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Good day and welcome to the Five9's First Quarter 2019 Earnings Conference Call. Today's conference is being recorded.
At this time, I would like to turn the conference over to Ms. Laukkanen. Please go ahead, ma'am.
Thank you, Operator. Good afternoon, everyone and thank you for joining us on today's conference call to discuss Five9's first quarter 2019 results. Today's call is being hosted by Rowan Trollope, CEO; Dan Burkland, President; and Barry Zwarenstein, CFO.
During the course of this conference call, Five9's management team will make projections and other forward-looking statements regarding the future financial performance of the company, industry trends, company initiatives, and other future events. You are cautioned that such statements are simply predictions and should not be unduly relied upon by investors and actual events or results may differ materially and the company undertakes no obligation to update the information in such statements.
These statements are subject to substantial risks and uncertainties that could adversely affect Five9's future results and cause these forward-looking statements to be inaccurate. A more detailed discussion of certain other risk factors that could cause these forward-looking statements to be inaccurate that you should consider in evaluating Five9 and its prospects is included under the caption Risk Factors and elsewhere in Five9's filings with the Securities and Exchange Commission.
In addition, management will make reference to non-GAAP financial measures during this call. Management believes this non-GAAP information is useful, because it can enhance an understanding of the company's ongoing performance and Five9 therefore uses non-GAAP financial information internally to evaluate and manage the company's operations. This non-GAAP financial information should be considered along with and not as a replacement for financial information reported under GAAP and could be different from the non-GAAP information provided by other companies in our industry. The full reconciliation of GAAP to non-GAAP financial data can be found in the company's press release issued earlier this afternoon and is also available on the Investor Relations section of Five9's website.
Now, I would like to turn the call over to Five9's CEO, Rowan Trollope.
Thank you, Lisa, and thanks to all of you for joining our call this afternoon.
We started off 2019 with a strong first quarter with $74.5 million in revenue, up 27% year-over-year. That is a Q1 record growth rate for us as a public company. And we had $11.8 million in adjusted EBITDA representing a 15.9% margin. Our momentum in enterprise continued in Q1 with our enterprise business growing to 78% of LTM revenue and our enterprise subscription business grew at 36% on an LTM basis, while our customers over $1 million in ARR continue to represent one of the fastest growing parts of our business.
And we continued to expand our existing customer relationships with our dollar-based retention rate which accelerated to 107% largely due to a recent record in enterprise. Thus, you know, we're at the beginning of the migration of the $24 billion contact center category to the Cloud. And this category has emerged as an increasingly important spend category for IT, as demonstrated by Morgan Stanley's recent survey showing that customer service is the number one priority for Cloud spending.
So as leading companies recognize that continually improving the customer experience can drive measurable returns, we see our role as a trusted partner to larger enterprises continuing to accelerate. Our progress with enterprises and our overall go-to-market motion is reflected by our customer wins this quarter.
So I'll now turn the call over to our President, Dan Burkland, who can give some specific examples of customer wins. Dan?
Thank you, Rowan.
Our Q1 enterprise bookings grew significantly year-over-year to a Q1 record and our pipeline reached another all-time high, while we continue to gain strong traction from our partners who influenced over 55% of our deals. We're also continuing to see additional traction with global channels, increased business with our systems integrators, and in scaling our International presence. This quarter we continue to see larger and larger deals coming in.
For example, a leading BPO with several thousand agents on their legacy system was experiencing reliability issues along with a closed architecture with limited ability to support their customers numerous integration requirements. They've chosen to migrate several of their existing customers as well as new customers over to the Five9 Solution due to its reliability and flexible open architecture. This initial order is anticipated to result in over $2 million in annual recurring revenue to Five9.
The next example is a leading federal funding source for mortgage lenders introducing a premises-based system which they found to be expensive, unreliable, and delivered a poor agent and customer experience. They required integration to both Salesforce and ServiceNow and after completing a bake-off with another Cloud provider, Five9 was selected due to our strong analytics including real time dashboards and performance management. We anticipate this initial order to result in over $1.1 million in annual recurring revenue to Five9.
The next example is a global provider of cleaning and hygiene products for the hospitality & healthcare markets. Five9 was introduced by a partner to replace their premises-based system and we competed with all the major premises and Cloud providers through an RFP process. The customer already a Fuze UC customer, looked at our strong partnership and integration with Fuze, as well as our deep Salesforce omnichannel integration, full suite of WFL Solutions powered by CSI, and commitment to deliver the solution in under 90 days. We anticipate this initial order to result in over $1 million in annual recurring revenue to Five9.
Now as we normally do, I'd like to share with you an example of an existing customer who continues to expand their use of Five9. This example is a leading Fintech provider of accounts payable and payment automation solutions. In 2017 they started with less than 100 seats in their Customer Support Group, while continuing to use another provider for their sales department. During a recent PCI Audit, it was determined that they were out of compliance using this alternate provider. After their security and IT teams inspected and recognized Five9's capabilities to help them maintain compliance, they moved all of their sales department over to Five9 as well. The company selected Five9 for the deep understanding of PCI regulations and proven experience in helping organizations maintain compliance, while also improving the customer experience. With this significant expansion to several hundred seats, the customer is anticipated to grow from 200K to over 600K in annual recurring revenue to Five9.
