Five9 Inc
NASDAQ:FIVN
Earnings Call Analysis
Q3-2023 Analysis
Five9 Inc
The third quarter results for the company revealed notable achievements, culminating in a revenue increase of 16% from the previous year, predominantly propelled by a compelling 28% growth in long-term (LTM) enterprise subscription revenue. The enterprise segment forms a lion's share of the revenue, accounting for 87%, underscoring its significance to the overall business dynamics. Testament to the company's efficacy in attracting and retaining major clientele, the enterprise business has led to expectations of enduring growth, with recurring revenue – constituting a dominant 92% of the total revenue – also rising by 18% year-over-year.
Adopting a long-term investment perspective, the company has directed funds towards obtaining new logos, which, while dampening the immediate adjusted gross margin growth, as evidenced by an 80 basis-point year-over-year decline to 16.6%, incubates potential for future revenue expansion. Complementing this, the adjusted EBITDA stood at $41.3 million representing a 17.9% margin. Despite these investments, non-GAAP EPS improved, showcasing a $0.13 increase per diluted share compared to the previous year, indicating effective cost management and profitability amidst an investment phase.
A new pinnacle was struck with the operating cash flow hitting $37 million, alongside a record free cash flow of $31.5 million, reflecting robust financial health and operational efficiency. Moving forward, while consumer spending trends indicate potential weakening in the company's prime consumer vertical, the company cautiously projects a 3% quarter-over-quarter growth with fourth-quarter revenue aiming at a midpoint of $237.6 million. This conservative stance is further reflected in full-year revenue guidance, pegged at an approximate 17% year-over-year growth to $909 million, a figure buttressed by the upswing in new logo acquisitions.
Looking into 2024, the company lays down a foundational guidepost of a 16% year-over-year revenue growth, which equates to an expected revenue of roughly $1.05 billion. This outlook banks on the presumed enduring strength in the new logo sector and an assumption of a steady economic backdrop. Noteworthy, non-GAAP EPS figures for 2024 mirror the street consensus of $2.16 per diluted share for the full year, with the initial quarters of the year likely to record the lowest EPS, following a historical trend.
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[ Audio gap] certain customers customer growth, anticipated customer benefits, company growth, the anticipated benefits from our recent acquisition of Aceyus, enhancements to and development of our solution, market size and trends, our expectations regarding macroeconomic conditions, company market position, initiatives and expectations, technology and product initiatives and other future events are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are simply predictions, should not be unduly relied upon by investors. Actual events or results may differ materially, and the company undertakes no obligation to update the information in such statements. These statements are subject to substantial risks and uncertainties that could adversely affect Five9's future results and cause these forward-looking statements to be inaccurate, including the impact of adverse economic conditions, including macroeconomic deterioration and uncertainty, including increased inflation, increased interest rates, supply chain disruptions, decreased economic output and fluctuations in currency exchange rates, lower growth rates within our installed base of customers, achieve the intended benefits from the acquisition of Aceyus and the other risks discussed under the caption Risk Factors and elsewhere in Five9's annual and quarterly reports filed with the Securities and Exchange Commission.
In addition, management will make reference to non-GAAP financial measures during this call. A discussion of why we use non-GAAP financial measures and information regarding reconciliation of our GAAP versus non-GAAP results and guidance is currently available in our press release issued earlier this afternoon as well as in the appendix of our investor deck and in the Investor Relations section on Five9's website at investors.five9.com. Lastly, a reminder that unless otherwise indicated, financial figures discussed are non-GAAP. And now I'd like to turn the call over to Five9's Chairman and CEO, Mike Burkland.
Thanks, Emily, and thanks, everyone, for joining our call this afternoon. I'm pleased to report strong third quarter results with revenue growth of 16% year-over-year, primarily driven by our LTM enterprise subscription revenue growing 28% year-over-year. Adjusted EBITDA margin for the third quarter was 18% of revenue, helping drive an all-time record for operating cash flow of $37 million, or 16% of revenue.
Let me start off by reminding you of the 3 continuing trends that drive our confidence in this market. First, enterprises are developing plans in a greater sense of urgency to replace their on-premise contact center solutions as legacy vendors have retrenched and slowed or even stopped development in some cases. Also, a reminder that in terms of cloud replacing on-premise, we believe that the penetration is still less than 20%.
Second, companies are enthusiastically pursuing digital transformation initiatives to enhance customer experience, cut costs and increase revenue. In this context, remember that contact centers are mission-critical systems, which are a source of brand loyalty and differentiation. And third, AI is becoming an even more important catalyst for enterprises to shift to the cloud. AI automation is clearly an area of focus for enterprises, as demonstrated by our greater than 80% attach rate on $1 million-plus ARR deals in the quarter.
Now I'd like to discuss the 3 main growth drivers for our business, namely, our platform, our march up market and our international expansion. Let me start with our platform. As you recall, in August, we closed the Aceyus acquisition. We have experienced significant momentum with the Aceyus solution as the number of Aceyus opportunities in the pipeline has increased over 30% in this very short period of time. As a reminder, Aceyus is a fit for our $1 million-plus ARR customers, giving us continued strength in our march up market. For example, they're opening doors for several Fortune 100 deals, although it's still early days.
A good portion of our innovation continues to be centered around our AI and automation portfolio, and we are seeing significant traction as a result of this innovation. For example, our professional services team worked on more than 250 AI deployments during the quarter. Additionally, bookings for our Agent Assist product increased 150% year-over-year, driven by our AI summaries customer trials.
It's clear that our practical approach to AI continues to deliver real, tangible value to our customers. This is directly tied to our core AI tenets, including our beliefs that AI should be available across our platform, that AI should be democratized and available to all customers, that AI should remain engine-agnostic, and that AI should be applied in a responsible and ethical manner.
