Excited, the last session of the day. Welcome everybody. I'm trying to make sure my antenna is up. For important disclosures, please see the Morgan Stanley Research Disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Barry, I think you also have a safe harbor to read.
You do indeed. Thanks, Meta. Before we start, we would like to remind you that today's discussion will contain forward-looking statements, including those regarding future events, trends, expectations, projections, and beliefs that may affect our industry or our company, product developments, AI, and potential growth drivers. Such statements or predictions should not be unduly relied upon by investors. Actual events and/or results may differ materially, and Five9 undertakes no obligation to update information in such statements. Please refer to our most recent Forms 10-K and 10-Q, under the caption "Risk Factors" and elsewhere in Five9's annual and quarterly reports filed with the Securities and Exchange Commission.
Great. Well, welcome everybody. I'm Meta Marshall. I cover the communication software space here at Morgan Stanley. We're delighted to have Five9 here with us today. We have Mike Burkland, CEO, Barry Zwarenstein, outgoing CFO, and Bryan Lee, interim CFO. All right, so Mike, it's great to have you back with us here at TMT. Maybe for those who are less familiar with Five9, just can you give a brief overview of the company?
Yeah, thanks, Meta, and it's great to see you again. Look, we're a cloud software company. We're helping and enabling some of the largest brands in the world reimagine or elevate their customer experience with our AI-powered CX platform. So we just surpassed $1 billion in revenue in 2024 with our Q4 results coming in with a nice acceleration on the top line: 17% total revenue growth for Q4, 19% growth in subscription revenue. And AI is becoming a very meaningful part of the business, with it coming in at 9% of enterprise subscription revenue and growing at 46% year- over- year. So that's us in a nutshell.
All right, well, perfect. Despite those kind of very strong numbers, for the past year, the CCaaS market has been challenging in that people are trying to say, you're demonstrating that CCaaS is a beneficiary of AI, but investors have seemed to be more cautious. Where do you feel like that disconnect lies, and what's the path to kind of closing that chasm?
Yeah, I think there's been a disconnect in terms of AI is a tailwind for us as we start to share some of these metrics that I just talked about with 9% of the enterprise subscription revenue mix and growing at 46% year- over- year. I think folks are going to start realizing what we've been saying, but I think it's been a little bit of a show-me type of mood out there. And I understand that. I get it, because AI is new for a lot of people. And look, we've been in the AI part of customer experience for a while. We acquired a company about four years ago. And again, we continue to lead the AI portion of this market in terms of our products and solutions.
But we also, I think, folks have kind of lost sight of the fact that our core market is massive, and there's a massive cloud migration happening in core CX and contact center. We're talking about a $24 billion annual recurring revenue opportunity, and we're still 40% penetrated in terms of cloud penetration. So I think it's really important for people to understand that AI is additive and a TAM expansion on top of a very attractive core market. And I do believe that, look, there's been a lot of AI bear thesis floating around for a couple of years around our category. And I think people are going to start to realize that, look, the Klarna example is not going to happen. Even the Klarna CEO came out and sort of said, "Oops, we were wrong." Look, our customers are trying to leverage AI on the margin.
If you think about what they're really doing, I talk to our customers all the time. We just had our customer advisory board last week. What they're attempting to do is actually not grow their agent count, say, 5% year- over- year. They're going to hold it flat, and they're going to leverage AI and self-service. We're powering all of the interactions, whether they're human-assisted or AI-powered. I think, again, I think there will be a shift in mentality.
Got it. Why do you think that you guys are better positioned, maybe particularly kind of with a more open approach versus some of your competitors?
Yeah, I talked about this on our earnings call a lot. I mean, look, our platform is platforms like ours, to be honest with you. I mean, we're the best at AI in our competitive set. But at the same time, even our competitors, we're all very well positioned because of the data. We talked about, look, brands are trying to deliver accurate and personalized self-service. If you're a consumer, we're all consumers. If that bot that you're interacting with, whether it's a voice bot or a chat bot, if it can't deliver accurate service and personalized service, you're not going to use it. And to these brands that were our customers, they realized that they have to deliver that in order for their AI to be used by consumers.
We're in a very unique position because not only do we have access to the latest and greatest engines or models, as we call them, but we also have the data. We have contextual data around the consumer on the other end of that interaction, as well as the brand and all of their offerings. We have historical interaction data that we are the system of record for that is absolutely required for personalization. Meta, if you're interacting with a brand and they don't have the interaction history that you've just experienced, guess what? You're going to have that horrific customer experience that we all hated for years with these legacy systems where you had to start from scratch every single time. And our data that we are the system of record for, the interaction history, is critical to delivering that personalized experience.
