Five9, Inc. (NASDAQ:FIVN) Q3 2022 Earnings Conference Call November 7, 2022 4:30 PM ET
Company Participants
Mike Burkland – Chairman and Incoming Chief Executive Officer
Rowan Trollope – Chief Executive Officer
Dan Burkland – President
Barry Zwarenstein – Chief Financial Officer
Conference Call Participants
Ryan MacWilliams – Barclays
DJ Hynes – Canaccord
Scott Berg – Scott Berg
Meta Marshall – Morgan Stanley
Taylor McGinnis – UBS
Peter Levine – Evercore
Sterling Auty – MoffettNathanson
Matt VanVliet – BTIG
Matt Stotler – William Blair
Will Power – Baird
Michael Turrin – Wells Fargo
Unidentified Company Representative
Thank you for joining us today. On the call are Mike Burkland, Chairman and Incoming CEO; Rowan Trollope, 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 of the company, industry trends, company initiatives and other future events, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are simply predictions, should not be unduly relied upon by investors. Actual events or results may differ materially, and the company undertakes no obligation to update the information in such statements.
These statements are subject to substantial risks and uncertainties that could adversely affect Five9’s future results and cause these forward-looking statements to be inaccurate, including the impact of adverse economic conditions, including macroeconomic deterioration, including increased inflation, increased interest rates, supply chain disruptions, decreased economic output and fluctuations in currency exchange rates, lower growth rates within our installed base of customers, the impact of the Russian-Ukraine conflict, the impact of the COVID-19 pandemic 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 is currently available in our press release issued earlier this afternoon as well as in the appendix of our investor deck and available in the Investor Relations section on Five9’s website at investors.five9.com.
And now I’d like to turn the call over to Five9’s Chairman and incoming CEO, Mike Burkland.
Mike Burkland
Thanks, Emily, and thanks to everyone for joining our call this afternoon. Before we jump into today’s call, given the recent announcement, I’d first like to turn it over to Rowan for a few comments. Rowan?
Rowan Trollope
Thanks, Mike. I want to reiterate my strong belief in the market opportunities ahead, and I’m optimistic that Five9 is well positioned to capitalize on those opportunities. Five9 is in great hands given Mike’s proven track record of success. During his 10 years as CEO, he established a vision to move the contact center to the cloud long before it became conventional wisdom.
The company’s revenue increased by 20 times, becoming one of the largest and fastest-growing public companies in the CCaaS market. And Mike and I have built a terrific partnership, and we’re committed to ensuring that the CEO transition is as seamless as it was four and a half years ago when he passed the torch to me.
It’s been my privilege to serve Five9 investors, customers and employees. The team here is truly best-in-class. To the investors and analysts on the call, I have always valued your feedback and trust in Five9, and I wish you all the best.
And finally, I’d like to express my gratitude to Mike and the rest of the Five9 Board for the opportunity to lead this terrific company. Thank you very much.
With that, I’ll turn it back over to Mike.
Mike Burkland
Thanks, Rowan. I want to express my sincere gratitude for your dedication and leadership over these last four and a half years. We wish you the very best in your next chapter.
As many of you know, I was CEO here for nearly 10 years and have been active as Chairman for the last five years. Five9 is a truly exceptional company driven by our passionate employees whose collective mission is to help businesses re-imagine the way they deliver customer experience. And I couldn’t be more thrilled to be back on the field with this team to continue fulfilling this commitment to our clients. I believe Five9 is extremely well positioned in this massive market as we continue to execute on product innovation, our march upmarket and international expansion.
We are still in the early innings of this long-term shift to the cloud driven by the following three market trends that we are seeing. First, the viability and desirability of cloud solutions is no longer questioned even in the largest contact centers. Cloud solutions now offer proven scalability, reliability, security and innovation. In addition, premise-based solutions are increasingly being end of life-d or are prohibitively expensive to maintain, giving companies more reasons to move to the cloud.
Second, in order to avoid being disrupted companies are vigorously pursuing digital transformation initiatives to enhance their customer experience. A central aspect of any such transformation is the mission-critical contact center. No longer is the key to success just shaving seconds off average handle time, but also to achieve strategic differentiation via superior customer experience.
Third, we believe our already huge TAM has more than doubled with the maturation and economic viability of AI-driven automation solutions, which can most easily be provided in the cloud. In a tight labor market with agents turning over rapidly, automating mundane routine tasks is an imperative. We believe these trends are gathering steam and will be with us for many years to come despite the current macro choppiness.
Now, I’d like to discuss what we view as the three main growth drivers for our business, namely our platform, our march upmarket and our international expansion. Let’s begin with our platform. As discussed on prior calls, the re-architecting of our platform has paid and is paying massive dividends. We have made great strides along a number of fronts. Our ability to scale to serve some of the largest cloud contact center deployments has clearly been demonstrated.
Our ability to deliver our service, either in our own data centers or via the public cloud, has allowed us to rapidly extend our global reach and offers the potential of gross margin improvements in the future. We have continued to make improvements in uptime, a crucial metric for customers. I am extremely pleased to report that over the past 12 months, we achieved an important milestone of Five9’s system availability. In other words, 99.999% uptime. This is a significant achievement, and my thanks go out to the entire team that enabled us to reach this key milestone.
In addition, this re-architecting of the platform allows us to innovate at a faster pace as illustrated by the three major new product capabilities introduced at our recent CX Summit. First, our new web-based administration currently provides our clients the ability to manage their contact center more effectively and will also provide access to our full range of applications and the ability to customize features to their specifications and needs.
