Five9, Inc. 2019 Q3 Form 10-Q Summary
Business Context and Reporting Period
Five9 provides cloud software for contact centers, including voice, chat, email, web, social media and mobile capabilities. The company serves more than 2,000 clients and generates revenue primarily from recurring subscriptions and related telephony usage. This quarterly report covers the three and nine months ended September 30, 2019, compared with the corresponding 2018 periods.
Financial Performance and Liquidity
| Metric | Q3 2019 | Q3 2018 | Change |
|---|---|---|---|
| Revenue | $83.8 million | $65.3 million | 28% |
| Gross profit | $49.3 million | $39.1 million | 26% |
| Gross margin | 59% | 60% | Down 1 percentage point |
| Income from operations | $0.5 million | $1.0 million | Down $0.5 million |
| Net loss | $1.6 million | $1.3 million | Loss increased $0.3 million |
| Adjusted EBITDA | $15.0 million | $12.8 million | 18% |
| Net loss per share | $0.03 | $0.02 | Loss increased |
| Metric | Nine Months 2019 | Nine Months 2018 | Change |
|---|---|---|---|
| Revenue | $235.7 million | $185.3 million | 27% |
| Gross profit | $139.2 million | $109.6 million | 27% |
| Gross margin | 59% | 59% | Flat |
| Income from operations | $0.2 million | $1.0 million | Down $0.8 million |
| Net loss | $5.4 million | $4.0 million | Loss increased $1.4 million |
| Adjusted EBITDA | $41.3 million | $29.9 million | 38% |
| Net loss per share | $0.09 | $0.07 | Loss increased |
Subscription and related usage fees represented 91% of third-quarter revenue and 92% of nine-month revenue. Annual dollar-based retention increased to 107% for the twelve months ended September 30, 2019, compared with 101% in the prior comparable period, primarily because larger clients increased agent seats.
Operating cash flow for the first nine months was $35.7 million, compared with $23.2 million in 2018. Capital expenditures were $12.8 million. Cash and cash equivalents increased to $120.6 million from $81.9 million at December 31, 2018, while marketable investments totaled $200.4 million. Working capital was $313.8 million.
At September 30, 2019, the company had $258.8 million principal amount of 0.125% convertible senior notes due May 1, 2023, recorded at a net carrying amount of $206.3 million. The notes’ estimated fair value was $373.8 million. The notes became convertible during October through December 2019 because the stock-price conversion condition was met; no conversion requests had been received as of November 5, 2019.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven primarily by larger clients, increased sales and marketing activity and improved brand awareness.
- Sales and marketing expense increased 40% in the quarter and 31% for the nine-month period, reflecting higher headcount, stock-based compensation, commissions and growth initiatives.
- Research and development expense increased 22% in the quarter and 28% year to date, primarily due to personnel costs.
- Gross margin declined modestly in the quarter because professional services revenue grew faster and carries lower margins; nine-month gross margin was unchanged.
- Net losses increased despite revenue growth, principally reflecting continued investment and higher interest expense associated with the convertible notes.
- Operating cash flow improved substantially, while 2018 investing and financing cash flows had been affected by the convertible-note issuance and related transactions.
- The company adopted ASC 842 on January 1, 2019, recognizing $8.9 million of operating lease right-of-use assets and $9.5 million of operating lease liabilities at September 30, 2019. The adoption did not affect operating results or cash flows.
- Stock-based compensation increased to $11.1 million in the quarter and $30.2 million for the first nine months, from $8.9 million and $21.0 million, respectively.
Outlook, Commentary, Risks and Unusual Items
Management expects to continue investing in sales and marketing, research and development, infrastructure and personnel. It expects cost of revenue and operating expenses to rise in absolute dollars, while certain costs may decline as a percentage of revenue as the business scales. The filing does not provide a formal revenue, earnings or margin forecast.
Management believes existing cash and cash equivalents will be sufficient for working capital and capital expenditures for at least the next twelve months. Future capital needs may depend on growth, client retention, sales expansion, product development, litigation, acquisitions and market acceptance. Additional financing may be unavailable or unfavorable.
Key risks include client attrition or reduced usage, competition, long enterprise sales and implementation cycles, service outages, dependence on telecommunications and internet providers, cybersecurity incidents, rapid technological change, difficulty managing growth, continued losses and the ability to service or repay the convertible notes.
The company recorded approximately $1.4 million of legal and indemnification fees and settlement contributions related to the Melcher litigation, including a $0.4 million settlement contribution. The litigation and related arbitration were dismissed, and management does not expect the remaining legal matters to have a material impact, although adverse outcomes could affect a future period.
Hosting and telecommunications commitments totaled $6.1 million for terms of up to 36 months. The company reported no off-balance-sheet arrangements and no material changes to previously disclosed risk factors.
Important Facts for Investors to Verify
- Whether revenue growth from larger clients and the 107% dollar-based retention rate remain sustainable.
- Whether continued sales, marketing, research and development and infrastructure spending converts into operating leverage and GAAP profitability.
- The effect of professional services mix, telecommunications costs, data-center investment and regulatory fees on future gross margins.
- The potential dilution, cash settlement requirements or refinancing needs associated with the $258.8 million convertible notes due in 2023.
- Whether cash, marketable investments and operating cash flow remain sufficient under lower-growth or higher-spending scenarios.
- Future stock-based compensation and its effect on reported expenses, adjusted EBITDA and shareholder dilution.
- Exposure to cybersecurity, service availability, third-party telecommunications, client concentration and enterprise implementation risks.
- Any developments related to the company’s legal matters, contractual commitments or future financing requirements.