Mike Burkland - Chief Executive Officer Barry Zwarenstein - Chief Financial Officer Lisa Laukkanen - Investor Relations, The Blueshirt Group.

Sterling Auty - JPMorgan Raimo Lenschow - Barclays Richard Davis - Canaccord Brendan Barnicle - Pacific Crest Securities Nikolay Beliov - Bank of America.

Good day and welcome to the Five9 Incorporated, third quarter 2014 earnings call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Lisa Laukkanen. Please go ahead ma’am..

Thank you operator and good afternoon everyone and thank for joining us on today’s conference call to discuss Five9’s third quarter results. Today’s call is being hosted by Mike Burkland, CEO; and Barry Zwarenstein, CFO.

During the course of this conference call, Five9’s management team will make projections and other forward-looking statements regarding future events or the future financial performance of the company.

We wish to caution you that such statements are simply predictions and actual events or results may differ materially, and the company undertakes no obligation to update the information and such statements. These statements are subject to substantial risks and uncertainties that could adversely affect our future results.

A more detailed discussion of these risk factors you should consider in evaluating Five9 and its prospects is included under the caption Risk Factors and elsewhere in our 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. The full reconciliation of the GAAP to non-GAAP financial data can be found in the company’s press release issued earlier this afternoon. Now, I would like the turn the call over to Five9’s CEO, Mike Burkland. .

Thank you Lisa. Welcome everyone to our quarterly earnings call. We are pleased to report strong third quarter results. Both revenue and bottom line performance were better than expected. Revenue for the third quarter increased 23% year-over-year to a record $25.9 million.

Our strong performance during the quarter was driven by the continued demand for Five9’s Could Contact Center software solution as more companies look to move away from legacy premise-based solutions and embrace the benefit of the cloud.

Our platform is designed to enable organizations of all sizes to optimize their Contact Center operation by enhancing agent productivity, improving customer satisfaction and driving cost efficiency.

We continue to see strong momentum in adding new enterprise clients, while also expanding deployments with existing clients, resulting in record quarterly bookings for Five9. In terms of new enterprise client wins and expansions, I’d like to share the following examples with you.

The first new client in a pharmaceutical company with several hundred feet that had been Avaya, Cisco and Aspect to handle its inbound and outbound servicing of patients, physicians and healthcare organizations for major drug manufacturers worldwide.

They are implementing the Five9 Virtual Contact Center software solution along with our leading workforce optimization solutions powered by NICE, including workforce management with real-time adherence, quality optimization for voice recording, screen recording and encryption to support PCI compliance.

The second new client is one of the largest providers of Senior Living Referral Placement Services. This client selected the Five9 blended inbound and outbound BCC software solution to replace their on premise legacy system for 400 agents, with anticipated growth well beyond that.

The third new client is a leading nation wide energy company with hundreds of agents across multiple contact centers. This client is integrating Five9 with its sales force CRM solution and is also implementing our WFO solution.

In addition to providing solutions for voice, we are also providing our complete multi-channel solution for inbound chat and email transactions, leveraging our intelligent routing engine, Five 9 Connect. The fourth example is an expansion deal with an existing client.

This higher education institution with online and campus based programs added 215 seats in over the last four months and is now in excess of 585 seats on the Five9 platform and they expect to grow further with us.

Finally, we continue to have strong momentum in multiple industries that require flexibility, scalability, reliability, security and reporting.

In addition, these clients often require solutions that adhere to regulatory mandate such as Telephone Consumer Protection Act calling to cell phones and PCI compliance when collecting Credit Card information.

During the third quarter we also introduced the Five9 Fall Release, which included our new Five9 TCPA Manual Touch Mode solution, which supports Contact Canter Compliance under the new Telephone Consumer Protection Act. In the Fall Release we also enhanced our CRM integrations with Oracle RightNow and Zendesk.

Deep CRM integrations provide our clients with seamless end-to-end solutions for customer interactions, approximately one-third or our enterprise bookings are generated or referred by CRM and other key alliance partners.

Our performance in the third quarter is evidence that our innovative cloud software solution is disrupting this very large Contact Center market, which includes 14.5 million agents across the world and represented a $22 billion market opportunity.

