Five9 Inc (FIVN) 2018 Q2 法說會逐字稿

Good day, and welcome to the Five9 Second Quarter 2018 Earnings Conference Call.

Today's conference is being recorded.

At this time, I would like to turn the conference over to Ms. Lisa Laukkanen.

Please go ahead, ma'am.

Thank you, operator, and good afternoon, everyone, and thank you for joining us on today's conference call to discuss Five9's second quarter 2018 results.

Today's call is being hosted by Rowan Trollope, CEO; Dan Burkland, President; and Barry Zwarenstein, CFO.

During the course of the 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 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 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 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 than the non-GAAP financial information provided by other companies in our industry.

The full reconciliation of 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 CEO, Rowan Trollope.

Thank you, Lisa, and thanks to all of you for joining us today.

It's been 3 months since I took the helm of Five9.

During this time, I've been focused on learning the operational cadence of the business, engaging with employees, our customers, and our partners and many of you, all of which has been a very positive experience.

Before joining, I was familiar with Five9 industry-leading products and its track record of successful execution.

As I've looked under the hood, my enthusiasm for the company has only grown.

I'll discuss my perspectives in a moment, but first, let me provide some highlights from the second quarter.

I'm very pleased to report that our second quarter results significantly exceeded our expectations on both the top and bottom lines.

Revenue was a record $61.1 million and the year-over-year growth rate accelerated to 28%.

Revenue growth continues to be driven by our Enterprise business.

Enterprise subscription revenue, the fastest-growing and most profitable part of our business, continued its multiyear pattern of growing in the 30s, posting growth of 37% on an LTM basis.

Adjusted EBITDA was $9.7 million, representing a record 15.8% margin, up 3.1 percentage points sequentially, demonstrating the considerable leverage in our business model.

Given the strong momentum in our business, we are raising 2018 guidance for both top and adjusted bottom line.

And now, my perspectives on the future of the contact center business in general and of Five9 in particular.

Contact centers are undergoing a significant technology-enabled transformation.

Historically, contact centers have been back-office functions, focused primarily on operational excellence and cost reduction.

The modern contact center has a broader, more strategic role, namely, to provide stellar customer experiences, driving up customer loyalty and increasing revenue.

Now 2 fundamental changes are helping drive this transformation.

First is the shift to the cloud.

The disruption of the legacy contact center vendors is just beginning.

The market for Five9 has been progressively opened up as we've proven our reliability, scalability and security.

And keep in mind that this is not a land grab but a steady replacement cycle lasting over a decade or more.

In short, the market is coming towards us.

The shift to the cloud is opening up the door to the next technology-enabled transformation for the contact center: artificial intelligence.

AI is transforming the technology landscape, and the prerequisite to AI is access to vast quantities of data.

It turns out that the Cloud Contact Center is a very rich space for AI and machine learning.

From virtual agents augmenting live agents, to transforming unused voice recordings into valuable business insights, to augmenting agents with AI-powered guidance, AI will play a transformative role for many years to come.

Our goal is to create the world's best self-learning, intelligent contact center delivered through the cloud and powered by AI.

Now one of my reasons for joining Five9 is that I felt we are better positioned than anyone else to achieve this.

Each day, our born-in-the-cloud platform with its proven reliability, scalability and security handles tens of millions of customer interactions, accumulating a treasure trove of voice recordings across many industries.

So we have the data.

We plan to leverage this data using our own technology as well as third-party AI platforms from industry leaders such as Google, Salesforce Einstein and IBM Watson.

Last week, we took an important step at the Google Next conference, where we announced our partnership with Google and their new Cloud Contact Center AI platform.

This fits perfectly into our recently announced AI-led Five9 Genius, and we demonstrated a real example of Five9 Genius using Google AI to deliver a next-generation virtual agent.

In summary, the cloud is becoming mainstream and the rise of AI is just beginning.

We believe it's inevitable that these technologies will transform the contact center as we know it today.

Neither trend is going to happen rapidly but both position Five9 for a bright, long-term future.

Switching gears now to execution.

While strategically, we are extremely pleased to be a disruptor in a massive market, what matters in the near term is continued execution.

This is what delivers results.

In this regard, our approach to execution is consistent with the approach taken by my predecessor, Mike; namely, first, attracting and retaining top-tier talent throughout the entire organization; next, delivering product excellence and innovation; next, further expanding our ecosystem of partners; and finally, strengthening our "customer first, do whatever it takes" culture.

Let me focus briefly on one of these, namely, customer relationships.

We believe that we're the industry leader when it comes to customer satisfaction.

And qualitatively, this is supported by my first-hand interactions with our customers and, quantitatively, by data such as our LTM annual dollar-based retention rate, which increased to 99% in the second quarter and which resulted in our high unit economics.

What drives this high level of customer satisfaction?

Well, first, our platform's completeness, scalability, security and, importantly, its reliability.

Over the last 12 months, we averaged 99.995% uptime.

Next, our direct customer relationships.

Even when partners are involved, we engage directly for sales, implementation and support with the end customers with the aim to ensure the highest level of customer success.

And finally, all of our enterprise customers get a high-touch on-site implementation performed by our professional services team.

And many of those customers opt for our personalized Premium Support service provided by our technical account management team.

In summary, I'm extremely excited to be leading Five9 as it continues to disrupt the contact center industry.