Second, our AI Insights offering, a brand-new product resulting from our investments in AI, addresses a key challenge felt by contact center operators. Today, many contact center managers are flying blind due to a lack of timely insights into conversational data. This new offering gives operators access to data once considered inaccessible, allowing them to pull insights and identify emerging trends. These insights can in turn be used to make more informed decisions on investments to improve customer and employee experience and the overall contact center ROI.
Third, our advanced Five9 analytics, which gives customers the ability to design and customize reports on their own contact center data in a true self-service manner. Conversational insight and analytics are critical in any modern contact center platform, and these innovations are designed to enable customer success.
Finally, we continue to make excellent progress with our IVA, which has strong market acceptance, especially given the tight labor market and high agent turnover. To illustrate the traction we are enjoying, note that the number of minutes of IVA usage in the third quarter nearly doubled year-over-year.
Next, I’d like to discuss our march upmarket. During the third quarter, we continued to show strong growth in the upper end of our Enterprise business. This traction is best illustrated by the record number of $1 million-plus ARR new logos added in the quarter. These $1 million-plus customers, which now represent approximately half of our recurring revenue, continue to be the fastest-growing part of our business and have a DBRR that is significantly higher than the corporate average of 118%.
Our traction with these bigger customers is in large part due to what I have been talking about. That is the re-architected platform, but also from the focus of our strategic sales team, which continues to be supported by a record pipeline. Another key factor that has benefited us greatly is the increasing, broadening and deepening of our partner network. These partnerships often serve as a force multiplier in our ability to fully satisfy our customers’ transformational objectives. One key aspect I would like to emphasize with respect to partners is the expansive set of integrations we have developed over the years.
Five9 has several hundred modern, feature-rich APIs that ISV partners and developers can use to integrate with the Five9 platform. The extensive suite of APIs covers virtually every area of the portfolio for integration with CRM, WFO, UC, AI, voice biometrics, speech analytics, business intelligence and many other applications. These and other certified integrations enable our enterprise customers to make the conversion to Five9 and easily integrate to their existing systems.
Lastly, I’ll cover our international expansion. As you know, we have been investing aggressively outside of the U.S. It has been a considerable investment. Our international go-to-market headcount has tripled since the end of 2020. And we have also recently established a new research and development center in Portugal.
These international investments are paying off. Our international bookings in the third quarter grew 78% year-over-year, and our international revenue grew 40% year-over-year. International revenue has grown at 40% or more for the seven quarters out of the last nine quarters. We expect to deliver continued strong international growth as we plan to increase the percentage of international revenue from 10% to the mid to high teens in the coming years.
Before I hand the call over to Dan, I would like to reiterate my enthusiasm to be back working closely with this amazing team, and I couldn’t be more optimistic about the opportunity ahead for Five9.
I will now turn the call over to our President and Chief Revenue Officer, Dan Burkland. Dan, go ahead.
Dan Burkland
Thank you, Mike, and good afternoon, everyone. I’m pleased to report that as we continue to move upmarket, expand internationally and deliver industry-leading innovation, our new logo bookings once again set a Q3 record. We continue to get great leverage from our channels, systems integrators and our ecosystem of partners, which helped us build our pipeline to an all-time high.
However, we are seeing the macro headwinds causing some customers to be more cautious and deliberate, leading to some areas of softness on the new logo side, particularly in the mid-market, and also on the installed base part of our business, which Barry will to discuss in detail.
On the new logo side, the mid-market softness is being offset by overachievement in strategic accounts and international bookings. And now as I normally do, I’d like to share some examples of key wins for the quarter.
The first example is a global BPO headquartered in Spain with their primary operations in EMEA and Latin America. They had been using an Avaya solution with very limited visibility and flexibility for them to tailor the system for each of their clients’ needs. They looked at other cloud providers and chose Five9 for our global presence, scalability, open API platform and ease of use.
In addition to Five9, we will integrate to a vast array of various CRMs used by their clients from the typical brands to homegrown proprietary solutions. They are also adding IVA on a client-by-client basis for self-service to help alleviate repetitive mundane tasks currently being handled by human agents. We anticipate this initial order to result in approximately $4.7 million in ARR to Five9.
The second example is a Fortune 200 global leader in heating, ventilation and air conditioning, or HVAC, systems with operations in over 160 countries. They, too, were coming off of an Avaya system and looked at other cloud competitors. They chose Five9 as they discovered that much of the customizations required extensive development on competing solutions, but were standard out-of-the-box capabilities on Five9.
They are moving forward with an extensive omnichannel solution with voice, chat, e-mail, SMS, along with the full WFO suite, including WFM, QM and interaction analytics. They’re also using our IVA self-service for warranty, claim status and order status while integrating to Salesforce and ServiceNow CRMs. We anticipate this initial order to also result in approximately $4.7 million in ARR to Five9.
The third example is a northeastern United States medical practice with over 350 locations, including clinics, physician offices and hospitals. The contact centers receive inquiries covering everything from patient scheduling, prescription refills, doctor-to-patient connections and so on. And they have been using an on-premise solution and were looking for the scalability, reliability and security along with flexibility of the cloud. They chose Five9 for those reasons as well as our proven integrations with several CRMs, including Athena, Epic and Salesforce, along with integration to Microsoft Teams UC to give them a visual directory with status to easily engage noncontact center resources.
They also are using IVA self-service for scheduling appointments, checking invoice status and making payments. They are using our workflow automation solution to perform proactive outbound notification for appointment reminders and overdue invoice reminders. We anticipate this initial order to once again result in approximately $4.7 million in ARR to Five9.
