Five9 Inc
NASDAQ:FIVN
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Five9 Inc
Earnings Call Analysis
Q2-2024 Analysis
Five9 Inc
In Q2, Five9 achieved a significant milestone by surpassing an annual revenue run rate of $1 billion. This impressive figure was largely driven by a 21% year-over-year growth in last twelve months (LTM) enterprise subscription revenue, contributing to a total revenue of $252.1 million for the second quarter. However, the company faced some challenges, particularly in the latter part of Q2, leading to revisions in their revenue forecasts.
Five9 announced a reduction in their annual revenue guidance, now projecting revenues to be around $1.15 billion, marking a 3.8% decrease from earlier expectations of $1.2 billion. This adjustment stems from slower than anticipated new logo bookings and a decrease in the dollar-based net retention rate (DBRR). Despite these hurdles, the company raised its midpoint of annual non-GAAP EPS guidance from $2.17 to $2.27, indicating management’s focus on improving operational efficiency and margins.
A key element of Five9’s strategy moving forward revolves around its commitment to AI technology, highlighted by the planned acquisition of Aqueon. This move is set to enhance Five9’s capabilities in orchestrating proactive and personalized customer engagements. The success of Five9's AI solutions was evident, with the AI Agent Assist product experiencing a remarkable 111% growth year-over-year, signifying a robust demand for AI-driven customer interaction tools.
The company demonstrated strong cash flow management, achieving $126 million in operating cash flow, equivalent to 13% of their revenue. This reflects Five9’s ability to maintain positive cash flow for 32 consecutive quarters. Furthermore, management is optimistic about the future, anticipating an inflection point in margins with expected EBITDA margins exceeding 20% in Q4 as they focus on managing expenses and scaling their operations effectively.
Despite the positive outlook with the AI strategy, Five9 has acknowledged facing macroeconomic headwinds. Customer budgets are currently scrutinized, impacting new deal sizes and leading to delayed decision-making. The lack of mega deals in Q2 compared to previous quarters has added to this uncertainty. However, the CEO and CFO feel confident about the long-term market potential as they navigate through these challenges, reinforcing the company’s growth trajectory fueled by ongoing innovations in AI.
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Thank you for joining us today. On the call are Mike Burkland, Chairman and CEO; Dan Burkland, President; and Barry Zwarenstein, CFO. Certain statements made during the course of this conference call that are not historical facts including those regarding the future financial performance and cash position of the company, expected improvements in financial-related metrics, expected ARR from certain customers, our proposed acquisition of Aquion, certain expected revenue mix shifts, customer growth, anticipated customer benefits from our solution, including from AI, the extent of the anticipated TAM expansion and our ability to take advantage of any such expansion, company growth, enhancements to and development of our solution, market size and trends, our expectations regarding macroeconomic conditions, company market position, initiatives in technology and product initiatives, including investment in R&D and other future events or results are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.
Such statements are simply predictions, should not be unduly relied upon by investors, actual events or results may differ materially, and the company undertakes no obligation to update the information in such statements. These statements are subject to substantial risks and uncertainties that can adversely affect Five9's future results and cause these forward-looking statements to be inaccurate, including the impact of adverse economic conditions, including macroeconomic deterioration and uncertainty, including continuing inflation, increased interest rate, supply chain disruptions, decreased economic output of fluctuations in currency exchange rates, lower growth rates within our installed base of customers and the other risks discussed under the caption Risk Factors and elsewhere in Five9's annual and quarterly reports filed with the Securities and Exchange Commission.
In addition, management will make reference to non-GAAP financial measures during this call. A discussion of why we use non-GAAP financial measures and information regarding reconciliation of our GAAP versus non-GAAP results and guidance is currently available in our press release issued earlier this afternoon as well as in the appendix of our investor deck that can be found in the Investor Relations section on Five9's website at investors.five9.com.
Lastly, a reminder that unless otherwise indicated, financial figures discussed are non-GAAP. And now I'd like to turn the call over to Five9's Chairman and CEO, Mike Burkland.
Thanks, Emily, and thanks, everyone, for joining our call this afternoon. I'm pleased to report that we achieved a key milestone in Q2 with annual revenue run rate exceeding $1 billion, primarily driven by LTM enterprise subscription revenue growing 21% year-over-year. Adjusted EBITDA margin increased sequentially to 17% of revenue, helping drive strong LTM operating cash flow of $126 million or 13% of revenue. .
Before I move on to the business updates, let me comment on our outlook for the remainder of the year. We are reducing our top line annual guidance by 3.8% based on the latest trends we saw in June bookings and other factors that Barry will elaborate on. In response, we will be laser-focused on managing expenses to generate improved margins and cash flow. As a result, we're raising the midpoint of our annual non-GAAP EPS guidance. This is also consistent with our objective of driving shareholder value through balanced profitable growth, further supporting our positive long-term outlook. And now turning to the business updates.
Today, I want to focus my comments on some announcements we believe will drive significant future growth for Five9 by improving AI-powered customer experiences. First, I'll comment on our agreement to acquire Aqueon and then I'll touch on our AI strategy and the latest innovations that are extending our leadership position in AI. I'm excited to announce our agreement to acquire Aqueon, a significant step in extending our AI-powered CX platform and market reach.
Today, brands are increasingly wanting to proactively reach customers for sales, e-commerce, collections and appointment reminders as well as service and support. Aqueon excels at orchestrating proactive outbound omnichannel customer engagement across numerous CX use cases. and has assisted leading financial services, retail and health care businesses to connect with their audiences and increase revenue through higher contact and conversion rates. Like a Symphony conductor, Aquion's platform uses AI and contextual data to predict, personalize and orchestrate when and how to best reach customers. Adding Aquion capabilities to Five9's Intelligent CX platform is a big step toward realizing our ambition to become the orchestration engine for every interaction across the entire customer journey, including marketing, e-commerce, sales as well as customer service.
