Five9, Inc. Q3 FY2023 Earnings Call

Certain customers, customer growth, anticipated customer benefits company growth the anticipated benefits, from our recent acquisition of Aceyus, enhancements to and development of our solution, market size and trends, our expectations regarding macroeconomic conditions, company market position, initiatives and expectations, technology and product initiatives, and other future events are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are simply predictions and should not be unduly relied upon by investors. 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, including the impact of adverse economic conditions, including macroeconomic deterioration and uncertainty, including increased inflation, increased interest rates, supply chain disruptions, decreased economic output and fluctuations in currency exchange rates, lower growth rates within our installed base of customers, achieve the intended benefits from the acquisition of Aceyus, and the other risks discussed under the caption Risk Factors and elsewhere in Five9's annual and quarterly reports filed with the Securities and Exchange Commission. In addition, management will make reference to non-GAAP financial measures during this call. A discussion of why we use non-GAAP financial measures and information regarding reconciliation of our GAAP versus non-GAAP results and guidance is currently available in our press release issued earlier this afternoon, as well as in the appendix of our investor deck, and in the Investor Relations section on Five9's website at investors.five9.com. Lastly, a reminder that unless otherwise indicated financial figures discussed are non-GAAP. And now I'd like to turn the call over to Five9's Chairman and CEO, Mike Burkland.

Thanks, Emily, and thanks everyone for joining our call this afternoon. I'm pleased to report strong third quarter results with revenue growth of 16% year-over-year, primarily driven by our LTM enterprise subscription revenue growing 28% year-over-year. Adjusted EBITDA margin for the third quarter was 18% of revenue, helping drive an all-time record for operating cash flow of $37 million or 16% of revenue. Let me start by reminding you of the three continuing trends that drive our confidence in this market. First, enterprises are developing plans with a greater sense of urgency to replace their on-premise contact center solutions as legacy vendors have retrenched and slowed or even stopped development in some cases. Also a reminder that, in terms of cloud replacing on-premise, we believe that the penetration is still less than 20%. Second, companies are enthusiastically pursuing digital transformation initiatives to enhance customer experience, cut costs, and increase revenue. In this context, it's important to note that contact centers are mission-critical systems, which are sources of brand loyalty and differentiation. Third, AI is becoming an even more important catalyst for enterprises shifting to the cloud. AI automation is clearly a focal area for enterprises, as demonstrated by our over 80% attach rate on $1 million-plus ARR deals in the quarter. Now, I’d like to discuss the three main growth drivers for our business: our platform, our march up market, and our international expansion. As you recall, in August, we closed the Aceyus acquisition. We have experienced significant momentum with the Aceyus solution as the number of Aceyus opportunities in the pipeline has increased over 30% in this very short period. Aceyus is a fit for our $1 million-plus ARR customers, giving us continued strength in our march up market. For example, they're opening doors for several Fortune 100 deals, although it's still early days. A good portion of our innovation continues to be centered around our AI and automation portfolio, and we are seeing significant traction as a result of this innovation. For example, our professional services team worked on more than 250 AI deployments during the quarter. Additionally, bookings for our Agent Assist product increased 150% year-over-year driven by our AI summaries customer trials. It’s clear that our practical approach to AI continues to deliver tangible value to our customers. This is directly tied to our core AI tenets, including that AI should be available across our platform, democratized, engine-agnostic, and applied in a responsible and ethical manner. Now, I’d like to focus on our march up market and international expansion. I’m pleased to report that we continue to see strong momentum up market and booking $1 million-plus ARR deals. As a reminder, $1 million-plus ARR customers make up more than 50% of our recurring revenue. I’m also pleased to report that our pipeline for strategic deals doubled year-over-year in Q3. Additionally, we had a record number of enterprise and strategic RFPs in the third quarter, which increased 66% year-over-year and 21% sequentially. This march up market and our continued international expansion are increasingly driven by our ever-growing network of global partners and their dedication to leading with Five9. I’m very pleased to share that IBM has expanded its relationship with us as a global SI partner, reselling Five9 along with their CRM and ITSM offerings, and also as a technology partner integrating watsonx with our AI solutions. This is a common model among large SIs as we are complementary and tightly integrated with solutions such as Salesforce, ServiceNow, Microsoft, Google, and others. We have now established ourselves as a global brand with the help of key strategic partners like IBM, BT, TELUS International, Deloitte, and Accenture, to name a few. Our partnership strategy is built not only on recruiting new partners, but also on enabling and empowering partners within our methodology of sell with, deliver with, and build with. This approach was one of the key drivers that led to our EMEA bookings growing 57% in Q3. Additionally, a US managed service provider who has been our partner for the past three years celebrated their largest quarter, with several new customer logo wins and over $4 million of incremental ACV added in the quarter. Their success is built in part on their ability to implement Five9 solutions integrated with their enterprise management platform and other services. Our leadership in the channel is further validated by the three leading technology solution distributors in our industry: Telarus, Avant, and Intelisys, ScanSource each recognizing Five9 as their number one CCaaS supplier. Furthermore, a recent channel survey ranked Five9 number one for top CCaaS solutions sold by the channel and number one in easiest to do business with. These partners, along with many others, are helping position us prominently within the global channel community. In closing, I’m very excited about our continued momentum out market globally and the success we have with our AI automation offerings. The opportunity ahead for Five9 has never been better, and I want to thank all of our employees who bring passion and purpose to their work daily to make this a reality. And with that, I will turn it over to our President and CRO, Dan Burkland. Dan, go ahead.

