Five9, Inc. — Form 10-Q Summary
Business context and reporting period
Five9 provides cloud-based contact-center software and related telephony usage through a SaaS model. The filing covers the three and nine months ended September 30, 2018, compared with the corresponding 2017 periods. The company served more than 2,000 clients and facilitated more than three billion interactions annually. Subscription and related usage fees represented 93% of revenue in both the quarter and nine-month period.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Revenue | $65.3 million | $50.1 million | $185.3 million | $144.8 million |
| Revenue growth | 30% | — | 28% | — |
| Gross profit | $39.1 million | $29.6 million | $109.6 million | $84.1 million |
| Gross margin | 60% | 59% | 59% | 58% |
| Operating income (loss) | $1.0 million | $1.7 million | $1.0 million | $(5.9) million |
| Net income (loss) | $(1.3) million | $0.9 million | $(4.0) million | $(8.3) million |
| Adjusted EBITDA | $12.8 million | $5.2 million | $29.9 million | $10.8 million |
| Operating cash flow | Not separately provided | Not separately provided | $23.2 million | $8.2 million |
As of September 30, 2018, cash and cash equivalents were $79.6 million and marketable investments were $200.0 million, providing $279.6 million of cash and investments. Reported working capital was $274.1 million. Total assets were $376.1 million and stockholders’ equity was $127.9 million.
The company had $258.8 million principal amount of 0.125% convertible senior notes due May 1, 2023, carried at a net amount of $193.7 million. It also had $13.2 million of capital lease obligations and no borrowings under its former $50 million revolving credit facility, which was repaid and terminated in 2018. Interest expense increased substantially because of the convertible notes and related non-cash discount amortization.
Material changes versus the prior comparable period
- Revenue increased 30% in the quarter and 28% year to date, primarily due to larger clients adding agent seats.
- Gross margin improved by approximately one percentage point in both periods, reflecting professional-services efficiencies, subscription scale benefits and improved usage economics.
- Operating income was positive for the nine-month period compared with an operating loss in 2017, but quarterly operating income declined because research and development and general and administrative costs increased.
- Net loss widened in the third quarter because higher operating costs and convertible-note interest more than offset revenue growth. The nine-month net loss narrowed year over year.
- Research and development expense rose 43% in the quarter and 26% year to date. General and administrative expense rose 130% in the quarter and 46% year to date, primarily due to higher stock-based compensation and personnel costs.
- Sales and marketing expense increased only 8% in both periods, partly because ASC 606 deferred a significant portion of sales commissions instead of expensing them immediately.
- Operating cash flow increased to $23.2 million from $8.2 million. The improvement included $21.0 million of stock-based compensation, $7.4 million of depreciation and amortization, and $4.8 million of non-cash convertible-note discount and issuance-cost amortization.
- Investing cash flow was $(202.5) million, primarily because the company invested $204.0 million in marketable securities. Financing cash flow was $190.0 million, principally from the convertible-note issuance.
Accounting, outlook, risks and unusual items
- The company adopted ASC 606 and ASC 340-40 on January 1, 2018 using the modified retrospective method. The adoption increased opening accumulated deficit by $24.1 million, primarily because $23.1 million of contract commissions were deferred and amortized over five years. It had no material effect on reported revenue timing but materially reduced current sales and marketing expense.
- Deferred contract acquisition costs were $28.2 million at September 30, 2018. Remaining performance obligations for contracts longer than one year were $93.4 million, with approximately three-quarters expected to be recognized over the next 24 months.
- Management expects operating expenses and cost of revenue to increase in absolute dollars as it expands headcount, infrastructure, sales and marketing, and product development. It expects these costs to decline as a percentage of revenue over time, but also states that losses may continue for the foreseeable future. No specific revenue or earnings guidance is provided in the filing.
- Annual dollar-based retention improved to 101% from 98%, primarily because larger clients increased agent seats.
- Stock-based compensation was $21.0 million year to date, compared with $10.7 million in 2017. Third-quarter research and development expense included an incremental charge related to modification of certain awards of a former executive.
- The company believes existing cash and cash equivalents will meet working-capital and capital-expenditure needs for at least the next 12 months. Future capital needs depend on growth, infrastructure investment, litigation, client retention, acquisitions and financing conditions.
- Key risks include client churn or seat reductions, intense competition, longer sales cycles for large clients, service outages, cybersecurity and data-privacy incidents, reliance on telecommunications and data-center providers, regulatory and tax liabilities, international operations, and continuing losses.
- 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 also faces contingent state and local tax liabilities of approximately $1.3 million.
- The convertible notes may require cash settlement or repurchase upon specified events and could dilute shareholders if converted. The capped calls cover approximately 6.3 million shares and are intended to reduce potential dilution up to a $62.80 cap price.
Most important facts for investors to verify
- Whether revenue growth and the 101% dollar-based retention rate continue, particularly among larger clients.
- Whether ASC 606-related commission deferrals create a sustainable improvement in reported margins or primarily shift expense into future periods.
- The effect of elevated stock-based compensation and non-cash convertible-note amortization on GAAP profitability and shareholder dilution.
- Cash generation relative to planned infrastructure, hiring and capital expenditures, and the company’s ability to meet or refinance the $258.8 million note principal due in 2023.
- The status and ultimate cost of the disputed USF assessment, state and local tax contingencies, and ongoing legal matters.
- Exposure to cybersecurity, service availability, third-party telecommunications, data-center, privacy and regulatory risks.