Five9, Inc. — Fiscal 2017 Form 10-K Summary
Business context and reporting period
Five9 provides cloud-based contact-center software and related telephony through a SaaS model. Its platform supports voice, chat, email, web, social media and mobile interactions. The filing covers the fiscal year ended December 31, 2017, with comparative results for 2016 and 2015. Five9 operated as one reportable segment and served more than 2,000 clients; no client represented more than 10% of annual revenue.
For the fourth quarter of 2017, revenue was $55.4 million, gross profit was $33.0 million, operating income was $0.2 million and net loss was $0.6 million. The filing reports quarterly information as unaudited.
Financial performance and liquidity
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Revenue | $200.2 million | $162.1 million | 24% |
| Gross profit | $117.1 million | $95.2 million | 23% |
| Gross margin | 58% | 59% | Down 1 percentage point |
| Loss from operations | $(5.7) million | $(6.5) million | Improved $0.8 million |
| Net loss | $(9.0) million | $(11.9) million | Improved $2.9 million |
| Adjusted EBITDA | $17.6 million | $8.4 million | Improved $9.3 million |
| Operating cash flow | $11.1 million | $6.8 million | Improved $4.3 million |
- Subscription and related usage revenue represented 94% of 2017 revenue; professional services comprised the remainder.
- Annual Dollar-Based Retention Rate was 98%, compared with 100% in 2016 and 96% in 2015. Management attributed the 2017 decline partly to the prior-year ramp of a large customer.
- Sales and marketing expense increased 26% to $66.6 million; research and development increased 14% to $27.1 million; general and administrative expense increased 16% to $29.2 million.
- Stock-based compensation rose to $15.3 million from $9.6 million, including approximately $1.0 million of incremental expense associated with modification of a former executive’s awards.
- Cash and cash equivalents were $68.9 million at year-end, including $25.0 million required to be maintained with lenders under the credit agreement. Working capital was $53.3 million.
- Debt included $32.6 million outstanding under a revolving credit facility, plus approximately $0.3 million related to the FCC civil penalty. The facility had $17.4 million available and matures August 1, 2019.
- Total debt and capital leases were $46.7 million. Contractual obligations totaled $62.7 million, including debt, capital leases, operating leases, hosting, telecommunications and maintenance commitments.
Material changes versus prior comparable periods
- Revenue growth accelerated the business to $200.2 million from $162.1 million, primarily due to larger clients, expanded sales and marketing activity and improved brand awareness.
- Net losses narrowed for the second consecutive year, from $25.8 million in 2015 to $11.9 million in 2016 and $9.0 million in 2017.
- Operating cash flow remained positive and increased to $11.1 million, although working-capital changes were a cash headwind, particularly higher accounts receivable and prepaid expenses.
- Gross margin declined modestly because of higher personnel and stock-based compensation costs. The comparison was also affected by a $3.1 million favorable reversal of accrued USF charges recorded in 2016.
- Interest expense declined to $3.5 million from $4.2 million, and 2017 did not include the $1.0 million debt-extinguishment loss recorded in 2016.
- U.S. clients generated 94% of revenue in 2017, while international revenue increased to $11.9 million from $10.6 million.
- Headcount increased from 780 to 860 employees, reflecting continued investment in growth and infrastructure.
Guidance, outlook, commentary, risks and unusual items
- Management expected revenue and operating expenses to continue increasing in absolute dollars as Five9 invested in sales, marketing, research and development, infrastructure and international expansion. It expected expenses to decline as a percentage of revenue over time, but also expected losses to continue for the foreseeable future.
- Management believed cash, cash equivalents and available borrowing capacity would fund working-capital and capital-expenditure requirements for at least the next 12 months, subject to operating performance and other capital needs.
- Adoption of ASC 606 on January 1, 2018 was not expected to materially affect revenue recognition or timing. However, sales commissions were expected to be capitalized and amortized over an estimated five-year benefit period, reducing reported 2018 sales and marketing expense by approximately $5 million to $7 million and increasing accumulated deficit by an estimated $18 million to $28 million at adoption.
- Five9 settled the Melcher litigation for a one-time payment of $1.7 million and incurred $1.8 million of related settlement, legal and indemnification cash payments in 2017. The NobelBiz patent litigation was dismissed after settlement in December 2017.
- A remaining USF-related dispute of approximately $0.8 million, including interest and penalties, remained subject to an FCC appeal. The company also carried approximately $1.5 million of accrued contingent state and local tax liabilities.
- In April 2017, Five9 identified suspected unauthorized acquisition of certain client information, believed to result from a remediated vulnerability. Expenses incurred to date were not material, but future litigation, regulatory and reputational exposure remained possible.
- The CEO resigned for health reasons effective December 2, 2017. The CFO became Interim CEO, the EVP of Global Sales and Services became President, and a CEO search was underway.
- Principal risks include continuing losses and accumulated deficit, competition, short client termination periods, service outages, cybersecurity and data privacy, reliance on third-party telecommunications and data-center providers, regulatory and tax compliance, international expansion, debt covenants, sales execution and dependence on key personnel.
Investor verification points
- Verify whether revenue growth, 98% dollar-based retention and larger-client expansion continued after 2017, and assess concentration and renewal trends.
- Reconcile adjusted EBITDA to GAAP net loss and distinguish recurring operating performance from stock compensation, legal settlements and USF-related reversals.
- Monitor cash consumption, the $32.6 million revolving balance, the $25.0 million restricted liquidity requirement and the August 2019 maturity.
- Assess the actual impact of ASC 606 and commission capitalization on reported expenses, accumulated deficit, cash flow and comparability.
- Track the remaining USF and state-tax contingencies, the Fried indemnification arbitration, and any consequences from the 2017 security incident.
- Evaluate management execution following the CEO transition and the company’s ability to achieve sustainable GAAP profitability.