Thanks, everyone, for joining us. I'm Rishi Jaluria. I cover software here at RBC. I'm delighted to have with me Mike Burkland, who's the CEO, and Barry Zwarenstein, who is the CFO of Five9. Before we get started, Barry, I know you wanted to say the Safe Harbor?
Yes. Before we start, I would like to remind you that today's discussion will contain forward-looking statements, including those regarding future events, trends, expectations, projections, and beliefs. As a matter of fact, our industry, our company product, our company product development, AI and automation, and potential growth drivers. Such statements are predictions and are not to be unduly relied upon by investors. Actual events or results may differ materially. Five9 takes no obligation to update information of such statements. Please refer to our most recent Form 10-K under the captioned risk factors and elsewhere in the financial and Five9's filings with the SEC. Thank you.
All right, perfect. Maybe let's just start with a little bit of an overview of Five9 for people who are generalists and new to the story. And maybe we can sink into that. You know, you obviously had a pretty nice bounce back quarter. Stock was up nicely on Q3. Maybe talk a little bit about what we got out of that.
Sure, Rishi. Yeah. So we provide software for large enterprises, actually, and mid-size and small enterprises as well, to essentially power their customer experience. And this is an AI-powered platform that we have. And we're about $1 billion in revenue. And we'll talk about some of the metrics. I would say for the third quarter highlights included subscription revenue accelerating to 20% year-over-year growth. And that makes up 80% of our revenue mix. So we really want to encourage investors to look at subscription revenue as opposed to the other 20% of our revenue stream that essentially is not really they're not growth factors for us. We can get into that. I would say another highlight was our AI revenue growth as well as bookings. Our AI revenue growth was 40% year-over-year in the quarter.
AI bookings on the net new side made up 20% of ACV bookings for the quarter, and that's a really important number. I think that's actually the most important number that I see. 20% of our ACV bookings went to new customers. That's a big number, and there were other AI highlights in terms of metrics as well. We talked about installed base bookings into our installed base, our AI upsell, cross-sell into our customer base grew 50% year-over-year, so lots of momentum in AI. Speaking of AI, we also announced our AI agent, which are, again, the next generation of what we call IVA and DVA, but we're going to start calling these AI agents. They're both digital and voice for self-service and front-ending of interactions. Really exciting. As an industry, we're moving toward more autonomous AI agents. It's really exciting.
Our customers are excited about it. Last but not least, Acqueon. We closed the Acqueon acquisition and announced a $4 million deal that was led by the Acqueon product that we now own, $4 million ARR. It was nice to get off to a great start with a recent acquisition. Yeah, I'll stop there.
No, I think that's super helpful. A lot of threads to pull on there. So maybe let's start on the AI front. I can imagine that's one of the biggest debates on the stock today is really understanding the footprint of AI. So maybe let's spend a couple of minutes on that. Starting first with, why should we not worry about seat compression as a result of AI?
Yeah. And this is a great question, Rishi. It's top of mind for everyone. And understand we have an end-to-end platform that powers interactions between a brand and their consumers. And we're all consumers, right? And we all want to interact with a brand in different ways, different channels, including, in some cases, self-service powered by AI or even with a human agent, which has AI kind of helping them do a better job. So that's at a high level. And we have software for powering all those interactions, whether they're AI-handled, true self-service, fully contained, digital or voice, or they're handled by a human agent with our AI assistance and copilot technologies. There's a lot of other AI products that we deliver to these brands.
But it's really important to understand that the more automation and the more AI, the more interactions that are handled by true self-service and less by human agents, that's actually a TAM expansion for us. We get more revenue per interaction for our AI software than we do for our software for human agents. So we're a net winner in this equation. The more automation and the more self-service through AI, that's actually better for us. A lot of people are kind of misunderstanding that, thinking that's a bad thing for us because the risk of agent counts going down. And again, we'll see how this all plays out. We're, again, as I said, a net winner with more automation through it.
Yep. Okay. So let's follow up on that now. Because I think the second question becomes, why do you have a right to win when it comes to AI? The two that I hear a lot are Salesforce with Agentforce and then now Microsoft with Copilot for Service, obviously admitting both are very new products. Maybe walk us through what gives you the right to win versus those larger companies.