As you can see, we continue to execute up market with larger and more complex customers, while also helping expand our footprint and offerings within our growing customer base.
With that, I'll turn it back to Rowan.
Thanks, Dan.
Now I'd like to discuss two areas where we enjoyed great momentum this quarter starting with Product. During Enterprise Connect Conference in March, we announced our Spring 2019 release which will be available this month. This really demonstrates the momentum we've created with our new technical leadership team. The Spring release focuses on three areas. First, a focus on larger enterprises. As we continue to move up market, we have further increased agent capacity to handle very large organizations and enhance the abilities of enterprises to customize and adapt our solutions to their business systems via new and enhanced set of APIs covering digital channels, data services, and data management for recording.
Next, as customer experience accelerates and strategic importance, our customers are increasingly demanding deeper integrations with their CRM in their UC System. And so we're expanding our SDKs and our APIs to provide that critical flexibility.
And finally, as we continue to expand internationally, we're launching new voice points of presence in Latin America and Europe accommodating the growth that we're beginning to see in these regions. So I'm really proud of the progress that we continue to make on the product front.
Now I'd like to share with you a brief update on AI as many of you will recall, we hired our CTO and Head of AI, Jonathan Rosenberg in January of this year, and since then, we've achieved several important milestones.
First, we've begun to build out our engineering team. Next, we've created an AI product roadmap and we've shared that with our largest customers. And not only has the feedback been overwhelmingly positive but to our surprise, and my surprise, we've received a tremendous breadth of demand from our customer base particularly from our largest enterprise customers. And finally, we demonstrated our AI leadership with Salesforce and Google at the Google Next Conference this past April. We demonstrated a three-way integration that enable agents using Salesforce to see suggested knowledge based articles in real time based on a customer's speech during a call. And we believe that this is an industry first integration between Five9 and Contact Center Company, a CRM company with Salesforce and Google's new contact center AI platform. So going forward, we remain laser focused on AI development and we're looking forward to delivering on our roadmap.
As optimizing customer engagement increasingly becomes a strategic priority and the market embraces the shift towards the Cloud to improve customer experience, we believe Five9 is extremely well-positioned to capitalize on these opportunities.
So to expand on our financial performance and guidance, I'll now turn the call over to our CFO, Barry Zwarenstein. Barry?
Thank you, Rowan.
Before getting into specifics, a reminder that unless otherwise indicated all financial figures I discuss below are non-GAAP. Reconciliations from GAAP to non-GAAP results are included in the Appendix of our Investor Presentation on our website.
This is another strong quarter. Revenue grew 27% year-over-year as compared with a 25% year-over-year growth we reported in the first quarter of last year. Our growth continues to be driven primarily by enterprise subscription revenue which is the fastest growing and most profitable part of our business.
Enterprise subscription revenue continued its multi-year performance of growing in the 30s posting growth of 36% on an LTM basis. Our enterprise business in total which includes not just subscription but usage and professional services as well made up 78% of our LTM revenue.
Additionally, our commercial business which represents the other 22% grew in the single-digit. We expect continued single-digit commercial revenue growth now that we have left the easier 2017 compare.
Recurring revenue accounted for 93% of our revenue. The other 7% of our revenue was comprised of professional services.
First quarter adjusted gross margins was 63.4% an increase of nearly 120 basis points year-over-year. First quarter adjusted EBITDA was $11.8 million representing a 15.9% margin, an increase of nearly 320 basis points year-over-year. First quarter non-GAAP net income was $10 million, a year-over-year increase of $5.5 million.
Finally, before turning to guidance, some balance sheet and cash flow highlights. DSO for the first quarter was 28 days. Our operating cash flow for the first quarter was $11.2 million, a year-over-year improvement of $3.2 million. We are optimistic about our potential for continuing cash generation given our long-term model on substantial NOLs and our low DSO.
I'd like to finish today's prepared remarks with a brief discussion of our expectations for the full-year and the second quarter of 2019. For 2019, we expect revenues to be in the range of $304 million to $307 million. GAAP net loss is expected to be in the range of $17.3 million to $14.3 million or $0.29 to $0.24 per basic share. Non-GAAP net income is expected to be in the range of $39.3 million to $42.3 million or $0.61 to $0.66 per diluted share.
Consistent with our previous discussions, this bottom-line guidance reflects expected increases in various growth initiatives particularly in R&D and in go-to-market initiatives to go after this massive market opportunity that is coming towards us.
For the second quarter of 2019 which is our seasonally toughest quarter, we expect revenue in the range of $72 million to $73 million. GAAP net loss is expected to be in the range of $6.7 million to $5.7 million or $0.11 to $0.09 per basic share. Non-GAAP net income is expected to be in the range of $7 million to $8 million or $0.11 to $0.13 per diluted share. This guidance for the current quarter includes the impact of the expected increase in growth investments, I mentioned a moment ago.
