed consistent because you're driving better up-sells?

Was this 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 slowly for that dollar-based 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 basically what is happening.

And we'll go next to Terry Tillman at SunTrust Robinson Humphrey.

Just a couple of questions for me.

First, and I don't know if this is for you, Dan.

I'll just throw it out there, and then whoever wants to answer, please do.

But in terms of some of these metrics, the ASP up to $640,000, that's good to see; concur -- or 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 it more in terms of the contribution coming from just bigger seat counts on these deals?

Or they're going bigger earlier with the number of seats and committed contact center sites?

Or is it more SKUs, and there's just a lot more attach of all these add-on capabilities?

So that's the first question.

Yes.

So Terry, I think -- this is Dan, and I think you hit on a number of factors that are contributing to that.

A couple of things are at play here.

One is we continue to go further and further upmarket as enterprises get more and more confident in the cloud.

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 customers seeing others of the same size and complexity moving to the cloud and moving to Five9.

So that's just a phenomena that just continues 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.

I mean, 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.

Okay.

And then just -- a follow-up question relates to in the prepared remarks talking about increased leverage from your ecosystem.

And I think over 55% of the business is influenced by partners of various types.

I'm curious, as it relates to thinking about your sales capacity growth into '18, 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?

You bet.

Thanks, Terry.

Yes, I think to answer the question, it's going to continue.

We're going to continue to grow our sales capacity at 30% to 40%, and I think you'll 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.

We haven't -- 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 bulk of the selling with that direct sales force.

And we'll go next to Scott Berg at Needham & Company.

This is actually Peter Levine, in for Scott.

So 2 questions.

The first question, I guess, is -- I guess, I'll ask around Avaya.

I know in the first quarter, you announced a number of new partnerships but also kind of winning a number of Avaya VARs, especially, I think, it was 2 or 3 of their top partners.

Can you talk about how those relationships have played out through '17 and expectations for '18, and I guess, the number of VARs still available up for grabs that you're kind of potentially going after here in '18?

Yes.

And this is Dan.

Thanks for your great question.

We continue -- and this is not anything new and anything we see changing dramatically, but we continue to see the Avaya installed base, which, as you know, is 25% to 30% by most estimates of the market share of contact centers.

And we continue to see that base really yearning 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 their Avaya VAR and want to have a cloud solution.

And that just hasn't been available to them through Avaya, so they've turned to Five9.

And we've signed up, as I -- as we said last year, over a dozen.

We handpicked those.

They had the best appetite.

They had the strongest bases that were, again, yearning for the cloud.

And we're being very careful not to just go widespread with all the Avaya VARs out there.

We want to make sure that we're spending the time and effort to enable them, educate them and really be able to leverage them by bringing them up to speed on Five9 and our cloud offering.

So that's what we've 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'll see the results occur over the next year.

Great.

And to piggyback off the last question, I mean, from 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 '17, but expectations for '18 on the professional service side.

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're starting to get leverage and efficiencies, I should say, from those teams.

Things along the lines are being able to templatize some of the call flows, being able to build tools to migrate databases of users over from a customer's 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 been trained, and they're much more proficient than they were before.

And we'll go next to Meta Marshall at Morgan Stanley.

This is Yuuji Anderson, on for Meta.

Can you speak more towards the opportunity leveraging partners like Salesforce and Oracle versus, say, developing more the traditional channel types?

Are these like entirely new opportunities?

Do they tend to be bigger, smaller?

Just any color there, I think, would be pretty helpful.

Yes.

They run the gamut, right?

They sell to customers of all sizes.

So when you look at Salesforce and Oracle in particular, they're 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're 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 oftentimes, joint development from our product teams working with their R&D teams to take things beyond just traditionally what we've termed as integration, and that is taking things to where we can provide unique offerings with the combination of Five9 and that particular CRM solution.

And so it runs 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 segue 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're kind of looking to launch?

Just any color there also would be helpful.

Sure.

Yes.

Thank you.

If you look at the R&D, 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 gently 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's usable and consumable and brings value to a customer's 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'll take our next question from Raimo Lenschow at Barclays.

Quick one for you, Dan.

If you look at the competitive environment, can you talk to -- well, you mentioned Avaya, and that -- 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 comprehensive 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.

Great.

So -- and I'll break it down into those 3 sections you just did, which is, if you look at the traditional premise folks, it's not only Avaya; it's Cisco, it's Genesys and several others, the aspects of the world that we replace on a regular basis, and really, that's because they've struggled with getting to the cloud.

We don't see or anticipate any change with them exiting Chapter 11.

I don't think that was a surprise that they were going to do so, and they have a large installed base.

