Five9, Inc. Q4 FY2023 Earnings Call

Thank you for joining us today. On the call are Mike Burkland, Chairman and CEO; Dan Burkland, President; and Barry Zwarenstein, CFO. Certain statements made during the course of this conference call that are not historical facts, including those regarding the future financial performance of the company, expected ARR from certain customers, customer growth, anticipated customer benefit, company growth, 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, including investment in R&D 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 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, everyone, for joining our call this afternoon. I'm pleased to share that we finished the year with strong results. Fourth quarter revenue grew 15% year-over-year and full-year revenue grew 17%. This increase continues to be primarily driven by our Enterprise business, with LTM subscription revenue growing 25% year-over-year. Adjusted EBITDA margin for the fourth quarter was 20% of revenue, helping drive a Q4 record for operating cash flow of $37 million, or 15% of revenue. As you all know, we take a balanced approach to delivering top-line growth and bottom-line profitability. Today I'd like to start off by commenting on the market opportunity ahead for Five9. We believe the market has never been better for large enterprises to move to the cloud. We are continuing to see strong momentum upmarket with new logos, as evidenced by our Q4 record in Enterprise bookings. In addition, our pipeline continues to grow, hitting another record high. We are seeing acceleration at the top of the funnel with Enterprise's strategic RFPs more than doubling year-over-year, which is a strong indicator of our market being at an inflection point. This market opportunity is being driven by three key ongoing trends. First, migration to cloud contact center platforms is becoming one of the highest priorities for enterprises, especially as many on-premise solutions are being phased out. With cloud penetration at approximately 20%, we believe there is a significant runway ahead. Second, Enterprises are laser-focused on improving the customer experience, and cloud contact centers are at the heart of enabling these businesses to reimagine their customer experience. Third, enterprises are increasingly leveraging AI to empower their businesses and cloud contact centers are becoming essential to deliver on their AI and automation initiatives. This market remains massive and underpenetrated, and we believe this is a durable, multi-year opportunity. Now I'd like to remind you of the three main growth drivers of our business: our platform, our march upmarket, and our international expansion. I'll start with the platform. We continue to strengthen our AI leadership in customer experience by infusing AI throughout our platform. We have been leveraging the power of generative AI to further expand AI-powered solutions such as Five9 chatbots and intelligent virtual assistants. In addition, generative AI is enhancing many other offerings in our AI and automation portfolio, including AI insights and AI summaries, which are gaining meaningful traction. For example, year-over-year bookings growth for Agent Assist, which includes AI Summaries, accelerated in each of the last three quarters, culminating in a sixfold increase in Q4. We believe much of this rapid growth can be attributed to the value we deliver to customers with our leading generative AI capabilities and our successful Try Before You Buy program. Our leadership in AI is also being widely recognized by the industry. We are excited to report that Five9 was named a global leader in the recently released 2024 Aragon Research Globe for Conversational AI. The report provides an in-depth analysis of leading contact center vendor strategy and product strengths in conversational and generative AI. Additionally, in the most recent Baird channel survey from late December, we were named as the contact center provider with the best AI solutions. Overall, we continue to see significant momentum in this area with AI and automation making up 17% of our total annual contract value new logo bookings for enterprise in Q4. Additionally, AI and automation products now make up 7% of our Enterprise subscription revenue. Next, I'd like to talk about our data strategy. Data has become more critical than ever in unlocking value in customer experience. The amount of data collected, the number of data sources, the explosion of data types, and the secure and responsible use of that data are all becoming vital buying considerations for contact center decision-makers. The benefits of having a strong data strategy are clear: more personalization to create an amazing and differentiated customer experience is just the tip of the iceberg. Richer insights for key stakeholders in the contact center, including agents, managers, and operators, lead to better decisions. Leveraging data with AI drives critical improvements for self-service and uplifts every agent to deliver the optimal customer experience. Five9 is the platform where customer experience data is created, utilized, and acted upon. We recognized this opportunity early on with the addition of the Five9 data lake. To build upon this, we recently acquired Aceyus, a leading solution to accumulate, normalize, and present rich and diverse data sources. We also integrate our data with other leading data sources to deliver exceptional customer experiences. We see data as the key to delivering a more personalized customer experience, and this continues to be an important pillar of our platform strategy. As you can see, we significantly strengthened our platform throughout 2023 and we are continuing to make key investments to enhance our leadership position in the market. A good example is FedRAMP, which will be a multi-year investment. However, we believe it will ultimately open up a huge market opportunity, not just at the federal level, but also with state and local governments that we believe will help us generate a meaningful new revenue stream long term. And now I'd like to focus on our march upmarket and international expansion. We continue to see strong momentum which Dan will touch on in a moment. As I mentioned earlier, enterprise and strategic RFPs are continuing to increase at a significant rate, which gives us confidence in our ability to continue marching upmarket in 2024 and beyond. Also, I want to point to one of the key reasons we have been so successful in winning and deploying some of the largest enterprise accounts. We continue to get feedback from our customers that they chose us not only for our market-leading platform but also because of our people. Our customer success model is a key differentiator. The vendor they choose must have the experts to ensure a smooth transition to the cloud, an improved customer experience, and better business outcomes. We have hundreds of customer experience experts globally that focus on transformation, migration, implementation, and ongoing optimization. We also collaborate with some of the best customer experience partners in the world that deliver a similar best-in-class experience. Our international expansion continues to be a growth driver. In 2023, international revenue grew 29% year-over-year. This strong growth was driven by the ongoing investments we are making, particularly in Europe. For instance, we expanded our presence in the region by activating local data centers and scaling our strong go-to-market team there. We also continued to strengthen our Porto engineering hub, increasing our headcount there by nearly 50% last year. Our success in marching upmarket and expanding internationally is increasingly being driven by our ever-growing network of global partners and their dedication to leading with Five9. For example, we recently announced the listing of our intelligent customer experience platform on Google Cloud Marketplace, which simplifies the procurement of Five9 and helps Google customers retire their Google Cloud Platform spending commitments. Also, we recently launched our new and enhanced Five9 University for partners, which provides comprehensive product training and certification programs to empower these partners in sales, implementation, and services. As a result, in 2023, the number of global partner sales certifications tripled year-over-year, and partner implementations doubled during that same period. In addition, we had 51 partners who booked more than $1 million in annual contract value in 2023. Before I turn it over to Dan, I'd like to say that we remain extremely optimistic about the opportunities in this massive and underpenetrated market. We have the right platform and the right team to capitalize on this long-term and durable growth opportunity. And with that, I'll turn it over to our President and CRO, Dan Burkland. Dan, please go ahead.

