2023-05-10 01:32:52 ET
Summary
- Five9 maintained double-digit growth despite an economic slowdown, with 20% YoY revenue growth in 1Q23.
- The impact of a potential recession on Five9's growth remains uncertain, with the possibility of worsening conditions.
- Despite challenges, Five9's resilience and strong product offerings make it a company worth watching, especially once the macroeconomic environment improves.
Introduction
Economic recessions can be challenging and have the potential to impact even the strongest of companies. Five9 ( FIVN ) is a tech company that has managed to maintain consistent growth over an extended period. Nevertheless, Five9's recent quarterly results indicate that the company is starting to face some challenges. While its growth may continue to slow down, the overall outlook for the company remains cautiously optimistic.
A Cloud Contact Center Pioneer
Five9 has made a name for itself as a leading cloud-based software provider for contact centers, offering an innovative alternative to traditional on-premise systems. Its flagship product, the Virtual Contact Center (VCC) cloud platform, has played a significant role in solidifying the company's reputation over the past twenty years. With a suite of tools and services designed to enhance customer engagement and experience, Five9 not only helps its clients drive successful sales and marketing efforts but also cuts operational costs and increases efficiency. The integration of artificial intelligence has the potential to take its services to new heights.
What sets Five9 apart from its competitors is its well-established presence in the market, boasting a global clientele of over 2,500 companies. This impressive customer base is a testament to the appeal and effectiveness of its product offerings. The company has consistently delivered strong financial results. In today's uncertain economic climate, which could pose challenges for tech companies, Five9's recurring subscription-based revenue model offers a level of predictability that may be attractive to investors looking for stability.
Diving into Five9's Financials
Five9 has a history of strong growth, consistently increasing its revenues over time. In the first quarter of this year, the company reported a 20% year-over-year (YoY) revenue growth, reaching a record $218.4 million. Adjusted gross margin remained fairly stable at 60.4%, and the adjusted EBITDA margin improved to 16.1% from 13.4% in the previous year. Adjusted net income experienced an 86% surge, amounting to $0.41 per share.
The enterprise segment saw significant growth, with a 31% YoY increase in the last twelve months' (LTM) subscription revenue. Besides the impressive earnings figures, there are three key metrics that further demonstrate the company's strength. First and foremost, approximately 92% of Five9's revenues are recurring, thanks to its subscription-based business model. This proportion of recurring revenues has consistently remained above 90% for several consecutive quarters.
Secondly, Five9 successfully signed new deals and established a strategic partnership with British telecom giant BT. This partnership has the potential to drive further growth in international markets, which is a crucial area for expansion. The company reported an impressive 48% LTM international revenue growth, maintaining its streak of over 40% revenue growth in 9 out of the past 11 quarters. By continuing to acquire more international clients and forming strategic partnerships with renowned companies like BT, Five9 could sustain its growth.
Thirdly, Five9 demonstrated strong cash flow performance. The company concluded the first quarter with its highest-ever cash flow from operations at $33.4 million and the second-highest level of free cash flow at $21.7 million. This illustrates that Five9 is not only generating robust revenues and earnings but also significant free cash flows, a combination that can be challenging for many fast-growing tech companies to achieve.
Looking Ahead: The Slowdown
However, Five9 is currently operating amidst challenging economic conditions, which are starting to impact the company's performance. Although revenue growth remains healthy, it is lower compared to the company's past achievements. The first quarter of 2023 marks the second consecutive quarter of 20% growth - a contrast to the previous 18 quarters, where the company consistently posted more than 25% YoY revenue growth. Similarly, LTM Enterprise Subscription Revenue Growth, another crucial growth metric, shows a 31% increase, which is respectable but lower than the 46% and 45% growth seen in 1Q22 and 1Q21, respectively.
The Federal Reserve's interest rate hikes, aimed at controlling inflation, have adversely affected the housing market and prompted businesses to reduce inventories. Companies are now facing increased borrowing costs, which will impact their profit margins. Economic growth slowed to a mere 1.1% in 1Q23, down from 2.6% in 4Q22. Considering the time it takes for rate hikes to fully impact the economy, the nation's gross domestic product is expected to decelerate further in the upcoming months, potentially pushing the economy into a recession. The Estrella-Mishkin recession probability index has risen to 68% - its highest level in over three decades.
I believe the oncoming recession will likely affect Five9's growth in the coming quarters. At present, it is uncertain to what extent the company's revenue growth will decline, or whether it has already reached its lowest point and could rebound in the future. In my opinion, the worst may still be ahead.
The potential recession and the associated decrease in corporate earnings will likely have a negative impact on Five9's performance. The company has acknowledged that the slowdown has already affected its clients in the healthcare and consumer industries, which are its largest and third-largest customer segments. As more and more of its clients, especially those in the US, experience pressure on earnings and profits, they may reduce spending on projects and become less inclined to undertake new initiatives, such as transitioning their contact centers to the cloud, despite the potential benefits. The slowdown in revenue growth already reflects this weakness, and it may become even more pronounced as the economy inches closer to a recession.
Despite these challenges, I believe there are two key factors that may help mitigate the impact of a weak macroeconomic environment on Five9's revenue growth. First, the company offers a service with relatively low market penetration, as many large enterprises still operate on-premise contact center solutions. The low penetration suggests that there may be significant room for growth, even in a contracting economy. This is likely why Five9 continued to attract customers in the first quarter.
What stands out is that during the ongoing quarter, the company secured a major deal representing annual recurring revenues [ARR] of up to $8 million with a large regional bank. Although such large wins are not frequent, the fact that Five9 could secure one in the current economic climate demonstrates that demand for its products remains strong. Additionally, the company signed smaller deals in the first quarter, including one with a healthcare technology service provider (ARR of around $4.7 million) that previously used an on-premises Cisco system, and another with a full-service regional bank (ARR of around $2.3 million) operating in the southern US. The latter used an outdated system but will now employ a wide range of Five9's services, including AI and automation solutions.
Secondly, the advantages of using Five9's cloud-based services extend beyond improved customer experience to include cost savings. With the growing incorporation of AI and automation, these benefits are becoming even more pronounced. During an economic slowdown, many companies might be drawn to digitization and cloud-based solutions for these very reasons, particularly if they are open to experimenting with new approaches to reduce costs and enhance returns.
Takeaway
Five9 has consistently achieved double-digit revenue and earnings growth, a trend that continued in the previous quarter. However, the economic slowdown is beginning to affect its growth, which may decelerate further in the upcoming quarters. The company could still continue to acquire new customers and secure deals, but growth may not occur at the same pace as before. I believe Five9 is an excellent stock with a great product, and I fully expect its growth to pick up once the macroeconomic environment improves. For now, its revenues and earnings might face pressure, so I would exercise caution with this stock. Nevertheless, it remains a good company worth keeping an eye on.
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Five9: An Interesting Tech Stock To Watch As The Economy Faces Pressure