I've been amazed by the talent and drive of the entire Five9 team, and I'm confident of a bright future.

I'll now turn the call over to our President, Dan Burkland, to highlight some of our recent enterprise wins and expansions.

Dan?

Thank you, Rowan.

I'm pleased to report another second quarter record for enterprise bookings in addition to our pipeline reaching another all-time high.

Now I'd like to share some key enterprise wins we had in the quarter.

The first example I'd like to share is a health-care company focused on early detection and prevention of certain cancers.

They use their contact center to interact with patients and instruct them on at-home cancer screening test kit procedures as well as with physicians to review test results.

They had been using a premises-based solution, which lacked the flexibility, analytics, remote agents support and management dashboards they needed to run their business more effectively.

They recognized the importance of having a deep integration to their Microsoft Dynamics CRM as well as maintaining HIPAA compliance.

They're implementing a complete end-to-end solution from Five9, including IVR, ACD, secure pay for PCI and advanced encryption for HIPAA compliance.

We anticipate this initial order will generate approximately $1.2 million in annual recurring revenue to Five9.

The next example is a global university with multiple campuses and online academic programs.

They have been using several premises-based systems throughout their locations, creating silos for distributing interactions reporting -- and were constrained by the limited connectivity creating inefficiency across their multiple locations.

One reason they chose Five9 was our Global Voice services, which is designed to allow optimal distribution of calls throughout the world.

The customer is also upgrading to a complete omnichannel solution with Five9 so that they can offer voice, chat, e-mail and social interactions to their students and customers.

The deep integration between Five9 and Microsoft Dynamics CRM allows the customer journey to have these interactions as well as recordings of all previous interactions to be written into and made accessible through their CRM interface.

We anticipate this initial order will result in over $1.1 million in annual recurring revenue to Five9.

My final example is one of the world's largest and most diverse hotel companies.

As the company has acquired many brands and properties, they accumulated a variety of different premises-based systems which could not scale, integrate or consolidate to operate as the desired efficiencies of one single company.

It was clear that the company needed to consolidate to a single global solution.

They evaluated several cloud competitors as well as their main premise-based provider and found that none were able to provide the single global solution with deep Salesforce CRM integration and enhanced mobility through visual IVR while also allowing them to upgrade their existing WFO by moving it to the cloud with Five9.

Ultimately, it came down to trust and confidence in Five9 to deliver their global needs of today as well as the direction that they see Five9 headed in the future.

We anticipate this initial order will result in approximately $700,000 in annual recurring revenue to Five9 with greater expansion very likely in the coming years.

Now I'd like to share an example of our existing customers who have continued to expand their use of Five9.

This online recruiter went live with Five9 in early 2016 with 160 concurrent seats.

Over the next 2 years, they had nearly tripled their seat count with us and most recently added over 485 seats.

Along the way, this customer standardized on Salesforce CRM, implemented our industry-leading Salesforce integration adapter and continued to leverage our robust Manual Touch Mode solution for TCPA compliance.

With this add-on order, we anticipate this customer will increase their annual recurring revenue to Five9 in the order of $2.2 million.

As you can see, we continue to provide our industry-leading solutions to help larger enterprises achieve their digital transformation objectives.

I'm very pleased with our momentum in the enterprise market.

As Rowan highlighted earlier, customer experience has become more strategic to enterprises, and doing so in the cloud is now mainstream.

With our expanding go-to-market team and ecosystem of partners, which again influenced over 55% of our enterprise deal flow for the second quarter, we believe we are extremely well positioned in this growing large market.

I will now turn the call over to Barry to provide more color on the second quarter financials.

Thank you, Dan.

This was another excellent quarter with revenue growing 28% and adjusted EBITDA margin increasing year-over-year for the 19th consecutive quarter.

Before going into specifics, some reminders.

Unless otherwise indicated, all financial figures are non-GAAP and under ASC 606.

Additionally, all growth rates are compared to the prior-year period unless stated otherwise.

Finally, note that the reconciliations from GAAP to non-GAAP results and from 606 to 605 are included in the appendix of our investor presentation available currently on our website at investors.five9.com.

We delivered another strong quarter, which exceeded our expectations.

Revenue was a record $61.1 million, up 28% year-over-year.

Revenue was up 4% sequentially, which is unusually strong given that the second quarter has been seasonally our toughest quarter.

The strong year-over-year and sequential revenue growth was again driven by the continued strong growth in our Enterprise business, which now makes up 76% of our LTM revenue.

Additionally, our commercial business, which represents the other 24% of LTM revenue, contributed stronger growth in and around 10%.

While we continue to concentrate our investments in the higher-ROI Enterprise business, we renewed our focus on the commercial business and improved execution.

Recurring revenue accounted for 93% of our revenue in the second quarter.

The other 7% of our revenue in the second quarter was comprised of Professional Services fees generated from assisting clients in implementing and optimizing the Five9 solution.

Second quarter adjusted gross margins were 63.8%, an increase of 150 basis points year-over-year.

Year-over-year adjusted gross margins have now increased each quarter for the last 22 quarters.

Turning now to expenses.

Second quarter non-GAAP, sales and marketing, R&D and G&A expenses were respectively 26.7%, 11.6% and 9.8% of revenue.

