Good day everyone, welcome to the Five9 Inc. third quarter 2018 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Lisa 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 third quarter 2018 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. We caution that such statements are simply predictions, should not be unduly relied upon by investors, and actual events or results may differ materially. 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.
For more detailed discussion of certain of the 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 that this non-GAAP information is useful because it can enhance an understanding of the company's ongoing performance. 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 the 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'd like to turn the call over to Five9 CEO, Rowan Trollope.
Thanks, Lisa. Q3 was another outstanding quarter, which our results significantly exceeded our expectations on both the top and bottom lines. I was blown away by the execution from the entire team as we not only executed well but accelerated our growth rate. The performance this quarter continues to reinforce Five9's position as a leader in our market. In addition, we stepped up investment in our strategic priorities and core technology while advancing our AI initiatives and building our talent bench. Before diving into some of our activities in the third quarter, let me provide some financial highlights. Revenue was a record $65.3 million, the year-over-year growth rate accelerated to 30%, driven primarily by our enterprise business.
Enterprise subscription revenue, which is the fastest-growing and most profitable part of our business, continued its multi-year performance of growing in the 30s, posting growth of 37% on an LTM basis under 606, but 39% on a more comparable basis under 605. Adjusted EBITDA was a record $12.8 million, representing a 19.6% margin, up 3.8 percentage points sequentially, demonstrating the considerable leverage in our business model. Given this ongoing momentum, we're raising 2018 guidance for both the top and bottom lines. I'll move on to some of our accomplishments and activities since the last time we reported. As many of you know, Five9 is a born-in-the-cloud SaaS company. We have always been obsessed with helping businesses deliver a phenomenal customer experience through the contact center. Today, we're doing that by creating the world's best self-learning intelligent contact center delivered through the cloud and powered by artificial intelligence.
Today, our platform serves customers of all shapes and sizes, no two customers are the same. We've achieved that by continuously and iteratively honing and refining those capabilities, guided by our customers' needs. That is only possible because we deliver a true multi-tenant cloud platform. In the last quarter alone, we delivered over 50 new features and capabilities, and we did all of that without the need for customers to reinstall or upgrade, and importantly, without any impact to service levels, maintaining Five9's industry-leading reliability. For example, in September at Dreamforce 2018, we announced a new set of capabilities going live on our platform that were targeted at deepening and strengthening our partnership with Salesforce. It was awesome to visit our overflowing booth, where our team frankly did an amazing job and generated a record number of leads.
At the conference, we were also recognized by Salesforce as one of the only trusted fast start CTI partners, enabling frictionless adoption of Lightning for the contact center. After Dreamforce, we attended Google Cloud Next conference in London, where we presented to a packed house, showing how Five9 and Google will bring artificial intelligence to our customers. The biggest investments for contact centers today are their people, and we believe AI will play a critical role in making those people more productive, more engaged, and more efficient by automating the routine tasks that they do every single day. We've been working together with Google on pilots with our key customers, and we're already starting to see very encouraging initial results.
Underscoring and validating all of this progress, I'm pleased to announce that we were named a leader in the first ever Forrester Wave for the cloud contact center, and acknowledged as having one of the largest market presences in the industry. Also, for the fourth consecutive year, we were recognized as a leader in the Gartner Magic Quadrant for contact center as a service. Both of these recognitions are external validation that Five9 is a trusted partner to enterprises, delivering a secure, reliable, scalable, and innovative platform with a compelling vision for the future. Also this quarter, I'm pleased to report that we have added new leadership in a number of areas, including our new CMO, Ryan Kam, a longtime Salesforce and AppDynamics creative and digital marketing leader.
I'm confident that Ryan is going to help us accelerate and refine our message to the market while further enhancing our demand gen initiatives. On the product front, I'm pleased by the quality of candidates we're seeing to lead our engineering organization. While the search continues, I continue to lead the product team directly, and that is providing me with invaluable firsthand insight on the product, on our customers, and also the marketplace. Overall, we made great strides in the third quarter, further solidifying our industry leadership position, building on our customer-first culture, and advancing product innovation to capitalize on the huge opportunity that's in front of us. And I continue to be amazed by the talent and the drive of the entire Five9 team since joining as CEO six months ago.
With that, I'll turn the call over to our President, Dan Burkland, to dive deeper into why enterprise customers are trusting our platform to handle their most critical customer interactions. Dan?
Thank you, Rowan. Just to touch again on the points Rowan mentioned, having spent 30 years in this industry and about to enter my 10th year here at Five9, it gives me a unique perspective throughout the years to observe enterprises with vast complexity, diversity, and challenges of many kinds. As a result, quarter in, quarter out, year in, year out, we here at Five9 have continued to build in the necessary functionality, security, scalability, and reliability while creating an open, configurable, and customizable platform to help enterprises modernize and innovate and ultimately exceed their customer experience goals. While building the platform and product are critically important, I've also found that product alone does not translate to success.
Equally important to product is, well, enterprises are choosing a partner, one that they trust will bring them the knowledge, know-how, and expertise to customize, optimize, and continuously fine-tune the solutions to meet the ever-changing nature of the customer environment, especially as we've seen consumer expectations evolve over the recent years like never before. That's why customers choose Five9 and build long-lasting partnerships with us. I'm often asked what helps us sell most effectively, and I always answer, "It's our customers." They love what we do for them, and they are the best sales advocates we have, sharing their experience with other prospective Five9 clients. With that, I'm pleased to report that Q3 enterprise bookings hit an all-time record, and our pipeline reached another all-time high. I'd like to share several new customers who signed on with Five9 during the quarter.
