Five9, Inc. — Q1 2017 Form 10-Q Summary
Business Context and Reporting Period
Five9 provides cloud software for contact centers through a SaaS model, including subscriptions, telephony usage, and professional services. The filing covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016. Five9 reported more than 2,000 clients and approximately 807 employees at March 31, 2017.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Revenue | $47.0 million | $38.0 million | +24% |
| Gross profit | $27.0 million | $21.4 million | +26% |
| Gross margin | 58% | 56% | +2 percentage points |
| Loss from operations | $(4.4) million | $(3.6) million | Loss increased |
| Net loss | $(5.3) million | $(4.9) million | Loss increased |
| Net loss per share | $(0.10) | $(0.10) | No change |
| Adjusted EBITDA | $2.6 million | $0.5 million | Improved |
| Cash flow from operations | $0.2 million | $0.1 million | Improved |
Subscription and related usage revenue represented 94% of total revenue, versus 95% in the prior-year quarter. Annual dollar-based retention increased to 99% from 98%, primarily because larger clients added agent seats. No single client represented more than 10% of revenue.
Operating expenses were $31.5 million, or 67% of revenue, compared with $25.0 million, or 66%, in Q1 2016. Research and development increased 18% to $6.8 million, sales and marketing increased 24% to $15.8 million, and general and administrative expense increased 36% to $8.9 million. Stock-based compensation rose to $3.1 million from $2.0 million.
Cash and cash equivalents were $56.5 million at March 31, 2017, down from $58.1 million at December 31, 2016. Cash used in investing activities was $0.5 million, primarily for property and equipment. Cash used in financing activities was $1.3 million, principally capital lease payments and debt repayments, partially offset by $0.8 million from stock option exercises.
Debt, Liquidity, and Capital Resources
Five9 had $32.6 million outstanding under a secured revolving credit facility with total capacity of $50.0 million and $17.4 million available for additional borrowing. The facility matures in August 2019, bears interest at prime plus 0.50%, and includes a potential 0.25 percentage-point increase if adjusted EBITDA is negative at quarter-end. The facility requires at least $25.0 million of unrestricted cash and includes other financial and operating covenants. Five9 was in compliance at March 31, 2017.
Total debt, net of discounts, was $33.4 million, excluding capital lease obligations. The company also had $0.8 million remaining on an FCC civil penalty payable. Management stated that cash and available borrowing capacity should be sufficient for working capital and capital expenditure needs through at least March 31, 2018, but noted that weaker operating performance or additional litigation, regulatory, or growth-related expenditures could adversely affect liquidity.
Material Changes and Unusual Items
- Revenue growth was driven primarily by larger clients, increased sales and marketing activity, improved brand awareness, and larger average deal sizes.
- Gross margin improved due to subscription scale benefits, usage efficiencies, and improved professional-services pricing and efficiency.
- General and administrative expense included $1.7 million for settlement of the Melcher litigation and $0.1 million of related legal and indemnification fees. The settlement was reached March 31, 2017 and required a one-time payment of $1.7 million.
- Adjusted EBITDA improved to $2.6 million, but this measure excludes the Melcher settlement and related fees, as well as depreciation, stock compensation, interest, taxes, and other items.
- The company adopted ASU 2016-09 for stock-based compensation accounting. The adoption reduced accumulated deficit by approximately $0.2 million and had no material net impact because related deferred tax assets were fully offset by a valuation allowance.
- In January 2017, the FCC Wireline Bureau ruled in Five9’s favor regarding the principal portion of certain 2008–2012 Universal Service Fund assessments, resulting in a $3.1 million reversal to cost of revenue. Disputes concerning interest, penalties, and other periods remain unresolved.
Outlook, Risks, and Contingencies
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, while declining as a percentage of revenue over time if scale benefits are achieved. The filing does not provide formal revenue or earnings guidance.
- In April 2017, Five9 was notified that third parties were suspected of unlawfully acquiring some client information. The company believes a vulnerability caused the incident and stated that it had been remediated. Impacted clients were notified; further expenses or losses could not yet be estimated. Insurance is likely to apply.
- The NobelBiz patent litigation remains pending and was stayed pending an appeal in related cases. Five9 believes it has strong defenses, has not accrued a loss, and cannot reasonably estimate the high end of potential exposure.
- Five9 has a $2.7 million accrued liability for disputed USF contributions and estimated interest and penalties. Pending FCC reviews could result in additional payments.
- Accrued state and local sales tax and surcharge contingencies totaled $1.9 million at March 31, 2017.
- The company has a history of losses, an accumulated deficit of $171.7 million, and expects losses to continue for the foreseeable future.
- Key operating risks include client retention and seat reductions, competition, longer enterprise sales cycles, service outages, dependence on third-party telecommunications and data-center providers, cybersecurity, regulatory compliance, international operations, litigation, and the ability to obtain additional financing.
- Five9’s contracts generally permit clients to change agent seats or effectively terminate with 30 days’ notice, increasing revenue and retention sensitivity.
- The company plans to adopt the new revenue recognition standard, Topic 606, on January 1, 2018. It had not yet selected a transition method and stated that its assessment had not identified a likely material impact.
Facts Investors Should Verify
- Whether revenue growth and 99% dollar-based retention are sustained, particularly among larger clients.
- Whether gross-margin expansion continues as usage, telecommunications, infrastructure, and professional-services costs grow.
- Whether adjusted EBITDA converts into consistently positive operating cash flow without relying on working-capital changes or excluding recurring compensation costs.
- The effect, if any, of the April 2017 client-information security incident, including remediation costs, insurance recoveries, regulatory actions, litigation, and client attrition.
- The ultimate resolution and cash cost of the NobelBiz litigation, disputed USF assessments, sales-tax contingencies, and other regulatory matters.
- Liquidity relative to the $32.6 million secured revolving debt balance, capital lease obligations, covenant requirements, and the company’s continuing operating losses.
- The impact of stock-based compensation, dilution from equity awards, and approximately 7.7 million potentially dilutive securities excluded from Q1 loss-per-share calculations.