Thanks, Mike, and good afternoon, everyone. I'm pleased to report that we had a record for enterprise bookings for any Q4, adding to our strong momentum upmarket as we continue to expand our go-to-market and technology partnerships. We exited the year with 183 customers that generate over $1 million in annual recurring revenue to Five9, representing more than 50% of our recurring revenue. In terms of large global partnerships, BT, TELUS International, IBM, and Deloitte, just to name a few, continue to invest and build global practices around customer experience and have chosen to lead with Five9. Now I'd like to share some examples of key wins for the quarter. The first example is a non-profit healthcare organization based here in the U.S. They had been using Avaya which was reaching end-of-life and lacked the innovation to deliver great customer and patient experience. We competed with the leading contact center as a service providers and were chosen as the most comprehensive end-to-end solution with the best services offerings to accomplish their goals. With Five9, they will access a complete omnichannel solution deeply integrated to both Epic and ServiceNow CRMs. They will also be using our advanced intelligent virtual assistant for both intelligent routing and self-service. Our Agent Assist for transcription and summaries, and our workflow automation to insert a whole set of conversational data into their CRMs. We're also providing a complete workforce engagement management suite powered by Verint, including workforce management, quality management, speech analytics, and performance management. We anticipate this initial order to result in over $3.6 million in annual recurring revenue to Five9. The next example is a prominent university where we are providing contact center solutions for their education, research, and healthcare facilities. They had been using Cisco, which did not meet their digital transformation initiatives, including giving the business more control over delivering exceptional experiences to their students, prospective students, healthcare patients, and alumni. They evaluated all of the major contact center as a service players and chose Five9 for our superior end-to-end technology solutions as well as our deep vertical expertise and strong references in education and healthcare. They will be using our proven intelligent virtual assistant and chatbots for both education and healthcare groups. They'll be leveraging our Agent Assist to generate transcripts and summaries with deep integration to Salesforce, Epic, and ServiceNow CRMs. They'll also be using our workforce engagement management suite powered by Verint for automated quality management, interaction analytics, and workforce management for automated scheduling and forecasting. We anticipate this initial order to result in approximately $2 million in annual recurring revenue to Five9. The third example is a healthcare services network of acute care hospitals, rehabilitation, physician groups, and retail pharmacies. They have been using a variety of solutions, including Cisco and Avaya, and were looking for a single consolidated and innovative platform in the cloud. With Five9, they will access a full omnichannel inbound and outbound solution, including proactive outreach via digital channels for appointment reminders, prescription refills, and test result notifications. Likewise, patients will be able to use our intelligent virtual assistant for scheduling appointments, refilling prescriptions, and locating a nearby specialty provider. Five9 will be deeply integrated into their Epic CRM and we also included the Five9 workforce engagement management solution, including quality management, workforce management, and interaction analytics. Once they are migrated over to Five9, they plan to add Agent Assist for agent coaching, transcriptions, and call summaries. We anticipate this initial order to result in approximately $1.6 million in annual recurring revenue to Five9. And now, as I normally do, I'll share an example of a customer who has expanded their use of Five9. This customer started with Five9 several years ago as a relatively small regional bank with about 50 seats. They grew organically to about 200 seats and then merged with another bank in 2022 where we expanded and replaced the Cisco system at the other bank. This brought their annual spend to over $1 million in annual recurring revenue. Then after the full rollout in Q4 of 2023, we added the final business unit, which also added our workforce engagement management suite powered by Verint and our chatbot and intelligent virtual assistant solutions. This customer will now generate over $1.9 million in annual recurring revenue to Five9. So as we enter 2024, we feel very strongly that our go-to-market engine is firing on all cylinders to take advantage of the massive transformation underway in customer experience, the accelerating migration to the cloud, and the increasing adoption of AI and automation. And with that, over to Barry for the financials. Barry?

