Q2 Holdings, Inc. — Q3 2016 Form 10-Q
Business and period: Q2 provides cloud-based virtual banking software and related implementation and support services, primarily to regional and community financial institutions. This unaudited filing covers the quarter and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods. Amounts below are in U.S. dollars, millions, except per-share data, percentages and user counts.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $38.3 | $28.0 | $108.1 | $78.5 |
| Gross profit | $18.7 | $12.9 | $51.8 | $35.9 |
| Gross margin | 48.8% | 46.0% | 47.9% | 45.8% |
| Operating loss | $(9.3) | $(7.0) | $(28.4) | $(16.5) |
| Net loss | $(9.5) | $(7.0) | $(28.8) | $(16.6) |
| Net loss per share, diluted | $(0.24) | $(0.19) | $(0.73) | $(0.45) |
| Adjusted EBITDA (non-GAAP) | $(1.1) | $(2.2) | $(5.8) | $(6.2) |
Revenue grew 36.7% in Q3 and 37.7% for the nine months. Management attributed most growth to more registered users at existing and newly installed customers, with additional contribution from higher transaction volumes. Registered users reached 7.8 million at September 30, up from 6.0 million a year earlier.
For the nine months, operating cash flow was $(1.4) million, compared with $0.4 million provided in 2015. Investing activities used $13.2 million and financing activities used $0.8 million; cash and cash equivalents declined $15.4 million to $51.6 million. Cash, cash equivalents and investments totaled $92.3 million at quarter-end. Property and equipment purchases were $13.6 million for the nine months.
At September 30, total liabilities were $102.8 million and stockholders’ equity was $102.5 million. Deferred revenue totaled $64.6 million. The company had no credit-facility borrowings outstanding; a $3.0 million letter of credit left approximately $22.0 million available. The credit facility matures in April 2017, and its accordion feature expired October 11, 2016, reducing maximum borrowings to $25.0 million. The company reported compliance with its financial covenants.
Material changes and drivers
- Q3 operating loss widened to $9.3 million from $7.0 million, despite higher revenue and improved gross margin. For the nine months, net loss widened to $28.8 million from $16.6 million.
- Operating expenses rose faster than revenue over the nine-month period: research and development increased 60.5%, general and administrative 42.9%, and sales and marketing 35.1%. Management cited headcount and infrastructure investment, public-company costs, and acquisition-related compensation.
- Stock-based compensation was $8.8 million for the nine months, compared with $4.9 million in 2015. Acquisition-related costs were $4.8 million, primarily milestone and retention compensation related to Centrix and Social Money.
- Deferred implementation, solution and other costs increased with customer growth and implementations; accounts receivable also rose. Customer cash prepayments increased deferred revenue and supported operating cash flow.
- Since December 31, 2015, cash and cash equivalents fell from $67.0 million to $51.6 million; current liabilities rose from $45.7 million to $60.5 million. Total assets were $205.3 million, versus $204.5 million.
Outlook, risks and unusual items
- No specific revenue, earnings or cash-flow guidance is provided. Management expects cost of revenue and operating expenses to rise in absolute dollars as it invests in customer implementation and support, infrastructure, sales and product development. It expects improved margins over the long term from scale and operating leverage, while noting that timing and realization are uncertain.
- Management expects general and administrative costs to remain elevated in Q4 2016, including audit and SOX-compliance spending, as the company becomes a large accelerated filer and ceases to qualify as an emerging growth company on January 1, 2017.
- Results can vary with customer implementation timing and capacity, user registrations, transaction levels, hiring and investment timing. Management cautions that quarterly comparisons may not indicate future results.
- Significant commitments include $52.8 million of operating lease payments and $28.8 million of purchase commitments, plus a $2.5 million acquisition holdback. These are contractual obligations, not current-period expenses.
- The company reports no material pending legal proceedings, no material off-balance-sheet arrangements, and no individual customer representing 10% or more of revenue or accounts receivable. It maintains a full valuation allowance against deferred tax assets.
- Revenue recognition depends on estimates and judgments, including allocation of contract consideration and capitalization and recoverability of implementation and solution costs. Goodwill impairment testing also depends on forecasts; no goodwill impairment had been recorded through the filing date.
Important facts for investors to verify
- Whether registered-user and transaction growth continues to translate into revenue growth, and how customer implementations affect the timing of that growth.
- Whether gross-margin gains persist as implementation, support and data-center costs rise, and whether operating-expense growth moderates relative to revenue.
- The trajectory of operating cash flow, receivables and deferred costs, and the extent to which customer prepayments continue to support liquidity.
- Credit-facility availability and renewal or repayment plans ahead of the April 2017 maturity, along with covenant compliance.
- The size and duration of acquisition-related compensation, stock-based compensation and increased SOX/public-company costs.
- Potential impacts of adoption of the new revenue-recognition standard, which the company was evaluating and expected to adopt beginning in 2018.