Five9, Inc. Q1 FY2024 Earnings Call

Joining us today are Mike Burkland, Chairman and CEO; Dan Burkland, President; and Barry Zwarenstein, CFO. Some statements made during this conference call that are not historical facts, including those about the future financial performance and cash position of the company, expected improvements in financial metrics, anticipated annual recurring revenue from certain customers, revenue mix shifts, customer growth, expected customer benefits from our solutions including AI, company growth, enhancements and development of our solutions, market size and trends, expectations regarding macroeconomic conditions, company market position initiatives, and technology and product initiatives including investment in R&D, are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. These statements are predictions and should not be overly relied upon by investors. Actual events or results may vary significantly, and the company has no obligation to update these statements. They are subject to substantial risks and uncertainties that could negatively impact Five9's future results and lead to inaccuracies in these forward-looking statements. These risks include adverse economic conditions, uncertainties such as ongoing inflation, rising interest rates, supply chain disruptions, decreased economic output, fluctuating currency exchange rates, lower growth rates among our customer base, and other risks outlined in Five9's annual and quarterly reports filed with the Securities and Exchange Commission. Additionally, management will reference non-GAAP financial measures during this call. A discussion on why we use non-GAAP financial measures and the reconciliation of our GAAP versus non-GAAP results and guidance is available in our press release from earlier today and in the appendix of our investor deck found on Five9's website. Lastly, please note that unless stated otherwise, all financial figures discussed are non-GAAP. I will now turn the call over to Five9's Chairman and CEO, Mike Burkland.

Thanks, everyone, for joining our call this afternoon. I'm pleased to report strong first quarter results with our subscription revenue growing 20% year-over-year and total revenue exceeding the midpoint of our guidance by 3 percentage points. As a reminder, our subscription revenue, which others in the industry refer to as cloud revenue, accounts for nearly 80% of our total revenue. Also, this 20% growth in subscription revenue does not include any benefit whatsoever from customers converting from on-premise to cloud since we do not have any on-premise business, and this growth is all organic, except for an immaterial amount. Adjusted EBITDA margin for the first quarter was 15% of revenue, helping drive strong LTM operating cash flow of $128 million or 14% of revenue. As you all know, we take a balanced approach to delivering top-line growth and bottom-line profitability. I will begin today by discussing our broader market opportunity, which continues to be propelled by three ongoing trends. First, the migration to cloud contact center platforms continues to be a top priority for enterprises, particularly as many on-prem solutions are being phased out. With current cloud penetration standing at approximately 25% to 30%, we believe there's a multiyear durable growth opportunity ahead. Second, enterprises are laser-focused on improving customer experience, which has become a strategic initiative aimed at driving better business outcomes. With our intelligent CX platform and our passionate experts, we are changing the game for some of the largest brands in the world and helping them reimagine their customer experience. And third, AI is revolutionizing the way brands enhance customer experience. With our AI-infused and data-driven intelligent CX platform, we're helping enterprises deliver personalized, connected and effortless experiences for their customers. These three trends are driving a massive market opportunity, and we are a clear market leader, given our platform, our success in moving up market and our strong international expansion. And now let me take each of those three growth drivers in order, starting with our platform. Five9's AI leadership has been a key reason why customers choose us. Our AI strategy is simple. We combine the power of the industry's leading engines with contextual data unique to each of our customers. We have always believed it's optimal to leverage the best engines in the industry, and the arrival of generative AI has further validated that strategy. Because of this, we believe we have established a significant lead in this market. By embracing the best engines and expanding them with contextual data, we can easily produce basic industry models. But more importantly, we can go beyond that to produce customer-specific models that are setting new standards in providing exceptional customer experience and also doing it responsibly by protecting the privacy of their data. Additionally, empowering customers with this is not just a matter of technology, it's also a matter of people. Five9's experts work hand-in-hand with our customers to gather the right data from the right sources to deliver these customer-specific models, resulting in what really matters, personalized CX and better business outcomes. We believe this strategy has allowed us to be more nimble than our competitors in adopting generative AI and using it across our platform. This has been demonstrated through our recent announcement of GenAI Studio, the industry's first tool that easily allows enterprises to combine best-in-class engines with their unique contextual data and to customize the models on an interaction-by-interaction basis, allowing for new levels of personalization. GenAI Studio can be customized by integrating any piece of data that our platform accesses during the processing of an interaction. This allows customers to leverage investments they've already made in integrations in our platform, which is one of the more complex and time-consuming aspects of implementation. This enables us to enhance their results when they use our AI products. Feedback from customers has been overwhelmingly positive as they will begin to gain these benefits in just a few days, given the ease of use of GenAI Studio. And it's not just customers saying we're ahead; we continue to earn awards and industry recognition from marquee analysts. And of course, nothing speaks to the success of our strategy more than numbers. For example, our AI and automation ARR bookings grew 15 times year-over-year in the first quarter. And now I'd like to focus on our march up market and international expansion. We're very excited to share that we signed our largest deal effort, a Fortune 50 financial services company, which is a testament to our continuing success in moving up market. Dan will share more details in a moment. But I just want to say, we're thrilled to add this win to our previously announced mega deals, such as the parcel delivery company, the healthcare conglomerate, and the global health insurance company. Additionally, as a result of this win, enterprises and the financial services industry are taking notice, and they're already pulling us into large financial services opportunities. As a reminder, our success up market is not just due to our award-winning platform but also because of our people and our partners. Our customer success model remains a key differentiator, as we have hundreds of CX experts globally at Five9, who execute a repeatable large enterprise playbook that focuses on transformation, migration, implementation, and ongoing optimization. Additionally, our collaboration with Premier CX partners around the world is driving our upmarket success and international expansion, as demonstrated by the following three examples. First, we are seeing increased momentum from large SIs. We have an ongoing initiative called Project Pull-Through, which enables and certifies a select group of partners to take on implementation and support services, and it is incentivizing these SIs to lead with Five9 in some of the largest global opportunities. Second, our Salesforce partnership continues to gain momentum, where we have become the first and only CCaaS partner of Salesforce to reach Summit status. This is a major step forward for our partnership. And it gives us early access to releases and APIs so that we can stay at the forefront with Salesforce. Our advanced BYOT integration for Service Cloud Voice is a great testament to this partnership. And third, our BT partnership is taking hold. As a reminder, we have a go-to-market reciprocal arrangement where they resell our Five9 solutions, and we also resell BT connectivity. This is not only improving sales in the U.K. and Ireland markets but also in other parts of the world, where they've been instrumental in helping introduce and secure Five9 business. These are just a few examples of our partners helping pull Five9 up market and also helping expand our global footprint. Before I turn it over to Dan, I'd like to make a few comments on our journey as a public company. As many of you may have seen a few weeks ago on April 4, we celebrated the 10-year anniversary of Five9's IPO by ringing the opening bell at NASDAQ. It was a perfect opportunity to reflect on our journey as a public company. Over these last 10 years, we've made significant progress on multiple vectors, including the following five examples: We grew revenue by 10 times in that 10-year period, virtually all organically. We increased EBITDA margins by 43 percentage points. We increased the number of $1 million-plus ARR customers from 3 to 183. We were one of the early pioneers of cloud contact center and have become a clear market leader and the largest pure-play cloud provider in our industry. And more recently, we have been leading the AI revolution in Contact Center and CX. Today, we're changing the game for many of the largest brands in the world as we help them reimagine CX with our AI-infused data-centric platform combined with our passionate experts. In addition to reflecting on our progress, I'd like to take a moment to thank our team of Five9ers. Our success over the last decade has been driven by their teamwork, commitment, and passion, and I want to personally thank every Five9er for all you do. We are still in the early stages of a massive transformation in CX, and I'm super excited about what we can achieve over the next 10 years. And with that, I will turn it over to our President and CRO, Dan Burkland. Dan, please go ahead.