Thanks, Mike and good afternoon, everyone. I’m pleased to report that we had a strong bookings quarter. Our pipeline reached another all-time high with our strategic accounts pipeline doubling year-over-year. Our sales of AI and automation solutions are seeing unprecedented momentum. As you know, the very high end of our market is lumpy regarding the timing of bookings. However, I’d like to remind you that the large enterprise category of $1 million to $5 million of ARR is the bread and butter of our business, and in aggregate is a larger contributor to our revenue growth than the mega deals. Now, as I usually do, I’d like to share some examples of new logo wins during the quarter. The first example is a healthcare insurance company that was moving away from an Avaya on-premise version that was being phased out. They chose Five9 along with one of our leading UC partners, with deep integration in order to gain visibility and provide seamless transfers between contact center workers and back-office employees, all from a single UI. We will also include our chat, email, SMS, QM, and interaction analytics, and we anticipate this initial order to result in approximately $2.3 million in ARR for Five9. The second example is a hospital billing and collections company. They were using Cisco that was managed by a third party, making add-ons and changes cumbersome and involving long lead times. They evaluated the major CCaaS providers and chose Five9. We are including the full omnichannel solution with email, chat, SMS, as well as both voice and digital IVAs. We are also providing them with QM, interaction analytics, WFM, and Agent Assist where they expect to reduce call handle times by up to 50%. We anticipate this initial order to result in approximately $2.3 million in ARR for Five9. The third example is a utility company serving many markets in North America. They were using a hosted Cisco solution that was nearing its end of life. They chose Five9 from all the major CCaaS providers, and we’ll be implementing our core offerings along with advanced solutions including chat, email, Agent Assist, our complete WFO suite powered by Verint performance management and gamification. This customer will also deploy our voice and digital IVAs for self-service to pay invoices, check account balances, and cancel or move service. We anticipate this account to result in over $2.2 million in ARR for Five9. As I normally do, I'd like to share two examples of existing customers who have expanded their use of Five9. The first example is a global pest control company that has been using our system for several years and was recently acquired by a European company using an on-prem legacy solution. The North America operations team was able to do a side-by-side comparison with real production traffic to compare performance over several months. They chose us for our superior reliability as well as our AI and automation portfolio. We anticipate their spend to increase from approximately $2.1 million in ARR to approximately $4.2 million in ARR. The last example is a leading global ticket sales and distribution company where we began providing our solution throughout Europe more than five years ago. In early 2022, we leveraged the strong success established with them in Europe to expand into their US operations where they saw increased call volumes. We continue to replace their legacy on-prem solution. This recent order increases their spend with us from approximately $1.2 million in ARR to over $2.2 million in ARR. As you can see, we are executing extremely well in landing some of the largest brands in the world as well as helping our existing customers expand and reimagine how they deliver customer experience. And with that, I’ll hand it over to Barry to cover the financials. Barry?