But it'll -- it's yet to be seen that they can deliver a true cloud solution, and we'll see from that point.

But we continue to replace all of the premise-based systems.

As far as our cloud competitors, Interactive Intelligence and inContact, the acquisition that Interactive or that Genesys made of 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'll lead with, which sales teams 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 tying yourself to something that's going to get perhaps discontinued.

So that bodes well for us.

inContact, as 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 is being the large enterprise player that they are, bringing inContact upmarket into some of those larger and larger opportunities, which I think only bodes well for our industry.

It helps validate cloud even further upmarket.

And then the third part of your question about the UC, you raised the example of RingCentral.

RingCentral has an OEM agreement with another cloud provider, and they continue to package that together when a customer does want a single solution from a single provider.

That typically happens in the low to mid-market for them.

Okay.

Perfect.

And then for Barry, like 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, 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 about the investment areas for '18 that you want to be focusing on?

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've done in the prior years is the revenue.

At this stage of the year, we're being prudent in terms of how much revenue seasonally we'll enjoy in the second half of the year.

We know fully well that 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'll be happy to do the same as we've 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 of the same in terms of investment in the various areas that we talked about repeatedly, and the year will unfold the way the year will unfold.

And we'll go next to Jeff Van Rhee at Craig-Hallum.

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'd love to hear a bit more 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 were some wording in there that sort of suggested maybe there is 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.

Yes, regarding that, it was just a global insurance provider, and their Canadian operations, again, were set up with several premise-based systems, and they wanted to consolidate.

They needed to secure an IVR self-service.

They wanted to make sure they had secure pay for PCI compliance to make sure they can collect credit card information and not have it even be visible to their agents.

They needed to make sure because of the Patriot Act that they kept call recordings and screen recordings in country and stored in Canada, that they never left Canada.

So we're actually partnered 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 scale -- is scheduled to result in over $5 million in revenue this first year.

And that's just the initial order.

And as we mentioned, there's potential to grow globally after that.

Got it.

Okay, that's great.

And then with respect to sales, just any changes certainly even 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're finding the talent, has there been any pivots with respect to methods, source, kind of skill sets you're hiring, tenure, any pivots at all?

Or is this continuing to stamp out exactly as you've done over the last few years?

Yes.

Certainly no pivots.

I think what's happened is it's allowed us to be far more selective in bringing in top-tier talent.

Five9, with our success over the last several years, we've got a brand.

We've got a reputation.

Barry mentioned it on the call, which is we absolutely strive and pride ourselves on executing.

And people recognize that, and I think we're becoming a very, very attractive place to want to work.

And so we got a lot more interest of top-tier talent coming toward us.

And it just gives us greater flexibility to be selective.

Okay.

And then just 2 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 maybe in a little more intense fashion than prior years?

Yes.

We've always mentioned that we have tailwinds in Q4 resulting from the seasonality from -- certainly, retail contributed this year significantly, and then we've also mentioned the ACA or health care and open enrollment.

And that was actually condensed.

The Affordable Care Act enrollment period was condensed into about half the period as it normally has been, and yet, they had 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 omnichannel side, any -- I'm just curious sort of the attach rates of the incremental capabilities.

What's changed in the last, say, 12 months, in terms of the omnichannel capabilities that you're seeing, particularly notable increases in demand or higher attach and the inverse of that, the things you might be seeing lesser attach?

Yes.

So omnichannel, for sure, is becoming more of a staple.

I'll say that 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 oftentimes 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 an expert at chat, doing multiple chats and also responding to e-mails.

So most companies are -- 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 every once in a while you'll get universal agents that'll 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've got some that are almost primarily voice, and -- but there is increase -- every year, we've seen an increase in the attach rate of omnichannel.

And we'll go next to Nikolay Beliov at Bank of America.

Barry, I just had a couple of questions for you.

Number one, during the prepared remarks, you talked about Q4 benefiting in from seasonal business in health care and retail.

Was it 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 health care, as Dan mentioned.

Okay.

And professional services came in at 5% of revenues lower than the previous quarters.

Is that the new trend in prof serv?

And kind of like what do you expect prof serv to be in 2018 as a percentage of revenues?

Are we talking about mid-single digit, 95 single digit?

So it is a little bit more lumpy than our recurring revenue.

If you rewind the movie back to when we went public, it was just 3%.

It increased on an annual basis by 1, 2 percentage points.

And for this year, it's difficult to predict exactly, probably go up maybe another 1 or 2 percentage points.

Longer term, we would see, like many other SaaS companies, that if we get to high single digits, low double digits.

Got it.

And Dan, I got a couple of questions for you.

That $5 million deal was fantastic, and it was broadly co-partner.