And now I’d like to focus on existing customers who have increased their use of Five9. Despite the growing macro headwind on the installed base side of our business, we continue to see sizable expansions in certain segments, especially in the strategic accounts. First, the parcel delivery service company that we’ve spoken of in the past added approximately $5 million to their anticipated ARR with Five9 to add on their APAC division, bringing the total anticipated ARR to nearly $55 million.
The second example is a regional bank who has been a Five9 customer for more than two years and was in the process of merging with another regional bank. That other bank had been using premises-based Cisco solution. And due to the many advantages we have over that solution, the customer is migrating all of their agents over to Five9 and also adding the full WFO variant suite as well as voice biometrics for customer authentication. This customer has gone from an ARR figure of approximately $600,000 to over $1.6 million with Five9.
In summary, as you can see, we continue to see strong demand upmarket, increased expansion internationally and excellent momentum with our channel partners.
And now I hand it over to Barry to cover the financials. Barry?
Barry Zwarenstein
Thank you, Dan. First, a reminder that unless otherwise indicated, financial figures I will discuss are non-GAAP. Reconciliations from GAAP to non-GAAP results are included in the appendix of our investor presentation on our website.
We had a strong third quarter with revenue growing 29% year-over-year. The LTM revenue split was 86% enterprise and 14% commercial, while the recurring revenue versus Professional Services mix was 91% and 9%, respectively. Our LTM dollar-based retention rate remained at 118% sequentially. Recurring revenue per seat again increased by low to mid-single digits year-over-year as it has in eight quarters out of the last nine quarters.
Given that we are facing uncertain times due to the macroeconomic conditions and due to the fact that we are in the most seasonal quarter, today, we are going to provide more detail into the revenue drivers than we customarily do. Please, though, bear in mind that we do not intend to routinely continue making these more detailed disclosures.
As we have mentioned on our last call, about half of our revenue growth comes from what we refer to as the new logo side of our business, namely landing and turning up new logos, which can take several quarters or even longer to move from bookings to revenue. The other approximately half of the revenue growth comes from installed base bookings, which promptly turn into revenue.
The new logo side of the business remained solid. During the third quarter, we turned up 46% more new enterprise seats than we did a year ago, the second highest number of new enterprise seats for any quarter. Incidentally, the only quarter where we had higher seat turnouts was in the fourth quarter of last year, when we ramped the parcel delivery service in advance of the holiday season.
Turning now to the deployment profile of the two new logo mega deals, that we discussed in recent calls. First, the parcel delivery service company is approximately 50% deployed, and we expect the remaining 50% to be substantially deployed by the end of 2023. Secondly, the healthcare conglomerate deal will start to be deployed in a limited way this quarter, and we expect full deployment by early 2024. Bottom line, we believe that despite the softness Dan mentioned in the mid-market, overall, we have a good combination of visibility and confidence when it comes to the new logo side of the business.
Turning now to our installed base. This part of our business will be facing slower growth in CDAS [ph] due to increased macro headwinds and, in some cases, customer-specific business challenges. We saw a solid growth rate mainly in five verticals, namely financial services, consumer, healthcare, outsources and real estate, which accounted for 61% of Q3 recurring revenue. These industries in total stayed flat sequentially in Q3 of this year as compared to a 6% sequential growth in Q3 of last year.
Within each of these five verticals, a common denominator was the macro environment where the customers were tightening budgets due to the slowdown in their business. There were, of course, company-specific drivers as well. For example, in healthcare, we saw a later and smaller sequential increases in open enrollment and telehealth activities. For the remaining 39% of Q3 recurring revenue, we saw a slightly higher sequential growth rate compared to last year, but it was not enough to compensate for the slower growth in the five verticals facing headwinds.
Turning now to the rest of the income statement. Third quarter adjusted gross margins were 61.4%, a decrease of 270 basis points year-over-year, but a quarter-over-quarter improvement of 70 basis points due to the moderation of our accelerated investments in Professional Services and public cloud.
We expect gross margins to increase sequentially by a small amount in the fourth quarter with the continued expectation that the annual gross margins for 2022 will be at a minimum of 61%.
Third quarter adjusted EBITDA margin was 18.5%, an increase of 70 basis point year-over-year driven by continued operating leverage. Third quarter non-GAAP EPS was $0.39 per diluted share, a year-over-year increase of $0.11 per diluted share.
Next, I’d like to share some balance sheet and cash flow highlights. I’m pleased to report that in the third quarter, we achieved record highs of our operating and free cash flow of $30.5 million and $17.9 million respectively, driven in part by the continued strength of our DSO performance, which came in again at 34 days. We have now delivered 25 consecutive quarters of positive LTM operating cash flow and we expected to increase meaningfully in the longer term, given, our ability to expand adjusted EBITDA margins, our substantial NOLs and our low DSOs.
And now I’d like to discuss our guidance for the fourth quarter and for the full year 2022, as well as provide high level commentary on 2023. In terms of top line, considering the macro and seasonal uncertainties, we are guiding Q4 revenue to midpoint of $204.5 million or 3% sequential growth, which is within the pre pandemic range of 2% to 4% that we’ve guided to in prior fourth quarters.
For the full year 2022 revenue, we’re guiding to 27% year-over-year growth or $735 million at the midpoint. And for the bottom line, we are guiding fourth quarter non-GAAP net income per share to midpoint of $0.41. This represents $0.02 quarter-over-quarter increase, which is at the high end of the pre pandemic range. For 2022, we are guiding non-GAAP net income per share to a midpoint of a $1.36.
I would now like to provide some preliminary high level commentary on our current thinking for 2023. For those of you who have been following Five9 for some time, that for the six years through 2020, we started each new year with prudent revenue guidance of 16% year-over-year growth at the midpoint, mainly due to the uncertainties around the magnitude of the seasonal impact on our business.