Thank you, Dan. We are pleased to report fourth quarter revenue growth of 15% year-over-year. This is despite the ongoing macro headwinds on our install base, which slowed growth in our normally seasonally strong consumer vertical. By way of illustration, a number of clients in the consumer discretionary subcategory experienced, for the first time since coming onto the Five9 platform, a fourth quarter sequential recurring revenue decline. In addition, we had a tough comparison internationally with a separately strong new lower speed turn-ups in the fourth quarter of 2022. Our last twelve months Enterprise subscription revenue, which now accounts for over 65% of total revenue, grew 25% year-over-year. Our Enterprise business made up 87% of last twelve months revenue and our Commercial business, which represents the remaining 13%, grew again in the single digits on a last twelve months basis. Also, recurring revenue accounted for 92% of our total revenue in the fourth quarter and the other 8% was comprised of professional services. Our last twelve months dollar base retention rate remained the same as last quarter at 110%. We expect Q1 last twelve months dollar base retention rate to be either flat or very slightly down, and we expect a positive inflection in the latter part of the year 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. Fourth quarter adjusted gross margins were 61.3%, a decrease of approximately 100 basis points year-over-year, but a quarter-over-quarter improvement of approximately 70 basis points. Fourth quarter adjusted EBITDA was $48.3 million, representing a 20.2% margin, a decrease of approximately 200 basis points year-over-year, but a quarter-over-quarter increase of approximately 230 basis points. Fourth quarter non-GAAP EPS was $0.61 per diluted share, a year-over-year increase of $0.07 per diluted share. Now, I would like to share our average concurrent seat count for the fourth quarter which grew 19% year-over-year to 349,675 seats. This is equivalent to approximately 525,000 seats on a named seat basis, a unit of measure that some others in the industry cite. As a reminder, we will continue to provide these metrics only on an annual basis. Finally, before turning to guidance, some balance sheet and cash flow highlights. I'm pleased to report that we achieved a Q4 record for operating cash flows of $36.5 million, driven in part by continued strength in our day sales outstanding performance, which came in at 32 days. We have now delivered 30 consecutive quarters of positive last twelve months operating cash flow and we remain optimistic about our potential for continuing cash flow generation given our long-term model, our substantial net operating losses, and our low day sales outstanding. I'd like to finish today's prepared remarks with the discussion of our full year 2024 and the first quarter guidance. As a reminder, for the last seven out of nine years, we've started with prudent revenue guidance of 16% year-over-year growth. For 2024, we are doing the same by guiding to a growth of 16% year-over-year at the midpoint, or $1.055 billion in revenue, which is in line with the high-level outlook we provided last quarter. This 16% year-over-year growth is, of course, a starting point and we will update our outlook as the year progresses. With regards to the bottom line, we are guiding 2024 non-GAAP EPS to a midpoint of $2.16 per diluted share, same as the outlook we provided for 2024 during the last earnings call. As a reminder, we plan to continue making strategic investments in innovation and go-to-market initiatives to enhance our leading position in the market. As for the first quarter, we are guiding revenue to a midpoint of $239.5 million. This represents a relatively flat sequential change, similar to last quarter's Q1 guide, but better than the prior historical range of 1% to 4% decline. Despite the ongoing macro headwinds, we are guiding to a better quarter-over-quarter change due to the muted seasonal uptick in the fourth quarter, which we expect to result in a less seasonal downtick in the first quarter. As for the remainder of the year, we expect a very small sequential growth in the second quarter and larger sequential increases in the second half. As a result, we anticipate slightly more than 50% of our annual revenue being generated in the second half of 2024. We expect first quarter non-GAAP EPS to come in at $0.38 per diluted share at the midpoint, a decline of $0.23 per diluted share sequentially. I would like to point out that the first quarter non-GAAP EPS is always the weakest of the year and the $0.23 per diluted share quarter-over-quarter decrease is within our historical range of prior first quarter guidance. For the remainder of the year, we expect non-GAAP EPS to increase to approximately $0.43 per diluted share in the second quarter and further improve in the second half. 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 fourth quarter performance. We will continue to invest strategically throughout the year to enhance our leading position by further innovating on our platform, marching upmarket, and expanding internationally.

Thank you, Barry. We will now begin the Q&A session. Our first question will come from Scott Berg with Needham.