Sure. Sure. And again, our customers, and we've surveyed our customers, and there's been other surveys out there. Look, these large brands want to purchase their AI technology from their CCaaS, CX platform vendor like Five9. And part of the reason is that we are this end-to-end platform for handling all of their interactions, again, whether they're digital or they're voice or whatnot. And it's so important to have the visibility across all those interaction types to power, say, a chatbot. If you have a standalone chatbot and it's not connected to a platform like ours, it's basically like tunnel vision. You don't have that chatbot, or if it's a live human on the other end of that interaction, the bot will not have visibility into prior interactions. Rishi was in touch with the contact center a week ago or two weeks ago, and this was their problem, right?
They have to actually start from scratch, and they don't have any of the contextual data to power that AI. So AI, just like humans, are dependent on contextual data about you, the customer, about the brand and their offerings, and about all the information and back-end systems. Our platform has all that visibility, all the CRM data, all the billing information data. We integrate with about 20 to 24 back-end enterprise systems in most of our deployments. So we get that visibility of the contextual data. And again, a standalone AI solution doesn't have that visibility to provide a true personalized customer experience. And our customers know that. And by the way, if one of our customers does want to purchase AI from Salesforce, they usually get a blend of our AI and Salesforce AI. And we monetize the connector.
We call it VoiceStream or TranscriptStream, which allows them to essentially have that visibility into our platform. But we monetize that on a volume basis. And it's very lucrative for us. So either way, again, we're going to participate in that revenue opportunity, whether or not it's through a partner solution or through our own solution and our platform. But at the end of the day, the most important thing is we win the platform, the CCaaS platform. That is the majority of the revenue. And we're having a lot of success with partners like Salesforce and others.
Yep. Yep. Maybe let's stick on the partner side. Can you talk a little bit about what you've done to build out that partner ecosystem? And you started by talking about how you're at the enterprise. You used to be known as more of an SMB mid-market player. Obviously, you've closed some very large deals over the past couple of years, and that perception has changed. Maybe can you kind of weave both of those together?
Yeah, absolutely. And again, our mid-market, as we talk about, has been, quite frankly, a lot of people have said this is just amazing, the mid-market. We went public, and again, Barry, I've been with Five9 17 years. Barry's been here 13. And we went public 10 years ago. At that time, we looked at how many million-dollar ARR customers we had when we went public, and it was three. And today, we have been closed at the end of the year with 183 customers delivering to us more than $1 million in ARR. So it's been a dramatic mid-market. And it's been, in large part, driven by, as well as our international expansion. International expansion and mid-market are two of our growth factors over the last several quarters.
Our multiple routes to market, as we call it, if we think about partners. We look at this as, again, one of our strengths is the multiple routes to market of multiple categories. It's the ISVs, right? These are technology partnerships with ServiceNow, Salesforce, Zendesk, other CRM vendors, some WEM partnerships that we have with the likes of Verint and Calabrio. And the list goes on. So there's the ISV partnership ecosystem, which brings us into a lot of deals. There are the classic VARs and resellers and SIs that are part of our ecosystem. And there are even referral partners that are part of this world of communications, as many of us know. And then, obviously, we have a very strong direct sales organization. So it's a diversified route to market strategy that we've taken. And internationally, we actually get a ton of our deal flow.
The deals are written on partner paper. It's a big part of the leveraging in our go-to-market.
Yeah. Super helpful. Maybe let's pivot then to talking about competition. Maybe first, I want to think about your core competitors to the other proper CCaaS. Because clearly, everyone knows just going to buy our losing share.
I like the way you said that. Proper.
So then if we really think about you, NICE, Genesys, maybe walk us through how you think about that, what's your differentiation, and any changes from that?
Yeah. Again, all the three of us are in a great position, and I think the markets are going to realize that over time here. This is a three-horse race when it comes to even mid-size enterprise and above. There's a lot of noise at kind of the SMB part of the market, but again, I think NICE, Genesys, and Five9 are all positioned extremely well. We all have what I talked about earlier. It's the power of the platform, right? We're providing AI-powered CX, but we're also providing that core platform, which is so valuable and so important. NICE is a public company, so you can see their numbers. If you look at kind of organic growth, we're growing faster. They're a little more profitable, but again, we're all going to do well in this market, and it's an exciting time.