These were 6.2 percentage points lower year-over-year for sales and marketing, of which 2.9 percentage points were due to the 605/606 transition, 0.6 percentage points lower for R&D and 1.3 percentage points lower for G&A.

Second quarter adjusted EBITDA was $9.7 million, representing a record 15.8% margin.

This was an increase of 9.6 percentage points year-over-year, of which 3 percentage points was due to the 605/606 transition and, as Rowan mentioned earlier, was an increase of 3.1 percentage points sequentially.

The adjusted EBITDA improvements continued to be driven by the strong growth in our Enterprise business, which enjoyed excellent unit economics and have consistently increased as a proportion of total revenue, and by the operating leverage we have consistently achieved.

Looking forward, we expect to continue to drive solid revenue growth and progress towards our second half 2019 and long-term adjusted EBITDA margin models of 22% plus and 27% plus respectively.

Our confidence in meeting these targets is based upon the persistence of the factors which had driven year-upon-year improvements thus far.

Second quarter GAAP net loss was $2 million while non-GAAP net income was $6.9 million.

Finally, before turning to guidance, some balance sheet and cash flow highlights.

We ended the second quarter with $274.3 million in cash and marketable investments.

This includes proceeds of $186.8 million from the convertible note financing that we closed in May, net of paying off our revolver debt, transaction costs and fees to purchase the capital, which increased the conversion price to $62.80 per share.

We expect cash net interest savings resulting from the use of our convertible proceeds to be approximately $2.5 million in 2018, of which $350,000 was realized in the second quarter and a further $1 million is expected in the third quarter and $1.1 million is expected in the fourth quarter.

DSO for the second quarter was 26 days.

As I have remarked before, the 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 that Rowan talked about earlier.

Looking ahead, we expect DSOs to increase gradually as the mix shift to Enterprise from commercial continues.

Our LTM operating cash flow as of June 30, 2018, was $24.6 million, a year-over-year improvement of $19.7 million.

We are optimistic about our potential for long-term cash generation given our adjusted EBITDA models, our substantial NROs, which we believe means we'll not be paying taxes for the foreseeable future, and our low DSOs.

Capital spending in the second quarter was $3.5 million, of which $2.4 million was financed by capital leases, and the remaining $1.1 million was paid in cash.

Moving forward, we expect to generally pay cash for new capital expenditures.

I'd like to finish today's prepared remarks with a brief discussion of our expectations for the third quarter and for the full year 2018.

Note that our guidance reflects no material difference in revenue between ASC 606 and ASC 605 and that the bottom line benefit from capitalizing and amortizing a significant portion of commissions will be in the range of $5 million to $7 million for the year.

For the third quarter of 2018, we expect revenue to be in the range of $61 million to $62 million.

GAAP net loss is expected to be in the range of $8.1 million to $7.1 million or $0.14 to $0.12 per basic share.

Non-GAAP net income is expected to be in the range of $5.1 million to $6.1 million or $0.08 to $0.10 per diluted share.

The guidance for the current quarter includes the following items: first, GAAP net loss includes $3 million in amortization of convertible debt discount and issuance costs; second, higher expenses anticipated in R&D; third, $1 million in net interest savings from the use of our convertible proceeds; and fourth, $1.5 million improvement due to lower commission expenses under ASC 606, which is a midpoint of the $1 million to $2 million range for the current quarter we're expecting due to this accounting change.

For 2018, we expect revenue to be in the range of $244.5 million to $246.5 million.

GAAP net loss is expected to be in the range of $14 million to $12 million or $0.24 to $0.20 per diluted share.

Non-GAAP net income is expected to be in the range of $24 million to $26 million or $0.39 to $0.42 per diluted share.

The guidance for 2018 includes the following items: first, GAAP net loss includes $7.9 million in amortization of convertible debt discount and issuance costs; second, higher expenses anticipated in R&D; third, $2.5 million in net interest savings from the use of our convertible proceeds; and fourth, $6 million improvement due to the 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 modeling purposes, we'd like to provide the following additional information: For calculating EPS, we expect our diluted shares to be 62.5 million and basic shares to be 59 million for the third quarter of 2018 and 62 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 third quarter of 2018 and $230,000 for the full year 2018.

Our capital expenditures for the third quarter of 2018 are expected to total approximately $4.5 million to $5.5 million.

For the full year 2018, we expect capital expenditures to be between $15 million and $16 million.

In summary, we are very pleased with our second quarter results, which demonstrate our consistent execution.

Going forward, we will continue to strive for solid revenue growth while progressing towards our second half 2019 and long-term financial targets.

And now, we'd like to open the call for questions.

Operator, please go ahead.

(Operator Instructions) We'll go first to David Hynes with Canaccord.

Rowan, maybe we can start with you on the AI strategy.

I'm curious, as you implement that, I mean, is that -- will Five9 be adding SKUs?

Is it about embedding AI into your core products?

Is it a means to drive price higher?

Just how does your AI strategy materialize in the numbers in the products for you guys?

Well, I think it's early days, first of all.

Thank you for the comment and the question.

It's early days on that front.

We did mention the intent to spend more money.

We're pushing the accelerator on R&D.

The primary focus of that is going to be on continuing our integrations with our ecosystem partners like Salesforce and deepening our partnership there, ServiceNow, Oracle and so on.