With respect to our expected revenue trends by quarter, we expect revenue to increase sequentially in the third, and particularly in the fourth quarter. However due to near-term renting of expenses, investors should expect a bottom-line improve only slightly in the third quarter and to be much stronger in the fourth quarter where we expect to again be reporting 20% plus adjusted EBITDA.
For modeling purposes, we would like to provide the following additional information. For calculating EPS, we expect our diluted shares to be 64 million and basic shares to be 60.2 million for the second quarter of 2019 and 64.5 million and 60.5 million respectively for the full-year 2019. We expect that taxes which relate mainly to foreign subsidiaries to be approximately $75,000 for the second quarter of 2019 and $190,000 for the full-year 2019.
Our capital expenditures for the second quarter of 2019 are expected to total approximately $6 million to $7 million. For the full-year 2019, we expect capital expenditures to be between $20 million and $24 million.
In summary, we're pleased with our first quarter performance, driven by the strong revenue growth, excellent unit economics, and the ongoing operating leverage. The modernization of the contact center continues strongly and the Five9 team continues to execute extremely well against this massive opportunity.
Before turning the call over to the operator, I'm pleased to announce that on November 12, Five9 will host an Analyst Day in New York City. We look forward to seeing many of you there. Operator, please go ahead.
Thank you. [Operator Instructions].
We'll take our first question from Meta Marshall with Morgan Stanley.
Thanks so much guys. Congrats on the quarter. You mentioned the Enterprise Connect that you were going to have a customer trial for some of the AI capabilities and I just wanted to kind of get an update on what that timing is looking like. And then maybe second on the AI piece, you mentioned starting to make some of the hires but just kind of where you finding people from. Are you finding it easy like are you having to hire people away. Just kind of what the breadth of the talent pool for AI would be helpful. Thanks.
Yes, thanks, Meta. This is Rowan. On the customer trial update, yes, we're -- so we're -- we actually shared this plan with all of our biggest customers at our Customer Advisory Board and got very, very positive feedback. So I think Jonathan asked for volunteers from our biggest customers to sign-up for some of the new -- some of the new capabilities and one specific capability that he's been sharing with them and I think all 15 customers asked to get on that list. So hugely, hugely positive on that front. We're not yet in pilot phase on that front. We did demonstrate some of this capability at the Google Next Conference but we don't have any of this in production yet with a customer. So stay tuned on that front.
With regards to hires, we're fine. We're actually hiring here at our headquarters here in Silicon Valley. So we're looking for folks in the Bay Area. And there's plenty of people here unlike perhaps some of the larger customers, larger businesses here who need to hire hundreds or thousands of people, we're looking for a small handful. And we've been able to so far attract the right talent to join our team. And Jonathan's been a great help with that because he's got a very solid reputation in the industry and frankly, I think the story that engineers like to hear is that you've got crazy good data and you've got a plan and a vision on how you're going to leverage that data. So we've already started to build that team and starting to see some early positive results from them, so. Thanks, Meta.
We'll take our next question from Raimo Lenschow with Barclays.
Congrats from me as well. And thanks for taking my questions. Can you talk a little bit about the -- what you see in the evolution of the industry, if you look at the more on the UC side, you see kind of all these different players kind of coming together and everyone is offering everything. And you mentioned on the earlier remarks that given your partnership with Fuze is working really well. What do you see in terms of the call center side like how you're kind of going to play out and how that's going to play out in a broader industry theme?
Yes, thanks. This is Rowan. I'll jump in on that. So the UC companies specifically ring 8×8, Vantage all now have either through partnership or through their own organic development or acquisition, a contact center offer Fuze included. And what we see is that at the lower end of the market, the sub 50 seats, the existing customers this is all Brownfield but every existing customer who has a UC system has a contact center attached to it and they need -- when they upgrade from let's say premises to Cloud phone system as the primary selling motion that the UC vendors do, they need to attach a contact center to that because you can't rip out the phone system and not also rip out the contact center at the same time.
So this is a sort of a necessity and I think it's a very valid sales motion for a bundled UC plus contact center offer at the lower end of the market. As you move up into the higher end is where you typically -- is where you see us and in contact and others, where there is no sort of direct connection to the -- from a buying center perspective between the call center and the UC folks. So UC when we go into the selling motion that we have, we're selling direct into the content, the Head of Customer Service or the Head of Sales or someone who's responsible for customer service or front-end really potentially running a contact center. And in those cases up market, there's this disaggregation of the stack and people want best-of-breed and that's where we really win.
So it's not that I actually believe that the UC go-to-market synergy is really there. There's a tremendous synergy at the low-end of the market. The high-end of the market it tends to be more CRM synergy that's necessary. We see our customers in these larger contact centers actually one for one ask us for more integration with their CRM systems and they don't -- they're not really looking for integration into UC.
As you know, our solution is totally web-based. There's no phone system, there's no PBX, there's no hardware sitting on people's desks, and so on, if you log into a web browser and we deliver the audio through the web browser. So that's the thing that I think a lot of our customers like.