Thank you, Mike, and good afternoon, everyone. I'm pleased to report that we had a record bookings quarter, and our partner and channel momentum has never been better. Our market-leading platform, the expertise of our people, and our relentless focus on helping customers achieve their CX business goals continue to propel us forward in this tremendous market opportunity. And now I'd like to share some examples of key wins for the quarter. As Mike mentioned, we are very excited to announce that we have contracted with one of the largest U.S. banks serving nearly 70 million customers worldwide. The bank has been using a variety of legacy systems and acquired directly as well as through M&A. I expect several years looking for a strategic partner who could help them transform and consolidate CX across their global footprint with a modern, innovative, secure, and scalable CCaaS solution. A key part of this migration to Five9 will include our recently acquired ACS solution, allowing them to centralize and normalize all of their data from many different disparate systems. They chose Five9 arguably for one reason: trust. They trust that Five9 has the platform, the people, and the partners to deliver an unparalleled CX solution. They purchased our full omnichannel solution, our IPAs, our WEM suite powered by Verint, and an integration to over two dozen CRM systems, including Salesforce and ServiceNow. We anticipate this initial order will roll out and ramp over several years and will ultimately result in over $50 million in subscription ARR to Five9. The second one I'd like to highlight is a company that specializes in higher education, helping universities with recruitment, enrollment services, guidance counseling, and fundraising activities. They had been using another cloud vendor, which was not meeting their needs. They will be using Five9 for a full omnichannel solution for both inbound engagements and proactive outreach. Our full WEM suite powered by Verint, our Agent Assist solution for call transcripts and summaries, and our performance dashboards, along with Microsoft Dynamics integration. We anticipate this initial order to result in over $3.8 million of ARR to Five9. The third example is an American radiology firm specializing in outpatient diagnostic imaging centers throughout the U.S. They have been using Cisco, which lacks the deep integration and functionality with Salesforce, which they had just rolled out last year. They chose Five9 for our end-to-end functionality, our deep integration and partnership with Salesforce, and our industry-leading AI and automation suite. They will start with our IVA and chatbots to intelligently route inbound inquiries to the best resources while also using transcription, call summaries, Five9 insights and analytics to identify where they can best introduce even more automation and self-service applications. We anticipate this initial order to result in over $2.8 million in ARR at Five9. And now as I normally do, I'd like to share an example of an existing customer who expanded with us. This customer is in the healthcare industry, where they provide non-emergency transportation services to and from many hospital networks throughout the U.S. They have been our customer for nearly three years and were spending approximately $2.3 million in ARR. In Q1, they expanded their operations both in the number of human seats as well as adding several hundred IVA ports with additional use cases and languages. With this Q1 expansion, we anticipate that ARR will increase from approximately $2.3 million to over $6 million. So as you can see, we continue to execute very successfully on our go-to-market initiatives, including our march up market, our international expansion, and the growth of our partner ecosystem. And with that, I'll hand it over to Barry to cover the financials. Barry?