Hi, everyone, thanks for taking my question here. Lots of them. Why don't I start with the fourth quarter results? Barry, your quarterly revenue tends to have variances around seat usage and implementation timeframes, and that tends to drive your outperformance, at least from a historical basis, in any one quarter on the revenue side. Q4 this year was your weakest revenue beat that I can remember in all the years covering the company. I guess, can you help us understand what was maybe different in the operations side of the business this quarter versus other quarters that have had stronger revenue outperformance? Thank you.

Yes, so it comes down to that part of our business. Approximately half that is from our install base. If there are fewer interactions coming into the contact center, there's going to be less demand for agents and less demand for our services. The numbers are very clear. We provided the JPMorgan Chase debit and credit card spending data, which showed low-single digit nominal growth, which means negative transaction growth, and that was the headwind that we were facing. In addition, I'd like to point out, in terms of the magnitude of the beat, Scott, we beat by 1%, which was admittedly lower than normal. We beat by 2% a year ago. The fourth quarter is very difficult to predict. Our customers have to take into account the degree of seasonality and do it in the context of a macro environment that's a little bit soft. And by way of illustration, if you look at the maximum and minimum beats over the last seven years, and you skip over the two COVID years because those were extraordinary, I'm going to give you four numbers, 2, 5, 4, 9. 2, 5, 4, 9 is Q1, Q2, Q3, Q4 spread between the minimum and the maximum beat in those quarters. And clearly, the variability is higher in the fourth quarter because of those factors that I was alluding to. So that really is the explanation.

Thank you.

Okay. Our next question comes from Ryan MacWilliams with Barclays.

Yes, it's good to see you. How should we think about the cadence of revenue growth throughout the year? Given the Q1 guide and the full-year guide, it seems like there's solid growth embedded in the second half of 2024. Anything to call out there besides seasonality? Thanks.

Yes, the basic reason over there is the fact that we've got good visibility on the new logo side. We've got this considerable backlog, and we still have three or four months or so of new enterprise orders that Dan and the team will bring in what we call go-gets that will count towards revenue in 2024. So we feel pretty comfortable that we're taking the right stance in balancing the prudence on the new logo on the install-base side with the visibility that we have on the net new.

And Ryan, I'll pile on just a little bit here. Our confidence in the rest of the year is really driven by what's in the backlog. We had a record Q4 bookings for Enterprise, and we've had very good quarters from a booking standpoint for the last several quarters. And that's what gives us a lot of confidence in the back half of the year.

And since Mike is piling on, I'm going to pile in as well. And that is that if you look at the guidance we gave, and we gave pretty explicit guidance, well, explicit obviously, for Q1, but also for Q2 and the revenue. And it doesn't take a rocket scientist to figure out that there is an acceleration coming in the second half of the year that is embedded into our guidance with our initial 16% starting point. There is one other thing that I neglected to mention earlier on, so this is not going to count against your one question, Ryan, but it's really for Scott. We also had a tough comparison in terms of international. We knew that going in, but in terms of the actual performance in the quarter, we had very good seat turnouts in Q4 2023, but even better ones from the first strategic account that we ever had, which was the British insurance company, plus FedEx, excuse me, the passive delivery company delivering, going up in Europe. Starting in 2022, very strong by the fourth quarter of 2022.

Appreciate the color. Unfortunately, I don't think I'll ever be confused for a rocket scientist, but..

Thanks, Ryan.

Okay. Our next question comes from DJ Hynes with Canaccord.

Hi guys, good to see everyone. Barry, I don't know if I'm thinking about this correctly, but maybe you can help me. So, seat count grew 19% last year. It grew 19% this year. But Enterprise subscription growth has continued to decline, right, which tells me price per seat may be declining, which seems at odds with everything that's happening with AI and attach rates. Just help me unpack the discrepancy between kind of seat count growth that's been stable and the declines in Enterprise subscription growth.

Great question, DJ, and thank you. If you calculate the numbers, you'll notice that you are correct. When you compare the recurring revenue per seat from Q4 2022 to Q4 2023, it has decreased by about 3%. The main reason for this decline is usage. We are onboarding more large clients who have committed contracts, often introduced to us by companies like BT and AT&T. A good example is our second biggest customer in the healthcare sector; they are currently not utilizing our services, although they might in the future. This situation is what led to the decrease. The positive aspects from AI and automation are still present, but they are not enough to compensate for a reduction as significant as 15% of our current revenue.

So ex usage pricing per seat continues to trend up. Is that the correct way to think about it.

It does. There are some other dynamics, like Latin America is growing a little bit faster and the prices there are a little bit lower. But if you're looking at the U.S., it is pretty much in line with how it's been growing in the past.

Okay, thank you, guys.

Okay. Our next question comes from Meta Marshall with Morgan Stanley.

Great, thanks guys. Question for me, I guess, just what do you guys see as your biggest bottleneck today? Is it getting budget authorization? Is it getting organizations to realize what approach they want to take to AI? Is it professional services? Is it just kind of the overall macro environment? Like, what do you think is kind of the biggest bottleneck you guys face with customers in getting them ramped?