Thank you, Dan. Third quarter revenue exceeded our expectations, growing 16% year-over-year, primarily driven by the 28% growth in our LTM enterprise subscription revenue. As a reminder, we believe we are well-positioned to resume historic levels of growth in the 30s with enterprise subscription once the macroeconomic headwinds on our installed base subside. Our enterprise business made up 87% of LTM revenue and our commercial business, which represented the remaining 13%, grew again in the single digits on an LTM basis. Now, I would like to provide color on our recurring versus total revenue. Third quarter recurring revenue, which made up 92% of total revenue, grew 18% year-over-year, the same year-over-year rate as in the second quarter. Third quarter recurring revenue grew 4% quarter-over-quarter, the same sequential rate as in Q3 of last year as new logo deployments offset slower growth in the installed base. Speaking of new logo deployments, note that the international rollout of the parcel delivery company and the deployment of the healthcare conglomerate remain largely on track, considering the inevitable ebbs and flows of implementations across multiple divisions. Total revenue, however, grew sequentially at a slower rate of 3% in the third quarter versus 5% in the third quarter of 2022, primarily driven by the lumpiness of our professional services revenue, which declined 3% sequentially coming off of a record high PS revenue in the second quarter of 2023. This type of fluctuation is typical for our professional services revenue, which has experienced negative sequential growth in at least one quarter in nine of the last 10 years. Our LTM dollar-based retention rate was 110%, a decline of two percentage points sequentially, mainly due to ongoing macro headwinds quoting subdued growth in our installed base. We expect the fourth quarter LTM dollar-based retention rate to be either flat or slightly down, and we expect a positive inflection in 2024, assuming no major changes in the economy. Longer term, we continue to expect our retention rate to trend towards the high 120s by 2027 due to a higher mix of enterprise customers, especially larger ones which have higher retention rates and higher ARPU from our AI, automation, and other offerings. Third quarter adjusted gross margins were 16.6%, a decrease of approximately 80 basis points year-over-year. As we mentioned last quarter, we are making upfront incremental investments to support our new logo momentum, which is hindering our ability to report year-over-year growth in adjusted gross margin in the near-term. Third quarter adjusted EBITDA was $41.3 million representing a 17.9% margin, a decrease of approximately 60 basis points year-over-year. Third quarter non-GAAP EPS was $0.52 per diluted share, a year-over-year increase of $0.13 per diluted share. Turning now to cash flow. We generated operating cash flow of $37 million, a record driven in part by continued strength in ESO performance, which came in at 32 days. We have now delivered 29 consecutive quarters of positive LTM operating cash flow. Third quarter free cash flow of $31.5 million was also an all-time high. We remain optimistic about our potential for continuing cash flow generation given our long-term model, our substantial NOLs, and our low DSO. And now I'd like to discuss our guidance for the remainder of 2023 as well as provide high-level commentary regarding 2024. We closely track numerous indicators focusing on consumer discretionary spending, as it directly impacts our seasonally strongest vertical in the second half, namely consumer. Based on JPMorgan Chase data, the nominal year-over-year growth in discretionary credit and debit card spending deteriorated progressively throughout the third quarter from 5% in July down to 1% in September, which was the lowest growth of the year. Importantly, what matters to Five9 is not normal spending growth, but rather transaction volume growth, which drives contact center inquiry volumes. In this regard, the 1% nominal growth in spending in September represented negative transaction volume growth. Given this trend, we are adopting a prudent approach to the fourth quarter and are assuming weaker seasonality in our consumer vertical. Therefore, we are guiding fourth quarter revenue to a midpoint of $237.6 million, which implies a quarter-over-quarter growth rate of 3%. This growth is in line with our typical guidance heading into the fourth quarter despite the weaker seasonality expected in our consumer vertical due to the offset from the ongoing strength of our new logo appointments. Accordingly, we are maintaining the midpoint of our annual revenue guidance at $909 million or 17% year-over-year growth. For the bottom line, we are guiding the fourth quarter non-GAAP EPS to a midpoint of $0.28 per diluted share, and we are raising the midpoint of the full year to $1.92 per diluted share, representing a year-over-year increase of 28%. I would now like to provide some preliminary high-level commentary on our current thinking for 2024. For those of you who have been following Five9 for some time, you know that for six years through 2020 and again in 2023, we started each new year with prudent revenue guidance of 16% year-over-year growth at the midpoint. For 2024, our outlook remains here for a 16% year-over-year growth or approximately $1.05 billion in revenue based on the ongoing strength in our new logo business and less challenging compares in our store base, assuming the economy does not deteriorate further next year. This, as usual, is a starting point and we will update our outlook as the year progresses. We expect revenue to continue following our typical pattern with slightly more than 50% of the annual revenue being generated in the seasonally stronger second half of 2024. In terms of non-GAAP EPS, we are comfortable with the current street consensus of $2.16 per diluted share for the full year in 2024. Additionally, we'd like to provide an outlook on the quarterly profile of our bottom line. If you look at our historical financials, non-GAAP EPS is typically the lowest of the year in the first quarter, and we expect this to be the case again in 2024. Therefore, we anticipate non-GAAP EPS in Q1, 2024 to be in the high-20s per diluted share, which we expect the bottom line to improve slightly in the second quarter and more meaningfully in the second half, especially in the fourth quarter. Please refer to the presentation posted on our Investor Relations website for additional estimates including share count, taxes, and capital expenditures. In summary, we are pleased with our third quarter results. While we remain prudent with our outlook, we continue to execute consistently against this massive market, and we believe we are well-positioned to accelerate our business once macroeconomic conditions improve.