In addition, the multimodal interactions handled by Aquion generate incremental contextual data that will further strengthen the value of our AI. Five9 and Aquion have already been partnering to win some of the largest enterprise CX opportunities in the industry. And we're very bullish on the opportunities we see in the pipeline. We anticipate the Aquion transaction to close in the second half of 2024.
Now turning to our AI strategy. Since 2018, Five9 has been focused on harnessing the power of AI to elevate CX. Today, consumers will tell you that their interactions with many brands are disjointed and not satisfactory. This is often due to customer interactions being spread across many platforms and touch points, each of which is siloed. This has driven our ambition to orchestrate every interaction between a consumer and a brand through Five9's Intelligent CX platform powered by Five9 Genius AI. Our platform provides advanced orchestration for elevated customer experiences, allowing us to bring together all of these interactions and personalize them using contextual data.
Our strategy has been consistent throughout embedding AI across our platform, delivering practical AI solutions that drive tangible business value and helping our customers leverage AI responsibly. Also, with our engine agnostic approach, we enable our customers to continually take advantage of the rapid innovation in AI. But technology alone is not enough to deliver this vision. And so we combine it with our trusted AI and CX experts to help our customers navigate through this evolving world of AI.
And now I'd like to share 2 significant steps we've taken to extend our leadership position in AI. First, we're excited to announce the general availability of Gen AI Studio. This pioneering product serves as a central hub for brands to apply Gen AI across all CX touch points within the Five9 platform and beyond. We now have the unique ability to break down data silos by leveraging contextual data, not just within our platform, but also from external systems, such as CRM, marketing, e-commerce and more, all through a single pane of glass. This comprehensive 360-degree view of the
customer experience enables us to deliver hyper personalization and improved business outcomes. And second, we're announcing the newest member of the Five9 Genius AI suite, AI Knowledge. AI Knowledge allows brands to provide concise answers to many common questions their customers might have by training custom Gen AI models with knowledge unique to their brand.
AI Knowledge can be used for voice and chat bots, enabling self-service answers to a much wider set of use cases than were previously possible with prior generation FAQ bots. That, in turn, reduces the need for calls and chats to reach live agents, saving brands money. AI Knowledge is also integrated into Five9 AI Agent Assist, allowing agents to get quicker and more accurate answers to customer questions. That allows them to offer accurate and faster service, improving CX while also reducing handle times and reducing cost. And best of all, AI Knowledge reduces the amount of time people have to sit waiting on hold, something all of us can appreciate.
These latest AI innovations are important additions to our market-leading AI portfolio, which today is enabling some of the world's largest brands to elevate their CX. Turning now to our market opportunity related to AI. As we've said in the past, AI represents a TAM expansion for Five9. For instance, if a hypothetical Five9 customer is able to automate 15% of interactions and therefore reduce seats and labor cost by 15%, given that we are providing the software for that automation, our subscription revenue increases on a net basis by 30%.
In other words, it's a win-win for both our customers and us. Now let's get a little more specific and take a look at 3 real-life examples from our customer base. The first is a health care company and a longtime Five9 customer with 1,000 agents that is a supplier of medical test kits. As call volumes were increasing, they implemented our IVA and patients were able to automatically schedule a pickup or delivery 3x faster without waiting in queue for an agent.
In addition, they saw overall agent handle time decline by 10%. And since that IVA implementation, Five9 total subscription revenue from this customer has increased 20%. The second example is a financial institution, which was seeing increasing call volumes. Within a month of our IVA implementation, they saw an 8% reduction in agent talk time while increasing customer satisfaction due to faster response times. In this case, Five9's total subscription revenue from this customer increased 30%.
And the third example is a Fortune 500 medical device company. Since the deployment of our IVA, overall call duration was reduced by 16% resulting in cost reduction. Five9 total subscription revenue from this customer increased 30%.
In summary, we remain very optimistic about the long-term opportunities in this massive market that is expanding even further with AI, and we believe we are well positioned to further strengthen our leadership position with the ongoing innovations to our Five9 Genius AI Suite. Our AI solutions are driving significant and tangible business outcomes for our customers to elevate CX.
And with that, I will turn it over to our President and CRO, Dan Burkland. Dan, please go ahead.
Thank you, Mike, and good afternoon, everyone. Today, I'd like to start off by discussing our bookings for the second quarter and sharing some key go-to-market initiatives. In Q2, we had a challenging bookings quarter, primarily due to customer budgets being more constrained and scrutinized. As a result, we did not have any mega deals, and we had fewer $1 million ARR deals than expected during the quarter. .
In addition, while we are very proud of our talented sales team, we are taking action to further improve our sales execution and efficiency, including recently promoting an accomplished 10-year Five9 veteran to EVP of sales, giving us a single 100% dedicated sales leader, and we're also realigning resources across market segments and partnering more aggressively with certain technology solutions and integrations.
And now I'd like to share some key wins for the quarter. The first example is a new customer who in March, was preparing to place a significant order with Five9, including the Aquion Solution. You may recall, last quarter, I described a Q1 deal over $3.8 million in ARR for a company who helps universities with recruiting, enrollment and fundraising.