So big market, lots of opportunity down market for bundlers and we're seeing great success on the standalone sale market. And by the way when we do see those customers who want UC, we have partnerships there where we can bring that together to the customer.
Perfect. That's clear. If I squeeze one more in, can you talk a little bit about the sales motions that you're seeing at the moment. You mentioned earlier like in the call like the RF -- like RFPs in but what we hear in our checks is you're seeing more and more seeing as like the industry leader in there. Have you noticed that it's less RFP and people kind of realizing the strength of Five9 coming directly to you like can you talk a little bit about their tenant to that?
Yes, this is Dan Burkland. Yes, we see a combination. I mean we certainly have our share of RFP processes that we go through and oftentimes doing bake-offs in PLCs with customers to get them comfortable with Five9 and with Cloud. And then we also see a lot of customers coming directly to us and bypassing the RFP process because they've already narrowed it down to a couple of choices and just making sure that we can deliver on the promise. And so, yes, I think it's a combination of both.
And we’ll take our next question from David Hynes with Canaccord.
Hey thanks guys. Congrats on the results. I don't know if this is better for Barry or Rowan but I wanted to ask about the dollar-based retention, a four point sequential uptick. I think that is as much as I can remember any more granularity on what's driving that. I mean I realize as enterprise grows into a larger part of the mix that that naturally is going to occur but it seems like an outsized step-up. So anything specific you could point to?
Yes. So, DJ, this is a reflection of the mix towards the enterprise as you alluded to. We've had a recent record in terms of enterprise retention and when the chips are down what really matters is the trust that they build with us. That trust is manifested in terms of uptime and when things go wrong as they do inevitably with any company, how we communicate with them and support them and that shows up.
Going forward, we cannot deny the possibility there may even be further increases because we have some pretty good tailwinds over here.
Got it. I love; I always loved your disclaimers, Barry. And then maybe a follow-up for Rowan, obviously some incremental investments this year, you yet asked a lot about AI but I think you've said that maybe the biggest area of focus is the CRM integration, so maybe you could just help me understand what exactly you guys are doing there right. I mean CRM integrations feel like they're already a strength of Five9 and you have all these robust integrations. So what do you need to kind of go deeper with your current partners?
Yes, absolutely. So actually the headline where most of the incremental R&D investment is going is into product innovation that is directed towards selling larger and larger enterprises. And the first thing on that list in terms of priorities that we hear from those enterprises is deeper integration almost out of the box with their CRM vendors. So that's not a sort of a binary you get it done and then it's done because the state-of-the-art here is moving.
Salesforce for example have been rubbing their APIs and coming out with new ways to integrate with the Salesforce platform. For example, we now have a way to do shared routing between digital channels that Salesforce bring and the channels that Five9 brings. So you can sort of customize that as you like. That was a recent launch by Salesforce as sort of a next-generation API. So we supported in our last release, we supported that so that customers can integrate.
So I'd say it's continuing to be a moving target as these systems get deeper and deeper integrated together. And the big driver for that is our large enterprise customers. Now there's other things that we're doing for those large enterprise customers around APIs and developer platform capabilities. So we talked about I think earlier on the call that we as part of this release that we're launching this month, we are delivering new APIs around UC integration and SDK is built on those APIs, so that we make it really, really easy for these larger enterprises to connect our contact center into their back-end and sort of adapt it to the various systems that they have. So that's kind of the main focus of the incremental investment in R&D right now.
Yes, okay. That's very helpful. Thanks a lot guys.
Thank you.
We will take our next question from Brent Bracelin with KeyBanc.
Thank you for taking the question. I'll start out, have a couple here. I'm going to start first one with Rowan here. Specifically on AI, I guess now that you've showcased the AI product roadmap with customers, love to get your thoughts on how you're kind of at least thinking about AI monetization. Do you think this is going to be a seat-based subscription, add-on software component, is this going to be kind of a consumption based opportunity? I know it's early days but any thoughts on the monetization of the what sounds like a pretty promising product roadmap?
Yes. There's two monetization models for the two different offers that we are looking at. The first one is the virtual agent which is you could think about this as a next-generation IVR that is entirely speech-based. So it's automated. And for that, we are looking at charging not in a seat basis but more on a port basis or on a usage basis in terms of by the minute. So today we include an IVR and that's kind of built into the price. In this upcoming release, we will have the hooks to be able to deliver this virtual agent capability with powered by some of the Google technology. And as we do that, we will charge -- the current thinking is charge by the minute because it's not attached to an agent. It's called deflection and then it exists at the front door of your -- to replace your IVR.
The second offer that we're looking at is Agent assistance which sits next to the agent in real time listening to the call and is making suggestions to the agent about the Next Best Action and prompting them with sort of scripted things that they can do and that is going to be up charged to the seat price. So it'd on by seat because it's attached to a human agent.