Gosh. I don't think there's any single bottleneck. I think what is important to understand is the strategic nature and the mission-critical nature of what we do to come in and really help companies transform how they're delivering customer experience to take what they're used to, probably having ten very independent, I'm using an example, in some cases, ten different contact centers with ten different operations managers running those. Just saying, hi, we're going to consolidate this into one virtual, and we're going to be able to distribute work throughout all of those locations and do so in a much different fashion with a lot more technology and automation and AI that wasn't previously available. So it's a lot of planning. The larger you go up the stack of larger and larger companies and large enterprises, the more difficult it is for them to organize and come to agreement on how to roll things out. So always when you go up-market, you're going to have longer lead times and longer rollouts. We'll move as quickly as they're capable of moving, and we have business consulting experts that actually work with them to help kind of try to speed that up. We also talked about the Aceyus acquisition to help speed that migration up, but it is a big undertaking, and so we're very realistic on how long it takes to bring these customers up. But I don't think they're not getting any longer. It's just that as we move up-market, we have to recognize that it's a lot more effort and work, not only on our side, but really on the customer side to get to the point where they can launch and then continue to ramp.

Great. Thanks so much.

Yes.

Okay. Our next question comes from Jim Fish with Piper Sandler.

Thank you for the question. Barry, I appreciate the information on AI revenue. Many long-term investors were anticipating that. Regarding this, do you have any insights on how we should view the growth rate for the year and what the 7% revenue could contribute to achieving the 2027 goal? Dan, could you elaborate on what sets your AI Assist product apart from similar offerings from competitors? Thanks, everyone.

Sure, I'll talk about AI, our Agent Assist product. Three components to it, there's the real-time coaching and delivering answers, so that the agent can be more proficient. The fact that answering your customer question there, see AI transcription and the AI summary of the call that gets inserted into the CRM, all part of our Agent Assist solution. If you look, you'll see others are all talking about those same capabilities. The key there is, if you're on our platform, you need to use our Agent Assist product. The reason is you have to have the platform listening to the conversation to perform the transcription and to summarize that transcription in real-time. If you're doing agent coaching, you have to have that in near real-time and feed it back to the agents. So when you ask what's the difference? There's probably not a ton of difference in what ultimately gets delivered. We all go about it slightly differently in the underlying technologies, but we're all delivering that same capability. But you can't take a Five9 customer, Five9 contact center, and use someone else's Agent Assist. That won't work.

So Jim, in terms of what happens at 70%, it would be easy just to say it's growing faster, therefore it's going to consistently increase. It's tempting, but I'm going to resist the temptation. And the reason I'm going to resist the temptation is the following. We've got a massive install base of 350,000 concurrent users and we are spring-loaded to take advantage of when this economy finally and inevitably turns around. Our retention rates have been in the mid-90s. When those transactions increase, it'll spread across that entire install base. And we are not going to be embarrassed if that overwhelms just by the sheer magnitude of the install base. The growth that we enjoy is clearly demonstrative of AI and automation.

Couldn't help but try. But thanks, guys. Appreciate it.

Thanks, Fish.

Our next question comes from Taylor McGinnis with UBS.

Yes, hi team, can you hear me?

Yes, we can, Taylor.

Okay, perfect. Hello, everyone. Thanks so much for taking the question. Maybe, Barry, can you talk a little bit about the assumptions embedded in the Q1 guide or at least the visibility you have to that outlook? So it implies some flattish sequential growth, but I think historically in Q1 you guys have done closer to mid-single digits. So have we gotten to the point where some of the softer usage activity that you've spoken about is no longer serving as an incremental headwind? I think you mentioned the 25% subscription growth. So could we start to see an improvement in sequential growth as we move throughout the year?

I'll take the last part first. Yes, the guidance would lead you to be pretty clear in assuming that we're going to see growth in the second half of the year. With respect to the dynamics around Q1 where you started your question with, Taylor, we normally would have in the past a 1% to 4% decline. The numbers are always there. We give a guide, go down 1% to 4% and then beat it each time. Now in Q4, we had a smaller uptick, so we're going to have a smaller downtick, and we've kept it flat. I really would not want to comment on, in terms of Q1, beyond the guide that we're giving, accepting to say that we feel comfortable with what we're given. We're doing it in an environment that is pretty uncertain. I'll make two comments on that. This external data, which is a window into our own clear data that we see from our customers on a daily basis, the JPMorgan data for Q1 is actually negative debit and credit card spending. So for sure the transactions are meaningfully negative. So we're taking that into account. We've just come off of an experience where, when you look at our biggest consumer, well, among our biggest consumer discretionary customers, in the fourth quarter, for the first time ever, since I came onto the platform, there was a sequential decrease from Q3 to Q4. Never happened before. And so we take this into account when we're doing our guidance.

Perfect. Thanks so much.