In summary, with the success we are enjoying at our enterprise go-to-market execution, including new client wins and expansions with existing clients, we believe Five9 is well positioned to capture a large portion of this market opportunity. I will now turn the call over to Barry to provide more color on our financials..

Thank you, Mike. As Mike mentioned, we are pleased with our third quarter results. Our revenue of $25.9 million was ahead of our expectation. This higher revenue, combined with higher than expected gross margins and effective expense control resulted in a non-GAAP net loss, which was considerably better than our expectations.

I will now provide a brief review of our business model. Recurring revenue accounted for 97% of our revenue in the third quarter. Recurring revenue is made up of monthly subscriptions, based upon the number of agencies and usage, which is based upon minutes.

The other 3% of our revenue is comprised of professional services fees generated from assisting clients in implementing the Five9 solutions and optimizing its use. Now moving on to our financial results for the third quarter. As I mentioned, revenue for the third quarter of 2014 was $25.9 million, up 23% from the third quarter of 2013.

Our revenue growth was primarily driven by the continued execution in adding new clients. Our dollar-based retention rate for the period ended September 30, 2014 was 97% compared to 98% for the period ended June 30, 2014.

As a reminder, this metric is derived by taking an average of the trailing 12 months of year-upon-year revenue changes from clients in our installed-based in the prior 12 months, similar to same-store sales.

Gross margin, adjusted to exclude all non-cash charges namely depreciation, amortization and stock-based compensation was 53.3% for the third quarter, compared to 46.4% for the same period in 2013. The improvement to our adjusted gross margin continued to be driven primarily by improved usage efficiencies, and by economies of scale.

It is important to point out that while usage revenues generate gross margins below our subscription margin, usage revenue comes with very minor incremental operating expenses and therefore generate considerable bottom line leverage.

Going forward, we are expecting further improvements to our adjusted gross margins to 65% to 70% in the long-term, driven by first continuing and considerable benefits from the expected economies of scales as revenue increases over time.

Second, improving gross margins on our PS service revenue, as a result of various steps being taken by new leadership in this area; and third, further improving usage in gross margins as we expect to get a return on the capital and expense investments we are currently making in value based routing and related initiatives.

Please note that a reconciliation of the GAAP gross profit to adjusted gross profit, as well as other reconciliations from GAAP to non-GAAP results is provided with our earnings press release. GAAP R&D expenses for the third quarter of 2014 totaled 21% of revenue or $5.5 million, compared to 21% of revenue or $4.4 million a year ago.

The increase was driven by personnel related costs, as we invested to enhance our industry-leading platform. GAAP sales and marketing expenses for the third quarter of 2014 totaled 36% of revenue or $9.3 million compared to 33% of revenue or $7 million for the third quarter of 2013.

Our sales and marketing expenses have increased as we continue to scale our sales capacity and as we spend on lead generation, both primarily aimed at the enterprise market opportunity. GAAP, general and administrative expenses for the third quarter of 2014 totaled $8 million compared to $4.2 million for the prior year period.

Included in third quarter 2014 G&A was a $2 million charge due to a potential settlement with the FCC Enforcement Bureau that if entered into would conclude an FCC investigation into 2008 to 2012, Universal Service Fund contributions and international carrier authorization compliance issues.

Excluding the $2 million charge, G&A for the third quarter was $6 million or 23% of revenue compared to 20% of revenue in the third quarter of 2013. The increase versus the prior year was driven in part by the expenses associated by being a public company and investments to improve our system.

Adjusted EBITDA loss was $5 million for the third quarter of 2014, compared to a loss of $5.3 million for the third quarter of 2013. GAAP net loss for the third quarter of 2014 was $11.4 million or $0.24 per share, compared to a GAAP-net loss of $7.7 million or $2.05 per share for the third quarter of 2013.

As mentioned earlier, included in the GAAP net loss for the third quarter of 2014 was a $2 million charge for the FCC settlement being negotiated. This charge increased the company’s GAAP net loss per basic and diluted share by $0.04 for the three months ended September 30, 2014.

Non-GAAP net loss for the third quarter of 2014 was $7.3 million or $0.15 per share, compared to non-GAAP net loss of $6.7 million or $1.76 per share for the third quarter of 2013. Regarding our tax rate, we have a substantial NOL balance that we will continue to utilize.