Very helpful. And again I appreciate the transparency given kind of early stages. Second question is really more towards Dan and that's trying to get at the heart of what we've seen here over the last two or three quarters. And that's an uptick in the million dollar deals, large enterprises. What's driving the large enterprise kind of wins at this point? Are there specific end-of-life catalysts to these on-prem systems? Is there now a higher priority with the C-level executives that are mandating a more agile, flexible kind of digital call center? What do you think are the fact, main factors driving these large enterprise wins for you guys over the last several quarters?
Yes, Brent, great question. Thank you. And I think it's several different factors, if you look at the appetite up market for Cloud in general, and specifically for Five9, is coming from a trust level that they have. Our ability to deliver not only the feature functionality that they desire and the openness to allow us to integrate with their other systems that are already in place in their enterprise. But really it's about being able to -- for them to trust the fact that we can give them increased reliability, we can secure their data, and protect their customers data better than they can and we can provide added redundancy so that if there was some type of a hiccup or something, that's going to occur in the network or in their system because we're monitoring the system 24X7 and seeing symptoms that might anticipate a potential impact to the system. We can make corrections that therefore don't cause an impact to our customer.
And so I think it's number of those factors and then obviously being on a current release level at all times and being able to innovate much more effectively with Five9 gives them that comfort level that we can take them and not only replace what they have today and give them more in each of those areas but also set them up for the AI roadmap and the innovations that we talked to them about that are coming in the next several years. The only way to really take advantage of those AI capabilities and do things like Agent Assist and do things like auto provisioning and really take their contact center to the next level and make it an engagement center.
The first step you have to do is to get to the Cloud because that's where you have to be to be able to leverage the data that's available. The millions of recordings and the billions of calls that we store in our system and in our infrastructure can be leveraged to make the machine learning that much more effective. And so we're starting to see that, if they don't get to the Cloud, they can't take advantage of those innovations as they come about.
Helpful color there. And my last question is just on partner influence deals. You talked about I think 55%, over 55% contribution for the last four or five quarters now. What do you need to do there to drive that higher? It just seems like the appetite of markets there. You have differentiation, are there things you can do to kind of accelerate partner influence deals and help me kind of understand the opportunity there?
Yes, absolutely. In fact that's a big investment area for our go-to-market engine here in 2019 which is -- we've always had partner influence and those come from whether it's a CRM, ecosystem partner, or whether it's some of our WFL partners or Master agents that are finding opportunities and providing us leads. The partners that we have brought onto the platform and brought into Five9 spans a much wider spectrum.
We're also seeing for the first time a real interest. We had several systems integrators, large systems integrators like Deloitte and EY and Accenture and others that would use us more opportunistically where they had a client that said we want to go digital transformation and we want to migrate to the Cloud. They would then lead with us. They've now started to build business practice around the Cloud transformation and are starting to lead their clients to Five9 as opposed to the other way around.
We've also seen a distinct difference and part of this is Rowan having come from Cisco and several other leaders having that background and working with large global distribution arms that again used to look at Cloud as well, I'll sign-up with you and I'll use you opportunistically where my client wants it. But they're starting to lean in and see that they can build a practice around really investing the time and resources not only on the pre-sale side because they have contact center organizations that are focused within contact center but they also have post-sale services organizations that are now recognizing that they can make money and be successful deploying and supporting Cloud based solutions like Five9, so lots of potential upside here in the future.
And we'll take our next question from Sterling Auty with J.P. Morgan.
Yes, thanks. Hi guys. Want to drill in on the Spring release and the capacity enhancements for a large enterprise. Can you remind us when you look at the bifurcation of the market, what does this open up in terms of what portion of the total addressable market does that now bring within reach to your solution?
Well, thanks, Sterling. We -- as you've seen, we have continued to grow that million dollar deal segment which is hundreds of seats plus. And as we get up into those 500 to 1,000 seat deals, more of these kinds of requirements are necessary. So more improved granularity on admin controls, deeper integration with their CRM back-ends, more programmability through APIs. So it's opening up for us, I would say more and more access to those deals that are larger than a 500, 1,000 seats even while we do have some of our largest customers in the multi thousands of seats.
The reality is that the number of seats is not always the driver. The number of seats is not the driver of scale; it's actually the scale of complexity. So you can have a smaller contact center with 1,000 seats that has much more complexity than a larger contact center with 5,000 seats for example. So if you look at a typical like healthcare Open Enrollment Contact Center, you could have some fairly, you could have thousands of agents but a fairly simple set of rules and configurations whereas if you look at a say online pharmacy with 700 agents, they may have much more complexity and much more needs for configurability and so on.
So it's not so much exactly the number of seats, it's the complexity for that that tends to be concomitant with larger deal sizes that we are primarily working on.
If you look at our backlog and sort of capabilities that we get asked for, that's the kind of stuff that we're delivering, is more controls, more configurability et cetera.
That makes sense. And then one follow-up question on the R&D front, the product roadmap, the AI et cetera. How do we translate that into the R&D investment moving forward and maybe a corollary to that is how is your experience in the current market environment for finding the kind of talent that you need to drive that vision forward?