Thank you, Dan. We are pleased to report that first quarter revenue reached a record $247 million, growing 13% year-over-year and exceeding the midpoint of our guidance by 3 percentage points. Subscription revenue was the strongest driver, growing 20% year-over-year in the first quarter and now makes up nearly 80% of total revenue. Quality and Enterprise subscription revenue grew 23% year-over-year. Our new logo deployments remained robust with CCaaS setting a Q1 record, demonstrating our focus on executing against a substantial backlog of implementations. On a geographic basis, our investments in EMEA are paying dividends. EMEA subscription revenue, which represents over 40% of international subscription revenue, grew 32% year-over-year in the quarter. Our enterprise business made up 88% of LTM revenue, and our commercial business, which represented the remaining 12%, grew again in the single digits on an LTM basis. Recurring revenue made up 92% of total Q1 revenue. As a reminder, recurring revenue is made up of subscription revenue and usage revenue. Usage revenue grew slower than subscription revenue. As a result, each year, we see a mix shift within recurring revenue, approximately 1 to 3 percentage points from the share coming from usage revenue to the share contributed by subscription revenue. The main reason usage revenue growth is slow is that as we move up market, our larger customers often use the existing carriers for usage. Additionally, our channel partners like BT and AT&T are also carriers, and we will not take business away from them. We see the continuing mix shift away from usage to subscription as a positive long-term trend for two reasons. First, given that subscription revenue consistently grows faster than usage revenue over time, this mix shift reduces the usage drag on total corporate revenue growth. Second, the mix shift improves total corporate gross margins over time, given that subscription delivers higher gross margin than usage. Professional services made up the other 7% of total Q1 revenue. I'd like to remind you that our long-term strategy is to enable our partners to deliver these services. This will gradually result in a mix shift away from PS revenue to subscription revenue. We see this as a positive long-term trend overall because our subscription delivers higher gross margins than PS. Additionally, PS revenue continues to be more lumpy, partly due to large mega deals. Our LTM dollar-based retention rate declined slightly to 109% as anticipated, given the macro conditions over the last several quarters. We expect the Q2 LTM dollar-based retention rate to be either flat or very slightly down and we continue to expect a positive inflection in the second half of the year, mainly because of customers with more than 12 months ramp. Longer term, our retention rate is expected to trend towards the high 120s by 2027 due to a higher mix of larger customers with higher retention rates and continuation of the trend towards selling more and more software, including AI and automation to our customers. First quarter adjusted gross margins were 16.8%, increasing by approximately 40 basis points year-over-year despite the lower-than-normal revenue growth and the substantial transitory investments we are making to support both our successful march upmarket and our successful international expansion. First quarter adjusted EBITDA was $37.6 million, representing a 15.2% margin, a decrease of approximately 90 basis points year-over-year, primarily driven by our strategic investments, most notably FedRAMP in India, both of which we expect to deliver significant long-term opportunities for us. First quarter non-GAAP EPS was $0.48 per diluted share, a year-over-year increase of $0.07 per diluted share. Before turning to balance sheet and cash flow, I would like to draw your attention to the progress we made on reducing stock-based compensation as a percent of revenue, which decreased from 24% three quarters ago to 18% in the first quarter. With regards to our balance sheet and cash flow highlights. In the first quarter, we continued our strong cash flow generation, delivering $128 million of LTM operating cash flow, equivalent to 14% of revenue. This is driven by our EBITDA and strong DSO performance, which came in at 33 days. We have now delivered 31 consecutive quarters of positive LTM operating cash flow, and we remain optimistic about our potential for continuing cash flow generation given our long-term model and our low DSO. As a reminder, we further strengthened our balance sheet with the issuance of new 5-year convertible notes in the amount of $747.5 million. After paying down a portion of our existing June 2025 notes, we added $330 million of net proceeds to our cash balance. We are pleased to have successfully completed the oversubscribed offering, obtaining favorable terms. We locked in a coupon of 1% and an effective fixed interest rate of 3.8%, including the cost that protects us from dilution until our stock price exceeds $122.18. We believe we are nicely positioned for many years to come. And now I'd like to finish today's prepared remarks with a discussion of our guidance for the second quarter and full year 2024. In terms of top line, we are guiding Q2 revenue to a midpoint of $244.5 million, which is in line with the commentary we gave a quarter ago during the earnings call. This represents a 1% sequential decline, in line with our typical negative growth guidance heading into Q2. For the full year, we are maintaining the midpoint of our revenue guidance at $1.055 billion. Given there's still considerable acceleration in the second half, we are being prudent and not putting through the Q1 beat to our annual guidance. Also, please note, we are not expecting any 2024 subscription revenue from the Fortune 50 financial services customer previously mentioned and only a moderate amount of PS revenue. As for the bottom line, we are guiding Q2 non-GAAP EPS to come in at a midpoint of $0.43, which is the in-line outlook we provided last quarter. For the full year, we are slightly increasing the midpoint of our non-GAAP EPS guidance from $2.16 to $2.17 per diluted share, reflecting our plans to continue investing in key growth opportunities to build our market presence upmarket and internationally. Additionally, I would like to provide more color on the quarterly profile of both the top and bottom line for the second half of 2024. We expect group revenue to increase sequentially in the third quarter and more in the fourth quarter. Given the shape of this revenue curve, we expect non-GAAP EPS to improve in the third quarter and more 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 first quarter performance. Many of the largest contact centers in the world are making mission-critical decisions to migrate to the cloud and the strategic investments we have been making are paying dividends as customers select our trusted CX platform to leverage the power of AI and deliver the best customer experience. This is only the beginning of our journey in defining the path for the CX market, and we believe the strength of our platform, our people, and our partners will pave the way for continued success.

