Q2 Holdings, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Q2 provides cloud-based digital banking, lending, leasing and banking-as-a-service solutions, primarily through subscriptions to financial institutions and other financial-services providers. Figures below are in U.S. dollars; financial statement amounts are rounded to millions.
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $103.8m | $79.7m | $293.8m | $228.6m |
| Gross profit / margin | $46.4m / 44.7% | $39.3m / 49.3% | $130.1m / 44.3% | $111.0m / 48.5% |
| Operating loss | $(19.8)m | $(13.4)m | $(79.4)m | $(44.9)m |
| Net loss | $(26.7)m | $(18.6)m | $(99.8)m | $(55.2)m |
| Adjusted EBITDA, non-GAAP | $8.1m | $5.6m | $16.1m | $9.0m |
- Revenue rose 30.2% in Q3 and 28.5% year to date. Management attributed growth mainly to added solutions and registered users, with contributions from the PrecisionLender acquisition and transaction growth. Nine-month revenue also included about $2.0m from Paycheck Protection Program-related solutions.
- Margins declined as cost of revenue grew faster than sales, including higher personnel, hosting and data-center costs and acquired-technology amortization. Q3 operating expenses also included $1.5m of unoccupied-lease charges. The nine-month operating loss included a $13.2m strategic-partnership termination charge.
- Q3 non-GAAP operating income was $5.0m versus $2.6m; nine-month non-GAAP operating income was $7.0m versus a loss of $0.01m. These company-defined measures exclude items including stock compensation and acquisition-related and amortization costs; they are not GAAP results.
- Cash used in operations was $22.0m for the first nine months, versus $1.3m used in 2019. Investing activities used $15.9m, compared with $20.6m provided in 2019; financing provided $303.0m, principally from the May stock offering.
- At September 30, cash and cash equivalents were $365.2m, investments $30.9m and restricted cash $3.5m. The company reported $396.1m of cash, cash equivalents and investments available as principal liquidity sources. Current assets were $480.6m and current liabilities $145.1m.
- Convertible notes had $546.2m aggregate principal outstanding, bearing fixed 0.75% coupon rates and due in 2023 and 2026. Their combined balance-sheet carrying value, net of discounts and issuance costs, was $441.5m. Interest expense, including non-cash discount amortization, was $20.9m for the nine months.
Material changes and unusual items
- In May 2020, Q2 issued common stock and received approximately $311.3m net proceeds. Shares outstanding increased to 53.9m at September 30 from 48.4m at December 31, 2019.
- Q2 paid $16.9m of Cloud Lending contingent consideration during the nine months; the final earnout was $21.2m, and all contingent consideration was paid by September 30.
- The strategic partnership termination generated a $13.2m charge in Q2 2020; $7.6m remained payable in 2021.
- Q2 vacated facilities in California, Texas and North Carolina and recorded $2.1m of unoccupied-lease charges in the first nine months. It also reported $32.9m of future payments under leases not yet commenced.
- Revenue grew, but the net loss widened and gross margin contracted. The company reported an accumulated deficit of $343.4m and stated it expects losses to continue for the foreseeable future.
Outlook, risks and contingencies
- Q2 gave no specific numeric revenue or earnings guidance. Management expected sales performance across solutions to remain slower than normal in Q4 2020 and the foreseeable future, while anticipating a gradual improvement in booking predictability and bookings from Q4 2020 through the first half of 2021. The timing and degree of improvement were uncertain.
- Management said COVID-19 may increase demand for digital financial services, but has delayed customer purchasing decisions and implementations, particularly for enterprise lending and portfolio-management solutions and European lending/leasing customers. The company expected continuing pressure on bookings, revenue, gross margins and operating cash flow. It did not expect further similar stimulus-program benefits after Q2.
- Q2 had reduced hiring and other investments mainly to essential support, delivery and infrastructure roles. It said available liquidity, together with operating cash flows, should meet requirements for the next 12 months under current expectations, while warning that further deterioration could require spending adjustments.
- Key risks include customer delays, extended payment terms and potential customer distress; implementation and service-capacity challenges; cyber, data-security and third-party hosting risks; competition and financial-services-sector consolidation; and the company’s sustained losses and convertible-debt obligations. One customer represented 14% of accounts receivable at September 30, although no single customer represented 10% or more of revenue in the periods reported.
- Contractual commitments totaled $706.3m, including convertible notes and interest, operating leases and purchase commitments. Management reported no legal proceedings expected to have a material adverse effect and no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether subsequent bookings, implementation timing and customer payment behavior confirmed or altered management’s COVID-19 outlook.
- Whether gross-margin pressure and operating cash use improved, and how much reported non-GAAP performance depends on exclusions and non-cash adjustments.
- The effect of the May 2020 equity issuance and potential conversion or dilution from the convertible notes and related warrants/capped calls.
- Whether liquidity remains adequate against the $706.3m of contractual commitments, future lease payments and continued operating losses.
- Whether expected credit losses, customer concentration, goodwill and intangible-asset valuations changed as pandemic-related uncertainty evolved.