So less than 10% of our investment is in AI, in R&D and we're a nimble small company with a great story and a pretty passionate executive leading that team and Jonathan. And so we don't have the needs to consume hundreds of PhDs from top universities. We are able to find almost rifle shot find the people and the value that we need and that's -- we're just at the beginning by the way of scaling that up. We have not yet run into, it's not like these people are sort of a dime a dozen. They're in high demand but we haven't had any problem finding the folks that we need and bringing them on board.
And frankly a lot of this is not actually so much AI capability, it's tuning existing AI technologies and platforms and plugging them into our backend systems and plugging and creating new user experiences around that. So maybe half of the work is true AI. And the other half is actually just implementation and hooking it up and so on. Over the balance of the year, we will be doing that.
That makes sense. Thank you.
Yes, thanks.
Makes sense. Thanks.
And we'll take our next question from Catharine Trebnick with Dougherty.
Hi, thanks for taking my questions. Based on the Spring release 2019 description of some of the product features are more oriented towards large enterprise and then your system integration relationships looks like if you're doing working with EY, or Deloitte Touche that it would seem like you're scaling to the large enterprise. Would you say that you're advocating the low end of the market the sub-250 market? How do you address that? Thanks.
No, far from it. As you've seen over the last year, our progress in the sub-50 particularly sub-50 seats contact centers is actually increasing and started to grow again. And so, yes we're focused on both segments of the market. If you look at the mix between the business it is skewing increasingly towards large enterprise but we remain committed to that commercial segment of the market that we have and continuing to grow. We made some leadership changes in Q1 of last year that resulted in that business growing over the last four quarters. So that business looking very healthy for us right now.
We'll take our next question from Richard Baldry with ROTH Capital Partners.
Thanks. I was curious Rowan as you've had more time in your seat and looked at your own tech stack and feature set about your appetite for tuck-in or strategic transformative acquisitions, capable resources that you've got on the balance sheet?
Yes. We have -- we continue to sort of look at the entire market and think about opportunistic places where we could tuck-in technology. Nothing right now that we're --that's on the table or that we're ready to announce, there's nothing in the wings on that front. My strong preference is a desire to build technology internally. However as we think about getting into some adjacencies and potentially on the AI front, we do think that there's technologies out there that might make sense for us. So that option is on the table but nothing's imminent.
Okay. And maybe for Barry, understanding that seasonally Q2 is a little tougher. We haven't really ever seen it go down sequentially as implied by guidance. So if there's any one-time usage or seasonal strength that was disproportionate in the first quarter. The growth in expenses and investment in the first quarter was quite a bit stronger than last year, so I would argue that you're seeing things that you do want to spend to keep up to the growth rate that's pretty attractive for the rest of the year. So any color there would be helpful. Thanks.
Yes, so top-line first that 3% reduction is pretty consistent with what we've done in prior years. Typically it is 3% one year, it was 4%. You're correct that we've actually gone up most years. One year, we were completely flat. And it's just being prudent at this stage. We know there is a seasonal headwind, this is our toughest quarter and we want to continue that philosophy that we've done to be prudent and I do remind you also that the year-over-year for the second quarter is 19% which is more than we typically do, is typically been 18% most years.
With respect to the bottom-line, I'm glad you mentioned the significant increase in expenses. We made it very clear on our fourth quarter earnings call that we were going to ramp up expenses and you're seeing that and you will continue to see it for the rest of the year including of course this quarter as well and the third quarter. And that's -- and what you're seeing in the bottom-line in terms of our guidance is a combination of the toughest revenue quarter combined with a meaningful ramp in these go-to-market initiatives and the R&D.
We'll take our next question from Jeff Van Rhee with Craig-Hallum.
Great, thanks. So guys on the larger deals you referenced the BPO lending source and cleaning products companies maybe use those examples as if you're displacing, so maybe take those three and just outline who or what it was that you displaced. And then secondly, just you've over time commented on win rates, so curious where they're sitting right now, how they're trending?
Yes, great. So I'll take that one, this is Dan. Thanks for that. So yes, the first one I mentioned was the large BPO and this is a BPO that has several thousand seats on their own legacy system that they've been managing. They found that system not to be adequate. It's been in place for a couple of decades now and so they look to Five9 to really accommodate not only a couple of key clients of theirs that are several thousand seats but also looking at all the new, new clients that they bring onto the platform.
So it'll be -- to be seen as far as how much we go and replace of that legacy platform that's there. And then but certainly it's more of a cap and grow. They're not going to be adding any more clients to that existing one. So that's the first.
The second one really was a more of a complex environment which was requiring Salesforce and ServiceNow simultaneous integrations for the different departments. And in that case, it was the typical premises-based system that was a combination of both Cisco and Avaya at that one. And again because of the strong analytics and reporting in the contact center industry, it's like the real estate analogy of location, location, location if you ask folks what they need in the contact center it's typically reporting, reporting, reporting. So the analytics is critically important to the success there. That was the reason for doing that.