And our first question is coming from DJ Hynes with Canaccord.

Congrats on the mega deal. That's great to see. Barry, I'm going to start with you, one of the numbers; I'm going to break the rules right up front, and that's a quick follow-up as well. So the last few years when you beat Q1, you've typically raised the full year outlook as well. This year, it was a beat and you reiterated what you mentioned on the call. Should we read anything into that in terms of further deterioration of demand or activity in the space? Just any comments there would be helpful.

Absolutely, DJ. Let me provide some context. We finished the quarter with a record number of logos installed and a strong backlog that offers us good visibility. At some point this quarter, we need to discuss the changes we anticipate in the second half and the factors behind these changes, including insights from our professional services. Overall, we feel positive about our position. However, we cannot overlook the significant reacceleration expected in the second half. Our guidance indicates a growth rate of 11.4% in the first half, which we expect to nearly double to 20.1% in the second half. This is a bold target, and we aim to remain cautious; therefore, we did not adjust our Q1 guidance.

Okay. Fair enough. And then, Dan, for you, maybe a more strategic question. Do you envision a future in which the pricing model in the CCaaS space significantly evolves away from seat-based pricing and more towards kind of transactional or interaction-driven pricing models? I mean it feels like AI has the potential to move in that direction. But I would love to get your thoughts on how the next three, five years look there.

Yes. Thanks, DJ. We absolutely are seeing that, and we're seeing it already. As you mentioned, with many of the AI applications, they're not really tied to a seat, and they're not really correlated to a seat. They can be, like as an example, even IVA at the front end. We do that per port, which we kind of equate as offsetting a seat. But there are many other applications like Insights, pulling Insights across an enterprise and getting information to make valuable decisions and those are already being tracked, things like transcription and our voice stream application. Those are all priced based on either per minute or per gigabyte or some other consumption measurements. So we're seeing that evolve and take place as we speak. But there's still software that sits in front of the agent that helps the human agent. That's the most prevalent. That will remain to be typically a seat-based model. You're absolutely right. Over time, we'll see that evolve and have more consumption-based pricing.

Our next question will come from Terry Tillman with Truist.

Congratulations on the record transaction. I have a question that may be slightly two-part. Regarding AI and automation, I am curious about the impact they are having on a seat or MRR basis per user. Additionally, with your interesting GenAI tools, have you undertaken any recent efforts to enable users to discover these tools programmatically? What have you observed in terms of uptake?