On March 30, we were still completing the SOW details for the Aquion portion and the customer agreed to place the orders for the Five9 solutions. Shortly thereafter, we completed the SOW and received an order for an additional $1.3 million of ARR for the Aquion portion, making that an anticipated $5.2 million ARR customer to Five9. The second example is a health care provider with the leading virtual care platform who is looking to improve and elevate experiences with their patients, doctors, nurses and pharmacies. They've gone all in with Five9, including our chat, e-mail, SMS, AI Agent Assist, Salesforce integration and the full WEM suite to enable hyper-personalized experiences at every touch point.
We anticipate this initial order will result in over $1.1 million in ARR to Five9. The third example is also in the health care field, a full-service pharmacy benefits management company, who had been using another leading CCaaS provider but do not feel they were getting the focus and attention from their provider to help them truly elevate their AI experiences and deliver better business outcomes. With an acceleration of AI and the vast array of solutions, companies are looking for a partner with a team of experts who will listen, analyze, tailor and apply continuous optimization and meaningfully improve those business outcomes.
As a result, they purchased our chat, e-mail, Salesforce integration, our WEM suite powered by Verint, voice stream for color authentication and our AI agent assist solutions, including transcripts and summaries. We anticipate this initial order will result in over $1.1 million in ARR to Five9. And now I'd like to share 2 examples of existing customers who have expanded their use of Five9 by adopting our AI and automation solutions to elevate their CX.
The first example is a health care provider who has been a Five9 customer since 2018. They had been spending approximately $4.5 million annually with Five9, they've been using several advanced solutions from Five9, including our VCC with SMS, AI Agent Assist and our workflow automation.
In Q2, they added our WEM suite powered by Verint to perform AQM, performance management and interaction analytics. With this add-on order, we anticipate their ARR with Five9 to now be over $6.1 million. The next example is a Fortune 200 company and a top-rated insurance provider who has been a Five9 customer for over 2 years, and has been using our omnichannel AI Agent Assist, voice IVA, digital IVA and our Verint WEM suite with an ARR over $4.9 million to $5.9 million. In Q2, they added 59 AI insights in order to leverage both real-time and historical conversational data to prescribe and apply the Five9 platform in ways that will result in maximizing business outcomes and truly elevate the customer experience.
With this add-on order, we anticipate their ARR with Five9 will now be approximately $5.5 million. While we've had some headwinds in Q2, our long-term outlook remains strong, given our leading platform and AI strategy as well as our continued partner and channel expansion. This was validated once again by the most recent Baird survey in July, where we were ranked #1 by far in each of the following 3 categories: The Best AI Solutions, Most Likely To Benefit From AI and the Easiest CCaaS Provider To Work With.
And now I'd like to turn it over to Barry to take you through the financials. Barry?
Thank you, Dan. We reported record revenue of $252.1 million for the second quarter with the annual run rate exceeding $1 billion. Looking at the components of revenue, as Mike mentioned, LTM enterprise subscription revenue grew 21%. Our Q2 total subscription revenue grew 17% year-over-year, driven by our new logo deployments, which continue to be strong increasing meaningfully quarter-over-quarter Q1.
Also, our AI and automation portfolio, which now makes up 8% of enterprise subscription revenue continues to be the fastest-growing category of our products, with AI Agent Assist, our second biggest AI offering after RVA, showing particularly strong growth of 111% year-over-year.
Our Enterprise business made up 88% of LTM revenue. Our commercial business, which represented the remaining 12%, grew again in the single digits on an LTM basis. Recurring revenue, which is comprised of both subscription and telecom usage, made up 92% of total Q2 revenue.
As a reminder, we expect the 1 to 3 percentage point mix shift from subscription to telecom used each year to continue. The main reason for this is because our larger customers often use their existing carriers for telecom usage. Additionally, our channel partners like BT and AT&T carriers, and we will not take business away from them. We see this continuing mix shift as a positive long-term trend for both corporate revenue growth and gross margins.
Professional services made up the remaining 8% of revenue. Our LTM dollar-based retention rate declined slightly from 109 to 108 as anticipated. Second quarter adjusted gross margins were 60.5%, decreasing by approximately 130 basis points year-over-year, primarily driven by the substantial but temporary investments we are making as we scale to support the momentum of our market and international expansion.
Second quarter adjusted EBITDA was $41.8 million, representing a 16.6% margin, a decrease of approximately 200 basis points year-over-year, primarily driven by our strategic investments, notably at Fagron and India, both of which we expect to deliver significant long-term opportunities for us.
Second quarter non-GAAP EPS was $0.52 per diluted share, same as Q2 of 2023. With regards to our balance sheet and cash flow highlights. In Q2, we continued our strong cash flow generation, delivering $126 million of LTM operating cash flow equivalent to 13% of revenue. This is driven by our EBITDA and by our strong DSO performance, which came in at 33 days.
We have now delivered 32 consecutive quarters of positive LTM operating cash flow, and we remain optimistic about our potential for continuing cash flow generation. Turning now to guidance. As you know, a quarter ago, we conformed our annual revenue guidance of 16% year-over-year growth $2.055 billion, which is based on 3 key assumptions. First, visibility into the ramp schedule of the backlog; second, contributions from the new logo ads; and third, an inflection the dollar-based retention rate in the second half of the year.
With respect to the first item, our assumption around our backlog remains unchanged as we continue to ramp our backlog largely on schedule with normal ebbs and flows. However, with regard to the other 2 factors, we saw trends in the latter part of the second quarter regarding new logo go gates and dollar-based retention rate, which are causing us to lower our forecast. Therefore, we are now guiding annual revenue to $1.15 billion, which is 3.8% below our prior annual guidance.