Thank you.

Our next question comes from Peter Levine with Evercore ISI.

Thanks, guys for taking my question. Maybe, Barry, for you, on the margin front gross margins. I know you made investments over the past year to kind of modernize your infrastructure, offloading services to partners. Then just give us an update on kind of how that's trending. And then how should we think about gross margins going forward? I know in the year it looks like it ticked down, but what's the expectation for gross margins?

Perfect. I’d like to ask the operator to direct the next question to either Mike or Dan. Regarding the gross margin, several factors contribute to the shift from international GCP instances, which have higher margins. There's also a moderation in some of our investments, particularly in professional services with Fairground, which is presenting a challenge. However, the overall picture involves revenue growth relative to fixed and semi-fixed costs. You can see this in the fourth quarter, which is typically strong. We don't want to sound overly confident, but we aren't particularly disappointed with our gross margins despite the overall revenue weakness we've been facing. To directly address your question about expected gross margins, we have several internal programs that will take time to fully materialize, but they will come to fruition. This is a key focus area for us. We recognize its importance and have strategies in place. If we see a positive shift in revenue, you'll notice a significant improvement in gross margin.

Any update on partners and offloading some of those pro services?

Yes, we've begun enabling more and more partners to take on. Obviously, on the sales side, they have the competency now to represent us, and we have thousands of people throughout the world representing Five9. We've also done what's called project pull-through, and we've referred to it before, where we've identified a select few partners that are willing to invest in getting certification for implementation and ongoing services of the platform. It's very important that we have that qualification requirement because we want to make sure that those partners are upholding the very high standard that we have for ourselves and delivering record-level NPS scores. We refer to them as plus 85. It's unheard of in our industry. Most folks are well below plus 50, and we maintain a plus 85 rating, and we want to maintain that. We hold our partners accountable to that as well. And Mike alluded to that in his comments earlier, but it's something that is allowing us to increase the percentage that go through partners. Internationally, we're over 50%, and domestically we're tracking very nicely in the high-20s as far as the number of projects that are now being led by our partners.

Thank you, guys.

Yes.

Sure.

Okay. Our next question comes from Michael Turrin with Wells Fargo.

Hi, great. Nice to see everyone. Appreciate you taking the question. Just a quick multiparter. So I'm curious if in Q4 if you saw any elongation tied to some of the M&A headlines, a lot of us on the investor side were focused on. And Barry, sorry, still a question for you. I know you're fatigued but maybe expand on the precision you have behind that second-half reacceleration. Because you also mentioned in the prepared remarks that Q4 can be tougher to forecast. It seems important for the forecast we have coming into '24. So maybe you can just add what gives you the confidence there as well. Thank you.

Michael, I'll start with the first question. I'll have Barry handle the second one. Dan, feel free to chime in, but there was no impact from some of those rumors that occurred relative to M&A. We set the record straight with a press release very quickly, and we did that for a reason. We definitely did not want customers and prospects and partners reacting to false news. So we were very clear with the press release. If you want to quantify it, it was a two-day delay in terms of potential sales cycle increase. But it wasn't a big impact. That's why we issued the press release. Barry?

So in terms of the procedure, here it is. Again, think about new logo versus install base. In terms of the install base, we've made the assumption that the economy is going to use the same phrase that I used before, remain somewhat soft for the rest of the year. Nothing big down, nothing big up. And based upon that, we've looked pretty closely at the dollar-based retention rate. We, of course, get the spot. We've looked at it pretty closely. We provided guidance that we would have a positive inflection on the dollar-based retention rate during the course of 2024, just like we said for Q4 of 2023. So we had $900 million, $910 million of revenue in 2023. If you use just the same dollar-based retention rate, no increase for the year, you've got $90 million, round numbers, $91 million from the install base. That's the one part. The other part, the balance of, say $55 million, $54 million is what's sitting in the backlog, and we have supreme confidence that Dan and his high-stepping sales team will be able to bring in before the end of May or end of June. And Andy and his high-stepping implementation team will implement by year end.

That's very helpful. Thank you.

Thanks, Michael.

Our next question comes from Siti Panigrahi with Mizuho.

Thank you for my question. Following up on your last answer, you mentioned your sales and implementation cycles. How does your implementation pipeline or go-live rate this year compare to last year, 2023? Additionally, could you provide an update on the progress of your large enterprise deals, particularly with the large healthcare conglomerate or Fortune 50 insurance companies?

