Q2 Holdings, Inc. — FY2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; quarterly figures below include the three months ended December 31, 2018. Amounts are in U.S. dollars.
Business context
Q2 provides cloud-based digital banking, lending and leasing, and banking-as-a-service solutions, primarily to regional and community financial institutions. A substantial majority of revenue continued to come from its digital banking platform. At year-end, Q2 reported 401 installed digital banking customers and approximately 12.8 million registered users; users processed more than $762 billion in transactions during 2018.
Key financial results
| Metric | FY2018 | FY2017 |
|---|---|---|
| Revenue | $241.1 million | $194.0 million |
| Gross profit / gross margin | $119.2 million / 49.5% | $94.5 million / 48.7% |
| Operating loss | $31.9 million | $26.9 million |
| Net loss | $35.4 million | $26.2 million |
| Net loss per share, diluted | $0.83 | $0.63 |
| Adjusted EBITDA (non-GAAP) | $19.0 million | $10.2 million |
| Cash provided by operating activities | $4.6 million | $9.5 million |
FY2018 revenue increased 24.3%. Management attributed $36.5 million of the increase to additional solutions and user growth, $8.5 million to higher transaction volumes, and $2.1 million to businesses acquired in the fourth quarter. The company reported a 49.5% gross margin and a 13.2% operating loss margin.
For Q4 2018, revenue was $67.2 million, gross profit was $31.7 million, and net loss was $11.9 million. Q4 2017 revenue was $51.7 million and net loss was $5.5 million.
Liquidity, debt and balance sheet
- At December 31, 2018, cash and cash equivalents were $108.3 million, investments were $69.0 million, and restricted cash was $1.8 million. Cash, cash equivalents and investments totaled $177.3 million.
- Current assets were $218.3 million and current liabilities were $73.7 million; working capital was $144.6 million.
- Total assets were $463.7 million, compared with $212.8 million a year earlier. Goodwill rose to $107.9 million from $12.9 million, primarily reflecting the 2018 acquisitions.
- Q2 issued $230.0 million of 0.75% convertible senior notes due February 2023. The year-end carrying value, net of unamortized discount and issuance costs, was $182.7 million. Reported FY2018 interest expense included $7.6 million of debt-discount amortization and $0.8 million of issuance-cost amortization.
- Operating cash flow fell to $4.6 million, while investing cash outflow was $171.3 million, including $130.7 million for acquisitions and $13.3 million for property and equipment. Financing cash inflow was $216.6 million, primarily related to the notes and associated warrant and hedge transactions.
Material changes and unusual items
- Q2 acquired Cloud Lending in October and Gro Solutions in November 2018. Cash purchase consideration was approximately $107.3 million for Cloud Lending and $25.5 million for Gro; Cloud Lending consideration also included estimated contingent consideration of $16.9 million. Cloud Lending sellers could earn up to an additional $59.5 million, subject to financial milestones.
- Operating expenses increased with continued hiring and investment. Research and development expense rose 27.3% to $51.3 million; general and administrative expense rose 21.0% to $45.0 million. Stock-based compensation increased to $29.2 million from $20.9 million.
- Other expense was $7.4 million, versus $0.4 million of other income in 2017, primarily due to interest associated with the convertible notes.
- Q2 adopted the new revenue recognition standard using the modified retrospective method. The adoption increased opening retained earnings by $15.8 million and added $7.7 million to reported FY2018 revenue; Q2 reported FY2018 net loss was $9.4 million lower than it would have been without the standard.
- Revenue retention rate was 114%, down from 122%; annual churn was 5.0%, versus 4.9%. The company attributed retention-rate movement in part to customer implementation timing.
Outlook, commentary and risks
Q2 did not provide specific numerical revenue or earnings guidance in the supplied filing text. Management expects investment in sales and marketing, product development, customer support and infrastructure to continue, with expenses increasing in absolute dollars. It expects losses for the foreseeable future, while citing potential longer-term margin improvement if revenue growth, scale and operating leverage materialize.
- Key risks include intense competition, customer adoption and renewal uncertainty, lengthy sales and implementation cycles, and dependence on third-party integrations, hosting and technology platforms.
- Cybersecurity, data privacy and regulatory compliance are significant risks given the sensitive financial information handled and the evolving requirements applicable to Q2 and its customers.
- Q2’s substantial operating losses and limited operating cash generation, debt repayment obligations, acquisition integration and potential contingent payments merit attention. Convertible notes may create cash needs or dilution if conversion conditions are met; warrants could dilute shareholders if the stock price exceeds their exercise price.
- Management reported effective disclosure controls and internal control over financial reporting; the 2018 assessment excluded Cloud Lending and Gro. The auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- How much future revenue and margin growth comes from existing-customer expansion versus newly acquired businesses, and whether the 114% retention rate stabilizes.
- Whether operating cash flow improves as implementation and deferred contract costs grow, and how cash is allocated after the acquisitions.
- The integration progress and performance of Cloud Lending and Gro, including the likelihood and amount of Cloud Lending earnout payments.
- The full economic cost, conversion terms and potential dilution or cash settlement exposure of the convertible notes, bond hedges and warrants.
- The effect of the revenue-standard adoption on comparability with prior periods; FY2017 was not restated.
- Whether cyber, privacy, regulatory, customer-concentration and third-party hosting risks result in material service disruption, costs or customer losses.