Let me elaborate in more detail. As Dan explained, our Q2 new logo bookings came in softer than expected, especially in the last few weeks of June, which is when we typically close a majority of our deals. Given that most enterprise new logos generally take 3 months to go live, 4 months to ramp, the lower-than-expected in June bookings are expected to have a negative impact on our Q4 recurring revenue forecast. In addition, the headwind will be particularly strong for PS revenue in both Q3 and Q4 since we start recognizing revenue as soon as implementation work starts.
Also, given the softer new logo bookings in Q2, we have prudently adjusted our new logo bookings forecast in the second half, which will impact our peers' revenue forecast for the remainder of the year.
Turning to DBRR, while we continue to expect customers with longer than 12-month ramps to positively contribute to DBRR, we are no longer assuming an inflection in the second half of the year. This is because we are prudently assuming a long muted seasonality in our service bookings than what we were originally forecasting to align with the weak economic data points that have been coming out recently, and this has been further confirmed by our discussions with top seasonal customers.
In terms of Q3, we are guiding revenue to a midpoint of $255 million or 1% quarter-over-quarter growth, which is the same as our guidance heading into the third quarter for 8 of the last 9 years. As for the bottom line, we will be laser focused on aggressively managing expenses and scrutinizing active strategic investments in order to improve profitability in the second half.
As a result, we are raising the midpoint of our annual non-GAAP EPS guidance from $2.17 to $2.27, with regards to the quarterly progression of our non-GAAP EPS, we are guiding to a midpoint of $0.58 for Q3 and $0.69 for Q4, which implies the EBITDA margin to improve sequentially each quarter with Q4, exceeding 20%.
Please note that our top and bottom line guidance does not include any impact from Aquion. We expect the 2024 revenue impact to be immaterial. Please refer to the presentation posted in our Investor Relations website for additional estimates, including share count, taxes and capital expenditures as well as a more detailed analysis and visual representation of the TAM expansion from AI that Mike discussed earlier.
In summary, we will remain focused on executing against this massive market opportunity that is further expanding with AI, which will drive long-term shareholder value. In addition, we look forward to updating you on our progress of achieving stronger profitability for the remainder of the year.
Operator, please go ahead.
[Operator Instructions]
Our first question today comes from Ryan MacWilliams from Barclays.
For Barry, just on the headwinds to the dollar-based net retention rate. Is this mostly macro impacting call volumes? Or are you noticing a pickup in customer agent headcount reductions? And was there any changes to churn rates in the quarter?
Yes. So I'll take the last part first. In terms of logo churn, no, there was no pick up. Dollar improved actually slightly during the quarter. In terms of the impact, the installed base is continuing to grow, it is simply growing at a slower rate. What we did was we highlighted our most seasonal customers, Ryan, by going back a few years, looking at the H1 to H2 change, which companies were the biggest drivers for that, and it was a tactic bunch, not just in consumer, but also in health care and education, things like fashion, Gourmet Foods, online education, health care insurance, home decor. And we spoke with them. And as Dan can elaborate, as we customarily do in the middle of the year, and they are talking about a meaningful reduction in terms of the rate of seasonal uptick in the fourth -- in the August to December period. And that's what we took into account.
They're still just core. They're still adding seats. They're still adding seasonally, but just doing so in a more conservative manner and not at the rates they once were. .
And I didn't address your usage part of the question. For us, they don't move in perfect tandem and in dollars, of course, the usage from -- telecom usage grows a bit slower over time. but they tend to move in tandem. .
So it's mostly changes in guidance from your customers around their plans for the fourth quarter. .
Succinctly stated yes.
our next question will be from Scott Berg from Needham .
Questions here, lots of them. I guess I wanted to start off with any changes in the sales organization. It sounds like a lot of changes, sounds a little bit like a knee-jerk reaction to a single quarter especially given your bookings last 4 quarters, 5 quarters have been generally pretty positive. You guys have been fired up with some large ones there. Help us understand why all these changes? And I guess, is it really a reaction to the second quarter or something more broadly that you're trying to roll out .
Yes. Thanks, Scott. And 1 thing just to note, we're in a room that we may be audibly challenged. So we're trying to speak up because we heard our mic wasn't quite picking up the audio. So we're going to be speaking a little louder than normal. If you have trouble hearing us, do not hesitate to let us know, and we'll repeat ourselves. .
But this was absolutely not a knee-jerk reaction in any way, shape or form. It's really a situation where we had an EVP of sales several years ago. I've been stretched thin with lots of different responsibilities across the company, and really enjoy my time with you all and working on strategy and working with our partners. And we just wanted to make sure we had somebody every single day that is 100% dedicated to the sales execution, making sure we have the right market coverage, doing some realigning of our segments.
I know we've talked about commercial and mid-market and enterprise and strategic teams and just making sure that we've got the most optimal coverage model so that we can maximize our bookings. So nothing -- it's not a lot of changes. It's really just adding more expertise and more focus into the sales execution. And that's going to be for the long haul. We had an EVP of sales leave about 4 years ago. And I said, "I'm not going to replace them. I'll just roll up my sleeves and do it all" and we've now come to a point where we're a $1 billion company on a run rate basis and really feel like we need to add to the leadership team. So that's what we've done.
Our next question comes from Matt VanVliet from BTIG.
I guess maybe looking at how the contract terms for a bunch of the AI and automation products are shaping up? How are your customers looking at purchasing that? And how much of a change in dynamic of revenue model do you expect to occur over the next couple of years? And sort of wrapped in that, can that maybe offset some of these lower seasonal uptick on a seat basis by adding more products. Thanks.