I do think investors are starting to figure it out, especially if you look at subscription revenue growth. As I said, accelerated. As a billion-dollar company growing 20% year-on subscription revenue growth.
Yep. Yep. So I want to drill a little bit into the numbers and give Barry a lot to talk about. But maybe just rounding out competition, you did kind of allude to some of the SMB competitors. So you've seen some of the UCaaS vendors get into this space, Zoom with Zoom Contact Center. RingCentral kind of announced their own rather than the white-labeled NICE. Have you seen any changes in that with the UCaaS vendors, even at the low end of the market?
Yeah. I mean, again, they have got to figure out kind of their next play. And if I were in their shoes, I would do the exact same thing. We do know the barrier to entry in our space is just significant. We've talked about it in the past and talked about it at dinner last night with some of our visitors. And the best data point is Interactive Intelligence. And this is still a few years ago, but it took them eight years. And they were an on-prem CCaaS, on-prem contact center vendor. And they basically started a project, fenced off an investment, a very large engineering effort. They know the space. They know what features they have to deliver. And it took them about eight years. Eventually, Genesys acquired them. And that's Genesys's cloud solution.
It takes a long time to be able to, and the bar is very simple. The bar to compete in our market is very, very simple. Can you replace on-premise Avaya, Cisco, or on-prem Genesys at scale with reliability, with all the features necessary, and nowadays with all the AI functions required that customers are looking for? So it's a high bar. There's a reason that it's been a three-horse race for quite some time. And again, we do expect more competition down at the low end of the market. By the way, 88% of our revenue is in the enterprise market, and 12% is in the SMB market. So again, it's a pretty small part of our business. And we do still do very well against them, partially because, again, most customers are looking for full functionality as opposed to the best price.
Yeah. That makes a lot of sense. All right. Maybe let's walk through that acceleration. So as you pointed out, you accelerated growth at scale. What were some of the key drivers that led to that growth?
Yeah. Barry, do you want to talk about that?
Yeah, so we went from 17% growth in subscription to 20% in Q2 to Q3. Remember, as Mike said earlier, this represents 80% of our total revenue. We'll continually go up, given that the other two parts of our revenue component, namely usage, 13% in total, and professional services, representing the remaining 7%, are not growing. In fact, contracting, unlike usage. So the acceleration came in the subscription, and there were three main drivers for that. First of all, we had a record intake from our backlog. Q3 record. Secondly, a key part of our business, our bigger customers landed big customer wins. But we're just talking now for a moment about $1 million plus. That's 55% or 56% of our total revenue, and that this last quarter was growing at 29%.
That also helped. The third and final factor was this shift in AI, as Mike said, grew at a 40% pace with the fact that Agent Assist, what we call it, people often refer to as a Copilot, grew 158%. Very strong growth there.
All right. Wonderful. Maybe let's talk margins for a second now. So you saw this big improvement in gross margin, about 130 basis points, 190 basis points improvement on the operating line. Can you talk a little bit about what were the drivers of margin expansion and then how we should be thinking about overall margin growth?
So very cool. So we've been investing a lot over the last few years, marching up market, growing international. And we're now on the downward slope on that. If you talk about Q3 in particular, where there was a 190, sorry, like 320 year -over -year, 190 to 320, there were three drivers there. The first one, and most important one, is the scaling against fixed and services structure. When our revenues go up, our margins go up. We see it for the last 10 years in the fourth quarter when our revenues are typically stronger, that's when the traditional margins are the highest. The second reason that we have returned to gross margin is that we did have a RIF in August, and that's continued in part as well. And then finally, there's a mix away from usage to subscription.
Let me just spend actually a little bit of time on this. When we went public 10 years ago, the usage is a long-distance telecom minute was 35% of our total revenue. Now it's down, as I mentioned earlier, to 13%. There are three drivers for that. The main one is these bigger customers that we're landing, they bring their own telephony. So every year, without fail, there's a shift between one to two percentage points in the total revenue from usage. We've got lower margins towards subscription, which has got margins in the 70s. The margins on the usage is in the 50s. That has a persistent, small but persistent benefit to gross margin. Looking forward, we would see continued improvement. We've indicated that for Q4 and further down the road as well.