Yes, great question. To answer your pipeline question, the pipeline is at an all-time record and that's really across most all the sectors, particularly upmarket in our enterprise and strategic accounts area. As we've mentioned before, more and more of these large enterprises are now embarking on large projects, digital transformation, RFPs to replace and get out from under the legacy platforms that they've been living on for many, many years. They really have no choice. It's not only that they're being pushed off of those platforms by the legacy providers because they're being either end-of-life or ending development, but they're also being pulled away from those and into the cloud by the advent of AI and the automation solutions that they can take advantage of. So that's one, pipeline's never been stronger. As far as the cycles to onboard new customers, yes, I mentioned that earlier, it's one of those where we've got to work through that with each customer independently. We've got the best services organization in the world with those experts that Mike had mentioned in his prepared remarks, which is so key because we can go in and really consult with them and help them understand how they can most easily and most effectively make that transition to the Five9 cloud and do so with the right business outcomes that they're trying to achieve. And that's what we pride ourselves on. And we think we do it better than anyone. It does give us the positive of having visibility into a backlog where we can see in future revenue for several quarters. So that's the comfort side of it, if you will. But yes, we're working always on tooling and making things more and more efficient and helping our customers get onboarded more and more quickly. But there are certain things. You've got integrations into lots of different platforms to be able to really extract the value from our AI and automation solutions. One of the biggest keys there is integrating to those data sources so that we can have more data feeding the engine that can then make the intelligent decisions that it needs to make. And that's the key is building in all those integrations before you flip the switch and go live. And once we do that, then it's a matter of ramping them up and bringing them on board.

Thank you.

Yes.

Our next question comes from Matthew Niknam with Deutsche Bank.

Hi, it's Matt Niknam from Deutsche Bank.

Sorry about that.

The question is about how healthcare and financials performed in the fourth quarter compared to typical seasonality, and if any unusual softness has been considered for Q1 in those two sectors. Thank you.

So the healthcare and the financials are the biggest and second biggest verticals, consumer being third. If you look at all the others aside from consumer, so the vast majority being financial and healthcare, they were pretty much in line in the fourth quarter in terms of sequential growth as they were the prior year. And we've not baked in any major headwind in those two verticals in Q1.

Thank you.

Thank you.

Thanks.

Okay. Our next question comes from Mike Latimore with Northland.

Great. Hi, everyone. Regarding the dollar-based retention number you mentioned, Barry, do you expect it to be 110% for the year or do you anticipate an improvement in the second half of the year?

That's correct. So it's currently 110%. We're not giving Q1, Q2 guidance. I think all we said very explicitly is that we expect an inflection in the second half of the year. We have the breakout between Enterprise and Commercial. We have the spot rate. We have, within Enterprise, the breakout between the bigger customers, which have demonstratively and consistently higher retention rates versus those that the smaller Enterprise customers. There is some art to it. There's no question. Our customers don't know exactly what they're going to be doing this quarter, a little early in the second half. But based upon the best analysis we can do, we feel comfortable in saying what we said.

Got it. Okay, thanks.

Sure.

Our next question comes from Catharine Trebnick with Rosenblatt.

Thank you for taking my question. Dan, this is for you. Are you noticing any changes in the RFPs from your large enterprise customers compared to a year ago? I understand AI and automation are part of it, but are there any other factors in these digital transformations that are influencing you to incorporate these feeds?

Thank you for the question, Catharine. I'll provide two key points instead of three since AI and automation aren't applicable here. Firstly, Genesis has announced they are phasing out their legacy on-prem and multi-cloud solutions, which has led to a new group of customers entering the market. For large enterprises, assembling a team, drafting an RFP, determining their needs, and launching the process can take several quarters. We've observed a doubling of RFPs year-over-year, particularly from larger companies, stemming from the Genesis change alongside ongoing demand for legacy Avaya and Cisco solutions. The second point pertains to services. Companies are coming to understand that purchasing a platform isn't enough; they need to partner with experts who have the necessary resources and experience. Many of our professional services team members previously worked for large enterprises, giving them firsthand experience with previous platforms. The importance of our technology combined with our expertise is increasingly noted in RFPs. When companies choose Five9, they often say it's because we tailored our demonstrations to their specific needs and challenges, involving our professional services team early in the process, showcasing our capabilities and business consulting expertise, which is often underestimated in our industry.

All right, thank you very much.

Our next question comes from Samad Samana with Jefferies.

Hi there. Good evening. Thanks for taking my question. Dan, I'll start with you so Barry can take a longer break. When I look at the subscription revenue added each year over the last several years compared to your annual sales and marketing expenses, it seems that the ratio is increasing. You’re spending more on sales and marketing, but the revenue added each year appears to be decreasing. Is it becoming more costly to acquire customers? Are you investing in expanding the sales team, and are we just waiting for that investment to pay off? Please help me understand how that sales and marketing investment relates to the revenue you’re seeing and what it means for your go-to-market strategy.

Yes, I know you directed that question to me to give Barry a break, but he's chomping at the bit to take it because you'll be surprised by some of the numbers that are a result of that. Barry?