And then the third one, I mentioned was the one that was already a Fuze UC customer which is a great partner of ours that we do integration with. So as Rowan mentioned earlier, the necessity typically for them as they go into and completely replace what they had on their premises was to move both the UC as well as the contact center to the Cloud they had already done, they did the UC first with Fuze and they did a contact center solution as well. And in that case, we replaced a standalone premises-based contact center solution and again brought them a full cluster of capabilities. So our win rates continue to be well north of 75% when we go head-to-head against our key competitors. We don't see that changing. In fact, we see a greater level of acceptance and win rates because I think what we're seeing is customers gaining the trust by seeing other referencable customers go through this process and make the transformation smoothly, easily, and seeing a vast improvement in their business by moving over to Five9. And the size and really the brand that we now represent in the marketplace is far different than it was years ago as you know.
Certainly. Well, I got you; on pipeline I know you've called out record bookings in pipeline. But with respect to pipeline coverage, there's obviously a whole bunch more detail that we'd love to get about the health and sort of momentum in the bookings in the pipeline but specifically with respect to pipeline coverage relative to the forward guidance, is there any more perspective you could share with respect to coverage to give us a real sense of the depth of the pipeline or alongside that maybe some more color around the bookings other than being a record for Q1 with your growth. They need to be a record but can you just detail that a little more on either of those if you would?
Yes, just that it continues to improve, it continues to grow. We watch very closely the ratio of pipeline to bookings and make sure that we maintain and increase that ratio, so that we always have a healthier and healthier pipeline from which to draw on. And that's really what fuels the growth of the company when we build up the pipeline. And the great news there is because we're getting that pipeline from an increasing number of sources back in the early days, it was a lot of digital marketing and a lot of marketing events and a lot of things that we did inherently.
Now it's become an entire ecosystem that helps feed us opportunities and leads and brings us to the table. And that's through ecosystem partners as well as the channel partners as well as the master agent community and systems integrators. So it's getting more and more and we're always growing our enterprise sales team in proportion to that increased pipeline and in proportion to the increased opportunities. So without getting into all the details, it's something we watch very closely and we make sure that the pipeline is healthy and that it's being filled with very qualified opportunities that we have a very high percentage to win.
And we'll take our next question from Jonathan Kees with Summit Insights Group.
Great, thanks for taking my question and I'll add my kudos to the results. Congrats there, I wanted to ask in regards to your services strategy, as you get more and more partners involved and they become more and more of your referrals or you work more closely in terms of the deployment. I guess at what point you're going to start parsing or push some of that services off onto them. I know you do most of the services yourself. I can understand the complexity especially with enterprise deployments that you have more control in terms of the deployment. But at some point, I guess what at some point in time in terms of when you go and look at trying to get maybe your systems integrators or your master agents to help with doing some of the enterprise deployment? Thanks.
Yes, so great question and great timing because what we're seeing is, as I mentioned earlier the opportunistic view that some of our partners had in the past about just using us where they needed to or wanted to provide Cloud. We're seeing customers and companies, partners of ours that are truly taking the next step and saying we'll make the investment to certify our post-sale services organization to do deployment and ongoing services for us. And that's -- that's great, that's really happening as we speak here in 2019. Part of that has to do with we've brought in a leader to the company from Cisco that has a great deal of experience. They do 100% through channels and it's been able to leverage some of those relationships and bring some very prominent global channels to us and they've already expressed a great deal of interest to take those steps because they want to be in the services business.
We don't necessarily want to be in the services business to that degree. So where we can leverage them all the better. So that's wonderful and that's -- it's something that for us, you mentioned leveraging the master agents, most of the master agents are more smaller shops with opportunity consultation and being able to help drive decisions of companies. But most of them do not have the services organizations and the services arms that the distributors and bars have.
So I guess -- so I guess that'll take time. So it appears that for the foreseeable future, you will still be doing majority of the deployment?
The majority, yes.
The majority, yes, that's a very good point. So the majority will remain but the trends will begin to offload a portion. Right now, we're offloading small single-digits as a percentage and we're starting to see a greater appetite for organizations to take on more and more. We've been doing that primarily with our International channels where they take on the services piece. We're now beginning to do that domestically as we speak. So still to be shown and not yet modeled into our financials for any impact for 2019. But I'm sure; we'll see that take hold here throughout the year.
And we'll take our next question from Dmitry Netis with Stephens.
Hey guys, thank you for taking the question. Couple of questions, Barry, for you maybe on the housekeeping front first, the 20% adjusted or 20-percent-plus adjusted EBITDA you mentioned on the call, I might have not been able to catch it right here. But were you referring I know you're spending a lot of OpEx here on R&D and such and expanding out into AI and other areas. But was that a comment -- kind of a long-term comment that you were reiterating or did you see that you were going to get there by fourth quarter of this year just trying to clarify that?
Yes. So I'm glad you brought that out. So you just rewind the movie a little bit. We had an interim target to reach 22% by the fourth quarter this year. We actually reached that a year early to get to 22.7% in the fourth quarter of last year. We decided that the responsible thing to do was to take a short detour in terms of doing the increased investments in both R&D and go-to-market that would cause the EBITDA margins to decline in the first, second, and third quarter compared to where that would have been. But by the end of the year, the fourth quarter of this year we would have a two handle on the EBITDA once again this is exactly what we said in the fourth quarter earnings conference call.