But specifically, your sales organization, do you need to build a special team that can go after these larger opportunities that you mentioned like you're getting some success there and the market -- the upper end of the market is opening up.

Do you need to do 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, much higher end of the market.

So we've been chopping at the bit and waiting for years to finally get to where our comfort zone is.

So I don't think we have to get any different skill set.

It's -- we're -- we've 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 environments, and we have to temper their enthusiasm to stay focused where the cloud has been most successful in that mid-market.

And we're now reaping the benefits of being able to sell into the larger end.

And one more for you.

Over the last 3 to 6 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 that inflection if it indeed happen in 2018 in terms of like both the product, we heard it first from you, talk about analytics recently.

What do you guys do in that area, too?

Yes.

You're exactly right.

And yes, the digital transformation message is out there, and it's being broadcast by lots of industries.

And we play very nicely into that and contribute to that as IT organizations of large enterprise want to move their contacts or their data center footprint off-premise and move it to the cloud.

We're a natural fit to go right with that.

And the way we do that is we're always focused on personalized customer experience, and that's 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 in the way that they want to communicate.

All the studies are out there that say if the consumer and customer aren't happy with the way they're being treated in that customer experience, they will deflect -- defect to an alternate or competing solution.

That's why a comment I made earlier was about there's less concern or focus on cost cutting per interaction and more focus on making that customer experience what that consumer wants and needs.

Second area is cloud innovation.

We've 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 chatbots and other things to market much easier and quicker and make them available to all of our customers because we're a subscription cloud-based service.

All of our customers stay on the current release.

And then the third area is really just being a 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 needs it.

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'll go next to Mike Latimore at Northland Capital Markets.

This is actually Nick Altmann, on for Mike.

We can hardly hear you.

If you can speak up a bit, that'd be great.

Can you guys hear me now?

Yes.

Yes, much better.

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 put 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.

And next, to KeyBanc Capital Markets, Brent Bracelin.

This is Steve Enders, on for Brent.

I was just wondering what your expectations are for 2018 with regards to the Avaya partners you signed up in 2017.

Yes.

Great question.

I think they're 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 wait out in hopes of getting a cloud solution, a true cloud solution from Avaya.

They've waited many years already.

And so I think there's an appetite there for the VARs to continue with their base and 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 long a 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'll go next to Richard Baldry at Roth Capital.

To mix it up, it's Rich Baldry, on for Rich Baldry this time.

Just quick overall strategic side, your market caps changed pretty dramatically over the past 12, 18 months.

I'm sort of 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 things you might be interested in, what types of things you'd be willing to look at as the company grows up.

Hey, Rich, this is Mike.

I'll take that one because I haven't said much on the call, but it's good to talk to you guys again.

From a downstream M&A appetite, we're always looking at interesting acquisition targets, especially in some areas like AI and other highly innovative market spaces, if you will.

Our currency is clearly better today than it was a year ago or 2 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 bases, but we may do some technology tuck-ins.

We're always looking for interesting opportunities.

We've done one in our history, as you know, and we'll see how it plays out.

And next, we'll hear from David Hynes at Canaccord.

I want to ask about how you're 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 your prepared remarks around kind of the Five9-controlled high-touch services models as a competitive advantage.

How does that evolve over time?

What's kind of the thinking around time line for that?

What's involved in the process?

Any color along those lines will be helpful.

Yes.

Great.

Thanks, DJ.

Looking at the channel leverage, as I mentioned earlier, we're 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.

It's not something that you just hand off to a channel in -- especially in the enterprise.

So I think you'll 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're very cautious.

We've 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've been the beneficiary of many of those where customers just say they can't get ahold of the expertise that they need in order to optimize and make the system do what they purchased it for.

And so we've 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're 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 someday, we will get leverage, and we will model that in when it comes.

Yes.

Makes sense.

And then to the extent that you can say anything about the CEO search process, what's the latest there?

And is there any time line you could share as to when you hope to have a permanent solution for that seat?

Yes.

DJ, this is Mike.

I'll take that one.

We're in the midst of this 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?

We're a $200 million cloud software company, growing very, very nicely with a huge TAM ahead of us.

And as we've talked about, this is the second -- top of the second inning of a 9-inning ball game.

So again, we're keeping the bar extremely high, and we'll update you guys when it's appropriate.

But as you can imagine, there's a lot of interest.

And that does conclude our question-and-answer session.

I'd 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 we have demonstrated the ability to execute and continue to generate momentum in the enormous enterprise market opportunity, and this sets us up well for 2018.

We look forward to seeing you as the year unfolds.

Thank you.

And ladies and gentlemen, once again, that does conclude today's conference.

And again, I'd like to thank everyone for joining us today.