Five9, Inc. quarterly report, Q3 FY2017

Five9, Inc. — Form 10-Q Summary

Reporting period: Quarter and nine months ended September 30, 2017; filed November 8, 2017. Five9 provides cloud contact-center software through a SaaS model, serving more than 2,000 clients and facilitating more than three billion interactions annually.

Financial Results and Key Metrics

Metric	Q3 2017	Q3 2016	9M 2017	9M 2016
Revenue	$50.1 million	$41.0 million	$144.8 million	$117.9 million
Revenue growth	22%	—	23%	—
Gross profit	$29.6 million	$23.2 million	$84.1 million	$66.7 million
Gross margin	59%	57%	58%	57%
Operating income (loss)	$1.7 million	$(1.9) million	$(5.9) million	$(7.8) million
Net income (loss)	$0.9 million	$(3.9) million	$(8.3) million	$(12.3) million
Adjusted EBITDA	$5.2 million	$2.7 million	$10.8 million	$5.5 million
Net income (loss) per diluted share	$0.02	$(0.07)	$(0.15)	$(0.24)

Subscription and related usage fees represented 93% of Q3 revenue and 94% of nine-month revenue, compared with 96% and 95%, respectively, in the prior-year periods. Professional services comprised the remainder.
Operating expenses were $27.9 million in Q3 and $90.0 million for nine months. Sales and marketing increased 28% in Q3 and 29% for nine months, reflecting higher personnel, commissions, stock-based compensation and marketing costs.
Stock-based compensation was $3.7 million in Q3 and $10.7 million for nine months, compared with $2.5 million and $6.9 million, respectively, in the prior-year periods.
Adjusted EBITDA is a non-GAAP measure and includes add-backs for depreciation and amortization, stock-based compensation, interest, taxes and unusual items, including the legal settlement and reversal of federal-fee interest and penalties.

Cash Flow, Liquidity and Capital Structure

Cash and cash equivalents were $63.4 million at September 30, 2017, up from $58.1 million at December 31, 2016.
Net cash provided by operating activities was $8.2 million for the first nine months of 2017, compared with $4.0 million in the prior-year period.
Investing cash use was $1.8 million, primarily for property and equipment. Capital equipment obtained under capital leases totaled $7.5 million during the nine months.
Net cash used in financing activities was $1.2 million, including $5.7 million of capital-lease payments, partially offset by $5.1 million from option exercises and the employee stock purchase plan.
The company had $32.6 million outstanding under a revolving credit facility with $17.4 million available. The facility matures August 1, 2019, bears interest at prime plus 0.50%, and is secured by substantially all company assets.
The credit facility requires $25.0 million of unrestricted cash and compliance with a minimum liquidity ratio. Five9 reported compliance as of September 30, 2017.
Total debt had a net carrying value of $33.1 million, including the revolving facility and a $0.5 million FCC civil penalty payable. Capital lease obligations totaled $12.9 million.
Accumulated deficit was $174.8 million. The company has a history of losses despite reporting quarterly net income in Q3 2017.

Material Changes Versus the Prior Comparable Period

Revenue increased 22% in Q3 and 23% for the first nine months, primarily due to growth from larger clients and increased sales and marketing activity.
Gross margin improved by two percentage points in both comparison periods, reflecting subscription scale efficiencies and improved usage efficiency.
Q3 operating results improved to operating income of $1.7 million from an operating loss of $1.9 million. Nine-month operating loss narrowed to $5.9 million from $7.8 million.
Q3 net income benefited from the absence of the $1.0 million debt-extinguishment loss recorded in Q3 2016 and a $2.1 million reversal of accrued federal-fee interest and penalties.
Nine-month results included $1.7 million for the Melcher litigation settlement and $0.1 million of related legal and indemnification fees. The settlement was paid during the period.
Annual dollar-based retention declined to 98% from 100%, primarily because the prior-year period benefited from the ramp of one of the company’s largest customers.
Effective July 1, 2017, Five9 extended the estimated useful lives of certain data-center assets from three years to three-to-five years. The change reduced depreciation expense by $0.8 million for both the quarter and nine-month period and increased Q3 earnings per share by $0.02.
Shares outstanding increased to 55.6 million at September 30, 2017 from 53.4 million at December 31, 2016, reflecting equity exercises and employee share issuances.

Outlook, Commentary and Risks

Management expects continued investment in sales and marketing, research and development, infrastructure and headcount. Costs and operating expenses are expected to increase in absolute dollars, although management expects them to decline as a percentage of revenue over time.
Management stated that existing cash and available borrowing capacity should fund working capital and capital expenditure needs for at least the next 12 months, but future capital needs depend on growth, client retention, infrastructure spending, litigation and potential acquisitions.
Management does not provide a clear quantitative revenue or earnings forecast in the filing.
Five9 disclosed a suspected April 2017 security incident involving unlawful acquisition of some client information. The company believes the vulnerability was remediated, notified potentially affected clients, and stated that costs incurred to date were not material.
The company remains exposed to service outages, cybersecurity incidents, third-party telecommunications and data-center failures, competition, client churn, longer enterprise sales cycles and international expansion risks.
A remaining disputed Universal Service Fund assessment of approximately $0.8 million, including interest and penalties, remains subject to a pending FCC review. The company has accrued approximately $0.8 million, offset by $0.7 million in other USF credits.
Contingent state and local sales taxes and surcharges totaled $1.6 million at September 30, 2017. Actual liabilities could differ from estimates.
The NobelBiz patent litigation remains unresolved. Five9 believes it has strong defenses and has not accrued a loss; the potential high end of any loss cannot currently be estimated and could be material.
Five9 settled the Melcher litigation for $1.7 million and was removed as a defendant, but a former Face It officer separately sued for advancement of legal fees. The company disputes the claim.
Five9 plans to adopt the new revenue-recognition standard, Topic 606, on January 1, 2018 using a modified retrospective approach. Management expects no material impact on revenue timing but a material impact on commission-expense recognition.
The company expects to cease qualifying as an emerging growth company after fiscal 2017, increasing compliance costs, including costs related to auditor attestation of internal controls.

Important Facts for Investors to Verify

Whether revenue growth and gross-margin improvement continue after the benefit from larger-client expansion and the data-center depreciation estimate change.
Whether the company can sustain positive operating cash flow and quarterly profitability while continuing elevated sales, marketing, research and infrastructure investment.
The effect of the 2018 Topic 606 adoption on commission expense, reported earnings and comparability.
Progress on the remaining USF assessment, contingent sales-tax liabilities and the NobelBiz patent litigation.
Use of the $17.4 million revolving-credit availability, compliance with liquidity covenants and the ability to refinance or repay the $32.6 million facility at maturity.
Consequences of the disclosed security incident, including any additional claims, remediation costs, regulatory action or client attrition.
Annual dollar-based retention and client concentration trends, particularly among larger customers with significant implementation and expansion potential.