We expect the dollar amount of taxes relating to our foreign subsidiaries to be approximately $90,000 for the year 2014. As of September 30, 2014 our cash, cash equivalents and short-term investments totaled $83.5 million. As of September 30, 2014 our debt totaled $48.6 million comprised of a revolver, term loan, notes payable and capital leases.

In addition, we have a $2 million payment obligation in connection with the FCC settlement being negotiated. Our DSO performance remains strong and our DSOs for the three period ending September 30, 2014 were 25 days compared to 20 days in the prior year.

Cash outflow from operations for the first nine months of 2014 was $20.8 million and free cash outflow was $25.8 million, after taking into consideration $5 million of capital expenditures for the first nine months.

I’d like to finish today’s prepared remarks with a brief discussion of our expectations for the fourth quarter and the full year of 2014. For the fourth quarter we expect revenue in the range of $26.2 million to $27.2 million. GAAP net loss is expected to be in the range of $10.6 million to $11.6 million.

Non-GAAP net loss is expected to be in the range of $8.6 million to $9.6 million. For the full year, we expect revenue in the range of $101 million to $102 million compared to the August 4, 2014 provided range of $99 million to $101 million.

GAAP net loss is expected to be in the range of $39 million to $40 million compared to the August 4, 2014 provided range of $38.9 million to $40.5 million. Non-GAAP net loss is expected to be in the range of $34.2 million to $35.2 million compared to the August 4 2014 provided range of $36.2 million to $37.8 million.

For modeling purposes we’d like to provide you the following additional information. For calculating EPS, we expect our shares to be 49.1 million for the fourth quarter and $37.6 million for the full year. Our CapEx is expected to total approximately $7 million for 2014. In summary, we are very pleased with our strong results for the third quarter.

The higher revenue and the gross margin improvement drove better than expected bottom line results. We remain confident in our ability to achieve our long term operating model of gross margins of 65% to 70%, and adjusted EBITDA margins greater than 20%, driven primarily by further improvement in gross margin and by G&A.

Lastly, before we turn to your questions, I’d like to mention our upcoming conference participation. We are presenting at the 2014 BMO Technology and Digital Media Conference in New York on Tuesday, December 9, and the Barclays Global Technology Conference in San Francisco on Wednesday, December 10.

And now, we’d like to open the call for your questions. Operator, please go ahead..

Thank you (Operator Instructions). We’ll take our first question from Sterling Auty with JPMorgan..

Yes, thanks. Hi guys. Got a couple of questions for you. Want to start with the upside in top line revenue.

Can you give us a sense, and I think given the gross margin results I probably can partially answers this, but how much of that upside was just the agency count growing in the quarter, driving it versus growth in usage based revenue?.

Yes, hi Sterling, good question. The upside was really driven proportionally. Our relationship between subscription revenue and usage revenue remains pretty constant..

Okay and then within the gross margins, I think Barry highlighted the items that will drive the gross margins up to that longer term target model, but in the quarter much better than what we would have expected.

Are you starting to see early returns on lease cost routing? What were the components that showed the improvement for gross margins this quarter?.

So Sterling, the sequential improvement was driven approximately equal, not exactly equal, between subscription improvement and usage improvement gross margin percentages. In terms of subscription, its what we’ve been saying all along, revenues goes up.

They were above our forecast and that against fixed and semi-fixed costs causes the margins to rise. In terms of usage, we’ve also got a very solid sequential improvement.

There is a host of different initiatives in terms of bringing on new carriers, different routings, but one thing I do want to emphasize is this is being done before the SBC, the Session Border Controllers platform is really up in running. This now is and we’ll start to see some improvements from that.

I’d be happy to elaborate on that further if you are interested..

Absolutely. So it sounds like – so with the SBC platform in place, we could expect further improvements here in the next couple of quarters..

Yes, not dramatic improvements, because we’ve had some pretty good improvements as well in a competitive market. But with our value based routing Sterling, we are pretty excited – the telecom team is pretty excited about what is in store for us.

Being able to evaluate calls in near real-time using pre-defined KPIs for things like mean, option score and seizure ratio, post out delays and be able to automatically sense when the quality of the call is deteriorating and perhaps even before the customer notices the quality degradation, rebalance it and get to a better routing and with higher quality voice comes a whole of additional collateral benefits..