We step us up to 20% in the beginning of 2021, primarily due to COVID benefits and then further to 24% in the beginning of 2022, driven by strong momentum in the business and a healthy macroeconomic environment at that time.
For 2023, given, the macro headwind and uncertainty that we are assuming will persist throughout next year, we’ll once again begin 2023 with an outlook of 16% year-over-year growth or $900 million in revenue. This of course, is a starting point and we will update our outlook as the year progresses.
We expect revenue to continue following our typical pattern with slightly more than 50% of our annual revenue being generated and the seasonally stronger second half of 2023. Also, given that the install base typically contributes approximately half of the annual revenue growth, next year, we may see a drop in the LTM enterprise subscription revenue growth rate from 37% we achieved in the third quarter into the high 20s due to the macroeconomic challenges.
We believe this will be temporary and will improve as macroeconomic conditions improve. Note that the enterprise subscription currently makes up over 60% total revenue. In terms of the bottom line, we expect 2023 non-GAAP net income per share to increase at a similar rate to the 16% revenue growth outlook and increase year-over-year from the midpoint of our 2020 guidance, at a $1.36 to $1.78 in 2023.
In addition, we would like to provide an outlook on the quarterly profile of our bottomline. If you look at our historical financials, non-GAAP net income per share is typically amongst the lowest of the year in the first quarter, and we expect this to be the case again in 2023. Therefore, we expect non-GAAP net income per share to be in the mid teen in Q1 2023. We expect bottom line to prove slightly in the second quarter and more meaningfully in the second half, especially in the fourth quarter.
Lastly, beyond 2023, we now expect to achieve the $2.4 billion revenue target in 2027, one year later than what we had previously predicted due to the current macro headwinds that we did not allow for originally. This target date assumes more robust macroeconomic conditions in 2024 and beyond.
And as a reminder, the drivers for this $2.4 billion, 2027 target are based on our expectation that our dollar base retention rate will turn toward the high 120s, that we will achieve continued momentum in our major market and that our international revenue will increase from the current 10% of total revenue to the mid to high teens.
Finally, please refer to our presentation posted in our investor relations website for additional estimates including share count, taxes and capital expenditures. In summary, we are pleased with our third quarter performance and while we expect to experience some volatility in the near term due to macro headwinds, we remain very optimistic of our ability to continue executing against this massive market to deliver balance growth.
Operator, please go ahead.
Question-and-Answer Session
Operator
Barry, thank you very much. [Operator Instructions] All right. First up today, Ryan MacWilliams has a question from Barclays.
Ryan MacWilliams
Okay. Thanks for taking the question. Mike, glad to see you are back looking forward to the path ahead and Rowan wishing you well in the next endeavor. Mike, any changes you’re anticipating as you step back into CEO role, how are you framing Five9’s current opportunity in this environment and how is it different from your previous tenure? Thanks.
Mike Burkland
Yes, thanks, Ryan. Good to see you. Nothing’s changed in terms of strategy. Rowan and I and the rest of the Board have been extremely well aligned in terms of our strategy. As you guys know, I’ve been Chairman for the last five years and we’ve been very, very close to Rowan and the rest of the team during that time. So no change in strategy. Obviously one of the highlights of Five9’s history for the last 15 years has been our ability to execute and we expect that to just be our strength going forward. So it’s onward and upward from here.
Operator
Thanks very much. We’ll take our next question from DJ Hynes with Canaccord.
DJ Hynes
Hey, guys. Mike, great to see you and Rowan we’ll miss you, but good luck with everything. I’m going to ask one of Dan, so Dan, for buyers that are delaying their cloud upgrade decision, what can they do to make their legacy systems work for them for the time being? Is it just operate status quo or are they looking at other like workflow technologies or upgrades around the edges to kind of extend the life of their systems? I’m just trying to get a sense for like what you’re selling against?
Dan Burkland
Yes, so DJ that –- and great question. And that’s been the big thing that customers that do have the legacy premises based systems is how much longer can they continue to squeeze out, yet another year from their current systems. And it’s difficult because they don’t have the innovation available to them. They’re typically siloed by location, so they’re not giving them the greatest economies of scale and they oftentimes aren’t being upgraded at the rate they once were.
In fact, many have been listed as being end of life here and will have very little, if any investment going into them. So that’s the decision that enterprises need to make. And so we’re still seeing a nice uptake of customers that want to move to the cloud and need to move to the cloud for that matter. And so that’s why our pipeline hit another all time high this quarter, as I mentioned in the prepared marks. And we see this trend continuing. We’ve had some soft spots, if you will, but customers are still very, very motivated to really embark and move their contact centers to the cloud for those reasons, especially on the innovation front.
We continue to get in and around 10% of our customers that are opting in for the IVA and other automation solutions, and you just can’t do that effectively when you’re on prep. So we’ll continue to see this trend for the foreseeable future. And as Mike mentioned, we’re still in the very early innings of this. The upgrade to the cloud started occurring, you could say 10 years to 15 years ago. It started with the small end of the market and we’re just now getting that very high end of the enterprise market once we established reliability, scalability and the innovation that they require. And so that’s a whole new market and really the biggest part of the market and that’s what we’re seeing.
DJ Hynes
Yes, Okay. Yes, that’s helpful color. I mean, it seems like the new large enterprise stuff continues to go pretty well.
Dan Burkland
Great. Thanks.
Operator
Next up from Needham, we have Scott Berg.
Scott Berg
All right. Hi, everyone. Mike, I echo the welcome back comment and Rowan look forward to catching up in the future and best of luck.