Our gross margins on the subscription part are in the 70s, which is very comparable to our company.
All right. Really helpful. Maybe sticking with some of the metrics, let's talk NRR, right? So we've seen an improvement in subscription growth, as we both talked about. But your NRR stayed relatively flat. When can we expect that to maybe inflect positive upwards and maybe even lead to better growth?
Yeah. So it's stayed flat at 108, as you indicated on an LTM basis. It's not inflecting up at the moment due to the fact that we have seasonal customers. And there is somewhat more mix in our product. It was better than we thought, and it would be in Q3, but it's still not like it used to be. It's not been an inflection Q4. In fact, this margin is better than that to be a slight decline. But we are certain in the knowledge that long-term is going to go up. And why do I say that? I say going back to those bigger customers. Those customers with a $1 million-plus in revenue, which is 56% of the total, they have dollar-based retention rates that are meaningfully higher than 108. And they're growing much faster as you would expect on percentage-wise.
You mentioned long-term. Maybe let's go to that. You provided some long-term outlook on the call. What drove the decision to provide that, especially ahead of the analysts or rather than waiting for the analysts to provide it?
Yeah. I made that comment a few times. And again, we do see a long-term opportunity for very durable 20%-30% growth in subscription revenue, right? And we just talked about subscription revenue in the quarter was 20%. So we're not talking about a massive leap of faith, but we are talking about that in particular because, again, I think it's important for investors to know how we view this market, whether it's our AI products or our CX platform. We talked about it earlier in terms of we're a net winner with this AI-powered customer experience revolution that we're going through. And we think it's important for investors to understand that long-term, we're very, very bullish on our growth outlook. This is a massive TAM. Still very underpenetrated in terms of cloud replacing on-premise and the core contact center part of the market.
AI just adds an additional TAM on top of that. With our platform, our people, I do believe we're well positioned. A great opportunity for many years to come and again, in a healthy macro, again, we're doing what we're doing in a pretty choppy macro still, and so that's why we made the comment.
Yeah. No, that's helpful. Maybe can you drill a little bit down into some of the macro pressures that you've seen? And when you think about the longer-term outlook, are you relying on macro improving, or is it more you can grow that rate in spite of macro pressure?
Yeah. Go ahead. Let me just start on that. Yeah. It's really very straightforward. We all know the fact that the consumer is the bulk of the U.S. economy. We all know the fact that they use debit and credit cards to move forward. And you can look at different. I'm sure RBC has a survey out as well, the ones we refer to as the Deloitte and McKinsey from Bank of America. Crystal clear. The transactions are going on a nominal basis or flat to down, depending upon where you're talking about year -over -year or quarter over quarter. And in an environment where transactions are real terms, post-inflation, are meaningfully down, you're not going to get a lot of growth. However, when the economy, as inevitably at some point, will come back, we are spring-loaded to take advantage of that.
Our dollar-based, excuse me, our global retention in the enterprise is mid-90s. People don't want to do hard transfers. And they stick around, especially when you've got a quality product with a high reliability like that. And so that'll come back at some point. We don't know exactly when. For Q4, which is typically sort of like a hockey stick for in the old days when the economy was booming, we would go up 8-12 percentage points. We're assuming basically a muted seasonality without that hockey stick this time. And we'll see what happens in terms of the actual sentiment. We did survey our customers a few months ago. We stayed very close to them. And universally, they stay in caution. Fortunately, we stick with that.
So now maybe let's bring the growth algorithm and margins now together. So we used to be a rule of 40-plus companies. I guess, number one, what's your confidence in getting back to that on a long-term sustainable basis? And number two, given investors are increasingly trying to figure out the right way to balance that, how should we be thinking about maybe free cash or per share growth as being a KPI for you going forward?
Can I start and you back me up on this? But so again, rule of 40, we're I think at 35 now, right? Using the EBITDA margin, right? So it's 15% total revenue growth in the quarter, the last quarter, 20% EBITDA margin. We're at 35. We've been above 40, as we know, quite significantly above 40 during COVID, and we are very confident in the long run to getting back above the rule of 40. Again, part of this is driven by just unit economics, right? We have very strong unit economics. Our business model has proven that over the years, and we've always had a lot of leverage through growth periods, so again, we're pretty confident in that leverage that we're going to get. We've already talked about in our guidance even about profitability even next year increasing.