That’s great. Last question on the OpEx, both R&D and sales and marketing I think were down sequentially.

Can you give us an update, the headcount as well as what other items were you able to mange to drive that downward result?.

Yes Sterling, I’ll let Barry chime in with some additional color if you’d like, but at the high level we were very, very diligent at managing expenses through the quarter and I would say that for the most part the savings came in just slower hiring in some places.

I would also note that on the sales and marketing side we have high trade show activity in Q2 and Q4 and less in Q3. So we got some benefit from, pretty significant benefit just from the timing of those trade show activity..

All right, great. Thank you..

Our next question comes from Raimo Lenschow with Barclays..

Hey, thanks for taking my question and congrats on a great quarter here. The first question I had was on, can you give us a little bit of color on the selling environment around enterprise and SMB. I know you don’t want to – you might not give us kind of numbers, but what are you seeing there in the market at the moment..

Yes, happy to do that Raimo. So again, another record quarter for us in terms of enterprise bookings. We continue to penetrate the enterprise market very, very successfully and as you know, we are making a living replacing legacy solutions like Avaya, Genesys, Cisco and Aspect. So the selling environment continues to be very, very good for us.

We continue to do larger deals and I’m just really pleased with the continued growth in our enterprise go-to-market execution and bookings..

Yes, and anything on the SMB side?.

Yes, continued growth in SMB as well. Its lower growth as I’ve explained to you guys in the past, but I was very impressed with our bookings execution and year-over-year growth in SMB bookings as well..

Okay, perfect. And then the next question I had was like, can you talk a little bit about – you obviously have very unique platform here, fully sizable platform.

What have you seen in terms of competitive deals? You talked about the Pharma deal, kind of the win against Avaya and Cisco’s, but how is that to now that you’re a public company, as well there is more publicity.

How is that message kind of getting into the market and did you see any changes compared to six or nine months ago?.

I think awareness is continuing to increase in terms of cloud adoption. We continue to benefit in a big way from CRM players like Salesforce, Oracle, NetSuite and other cloud leaders.

We integrate tightly with those solutions and as more and more enterprises are moving their CRM to the cloud, that is a great influence and the driver behind a lot of our deal flow. A lot of those deals that we close in any given quarter, especially in enterprise are either referred to us or we work jointly with those partners..

Yes and then last question from me is like, obviously we had very good investment levels into kind of growing the business further. Barry, we now starting the budgeting process for next year and obviously people are kind of looking at that mix between growth and profitability more in the current market environment.

What are you kind of seeing at the moment? I know you can’t give guidance for next year, but like how are you seeing that in the budgeting discussions that you guys have playing out?.

Yes, so you are exactly right Raimo. We are in the early stages and it is a very delicate balance. I mean we’ve demonstrated this last quarter, the significant improvement in EBITDA. It’s a trajectory we plan to continue over the long term. But we have some extremely compelling projects and opportunities in terms of R&D and sales and marketing expenses.

So we’ll have to evaluate that, we are not prepared to give specific numbers at the moment.

The one thing I would say, that I do want to mention in this context, just as you think about your models for 2015, we are not giving guidance as you mentioned, but please bear in mind that with January 1 comes a new reset on the social security and the unemployment taxes and that does tend to cause a sequential increase and expenses of a material amount.

But beyond that, we don’t have any comments at this stage..

Perfect, thank you..

Our next question comes from Richard Davis with Canaccord..

Thanks. I guess two questions. On call you mentioned and you kind of touched a little bit on this, but BPO was a little bit soft when you announced the previous quarter.

(A) How is that going? And then (B) more broadly, would it ever make sense product development wise to kind of add may be a predictive analytics engine to the out bound call engines, so your customers would have – you can sell that as an add on to help their out bound success.

I mean we’ve seen it in another areas like SPS Commerce has done better in a different space, but has done it with a call trading partner analytics, but you know kind of help your clients whatever, win more business and things like that, thanks..

Yes, good questions Richard. So BPOs are very, very strong in the quarter. We had several deals with BPOs. It continues to be a good target market for us and our penetration rates in the BPO space continue to go on plan, so to speak.