Rowan Trollope
Thanks, Scott.
Scott Berg
Yes, I guess, Barry, I wanted to expand upon the slower customer expansions that you talked about. And I don’t know if it’s a question for you or maybe Dan or someone else. But your customer expansions really break down into kind of three categories as I see them, one customers that are moving your product from maybe one division or department to another one. Two, there’s some seasonal hiring around the holiday kind of timeframes. And then three, it’s just general hiring, obviously, within their businesses. If we were to dissect the slower expansions, what would you kind of put the – what categories would you put those headwinds into? Thank you.
Barry Zwarenstein
Yes, Scott, we don’t have that analysis. So this is somewhat anecdotal, I hope you understand that. But based upon everything that we’ve seen and heard it’s between the second and the third categories that you mentioned, in particular the seasonal expansion. We, as you know, have always enjoyed historic growth, dramatically historic growth from Q3 to Q4. And if you look at the history, it’s between 8% and 12% or 8% and 11% sequentially.
We’re not seeing it this year. Let me just give you one illustration Scott, what about biggest verticals, consumers? Actually our third biggest verticals, and it’s a central one in terms of the number of people there. There’s 116 enterprise accounts, 248 commercial accounts. So it’s a big sample. And if you go back as far as you possibly can with records that are readily available to each year, you could count on it Q2, Q3 to Q4, there’d be a meaningful material improvement in revenue. This year there was a few change, it’s just basically flat and we talked about it also in the total core with respect to all five top verticals that they experience. So I would say it’s a combination of seasonal because we can clearly identify some of the usual people in healthcare and retail, but then also in the other areas, whether it’s constructions of closes whatever would be more on the organic side.
Dan Burkland
Yes, and just add to that, those go hand in hand. As you know, Scott, if the seasonal headwinds are affecting the seasonal adds, they’re organic growth that they normally achieve, which means they don’t need to hire as much. So you could call it seasonal or you could call it hiring. They kind of go hand in hand. They’re going to hire additional workers when they meet them and if they don’t see the demand for their products, they’re not going to add the seats to the contact center and hire the folks that fill those seats.
Scott Berg
Great. Thank you for taking my question.
Operator
Moving on to our next question. This is Meta Marshall, Morgan Stanley.
Meta Marshall
Great, thanks so much for the question. A couple or a question of two parts for me. Just in terms of when do you kind of find out from customers that either they’re not going to – like just trying to get a conversation if they’re not expanding or they’re contracting the seat counts and/or is that just something you just kind of see in the numbers in retrospect? Or are there kind of a conversation happening where you can say, hey, we can give you these additional products to help ease this transition if you’re having problems with kind of overall macro? So one just, is it a conversation or something you see in retrospect and then you gave the vertical breakdown, but just is that something that we’re seeing more on the SMB side or the enterprise? Thanks.
Dan Burkland
Yes, so, Meta this is Dan. Great question and let me remind the group here. I want to break down the installed based bookings into two categories because you touched on both of them. One is the seat adds and you mentioned contraction. Very rarely are our customers unless their business is just suffering where they actually would lower seat counts. They’re just not growing at the rates we’ve seen and we’ve seen two very solid years. So it’s one is it’s tough compares on the add side. So the seat adds being the growth slowing, but we are offsetting that with – like you said, going back to the base and saying, aha, we’ve got more applications we can upsell and cross sell new applications.
Both Q2 and Q3 of this year were our two largest quarters for selling into the install base upsells and cross sells, non seat adds. And so we’re seeing those two factors working together. But there’s no question the headwinds have affected the hiring on their part and therefore, as I mentioned earlier, the seat adds on their part.
Mike Burkland
And if I could just add, and also in terms of how far in advance do we know. We do get some notification because we get a notification of 30 days notice before they can flex down or up or down in this case. So we do get that. We also – for the bigger clients in particular, really outstanding account management teams is really very close to the bigger customers in particular and can begin to sense it. But at the end of the day, you don’t have clear buoyancy into so many customers across almost 3,000 customers.
Dan Burkland
Yes, in some cases they don’t know until it’s pretty close.
Mike Burkland
But that’s truly an excellent point because they do have the right to flex. And often, they don’t know it, Dan just did. I mean, just look at excess inventory, some retailers, et cetera.
Dan Burkland
Thanks, Meta.
Operator
Moving on to our next question from Taylor McGinnis at UBS.
Taylor McGinnis
Hi, can you – hi, can you hear me?
Mike Burkland
Yes, Taylor. Yes, we can.
Taylor McGinnis
Okay, perfect. Sorry about that. Yes, so you guys talked about a lot about sequential quarter-over-quarter, trends within seat count growth, but any chance you can comment or provide a little bit more color on year-over-year growth trends and if we run some math, it seems that the guide this year applies somewhere in the low teens. Seat count growth assuming that ARPU growth continues in the low kind of to mid single digits that you talked about. And then as we look into next year, it looks like the guide implies something similar on the seat count level. So maybe you can just provide more color on the assumptions there and how you get comfort that seat count can continue at the same pace year-over-year going into next year.
Mike Burkland
Yes. So seats come in two flavors. And we sometimes confuse you perhaps a little bit because we just use the terms somewhat in interchangeably. The one category is when we are turning up new seats from new logos. And we call those turn ups typically. And then within the listing base, besides selling more to each customer or each seat, we also have the expansions that we’ve been just been discussing.