Thank you, Barry. Our first question will come from Ryan MacWilliams with Barclays. Please go ahead, Ryan.

Hey, guys. Just to double-click on the fourth quarter commentary. So, are your customers ramping agents, as you expected for seasonal use cases and you’re simply taking a prudent approach regarding call volumes during that period? Or is there anything different?

Yes, they are improving in the installed base. We are being cautious, which is appropriate given the current environment. I want to highlight the JPMorgan credit card discretionary spending metrics, which align well with our internal numbers. Keep in mind the trends of five, three, one in July, August, and September. We are closely monitoring what is happening in our consumer vertical each month. Credit card and auto loan delinquencies are now at a 20-year high. The latest JPMorgan survey revealed that 44% of respondents plan to cut back on discretionary spending. This morning, the CEO of Target mentioned experiencing seven consecutive quarters of declining transaction volumes. We don't feel confident enough to simply absorb these challenges; thus, we are adopting a cautious stance. This has always been our approach, and it has proven effective for us.

Appreciate the color. Thanks, guys.

Thanks, Ryan.

Good afternoon. Thank you, Mike, Dan, and Barry. I have a question that may break down into two parts. Dan, you highlighted the significance of the $1 million to $5 million deals, which constitute a substantial portion of your growth—an interesting data point. However, what is your perspective on the $5 million-plus deals? How do you perceive the volume and pace of those larger transactions over the next 12 months compared to three months ago? I’m not holding you to a specific quarter, but I’d like to know your thoughts on that activity. Additionally, with the unprecedented adoption of AI and automation, how much do you anticipate these factors will influence the larger deals? Thank you.

Great questions, Terry. If you look at the upmarket, the $1 million-plus deals, the $1 million to $5 million range is absolutely the biggest growth driver for us from a revenue perspective. Those are contact centers with 500 seats or above. Those big mega deals are very few, which is why they are so lumpy. That market is just starting to look at CCaaS for the first time, and we’ve been fortunate enough to capture some early adopters. However, we’ve always said, don’t expect those each and every quarter. We saw great momentum from the $1 million to $5 million range. As you can see, those typically implement and turn into revenue more quickly as they are much more predictable in that cycle. As for the high-end pipeline, looking at the next year, I couldn’t be more optimistic. The demand perspective shows a lot of potential, given the RFPs; 66% increase in the number of RFPs and 21% sequentially from Q2 to Q3 alone. This comes from the end-of-life of many premise-based systems, indicating to customers that they need to shift to the cloud. I see a bright future for the $1 million-plus categories all the way through the mega deals, as those companies must transition and they’re starting on the process now. Also, it’s essential to recognize that with longer sales and implementation cycles, we might not see immediate results, but there’s substantial business potential. Regarding the second part of your question about AI and automation, we are seeing unprecedented momentum there. We had an attach rate for our $1 million-plus ARR deals of around 80% for one or more of the applications in our eight AI and automation applications. That attach rate has been strong, and the RFPs are now proactively requesting it, which is central to our conversations and solutions of improving, reinventing, and delivering better customer experiences. It's all about how we automate and utilize new technologies to help agents become more efficient. A major component is our ability to summarize calls for agents immediately, saving them from post-call documentation. Overall, now is an incredibly fortuitous time for us.