Second is on our public cloud transformation.

So we are leveraging public cloud services more and more.

And then third is on AI.

And as we look towards AI, I would say it's too soon to tell with regards to your specific question about SKUs and so on.

But of course, we do.

We have been publishing blog posts and other material about how we see AI affecting the contact center.

And I'd say if I had to sum it up, I would say it's going to ultimately impact every part of the contact center but too soon to tell exactly how, and really, this is the beginning of a -- I would say a very long shift as AI starts to impact every part of the call center from the ACD to the IVR to voice of customer analytics and so on.

So early days but more to come.

And again, we'll take more on the blogs -- we're sharing more on the blogs about that.

Sure.

Yes, we'll stay tuned.

And then maybe one for Dan just in terms of kind of what you see in the field.

So I think that the deal flow from partners number has remained kind of in the ballpark more than 55%.

Does it feel like that starts to plateau at some point?

Does partner contribution continue to increase?

I mean, how do you see the mix of kind of partner versus direct playing out here over the next, I don't know, 2 or 3 years?

Yes.

Thanks, DJ.

That's -- you hit it, which is we continue to see leverage from our vast ecosystem across the board, and remember, that includes all of our partners, so whether they be CRM-integrated partners, ISV partners, in addition to resellers and master agents and referral partners.

So it's across-the-board, the 55%, and we continue to see additional leverage.

Part of that is gained by our increasing brand and increasing confidence and trust that the end users have in Five9.

So it's bringing around new partners of all of those types at a continued rate.

And that rate continues to grow in proportion to the business growth that you're seeing from us.

And we'll go next to Sterling Auty with JPMorgan.

So I wanted to also follow up on the AI line of questioning.

So how should we think about specifically Google, AWS, Microsoft and some of their AI endeavors as partners versus could they eye this market as something that they want to take a bigger piece of?

And ultimately, could they end up being some of your biggest competition moving forward?

And how do you navigate those waters?

Yes, I don't think so.

If you look at what Google announced 2 weeks ago, so we -- just to refresh everyone on the call.

We announced a partnership with Google at their Google Next event.

Google launched the Google Cloud Contact Center AI platform, and that's really providing underlying -- the underpinnings of AI sort of enablement is the way you should think about it.

So automatic speech recognition, text-to-speech, natural language processing.

So what Google said at their event is their intent is to bring their very substantial investments in artificial intelligence to the contact center and other industries.

The contact center was first -- the first one they announced.

And they also were explicit that their intent is not to become a contact center app provider.

And that certainly would be -- is not surprising given that Google sort of recognizes that they are not an app -- enterprise app company, per se.

And so the way that I see it is, at least in the case of Google, they're using their substantial AI technologies to draw more customers onto their Google cloud platform.

I think the same should be said of Microsoft.

Very similar technologies, by the way, are available from Microsoft on Azure and the same thing from Amazon.

So I think they all have a desire to take AI technologies and build them into that platform to allow for developers to get more and more capability on their cloud platform.

So in one way, it's a race to the cloud and a way to differentiate for these guys.

And then in another way, for us, it's a leverage point for us because we don't have to go and do that heavy lifting.

And this is technology that they've developed over many years, really, on the backs of their consumer businesses, where they were able to get the data.

What has been a struggle, I think, for all of these cloud vendors is to get the enterprise data, and that's something that the app vendors have.

So what we have uniquely in this case is we have the data.

Five9 as a Cloud Contact Center, we've got over 15 million voice recordings per day on our platform in the enterprise context, and that is not something that I think any of these -- well, certainly not Google doesn't have access to, and so we -- they also were very clear, by the way, in that announcement that Google have access to -- that they will not be accessing that data.

That they will allow us to train their models, but we will retain the data on behalf of our customers.

And that's certainly a big concern of customers is they don't want that data getting out and being used for advertising or other things.

And then the second point is, in the case of the contact center, what we really have is domain-specific data.

So while -- just to give you an example what I mean by domain-specific, a health-care claims call and the lingo that you use on that call is very, very different than a roadside assistance call, for example.

And the machine learning models have to be trained uniquely for those individual domains, and that's an area of expertise that we have because we sit right with these customers implementing these contact centers.

So to sum it all up, I think it's a very positive development for the contact center industry and more specifically for cloud -- pure born-in-the-cloud contact centers that are truly multitenant.

Okay.

Perfect.

And one follow-up, just -- you guys have been so consistent on the enterprise business.

One thing that is different is the improvement in the commercial business.

Can you be a little bit more specific in terms of the changes that you made?

Was it just putting more dollar resources to work?

Or what other things helped that business this quarter?

And is it sustainable?

So I'll let Dan comment on that.

Sure.

Yes.

So if you look at that side of our business, as we've talked about before, it had been in and around 10% from a growth perspective, fell into the single digits and has returned just been around 10%.

It's too early to tell if that's a trend yet, but we did have a strong quarter of execution with our commercial business and strong retention rates, and it made for an improvement there.

But stay tuned.

We anticipate that with our strong investments in Enterprise and our increasing brand and trust that the market has in us, it's going to drag along and pull commercial business with it.

And we certainly will take that business all day long.

We'll go next to Meta Marshall with Morgan Stanley.