In terms of our year-over-year growth, we haven’t shared that in the past and it’s just not something we want to do. On the first category, you did get some indication from the 46% of new logos [indiscernible] that we had. And Dan and the team have been talking quite some time about the success that they’re having with these bigger customers. In fact, we had a record in terms of $1 million plus customers in the quarter. So that gives us a fair degree of confidence on that side of it. With respect to the expansion in the install base, we’ve assumed a weaker – continuing weaker economy into next year and into the fourth quarter. We don’t see that turning around. And we’ve done the best that we believe we can in terms of aligning for that.
Taylor McGinnis
Awesome, thank you.
Operator
And we’ll move on to a question from Piper Sandler and Jim Fish.
Unidentified Analyst
Hey guys, thanks. This is Quinton [ph] on for Jim Fish. As large contact centers continue to adopt Five9, we’ve seen them typically utilize partners on the WFO side over the internal offering. Do you need to further invest behind the virtual observer tech stack to make the product more viable for the enterprise or our enterprise features and functionalities and investment that just makes more sense to look at inorganically? Thank you.
Mike Burkland
Yes, great question and we absolutely have two platforms for a reason. When we talk about the partner one, that’s one that’s Verint, which we OEM and provide the full suite. And although we get very healthy margins from that even though it’s a third-party product and we have customers at the high end of the market that have spent better part of a decade or two being comfortable and familiar with that platform. So in some cases they ask for it by name. We’ve mentioned on these calls before, in some cases, we don’t even need to demo it.
It’s a known quantity, and they can get on the latest release and pay for as a service and transfer all their data over to our Verint platform to their existing one. So that adoption rate is easy and elegant for them to continue on with that platform. So I don’t know that we’d ever really want to come in and try to convince them to switch to a different platform.
Having said that, we are absolutely investing in our VO solution and what it can bring to the market. Right now, we look at that as kind of our small to midsize offering and then our Verint offering at the high end of the market. The VO solution will continue to expand and be more robust from a feature functionality because small to midsize businesses still want the more functionality that previously, it was only available at the high end of the market. So we’ll continue to invest there. And that will slowly creep up, as you can imagine, as it gets more capabilities.
Unidentified Analyst
Awesome. Appreciated. Thank you.
Operator
Moving on to Peter Levine at Evercore.
Peter Levine
Thanks for taking my questions. Welcome back, Mike and congrats Rowan, on your future endeavors. Maybe the first one for you, Barry, can you reconcile the initial thoughts into the 2023, 16% guidance? Does that bake in like the worse macro case scenario? Or is this just more of a normalized cadence of pre-guided – pre-COVID guidance? Just kind of help us what’s in that guidance.
Barry Zwarenstein
Yes. So, we’re assuming this as a matter of interest rates and inflation and disparity between the job openings and the people looking forward to continue not to take another big step down, frankly. We – and that 16% is that basic economic scenario. And within there, it has a continuing two-legged stool if you will, with one leg a little bit shorter than the other one. The one that’s solid is the new business. This is a strong industry that’s just a sense, but it’s about, and ROIs are really stunning. And we can deliver. It’s on the expansion side that we’ve taken that extra precaution.
Peter Levine
And then maybe one for you, Dan is I would think the IVA and the tight labor market would sell itself. So curious, like what’s holding customers back from going all in with automation given the ROI, again the tighter labor market? So I mean, are there limitations to what IVA really offers? Or customers are just being hesitant to not ready to kind of go on?
Dan Burkland
Yes. That’s an awesome question. There’s really two primary reasons that I would focus on. One is, you’ve got to be very careful on what applications you’re going to try to automate, meaning it’s got to be a conversation that the customer is going to ask on a highly frequent basis and have the numbers. I mean you’ve got to have high volumes of numbers because the professional services and the customization that’s required to build those applications is not trivial. So it does require a significant investment.
So, you’ve got to look at things that are very, very common. What are people calling into and asking for 100 of times a day and tying up human resources that you can truly get some significant ROI by automating it. So that’s the first step. And then the second one is, while you’d love to think you could just put IVAs in and let IVAs have conversations with humans, there’s also the demographic of and the type of inquiry that’s happening, right?
When I say the demographics, there are certain demographics that you may not want to just offer them a full automated solution for regardless of how simple and straightforward most of us would think that is. They just are averse to wanting to communicate with something other than a human at this point.
Will that change over time? Absolutely. And that’s why we see the adoption will continue to rise and continue to become more prevalent as a society becomes more comfortable talking to voice interfaces and automated chat interfaces as we get the intelligence and the machine learning algorithms more and more accurate to where people accept the answers they’re getting. Because the worst thing we want to do is create that frustration that we all saw in the commercials where people are saying, “Oh, agent, agent or representative.” And they’re not having a good experience because of the automation. So it’s a balance. You’ve got to pick your spots and do it effectively, and that’s what we’re doing.
Mike Burkland
Yes. Peter, I would just add that our IVA minutes nearly doubled over the last year. So this is exciting stuff for our customers. It is also future-proofing their decision around their contact center solution. They want to know that their cloud contact center provider is on the cutting edge when it comes to AI and automation. And they certainly have chosen Five9, and so many opportunities to do that.
Dan Burkland
And just to clarify one thing. We talk about 10% of our new bookings being IVA. Those are dollars. So when you say go all in, when a customer, let’s say, a 500-seat customer says, “Oh, this is great. I’m all in. I want to go IVA.” Well, what percentage of your calls are you truly going to deflect over? In some cases, it’s like, well, 1% or 2% or 3%. Well, that – to them, that’s going all in. I mean to flex 3%, and we’re saving 3% of those agents times 500, that’s 15. That’s 15 IVAs. You add those dollars up; it doesn’t offset the 500 or 385 human seats that we’re selling. So even though if somebody thinks they’re all in, it may only result in 5% or 10% of the spend.