The first example is a biopharmaceutical company who had been using an outdated on-premises system for their global operations. The customer was unable to efficiently manage their operations across multiple sites, could not adequately integrate to Salesforce CRM, and had limited visibility and control over its data, which prevented it from delivering an optimal customer experience. With Five9, this customer is implementing a full omnichannel solution with voice, chat, email, SMS, visual IVR, performance dashboards, in addition to the Five9 WFO suite powered by Verint. We expect this initial order to result in approximately $2.2 million in annual recurring revenue to Five9. The second example I'd like to share with you is a major public utility providing power and water to its customers. The customer had been using an on-premises legacy system that had become outdated and required expensive maintenance and upgrade costs.
Five9 was able to show them a complete end-to-end solution, including MPLS Agent Connect, omnichannel for voice and email, along with Five9 WFO powered by Verint, and integration to their existing PBX. We anticipate this initial order will result in approximately $1.6 million in annual recurring revenue to Five9. The third example was a market-leading producer of medicines and vaccinations. They had been using a combination of an on-premises system and another cloud offering, neither of which had deep integration to Salesforce and also created silos between the two disparate systems. They began their search for a modernized, all-in-one contact center solution about a year ago and included many vendors in their evaluation.
Five9 was selected for its flexibility, rich WFO solution powered by CSI, deep integration with Salesforce CRM for omnichannel, ability to connect to the customer's existing global MPLS network, and Five9 Genius for artificial intelligence agent assist in the future. We anticipate this initial order will result in approximately $1.6 million in annual recurring revenue to Five9. I'd like to share with you an example of an existing customer who's continuing to expand its business with the assistance of Five9. One of the fastest-growing insurance brokers in the U.S. began as a Five9 customer in 2016 for 400 of their seats and continued to grow over the next few years to nearly 1,500 concurrent seats, adding over 300 in the most recent quarter.
The reason for this continued expansion is the trust that they have in Five9 to provide them with critical resiliency and security. More importantly, they are looking for a partner to deliver a holistic enterprise solution across all of their departments. As you can see, our industry-leading solutions enable enterprises to achieve their digital transformation objectives by leveraging critical customer data to enhance the customer experience. I'm very pleased with our momentum in the enterprise market, which continues to be driven by our proven track record, validation from third-party trusted sources like Forrester and Gartner, and our strong referenceable customer base. In addition, our expanding go-to-market team and ecosystem of partners, which once again influenced more than 55% of our enterprise deal flow in the third quarter. We believe we are extremely well-positioned in this growing large market.
Now I'd like to turn the call over to Barry to provide more color on the third quarter financials.
Thank you, Dan. This was another excellent quarter, with revenue growing 30% and adjusted EBITDA margin increasing year-over-year for the 20th consecutive quarter, reaching 19.6%. Before going into specifics, some reminders. Unless otherwise indicated, all financial figures I discuss below are non-GAAP and under ASC 606. Additionally, all growth rates are compared to the prior year period unless stated otherwise. Finally, note that the reconciliations from GAAP to non-GAAP results and from ASC 606 to ASC 605 are included in the appendix of our investor relations presentation available on our website. Third quarter revenue was a record $65.3 million, up 30% year-over-year, our fastest growth rate since we went public in 2014. This strong year-over-year growth was driven by the continued growth in our enterprise business, which makes up 76% of our LTM revenue.
Additionally, for our commercial business, which represents the other 24%, the strength we saw last quarter continued this quarter, with growth now over 10% year-over-year. Recurring revenue again accounted for 93% of our revenue. The other 7% of our revenue was comprised of professional services. Our annual dollar-based retention rate on the recurring revenue in the third quarter was 101%, up from the 99% we reported last quarter. Third quarter adjusted gross margins were 64.3%, an increase of nearly 130 basis points year-over-year. Adjusted gross margins have now increased each quarter for the last 23 quarters. Turning now to expenses. Third quarter non-GAAP, sales and marketing, R&D, and G&A were respectively 24.8%, 10.6%, and 9.4% of revenue.
These were respectively six percentage points lower year-over-year for sales and marketing, of which 2.8 percentage points were due to the ASC 605, ASC 606 transition, 0.8 percentage points lower for R&D, and 1.2 percentage points lower for G&A. Third quarter adjusted EBITDA was $12.8 million, representing a record 19.6% margin. This was an increase of 9.2 percentage points year-over-year, of which 2.8 percentage points were due to the accounting transition. The adjusted EBITDA improvements continue to be driven by the strong growth in our enterprise business, which enjoys excellent unit economics, and by the ongoing operating leverage. Looking forward, we expect to continue to derive solid revenue growth and progress towards our second half 2019 and long-term EBITDA margin models of 22%-plus and 27%-plus respectively.
Our confidence in meeting these targets is based upon the persistence of the factors which have driven year-over-year improvements during the last few years. Third quarter GAAP net loss was $1.3 million, while non-GAAP net income was $11.1 million. Finally, before turning to guidance, some balance sheet and cash flow highlights. DSO for the third quarter was 29 days. As I have remarked before, we believe that excellent DSO performance is an indication not just of payment terms and the mission criticality of our solution, but also of the level of customer satisfaction. Looking ahead, we expect DSOs to increase gradually as the mix shift to enterprise from commercial continues. Our LTM operating cash flow as of September 30, 2018, was $26 million, a year-over-year improvement of $15 million.
We are optimistic about our potential for long-term cash generation given our adjusted EBITDA models, our substantial NOLs, and our low DSOs. Capital spending in the third quarter was $3.4 million, essentially all of which was paid for in cash. I'd like to finish today's prepared remarks with a brief discussion of our expectations for the fourth quarter and the full year 2018. Note that our guidance reflects no material difference in revenue between ASC 606 and ASC 605. That the bottom line benefit from capitalizing and amortizing a significant portion of commissions will be in the range of $6 million-$7 million for the year. For the fourth quarter of 2018, we expect revenue in the range of $65.8 million-$66.8 million. GAAP net loss is expected to be in the range of $2.7 million-$1.7 million, or $0.05-$0.03 per basic share.