Matt. I'll start. Dan, feel free to chime in. But we've talked about pricing for a while now, Matt, in terms of AI and automation solutions and we offer both consumption-based pricing and other models for all of our AI solutions. I want to be clear about that. Again, some are more appropriate on a per seat basis and are more appropriate on a per port basis, some are more appropriate on a consumption basis. And quite frankly, we offer options to our customers relative to that.
We've also talked about the expanded TAM from AI. And you'll see on our investor presentation up on the website a quantification of that. I talked about it in my prepared remarks. And in a 15% automation case where everything -- 15% of transactions go to self-service, we get a 30% increase in our TAM. And happy to do a little more math and there's some math on the -- in that slide on the investor deck as well. But Dan, feel free to chime in.
Yes. No, you said it well. And absolutely, we want to give flexibility to the customers to purchase in a way that fits their business model the best. And sometimes that's per seat, but there's obviously lots of AI products that don't really tie to a seat like Insight, as an example, I gave 1 of the examples of customers. That's across the domain or across the tenant, if you will. .
And so certain things are best done on a consumption basis, whether that be on a per minute, like our long distance usage or whether it be on a per gig of data. We have transcription services and summary services. And so those are clearly -- some people want to just add that to their seat if it's for a human, but others will want to simply do it on a consumption basis, especially when we're transcribing and delivering summaries of things like IVAs or DBAs, they really don't tie to an agent. So therefore, it's more appropriate to do it on consumption.
Next, we'll hear from Arjun Bhatia, William Blair. .
All right. Perfect. So I understood, I think, what you were saying about the seasonal patterns and how you're baking that into outlook. But when you think about the June bookings, how much of that would you attribute to macro versus go-to-market execution? And then Barry, what would you encourage us to think from June bookings and Q4 seasonality as we just think about our 2025 growth estimates.
Yes, great question about the bookings. It's absolutely a combination of the 2. I mean, when we look at it and we say, is the scrutiny and budget constraints macro in some senses, sure. Budgets are tight, people are prioritizing, you got to build and deliver a very compelling ROI to get to the top of this stack, if you will, and get prioritized. But there's also sales execution, in my mind, wasn't up to snuff. It certainly wasn't up to the standard that we like to hold our folks to.
We've had 1 of the most and continue the most productive world-class sales organizations that we're extremely proud of, but we're never going to rest on our laurels. We're always going to want to look for new ways to maximize the effectiveness and maximize our success. And so just adding more focus and being able to execute at an even higher level is something that we're looking forward to. But yes, a little bit of macro, a little bit of sales execution, little bit of customers kind of having all this technology coming at them, not only from us and from the other folks right within our space, but lots of SaaS products are facing the same dilemma, which is how do you help the customers prioritize their budgets. And we're focused on it.
We're very bullish about the future. And as Mike mentioned, we've got a portfolio that's just continuing to be very accepted by our customers and prospects and they love where we're going with everything. So long term, we think we're absolutely in a driver seat to help drive this market. .
And Arjun, with respect to 2025, we would like to give you an outlook, but we are creatures of custom, and we customarily do this in November when we report our third quarter to give an initial look, and then firming up later on. And especially given the current turbulence in the economic environment, we prefer to stick to that pattern. .
Next, we'll hear from Piper Sandler, Jim Fish.
Great. I turned into a Fisher as opposed to a Fish. But I don't have as good of a sure as Ben fleet, but apologies for that. I did want to work off of Ryan's prior question on kind of 2 aspects guys. You guys had been expecting NRR to be troughing. I get the rationale why, but why wouldn't NRR kind of stay at this range into the foreseeable future? And how much do these AI cross-sells actually impact NRR at this point? .
So again, let me take the last part first. The cross-sell for AI is somewhat helpful. But to be perfectly candid, the attach rate is much higher on the new bookings. And it's still so small in the installed base that it just can't move the needle that materially.
In terms of the NRR, you do need to think of it in terms of 2 buckets, top bucket, which is somewhat smaller but important and then the bottom bucket, which is bigger. In terms of the top bucket, these are the mega deals as we find a calling them that take more than 12 months to go live and therefore, help in the meantime. And that has been the case. We predicted it would be the case, and it is a case with normal ebbs and flows.
Where we are seeing clearly that some slowing of the growth is in the bottom bucket, if you will, the regular run-of-the-mill deals. And we know as sure as people can be, that's not to do with the negative aspects of AI, it's not that people are reducing the seats through case of a it's simply because of the macro environment. When we speak to these customers, we look at things like I forget the exact phraseology, but a difficult environment constrained. We're getting out of that particular business, et cetera. And that's what's driving the DBRR.
One thing, though, that we are supremely confident about is that at a certain point in time, don't know when, that economy is going to rebound. And we will then be in extremely good position because our lower retention has been excellent, and it's easy to add seats to accommodate that extra growth.
Next, we'll hear a question from Siti Panigrahi from Mizuho. .
I want to focus on the acquisition. It looks like you have partnership with them more than 2 years now, and you guys talked about some of the deals like ARR more than $1 million, $1.5 million kind of per deal basis. So help us understand like how many customers do they have? What kind of overlap you have, and what's the revenue run rate they have? And Berry, like when you said no revenue contribution, is it because of the defer write-down or anything else?
Yes. Barry, I'll start, and then you can chime in. Siti, thanks for the question. We're really excited about Aquion, they as I said in my remarks, they bring us an ability to expand into a broader category beyond inbound customer service. Now we have outbound solutions, but theirs is an omnichannel outbound proactive engagement platform, and it's best-in-class.
And it really brings us into the world of marketing and e-commerce and sales in some respects. So it's a massive opportunity. It's a big step for us on our mission to really be the orchestration engine for interactions between a brand and the consumer across the entire customer journey.