So whether it's our AI solutions or, frankly, a third-party point solution that's delivering an AI solution for a given use case, which we do have sometimes occur, especially in certain verticals, they plug into our platform so that they can have access to all the data. And if they don't plug into our platform, and we do monetize that through our APIs, if they don't, they're not going to be able to deliver that personalized experience.
Got it. Barry, maybe turning to you. You saw some incremental acceleration in subscription revenue in the second half. Can you just walk us through some of the key factors that drove that improvement and how much of that was seasonality versus customer ramps?
Thanks, Meta. So appreciate you bringing up the subject of subscription revenue because it's really the single best indicator of the health of the business overall. Before I go into that acceleration, let me just put the revenue streams in context. Subscription revenue accounts for 79% of the total revenue. The balance is made up of two components: usage minutes, long-distance minutes, and professional services. And for reasons that we can go into separately, those are growing slower, or in the case of PS, are not growing at all. And shifting the amount of the total revenue that comes from subscription each year up by about one to three percentage points.
And just incidentally, even though it's not the focus of the question, that actually gives us a tailwind for product mix and margins because the margins on the subscriptions are in the 70s, while in the case of usage, it's in the 50s. And in the case of professional services, it's close to breakeven. So yes, indeed, the subscription revenue grew 18% year- over- year in the first half, 19% in the second half. And what caused that acceleration? Four things. First of all, in Q4, we had strong seasonality in our healthcare and consumer. And nothing like it was in the heyday when the economy was strong, but still pretty good. Secondly, we had one of our biggest customers, which has been on a multi-year implementation, a healthcare conglomerate, that came towards the tail end of the implementation in the second half of the year.
The way that these implementations go, they accelerate. Most of the, well, not most, but a disproportionately high amount of the implementation occurred towards the end, which was in the second half of 2024. The third reason is AI, as you heard Mike talk about it, grew 46% year- over- year in the fourth quarter, 40% in the third quarter, compared with a three-handle a year ago in the second half of the year. Then finally, we got a little bit of assist from an acquisition we made of a company called Aceyus. Those are the four reasons that it accelerated.
Got it. And so, Bryan, how should we think about the carryover of these dynamics into 2025? Could NRR expand from large customers ramping, or are there any deals that are ramping in 2025 that we should be mindful of?
Yeah, absolutely, so I'll actually address a couple of the points that Barry mentioned, so the seasonal uptick that we saw that was stronger than the year-ago period and our expectations, that actually creates a downtick that's bigger than what we saw the same Q1 of last year, so that's a tough comparison that gets created, and also, given all the uncertainty in the macro and data points like January retail sales coming in at the lowest point that we've seen over the last two years, we're assuming a more muted seasonal uptick in the back part of 2025, so that's one tough comparison from a guide perspective.
The second piece, what Barry mentioned, our largest customer on a multi-year journey, being at the end of it where you're contributing most to revenue, that does create a tough comparison because if you think about 2025, we do have a strong backlog of customers that are ramping, and we have great visibility into that, and we have a very large customer that's in the early part of a multi-year journey there, so the revenue contribution will be smaller in 2025, so again, another tough comparison, but I do want to point out that we do always have a prudent guidance philosophy, and that hasn't changed, although we're not expecting big beats in this kind of environment throughout the year, so that's on the revenue guidance. Now, DBRR, there are some factors that I want to point to. Of course, a tough comparison still exists for DBRR as well.
But there are some positive factors, as Barry mentioned, AI momentum that we're seeing, that accelerated to 46% year-over-year growth in Q4, 9% of revenue. We expect that momentum to continue into 2025, which should be a tailwind from a DBRR perspective. The other side is million-plus ARR customers. They represented 56% of subscription revenue in Q4, growing 26% year- over- year. And they have DBRR that's significantly higher than the 108% that we just reported. So that also will be a tailwind. So when you net it all out from a DBRR perspective, you're going to have some fluctuations, but within small bands throughout the year.
Okay, got it. Mike, maybe turning back to you, your Q4 installed-based bookings reached the highest level in eight quarters. Just what's driving this momentum, and how sustainable is that?
Yeah, it's improved sales execution. We made some changes about a year ago, actually, to our installed-base sellers. We actually bifurcated the role into CSMs and ADs. ADs are responsible for upsell. CSMs are responsible for just managing customers and handling any issues. And that is paying off. So the restructuring that we did a year ago was definitely we're just being more proactive in terms of upsell, cross-sell, as well as upselling AI. Our AI bookings to our installed base was up 50% year- over- year in Q4. So we're seeing, again, just better execution from our installed-base sales team. And by the way, we're seeing improvements on the net new side as well. But again, that was a more recent change.