Non-GAAP net income is expected to be in the range of $8 million-$9 million or $0.13-$0.14 per diluted share. This guidance for the current quarter reflects higher anticipated R&D expense. For 2018, we expect revenue to be in the range of $251.1 million-$252.2 million. GAAP net loss is expected to be in the range of $6.7 million-$5.7 million or $0.12-$0.10 per basic share. Non-GAAP net income is expected to be in the range of $30.4 million-$31.4 million or $0.49-$0.51 per diluted share. I would also like to provide insight into our current thinking for 2019. While we are not providing formal guidance at this stage, we can provide some high-level commentary. First, with respect to revenue, we are comfortable with the current street projections for the full year 2019.
We expect revenue to follow our typical seasonal pattern, with a sequential growth being stronger in Q3 and Q4, and Q2 being relatively flat. Second, with respect to non-GAAP net income, we are also comfortable with the current street projections for the full year 2019. However, we would like to remind you that there's meaningful increase in cost and expenses in the first half due to the FICA reset and, importantly, the increased investment in R&D that we have been talking about. Please note that these increased first half expenses are expected to occur during the seasonally weaker part of the year. For modeling purposes, we'd like to provide the following additional information. For calculating EPS, we expect our diluted shares to be $63.5 million and basic shares to be $59.5 million for the fourth quarter, and $62 million and $58 million, respectively, for the full year 2018.
We expect our taxes, which relate mainly to foreign subsidiaries, to be approximately $60,000 for the fourth quarter and $211,000 for the full year of 2018. Our capital expenditures for the fourth quarter are expected to total approximately $4 million-$5 million. For the full year 2018, we expect capital expenditures to be between $14 million and $15 million. In summary, we are very pleased with our third quarter results, which demonstrate our consistent execution. Going forward, we'll continue to strive for solid revenue growth while progressing towards our second half 2019 and long-term financial targets. Now I'd like to open the call for questions. Operator, please go ahead.
Thank you. To signal for a question at this time, please do so by pressing star one on your telephone keypad. If you are using a speakerphone today, please ensure that your mute function has been turned off to allow your signal to reach our equipment. Again, that's star one for questions at this time. We'll hear first from Sterling Auty with J.P. Morgan. Please go ahead.
Hi, guys. This is Sahil Sharma on for Sterling. Congratulations on the quarter. My question is that the SMB segment grew again by double digits this quarter. How's the focus going to be going forward?
Well, this is Rowan. Hey, thanks a lot for the comments. We did see the commercial segment continue to grow, as you mentioned. We're going to keep putting focus there. I'll throw it over to Dan, who I think can give some more of the commentary about what specific things we've done that's driving some of that performance.
Yeah. Great, Rowan. Thank you for the question, as you saw in the last couple of quarters, we've seen execution and just a closer focus on making sure that we maintain our base of customers, continue to grow with them and expand them, as well as capture new clients in that space. While it had been growing in the small single digits previously, it's picked back up into the 10-plus% range.
Yep, that's very helpful. Thank you.
Yep. Thanks.
Thank you. Our next question will come from Scott Berg with Needham.
Hi, Rowan, Dan Burkland.
Hey, Scott.
Thanks for taking my questions today. I have two quick ones. We'll start with, Rowan, wanted to see if you can talk about some of the consolidation in the space. Over the last three or four months, you've seen companies like Vonage buy or acquire NewVoiceMedia, and obviously RingCentral got involved, and Talkdesk has announced some fundraising in general. Just wanted to see if you have any thoughts on what that means to maybe your opportunities and what you're seeing competitively.
I think the folks are picking up on something that we've known for over 10 years here at Five9, and that's that cloud contact center is a massive opportunity. It's no surprise that these folks are coming to the party. Obviously, each of those companies is taking a different approach. RingCentral obviously has a partnership with NICE and bought Dimelo, which is a piece of the contact center. So I wouldn't say they've achieved a contact center offer of their own yet. NewVoiceMedia being acquired by Vonage, they seem to be on the path through their string of pearls of acquisitions to attempt to build a complete sort of collaboration stack offer to the market. NewVoice has really kind of fallen off the map for the last few years, primarily obviously based in Europe and historically only really available as part of Salesforce.
Twilio just kind of dipping their toe in the water with Flex, I think that one's too soon to tell. The bottom line is all of these folks are seeing the opportunity to disrupt the legacy vendors, right? The premises and even hosted, so-called cloud offers just aren't what customers want. They want real cloud offers, and that's what these new disruptors are following Five9 on.
Got it. Helpful. My follow-up is probably for Dan. Dan, your sales and marketing efficiencies, at least how we calculate them, have been improving significantly the last year, 18 months. Given the growth rate that I would consider to be off the charts this quarter for you guys, any thoughts on investing in some of your capacity, maybe a little bit more aggressively going forward? Because whether it's deal sizes getting bigger, maybe more deals in the funnel, you're doing something right there. Just to know if you have opportunities to invest even faster today.
I appreciate it, Scott, and thank you for the comment. We're seeing an increase on several fronts, and I think several factors are contributing. You mentioned an increase in productivity is one, an increase in our customer base and growing with Five9 is a second, and increasing our reach through our different channel and ecosystem partners and just our brand as a whole. Like we said in the earlier comments, being recognized as a leader by Gartner for four years in a row now, and certainly by Forrester in their first wave. It's giving us momentum in several different areas. We continue to kind of hit on all cylinders, and I think you're seeing that in the results, and we have no reason to slow that down or change our strategy.