And now I'd like to focus on our march up market and international expansion. I'm pleased to report that we continue to see strong momentum up market and booking $1 million-plus ARR deals. As a reminder, $1 million-plus ARR customers make up more than 50% of our recurring revenue. I'm also pleased to report that our pipeline for strategic deals doubled year-over-year in Q3. In addition, we had a record number of enterprise and strategic RFPs in the third quarter, which increased 66% year-over-year and 21% sequentially.
This march up market and our continued international expansion are increasingly being driven by our ever-growing network of global partners and their dedication to leading with Five9. I'm very pleased to share that IBM has expanded their relationship with us as a global SI partner, reselling Five9 along with their CRM and ITSM offers and also as a technology partner, integrating watsonx with our AI solutions. This is a common model amongst large SIs, as we are complementary and tightly integrated with solutions such as Salesforce, ServiceNow, Microsoft, Google and others.
We have now established ourselves as a global brand with the help of key strategic partners like IBM, BT, TELUS International, Deloitte and Accenture, to name a few. Our partnership strategy is built not only on recruiting new partners, but also on enabling and empowering partners within our methodology of sell with, deliver with and build with. This approach was 1 of the key drivers that led to our EMEA bookings growing 57% in Q3.
In addition, a U.S. managed service provider who has been our partner for the past 3 years celebrated their largest quarter with several new customer logo wins and over $4 million of incremental ACV added in the quarter. Their success is built in part on their ability to implement Five9 solutions integrated with their enterprise management platform and other services. Our leadership in the channel is further validated by the 3 leading technology solution distributors in our industry: [ Talaris, Avant, and Intelisys ScanSource, ] each recognizing Five9 as their #1 CCaaS supplier.
Furthermore, a recent channel survey by Baird ranked Five9 #1 for top CCaaS solutions sold by the channel and #1 in easiest to do business with. These partners, along with many others, are helping place us in a prominent position within the global channel community.
In closing, I'm very excited about our continued momentum out market globally and with the success we are having with our AI automation offerings. The opportunity ahead for Five9 has never been better, and I want to thank all of our employees who bring passion and purpose to their work every day to make this a reality. And with that, I will turn it over to our President and CRO, Dan Burkland. Dan, go ahead.
Thanks, Mike, and good afternoon, everyone. I'm pleased to report that we had a strong bookings quarter. Our pipeline reached another all-time high, with our strategic accounts pipeline doubling year-over-year. And our sales of AI and automation solutions are seeing unprecedented momentum.
As you know, the very high end of our market is lumpy with regards to the timing of bookings. However, I'd like to remind you that the large enterprise category of $1 million to $5 million of ARR is the bread and butter of our business, and in aggregate is a larger contributor to our revenue growth than the mega deals.
Now as I usually do, I'd like to share some examples of new logo wins during the quarter. The first example is a health care insurance company that was moving away from an Avaya on-premise version that was being end of lifed. They chose Five9, along with 1 of our leading UC partners, with deep integration in order to gain visibility and provide seamless transfers between contact center workers and back-office employees, all from a single UI.
We will also include our chat, e-mail, SMS, QM and interaction analytics, and we anticipate this initial order to result in approximately $2.3 million in ARR to Five9. The second example is a hospital billing and collections company. They were using Cisco that was being managed by a third party, making moves, adds and changes cumbersome and also long lead times. They evaluated the major CCaaS providers and chose Five9. We are including the full omnichannel solution with e-mail, chat, SMS, as well as both voice and digital IVAs. We are also providing them with QM, interaction analytics, WFM and Agent Assist, where they expect to reduce call handle times by up to 50%. We anticipate this initial order to result in approximately $2.3 million in ARR to Five9.
The third example is a utility company serving many markets in North America. They were using a hosted Cisco solution that was nearing its end of life. They chose Five9 from all the major CCaaS providers. And we'll be implementing our core offerings, along with the advanced solutions, including chat, e-mail, Agent Assist, our complete WFO suite powered by Verint, performance management and gamification. This customer will also be deploying our voice and digital IVAs for self-service to pay invoices, check account balances and canceling or moving service. We anticipate this insurer to result in over $2.2 million in ARR to Five9.
And now as I normally do, I'd like to share 2 examples of existing customers who have expanded their use of Five9. This first example is a global pest control company who had been using our system for several years and was recently acquired by a European company who is using an on-prem legacy solution. The North America operations team was able to do a side-by-side comparison with real production traffic to compare performance over several months. They chose us for our superior reliability, as well as our AI and automation portfolio. We anticipate their spend to increase from approximately $2.1 million in ARR to approximately $4.2 million in ARR.
This last example is a leading global ticket sales and distribution company, where we began providing our solution throughout Europe more than 5 years ago. In early 2022, we used the strong success we established with them in Europe to parlay this into their U.S. operations, where they saw increased call volumes. We now continue to expand as we replace their legacy on-prem solution. This recent order increases their spend with us from approximately $1.2 million in ARR to over $2.2 million in ARR.
So as you can see, we are executing extremely well in landing some of the largest brands in the world as well as helping our existing customers expand and reimagine how they deliver CX to their customers. And with that, I'll hand it over to Barry to cover the financials. Barry?
Thank you, Dan. Third quarter revenue exceeded our expectations, growing 16% year-over-year, primarily driven by the 28% growth in our LTM enterprise subscription revenue. As a reminder, we believe we are well positioned to resume historic levels of growth in the [ 30s with ] enterprise subscription once the macroeconomic headwinds on our installed base subside. Our enterprise business made up 87% of LTM revenue, and our commercial business, which represented the remaining 13%, grew again in the single digits on an LTM basis.