So I'll just repeat that. In terms of the size of the business, it's still a pretty small business. And that's the kind of acquisition we look for, great technology, very innovative, very synergistic in terms of the customers that we win together. Some of the largest of our large enterprise customers are megas are using Aqueon, and that to us is a huge proof point.
And you heard the size of the deals from an ARR perspective in terms of the Aquion solution. So this is not a tiny revenue opportunity going forward, even though it's a fairly early stage company, frankly, I think we picked them up at the perfect time. So that's the kind of acquisition we like to do. Barry? .
Yes. And while the company is going to be growing. Currently, it's still quite small, as Mike said. In particular, with respect to Q4, and you alluded to this in your question, we need to look at the -- all of their contracts in detail, put them under the Five9 accounting policies and see what sort of haircut there is, there will be a haircut we know that already. then we just haven't had the time to do that yet. So stay tuned. We'll keep you fully informed about what actually transpires. .
Next, we will hear from Terry Tillman, Truist.
It's a bit of a multiparter, but there's a number of things to unpack. So hopefully, you'll bear with me here. I mean this is 1 of those areas that I feel like is an imperative contact centers, you I've been talking about it for a while as well. If you want to do AI and automation, improve CX, you got to get to the cloud. So some of the deals that slipped out of June and you didn't close any mega deals, I think you said I mean what are they saying? They're just going to kick the can down the curve to '25 or '26, Or do you think some of these deals are going to close in the 3Q and 4Q, and you just want to be conservative?
And kind of related to this, because of these mega trends, what are you seeing at the top of the funnel and around demand gen. Is any of that changing some of those forward leading indicators.
Yes. Thanks, Terry. I'll start it and feel free to chime in, Mike. But if you look at the quarter, the end of June, in particular, which is we naturally, like many sales organizations have quite a hockey stick right at the end of the quarter. And some of the decisions, like you said, are they just going to stick with prem and kick it down the road some more it's less that and more looking at the prioritization of their budgets, right?
They've got to look at things that are going to return right away. And a lot of things in some of the larger mega deals and multimillion dollar annual deals, they know that ROI isn't going to start realizing itself for a year plus. So it is 1 of those things that's easy to kind of say, "Oh, we need a return in the next 6 months " that's not even going to start generating a return for a year plus.
The other thing to note is that we had some pushes as well that just pushed out into the next quarters. One of the reasons for our adjusted guidance is that those deals that happen from now on don't contribute to the year from a revenue perspective.
So as bullish as we are with our pipeline and with our market coverage and top of funnel, as you mentioned, it still doesn't help us for this year because the commercial business, yes, we can get that up and running and the stuff we sell in this quarter, we can get a little bit of revenue by the end of the year. But for the enterprise business and the strategic business, those are definitely 2025 impacts to the revenue number. Anything else?
Yes, I'll just add 1 thing, Terry, and that is RFPs continue to be at record levels. So to me, that's always a good indicator of the health of the demand in the market. And we see that continuing to stay at that new normal, which is relatively double what it was, say, 5, 6 quarters ago.
And 1 other thing to add, we talked -- and I talked in the prepared remarks about the added focus on our partnerships. We're also seeing our channel partners and our routes to market enjoying, as I mentioned, they've rated us in the Baird survey #1 and easy to do business with, number one, in our preferring AI story and solutions. And number one, as far as most likely of all the folks that they distribute, who's going to benefit most from AI and they chose Five9 by far. So we're feeling very good about that approach, and they help fill the top of the funnel along with us. .
Next, we will hear from DJ Hynes from Canaccord.
Guys. So Barry, your old guidance had pretty material reacceleration baked into the second half. It was predicated on kind of the implementation backlog standing up, where it sounds like nothing has really changed there.
And then the seasonal stuff kicking in, right? I understand that that's not happening. Does this mean that the acceleration gets pushed out by a couple of quarters? Or is what you're seeing now calling into doubt that, that reacceleration happens?
So we cannot comment, DJ, on the timing of the reacceleration because we've given our guidance, and we're not going to go beyond that, we've been pretty explicit about that. I do want to -- and I'll stop there.
I mean if there was ever a time to make an exception to the rule Barry this is the time.
So the -- what I'm a bit worried about in all of this conversation is that there's been a lack of clarity in terms of our responses in terms of what has driven that reduction in the guidance that you asked about. And there are 3 and I'll give you the ordinal ranking.
The biggest and most material by a margin is the lower go-gets that we referred to. You may be a bit surprised by that, but we got -- we got meaningful PS revenue, especially as the companies go higher and higher up in the chain and scale. We also have the Q4 revenue from the Q2 on the recurring revenue. I'm talking about subscription revenue. And so that is the biggest 1 of the 3. The second 1, we, obviously, like all other companies, share with the Street a number that's a little bit lower than our internal forecast that we have scrubbed very, very carefully.
We don't want to do this more than once every 10 years type of thing. And we -- this is not an environmental big beads, but we -- that is the second biggest. And the third biggest is the 1 that we've been spending the most I'm talking about, which is the seasonal. And that's actually the ordinal ranking. So I wanted to get that off my chest.
All right. I appreciate it. .
Next, we will hear from Taylor McGinnis from UBS. .
Can you guys hear me? .
Perfect.
Awesome. Barry, maybe just wondering if you could just give us a little bit of color on the 3 different buckets and how those might be impacting the guide. So for instance, if we look at the old guide and the incremental recurring revenue or ARR needed in the second half to hit that guide. Can you maybe give us a sense of the portion of that, that was coming from existing ramps, new logos and the seasonal increase so -- and then how that might differ under the new guide, just so we can have some help there in quantifying it.