And we’ll now move on to DJ Hynes with Canaccord.

Hey, guys. Good to see everyone. Mike, Dan, maybe I could ask you to double-click on some of the Aceyus commentary. Integration progress, you gave us some color on kind of how that's contributing to deal flow. I'm curious also, I mean Aceyus in the past has been a business that's worked with other large contact center vendors in the space. How have you been treating that? How are you thinking about it now that you own the asset? Any color there would be interesting.

Yeah, sure DJ. The momentum is off to a very quick start with Aceyus. Again, we closed that deal in August not very long ago. As I mentioned, the combined pipeline for Aceyus solutions is up 30% in just a couple of months. They’ve opened doors for us to sell CCaaS into their base, especially major Fortune 100 accounts, and it's on track, ahead of schedule in terms of the impact it's having on our business. The influence is happening on our deals, and it’s impacting both our prospects and their existing customer base. Their employees have really leaned in, as have ours, and the integration of our teams is going perfectly.

Great. Thank you.

You bet.

Hey, this is Seth on for Taylor. I was wondering, if you could elaborate a little bit on the timing of the large deal ramps? Maybe more specifically, is the parcel delivery service still scheduled to be fully deployed by the end of this year? The healthcare conglomerate by early 2024? And then maybe a little bit of an update on where the Fortune 50 global healthcare insurance company is in their ramping lifecycle. That would be great. Thank you.

Yes, they're on track. They're proceeding as planned. The parcel delivery service rolled out in the Americas right away. They’ve recently rolled out to Europe and are in the process of rolling out to Asia Pacific. So that is right on track to conclude by the end of the year or beginning of next year. As for the healthcare conglomerate, they're in process and proceeding as planned. They have twelve different businesses or companies under them, so each is operating in parallel at various stages. We expect that to continue throughout 2024 before they reach full strength. Regarding the healthcare insurance company, that's a longer ramp. They haven’t even started yet, so that will not begin to generate revenue until the second half of 2024.

Thank you.

Yes.

Thank you for the question. Barry, I'm surprised I'm the first one to ask this: what needs to go right or wrong to achieve the 16% target for 2024? I understand that the 16% target has generally been conservative in the past, but with your Q4 guidance, you're projecting an exit rate of about 17% for this year. Can you walk us through the confidence in maintaining 16% as a sustainable rate, especially considering you are now comparing against some of the larger deals from this year? Thank you.

Yes Fish. So the 16%, I’d like to emphasize, is a starting point for us. Think of it in two components: new logos and the installed base. In terms of the new logos, we have a huge backlog that is going to be deployed, not just the megadeals but also the bread and butter of $1 million to $5 million deals that greatly contribute to revenue. The parcel delivery service and healthcare company will be helpful toward revenue in 2023 and into 2024. The dots are much bigger by quantifiable amounts; they deploy faster and can make a considerable difference. So between that backlog and what we call the go-get—Dan and his team are methodically working to capture these RFPs with high win rates. On the installed base side, we take comfort from the fact that we are beginning to lap the weak macro conditions experienced in recent quarters. We wouldn't say in our prepared remarks that the fourth quarter may be flat or slightly down unless we felt pretty optimistic about 2024. As far as guidance goes, it comes down mostly to the installed base. It’s mainly about the macro-economic conditions and new logo contributions.

Got it. Thanks, guys.

Thank you.

Hi Mike and Barry. Thanks for taking my questions here. Barry, I wanted to follow up on the question on the 2024 guidance a little bit. Kind of a two-part question: how should we think about the linearity of the revenue? You have a couple of large deals coming online as that has been discussed here, but I just didn’t know if the cadence for the revenue side is pretty linear. What are your assumptions around seat growth in your installed base? You’ve obviously had some challenges in Q3 and you’re being more prudent here in Q4, so how should we think about your calculus around seats in the installed base next year? Thank you.