Now I would like to provide color on our recurring versus total revenue. Third quarter recurring revenue, which made up 92% of total revenue, grew 18% year-over-year, the same year-over-year rate as in the second quarter. Third quarter recurring revenue grew 4% quarter-over-quarter, the same sequential rate as in Q3 of last year as new logo deployments offset slower installed base growth. Speaking of new logo deployments, note that the international rollout of the parcel delivery company and the deployment of the health care conglomerate remain largely on track, considering the inevitable ebbs and flows of implementations across multiple divisions.
Total revenue, however, grew sequentially at a slower rate of 3% in the third quarter versus 5% in the third quarter of 2022, primarily driven by the lumpiness of our professional services revenue, which declined 3% sequentially, coming off of a record high PS revenue in the second quarter of 2023. This type of fluctuation is typical for our professional services revenue, which has experienced negative sequential growth in at least 1 quarter in 9 of the last 10 years.
Our LTM dollar-based retention rate was 110%, a decline of 2 percentage points sequentially, mainly due to the ongoing macro headwinds [ coding ] subdued growth in our installed base. We expect fourth quarter LTM dollar-based retention rate to be either flat or slightly down, and we expect a positive inflection in 2024, assuming no major changes in the economy. Longer term, we continue to expect our retention rate to trend towards the high 120s by 2027 due to a higher mix of enterprise customers, especially larger ones, which have higher retention rates and higher ARPU from our AI and automation and other offerings.
Third quarter adjusted gross margins were 16.6%, a decrease of approximately 80 basis points year-over-year. As we mentioned last quarter, we are making upfront incremental investments to support our new logo momentum, which is hindering our ability to report year-over-year growth in adjusted gross margin in the near term. Third quarter adjusted EBITDA was $41.3 million, representing a 17.9% margin, a decrease of approximately 60 basis points year-over-year. Third quarter non-GAAP EPS was $0.52 per diluted share, a year-over-year increase of $0.13 per diluted share.
Turning now to cash flow. We generated operating cash flow of $37 million, a record, driven in part by continued strength in ESO performance, which came in at 32 days. We have now delivered 29 consecutive quarters of positive LTM operating cash flow. Third quarter free cash flow of $31.5 million was also an all-time high. We remain optimistic about our potential for continuing cash flow generation given our long-term model, our substantial NOLs and our low DSO.
And now I'd like to discuss our guidance for the remainder of 2023 as well as provide high-level commentary regarding 2024. We closely track numerous indicators with a focus on consumer discretionary spend, given that it directly impacts our seasonally strongest vertical in the second half, namely, consumer. Based on JPMorgan Chase data, the nominal year-over-year growth in discretionary credit and debit card spending deteriorated progressively throughout the third quarter from 5% in July down to 1% in September, which was the lowest growth of the year. Importantly, also note that what matters to Five9 is not normal spending growth, but rather transaction volume growth, which drives contact center inquiry volume. In this regard, the 1% nominal growth in spend in September of this year represented negative transaction volume growth.
Given this trend, we are adopting a prudent approach to the fourth quarter and are assuming weaker seasonality in our consumer vertical. Therefore, we are guiding fourth quarter revenue to a midpoint of $237.6 million, which implies a quarter-over-quarter growth rate of 3%. This 3% sequential increase is in line with our typical guidance spend heading into the fourth quarter despite the weaker seasonality expected in our consumer vertical due to the offset from the ongoing strength of our new [ logo appointments. ] Accordingly, we are maintaining the midpoint of our annual revenue guidance at $909 million, or 17% year-over-year growth.
As for the bottom line, we are guiding fourth quarter non-GAAP EPS to a midpoint of [ $0.28 ] per diluted share, and we are raising the midpoint of the full year to $1.92 per diluted share, which represents a year-over-year increase of 28%. I would now like to provide some preliminary high-level commentary on our current thinking for 2024. For those of you who have been following Five9 for some time, you know that for the 6 years through 2020 and again, in 2023, we started each new year with prudent revenue guidance of 16% year-over-year growth at the midpoint. For 2024, our outlook [ we gain net ] for a 16% year-over-year growth or approximately $1.05 billion in revenue based upon the ongoing strength in our new logo business and less challenging compares in our store base, on the assumption that the economy does not deteriorate further next year.
This, as usual, is a starting point, and we will update our outlook as the year progresses. We expect revenue to continue following our typical pattern, with slightly more than 50% of the annual revenue being generated in the seasonally stronger second half of 2024. In terms of non-GAAP EPS, we are comfortable with the current Street consensus of $2.16 per diluted share for the full year in 2024. In addition, we'd like to provide an outlook on the quarterly profile of our bottom line. If you look at our historical financials, non-GAAP EPS is typically amongst the lowest of the year in the first quarter, and we expect this to be the case again in 2024. Therefore, we anticipate non-GAAP EPS in Q1 2024 to be in the high 20s per diluted share, which we expect bottom line to improve slightly in the second quarter and more meaningfully in the second half, especially in the fourth quarter. Please refer to the presentation posted on our Investor Relations website for additional estimates, including share count, taxes and capital expenditures.
In summary, we are pleased with our third quarter results. And while we remain prudent with our outlook, we continue to execute consistently against this massive market, and we believe we are well positioned to accelerate our business once macroeconomic conditions improve. Operator, please go ahead.
Thank you so much, Barry. [Operator Instructions] We thank you for your cooperation in advance. And now our first question will come from Ryan MacWilliams with Barclays.
Just to double click on the fourth quarter commentary. So are your customers ramping agents as you expected for seasonal use cases, and you're simply taking a prudent approach around like call volumes during that period? Or anything that's different there?
So yes, they are ramping, better [ installed base. ] And -- we are taking a prudent approach, and that this is an environment to do that. I really want to emphasize that JPMorgan debit -- credit card, discretionary spending metrics. And because the internal numbers actually tracked very well. Remember, there's 5, 3, 1 for July, August, September. And internally month-by-month, that what is happening in our businesses, were on the consumer vertical.