It's working very well. We just look forward to continuing to expand. The market continues to bring us further up into larger and larger deal sizes. We also see expansion outwardly into new markets and new geographies. I think it's a great situation to be in. Like we've said many times before, we're at the early stages or early innings of a ballgame, if you want to state that, but there's a whole lot of market left, and we're at the point where if you look at the penetration rate of folks that have made that transition over to cloud, it's still, by most accounts, in that 10%-20% range. There's a whole lot more to go.
Great. That's all I have. Those are my questions, guys.
Yep. Thank you.
Thanks, Scott.
Thank you. Our next question will come from Meta Marshall with Morgan Stanley. Please go ahead.
Great. Thanks. I just wanted to kind of get some insight on the professional services group, because I know in some ways it had been a gating item to growth, and now it no longer kind of seems to. Just getting a sense of, are implementation times shrinking? Is that group just becoming more experienced? Just something that seems as if you're getting better leverage out of that group. Maybe a second question-- Oh, sorry. Go ahead.
Oh, that's fine. Go ahead. Second question.
The second question is just on the usage element to Q3. I know obviously election season, kind of annual enrollment, just was there any excess contribution of usage in Q3 that you think is above normal seasonality? Thanks.
Meta, this is Dan. I'll handle the first question on PS. We're just seeing greater efficiencies out of that team. We've actually brought in some new leadership to head up professional services with folks that have had experience in working both in building and scaling and applying tools and methodologies that allow us to do things better. We continue to gain more and more experience, having been doing this ourselves for many years, and starting to leverage some third parties in that effort as well. I think when you look at all three of those vectors, you're going to see some continued improvement. We have no reason to believe that we won't achieve our goals of moving that professional services into a positive margin as opposed to negative. We're on track to do that and look forward to continuing to show improvement there.
Meta, with respect to the usage, nothing special there. It tracks pretty closely with our seat growth, which was strong. Yes, with the elections, we didn't see very much change. In fact, we didn't even track it this time. Much of that is despite your phone ringing incessantly at home, is coming through digital, Open enrollment only just started this quarter.
Got it. Thanks, guys.
Thanks, Meta.
Thank you. We will move to Michael Latimore with Northland Capital Markets. Please go ahead.
Hey, hi. This is Vijay Dever for Michael Latimore. Thanks for taking my question. I know you talked briefly about your search for the new CTO. Could you just give me more updates on how the process is going forward, and do you have any definitive timeline for getting the new leadership in place?
Yeah. Thanks, Vijay. This is Rowan. First of all, I would say we are seeing very strong interest. We have had lots of candidates from across the Silicon Valley and elsewhere applying and interested in the role. I think the profile of the company is to credit for that and the huge market opportunity when people see, and especially when people hear about the data that we are sitting on. The idea that we have four and a half billion minutes of recorded phone calls per year that we could start to leverage from an AI perspective. That brings out the best. That is the kind of things that top talent in the Valley are looking for. It is one of my highest priorities. It has been going really well. I am also taking the time to get it right. This is a key hire for us.
I do expect to have it wrapped up shortly.
Okay, great.
Just to finish off the thought, I guess, in the meantime, while I've been doing the search, I've been leading the team directly, that has been invaluable to me as the CEO to dig in with our customers, with our engineering teams, to understand the product and the marketplace, that much more deeply. Frankly, I've been very, very impressed with our engineering teams who have just done a phenomenal job at delivering the kinds of innovation that we've had up until now, you should see what's in the pipeline. It's very exciting.
Great. I think you haven't spoken much about the channel bookings. Do you have any number over there on how the channel sales going on?
I'll let Barry comment on numbers, but I'll just say that the channel is important to us. We've shared before in our deck as we've been out with investors that the channel contributes to a big amount of the referrals that we get. They touch a good number of our deals. That's only going up, we believe. I recently came back from Europe, where the channel interest in Five9 was off the charts. They're sort of seeking us out by every channel they can possibly find to sort of get ahold of us, and they just are hearing it from customers. I think the demand for Five9, the increasing awareness of the brand, is really translating into some very, very strong interest from the channel. It remains a priority, and it's increasing in priority for us. Dan, Barry, you want to add color to that?
Yeah, sure. We continue to get increased leverage from the channel across the board. When we say the channel generically, you're talking about different categories, right? We have the master agent community, which still gets written directly. Those deals that they bring to us and they consult for and really have great influence over the enterprises, they bring those opportunities to us, and then we work them and close them and contract directly with the end user customers. Those are still channel sourced deals, if you will, or channel sourced business. That's been great. Those are on a referral business, and that just continues to grow and now represents over 30% of our business in enterprise that comes from the variety of channels. Big part of that is the master agents, as I mentioned, and their sub-agents.
Also you've got referral partners and just the consulting community that refers business to us. Then you've got your true resellers, mostly VARs that want to take the product in the old traditional methodology, put it on their paper and service that customer as their own. That's a lesser piece of the business because as a cloud provider, end customers know that it's our platform, it's in our data centers, it's monitored and managed 24 by seven, and all the upgrading and capabilities that we deliver to them are pushed directly from Five9 to the end user customer. They tend to want to contract more often with Five9, than traditionally going through a VAR and contracting with them. That does not mean that we're not getting huge leverage from those channels.
Great. Thank you.
Thanks, Vijay.
We'll move next to Matt VanVleet with Stifel. Please go ahead.
Yes, hi, thanks for taking my question. I guess looking out towards the end of the year and into 2019, as you talked about really strong pipeline, what's sort of the broader mix of deals that are rip and replace a legacy solution or build on top of or up and around a legacy solution versus companies out there now sort of embracing the whole customer service element and standing up net new contact centers, and how much of that is driving the business?
