Five9, Inc. — Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2018; filed August 6, 2018. Five9 provides cloud contact-center software and related subscription, telephony usage, and professional services to more than 2,000 clients. No client represented more than 10% of revenue.
Financial Performance and Liquidity
| Metric | Q2 2018 | Q2 2017 | Six Months 2018 | Six Months 2017 |
|---|---|---|---|---|
| Revenue | $61.1 million | $47.7 million | $120.0 million | $94.7 million |
| Revenue growth | 28% | — | 27% | — |
| Gross profit | $36.3 million | $27.5 million | $70.5 million | $54.5 million |
| Gross margin | 59% | 58% | 59% | 58% |
| Operating income (loss) | $0.2 million | $(3.2) million | $0.04 million | $(7.6) million |
| Net loss | $(2.0) million | $(4.0) million | $(2.6) million | $(9.3) million |
| Net loss per share | $(0.04) | $(0.07) | $(0.05) | $(0.17) |
| Adjusted EBITDA | $9.7 million | $3.0 million | $17.2 million | $5.6 million |
| Cash flow from operations | — | — | $13.7 million | $0.2 million |
Subscription and related usage revenue represented 93% of revenue in both the quarter and year-to-date periods, compared with 94% in the prior-year periods. Revenue growth was primarily attributed to larger clients, increased sales and marketing activity, and improved brand awareness.
Operating expenses were $36.1 million in the quarter and $70.5 million year to date. Sales and marketing expense declined to 29% of revenue from 35% in the prior-year quarter, principally because ASC 606 deferred a significant portion of sales commissions. Stock-based compensation increased to $6.8 million in the quarter and $12.1 million year to date, compared with $3.9 million and $7.0 million, respectively.
At June 30, 2018, cash and cash equivalents were $166.2 million and marketable investments were $108.1 million, for total cash and marketable securities of approximately $274.3 million. Working capital was $266.3 million. Net cash increased $97.2 million during the first six months, primarily from convertible-note financing.
Debt and Financing
- In May 2018, Five9 issued $258.8 million aggregate principal amount of 0.125% convertible senior notes due May 1, 2023, generating approximately $250.7 million of net proceeds.
- The notes had a net carrying value of $190.6 million at June 30, 2018 because of the separately recorded conversion-option equity component and debt issuance discounts. Their estimated fair value was $269.7 million.
- The initial conversion price was approximately $40.82 per share. Capped calls covering approximately 6.3 million shares, with an initial cap price of $62.80, cost $31.4 million and are intended to reduce dilution and excess cash settlement exposure.
- The prior $50.0 million revolving credit facility was repaid in May and terminated July 1, 2018. The facility required a $25.0 million unrestricted cash compensating balance while outstanding.
Material Changes Versus the Prior Comparable Period
- Revenue increased 28% in the quarter and 27% year to date, while gross margin improved by approximately one percentage point to 59%.
- Operating results improved from losses to approximately break-even at the operating-income level, and net losses narrowed materially.
- Operating cash flow increased to $13.7 million from $0.2 million, although the improvement included substantial non-cash stock compensation and convertible-note discount amortization.
- Five9 adopted ASC 606 and ASC 340-40 on January 1, 2018 using the modified retrospective method. The adoption reduced opening accumulated deficit by $24.1 million, primarily due to capitalization of $23.1 million of contract commissions.
- For the six months, ASC 606 increased reported revenue by $1.1 million and reduced sales and marketing expense by $3.3 million versus results calculated under the prior standard, increasing operating income by $4.0 million. Operating cash flow was unchanged, but deferred contract acquisition costs increased cash usage by $3.3 million.
- Annual dollar-based retention improved to 99% from 98%, primarily because larger clients increased agent seats.
Outlook, Commentary, Risks, and Unusual Items
Management expects continued investment in sales and marketing, research and development, infrastructure, and headcount. It expects cost of revenue and operating expenses to increase in absolute dollars but decline as a percentage of revenue as the business scales. Management stated that existing cash and cash equivalents should be sufficient for working capital and capital expenditures for at least the next 12 months; no formal revenue or earnings guidance is presented in the filing.
- Five9 continues to report a history of losses and had an accumulated deficit of $153.9 million at June 30, 2018. Management expects losses may continue as it invests for growth.
- Revenue contracts can generally be reduced or effectively terminated on 30 days’ notice, increasing exposure to client churn, seat reductions, and usage volatility.
- Key operating risks include competition, longer sales cycles for larger clients, service outages, cybersecurity incidents, reliance on third-party telecommunications and data-center providers, international expansion, and rapid technological change.
- The June 2018 repeal of U.S. net-neutrality rules may permit internet service providers to impair, degrade, or increase the cost of access to Five9’s services.
- Five9 faces regulatory and tax contingencies, including approximately $0.8 million of disputed historical USF assessments and $1.3 million of accrued state and local tax and surcharge liabilities. The FCC civil penalty was fully paid by June 30, 2018.
- The company must comply with the EU GDPR and expects continuing compliance costs and potential exposure to significant penalties. It also identifies the California Consumer Privacy Act, effective January 1, 2020, as a future compliance consideration.
- The company is advancing legal fees for a former Face It officer in the Melcher litigation. The arbitrator ordered advancement, while Five9 disputes the claimed amount and is pursuing potential recovery from former Face It stockholders.
- The filing identifies potential dilution and liquidity risk from conversion or cash settlement of the convertible notes, including potential cash repurchase obligations following a fundamental change.
Important Facts for Investors to Verify
- Whether revenue growth and the 99% annual dollar-based retention rate continue, particularly among larger clients.
- The extent to which improved profitability reflects sustainable operating leverage versus ASC 606 commission deferral, stock-based compensation, and other non-cash adjustments.
- Future cash generation relative to the $258.8 million principal maturity of the convertible notes in 2023 and potential conversion or repurchase obligations.
- Client churn, agent-seat expansion, usage trends, professional-services margins, and the effect of short termination periods.
- Resolution of the disputed $0.8 million USF assessment, state and local tax contingencies, and the Melcher-related indemnification dispute.
- Compliance costs and potential liability associated with GDPR, CCPA, FCC requirements, telecommunications taxes, and cybersecurity events.