And so we look at that. We look at the fact that credit card delinquencies, auto loan delinquencies are at the 20-year high. We looked at the fact that the most recent JPMorgan survey on consumer discretionary spending at 44% of them saying that we're going to reduce it. You switch on CNBC this morning and you hear the CEO of -- of Target saying that he's had 7 quarters of both nominal and real transaction reductions. And we frankly just don't have the fortitude to say we're going to just pass through that. So we're taking a prudent approach. And that's what we've always done, and it's worked out for us.
And we will move on to Terry Tillman with Truist.
My question -- and it is 1 question, but it might almost delve into like a 2-parter. Maybe, Dan, for you in terms of -- you did emphasize the idea of the $1 million to $5 million deals. There's a lot of bread and butter there. In fact, you did say that it's a bigger proportion of your growth, which I think is an interesting data point. But what about the $5 million-plus deals? So those 7- and 8-figure transactions, how do you feel today about the volume and velocity of those over the next 12 months versus 90 days ago? So not pinning you to a quarter, but how do you feel about those and the activity? And then secondly, unprecedented adoption of AI and automation. Unprecedented is a pretty important word. How much are -- are you expecting those to increasing play in those larger deals?
Yes. Great, Terry. Great questions. I'll start with -- if you look at the upmarket, the $1 million-plus deals and kind of that $1 million to $5 million range absolutely is the biggest growth driver for us from a revenue perspective. There's a lot of them, if you think about it. That's typically a contact center with 500 seats or above. Those big, large mega deals, there's very few of them, and they're -- that's why they're so lumpy. And that's a market that's just starting to look at CCaaS for the first time. There are quite a few, but there's only a few that come up for grabs each year. And we've been fortunate enough to capture the early adopters of those that we've talked about before. So we've always said, don't expect those each and every quarter. We saw great momentum from the $1 million to $5 million range. And remember, those implement quicker, they've turned to revenue quicker, and they're much more predictable in that cycle about how quickly that will happen.
As far as looking at the high-end pipeline, like you said for the next year, I couldn't be more optimistic about it. If you look at what's happening from a demand perspective, Mike mentioned it in his comments about the number of RFPs. 66% increase in the number of RFPs, 21% sequentially from Q2 to Q3 alone. And that comes from a couple of things. One is the end of lifing of a lot of the premise-based systems. Or the end of development on those systems, which implies to customers that they've got to make this move to the cloud. So we see that whole market, the $1 million-plus all the way up through the mega deals. They've got to make this transition to the cloud. And they're starting on that process now.
The thing that makes me feel like there's no better time to be in this space is that all those companies will make that transition and you look at the millions of seats that are out there to do so. And it gives us great optimism. But remember, there's a sales cycle, and then there's an implementation cycle. And so you don't see it hit our books right away. And so I couldn't feel stronger about it. And I feel that there's a lot of business coming in the top of the funnel, which gives us great optimism about the future.
The second part of your question -- was the AI and automation, unprecedented momentum there. We had an attach rate of our $1 million ARR deals of right around 80% for some -- 1 or more of the applications in our 8 AI and automation applications. And that attach rate has been very, very strong. The RFPs that are coming out are requesting it proactively now. And that's really the majority of the conversations that we're having and the positioning of our solutions are all about how can we help improve, reinvent, deliver a better customer experience. And it's all centered around how do we automate, how do we bring in these new technologies, how do we help not only automate to let the end user self-serve, how do we automate to help our agents be more effective and be more efficient with their time? A big 1 is call summaries, being able to just summarize the call for the agent instead of them having to put in their notes. After a post-call wrap up, if you will. All things that help those customers do more and serve their customers better with less resources. So it's -- it couldn't be a better time. So thanks for the questions.
And we'll now move on to DJ Hynes with Canaccord.
Good to see everyone. Mike, Dan, maybe I could ask you to double click on some of the Aceyus commentary, integration progress. You gave us some color on kind of how that's contributing to deal flow. I'm curious also, I mean, Aceyus in the past has been a business that's worked with other large contact center vendors in the space. How have you been treating that? How are you thinking about it now that you own the asset? Any color there would be interesting.
Yes, sure, DJ. The momentum is off to a very quick start with Aceyus. Again, we closed that deal in August, as you know, not very long ago. As I mentioned, the pipeline for Aceyus solutions, the combined pipeline, if you will, that they had plus ours now is up 30% in just a couple of months. They've also opened some doors for us to sell CCaaS into their base. It's a major Fortune 100 accounts, and it's right on track, so to speak, I'd say, ahead of schedule in terms of the impact it's having on our business. The influence is happening on our deals, and the influences it's having on just prospects in our customer base as well as their customer base. I'll also add that their employees have really leaned in, and ours have as well, and the integration of our teams is just going perfectly well.
UBS' Seth Gilbert has the next question.
This is Seth on for Taylor. I was wondering if you could elaborate a little bit on the timing of the large deal ramps? Maybe more specifically, is the parcel delivery service still scheduled to be fully deployed by the end of this year? Health care conglomerate by early '24? And then maybe a little bit of an update on where the Fortune 50 global health care insurance company is in their ramping life, that would be great.
Yes. They're on track. They're proceeding as planned. The parcel delivery service rolled out the Americas right away. They've recently rolled out Europe and are in the process of rolling out Asia Pac. So that is right on track to, as you said, conclude right around the end of the year or beginning of next year. And then if you look at the conglomerate, the health care conglomerate, they're in process and proceeding as planned. They got like 12 different businesses or companies underneath them. So each of those are operating in parallel and rolling out in parallel at different stages. We expect that to go throughout the rest of 2024 before they're at full strength. And then the 1 that you mentioned, the health care insurance company, that's going to be a longer ramp. They haven't even started yet. And so that will not hit until -- start hitting revenue until second half of 2024.