Yes. So thank you, Taylor. And what I'm actually going to do is talk about the recurring revenue increase year-over-year, assuming 8% PS for the second half of this year as well. And from memory, I may be off a little bit, but not by much. We're talking about a year-over-year increase in the second half of recurring revenue in the order of $42 million. And the breakout of that is roughly 70% of that from the installed base, 30% from the logo, the PS and the recurring revenue in the fourth quarter.
Next, you will hear from Peter Levine from Evercore. .
I appreciate all the color. Maybe just 1 on just gross margin, op margin. You've seen some compression. You kind of talked about the FedRAMP investments on the infrastructure, but maybe show us like when is the inflection, right? Because I think that's maybe 1 pain point for some is we're not seeing the leverage in the model as we would have expected at this point in time. .
Mike, can I take that? .
Sure, Barry. Go ahead. Yes. .
We're going to see inflection in gross margins in the second half of the year. We've guided to that explicitly with our 227 EPS, and you can get from there to the EBITDA margin, which we've said explicitly, Q3 will be higher than Q2 and Q4 will be higher than Q3, it will be above 20%. .
We feel very good about that, Peter. There's no 100% certainties, but the stars and the moon are aligning to get some dividends. We still continue with FedRAMP, but it doesn't hit too much in the core aspect. India might come live pretty soon. And between all of these initiatives starting to pay dividends, we will see improved gross margins in the second half.
And if I can, are you seeing any pricing compression just on their core voice contact center seat? I know it's typically been $150 per month. Is that steady? Are you seeing any -- I know there's a lot more competitors in the space today than it was 12 or 24 months ago. Maybe just any color on the core voice seat.
Yes. It's stayed very steady. In fact, yes, there's occasions on a deal-by-deal basis where somebody will get super aggressive to go try to buy business. But for the most part, we've maintained very, very steady pricing on the core. And the beauty there is we've got so much more add-on SKUs that when we look at a given customer, and we used to sell an enterprise with 10,000 employees and you've got, let's say, 1,000 seats or so.
When we would go into those environments, the revenue that we could extract or get the wallet share, if you will, that we could get from that customer was much lower, even just 2, 3 years ago, because we've added so much more to the portfolio. When you start looking at the different AI solutions that we have, obviously, the IBA is the most common and most prevalent. But then you've got the whole WEM suite, we've got other partnerships that we brought in to resell other products.
So we're getting more and more. If you look at our revenue per seat metric, it's continued to rise very steadily across our base over time. So it's not price erosion. It's actually been moving in the other direction in a positive way.
Next, we will hear from Meta Marshall, Morgan Stanley.
Great. Maybe a question just on, you noted kind of sales execution. But I guess I just wanted to get a sense of, is the time to get these deals signed off on elongating just because of the amount of things that you're kind of throwing into the RFPs?
Like while you're trying to throw in kind of AI and other pieces of it, it's just kind of taking longer to get those approvals more so than execution? And then just as a second question, I know you guys have kind of expanded the professional services into the channel or kind of enabled more implementation by the channel? Just any different trends that you're seeing there?
Yes. Thanks, Meta. So I cover the first one. As far as the added approvals and several extra meetings with all the data that's flowing around with AI and all the different solutions, absolutely, you have more meetings, but that's been the case for several quarters. I mean we've talked about that for the last year to 2 years. And so once you have that initial delay, it shouldn't affect sales, right?
It's just that we started the deals earlier when they come in. So we track very closely days to close from the moment that the opportunities entered into our system to when it closes. It had elongated a little bit a while back because of that extra time in Q2, we had some elongated sales cycles as well. But I don't equate it with that and the approval is necessary as much as I do with the the budgets and the prioritization and the timing of the customers are in the same boat, right?
They're looking at the macro economy and having to pulling the trigger on spending their entire budget and they've had budgets being reduced, too. So it's just a more competitive environment, not so much with our direct competitors, but you're competing for overall spend by those enterprises. And some of those folks have kind of paused or delayed or pushed some of their budget to later in the year because they want to wait and see what's going to happen with the economy as well.
And Meta, I'll comment on your other question about what we call project pull-through, right? This is enabling third-party partners to do the implementations. We continue to see the percentage of implementations being done by partners increase consistently every quarter. Andy and team have done a great job of just leaning in with more partners. We're still being pretty focused here in terms of how many partners were allowing to do this because, again, white glove/NPS scores or we're -- we've always taken a lot of pride in that, and we're making sure that our partners continue to do that, and they are doing it very well.
Our next question comes from Samad Samana from Jefferies.
Good evening. Maybe first one, just appreciate all the disclosure. There's a lot of moving parts. But if I just -- if I think about the implied 4Q guidance, I think it implies 9% subscription revenue growth, Barry. And what I'm trying to understand is to get to that number it tends to suggest that maybe new booked dollars were down in the first half of the year versus 2023. Is that right?
Is new book ARR down, flat or up for the first half, and I guess, more importantly, in 2Q because just the magnitude of that $40 million reduction to the implied 4Q numbers suggest that like new bookings may be actually coming in are declining or contracting. Can you just help us understand that part of it, please? .
Yes. One thing, great, Samad. -- one thing you've got to understand is that the mega deals and those million-dollar deals cause lumpiness in quarter-to-quarter and year-over-year, quarter-over-quarter, when I say Q2 versus Q2. You may recall, last year in Q2, we had a significant $20 million insurance company that we booked.