Yes. So if I look first at the question regarding the seats and how much is being impacted or how much that's being affected by AI and automation, what we're seeing is an uplift. We've talked for many quarters about the fact that our AI applications, when you start to automate interactions, we actually collect more revenue for those, whether it's a like-for-like or you're taking calls that are 100% self-served through an IVA that used to be handled through an agent. We're getting twice the revenue; think of it as per interaction, but it's really on a per seat basis, but on a per port basis. But we're collecting rather than just north of $200 per seat for the human agent software. As we talked, we would get nearly double in the $400 range when we automate those interactions. And then you talk about the rest of the AI portfolio, that's incremental add-on revenue that we achieved. So the wallet share that we achieved from our customers as they increase the automation and move more towards AI goes up, not down. And we're seeing our customer base from a seat perspective when they do adopt AI and automation, it's additive. It's usually giving customers added convenience, one more choice to interact with that brand, driving more and more time that an individual spends with that brand, not taking it as a cannibalization of the human seats.

And Terry, I'll pile on. Our GenAI Studio is an industry first, as I mentioned in my remarks. And again, we're going to continue to out-innovate the competition, delivering more AI products across our platform, and most of those are upsell opportunities to our base, as you mentioned in your question.

We'll now move on to Taylor McGinnis with UBS.

It's Seth Gilbert on for Taylor. We'd love to know maybe a little bit about the vertical seasonality, as you mentioned before, Barry, the guide still assumes a recovery to growth of about 20% for the year. So how do verticals like consumer kind of influence the second half acceleration?

Yes. It has a moderate influence in the sense that we are not experiencing the decline we saw in the fourth quarter of 2023, when, for the first time, a segment of the consumer vertical in discretionary spending contracted. We are transitioning to more typical comparisons, and our installed base is being managed very effectively, which will also contribute positively. Regarding the verticals, it primarily depends on the overall macro economy. We recognize that there are challenges out there, but we have accounted for these to the best of our ability in our planning.

Maybe just a quick follow-up then. Are there any verticals that are outperforming or underperforming conversely that you would call out if it's not consumer?

I can't comment on the end of the year, but regarding Q1 2024, the third largest consumer segment was anticipated to be somewhat weaker than expected. This is confirmed by recent data. If I could elaborate, a significant portion of the economy, perhaps around two-thirds or more, is driven by consumer spending, where people primarily use cash and occasionally Bitcoin, but mostly rely on credit and debit card transactions. Evidence shows that even month-to-month, JPMorgan, the largest credit card issuer, and UBS, which also has credit cards, are experiencing similar trends. Overall, the consumer activity is slightly weaker as we anticipated, while the other segments have remained comparable to previous quarters, showing a slight increase in the first quarter.

Our next question will come from Ryan MacWilliams with Barclays.

So despite the changes in technology and some of these new AI solutions being introduced, Five9 has now seen some of its largest deal wins over the last two years. So given what these technology changes, what do you think these large enterprise customers are choosing to move to the cloud now, and does this increase contact center complexity? Does that benefit Five9 given your track record of pulling these larger deals? Like are you seeing these customers want to have a one-stop shop for your one source of truth for data for all of these AI solutions?

Yes, I'll start, and Dan, you can chime in. Ryan, great question. We've talked about this before. The shift to the cloud is happening for many reasons, the strategic nature of CX, the end of life of these on-premise legacy solutions, AI and the opportunities that provide these large brands to change the game and reimagine their CX, right? So yes, it's way more complex. And that helps us. That's a huge tailwind for us over the next 10 years as complexity almost always accrues to the platform players. And again, you have to have the breadth of platform to not just deliver the applications across that platform but again, the end-to-end visibility that powers the AI. And we talked about GenAI Studio in my prepared remarks, I talked about it, it is a unique differentiator that allows us to leverage the most advanced engines, whether LLMs or small language models, whatever they are, we're engine-agnostic, but it's the combination of combining those engines, the best in the world, the best of the time, and those are going to continue to advance with contextual data. And the only way you get to all the contextual data across an enterprise and a brand is by having the platform. So this GenAI Studio is a game changer. It is putting us out ahead of our competition. And by the way, again, we don't spend a lot of time talking about competition. I'll just say this: We talked about it in my prepared remarks; the generative AI revolution validating our decision long ago to be engine-agnostic. A lot of our competitors didn't take that approach. They've built their own engines. And guess what? They're having to throw away all that investment they made and pivot and play catch up to Five9.

Moving on to Matt VanVliet with BTIG.

I wanted to check in on sort of where you're at on the FedRAMP process? And maybe more importantly, how that's helping you win new deals, both in the federal market, but also the trickle down into the state and local, maybe even higher end as well. Just kind of what you're seeing in those verticals?