Moving on to Jim Fish with Piper Sandler.
I guess, Barry, for you, surprised I'm the first 1 to ask this, what has to go right or wrong at this point to hit that 16% '24 guide? I know the 16% has tended to be conservative in the past, but with your Q4 guide here, you're exiting at about 17% for this year. So I guess, walk us through the confidence for 16% to be kind of that sustained rate -- prudent sustained rate, especially as you're lapping some of the larger deals in terms of what they added for this year.
Yes, Fish. So the 16%, which I'd like to emphasize is a starting point for us. Think of it in 2 components, new logos and secondly, the installed base. In terms of the new logos, we have a huge backlog that is sitting there that's going to be deployed, not just the megas. But the bread and butter of $1 million to $5 million deals. And as Dan or I think mentioned earlier on, it might have been mine, that's a meaningful part of the revenue. In fact, the -- well, both the parcel delivery service and the health care company are helpful towards the revenue in 2023, and therefore, also in 2024.
The -- the [ dots, ] if you will, rather than the wells are much, much bigger by quantum amounts. They deploy faster, and they are a size that they can make a difference. So between that backlog and what we call the go get, the gentleman sitting there on my right, Dan Burkland, he and his team are not just sitting on their ducks. They've got all these RFPs. They've got arguably the best go-to-market machine in the industry. And that can also bring in some more business as well aside from the backlog. So that's on the new side.
On the install base side, we take a lot of comfort from the fact that we are beginning to lap the weak macro conditions that we've experienced in the recent quarters. And we wouldn't be saying in our prepared remarks that the fourth quarter may be either flat or down or slightly unless we felt pretty sanguine about '24. And it doesn't -- it's very basic thing that you can do for yourself in terms of whether that alone contributes to the extra $145 million of revenue year-over-year.
We'll now hear from Scott Berg with Needham.
Barry, I wanted to follow up on the question on the '24 guidance a little bit. Kind of a 2-part question there is, one, how should we think about linearity of the revenue? You have a couple of large deals coming online as that has been fully discussed here, but I just didn't know if the kind of cadence for the -- on the revenue side is pretty linear. And then what are your assumptions around seat growth in your installed base? You've obviously had some challenges in Q3 and you're being more prudent here in Q4. How should we think about your kind of calculus around seats on the installed base next year?
Yes. Thanks, Scott. So in terms of the linearity, we -- every year, have got a very consistent pattern, about a little over half is in the second half of the year, call it, 51, 52, 1 year resumed, 53. And the balance, of course, in the first half. It's not going to be any different this coming year despite the puts and takes in terms of some of the deals that are ramping.
In terms of the year-over-year comparison, it was astutely pointed out in a recent research from somebody that that compares are tougher in the first half. So you'd expect the bigger increases in the second half year-over-year. In terms of the seat growth in the installed base, I don't think we're in a position -- I know we're not in a position to comment further at this stage beyond looking at the dollar-based retention rate, that's the best indicator of what's going to be happening in the installed base. So of course, it will grow. But at what rate will depend on probably a number of factors, but mostly the macroeconomic conditions.
I do want to mention as an aside, this is all about the logos -- each individual logo being a little bit slower on average than logo churn. We -- our logo churn is excellent, somewhere in the mid-90s on the enterprise side. And what we talk about it internally is that when inevitably, the American economy turns around, we will benefit from that directly because we spring loaded. We can turn up the seats overnight. And so when the transactions pick up, agents will pick up, and we'll see that right away. And by the way, just as an aside, also now having profitable places.
We will now hear from [ Arjun Bhatia ] with William Blair.
Perfect. I fully appreciate the conservatism in Q4, right? I think we're all kind of looking through the choppiness in the macro. But Barry, I think you mentioned that you had started where there were data points that suggest that in September, things have gotten weaker. Have you seen any change in your transaction volumes in September? And just as you think about your vertical exposure, is there opportunity for other verticals to offset perhaps some weakness in the consumer vertical as you look at Q4 -- 2024?
Yes. So let me first deal with the other verticals. There is a health care vertical, which is also a seasonally important vertical with the open enrollment and the like. Our indications on that is similar to what we expected when we said that guidance of no meaningful upside thus far. It's just gotten started about, I think, 2 weeks ago. In terms of the consumer, it's in the month of October, it's pretty much in line, nothing dramatic to what we always -- just from what we were assuming at the time.
Moving on to Meta Marshall with Morgan Stanley.
Great. Maybe Dan, a question for you. With so many of these deals kind of having AI attached or some sort of angle to them. Just what are you seeing in terms of bottlenecks, either in do they take longer to get signed? Is it data privacy? Is it just what is the scope of what they want to do? Just trying to get a sense of where people are. I'm figuring out what they want to actually -- what type of virtual solutions they want to use.
Yes. The attach rate is wonderful. Do they take a little longer? Yes, I think on average, if you look back a few years, yes, but the whole -- if the whole lot takes slightly longer, which also comes with moving upmarket, as we've done. That's fine. It's a gradual process. It's not a significant metric that really impacts anything from our perspective. And yes, the customers tend to -- they sign up for an AI application. We go in, we implement. And oftentimes, our professional services team and consulting teams will work with them to find new use cases, additional use cases and really do a cross-sell, upsell kind of in progress while they're implementing the solution, which tends to happen with any innovation that's new to the buyer. And they have -- it's not a replacement in that sense. So they're experimenting. They're finding new use cases and we see great momentum, as I mentioned, with our AI and automation portfolio across the board.
And Meta, I would just add to that, AI and automation revenue is growing faster than any other product area for us. That's what revenue. And I already talked about it in my prepared remarks about 250 projects, AI and automation projects being worked on by our professional services team in the quarter.