We didn't have that this quarter. So could you say that bookings were down? You could. But the revenue that $20 million insurance company is generating, that's a long, long implementation cycle. So the health of the bookings that occurred, meaning the timing of when they convert to revenue, we didn't have any of those big mega deals that are going to start revenuing in a year or 2 from now.
So in 1 sense, most of that will get revenue starting at the beginning of 2025, so it's hard to just look at a singular quarter and ascertain and come to a conclusion that aha, that's an impact. It depends what's in those bookings. So if you take out some of those big anomalies, we had a very, very steady solid quarter, I'll put it that way. But we just didn't have those big -- when you looked at the $1 million deals that I shared, right, 1.1, 1.1, and then we had the 1 that kind of straddled the Q1, Q2, which was more significant. But that's overall pipeline is healthy. We feel very good about the top of funnel as well as what we're forecasting for the remainder of the year.
Great. And then maybe just a follow-up. I fully appreciate the complexity of -- we have a world that is changing rapidly, and there's a lot of volatility. And I guess my question though is it feels like it's been about 4 to 6 quarters where it seems the visibility and the guidance is lower or maybe there may not be as much visibility as anticipated.
Just as I look at the guidance history, is it time to maybe rethink the way that you're building up your guidance. You're making some kind of permanent change to the assumptions because I think that's creating volatility in our estimates and the outlook. I'm just curious if there's any rethinking on the framework to guidance in and of itself.
Soma, very fair question. The only issue I have with that is the tense, It's implying a future test about the rethinking. We've rethink. We're not going to be -- this -- we're not going to have big beats, it's not the environment for them. But we've looked for every foreseeable thing that we could look for and put it in there. And, of course, there's always knowns and unknowns, but leaving that as a single exception, we've done the very best we can. We don't like that environment that we were in.
Understood. I appreciate the frankness as always and thank you for the color.
Our next question will be from Michael Funk from BoA.
so kind of related to the last question, Barry, on the derisking of the guidance and the confidence level in the guidance. I understand you talked to customers to help you think about the back half of the year, maybe a little bit less ramp in fourth quarter. What is your impression though the customers' outlook for the economy. There's a lot of debate around recession, no recession, does the outlook incorporate a recessionary environment or not? And if that did occur, would that be more down aside to your guidance?
Yes. Great question, Michael. Thank you. And it's perplexing to me. There's a huge debate about are we in the recession or are going into recession, are we not Jamie Dimon taking it from 20% to 35% risk, you look at the Bank of America, Credit and debit card spending in June, it was down per household by 0.5. And by the way, that's nominal, real turn which matter to us it's negative. JPMorgan Chase data is similar. And when we look at our actual internal data. And it's clear that it's not as strong as it was in the past. .
And so in short, in summary, let the debate go on. What we are seeing is weakness amongst not just the consumer vertical, but 1 or 2 others a little bit, which we've allowed for in the projections, but also a little bit in health care and education, which are the other 2 verticals that have some degree of seasonality.
Yes. I would just add, Michael, that we talk to our customers, we definitely talk to our seasonal customers. And while they cite kind of the economic conditions, they usually stop short of predicting recession versus something less than that. So -- but again, we look at the comments in those discussions with all of our seasonal customers. And we talked to all of them, and they're obviously citing just this uncertainty out there. .
Sure. So our customers, the comments are things like ongoing choppiness, retailer cautiousness, challenges from global macro and geopolitical. I don't know. This is not Five9 speaking, this is our customer. Expect macro headwinds to continue throughout this year, et cetera, et cetera. .
But is your view though the customers are projecting a recession before Wall Street is projecting a recession. Right now Wall Street is probably more soft landing in a recession, it sounds like your customers though are gearing up or spending like it is going to be a recession or is a recession? I guess that's really the question. .
They may well be, and we could maybe do an ADP and start a sideline business with an Index or some assortment. But they're not being very confident. But they are still growing a little bit, but just not as fast. .
One thing to remember, that's not them making those comments about them not spending money or not purchasing software. It's about them not getting more volume into their contact center. So they're talking about, hey, our volumes coming into our contact centers are growing, but they're not growing at the rate they did last year. And so that's what that is. It's not to say that they're suffering or they're thinking recession or they're thinking things are slowing down. It's just not speeding up and they're not inflecting seasonally like they did last year. .
Our last question today comes from Catharine Trebnick from Rosenblatt.
On your $1 million ARR deals typically that's where you really have your bread and butter during the quarter. So could you poke a little bit more? Is that a lot -- a very competitive area now with more players, more pricing or is it just a delay? Because it seems like you're saying the funnel is healthy, and the pipeline is healthy. So I'm just trying to reconcile that.
It's delay in timing and our deal sizes were smaller this quarter. It's just -- yes, I can't put my finger on a precise reason. But I think when you look back and we take a look at the overall health of the pipeline, yes, it just was a lull for us, not concerned about it. We're taking action to go make sure we can make up for it, and get back on the track that we love being on, which is to execute at a very high level.
And so we're taking actions to go do that. We set a high standard for ourselves, and we like to always live up to it. And we didn't do that in Q2, but rest assured, we feel very good about our long-term prospects all the way back to the beginning and the top of the funnel, our partner community, the customer sentiment there's -- across the board, we feel very good about the long-term future.
That concludes the Q&A portion of our call. Mike, I'll turn it over to you for closing comments. .
Yes. Thank you. I just want to say a quick heartfelt thank you to our Five Niners, our team, to your passion, your commitment to helping our customers achieve elevated CX, especially AI-powered elevated CX. So thank you to the entire Five9 team for all you do, we remain very, very excited about the future in this market. So we'll keep you posted as the next couple of quarters unfold. Thanks for joining.