Thanks, Scott. In terms of linearity, every year we have had a consistent pattern, with a little over half of revenue generated in the second half of the year. It’s not going to change this coming year despite the puts and takes regarding deals ramping. For last year, some of the year-over-year comparisons will be tougher in the first half, so you’d expect bigger increases in the second half year-over-year. As for seat growth in the installed base, we’re unable to comment further at this stage beyond looking at the dollar-based retention rate, which is the best indicator of what's going to happen in the installed base. It will grow, but the rate will depend on many factors, mostly macroeconomic conditions. Our logo churn is excellent, sitting in the mid-90% range on the enterprise side. When the economy rebounds, we will directly benefit, as we can quickly add seats and increase agent counts overnight.

Excellent. Thanks for taking my questions, guys.

We will now hear from Arjun Bhatia with William Blair.

Thanks, guys for taking the question. I fully appreciate the conservatism in Q4 right? I think we're all looking through the choppiness in the macro. But Barry, I think you mentioned that you had started with data points that suggest that in September, things have gotten weaker. Have you seen any change in your transaction volumes in September? And just as you think about your vertical exposure, is there opportunity for other verticals to offset some weakness in the consumer vertical as you look at Q4 – and 2024?

Yes. First, let me address the healthcare vertical. Our indications on that are similar to what we expected when we guided. That’s gotten started a couple of weeks ago, so nothing significant so far. Regarding the consumer vertical, for October, things are pretty much in line with what we assumed at the time.

Got it. Thank you.

Moving on to Meta Marshall with Morgan Stanley.

Great. Thanks. Maybe Dan, a question for you. With so many of these deals kind of having AI attached or some sort of AI angle to them. Just what are you seeing in terms of bottlenecks? Is it that they take longer to get signed? Is it data privacy? What is the scope of what they want to do? I’m just trying to gauge where people are figuring out what they want to use.

Yes. The attach rate is wonderful. Do they take a little longer? Yes, I think on average if you look back a few years. However, the whole lot takes slightly longer owing to moving upmarket, as we've done. But that's a gradual process, not significant enough to concern us during the sales process. We need to ensure you have that extra meeting. In some cases, we may need to go to the data security and legal teams to ensure we have the right documentation to protect customer data. In some instances, we’re taking data from transcriptions and sharing via a third party to summarize. There are simply additional steps in the process now. Customers are using our AI strategy as a key evaluation criterion and establishing it extensively which helps win business for Five9, allowing us to hit the ground running and not need to develop everything from scratch ourselves.

And Meta, I would add that our AI and automation revenue is rapidly growing compared to other product areas. In my prepared remarks, I mentioned 250 AI and automation projects being handled by our professional services team in the quarter. Thus, we see the results in terms of improvement in revenue and growth with many ongoing projects.

Samad Samana with Jefferies has the next question.

Hey guys. This is actually Billy Fitzsimmons on for Samad Samana. Barry for you and I hate to ask a similar question to what other people have already asked. But I do want to triple-click on the 2024 outlook. And then just so we're all clear. And maybe to ask what Jim and Scott asked in a slightly different way. But obviously, that 16% number is a starting point; it remains early. Can you walk us through maybe some of the other factors incorporated into that number? How do you think about factors like continued strong deal activity, continued international expansion, channel momentum, AI-enabled product adoption – into that outlook? And does that 16% number incorporate continued weakness in some of the more challenging verticals or could it benefit from some improvement? And if I could sneak in one for Dan, you've talked for the last couple of quarters about strong channel momentum. What inning are you guys in that journey? And where can that go from here? Thank you.

I’ll go first. I’ll try to provide a different perspective here, Billy. International markets are becoming more significant, contributing one percentage point to total revenue each year. Although growth in Europe has slowed due to macroeconomic challenges, we see potential there, and we expect that stronger growth will continue in 2024. Regarding the channel, I will defer to either Mike or Dan to address that topic since they are enthusiastic about it. Generally, we focus on two aspects of growth: our installed base and acquiring new customers. On the new customer side, we have a strong backlog to work with, demand remains high, and we are confident in our ability to win contracts. As for the installed base, we have surpassed the weaker macro conditions from recent quarters. We wouldn't be indicating in our prepared remarks that the fourth quarter might be flat or decline unless we were confident about 2024. It’s crucial to base everything on the outlook provided.