So we're starting to see kind of the -- the end result, if you will, right, the lagging indicators of some of the things we've been talking about over the last few quarters in terms of momentum in bookings and attach rates. Starting to show up in revenue, and revenue growth as well as a lot of active projects, not to mention a continuation on the bookings, I mentioned Agent Assist in terms of 150%.
Samad Samana with Jefferies has the next question.
This is actually [ Billy Forsimmons ] on for Samad Samana. Barry, for you. And I hate to ask a similar question to what other people have already asked. But I do want to triple click on the 2024 outlook. And then just so we're all clear. And maybe to ask what Jim and Scott asked in a slightly different way. But obviously, that 16% number is a starting point and it remains early, but can you just walk us through maybe some of the other factors that were incorporated into that number? How do you think through things like continued strong deal activity, continued international expansion, channel momentum, AI-enabled product adoption into that outlook? And does that 16% number incorporate kind of continued weakness in some of the more challenging verticals or a potential improvement? And if I could sneak in 1 more for Dan. You've talked for the last couple of quarters about strong channel momentum. What inning are you guys in that journey? And where can that kind of go from here?
I'll go first, then.
Yes.
So I'm going to try and be creative over here, Billy, in terms of coming up with a different answer. You gave me some avenues though, which are going to go down. International is clearly [indiscernible], becoming increasingly important. It goes up 1 percentage point as a percent of total revenue each year. The growth has slowed actually in Europe as well this last quarter, down to, I think it was 28% because they, too, are facing macro headwinds.
But we are operating in a very fertile field there. And that superior growth rate will almost certainly -- will extremely likely to continue in 2024. The channel I'm going to target -- and ask either Mike or Dan to answer because they get really passionate when it comes to that -- and channel is more important on the international side. And then -- but just generally, the drum that we've been beating is the 2 halves of the growth are installed base and the new logos. On the new logos, you're looking at 3 very serene people. In terms of the RFPs are there, we can execute against the -- manage that. We don't worry about the demand. It's getting the continued high win rates.
On the installed base, we've lapped it. There's no particular verticals that we should be worried about at all. But having said that, if you had asked this question 10 months ago, we wouldn't have guessed anything about Silicon Valley Bank. So you need to -- we need to be prudent at the start of the year.
And can I just layer on a couple of things. The optimism around '24, quite frankly, is built mainly on our backlog. It's all the bookings momentum that we've had over the last few quarters that have yet to turn to revenue. As well as, again, that flow of demand that we're seeing inflect. And this is -- this RFP number that I talked about, 66% growth year-over-year and 21% sequentially. You can see that accelerating, and we can see it accelerate, we can feel it. And again, those are enterprise and strategic RFPs. A lot of these enterprise deals will be shorter sales cycles and potential revenue impact in '24.
But the good news is, as Barry said, with DBRR assumptions that are very reasonable, you can kind of do the math in terms of what 16% revenue looks like from a dollar perspective, what that contributes next year. If DBRR is relatively stable, which we believe it will be, you can see it doesn't take a whole lot of turnups from our backlog to drive 16% revenue growth. So we're very comfortable with that. And then if I could start on the channel, Dan, you can chime in, in terms of what inning we're in, I would say we're in about the second or third inning in terms of our channel maturity.
And -- this is very similar to what you saw, I would say, 2, 3 years ago in terms of just larger enterprises adopting cloud. The channel has been kind of holding on to legacy and on-premise until a few years ago when they started to lean in with us. And again, being named #1 by the top 3 technology distributors, that's a huge, huge accomplishment by our channel team. We've got the best in the business. [ Jake Butterball ] and his team have absolutely crushed it. So we're kind of punching above our weight in some respects, but I do believe we're still in the second or third inning.
And just to add to that on the channel front, if you look at the large announcements that we've made with big partners, [ IBM ] this quarter, TELUS International, BT. We're just getting started with them. And they own and really help manage digital transformation projects for the largest companies in the world. And they have now made that pivot to Mike's point, over to, oh, we've got to go in and lead with CCaaS and lead with cloud solutions. And lead with AI and automation. And so we're in the process of educating, training and certifying those folks to come up to speed, and they will be a force multiplier for us in a tremendous way.
And if I give you 1 statistic, just a short time ago, if you look at 2019, we had 19 partners that brought to us -- you asked about the pipeline and how much of that top of funnel comes from the partners. We have 19 partners that brought us over $1 million of ACV, annual contract value deals in that year, 2019. This year, we've had 63 such partners bring us over $1 million in ACV. And that number is only continuing to grow. And so as Mike said, we're in the second or third inning. I would argue that from a revenue influence and lead opportunity, we could be even in the first inning, especially at the high end of the market because that really hasn't been available to us until just recently. And we like the position we're in. If you read the Baird's survey that they did and look at where we sit when we do sign up a partner, how they feel about us compared to our competitors in this market, we were rated #1 in many, almost every category of who's going to win this market, who's doing best in AI, who's the easiest to work with. We really pride ourselves, and Jake and his team are doing an amazing job of enabling the partners, educating them and making sure that we operate with integrity in this space because they want to turn to somebody they know they can trust to deliver what they're promising to their clients.
So Billy, in summary, that's how we feel about the 16%.
Well, thank you very much. Appreciate it.
Moving on to Peter Levine with Evercore.
Maybe to add to that last question. I know you opened up the channel, I think, to do more pro services to start offloading that, I think, earlier this year. So maybe just walk us through kind of where that evolution is today? And then second one is to Barry, is I know there's a -- you talked about scaling up the 70% gross margins. Can you maybe help us frame the trajectory of when we get there? Is it more of the partners? Is it ARPU? Just help us understand trajectory to that 70% gross margin target.