Okay, got it. Bryan, you noted that the million-plus ARR customers were growing 26% and having kind of meaningfully higher DB&E. Just what's driving the stronger performance in this sleeve relative to the rest of the customer base?
Yeah, there's really two components, so number one, we continue to see strong momentum in winning new logos that have million-plus in ARR, so in Q4, where we just closed the quarter, we had the highest number of million-plus ARR new logos for any quarter in 2024, and secondly, when we win these customers, oftentimes they continue to expand with us, adding new business units, adding new geographic regions, or adding additional software from our platform, so a perfect example of that is in Q4 during the earnings call, we talked about an expansion example where one of our largest customers who has been growing significantly with us over time, they actually added yet another business unit that's expected to generate $1.2 million in ARR, and we had them up and running in 60 days.
So those two factors combined make the million-plus ARR category the fastest-growing part of our customer base.
Got it. Mike, at the higher level, you've indicated kind of a long-term opportunity for 20%-30% subscription revenue growth. Just what are the key assumptions underlying this target, particularly with where we are kind of in near-term growth expectations?
Yeah, I would say three things, Meta. It's better sales execution, improving sales execution, which we're definitely seeing and working on still. And we're not done, but that's, I think, going to be a contributing factor. A healthy macro is another element to this. And I would say AI. Again, it's growing rapidly and becoming a real meaningful part of the mix. But again, we did deliver 19% subscription revenue growth in Q4. And we're talking about, in the long term, 20%-30%. Again, this TAM is massive. Our core TAM is huge, as well as the AI TAM that's now added to it. So we feel very good about that 20%-30% in the long run.
Okay. I mean, how do you see the competitive environment today, both from kind of traditional CCaaS vendors and the number of new entrants into the space, both large platforms or large clouds and kind of smaller conversational AI specialists?
Yeah. Look, the enterprise CX or contact center market that we've been in and is kind of the bulk of our business still, it's still a three-horse race up market, right? There are some up-and-comers that are trying to break in. But we've seen this movie so many times over the 17 years I've been here at Five9. There's just been time after time after time, and I could state names, and I won't get into names, but there are folks that try to build what we have in our core business. And it's just hard. It's thousands of features and global networks and redundancy. To deliver that at scale with reliability, with all the features required, is just hard. And the bar is truly, can you replace Avaya on-premise? Can you replace Cisco on-premise? Can you replace Genesys on-premise? And that's where the bar is set.
And so we just, again, it's going to remain a three-horse race for a period of time in the enterprise space. We think it could be a long time, but we'll see. Look, there's a reason that folks want to come into this market. This is the irony of where our stock has been trading. It's like, if there's so many people that want to be in this space, then why aren't people realizing that? And it's a very attractive market. And we don't expect to have it to ourselves forever. But we know we're going to win way more than our fair share because we're out ahead, not just in AI, but in the core parts of our CX offering. So I would just kind of leave it there. I think when it comes to AI, again, are there more players in the AI part of this equation?
Certainly, there are. But what I talked about before, the need to integrate to our data, no matter whose AI it is, we're going to monetize the situation, if you will. It's either our AI, and we're going to monetize it at a certain level. Or if it's a third-party AI point solution that has to connect to our platform to get to our data, we'll monetize that as well.
Have there been any kind of meaningful impacts to pricing, either in that core CCaaS market or on the conversational side?
No, the core market has been very steady in terms of pricing. Unlike other markets, there just has not been pricing pressure in our core market. When it comes to AI, we're all pretty aligned in terms of the players out there. It's mostly consumption-based pricing models or capacity-based. All of our AI products are consumption-based or capacity-based in terms of the pricing. And customers do like that. They really appreciate it. But they also do want to be able to predict what the cost of software is going to be. So we tend to align with them around pre-committed consumption, as opposed to what we do on the long-distance usage side of things, which is truly in arrears based on what they use. This is pre-committed consumption.
Okay, perfect. Maybe turning to Salesforce specifically, you've been vocal about the strength of your partnership and ability to not only coexist, but kind of benefit from similar offerings like Agentforce. Just what does Five9's monetization look like in these joint opportunities? You kind of just alluded to it, but maybe kind of talking about Salesforce and Agentforce more specifically.