In our kind of diligence, one of the questions that's kind of come up is the value of the data libraries itself and the difficulty of translating that into AI, whether it be because people kind of mentioned the wrong words or say cancel on a call where they may not have meant cancel, and that being a significant hurdle.

So if you could just talk about, would you just plan on monetizing the data through eventual AI subscriptions?

Or would it be through potentially even monetizing the datasets themselves?

That's kind of the first question.

If you could answer that first, that would be great.

Sure.

Thanks, Meta.

I'll take that one.

This is Rowan.

So I mentioned more than 15 million voice recordings per day, and those really haven't been that interesting until recently.

Before the latest developments in AI, it was very expensive to take these sort of giant WAV files of customers talking and accurately transcribe those into text.

And that is what has changed really dramatically in the last year and specifically from Google and others.

And so that's one big hurdle.

And furthermore, it was -- you could do it before, but it was much more expensive.

Google is -- the rack rate for translating speech to text is now $0.05 a minute, and that's only going to go down, and that's Google's rate.

There's others who are cheaper.

So that's a big shift.

The other big shift is that this text speech -- recorded speech is -- we're being able to do the transcription of that in realtime at human-level accuracy.

And that introduces other opportunities.

So I think to answer your question, both ways are possible.

We have been publishing -- I published 2 blogs in the last couple of weeks or 3 weeks maybe on how exactly we see this affecting the contact center, and it's both through new capabilities that we can sell as well as providing things like business insight.

So given all of those voice recordings and given all of the text and e-mail traffic that is flowing through our pipes and recorded in our back end, we can apply things like natural language processing on top of that to sort of give you real-time insight into what your customers are saying.

So this shift of the contact center from being a back office call center to a sort of revenue-generating, highly business relevant function is going to be bolstered by AI in a whole variety of ways, really.

Okay.

Got it.

That's super helpful.

And then maybe the second question.

You guys have tended to be a little bit more conservative about forward guidance.

And so just -- it's a pretty meaningful raise.

And just breaking down, is that deals are taking a shorter time to close.

They're larger when they're coming in.

You're seeing more add-on to existing customers.

Just kind of what is giving you confidence on the guidance range?

Yes.

Overall, what's giving us confidence, Meta, in the guidance is simply the predictability and visibility that we have into the business.

We're not embarking upon voyages of discovery here.

We know the market pretty well.

We've got -- you have to have a very adequate product.

Otherwise, you're not going to switch from the premise to the cloud.

We've got all the scalability and reliability.

And the market is so huge, we just know that the biggest single thing, the bookings, and then the eventual translation is there.

So it's a combination of all those things that you see.

We're going in now to the stronger part of the year, seasonally stronger second half, and we don't know exactly how strong it will be.

So we've taken a prudent stance at this stage.

And if things turn out to be better, then we'll raise it even more.

And then just one thing to add -- thank you, Barry.

Just one thing to add.

We haven't -- we are not changing -- this being my first earnings call, we're not changing our approach to guidance.

The way that we've done that prior before, we're doing it the same way.

So there’s no shift here.

This is just the reflection of the business performance.

And if you look at our guidance and you go and compare it with the past, you'll see that it's very consistent with the pattern that we've done in the past.

We'll go next to Scott Berg with Needham & Company.

I guess, so many questions, so little time, but let's start off with the strong second quarter performance.

You guys called out the commercial side.

Obviously, the Enterprise LTM growth rate you made really strong as well.

The beat was certainly larger than we've seen recently, and the 28% growth rate is great.

But how much of that beat was due to the commercial business versus the Enterprise business or anything onetime in nature in the quarter, that would be great?

Scott, nothing onetime at all.

The commercial business did contribute.

I'm not going to say exactly how much, whether it is 1, 2, 3 or whatever percent, but it did.

It made what was a good quarter an excellent quarter.

Great.

That's helpful.

And then, I guess, Rowan, another follow-up on the AI and specifically the Google partnership.

I know you and I have had some discussions around on this.

But how much of this is going to be pushed -- the customer pull versus customer push?

And you mentioned it's going to be kind of a long tail.

It's going to take some time to evolve.

But I guess how long do you think it'll take?

I'm not expecting specific time frames, maybe a couple, 3, 4 years before customers embrace this.

And then does it actually accelerate how Enterprise customers use these technologies going forward?

Sure.

Thanks, Scott.

Well, like I said, we're at the beginning of, I think, a steady shift of the technologies within the contact center.

And by the way, the contact center is no different than any other industry in this way that AI is transforming every segment.

I think we've been pretty explicit about the 5 pillars of this transformation that we see happening over time.

I'm not smart enough to be able to predict how quickly that's going to happen.

We're in the early stages of developing this.

With the launch of Five9 Genius that we had earlier this year, which is our platform for AI, we've seen strong interest from our customers.

And if you look at the activity happening at Salesforce with Einstein, certainly the Google platform that they launched and others, I think one, at the Google conference breakout, just as an anecdotal piece of evidence, there was 1,000 people in attendance for their contact center AI platform.

1,000 people.

And the room was overflowing and people couldn't get in.

And people asked me why I came to Five9.

I think -- and Scott, you and I have talked about that.

So I don't want to make any predictions about how quickly or how slowly.

I think generally speaking, things are slower than you want, and then they're faster than anyone expected.

And when exactly that happens, I don't know yet, but we're actively engaged in it.