Peter Levine
Okay, thank you very much guys.
Operator
We will move on now to Sterling Auty at MoffettNathanson.
Sterling Auty
Thanks. Mike, welcome back. I can’t believe they dragged you out of retirement. You’re traveling the world, and now you’re back in the grind with the rest of us.
Mike Burkland
Good to see you, Sterling. Thank you.
Sterling Auty
And Rowan, congratulations. Good luck. We’re all waiting with bated breath to figure out where the heck you’re going. So, we’re waiting for January to see that news. All right. So my question would be, Mike, I think the one thing that we look at Rowan’s tenure and doing was attracting some very high talent in terms of technology, innovation, et cetera. What are you going to do to retain and continue to attract that caliber of talent to drive that automation that Dan just spoke about? And then one just administrative one. When you guys talk about the mid-market weakness, is that all encapsulated in the 86% that’s enterprise? Or is that a blend of some of the 86% and some of the 14%?
Mike Burkland
Yes. So Sterling, I’ll take the first one, and I’ll let Dan probably take the second one. But you’re right on, Sterling. I mean when we recruited Rowan five years ago, when I got cancer, it was with the intention of bringing in a person with the product, depth and breadth that Rowan has. And what he’s contributed is unbelievable over the last five years. We have moved the platform so far forward. We’ve now become truly ambidextrous.
I mean you guys remember us back in the days when people would think of us as a very sales-led company. Today, we’re truly ambidextrous when it comes to technology and platform and innovation as well as our go-to-market strengths, not to mention our other functional areas, which are critical to the business. But the good news is I’m not coming in from the outside. I’ve been Chairman of the Board for the last five years. I was involved in recruiting many of the senior leadership that has been brought in over the last five years. I have great relationships with the leadership team here, including not only the ones that were here when I was CEO, but also the ones that have been brought in over the last five years while I’ve been Chairman.
So, I look forward to continuing to work with them. They are engaged and enthusiastic about the future. And it’s just a great time to be in the contact center market in spite of the macro backdrop that everybody is facing today.
Sterling Auty
And Barry, the mix, the 86-14 [ph] versus the weakness in mid-market, where does that fall? Is it in both categories?
Dan Burkland
I’ll take it. It’s primarily the mid-market, which is the smallest end of that enterprise number of the 86%, a little bit on the higher end of the commercial. But we’re seeing nice volumes in the commercial business primarily driven by the channel expansion. We’re getting more and more channels bringing business to us, and they have a lot of those high quantity of leads and opportunities at the small end. So not really – even though there are headwinds facing some of those smaller customers, we’re still seeing a pretty sizable growing pipeline there.
Sterling Auty
Makes sense. Thank you.
Mike Burkland
Thank you.
Operator
Moving on now to Terry Tillman at Truist.
Unidentified Analyst
Great, thanks so much for taking the question. This is Robert on for Terry. In the past, I believe you all called out 10% to 20% fee reduction options on most contracts within the enterprise installed base. Has there been any meaningful exercise of these reductions in 3Q versus 2Q? And if so, what’s roughly been the magnitude? Thanks.
Dan Burkland
Yes. It’s pretty rare. I mean it’s an ability there gives us a built-in floor at 85%, 90% of the contract that they set up for initially. Most customers – we’re talking about a reduction in the growth rate of the seat adds that organizations have from either their organic growth or as was mentioned earlier by Scott, growing into new departments or expanding into other areas if they do M&A-type activity.
So it’s just about slowing of growth. It’s not really, oh my gosh, customers are contracting. There are a few and there are a few businesses and they’re spotty. It’s here and there where so many has a significant reduction in their business, and therefore, needs to reduce. But it’s – that’s not the situation. We’re talking about slow growth off of two very, very high-volume growth years with very high percentages of the installed base seat add. So it’s – part of it is going up against a couple of tough comparisons.
Unidentified Analyst
Great, helpful nuance. Thank you
Operator
Moving on now to Matt VanVliet at BTIG.
Matt VanVliet
Good evening guys. Thanks for taking the question. I guess on the international side, still showing a lot of strength there and some good progress. I guess, what additional investments do you expect to be making there? Should we plan on those moderating? Or is there still such a big opportunity that you’re going to continue to add headcount? And then kind of a second part of that, how much are you relying on channel partners and sort of other partnerships to further expand internationally relative to what you look like in the U.S.?
Mike Burkland
Yes. Matt, I’ll take the first part of that. International is an absolute strategic growth factor for us. It’s still early days in terms of our international expansion. That’s both channels and direct sales in terms of our go-to-market investments we mentioned earlier. It is – if you look at our growth in bookings over the last year, I think it was 78% increase in bookings internationally. It’s a tremendous growth vector for us. And we’ll continue to invest very similarly over the coming years. We’ve got a lot of headroom there.
Matt VanVliet
Thank you.
Mike Burkland
You got it.
Operator
We will move now to William Blair, Matt Stotler.
Matt Stotler
Hey everybody. I’ll echo the sentiments. Mike, good to see you again it’s been a while. And then, Rowan best of luck with what’s next to come and look forward to speaking with you again in the future. Maybe just one kind of double-clicking, Barry, on the thoughts on margins going forward. So we got the EPS guidance, it’s very helpful. In terms of how you’re thinking about, especially looking to 2023 and the levers do you have to pull there, what are kind of the puts and takes? And how do you expect to continue to recognize leverage going forward with the – obviously, you guys have been running at a healthy relative market to a lot of companies out there so far. But further levers there, how we should be thinking about that over the next year or so would be helpful? Thank you.