To build on this, the optimism about 2024 is mainly based on our backlog. It is all about the bookings momentum that we’ve had over recent quarters, waiting to convert to revenue. That demand seems to be inflecting, and the number of RFPs is increasing by 66% year over year and 21% sequentially. Many of these enterprise deals will have shorter sales cycles and potential revenue impacts in 2024. Good news is our DBRR assumptions are reasonable, and you can do the math on what 16% revenue growth looks like based on those numbers. If DBRR is stable, it won’t take much of an uptick from our backlog to achieve 16% revenue growth, so we feel really positive about that. When it comes to our channel, Dan, would you like to weigh in as to where we are in that journey?

When looking at our channel, we’re in the second or third inning regarding maturity. This is similar to what you saw two, three years ago, as larger enterprises begin adopting cloud solutions. The channel had been holding on to legacy and on-premise systems until recently when they leaned into us. Given recent announcements with large partners like IBM, TELUS, and BT, we’re just getting started. They lead various large digital transformation projects for major companies worldwide. We are targeting education and certifications for our partners as they pivot to leverage CCaaS and cloud solutions. Significantly, we had 19 partners generating over $1 million in ACV deals in 2019; today, we have 63 such partners. That number keeps growing rapidly. In summary, we're in our second or third inning but advancing quickly.

So, Billy, that's how we feel about the 16%.

Thank you very much. Appreciate it.

Great. Thanks, guys. Maybe to add to that last question. I know you opened up the channel to do more professional services to start offloading that earlier this year. So can you walk us through the evolution of that? And then could you help frame the trajectory of when we might reach the 70% gross margins? Is it more driven by partnerships? Is it ARPU? Just help us understand the trajectory toward that 70% target. Thanks.

Yes, Peter, great questions. I’ll begin by answering the professional services and what we call project pull-through, which involves enabling our third-party partners to implement solutions. This was a strategic initiative initiated about a year ago, and it is going exceptionally well. Internationally, a majority of our deals are being implemented by external partners. We’ve seen a significant increase, even domestically, in the percentage of deals managed by partners. We haven’t disclosed that yet, but we will in the future. The growth is right on track regarding our KPI objectives since I initiated this strategy. We are thrilled to see the progress as third parties are getting trained, enabled, and successfully deploying our solutions while maintaining the mid- to high-80s NPS scores we've consistently delivered with our team.

Now to explain how our gross margins can reach the 70% mark, we need to consider our revenue breakdown as each part has different impacts and drivers. Our revenue breakdown is 75% subscription, by the way two-thirds of that is enterprise but the rest is commercial, with 17% being usage and 8% professional services. I will share insights on the latter two segments first before focusing on the significant driver. Regarding professional services, while it is currently in the low double digits negative, we don’t mind that too much; happier customers utilize software quicker. There is potential to improve efficiencies without needing to scale for every mega deal that arrives. The second area is usage, and we’re solidly in the 50s here. International opportunities exist, but the significant factor is a shift from usage to subscription revenue increasing by 1-3 percentage points each year. For instance, when we went public in April 2014, usage was around 35% of total revenue and has now halved. This trend will continue. Now we come to the subscription side of things, where the main driver remains fixed costs – the more revenue grows faster than the costs, the stronger the margins, leading to our fourth-quarter subscription gross margin always being the highest due to revenue peaks. We are investing in professional services for these mega deals, and we are making rapid strides internationally, including in India, South Africa, and elsewhere.

Thanks, guys.

Thanks, Peter.

Thanks for taking my question. It's good to hear about the large deals and a strong pipeline, but I just want to ask about what you're seeing in this environment? Are you seeing more deal scrutiny? Are you seeing more customers looking more closely at their AI strategies before signing any deals? Any color would be helpful.

Yes. Regarding deal timelines, we see a natural process when introducing something new to the market. It’s often not a replacement, so it takes a bit longer. However, it is insignificant and has not caused us any concerns during commercial discussions. We ensure we have well-prepared follow-up meetings. We may need to liaise with the data security team and legal to make sure we have the correct documentation. Just to clarify, when we share data from transcriptions, we employ third parties, and there are naturally extra steps involved in the process. Customers are evaluating our AI strategy extensively and using it as a key criterion in the evaluation process. We are leading the market in AI, and customers are expressing interest in our AI strategy, stating that we are future-proofing them.