Yes, Matt, we're very, very early in that process. We're aiming for the end of 2025 to be FedRAMP certified. We haven't really begun a go-to-market motion in earnest yet. We're still doing state and local government business. We've been doing that for quite a while. But again, it's going to be another 1.5 years or so by the time we're truly in that market.

It's beneficial for us from a market entry standpoint, particularly with large financial institutions and others that want assurance we're progressing towards FedRAMP authorization. These institutions serve federal clients and agencies, and they need to ensure we're on track. This has influenced our ability to secure business. However, as Mike mentioned, we haven't fully launched our market efforts yet. By the end of this year, we expect to be in the application process, and once we have a sponsor, it typically takes around 12 months to receive authorization to proceed.

I want to mention that we are currently exploring investment opportunities that we are leveraging, and I believe our management team has shown the ability to select the right investments. This includes FedRAMP, which involves a significant financial commitment. We will provide you with a quarterly update on these investments. For the first quarter of 2024, the cost was $1.9 million, contributing 77 basis points to EBITDA.

The next question comes from an indiscernible speaker.

I know you guys talked about Q4 as a record booking, and you were expecting some of those go-live that’s embedded in your guidance in the second half. So wondering, how is the go-live going? And do you have visibility into their go-live? And have you baked in any kind of conservatism in case that any go-live was delayed?

Yes, I'll begin, and Barry can join in as well, but the go-lives are progressing very well. We activated a record number of seats in the first quarter. We handle our backlog of products, seats, subscriptions, and other AI solutions similarly to a pipeline. Once we secure that business, our product support team and implementation team closely track the metrics and our deployments. We recently shared this information at our board meeting, so we have excellent visibility on it.

I would like to add two points to that. The topic you raised is crucial as it relates directly to the change in our dollar-based retention rate. Regarding spot rates, we have provided the last twelve months' figures, which have remained steady over the past three quarters. However, the growth will come from our larger customers as they begin to go live, which is essential for us. We have a strong team that consistently meets or exceeds the number of seats we project for each quarter. Their approach is grounded in reality rather than just aspirations, and they work effectively behind the scenes. While customers may have their own thoughts, they are generally very encouraging.

Thomas Blakey with KeyBanc has the next question.

Congratulations on the mega deal. I have a two-part question. Dan, for you, just if you could highlight one or two keys for winning this deal. I know you talked about trust and whatnot, but just trying to view how this could impact future wins down the road where we're seeing deals get larger and larger here. And then, Barry, for you on backlog, you mentioned that, I think, in your preamble, maybe talk about any type of cushion you might have there as it relates to the sharp uptick in growth into the second half, that would be helpful.

Great questions. Regarding the large bank, as mentioned earlier, trust was a key factor. They conducted a thorough inspection and audit of us and our competitors, unlike any other process we've seen. They spent several days at our corporate offices, not just evaluating the product and platform but really assessing our capability to support their large and complex operations. While discussions about product and innovation are essential, they were particularly focused on how we would help them achieve their business outcomes, requiring us to demonstrate that through hands-on engagement rather than just presentations. We had many technical team members from the bank that spent several days with us on multiple occasions to gain a deep understanding of our capabilities and the partnerships we can leverage. Looking at the shift to cloud solutions, especially in AI and automation, they recognized the importance of cloud-to-cloud integration, which allows for enhanced data utilization and improved experiences. Our partnerships, particularly with Google for AI applications, were significant in this context. Their confidence in our ability to deliver comprehensive support for a global organization like theirs was influenced by our expertise and the strength of our professional services team, many of whom have previously worked with major financial institutions. Additionally, our acquisition of ACS played a role in the decision-making process, as it enables us to aggregate and normalize data from various systems they operate, ensuring smoother transitions without operational disruptions. This capability is crucial for them, especially when they need to understand reporting and metrics without worrying about the underlying systems.

To address the second part of your question, we anticipate needing an additional $116 million in year-over-year growth to achieve this reacceleration, which will now span three quarters instead of just the second half. This $116 million is divided into two parts: $64 million will come from the DBRR, while the remaining $52 million will originate from new logo deployments that you mentioned. The majority of this growth will stem from the DBRR, and this estimation is based on a figure of $110 million prior to the inflection. Most of the $52 million is primarily in our backlog, although not entirely; there are some elements we expect to complement in the next month or two. Overall, the bulk of it is in backlog. Additionally, we previously discussed the expertise and capabilities of our professional services team.

Meta Marshall with Morgan Stanley has the next question. I think Meta might be joining us audio-only today.