Barry Zwarenstein
Yes. Thanks, Matt. So let me first start with Q4. We – our 2022, what we’ve said is that we expect to be at 61% or more. And that’s a slight – involves a slight increase – a very slight increase from Q3 to Q4. I’d like to – if you don’t mind, we’re not in a position to give gross margin guidance for 2023, Matt, specifically. But let me make the following overarching comments and also talk a bit about the longer term.
The reason that we are now able to improve our margins is twofold. Given these mega deals that have come in across the world, we’ve had to have an extraordinary ramping of our professional services organization across the world into countries that we hadn’t been in before and with no revenue corresponding to that.
The other is the significant investment in terms of operations, particularly in the public cloud, to build extra capacity to accommodate the growth that we’re seeing there to go internationally with a fair degree of speed. And also an IVA’s [ph] initiative, which potentially, as Mike talked about in his prepared remarks, will allow us to go between the public cloud and our own data centers and maybe get some margin improvement there.
When you think though about our margins long term to get to that from the current approximately, say, 61% up to 70%-plus, you need to bifurcate the revenue into its three bucket because they’re very different drivers. 90% is Professional Services. Of the 91% that is recurring, you’ve got roughly – very roughly 80-20 subscription and usage.
Where we have in the past, and there’s no guarantees in business that we expect that in the future, we will continue to get the leverage against fixed and some fixed costs. We’ll maybe get the extra margin from the oscillation between our own data centers and public cloud. We certainly will expect to continue – well, we would strongly expect to continue to get the ARPU increases that we have been doing that are exposed to and have those margins improve.
On the usage, we don’t expect any major changes those margins are in 15 [ph] and then finally, on the Professional Services, which are – oscillate around breakeven typically, we can see that, like many other B2B companies, going into high single digits or maybe even low double digits over time.
Matt Stotler
Very helpful. Thank you.
Operator
We have a question now from Will Power at Baird.
Will Power
Okay, great. Thanks for sneaking me in a question probably for Barry, whoever wants to take it. I know you’ve talked about some of those pressures on seat expansion in the installed base. I wonder if you could talk about what you’re seeing from a usage standpoint. Has that been a source of pressure? What are the risks there in some of these hardened industries, 60%-plus of the business you referenced. And I guess kind of in tandem with that, would love to get any other perspective just on linearity on those broader trends through the quarter, installed base and/or usage and into October. Is there any sign of stabilization? Have you seen it continue to worsen? Just any comments there would be helpful, too. Thank you.
Barry Zwarenstein
Yes. So let me deal with the first one. It’s very simple and straightforward. If you exclude the pandemic period, where there was both ways. And so in one case, it was – in Q3 of 2021, the usage just – excuse me, Q3 of 2020, usage just took off because people work out to work in COVID. And there was enough agents and the big explosion. Conversely, a year later, the seats were expanding, and there were not enough agents, so the usage was.
But if you exclude pandemic, the rates of growth are very much similar with a slightly lower growth rate on the UC side. There’s no additional products. You can need speak something else today. There is even slight price declines. So a very normal trend aside from pandemic. In terms of the linearity, well, I’d love to be able to say to you that October is just great and things are looking better. We just are not in a position to do that. We’re telling it as we see it right now.
Will Power
Okay, thank you.
Operator
Moving on to Michael Turrin at Wells Fargo.
Michael Turrin
Hey there. Thanks, appreciate you taking the question and for sneaking on as well. Barry, appreciate some of the supplemental information you provided, the metrics, the drivers, the historical reminders around just prior context and guidance. Is there anything you can add just to help us compare and contrast how what you’re currently seeing compares to what you might have considered within previous framework? Does the macro add more uncertainty than you would have historically contemplated? Does the move towards enterprise and larger deals help with visibility relative to what this business looked like years ago when it was smaller? I think just everyone is kind of wondering what to do with the input, and your thought process would be incredibly valuable here. Thank you.
Barry Zwarenstein
Yes. Great question, Michael. It’s – to answer that, we’re going to again talk about the existing new logo business or the new logo business and then the installed base and maybe do a historical sort of perspective. In terms of the new logo, there’s no ifs and buts about it. We just have so many more levers to pull domestically and internationally by size.
And we’ve got arguably, and I welcome any argument on it, one of the best sales and marketing teams in the industry. And the market is strong, and we’ll continue to see the growth over there. And as I said actually in the prepared remarks on that side of the business, we have visibility and confidence, and the backlog is a good indication of that.
The other half of the annual and quarterly revenue growth approximately comes from the installed base. And there, it’s difficult to say. We were – with the benefit of hindsight, we underestimated the macro impact on certain of our verticals. At the time, we believed we were being prudent, as we always really try to be. But – and we – but based on what we knew at the time, that’s what we said. And we’re chasing by that, and we’ve certainly taken that into account, and we’ll see.
Michael Turrin
Thank you.
Mike Burkland
Thanks, Michael.
Operator
And ladies and gentlemen, unfortunately, that’s all the time we have for questions today. So let me hand things back over to Mike and the team for any additional comments.
Mike Burkland
Yes. In closing, I’ll just say it’s great to be back. It’s great to see many of you that I’ve known for a long time, and it’s – I look forward to reconnecting but also making new connections with many of you that are new to the story here over the last five years. But as I mentioned before, I just believe so strongly in the market opportunity ahead for Five9. I couldn’t be more optimistic about the future of this business in spite of the macro headwinds that are facing us in the near term. And I just want to thank you for joining the call today. Thank you.
Operator
Once again, thanks everyone for joining. That will conclude today’s call. Have a great day.
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