This is Dan. Great question. It's very rare that you find somebody just standing up a 500-seat contact center from scratch because you got to have a business and have volume of customers that are wanting to contact you daily. That's typically something that grows from the ground up. Those typically start rather small. It's also a critical reason why we continue to stay focused on our commercial business because a lot of businesses that do come about start in a small sense and then grow to become very large enterprises. We capture quite a lot of those. The vast majority, really the lion's share of the business that we're working with clients on is taking their entire operations and their old legacy environments where they've built silos of technologies that require expensive upgrades, difficulty integrating site to site, routing calls across sites.
It's very difficult to manage that, and you end up with a big staff and a lot of inefficiency that gets created. That's really been something we've been living off of from day one. As a cloud provider, we create one virtual contact center, as you know. It is primarily helping companies take that digital transformation strategy and move and use the contact center as one of those areas that they want to migrate and get a technology footprint out of their own data centers and leave it up to experts like us to take that over. To answer your question in a long-winded way, we're transforming the legacy on-premises systems over to the cloud.
In fact, when we show them the future-proof and the investment protection that they can gain by working with a cloud provider like Five9, oftentimes, because they love the fact that we can continue to innovate and help them achieve their ultimate goals. What they want day one is they say, "Great. The first step is take all my legacy stuff out, get it off my premises, give me a like-for-like solution, and then we'll innovate and expand from there." That's one thing that we've become very good at. In fact, the comment earlier about professional services, because we're doing a lot of the work to replace what they have, we know what is involved there, and then we continue to enhance and add capabilities. Again, the lion's share is primarily taking old legacy systems and moving them to the cloud.
If I could add, I'll just add one thing, that's a great color behind it. This is anecdotal, but I was with the CEO of a Fortune 500 company last week, he was quite animated about his contact center, and really it was this sort of story about digital transformation. What he was on about was, "Look, my customers are leaving me because they are getting a better experience from someone else." He was really concerned about this, so you could say that digital transformation, at least in the case of this CEO, was the spark that lit the fire, and that fire eventually sort of turns into, as it rolls downhill in the organization until the contact center people, when it hits them, it's like their hair really is on fire. That's what's a big driver of our business.
I can hear it when I talk to these CEOs. It is a massive priority for them. It's a life and death issue in many cases. It's either they transform their customer experience, or they realize they're not going to be in business for long.
When you look at some of those situations where we're talking about big digital transformations, how many customers are you seeing that the actual sort of voice telephony element of the contact center is becoming much less important and maybe less of a strategic driver of a business decision versus your ability to engage with the customers digitally across multiple channels, across social media if need be? Because we're seeing a lot of investment, you touched on a couple of them before from some of your competitors that haven't gone to building out the full solution, but are attacking it from just the digital elements. Are they sort of fringe getting involved in some of these RFPs for customers, ultimately maybe you win with a broader solution, but they can offer that at maybe a lower ticket price?
How are you, I guess, fighting off that competition as companies feel like the digital element is maybe the most important?
Yeah. Well, first of all, we have a complete offer. They turn to us for not only voice, but for messaging and email and all of the channels. We work better than anyone else with the CRM vendors, including most notably Salesforce, where you can run in a blended mode. If you've chosen, for example, Salesforce for your messaging or email, you can work really well with Five9 providing voice or other capabilities, and that's something that we announced at Dreamforce 2018. Back to the sort of the broader question around what drives this, it's less and less a technology upgrade conversation around telephony.
In fact, we just went through a list of all of the possible integration points between unified communications and CRM. We're talking probably five times more integration points between a call center and a CRM system than between a call center and a UC system. What people are seeing here is a transformation of the overall digital experience touches on lots of the parts of their business, and the call center sits at the center of a lot of those things and needs to integrate really tightly into those. CRM and all the associated capabilities that come along with CRM are a big driver of that. That's really where you're seeing these things get connected, and we do a tremendous job at integrating with those guys so that you can get a very seamless solution crossing from voice and messaging and email and so on.
Do you want to add anything, Dan?
Yeah. Just to add to that, over the last several years, you may have thought, "Oh, the digital channels are coming into play. Are they cutting into the importance of voice?" As you mentioned, is voice becoming more of a commodity piece? What's happening is just the opposite. Right now, just in the last year or so, with the advent and really artificial intelligence coming about, we're finding that customers are more and more interested in figuring out, "How do I mine the data that is in all of my voice conversations?" If I have 500 agents in my contact center, I've probably got 300 of them talking to customers all day long, there's a lot of valuable data that's there. What CRM solutions have relied on is those agents to disposition calls with a couple of categories about what the call was about.
We're finding that now with the AI capabilities that Rowan mentioned earlier about with Google being able to transcribe those voice conversations and extract the data from the conversation, then perhaps put it into the CRM and have it stored indefinitely as key elements of that interaction is so important. That doesn't even touch on the agent assistants and virtual agents that ultimately could become available to us. When you look at voice is actually making a resurgence and really becoming so important to enterprises. They're finding out, "How do I capture my calls? How do I record them? How do I keep them indefinitely? Then how do I transcribe them so that I can data mine them and pull that important data out of those conversations?" Because historically, it's been very difficult to get to that data.
You have to have people sit and transcribe, they can only listen to 2% of the calls if they want to pull data out of them. Very much a new trend.
All right, Dan. That's great insights. Thank you.
Thanks, Matt.
Thank you. Our next question will come from Raimo Lenschow with Barclays. Please go ahead.
Hey. Thanks for taking my questions, congrats on that great quarter from me as well. Can I stay on that subject around AI? If you think about, Rowan and Dan, what you just talked about, is that going to be you as the guy that has to help with that AI, or is that going to be the stuff that comes from the CRM vendor? That was my first question. In other words, how much more intelligent does your system need to be versus where the CRM vendors need to go?