Yes, Peter, great questions. I'll go first on the -- what we call project pull-through, as you mentioned. That is enabling our third-party partners to do implementations for us. And that was a strategic initiative that I kicked off about a year ago. And it's going amazingly well. Internationally, a majority of our deals are being implemented by third parties. And even domestically, we've seen a dramatic increase in the percentage. We haven't disclosed that yet, but we will in the future. But it's a growing percentage and right on track in terms of what our KPI objectives were when I rolled this out. So I'm thrilled to see the progress of, again, third parties being trained, enabled and actually doing deployments.
And we've solved for 1 of the critical success factors, is NPS scores. As you know, we deliver with our own professional services team NPS scores in the mid- to high -80s consistently year in, year out. We're holding our partners to that same NPS score, and they're delivering on it. But again, we've been very strategic and very stepwise in terms of who we sign up, how we trend them up and helping them be successful.
And Peter, in order to explain how the gross margins we believe are going to get to this -- into the 70-plus, you have to understand the revenue breakdown because each have different drivers and different amounts. So the revenue breakdown is 75% subscription. By the way, 2/3 of that is enterprise, but the rest of that is commercial. 17% is usage, and 8% is the professional services. I'll start with the less important ones and then move to the most important one. The less important 1, because it's a relatively small part of the total equation, is the professional services, which is now in the low double digits negative. We don't mind that too much. It makes -- a happier customer brings up the software quicker. And there is potential, like many other companies, through better efficiencies and not having to scale for every single mega deal that then brings into the door. Because that's what we've been doing over there. So that can get into the single digits, high single digits. But that's not our driver. It's helpful. The second area is usage. And there, we're in the 50, solidly in the 50s. That's not going to -- internationally, we have some opportunities. We've also got the incentives there, but that's not going to something dramatically improve. What is happening is that there's a shift in the mix from usage to subscription every year, 1 to 3 percentage points. And just to illustrate that completely, we went public in April 2014. Usage was about 35% of the total. It's now half of that, and that's going to continue. So we've got a mix shift there.
Now we come to the subscription. And there, it comes down to a very straight point. The basic juice over there, which is certainly worth the squeeze, is the fact that we've got fixed costs, [indiscernible] fixed costs, and we just -- we have the revenue growing faster. That's why if you look individually at each fourth quarter, the subscription gross margin is always the highest because that's when the revenue is highest.
Plus, we've got some additional initiatives. I'll make just 1 quickly. So when we were guiding international, being dragged there to some extent by these bigger accounts, we went fast and furious with GCB. The indications are operating strongly that if we do it in our own data centers, we can actually do it for certain tasks cheaper. And that remigration is something I talked about in the call, but these things take time. In the meantime, we're investing further in international, in India, South Africa, other places. And also in professional services for these mega deals. And we always -- yes, I'll leave it at that.
Siti Panigrahi with Mizuho.
It's good to hear about the large deals and a strong pipeline, but I just want to ask about [ whole or close rate ] you're seeing in this kind of environment? Are you seeing more deals scrutiny? Are you seeing more [ rate ] customer looking at more in better AI strategy before signing the deal? Any color would be helpful.
Yes. As far as deals getting extended, there's a natural -- when you bring something new to the market and you bring something that they haven't seen before, it's not a replacement. It takes a little longer. But as I mentioned earlier, it's insignificant. It's not something that keeps us up at night or even as a concern during the sales process. It's just make sure you have that extra meeting. In some cases, you have to go to the data security folks and legal to make sure that we have the right documentation there to protect their data. Because in some cases, we're taking data from a transcription of a conversation and moving it to a third party to have that summary. As an example, when we use GPT to summarize our transcriptions, we're having a third party do that, obviously. So there's just extra steps in the process, but we make sure we're aligned to those and have our sales teams directed to those. So it's -- it's great. I mean, the interest is there, and everyone's gotten through it. I think we're past the times of having to create those documents. And so now it's just a matter of having the templates and moving forward.
Are you seeing customers evaluating their AI strategy so that as part of that, they're delaying anything? Or do you think that that's a separate process altogether?
Thank you for asking that question. They absolutely are using our AI strategy as a key criteria and evaluating it extensively. And it's oftentimes the thing that wins business for Five9. We believe we're actually pioneering and leading the market when it comes to AI, that Baird study nets that out. Our customers are explaining that to us as well. We've made a couple of strategic acquisitions that allowed us to kind of hit the ground running and not have to develop from scratch ourselves.
So we believe we're leading the market in this area. And we're excited that even the deals that happen that may not have a big revenue component tied to the AI, their decision criteria was precisely because of our AI strategy and our AI portfolio and road map and the way that we're going about it, they said, "We want to do business with you, you're future-proofing us, you're giving us what we want in the direction we want it."
Matt VanVliet with BTIG has the next question.
I guess staying on the theme of AI and some of the automation features, you mentioned 80% of new deals had that. But I guess the next level question that we're wondering is, one, how much additive to the deal value do you think that's bringing on new deals? And then second part, maybe more importantly, of the installed base, what is the penetration rate on that? And how much are you adding there, knowing that -- so earlier in the year, there was a lot of concern it would be cannibalizing your normal seats. But how much of an uplift on sort of a net dollar retention are you seeing as customers add that today?
Yes. Thank you for that question. So we messaged a few quarters ago, in and around 10% of the net new bookings were the AI and automation suite, and it remains that. A slight uptick to that is what we're seeing. But keep in mind, that's just the initial order. That's the customer that says, "Great, I'm going to migrate off my on-premise legacy system into your cloud. And yes, let's start with an IBA or an Agent Assist app." Once we get in there, and I alluded to it earlier, the PS group gets in there and starts talking to the people on the floor, not the buyer, the people on the floor that are running the contact center and the types of calls that they're getting and how we can help their agents be more effective. We start putting in things, and that's where we're seeing increased momentum.