Yes, Samad, it's important to consider that there are essentially two businesses operating together, and Dan and the team are focusing their spending on acquiring new customers. The subscription numbers you mentioned include a somewhat weaker customer base, which is a reality. I've already outlined this earlier. When dollar-based retention rates fall from the 120s to the 110s, it affects about half of our business. This isn't about customer turnover; it's specifically related to our enterprise clients. However, I want to emphasize that we're well-positioned to benefit when the economy eventually improves, as our enterprise logo retention rates have consistently remained in the mid-90s. While there are fewer transactions, the clients are still present, which is a contributing factor. Additionally, there's another reason worth noting, although it's not the main factor. It involves the large healthcare and delivery companies, which don't always contribute dollar for dollar. If they did, we’d be living a very different lifestyle. These transactions can be inconsistent, but they do support our bookings.

I want to emphasize once more the efficiency of our sales and marketing. We have many internal metrics that we don't share publicly. One metric I've tracked every quarter for 16 years is the cost of acquiring a dollar of annual contract value bookings from new customers. While we don't disclose the specific booking numbers, I can tell you that this metric has remained very consistent over a long period, and I would describe it as best in class.

Great. Maybe, Barry, just a housekeeping question. I apologize if I missed this, but I just want to make sure about the guidance concerning third-party public data and its directional correlation. Is it reasonable to assume that if that trend continues before you guys report, we can use it as an indicator for what will happen? So if it continues moving in one direction, for better or worse, can we rely on that? Also, what are your expectations for the rest of this year? Do you anticipate that it will stay at the levels we've observed in January and February, or is there a chance it could worsen or improve?

That's a very good question. To address the first part, yes, we've thought about pointing you in that direction because it's a publicly accessible reference point. In fact, in some cases, it even tracks monthly in addition to quarterly. Looking ahead, I've mentioned that the figures might vary between institutions like JPMorgan and UBS, and I won't list all the banks, including Bank of America, as their numbers might differ as well. However, the indicator we consistently refer to was negative in January, both on a nominal and transaction basis. We took this into consideration but don't believe the situation is dire. There are enough positive comments out there, although there are certainly areas of weakness reflected in the overall data, and that has been factored in. We've provided our guidance and are confident in it. You will need to draw your own conclusions when you review the data from January and February during our quiet period and determine whether it's positive, negative, or neutral.

Understood. Appreciate the time as always. Thank you.

Thank you.

Thanks, Samad.

Our next question comes from Matt VanVliet with BTIG.

Hi, great. Thanks for taking the question. Good afternoon. I guess when you're looking at the nearly doubling of the RFP activity on the upmarket customers you talked about, curious on what you're seeing in terms of sales cycles. How are those RFPs sort of processing along on a normal timeframe relative to in the past? And then, how are you feeling about your ability to execute on those deals relative to where the macro is today?

Yes, they are following their usual procedures from a linked standpoint. We've moved upmarket, so the larger deals we are working on have longer sales cycles due to their complexity. The emergence of AI and automation has contributed to slightly longer sales cycles, but that was a one-time shift as it became part of the RFP scope. Overall, everything is as anticipated, and we feel optimistic about our chances and our ability to close these deals at an unprecedented rate. We have taken the lead in the market by securing two of the largest and most complex projects globally. We've shown that we can implement these efficiently and on time, and they serve as references for us. We are confident about our future opportunities, and everything looks positive. Thank you for your question.

Great, Dan. Thank you.

Yes.

Thank you.

Okay. Our final question comes from Thomas Blakey with KeyBanc.

Thank you for fitting me in. I wanted to ask a couple of questions, starting with the consumer segment, Barry. I know this has been a challenge, but it should be improving. Could you share your expectations for the Consumer segment in the second half? There were a few inquiries about visibility on this, so I would like to hear the specific expectations for the installed Consumer vertical moving forward. Additionally, Dan, you mentioned the record pipeline. Could you provide an update regarding the pipeline, especially in terms of megadeals? That would be helpful. Thank you.

Tom, I'm afraid I'm going to have to disappoint you on your second last question because we're not going to be sharing the explicit vertical expectations for each quarter of 2024, I'm exaggerating for effect. We have an overarching view that we've shared and want to limit it to that.

The mega-deal pipeline is looking very strong, and as I mentioned earlier, it's at a record high. We have expanded our team to focus on these strategic accounts and mega deals. The bookings for these deals can be quite unpredictable, arriving at various times, which can cause fluctuations in our numbers due to their size. However, I am very optimistic about the future and the opportunities that are ahead of us.

Tom, to provide some response, the consumer segment is by far the most variable. When we examine the year-over-year comparisons for the entire company, not just the consumer segment, we are entering a progressively easier situation as each quarter passes: 20, 18, 16, 15. Therefore, the second half of the year is clearly easier, including for the consumer sector.

That was the leading question. Thank you, Barry. Thanks. And if I could, in closing, I just want to say a quick thank you to all the Five9 employees as well as our partners for all their great work, their hard work, their dedication, they are the reason for our record results in 2023. I am so excited about 2024 as we surpass $1 billion in revenue and continue to go after this massive market opportunity ahead. So very exciting times. Thank you for joining us, everybody, and look forward to keeping you updated as we progress through the year. Have a good one.

Goodbye.