Yes, I apologize. No one surpasses frozen video. The question revolves around migration, particularly as deals become longer or larger, which is certainly a consideration. Aceyus has been instrumental in this aspect. I'm curious if there is a way to quantify how Aceyus may reduce those migration cycles. Additionally, regarding the service provider and service integrator channels, did you leverage those partnerships to assist with migrations? Is the speed of these migrations aligned with what you've observed in your own channel? I'm trying to understand the trends related to the pace of migration.

Yes, I'll take the last part of the first. Thanks, Meta. When you look at the migration, it's very much in sync, whether there's a systems integrator involved or not, they tend to help them take and offload a lot of the project management and program management and help work with the customer through a large-scale migration. But most of the actual work of the configuration and integration effort is done by our professional services team. Now we're in the process of enabling those SIs to get certified and really get their skill set to where ours is. We have a very, very high bar that we set for what we require and demand. And we're starting to get leverage from those. The goal is to ultimately move more and more off our personnel and onto theirs for obvious reasons. But that's something that it's really hard to shorten it too much. Yes, the tools help, like I said, in that last example with Aceyus. But for the most part, it's a matter of going as quickly as the customer can. We'd like to obviously move as quickly as they're able so that we can get to revenue sooner. But there's a lot of planning and oftentimes, there's a lot of changes that they're doing. And so they have to have a lot of internal meetings themselves in order to make some important decisions.

I'll move on to Jim Fish with Piper Sandler.

Nice to get the win on the board here, and I'm sure you're sick of answering the question about stagecoaches, Barry. So actually building off of that last question, you guys mentioned incentivizing these SIs to lead with Five9 through, I think you called it project pull-through. Can you just walk us through what you're changing in terms of these incentives and any go-to-market changes outside of this that you're planning on this year? And with that SI aspect, kind of how we should think about SI contribution today in terms of how much is pulling you guys in versus where you expect it could be over the next couple of years?

Yes, I'll begin, and Dan can add his thoughts. We initiated Project Pull-Through nearly 18 months ago, which was intended to engage more with system integrators and other resellers who aim to include services revenue in their offerings. If you analyze our business, you'll notice that subscription revenue is a crucial metric that everyone should focus on. As we transition some services to system integrators and partners, we won't capture that revenue, which explains the differing growth rates between our professional services revenue and usage revenue relative to subscription revenue. This approach aligns with our business strategy and is beneficial for our margins. We called it Project Pull-Through because we realized that incentivizing these system integrators and resellers to include services revenue makes them more inclined to involve us in deals. Eighteen months ago, we were missing out on this opportunity, which is why we started the project. It's positively impacted our performance in the upper market, and while it's still early, we're seeing a significant portion of our implementations being handled by third parties, especially internationally, along with notable growth in our U.S. implementations.

Baird's Will Power has the next question.

I come back to the Fortune-50 win. Great to see that. Congratulations. I mean it sounds like professional services and your ability to execute are big pieces of that. But I'd love to get some color as to how important AI was and how focused were they on the IVAs and the capabilities you have there? And what kind of stood out in your platform on that front, perhaps versus others? And I guess kind of tied to this kind of mega deal thought process. I mean any qualitative color as to how the pipeline is building for other dolphins and whales, I guess, as you look forward?

Sure. Thank you, Will. When examining the dolphins and whales, even without that significant bank, the pipeline remains at a record level. It's still very strong even after accounting for that deal which did decrease the pipeline substantially due to its size. Overall, the pipeline is quite healthy. Regarding AI, it played a crucial role in their decision-making process. Many banks, including this one, already have considerable automation and self-service on their legacy systems, but those systems lack effectiveness and accuracy. Old speech-enabled IVR from a decade or more ago allows for basic functions like checking balances, but it's not nearly as sophisticated as today's technology. A major factor was how they would transition to modern IVAs. Fortunately, we have the inference from that acquisition and the upgrades we've implemented to provide what they consider the best IVA solution for self-service, as well as integrating our Agent Assist. Our partnership with Google enables us to analyze real-time conversational data and retrieve accurate information from the appropriate sources. For a large bank with numerous CRM systems, it's essential to extract the right data to effectively respond to customer inquiries. While these tasks may seem highly technical, we outperform competitors due to our engine-agnostic solutions, our speed in collaborating with various engines, and our flexibility. They were able to request specific engines for particular use cases, and they even considered developing their own solutions tailored to their data to expedite information retrieval, eliminating the need to search through multiple databases. If they have a specific use case, they prefer a highly personalized, customer-specific solution to access data swiftly.

We'll now hear from Scott Berg with Needham.

Everyone, a really nice quarter. Mike, you'd made a comment on the Summit Status with Salesforce. I think that's an interesting comment because they effectively partner with all your competitors in the space as well, whether they be in investments or they really partnered supposedly tightly if you're a company based in Seattle. If you're the first one on the status, I think that's kind of interesting. Help us understand a little bit more maybe what this can give you outside of an early look on technologies, etc.