Yeah, we've had a long partnership with Salesforce, and we're close partners. We have a very large swath of customers together. And the most important thing for people to understand is to run customer service for any brand, they have to have two platforms. They have to have a CRM platform, and they have to have a contact center platform. You just can't survive without both of these. And so our philosophy has always been to be a great partner with Salesforce and ServiceNow and Zendesk and the Dynamics side of Microsoft. Because at the end of the day, we get brought into opportunities, and we coexist with these strategic partners because we work so well together. When we think about digital channels as a kind of rearview mirror, some of our competitors actually tried to compete with Salesforce for digital channels and desktop.
It didn't work out so well for them. And our philosophy has always been, look, let's be a great partner to Salesforce and other CRM vendors that we integrate to, but let's do what's best for the customer. And today, obviously, our AI solutions are the most mature in the market. Agentforce is brand new. It's essentially a chatbot today. They're going to continue to invest there. And again, we're going to work in partnership with Salesforce to deliver the entire solution, CRM, CCaaS, and AI with whatever products are best for the customer. If we're winning the core contact center platform business, if you look at it just from a mixed standpoint, 80% of our bookings today are core and 20% is AI. We'll take that core all day long and give up a little bit of the AI to win more of the core.
And then just what does that monetization look like on the data that they need as Agentforce or any of these other kind of voice tools advance?
Yeah, so if it's a point solution or if it's Agentforce someday that is the AI of choice for a given use case. And by the way, it's almost always going to be a blend. Our AI for certain use cases, theirs for others. When it is their AI, in the case of an IVA or an AI agent, a voice agent, we monetize that through VoiceStream and TranscriptStream. And that equates to anywhere from about 40, we've said 40-50. It's all consumption-based per minute because, again, you got to integrate with the real-time interactions that are flowing through our platform to power that AI. So they can't do their job properly unless they have our data at real-time access to it. We use VoiceStream and TranscriptStream to give that access.
It equates to about $40-$50 per month in recurring revenue to us per AI agent, assuming that AI agent is as efficient as a human. But they're probably going to be much more efficient because they're available 24 by 7, and they don't take coffee breaks, and they don't chit-chat. So you could actually, and it's all consumption-based. So it's probably going to end up even higher than 40-50. It could be 60-75.
Okay, perfect. You've noted some analysis paralysis or just kind of deal cycles taking a little longer among customers from AI has continued to moderate in Q2 of 2024. From Q2 of 2024, I'm sorry about that. What steps are you taking to help educate the customer on capabilities and just kind of improve or speed up that sales cycle evaluation?
Yeah, I love that question, Meta, because it's a big part of what we do and how we do it. Look, as we went through in Q2, we saw the peak of this. I call it the AI fog. And it was basically every CIO, every customer experience leader in these large brands was being told by their CEO, go figure out AI. And it was just kind of this massive learning curve that these customers had to come up on. And it really has gotten a lot better since Q2 in terms of the AI distraction or AI fog around decisions. But part of that is this is our role. It's our role to be the AI experts.
We're investing so much right now in enabling all of our salespeople, all of our customer-facing teams to become truly the AI experts that our customers and our prospects are going to lean on to help guide them through this new world of AI. And it's working. We have not just enabled our people, but we have given them products, tools. AI Insights is a perfect example. We can go into an account, turn on AI Insights, let it basically process all of the interactions coming into that brand and categorize it and help them understand where their automation opportunities are. So we're using our products and our technology and our expertise to come in and help these customers really build up what we call an AI Blueprint. It's a roadmap for them to deploy our AI solutions. Where do they go first, second, third, and fourth, so to speak?
And it's working really, really well. And so that's also a differentiator. Our people are a big part of why we're winning these large, large, large brands. They trust us to help them succeed.
I mean, we hear from resellers a lot that there tends to be, okay, I've evaluated a million point solutions. I just need somebody to kind of pull this together into a platform. Is that part of kind of what you started seeing at the tail end of the year is just that ability to sell a platform and kind of solve the problem for us?
Absolutely. And they had to go through a learning process of saying, okay, what else is out there? What's real? What's a point solution? What's going to give me tunnel vision in a certain use case versus provide this truly accurate and personalized experience? And so I think customers are learning pretty quickly, and it's good to see.
Okay. You mentioned towards the latter portion of 2024, you made some changes to the sales organization to improve execution. Are they largely complete, or are there incremental changes that you're considering? And then additionally, what steps are being taken to kind of minimize disruption from both Barry's retirement as well as Dan Burkland ?