We'll go next to Randy Lenschow with Barclays.

This is Mohit Gogia on for Raimo.

The first question, I guess, is for Rowan.

So you guys have discussed the integrations in terms of AI, in terms of CRM, but I was also wondering if you can discuss your recent partnership with, I guess, expanded partnership with Fuze on the UC side.

I'm just wondering if you can discuss the strategy there because we've also seen in our communications that the UC and contact center market are sort of like converging somewhat.

So I'm wondering, how do you think about that convergence and what's the strategy with that partnership going forward?

And I have another question.

Yes.

Thanks, Raimo -- I'll mention -- oh, Mohit.

Thanks, Mohit.

I'll mention the convergence and then I'll talk about convergence and turn it over to Dan for what we were seeing with Fuze.

What's not happening is convergence, but what is happening is a recognition by the UC vendors, particularly the cloud UC vendors, that in certain segments of the market, there is a go-to-market synergy that is really terrific.

And that is traditionally the contact center -- the PBX essentially came bundled with the contact center or attached to a contact -- a contact center came attached to a PBX, and so there was a legacy reason for that.

And as a result, many customers have an economic buying center that bought the infrastructure, and that included the contact center.

That's less true as you move upmarket.

And certainly, our customer and our buyer is generally outside of IT, and so we don't see that as much.

We don't encounter -- when we sell a contact center, we don't drag along a UC, but the inverse is not true.

The UC vendors do see a need to -- if you're going to replace your legacy UC infrastructure and there's a contact center hanging off it, you kind of need to have an answer.

So there's an nice synergy in go-to-market, and that led to our Fuze partnership.

And that's what I think is reflected in what the other cloud UC vendors have been doing.

The second point is where cloud UC is largely a commodity and a lower price point, lower ASP, the Cloud Contact Center has a very high ASP.

It's very sticky, and it's very high margin.

And so it's a nice business for them to be able to get into.

And so all of that led Fuze to partner with Five9.

And, Dan, you want to comment more about that?

Sure.

So Rowan said it perfectly, and that is if you just -- there's definitely an interest on the UC side and those players for, as Rowan mentioned, when they're going to replace a legacy PBX, it oftentimes has bundled-in contact center.

So they have to have a solution for that if they're going to make that replacement of a legacy platform.

But we don't necessarily need it because we can coexist and interoperate with any UC solution.

So while we're thrilled about the partnership with Fuze and we're thrilled that they're bringing us into their deals, where that occurs, where they need to provide a Cloud Contact Center solution along with their cloud UC.

We're not bound by that same restriction because we can put ours on top of any UC platform if the customer wants to go ahead and retain their legacy UC platform.

If they want to make a change to that, then it's a great opportunity for us to bring in one of our partners like Fuze.

And bigger than UC, just to add one final thought, is CRM.

CRM is really the biggest driver of the Cloud Contact Center transformation.

And what you'll see is as Salesforce continues to drive the transition of that market to the cloud, that drives customers to say, gosh, this experience center, my engagement technology, whether it's a legacy on-premises contact center, I need to go upgrade that and let's go look at cloud options that integrate really well with the sales force and so on.

And so it's moving and becoming more of a CRM-oriented technology than an infrastructure technology with the move to the cloud.

That's very helpful color.

And if I can ask a quick question to Barry as well.

So Barry, you mentioned the confidence on the intermediate EBITDA target of 22% plus.

I'm just curious as to -- there were some commentary around sort of like increased R&D expense.

So just in that context, does that shift the goalpost on R&D sort of like targets you have laid out for second half 2019?

Obviously, EBITDA targets sort of like still confident around reaching those.

But is the goalpost moved on R&D targets at all?

Or is it not the case?

Mohit, the goalposts have not moved.

It's 22%-plus in the second half of next year.

Yes, we're certainly going to tap the accelerator on R&D.

It's provided for in our guidance and in our longer-term modeling.

Okay, so the R&D target of 9% to 11% is still sort of like consistent with what you're seeing right now?

Yes.

It's right now a fraction of the 11% at 11.6%.

Now I'm not going to lose a lot of sleep if it turns out still to be 0.6 percentage points over, but those are the type of things we're talking about.

We'll go next to Richard Baldry with Roth Capital.

Maybe from a very high level now that your market cap stepped up pretty meaningfully and you've just tapped capital markets also pretty meaningfully, talk about any changes to your M&A strategy or plans with the added capital and access to capital.

Yes.

Thanks, Rich.

No change there.

We didn't do the convert with the intent to go make acquisitions.

We did the convert to take advantage of the unprecedented low rates in capital and especially in a rising rate environment, that seemed prudent to us.

We also never did a follow-on raise as a public company.

So it was a sensible thing to do as well as you can see the effects in our numbers as we've retired our revolver and are beginning to switch from capital leasing to purchasing that equipment.

So there's real benefits to doing that convert.

And no changes.

That was by the way started before I began as CEO, and so there's no change to our acquisition strategy at this time.

Last quarter, I think in the discussion, there was sort of a focus on the 53% of revenues coming in the second half over the past 3 years.

Given the upside in the second quarter, do you think that seasonality has changed?

And what would be changed, the drivers to that?

Do you think that's a long-term change in the seasonality of the business?

Yes.

