Q2 Holdings, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019; filed November 7, 2019. Q2 provides cloud-based digital banking, lending, leasing and banking-as-a-service solutions, primarily on a subscription basis to financial institutions and fintech companies. Financial figures below are in millions of dollars unless stated otherwise.
Financial performance and liquidity
| Metric | Q3 2019 | Q3 2018 | First nine months 2019 | First nine months 2018 |
|---|---|---|---|---|
| Revenue | $79.7 | $60.5 | $228.6 | $173.9 |
| Gross profit / margin | $39.3 / 49.3% | $30.4 / 50.2% | $111.0 / 48.5% | $87.5 / 50.3% |
| Operating loss | $(13.4) | $(7.3) | $(44.9) | $(19.2) |
| Net loss | $(18.6) | $(8.9) | $(55.2) | $(23.5) |
| Adjusted EBITDA | $5.6 | $5.7 | $9.0 | $15.9 |
| Operating cash flow | Not separately provided | Not separately provided | $(1.3) | $(3.9) |
- Q3 revenue grew 31.6% year over year; nine-month revenue grew 31.5%. Subscription revenue was $56.1 million in Q3 and $160.3 million for the nine-month period.
- Q3 operating margin was approximately negative 16.8%, versus negative 12.0%; net margin was negative 23.3%, versus negative 14.6%. For the nine-month periods, operating margin was negative 19.6% versus negative 11.0%, and net margin was negative 24.1% versus negative 13.5%.
- At September 30, cash and cash equivalents were $601.2 million and investments were $35.7 million. Total assets were $977.7 million; stockholders’ equity was $381.8 million.
- Convertible notes had $546.3 million aggregate principal outstanding; their combined balance-sheet carrying amount, net of discounts and issuance costs, was $419.3 million. The notes bear 0.75% stated interest, with maturities in 2023 and 2026.
Changes versus prior comparable periods
- Management attributed most revenue growth to additional solutions sold and registered-user growth among new and existing customers; acquired businesses contributed $5.3 million of Q3 growth and $13.1 million of nine-month growth. Higher transaction volumes also contributed.
- Costs grew faster than revenue: Q3 cost of revenue rose 34.2%, and nine-month cost of revenue rose 36.2%. Gross margin declined in both comparisons. Research and development increased 52.0% in Q3 and 57.4% for nine months, reflecting investment in personnel and product development.
- Net loss widened, including increased operating expenses and higher interest expense from the convertible notes. Stock-based compensation was $10.1 million in Q3 and $28.5 million for nine months.
- Nine-month operating cash use improved from $3.9 million to $1.3 million, while financing provided $473.9 million, including proceeds from the June stock offering and 2026 notes.
Outlook, risks and unusual items
- Management expects continued investment and higher costs in absolute dollars for customer implementation and support, infrastructure, sales and marketing, and research and development. It anticipates potential long-term operating leverage as revenue grows, but gave no specific financial guidance in the supplied filing text.
- Q2 reported $953.5 million of remaining performance obligations at September 30; it expected to recognize about 49% over the next 24 months and a further 39% in months 25–48.
- On October 31, 2019, after quarter-end, Q2 completed its acquisition of PrecisionLender for $510 million in cash, subject to customary adjustments; $4.8 million was placed in escrow. The acquisition is a major post-period use of liquidity and its results are included only from the acquisition date.
- The 2023 notes became convertible at holders’ option for the fourth quarter after share-price conditions were met; one note had been converted by the filing date. Conversion or fundamental-change repurchase obligations could require cash or cause dilution. Capped calls on the 2026 notes are intended to offset potential dilution or cash settlement only up to their cap.
- Key disclosed risks include sustained operating losses, execution and integration of acquisitions, implementation delays, competition, reliance on third-party systems and hosting, cybersecurity and privacy exposure, and regulatory requirements affecting financial-services technology providers. Management said it was not party to legal proceedings expected to have a material adverse effect and reported effective disclosure controls as of September 30.
Important facts for investors to verify
- Post-acquisition cash, debt and liquidity after the $510 million PrecisionLender payment, and how those compare with management’s stated expectation that liquidity would cover the next 12 months.
- PrecisionLender’s purchase-price adjustments, acquired assets and liabilities, integration costs, and contribution to revenue and cash flow after closing.
- Whether revenue growth can continue while gross margins, operating losses and adjusted EBITDA trends improve; assess the effects of acquisition contributions and rising operating expenses.
- Convertible-note conversion activity, possible cash settlement or dilution, and the contingent Cloud Lending earnout, estimated at $21.7 million at September 30.
- Customer and registered-user growth, retention and implementation capacity; the filing text gives September 2019 registered users of 14.1 million but no current installed-customer count or current-period retention rate.