Five9, Inc. — Q3 2014 Form 10-Q Summary
Business Context and Reporting Period
Five9 provides cloud contact center software, including voice, chat, email, web, social media and mobile functionality. The filing covers the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods. Five9 reported more than 2,000 clients and 586 employees worldwide at September 30, 2014.
The company completed its initial public offering in April 2014, selling 11.5 million shares at $7.00 per share and receiving $71.5 million of net proceeds after offering costs reflected in cash flows.
Key Financial Metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Revenue | $25.9 million | $21.1 million | $74.8 million | $60.5 million |
| Revenue growth | 23% | — | 24% | — |
| Gross profit | $12.4 million | $8.8 million | $34.7 million | $24.3 million |
| Gross margin | 48% | 42% | 46% | 40% |
| Loss from operations | $(10.4) million | $(6.8) million | $(27.2) million | $(20.8) million |
| Net loss | $(11.4) million | $(7.7) million | $(28.4) million | $(22.7) million |
| Adjusted EBITDA | $(5.0) million | $(5.3) million | $(18.3) million | $(16.9) million |
| Basic and diluted loss per share | $(0.24) | $(2.05) | $(0.84) | $(6.19) |
Subscription and related usage fees represented 97% of revenue. The company reported a 97% dollar-based retention rate for the twelve months ended September 30, 2014, compared with 102% in the prior comparable period.
Operating expenses increased to $22.8 million in Q3 and $61.9 million for the first nine months, representing 88% and 82% of revenue, respectively. Sales and marketing, research and development, and general and administrative expenses all increased, principally due to headcount, growth initiatives, infrastructure investment, public-company costs and stock-based compensation.
Cash Flow, Liquidity and Debt
- Cash used in operating activities was $20.8 million for the first nine months of 2014, compared with $15.4 million in the prior-year period.
- Investing activities used $30.5 million, primarily reflecting $30.0 million invested in short-term U.S. Treasury bills and $0.5 million of capital expenditures.
- Financing activities provided $87.0 million, including $71.5 million of IPO proceeds and $19.6 million of net proceeds from a term loan.
- Cash and cash equivalents were $53.5 million, and short-term investments were $30.0 million, for total cash and short-term investments of $83.5 million at September 30, 2014.
- Net carrying value of total debt was $39.1 million, including a $12.5 million revolving line of credit, $20.0 million drawn under the 2014 term loan facility and approximately $2.9 million owed to USAC, net of debt discounts. Capital lease liabilities totaled approximately $9.5 million.
- The $12.5 million revolving line of credit matured in March 2015. The 2014 term loan facility had $10.0 million of additional borrowing capacity available through February 2015, subject to compliance with its terms.
Management stated that existing cash, short-term investments and available borrowing capacity were expected to fund working capital and capital expenditures at least through September 30, 2015. The company also stated that additional financing might be required depending on growth, spending, acquisitions and operating performance.
Material Changes Versus the Prior Comparable Period
- Revenue increased 23% in Q3 and 24% for the first nine months, driven primarily by new clients; new clients accounted for approximately 93% of Q3 revenue growth and 63% of nine-month growth.
- Gross margin improved by six percentage points in both the quarter and nine-month period, reflecting improved usage efficiencies and economies of scale.
- Despite revenue and gross-margin growth, operating loss and net loss widened because operating expenses grew faster than revenue. Q3 sales and marketing expense increased 33%, research and development increased 25%, and general and administrative expense increased 89%.
- Interest expense increased substantially because of higher average debt balances.
- Dollar-based retention declined to 97% from 102%, attributed partly to lower usage from one client amid competitive international calling prices and the termination of a large financially troubled client in 2013.
- The IPO converted all outstanding convertible preferred stock into common stock and reclassified warrant liabilities to additional paid-in capital.
- A $2.8 million contingent state sales-tax liability was reversed in the second quarter after a favorable state ruling, while a $2.0 million FCC settlement charge was recorded in Q3.
Outlook, Risks, Contingencies and Unusual Items
Management did not provide formal revenue or earnings guidance in the filing. It expected continued investment in sales and marketing, research and development, infrastructure, international operations, client support and public-company functions, with operating expenses and cash usage expected to remain significant. Management also expected losses to continue for the foreseeable future.
- FCC and USF matters: Five9 accrued $4.4 million for unpaid USF contributions, interest and penalties, in addition to a $2.9 million USAC promissory note. In October 2014, the company tentatively agreed with the FCC Enforcement Bureau on a $2.0 million civil penalty, payable over approximately 36 months, subject to a consent decree.
- Additional regulatory exposure: Potential back assessments for 2003–2007 remained unresolved, and the company was seeking credit or recovery for up to $3.1 million of prior indirect USF payments.
- Patent litigation: NobelBiz alleges infringement of two related patents. Claim construction occurred in August 2014, with the court’s order pending; no loss was accrued because management did not believe a loss was probable.
- Service outage: A March 2014 outage at the Santa Clara colocation facility resulted in client service credits but did not materially affect reported revenue.
- Business model risk: Many clients can reduce agent seats or effectively terminate with 30 days’ notice, making retention and usage trends important.
- Infrastructure and third-party dependency: Service availability depends on third-party telecommunications providers and data centers. Future outages, security breaches or capacity constraints could result in credits, damages, lost clients and reputational harm.
- Profitability and financing: The company had an accumulated deficit of $119.2 million and continued negative operating cash flow. Debt is secured by substantially all assets and subject to covenants, including a $5.5 million cash requirement under the revolving credit agreement.
Important Facts for Investors to Verify
- Whether revenue growth and improved gross margins can continue while sales, marketing, research and development and public-company costs expand.
- Trends in dollar-based retention, usage revenue, client additions, agent seats and pricing, particularly given the 97% retention rate.
- The final FCC consent decree, civil penalty terms and any additional USF assessments for earlier periods.
- The March 2015 revolving-credit maturity and the company’s ability to refinance or repay it without materially reducing liquidity.
- Operating cash burn, debt service requirements and whether management’s liquidity projection through September 2015 remains reasonable.
- The status and potential exposure from the NobelBiz patent litigation.
- Reliability of third-party data centers and telecommunications providers following the March 2014 service interruption.
- Potential dilution from outstanding options, restricted stock units, warrants and employee equity plans; approximately 13.9 million shares were reserved for future issuance at September 30, 2014.