In terms of predictive analytics in our outbound solution, we are definitely working on some analytics based enhancements to our solution over time. I don’t want to say that those are right around the corner, but we are definitely looking at that area as a potential expansion of our product footprint..

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It’s not pricing specific. We have not changed our pricing in the last quarter, so we did have that increase a while back, but not a significant one.

It is a focus on utilization, but its also just as we move up stream into these larger enterprise opportunities, there’s a requirement for more hours and that’s really an opportunity that is still ahead of us in many respects.

And again, it does have to do with utilization and taking our professional services organization into more an Enterprise model from the historical SMB model and we are well on our way to doing that. I brought new leadership into that organization within the last couple of quarters and that’s working out very well..

Great, thank you..

Our next question comes from Brendan Barnicle with Pacific Crest Securities..

Thanks so much. Mike, last quarter you shared with us the plans for rolling out the data center in Europe and then that further roll out there. I was wondering if you had any update. I think on the last call you talked about having that maybe late this year..

Yes, we have gone live with our UK data center. We’ll be putting our first customer up later this quarter in that data center. So on track, and enthusiastic about our expansion internationally..

Great. And then Barry, dollar cost retention rate ticked down, just a little bit down to 97%. We thought it would tick up a little bit sequentially.

Can you just remind us of the puts and takes that go into that on a quarterly basis?.

Yes. So as far as the dollar based retention rate, we were pretty heavily influenced by two accounts, who were in the base a year ago and who are not in the base now and it was actually two larger accounts.

One of the two, we were providing both the seats and usage as we almost invariably do, but this is an international account and as we’ve talked about in the past, we did not have competitive rates at the time on international and they decided to take their international business elsewhere and so we lost a meaningful chunk of revenue from that.

Secondly, there was another client, also a major client who we terminated for non-payment and non-compliance of the terms of the contract. If you exclude those two, we actually had an improvement year-over-year..

Great. And then cash flow is also better than we had expected. As I looked at it, I didn’t notice anything in particular that stood out. It looked like it was just sort of better outlook across each item, but was there anything in particular that was driving, what looked to me like better cash flow..

Yes. So if we look at operating cash flow and I can talk about the free cash flow as well, we actually improved by $1.8 million sequentially.

Now clearly the improvement in EBITDA was a large part of that, but in addition to that, I do have to point out that in the second quarter we had disbursements for IPO expenses that had been accumulated on the balance sheet..

Got it. Thanks for the clarity, thanks guys..

Thank you..

(Operator Instructions) We’ll take our next question from Nikolay Beliov with Bank of America..

Hi, thanks for taking my questions. The first one I had was, you recently mentioned that your sales capacity is about to go up about 30% to 40% this year. Sounds like it’s going to be Q4 back end loaded and a couple of questions here.

I mean should we expect a similar level of increase for 2015 and how the sales ramp up this year might affect the seasonality of revenues next year, in guiding to that, but maybe it sounds like the two, the second half of next year is going to benefit from the sales ramp more than the first half..

Yes, hi Nikolay. Good question.

Our sales capacity growth has been in and around that 30% to 40% year-over-year for enterprise reps and that has actually been fairly steady throughout the year, so that actually will not have an impact on kind of the shape of the curve through the seasons if you will, and I do expect that growth rate in terms of sales capacity to continue into next year..

Got it. And if you can just – in the past you’ve provided the split between Enterprise and SMB percentage of revenues and the gross image..

Yes, approximately 60% of our revenue comes from Enterprise and the other 40% coming from SMB and I should also provide color on the sales capacity growth for SMB is lower as I’ve said in the past, in and around 10% year-on-year..

And my last question is around, you recently launched chat and email as additional capabilities. What about video? I mean, for example sales for the service cloud now they have video capability. I don’t know whether they own that or they are expecting that from call center providers like yourself..

Yes, good question Nikolay, and email and chat attraction is going very, very well for us, so we are excited about delivering that product to the market or those products I should say. Video is something we are looking into further and working with our customers to potentially put it closer on our roadmap..

Thank you..

We have no further questions at this time. I would like to turn the conference back over to management for any additional closing remarks..

All right. Well, thanks everyone for joining us. We really appreciate it. We will talk to you soon I’m sure..

That does conclude today’s conference. Thank you for your participation..