We've got 250 projects that we're working on for a couple of reasons. One, we talked about pivoting and selling more software when the seat tabs were slowing, that the growth was slowing, and we've done that very effectively. Secondly, as we get in and we find there's many more use cases than we first started out when -- a salesperson isn't going to delay their sale to keep adding more and more use cases. They're going to go close the deal if the customer is ready. And so we get a lot of that out. And then thirdly, if you look at the actual applications themselves, they've matured. We talked about Agent Assist. We talked about Agent Assist 2 or 3 years ago. Well, today, it includes something called summaries. I can take the transcription, I can summarize it in about 3 seconds. I can deliver that summary back. I can pump it straight into the CRM. The agent tomorrow can look at that summary of what happened in today's call and make better judgment and get right to the point very -- much quicker. So and it cuts back on that wrap-up time for the agent.
So we're incorporating this AI, again, an unprecedented level of momentum and interest in the whole suite. And it's both for net new, where we're getting a great attach rate, but it's really the installed base that's starting to really see an appetite for doing more than just dipping their toe in the water, as we've talked about before.
Moving on to Michael Turrin with Wells Fargo.
I appreciate you taking the question. Nice to see everyone. Barry, you had some commentary on the retention rate. I know we've talked about it in the past. It's 110%. And it sounded like you have some confidence that can maybe bounce back at some point in '24. So just want to understand the trajectory a bit better if there are certain milestones you're looking for, how much of this is lingering impact from prior periods and just also gauge confidence and the potential for that metric to get back up into the 120s over time and the drivers there?
So Mike, I don't want to take issue with the phraseology, but you said bounce back. They're not bouncing yet. This is an LTM number, moves slowly.
Slowly, gradually. And higher.
Yes, thank you. So -- and really, in the near term comes down to 2 things. It comes down to, a, the macro just staying middling, neither going much better or much worse, a little bit better, a little worse. That's all we're asking for, because then we get the easier compare. And the other thing that's important is that some of the longer term -- the health care company, for example, is a good example. They start granting, and that gives us a very nice tailwind. Because they're big, and they start from a tiny base. So it's a disproportionate impact. You with me?
Yes.
Okay. Then on long term, the basic fundamental reason that we have confidence around reaching the high 120s is the fact that these $1 million-plus customers, which are growing every quarter that -- we don't give you the numbers in every year, which is already more than [ 50% ] of recurring revenue, as Mike mentioned in his remarks. Those have an appreciably higher dollar-based retention rate. Which makes sense, doesn't it? I mean, it's a big company, certainly grow organically, but there were so many acquisitions, they buy new stuff, et cetera. And that mix impact from that fast-growing $1 million-plus, which is much faster than the rest of the business in dollars and -- yes, in dollars, is what gives us that confidence.
We have time for 1 additional question, which will come from Will Power with Baird.
Great. Thanks for the comments on our survey. We spend a lot of time on that.
Happy to help.
Yes. Well, the AI commentary did look good. You're right. Let me ask you about the strategic deal pipeline comments doubling year-over-year. I mean, it sounds like you continue to see very good momentum there. And I know you've kind of touched on that, but perhaps dig into kind of the key drivers of that? And how do we think about kind of the confidence level and converting that? How do we think about conversion rates going forward versus what you've seen? I mean, anything to kind of keep in mind on that front?
Yes. If I go back 2 to 3 years in time, there were some large enterprises that would take meetings. They were just checking what was out there, and they had really no interest and no immediate need to move to the cloud. Two factors are happening, 2 main drivers. One is, the legacy platforms that they're using today -- and many of these large companies have all of them, right? They have all 3 of the major platforms, the -- [ Avaya, ] Cisco Genesis. And all of them are either end of lifing or being told they're not going to further develop on those. So the sign is there that they've got to get off those platforms. That's one. I'll give 3 factors. Second, we had to demonstrate in the CCaaS world -- and particularly, Five9 has demonstrated that we can scale and deliver the reliability that they absolutely require table sticks before they'll even consider moving. And we've done that and proven it because of those 2, I'll say, 2 early adopters. They were like 2 that made decisions far before anyone else. And I mentioned this in the last meeting. The others have now taken notice. If it's good enough for them, it must be good enough for us. And we're being pushed our legacy providers saying they're end of lifing, we're being pulled by this AI and automation, innovation that's coming about. And they realize the only way to take advantage of that is to move to the cloud.
And so that's why the RFP volume is up. That's why even the ones that haven't issued RFPs yet are taking meetings to say, "Help, how do we start this process?" They're turning to the SIs, they're turning to us because they recognize, "Oh no, this process may take us a year or 2 to get through." And they're almost feeling like there's pressure there to do it quickly because they want to take advantage of AI and automation, and it may take them a year or 2 just to get through a decision process and start to implement. So that's why we're seeing such great momentum.
And Will, I know Dan won't brag, so I would brag for him. We've got the best go-to-market team in this industry by far. And so when you think about pipeline doubling and our ability to go convert that and win business, I have so much confidence in this team, and it's a team that has actually grown so significantly over the years from our competitors. There are so many people that want to be on the Five9 team, quite frankly. So we're able to track the best and brightest on this team, and they are just superstar. So I have no doubt that they're going to convert way more than our fair share of that pipeline into wins for Five9. And you can see it in our win rates. So I'll leave it at that.
And again, this does conclude today's Q&A session. Mike, I'll turn it back to you for closing comments.
Yes. Thank you very much for joining us today. I'll just say this. I can -- so excited about the future for Five9. We have seen this dramatic inflection, quite frankly, we've been jog talking about in terms of large enterprises adopting cloud, shifting off of these legacy on-premise solutions. And I think the most exciting metric that I talked about today is the leading indicator, the leading, leading indicator, and that is the RFP flow. So 66% growth in RFPs for strategic and enterprise, 21% growth sequentially. So that is a very good leading indicator for the inflection in our business opportunity. Thanks for joining.