Again, if you think about what I said before, subscription revenue growth, 20% this last quarter in a really choppy environment. We do think long-term is upside to that. It ought to put us well above that threshold in the long.
Maybe just on the free cash for sure.
So, operating cash flow, we had a record. We're leaving around about $41 million. The free cash flow was also a record, $20-something million. And on the per-share basis, we are pointing to the dilution, which was overall been pretty carefully managed by our board compensation team. And we're 2.2%. So very respectable dilution. And then we take a moment to kindly talk about the stock-based compensation revenue because there are some people who are not going to invest until we get to GAAP profitability. Well, on the stock-based compensation, we've come down 8 percentage points from a year ago, from 2015. Part of that is the legacy of a transaction that didn't happen, and there was a stock award that went not high. And there'll be continued responsibility on that.
If we look at the two one-time items, the cost of revenue and the tax benefit related to Acqueon acquisition, we were slightly GAAP profitable in Q3 and pointing towards GAAP profitability in our guidance for Q4.
All right. Really helpful. I do have a bunch more questions, but I do want to give if there's any questions from the field before jumping back in. All right. I'll jump back in then. Maybe I want to go back to talking about AI. So you talked about monetization, and there's uplift that you can get from it. How do you think about what that uplift looks like over the long term?
Yeah. At the highest level, we actually put this on our investor deck, so feel free to look at that. It's on our website in terms of the TAM expansion related to AI and automation. And it's very simple math. And again, it really comes down to the revenue we get per interaction for AI-powered interactions and true self-service versus helping a human agent with more knowledge. So again, if you look, we have actually 10 different AI SKUs across the CX spectrum in our platform. And we're developing additional innovative products like AI Knowledge and AI Insights, which are really to help large brands figure out how to go down this AI journey. We also introduced, I should talk about this a little bit, a new program we call the AI Blueprint program. And it's really our AI experts.
We have deployed a lot of AI for some very large brands to help power their CX. And we're leveraging that expertise in a program called AI Blueprint, where we're helping our customers and prospects figure out how to navigate this new world of AI. It is very complicated. I think the learning has actually really increased. I think in Q2, there was a lot of deer in the headlight kind of looks from customers, kind of trying to figure out how they're going to leverage AI in a practical, high ROI, business outcome-driven value proposition at the end of the day. And our AI experts are helping a lot of these customers kind of figure out where to go first, second, third on this AI journey. And it's a big part of our job as a software provider, especially software as a service.
CCaaS is an important component of what we do. We don't just throw technology at our customers. We actually help them figure out how to leverage our platform to deliver better CX, better customer experience for their consumers. Again, whether it's AI-powered or it's human-assisted, their goal is to deliver great CX, but we're also helping them do it at higher efficiency and lower cost. So the ROI, the financial ROI, is actually a big part of, to me, what makes this such an exciting period. Because if you look back five, six years ago, our value proposition to a lot of these large brands was, well, let's take you off these legacy on-prem solutions, and we'll move you to the cloud in a kind of a like-for-like feature set. And it's like, okay, well, you're getting rid of some headaches for me.
And yes, there's ROI in that. But now with the AI labor arbitrage opportunities and the efficiency gains, there's such a great financial argument to do this and do it quickly. It's becoming a catalyst for new customers for us, and it's playing out very nicely.
All right. Maybe in the minute we have left, how should we be thinking about how AI is going to change the way that you price and the way you sell?
Yeah. I think all the entire world right now is trying to figure out kind of pricing models for AI. All of our AI SKUs are available on consumption-based pricing with, in many cases, pre-committed consumption blocks, if you will. And again, but we've also introduced an opportunity for new prospects as well as our customers to essentially stick their toe in the water with some of our AI solutions and kind of pay as they go in pilots and so forth. So having that consumption-based pricing model is really important for them to be able to not have to go look for a bunch of budget upfront, but get started with our AI, even if it's on a small scale, figure out the use cases and the ROI, prove it. I always say pilot-proof scale. We're helping our customers do that with AI.
Awesome. I think it's a great place to jump off. Mike Burkland, thank you so much.
Thank you.