Great. Thank you.

Good afternoon, guys. Thanks for taking the question. I guess, staying on the theme of AI and some of the automation features, you mentioned that 80% of new deals had that. But we were wondering how much additive value you think that’s bringing on new deals? And then, second part, more importantly, of the installed base, what is the penetration rate on that? How much are you adding there? Knowing that earlier in the year there were significant concerns about it cannibalizing your normal seats. What’s the net dollar retention look like as customers add that today?

Yes, thank you for that question. A few quarters ago, we communicated that around 10% of net new bookings were from AI and automation solutions, and this remains the case with a slight uptick. However, keep in mind that those numbers reflect the initial order—the customer agreeing to migrate from their on-prem solution to Five9 and including an IBA or Agent Assist application. Once we’re in, our professional services team engages, meeting with end-users for opportunities to help enhance their efficiency. We’ve developed a context where the AI and automation initiatives yield more opportunities. In fact, the applications have matured: Agent Assist now includes summaries that can document transcriptions and return them within seconds to integrate into the CRM systems. Agents can access these summaries to enhance their responses to client inquiries. Overall, the AI momentum and interest is extending to both new customers and the existing customer base, resulting in increased opportunities.

Moving on to Michael Turrin with Wells Fargo.

Hey, great. I appreciate you taking the question. Barry, you had some commentary on the retention rate. I know we’ve talked about it in the past. It's at 110%. And it sounded like you have some confidence that can maybe bounce back at some point in 2024. So I just want to understand the trajectory a bit better. Are there certain milestones you’re looking for? How much of this is lingering impact from prior periods? And just to gauge confidence in the potential for that metric to get back up into the 120s over time and the drivers?

I want to clarify the phrase 'bounce back' since this is an LTM number that moves slowly. In the near term, it comes down to two components. First, the macro environment needs to remain stable—ideally improving slightly without significant drops. This will help us get easier comparisons. Second, long-term engagements or contracts such as the healthcare company starting would offer a beneficial tailwind. That particular customer will have a disproportionate revenue impact due to their scale beginning from a low baseline. Many of our $1 million-plus customers are growing every quarter and are already over 50% of our recurring revenue, which indicates that they hold higher retention rates and ARPU.

Thank you.

Sure. Thanks, Michael.

Great. Good afternoon. Thanks for the comments on our survey. We spent a lot of time on that.

Happy to help.

Yes. Well the AI commentary did look good. You're right, let me ask about the strategic deal pipeline comments doubling year-over-year. It sounds like you continue to see very good momentum there. I know you’ve touched on that already, but could you dig into the key drivers of that? How do we think about the confidence level in converting that pipeline? How do we think about conversion rates going forward versus what you've observed? Any context on that front would be beneficial.

Yes. If I look back two to three years, significant enterprises would take meetings merely to check what was out there without genuine interest in transitioning to the cloud. Two major factors are occurring now: First, legacy platforms are becoming end-of-life, prompting companies using the major platforms like Avaya or Cisco to replace them and shift to the cloud. Second, we built a foundation of demonstration, reliability, and capability across our offerings, showing that we could scale with large enterprises. This has been evident since we captured early adopters. Others are now recognizing that if it's good enough for those enterprises, it's credible. Moreover, customers are being urged to transition due to internal pressures facing the legacy platform end-of-life, notably as they acknowledge the impending advantages of AI and automation in the cloud. Increased RFPs indicate that companies are proactively seeking to understand how to manage this transition which can sometimes take a year or two to process. Overall, we observe great momentum in our pipeline.

And Will, I know Dan won’t brag, but I will. We have the best go-to-market team in this industry by far. When you reflect on the pipeline doubling and our capability to convert that into business, I am extremely confident in our team’s performance there. You can clearly see our win rates elevating as we move ahead.

Great. Thank you.

Thank you everyone for joining us today. I am excited about the future for Five9. We see a dramatic inflection in large enterprises adopting cloud solutions and moving from legacy on-premise systems. The most promising metric shared today is the leading indicator—our RFP flow showing a 66% growth in RFPs for strategic and enterprise categories, marking a sequential growth of 21%. This is a very promising indicator of the potential growth for our business. Thanks for participating.