Yeah. This is Rowan. Thanks, Raimo. It's a combination. What Dan was just referring to, and what we've been talking about really is exclusive to the contact center. We're sitting on probably the biggest source of dark data in the enterprise today, and that is customer voice conversations. You're talking, again, I mentioned that earlier, 4.5 billion minutes a year that flow through our pipes that we can use to train artificial intelligence systems. It turns out, all of that is data. When you think of it's data, but what is it really? It's what your customers are telling you they want from you, and what problems they're having with your product or service.
It's incredibly valuable, and absolutely, I think the vast majority of the value that needs to be extracted from that, or a huge amount of that value, is going to come directly from us. We are working with several pilot customers right now. Google is our technology partner, but we actually are partnered with other vendors as well on the back end, so it's not exclusively Google. We can bring to bear any AI technology that we so choose. We have sort of three ideas and three initial legs to the stool around the pilots that we're doing with our customers. We're learning at this point. Again, you're not going to see the returns here measured in quarters, but probably in years.
The longer-term opportunity to automate the really boring drudgery that most call centers do day in and day out, is really the opportunity that AI presents. That is a 10 times larger TAM opportunity than just selling the existing technology that we do today. Think about our current TAM is sitting at about $24 billion per year, but there's $250 billion spent a year in contact center labor. The only way to automate that labor is to get access to massive amounts of data and train artificial intelligence systems to start to augment and replace, ultimately, the routine and repetitive calls and scenarios that are coming into those agents. That's the opportunity.
Okay, perfect. Okay, makes total sense. Can you double-click a little bit on the partner competitive landscape as it is evolving? You've been working for a few quarters now with Verint. NICE, obviously, has an acquisition that they need to work on and how they are in the market in Genesys. Can you just double-click a little what you're seeing out there?
Yeah. NICE is both a partner and a competitor, obviously. Verint is a partner. They're our lead partner from a WFO perspective, and they have a tremendous market share in that category. We deliver that as part of our service. When customers choose to go with WFO, especially at the higher end of the solution, we bring in and host and deliver Verint as a part of our service. We also have other vendors that we use for the lower end of the market. That's how we partner in the WFO/WFM space. We have a number of those partnerships, and they're working really well. In terms of competitively, obviously we see NICE inContact.
If you see the latest Gartner Magic Quadrant, both NICE and Five9, we remained in the top upper right-hand side of the quadrant, with the third competitor sort of dropping down on ability to execute. I think that's just a reflection of market presence. The fact is that NICE and Five9 are the clear breakaway leaders in the cloud contact center space.
Yeah. Okay, perfect. Okay, makes sense. Good luck. Sounds good.
Thanks, Raimo.
We'll go next to Zack Turcotte with Dougherty. Please go ahead.
Hey, guys, it's Zack on for Catharine Trebnick. I just want to jump back to the sort of multi-channel contact center approach again. First, how do you see your average deal size changing, say, in the past 12 months with the constant addition of features and capabilities and expanding across more channels? Secondly, do you think that companies like Vonage and Twilio might have somewhat of a competitive advantage in this sense, since they have the inherent CPaaS capabilities and can build APIs or have the API toolkits to build more customized solutions as these customer demands widen? Thanks.
Do you want to take the first part, Dan?
Yeah, sure, Zachary. This is Dan. Regarding multi-channel, yeah, that continues to be one of the vectors that helps us get larger deal sizes. The primary one, when we add chat or email or SMS or one of the other channels to the contact center, it's still just a small addition to the bundled capabilities that that agent has with us. That doesn't contribute a ton to the uplift in size. The main uplift in our deal size is from the size of the customers. The cloud contact centers, cloud has been adopted over the years further and further up market as people see others trusting the cloud.
You've got to build in the security, the scalability, the reliability, and show them that you're improving in each of those areas, also giving them an ability to innovate and customize the solution more effectively than they can today with their premises solution. I would argue that most of those customers that do want multi-channel from us, they want a finished product. They don't want an API where they have to go build an email solution and figure out how to build all the feature sets that go into that. They want something that's already built-in and that's been built specifically for contact center, yet has the openness and flexibility for them to come in and make it tailored to their own needs and requirements.
It's interesting because it's kind of a misnomer when there's a perception, sometimes misplaced, that, "Gee, if it's in the cloud, I'm going to have less flexibility or less openness," and it couldn't be further from the truth. Building the platform with the proper APIs and SDKs gives that customization capability to all of our customers, and they enjoy the ability to do that, as we said in the earlier remarks. Rowan?
I would just add that our product has over 300 APIs that developers can and do use to customize it and tune it for their specific environment. I said earlier, no two contact centers are the same. What we've been doing for the last decade is iteratively honing and refining our feature set with our customers in each new segment that we enter. We've gotten really good at delivering that value quickly. The length of time to take our product from the first time you talk to us until you've deployed it is still very short when compared to what you would need to do if you attempted to sort of do it yourself, hiring developers, and working through that process.
I think that the CPaaS, to speak specifically to your question about CPaaS, its origination in the sort of a different space than ours. It came up originally for developers to be able to embed communications into their applications. I think that that's a hugely positive development. Obviously, Twilio's done very well with that, as had Nexmo and Plivo, both I think, as well as Tropo. There are the host of CPaaS providers that you can use or even going directly to Amazon in some cases. I see the customers that I've talked to, they do use those technologies. They're often used by a different team than the call center team. They're used by the product team where they're looking to do integrations into the product. Often orthogonal use cases to the classic contact center use case.
Sometimes they're similar, they're often orthogonal. I think that it's an adjunct and it's an interesting new take on how to build more and more communications with your customer. Ultimately, it is a reflection of the same trend that we said earlier, which is, look, you need to communicate with your customer more. The more places you can embed those communications and that you can transform those communications with your customer, the better. In our case, it's really all about the contact center, and the classic contact center. In the case of CPaaS, it's about building that into your mobile app or building in capabilities into doing authentication through SMS and so on. I think it's an interesting adjunct and a new step here for this market, we'll see how it plays out.
