Five9, Inc. 2018 Form 10-K Summary
Business Context and Reporting Period
Five9 provides cloud-based contact-center software and related telephony services under a SaaS model. Its platform supports voice, chat, email, web, social-media and mobile interactions. The filing covers the fiscal year ended December 31, 2018, with comparisons to 2017 and 2016. The company reported more than 2,000 clients, over five billion annual call minutes and 983 full-time employees.
Key Financial Metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Revenue | $257.7 million | $200.2 million | 29% increase |
| Gross profit | $153.6 million | $117.1 million | 31% increase |
| Gross margin | 60% | 58% | Up 2 percentage points |
| Operating income (loss) | $7.0 million | $(5.7) million | Improved by $12.7 million |
| Net income (loss) | $(0.2) million | $(9.0) million | Loss narrowed by $8.7 million |
| Adjusted EBITDA | $46.4 million | $17.6 million | 164% increase |
| Cash flow from operations | $38.6 million | $11.1 million | Increase of $27.5 million |
Subscription and related usage revenue represented 93% of total revenue. Annual Dollar-Based Retention Rate improved to 103% from 98%. Approximately 93% of revenue was generated from U.S. billing addresses. No client represented more than 10% of revenue.
Fourth-quarter 2018 revenue was $72.3 million, gross profit was $44.0 million, operating income was $6.0 million and net income was $3.7 million. Fourth-quarter 2017 revenue was $55.4 million and net loss was $0.6 million.
Liquidity, Debt and Capital Resources
- Cash and cash equivalents were $81.9 million, and marketable investments were $209.9 million, for total cash, cash equivalents and investments of $291.8 million at December 31, 2018.
- Working capital was $286.0 million, compared with $53.3 million at December 31, 2017.
- Five9 issued $258.8 million of 0.125% convertible senior notes due May 1, 2023, receiving approximately $250.7 million of net proceeds. The notes had a net carrying value of $196.8 million at year-end.
- The former $50.0 million revolving credit facility was repaid and terminated in 2018.
- Capital expenditures were $9.3 million. Net cash used in investing activities was $216.7 million, primarily reflecting purchases of marketable investments.
- Management stated that existing cash and cash equivalents should be sufficient for working capital and capital expenditure needs for at least the next 12 months.
Material Changes Versus the Prior Comparable Period
- Revenue growth accelerated from 24% in 2017 to 29% in 2018, primarily from larger clients increasing agent seats.
- Gross margin increased to 60% from 58%, reflecting improved professional-services efficiency, subscription scale and usage efficiency.
- Operating results turned positive, although net income remained slightly negative because interest expense increased substantially after the convertible-note issuance.
- Interest expense increased to $10.2 million from $3.5 million, including $8.1 million related to the convertible senior notes.
- Research and development expense increased 26% to $34.2 million; management expected R&D spending to increase at a faster rate in 2019.
- Stock-based compensation increased to $28.5 million from $15.3 million and represented a significant adjustment to adjusted EBITDA.
- Adoption of ASC 606 and ASC 340-40 resulted in a $24.1 million reduction to opening accumulated deficit and capitalization of $30.9 million of deferred contract-acquisition costs at year-end. The adoption increased reported 2018 operating income by $8.4 million versus the amount that would have been reported under the prior standard, primarily because commissions were deferred and amortized over five years.
Outlook, Commentary, Risks and Unusual Items
Management expects to continue investing in sales and marketing, infrastructure, international expansion, research and development and new AI-enabled applications. It expects expenses to rise in absolute dollars while generally benefiting from scale, but specifically anticipated R&D expense to increase as a percentage of revenue in 2019. The filing does not provide a clear numerical revenue or earnings guidance range.
- The company remains exposed to intense competition from cloud and legacy contact-center vendors, including larger providers with greater resources.
- Client contracts can generally be changed or terminated with approximately 30 days’ notice, creating retention and revenue-visibility risk.
- Service outages, cybersecurity incidents, data breaches and failures by third-party telecommunications, data-center or public-cloud providers could result in client losses, credits, litigation or regulatory penalties. The filing discusses a 2017 client-information incident that management believes was remediated and whose costs were not material.
- Five9 has a history of annual losses and an accumulated deficit of $151.5 million. Continued profitability is not assured.
- The convertible notes create potential cash obligations, dilution risk and non-cash interest expense. Holders may require repurchase after a qualifying fundamental change, and conversion may require cash, shares or both.
- The company accrued $1.1 million for potential state and local sales taxes and surcharges and $0.9 million for disputed historical Universal Service Fund assessments. The related FCC review remained pending at year-end.
- International operations, GDPR and other privacy requirements, TCPA and telecommunications regulation, tax changes, foreign-currency movements and Brexit-related uncertainty remain material risks.
- Professional-services offerings typically carry negative margins, while usage revenue generally has lower margins than subscription revenue.
Important Facts for Investors to Verify
- Confirm the sustainability of positive operating income and the effect of convertible-note interest and non-cash amortization on future GAAP earnings.
- Evaluate whether 103% dollar-based retention and larger-client seat expansion continue, given the generally short termination notice period.
- Reconcile adjusted EBITDA to GAAP results, particularly the $28.5 million of stock-based compensation and other excluded items.
- Assess the effect of ASC 606 commission capitalization on reported margins, operating cash flow and future amortization expense.
- Review the $258.8 million note maturity, conversion terms, potential dilution and liquidity required for cash settlement or repurchase.
- Monitor pending USF assessments, sales-tax contingencies, indemnification obligations and the Melcher-related advancement and recovery claims.
- Verify service reliability, cybersecurity controls, third-party infrastructure dependence and the company’s ability to fund continued international and R&D expansion.