So currently, if you look at our guidance, it's 49% first quarter, 51% second -- first half, 51% second half.

And as you said in your question, over the last 3 years, it's been 47%-53%.

So we're just being prudent at this stage.

We don't see any major change in the seasonality between the first half and the second half.

We'll go next to Terry Tillman with SunTrust.

This is actually Courtnei Sanders on for Terry.

Our first question is on sales capacity and early planning for 2019.

Now that we're past the midpoint of this year, how are you feeling about sales capacity going into next year?

Yes.

As always -- and thank you, Courtnei.

Appreciate that.

As we stated in the past, we continue to grow our sales teams in proportion to the growth of the business.

And so we'll continue to add to our Enterprise team and our channels team as we grow the business and as we expand internationally.

Our second question I wanted to ask about, enterprise subscription growth this quarter was really strong again, I think, at 37%, you said.

Could you talk about the sustainability of that mid-30s growth rate in Enterprise going forward?

Maybe just your comfort level with the ability to continue growing at that level?

Yes, Courtnei.

So I'm going to build on what Dan just said.

It's really commensurate with our growth in our direct sales force and our channels and so on, international being an additional opportunity.

And as I also responded in one of my very first questions, we do have a huge market ahead of us, 6.4 million agents in North America, barely -- at the most, 15% penetrated.

We've got the right product, the right team, the right service levels and so on.

And so this is, in our judgment, a very extended decade or more type opportunity that we can avail ourselves of and continue doing what we've been doing now for years.

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

Several from me, guys.

First, I guess, Rowan, just with respect to the public cloud, you mentioned the transformation.

Could you just expand on that, give a little better sense of kind of timelining goals, level of aggression, what you're hoping to accomplish by when?

Just a few more benchmarks in terms of how we should think about that.

Yes.

Yes, absolutely.

Thanks, Jeff.

So there's -- what I mentioned earlier is our biggest priority right now is integrations with CRM vendors and, moving to the public cloud certainly is not that.

We are already in the public cloud in some ways, so the second priority for us -- the first is innovation, second is public cloud.

We're already in the public cloud for our Five9 Global Voice.

As we've been selling more and more multinationals and also selling more internationally, we needed to have a presence globally and Five9 Global Voice gave us that by deploying our voice pops into the public cloud.

And you're going to see us continue to leverage the public cloud as we expand, and it's about expanding there.

The primary drivers, I think, first and foremost is access to technology that's only available in the public cloud.

So there are -- if you look at the innovation coming out of whether it's Amazon or [GCP] or Azure even, there's a tremendous amount of innovation and cost effectiveness that can be achieved by jumping onto those platforms using their managed services, using their technologies just to boost and accelerate your business.

And so that's a big one, is getting access to that.

The second driver is agility.

We want to be able to expand, not only globally but just expand into new availability zones and take advantage of things.

And we think that as we expand our product into public cloud, we're going to get more and more agility.

So those are the drivers.

I would say cost savings is not the primary driver.

It's really too soon to tell if we would see cost savings because we already run very efficient operations, and you can look at our gross margins to see that that's the case.

And we've got -- we get very consistent in improving leverage on our infrastructure.

So we're running very efficient operations, and we're running very reliable operations.

So the shift to the public cloud is more about agility and access to technology.

Okay, great.

Got it.

And then just one more from me.

Back to commercial, just to be clear.

Was there a change in resource allocation that drove the revenue upside?

Or was the revenue upside a change in customer behavior?

Kind of trying to figure which of those 2 is the emphasis.

Yes, not the first.

Our commercial team stayed right where it was, steady -- moving along a steady course as they always have been.

So again, we don't want to look at 1 quarter and have it trended that way.

We're hopeful that, that will continue.

But again, it's a matter of our brand and our presence and the trust factor of just pulling through businesses of all sizes moving to Five9.

And that's just, I think, more of a macro effect if you look at the marketplace.

And we look at that -- we talk about that 15% penetration of companies that have moved from legacy premises systems into the cloud.

That applies, and we're probably a point further down the path where commercial-sized businesses have moved more rapidly over the years.

And so we're at a further stage than the 15%.

And so we want to make sure that we don't ignore that business or turn away from it, while we also want to make sure we invest

(technical difficulty)

the higher unit economics and certainly more profitable enterprise business.

But like I said before, in the opening statements, we'll take that business all day long, and it continues to be a good contributor.

We'll go next to Matt Van Vliet with Stifel.

I guess, first off, looking more broadly at the overall competitive landscape with some of the offerings, like DAI enablement from Google.

How are you approaching this to [innovate?] I mean, does this slow down or does it actually accelerate migration from legacy systems with some of the enablement?

And does it help close the gap from a functionality standpoint of some of the on-prem competition to some of the advanced features that you can already offer with the cloud architecture?

Matt, this is Rowan.

I'll jump in on that one.

Maybe Dan can give us a view from what he sees in the field.

There's a continuing closing of that functionality gap that had been driven for years in the Cloud Contact Center space, which I'd say we're done with.

So there is no gap functionality between premises and cloud at this point.

Any large customer can shift onto our cloud platform.

They do that consistently and repeatedly.

Now the shift that's happening over time is largely probably driven -- the steady shift is largely probably driven by the long life cycles of existing equipment and infrastructure.