Thank you. We will take our next question from Jeff Van Rhee with Craig-Hallum. Please go ahead.
Great, thanks. Congrats, guys. Just a great quarter. Several questions for me. First, just I guess starting at a high level, if I look at the guide, roughly 16%, if I have the math right, on 19, just essentially saying you are comfortable at this early point with the consensus. Last several quarters, obviously, showing accelerating growth, and it has just been, particularly the last two quarters, really standout growth. When you look at that forward number, I get it, I have followed you a long time. You guys are really cautious and conservative and then just deliver the outperformance as you go. It demands asking, do you see anything that suggests-
Over a few quarters, yeah.
Yeah, exactly. Anything that suggests that level of deceleration or incremental caution than what you might have thought 90 days ago?
Jeff Van Rhee, the short answer is no. We are just at this stage, as we traditionally have been, prudent. There is a seasonality aspect to our business. We want to be able to wait and see exactly how that turns out and merges before we commit to it. The business remains robust. There is across both now the enterprise and commercial. We will see what happens as we get closer to giving formal 2019 guidance, you should not read anything beyond what I just said into that 16%.
Okay. Dan Burkland, maybe on the sales side, just can you talk a little bit about sales recruiting, the pace of ads thus far in the year, sort of your preliminary thinking about 2019 to the extent that you are willing to share it with me, sort of just open-ended, talk to me about what is changing, because you have certainly added a lot of capacity. I know you have gone for people that are known entities historically and been remarkably consistent at bringing them on and scaling, just talk about how that is trending and what you are thinking about 2019.
Yeah. Great question. It continues to get better and better. When you look at the opportunity, for the reasons I mentioned on an earlier question, with our success and our growth and our accelerated growth, our brand, our reach that continues to get through to more ecosystem partners, more channel partners. There is a lot of things happening that make Five9 a great place to work, not to mention our culture and just, I think the integrity in how we do business. That is a testament that is validated by our customers every day that we work with them. I think we have a very attractive and envious place to be, and we continue to get our door knocked on more and more quarter in, quarter out. It has gotten better and better, and it allows us to be more and more selective as we go through that recruiting process.
I could not be more pleased with the team that we have and be more proud of the leadership team that we have in the field, selling as well as on the commercial team. Again, it just allows us to attract better and better people all the time. One thing that is different when we go out into the market and we are recruiting folks that are even at the individual contributor level, there is a criteria that we look for, knowing our future and knowing how we are going to grow this business and continue to expand and be a leader and take this company to whole new levels.
It's important for us when we do recruit folks, and we've been doing this for the last several years, is to make sure that they not only have the experience and success in their DNA of selling, but also that they have aspirations, and that either through experience of their own or aspirations to grow, and that they are management material. It's been very easy for us to promote from within and promote successful people and have them either turn into great leaders or have that experience already under their belt, where they come in as an individual contributor and then jump into a leadership role once they've learned the Five9 way. I think we're in great shape there, and we're hitting on all cylinders when it comes to sales.
Got it. Last one then. I guess, obviously, with the top-line acceleration, to what extent is the market itself accelerated in the last 12 months? Asked differently, how does it feel this quarter, say, compared to 12 months ago, in terms of the spend environment and the rate of growth in the overall market?
Yeah, I think the spending is certainly there. It was a little different way back in the CapEx days when we were selling premise solutions, and you needed those CapEx dollars. I think we're pretty much immune to some of the macroeconomic conditions we've seen way back over the years. We've done well even when times were tough. Having said that, in today's market, we're seeing the momentum continue. Really, aside from that spending, I think it's more about what Rowan had mentioned earlier. It's about companies realizing that they need to change the way that they deliver a customer experience, or they're going to get left behind and be out of business. More and more, you see it even in the media. You turn on the television today, and you see a commercial, and they all talk about the competition to deliver a better experience.
That's said more often today than, "I'm building a better product, and I'm giving you a better product." It's more about, "I'm going to deliver you something that you're going to enjoy, and you're going to want to work with my company." That difference in messaging translates to companies realizing, "I've got to go through this transformation and get to where I can deliver the optimal customer experience." To do that, the first step is get off the old legacy technology to where I have a solution that gives me the visibility and control over my data so I can inspect it and get insights to what my customers are thinking. I've got to know the customer journey and which ones are working and which ones are not working so that I can make the changes in how I deliver an experience to a customer.
Big part of that's in the contact center. It's not just in the contact center, but that's a big part of it. I've got to get on the foundation and on the platforms that allow me to then navigate and be able to change as I recognize my customer wants change, or I recognize that my customer needs a change because I'm not succeeding with them.
This is Rowan. I'll just add specifically around market growth. We don't have good data around that. What we do have good data around is our win rates, which continue to remain strong. About three-quarters of the deals on the cloud side that we win. That remains strong. What I think you need to pay attention to is as customers look to transition to cloud vendors, are we getting our fair share? The answer is, not only are we getting our fair share, we're getting more than our fair share, which is great. Then second, look at our dollar-based retention rates. Those are up again this quarter, up over 100%. Barry, correct me if I'm wrong. 100-
101
101% dollar-based retention rates. What that should tell you is not only are customers moving onto our platform, but once they move onto our platform, they buy more. That's really important to keep in mind. 101% dollar-based retention rate and win rates remaining strong, while we don't have data, it certainly feels like the market is robust as people continue to accelerate the shift to the cloud.
Yeah. Got it. Well, another great quarter. Thanks. Appreciate it.
Thank you.
Thanks.
Thank you. We'll move now to Terrell Tillman with SunTrust. Please go ahead.
Hey, good afternoon. Thanks for fitting me in. Hi, Lisa, Rowan, Barry, and Dan. I'll try to go through these really fast because I know we're past an hour. On the commercial business, any reason why this higher growth that you've seen over the last couple of quarters can't be sustained into the fourth quarter and into next year?