To avoid any confusion though, let me hasten to add that we always have a long-term model out there, it's in our Investor deck on our website and that calls for 27% adjusted EBITDA margins down the road.
Excellent, that's probably what I heard. So thank you for clarifying. You'll get the two handle by Q4. Great. And then if I can move on to the margin -- gross margin that is was down 100 basis points, 150 basis points Q over Q. I had imagined Q4 is mostly usage and Q1 always starts out slower but it is up nicely year-over-year. So I guess the question -- in fact, the question if this kind of ramps as you go through the year and kind of builds back up to that exit rate of 65% and potentially even higher as you move towards your target model, gross margin as you march through the quarters this year. Any comments there?
Yes, sure. So our gross margins, I think every single year I'm pretty confident every single year do decline Q4 to Q1, that's driven by the fact that we have revenue that loses some of the seasonal tailwind that we have in the fourth quarter which is always our strongest quarter. And then combined with that is we have normal hiring this year that's stronger than normal some hiring over there, and also the FICO reset. With respect to the expectations for the second quarter, you should expect to see a slight decline because of this continued investment and including the fact that it is our seasonally weakest quarter. And then by the end of the year with a revenue dependency, we'll see an improvement.
Okay. And I'll take the rest -- I'll take the margin question offline but if I may ask one last one for Rowan more of -- sort of going back to the commercial segment, I'm just trying to reconcile guys your comments, you had very strong performance in the last two quarters in the double-digits type percentage growth rate. It was down into the single-digits, you said in the March quarter and you said you didn't expect that to climb back up into those double-digits as it would continue to stay in that single-digit growth rate. Yet you had mentioned that there will be or this continues to be a strategic segment for you. I know it's been declining as you focus more on the enterprise. So just kind of a high-level thought there. How we should think about it or why should that segment continue to stay in the single-digit?
Yes. So we project that it will continue in the single-digit. Starting in Q1 of last -- part of the reason for that by the way is that starting in Q1 of last year, we made changes to the execution as we changed the leadership of that team and changed the way that the team was going to market. And that drove solid performance double-digits over the last four quarters. Now we've lapped that and we're into the harder compares starting in this Q1 and so I think you'll see that single digits performance continue, growth continue. It is -- while we see a much higher return on our investment from a LTV to cap ratio on the enterprise side, the commercial side is still a good chunk of our business, 20% thereabouts. And so we want to continue to deliver that to our customers. And frankly many of those smaller customers turn into bigger customers over time. And so while you don't see the LTV right away as you projected out and you see select customers that actually those smaller businesses that grow, we actually do see that as a valid acquisition of enterprise businesses.
So having both segments for our business is a nice way to diversify across these segments and also -- it's also a good discipline for the business to have the SMB or the commercial segment because it forces us to make sure that the product works really well out of the box and has a great user experience and it's easy to use and so on and that's something that you're forced to do when you have that commercial segment.
So we like it. It's a good chunk of the business. We want to continue to see that grow although when we're making net incremental investments we're driving those primarily towards the enterprise which is why we're not; we're continuing to see the mix shift towards enterprise but should continue to see modest single-digits growth in commercial.
And we'll take our next question from Terry Tillman with SunTrust.
Hi guys, how's it going? It's actually Nick [ph] on for Terry. Just one quick question, thanks for squeezing me in. So I just was hoping you guys could give us an update on growth in the international side of the business and maybe its timing that we think it's here to come more of a material growth area for you guys. Thanks.
Yes, this is Dan. I'll take that. So we're continuing to scale our go-to-market efforts in our International markets where we have presence and then we're continuing to leverage as I mentioned earlier signing up more and more channel partners that have global reach, they're actually pulling us into those markets by default because they have the presence there and have the locations and the people. So from a go-to-market perspective, we're getting broader -- a broader footprint if you will and broader experience.
Now it does take a number of things to succeed in several international markets including the marketing piece getting a brand, getting established customers in a local community and et cetera. We've done most of that in Europe and in Latin America. But as we build out, our voice, point of presence throughout the globe to handle global customers, it gives us a natural way, a natural entree into putting resources around those global voice pops as well as leveraging certain partners.
So we have several smaller partners in some of those regional, regional-based partners and then we have several of the global partners that are just starting to come online with us. It's moved the needle slightly in our international bookings and revenue figures but not growing quite because when you look at our overall growth rates in enterprise, it's growing very proportionate to that growth but we may see that accelerate probably near the end of this year, beginning of next year.
And that concludes today's question-and-answer session. I'd like to turn the call back over to management.
Thanks a lot. So thanks to the team, great quarter, awesome record results for Q1 as a public company with the growth rate and thank you all for joining our call today. We're looking forward to an incredible 2019. Thank you.
And that concludes today's conference. Thank you for your participation.