Yes, Scott. I believe it comes down to visibility and technology, as mentioned in our prepared remarks, and Summit Status is very objective. It’s based on the business we've done together. Ultimately, that's how they assess that status and determine who qualifies for it. It serves as a reliable metric for gauging the amount of business we've conducted with Salesforce; it's significant. It truly is a significant matter for both them and us.

Moving on to Michael Turrin with Wells Fargo.

Some encouraging commentary throughout here. I want to go back to the key metrics, Barry, and what needs to happen for those to trough. It sounded like flat to slightly down in terms of retention for Q2. You've been talking about the second half move up. I mean how much do you still need to execute to get there? And maybe you and Dan can just speak through confidence, visibility, how that's progressed from when you initially framed the '24 outlook to where we currently sit?

It's easiest to break it down into three categories: new, established, and the installed base of professional services. For the new category, the backlog was mostly in place and has increased slightly over the past three months, though there haven’t been any significant changes. Regarding the dollar-based retention rate, it has decreased by one percentage point this past quarter as anticipated. This decline is due to the fact that while spot rates have been stable for three quarters, we have dropped off from one of the higher rates and haven't had anything higher to compare against, which has resulted in a slight decrease. However, we are now clearly seeing the flow we expect, although we can't guarantee it. Notably, the last time we observed an increase in the dollar-based retention rate was in the second quarter of 2021, which feels like a long time ago. We are optimistic that the economy will cooperate, as there is a close correlation. Additionally, our analysis indicates that we have several significant enterprises that started contributing to our base in the second quarter of 2023, which are ramping up now. This includes more than just healthcare companies and will also have a positive impact on the spot rate, if you understand what I mean. Lastly, we anticipate some support from professional services, particularly from a major Fortune 50 financial services company, which will also contribute positively.

Samad Samana with Jefferies has the next question.

Barry, I have a question for you. Just thinking about the monetization of AI, I think someone earlier had asked about maybe a pricing model shift. And when I think about maybe gross profit dollars per $1 of AI revenue versus maybe what you would get for core subscription, if it's obviously double the revenue, you should get more gross profit dollars that when you factor in maybe WFO as well. I guess what I'm trying to figure out is, should we think about AI being a gross profit dollar tailwind as well and maybe just on the top line? And how should we think about that flowing through maybe over the next year or two?

Yes. I will refrain from discussing this for the upcoming year. The reason for this is that we have five reasons why gross margins will increase over time, with the largest factor being revenue growth in relation to fixed and semi-fixed costs. We are pleased to have maintained our gross margins despite the current slower revenue growth. I won’t delve into specifics about revenue, but one of the factors contributing to the improvement is the upsell, cross-sell, and attach rates from our AI and automation solutions, which result in significantly higher gross margins. These attach rates are notable in both new bookings and our existing client base, and they exceed small percentage increases. Additionally, regarding the other items mentioned, they relate to our previous comments and the gradual shift in revenue mix from both usage revenue and professional services, which have historically generated negative gross margins. As for the third factor, we also anticipate some one-time investments that are temporary. There are costs associated with our operations in India that we haven’t seen corresponding revenue for yet. Furthermore, we have several initiatives within the professional services organization aimed at eliminating negative gross margins.

We have time for one additional question. So our final question is going to come from Peter Levine with Evercore.

This is Bill on for Peter. With the healthcare expansion story going from $2.3 million to $6 million of ARR, how often will this kind of increase be the norm? Or should we think of this kind of uplift as an every now and then?

It's at that amount, I would say it's an every now and then. That's why I highlighted it. But we get our installed base customer, we talked about, I think, last quarter about the folks that are focused on our installed base, we had individuals that were wearing both hats of CSM and seller. So they were taking care of day-to-day issues with the customers and then putting their sales hat on and trying to do cross-sell, upsell. We've actually taken that team and divided it into separate individuals for each customer. So they now have a CSM that's responsible for the day-to-day and they have a seller that's there to upsell, cross-sell that carries a bookings quota. And they're primarily focused on these applications, the cross-sell and upsell applications. That will take effect and show itself over time. But that's what typical most software companies about our size go with that mix of hunter and farmer even in the installed base. And that should contribute nicely to it. And we're seeing software being sold to our installed base at a good rate and that will only increase as we roll out more and more of these.

And again, this does conclude our Q&A session. So I'll turn it back to you, Mike, for closing comments.

Yes. Thank you very much for joining us today. As I said in my prepared remarks, it's been an amazing journey, 10 years as a public company. I am really looking forward to the next 10 years and seeing what we are able to achieve as a team. I want to thank all the Five9ers one more time, and thanks again for joining the call.