Well, remember that we had some weak compares from the previous year, so that's certainly one factor. We have made changes to the team from an execution perspective, but I'll repeat what we said last quarter. Two quarters don't make a trend, so we're just being prudent in regards to forecasting that part of the market. Obviously, when you see our CAC to LTV ratios and you look at enterprise being a six to one, or one to six, I guess you should say, CAC to LTV versus the commercial market being two to one, we want to continue to invest in that enterprise business, which is also growing faster. I think we're confident in what we've changed in the commercial team that now that is working. The market is obviously strong and the overall economy is strong.
Our brand presence and awareness of our brand continues to be strong. We've got our new CMO as well joining us, so we think that that's going to continue to accelerate. We feel good about the commercial business, but there's a variety of factors here.
Okay. Just lastly, the pilot work related to some of the AI initiatives, Rowan. I appreciate the idea that could potentially significantly expand the TAM, more of this conversational automated interactions. Will that change kind of the makeup of how you charge for your software? Could some of these AI-driven deals start to become meaningful in the revenue stream in 2019? Thanks again.
Yeah. I'll take those questions one at a time. Yeah, the way that we charge, there are 3 different offers that we've been piloting with customers, and it depends which of them sort of gets traction first. One of them is a business IQ or business insights capability where we translate all the calls to text, then we extrapolate based on those what the call dispositions were. We pull out the insights like, what did the customer say? We can do that at scale in an automated way, not previously possible. That one is a new business or would be a new way of charging customers, a new offer that we might have to customers. Second is that virtual agent and agent assist.
On the virtual agent, I think that's an interesting one we may look to charge on a per minute or per hour basis. There could be different ways of modeling that. It's similar that to today, we sell a seat for an agent, then we sell an LD charge for usage. I think that would be similar, but instead of having it attached to a human, it would be attached to a virtual agent. We would no longer be linked to the number of agents in the call center. You might, for example, buy 1,000 human agent licenses from us, but scale up and get 2,000 additional virtual agent licenses from us. That's speculation at this point, and I think that's reflective of the second question, which is, I don't see this materially affecting our revenue in 2019. We're taking our time to get this right.
It's a long-term transition for the market. There's been a lot of false promises in the AI world in general, including the recent bot hype that sort of went up and down. We're in this for the long haul. We want to make sure that we work with customers, get a solution in place that really works and is practical. I think that we just should be careful about assuming any revenue coming in on that anytime soon.
Thank you.
Thank you. We'll keep you posted.
Our final question today will come from David Hynes with Canaccord. Please go ahead.
Hey, thanks, guys. Nice set of numbers. Two competitive questions from me. It's been eight months since Avaya closed Spoken. Any sign now that they at least have some cloud migration talking points that they can leverage? I don't know if that's slowing down decision-making among potential defectors. You guys clearly have strong win rates when the decision is made to go to the cloud. Are they having any traction, at least improving retention at all now that they have a cloud product they can speak to?
You could ask them about their retention because we don't know that. The answer to your question is no and no. We're not seeing it slow down our business, and certainly on the surface, what we have visibility to, Spoken is not a cloud SaaS contact center. It doesn't seem to be impacting our business one iota. Dan?
Yeah. Not at all.
Okay.
They continue to be the biggest donor of install base legacy solutions that we replace each and every day.
Sure. Then one more on the competitive front. You guys, you called out the Gartner Magic Quadrant, obviously there are a lot of influences at play in these things. We don't put a whole lot of credence in them, but we know buyers pay attention. I need to ask, NICE inContact leapt ahead of Five9 in ability to execute this year. Any comments there or thoughts on what's driving that perception in the field?
Well, I wouldn't say they leapt ahead of us. You're measured in millimeters, let's be clear. Certainly, we wouldn't necessarily agree with that judgment. We think we are executing terrifically well, but we don't have visibility into what NICE is doing in the marketplace. We do have visibility into our win rate, which remains at about three out of every four deals, so we're pretty confident of that. After Cisco and Avaya, our third biggest takeout still remains NICE inContact, which is extremely strange because you wouldn't assume that after a customer has moved to a cloud platform, they would move again. They are. That's an interesting data point, that's what we have visibility to. With regards to some of the factors that drive that Gartner Magic Quadrant, they lay those out pretty clearly.
One of them where NICE gets credit is their international traction and also their traction with the channel. I said earlier, I just came back from Europe, there is a huge wave of interest for Five9, they're hearing, I guess the channel partners are hearing it from customers. We've been thoughtful about how we're going to leverage the channel. Like AI, we're in this for the long haul. We want to make sure we get it right. It's easy to go too quickly with the channel, we wanted to make sure that our product and integrations and capabilities were really ready for the channel. It's a key area of investment for us. It's going to be a key growth driver for us, going forward.
Yep, got it. Okay, helpful color. Thanks.
Great. Thank you.
Thank you. That will conclude our question and answer session for today. I'd like to turn the call back over to management for any additional or closing remarks.
Thanks, operator, and thank you to everybody for joining our call today. Thanks for all the great questions. Most of all, I'd like to give a special thank you to our customers and our employees for delivering yet another stellar quarter. To wrap up our call today, let me summarize where we are. First, we see an enduring growth opportunity in the market that's reflected in our financial results and in our industry recognition. Next, we're confident in our ability to continue to execute as a leader in our space by delivering on the world's best intelligent self-learning contact center, delivered through the cloud and powered by AI. Finally, I believe that the contact center is going to change more in the next five years than it has in the last 25 years combined. Thanks for joining our call today.
Thanks to the Five9 team, and thanks to all of our customers. Good afternoon.
That will conclude today's conference. Thank you all once again for your participation, and you may now disconnect.