These contact centers are conservative in general and tend to -- and the average life of these systems is 7 to 10 years.

And so that's why we talk about this steady shift towards the cloud.

It's less about functionality and more about now that we've crossed -- now that the technologies in general have crossed that point at which we have enough capability and scale and ability to [stress] all those customers to driving them up to our platform.

The second part of your question was around AI, and you mentioned Google and others.

Look, I think that those are things that you can only do in the public -- with a public cloud solution like ours.

As you look into a legacy premises vendor, what they have had is a story of we will host your contact center in our cloud, which really doesn't work because, from an AI perspective, when you think about what's necessary for an AI, it's really the prerequisite is vast amounts of data.

And so when you think about a multitenant cloud solution is what needed to take best advantage of AI because you have more data.

So the more data you have, the better you become.

And if each company can only rely on their data to train AI, that's just not going to work as effectively if at all.

And so I do think that as these technologies come online, it will be more and more of an attractor to move to public cloud contact centers.

With regards to what we're seeing in the market with our customers, would Daniel want to add any comments there?

Yes.

And I think Rowan mentioned it well, Matt, which is -- and I think the gap you were referring to, does it allow the premises guys perhaps to partner and leverage some of those AI technologies to bring that gap closer and allow them to catch up functionality wise?

And I think just the opposite.

As Rowan mentioned, it furthers the gap because really getting into the cloud in a multitenant solution is a prerequisite to be able to really allow AI to be effective because you've got to take those millions of recordings and millions of trials to teach the system, the machine learning, like the example Rowan mentioned earlier about roadside assistance versus health care.

Just like we teach an agent to be an expert in one of those areas, we have to teach the system to be an expert in a specific area.

And if you come in on a premises solution, you have no history and no data to be able to teach the system.

And if you're processing a few thousand calls a day, it will take months and months and maybe years to teach the system like you would an agent.

Whereas, if we have millions of recordings in one specific industry, we can teach that system very quickly how to handle certain requests and learn the lingo and learn the languages and learn even the slang that is used by a caller to ask questions or to request things that you can't get from having just a few trials, if you will.

We'll go next to Mike Latimore with Northland Capital Markets.

This is [Rasheed] for Mike Latimore.

Do you think Five9's platform is well suited to handle the increasing text messaging and chat volumes?

Or are there any investments you're considering on that front?

Yes -- no.

This is Dan.

We're handling it just fine.

I mean, we have the chat solution that we've had for several years, and it seems to be doing very, very well on the SMS side.

We integrate and partner with a variety of companies that provide us those solutions as well.

So the platform, certainly not any issue to being able to take on that additional business.

I had just one more question.

So what percentage of bookings came from current customers in the quarter?

We don't disclose the percentage that comes from existing other than our dollar-based retention rates, which increased overall across both segments of our business to 99%, up from 98% last quarter, and that's on an LTM basis.

And keep in mind that in the Enterprise business, much stickier, much longer lifetimes with our customers.

And so that rate is well north of 100 on the Enterprise side and south of 100 on the commercial side.

We'll go next to Brent Bracelin with KeyBanc.

Barry or Dan here, I want to go back to the growth rate.

I mean, obviously, highest year-over-year growth rate in 2 years.

That was the highest sequential growth rate in 5 years going back.

And I know the LTM stats you give skew 1 quarter trend.

But as we think about just the magnitude of upside in the quarter, the best growth profile we've seen in years, how much of this is all commercial or -- and the continuation or Enterprise?

And really just trying to drill down into what drove the magnitude of upside in commercial.

Were there some new partners there?

Anymore color there would be helpful.

Yes.

So Brent, really just to amplify, let there be no ambiguity around the fact that this business, and the quarter in particular, which is typically one of our weaker quarters by the way, is joined by the Enterprise.

So we had this really continuing good business that illustrated by the LTM subscription growth rate of 37%.

The cherry on the top was the commercial business as a result of the focus that came there and improved execution.

We don't know at this stage whether it's going to continue.

We obviously continue to focus on it.

The economy certainly was a tailwind in the second quarter.

But we can't make any guarantees at this stage that it stays in and around 10%.

Was there a new software kind of release in the quarter?

Was there a change in win rates or a competitor that really dropped off?

Any other sector intelligence that you guys can factor the uptick in commercial at this point?

Yes.

I wouldn't try to put it on any one thing.

I think if you look across the board, I mean, remember, we had some low growth rates -- lower growth rates, I should say, on the commercial business last year.

So part of it is an easier compare, which caused it to go up.

But yes, we did have new releases.

We continue to increase reliability we continue to increase the efficiency with which we implement our customers.

And we always have high-touch not only implementation process but ongoing support.

And so I think a part of it is the fact that when you take care of your customers and you build your NPS scores up to all-time highs and you keep your satisfaction of your customers where it needs to be, it continues to show in the loyalty numbers and the low churn numbers.

And so part of that is just making sure that customers feel very comfortable in continuing on with Five9, and I think you see that in the improved dollar-based retention numbers.

And combine all of that with an extremely reliable platform.

At this time, I would like to hand back to management for any additional or closing comments.

Okay.

Well, I'd like to thank you all for joining us today, and I look forward to seeing many of you at upcoming conferences during the quarter.

Thank you.

That does conclude today's conference.

We thank you for your participation.