Q2 Holdings, Inc. — Q3 2018 Form 10-Q
Business and period: Q2 provides cloud-based digital banking software, primarily to regional and community financial institutions under SaaS subscriptions. This unaudited report covers the three and nine months ended September 30, 2018, compared with the same 2017 periods. Unless noted otherwise, amounts below are in U.S. dollars.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $60.5m | $50.1m | $173.9m | $142.3m |
| Gross profit / margin | $30.4m / 50.2% | $24.3m / 48.5% | $87.5m / 50.3% | $69.4m / 48.8% |
| Operating loss | $(7.3)m | $(5.9)m | $(19.2)m | $(20.6)m |
| Net loss | $(8.9)m | $(5.8)m | $(23.5)m | $(20.6)m |
| Net loss per diluted share | $(0.21) | $(0.14) | $(0.55) | $(0.50) |
| Adjusted EBITDA (non-GAAP) | $5.7m | $3.6m | $15.9m | $6.1m |
Revenue grew 20.8% in Q3 and 22.2% in the nine-month period. Management attributed growth mainly to more registered users at existing and newly installed customers, and higher transaction volumes. Q3 revenue comprised $41.9m subscription, $10.4m transactional, and $8.2m services and other revenue.
For the nine months, operating cash flow was $(3.9)m, versus $1.3m provided in 2017. Investing activities used $56.9m, including $12.2m of property and equipment purchases and net investment purchases. Financing provided $214.5m, principally from convertible-note proceeds, warrant proceeds, and stock-option exercises, less the bond-hedge purchase. Cash, cash equivalents, and restricted cash were $214.1m at September 30.
At quarter-end, cash and cash equivalents were $211.8m and investments were $86.2m, or $298.0m combined liquidity. Current assets were $342.8m and current liabilities $61.0m. Convertible notes had $230.0m principal outstanding and a net carrying value of $180.1m; total liabilities were $275.1m.
Material changes and notable items
- Q3 gross margin improved to 50.2% from 48.5%; nine-month gross margin rose to 50.3% from 48.8%. Operating expenses increased, including research and development, while the nine-month operating loss narrowed. Q3 net loss increased, reflecting higher interest expense and acquisition-related costs.
- Q2 adopted the new revenue standard on January 1, 2018 using the modified retrospective method. Adoption increased opening accumulated equity by $15.8m. As reported, it increased 2018 revenue by $0.9m for Q3 and $4.8m for the nine months, and reduced nine-month net loss by $6.2m. Prior-year figures were not restated, so comparisons are not fully like-for-like.
- In February 2018, Q2 issued $230.0m of 0.75% convertible senior notes due February 2023. The notes have an initial conversion price of approximately $57.38 per share. Q2 paid $41.7m for bond hedges and received $22.4m from warrant issuance; warrants have a $78.75 strike price.
- After quarter-end, Q2 closed its Cloud Lending acquisition on October 15, 2018, for $105.0m, with potential additional consideration tied to future financial metrics. $10.5m of the purchase price was placed in escrow. The acquisition is not reflected in September 30 balances.
Outlook, risks, and contingencies
Management gave no specific numerical revenue or earnings guidance in this filing. It expects continued investment in sales, research and development, implementation and support, and technology infrastructure. It anticipates expenses to rise in absolute dollars, while expecting operating leverage and lower expense ratios over the long term as revenue grows. Management cautions that customer implementation timing and investment levels can make quarterly results variable.
- Operating cash flow turned negative amid increased receivables, contract assets, and deferred implementation and solution costs. Continued growth and investment may require cash before related benefits are realized.
- The notes create future repayment and refinancing obligations; conversions, if permitted and elected, could require cash settlement and affect liquidity. The warrants and note conversions may also dilute shareholders or affect the stock price.
- Q2 reported $41.3m in operating lease obligations and $44.2m in purchase commitments; its contractual-obligations table totals $323.2m, including notes and interest. It also recorded a $0.7m charge for vacating part of a south Austin office.
- Q2 said it had no legal proceedings expected to have a material adverse effect. It reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Assess how much reported revenue growth reflects underlying customer and usage growth versus the new revenue standard; the filing attributes $4.8m of nine-month revenue to adoption.
- Track operating cash flow, receivable and contract-asset growth, and deferred implementation and solution costs as the company scales.
- Review the Cloud Lending acquisition’s final consideration, any performance-based payments, integration progress, and effect on liquidity and results.
- Monitor convertible-note conversion conditions, potential cash settlement needs, and possible dilution from the notes and warrants.
- Consider the scale of stock-based compensation, which was $20.6m for the first nine months, when evaluating non-GAAP adjusted EBITDA.