Yeah, yeah. Very good question, Meta. Yeah, so in early Q3, we made some org changes, brought in a new leader over sales, a hands-on leader. By the way, not someone from the outside, someone who's been with us for 10 years, known quantity. Everything he's touched has turned to gold. I mean, he is just a rising star in our company. So very little disruption, if any. I mean, we saw a very good Q3 performance out of that team, the net new team. We saw an even better Q4. So again, we've always tried to do things in a seamless way. No matter what changes we make, and it's similar to what we're doing with Barry and Bryan here. I mean, Bryan's been with us 11 years. Barry's been with us.
13.
And look, we're going to make this as seamless as possible. And again, culture does matter when it comes to these sort of things.
Barry, any other comments you want to say just kind of on the transition?
This is an incredible company with a great market and a great culture, and I'm not going to deny that I really enjoy it. At the same time, there's a time and place for everything, and after 13 years, it's a time to move on and retire, and I take a lot of comfort in the fact that we've got a very safe pair of hands here with Bryan.
Great. So Bryan, maybe turning to you on profitability. You saw a strong exit rate on gross margins in Q4. Can you just walk through kind of expectations on the gross margin line and then maybe kind of how that carries down to operating margins?
Yeah, absolutely. So I know Barry touched on some of this, so I'll elaborate a little bit more. So in Q4, as you mentioned, we did have very strong gross margin expansion, both sequentially and year- over- year. And there were really three key drivers there. It was revenue growing against fixed and semi-fixed costs. It was a full quarter benefit of the RIF that we did back in August. And then just general tight expense management across the board. So going into 2025, all those factors will still be there. The benefit from the RIF will last through August of 2025. Now, on top of that, what Barry mentioned earlier about the mixed shift in revenue from usage to subscription, that's by design. It's our larger customers bringing telephony on their own or our largest partners also offering their own telephony.
So that mixed shift of 1-3 percentage points with 50% gross margin in telecom usage versus 70%+ in subscription, that's what's helping the overall gross margin. And from professional services as well. It's by design. We're enabling our partners to take on more. And that's going to shift the revenue towards subscription and therefore gross margin expansion as well. So we haven't quantified exactly what the gross margin or EBITDA margin target will be for 2025. But what we said is on an annual basis, it will improve year over year.
Okay, and then just free cash flow, maybe how to think about free cash flow and lifestyle.
Absolutely. Yeah. So free cash flow, typically, if you look at our historical average, there's a conversion rate of about five percentage points from EBITDA margin to operating cash flow margin. And then from there to free cash flow margin is about six percentage points. Now, if you look at Q4, that was precisely the same spread. We had 23% EBITDA margin, and then we had 12% free cash flow margin. And we came in at a record free cash flow for the quarter as well. Going forward, that 11 percentage point spread is a good proxy. But having said that, we are focused on gaining more efficiency both in terms of working capital and in terms of CapEx to further improve that.
Okay. Mike we talked about it earlier, just in terms of you weren't seeing kind of a decrease in users or kind of agents, but you recently decided to kind of stop disclosing seat counts. Just how are you giving comfort to investors that we're not seeing kind of a massive change in agent counts?
Yeah. I think the most important metric, as Barry mentioned earlier, is subscription revenue. And that is encapsulating both software for human agents as well as AI software, which isn't based on a seat. It's consumption-based, right? And there isn't always a, there's not a human seat underneath that. It's becoming a bigger and bigger part of our mix. And therefore, subscription revenue really is the right metric to look at overall and 19% growth in subscription revenue. Again, it's the metric that will indicate how many customers are coming onto our platform and how many solutions from us they're purchasing. And I would say the other element here is AI. If you look at our AI revenue, 46% growth year- over- year. It's 9% of our enterprise subscription revenue.
I would say those two metrics are the ones that people should pay attention to to understand how our business is trending.
Okay. Maybe last question, Mike or Barry, I don't know which one of you guys want to take it, but a question we've been asking to everybody this week. You guys are selling a lot of AI software. Just how are you using AI internally?
Yeah, I think we're. I wouldn't say we're cutting edge yet. We've been very focused on our customers and our solutions that drive customer experience. We use obviously our own customer experience AI solutions for our customer support and customer service. And we're using it from a productivity perspective more and more, but it's a little bit more grassroots, I would say, than mandated from the top down. That's not my style. But anyway, I'm excited about the opportunity for us internally as well over time.
Perfect. All right. Excited about the story, and thanks so much for being here today.
Can I finish with one thing?
Yeah, definitely.
Can I just say thank you to Barry for the years of service? No, I mean it, Barry. Congratulations.
Thank you.
Thank you for everything, but also just congratulations on your retirement. 50 years you've worked six public companies. What a superstar. How about a round of applause for Barry?
Thank you. Thank you, Mike.
Yes.
Sorry, I couldn't.