Q2 Holdings, Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Unaudited results are compared with the corresponding 2019 periods. Dollar amounts below are in millions unless stated otherwise.
Business context
Q2 provides cloud-based digital banking, lending, leasing and banking-as-a-service solutions, primarily through subscriptions to financial institutions, alternative finance and leasing companies, and financial technology companies. The October 2019 PrecisionLender acquisition expanded its commercial banking and portfolio-management offerings.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $97.6 | $77.6 | $190.0 | $148.9 |
| Gross profit | $44.4 | $37.6 | $83.7 | $71.7 |
| Gross margin | 45.5% | 48.4% | 44.0% | 48.1% |
| Operating loss | $(32.3) | $(14.4) | $(59.5) | $(31.5) |
| Net loss | $(39.0) | $(17.3) | $(73.1) | $(36.6) |
| Basic and diluted loss per share | $(0.76) | $(0.39) | $(1.46) | $(0.83) |
Q2 revenue grew 25.7%; six-month revenue grew 27.5%. Subscription revenue was $70.2 million in Q2, up from $54.1 million. For the quarter, management attributed revenue growth chiefly to additional solutions and Registered Users, the acquired business, PPP-related offerings, and higher transaction volumes.
Q2 cost of revenue rose 32.8%, faster than revenue, and six-month cost of revenue rose 37.6%. Management cited personnel and infrastructure growth, transaction and third-party costs, and acquired-technology amortization. Stock-based compensation was $10.8 million in Q2 and $25.3 million for the first half.
Non-GAAP measures: Adjusted EBITDA was $8.1 million in Q2 versus $3.2 million, and $8.0 million for the first half versus $3.5 million. Non-GAAP operating income was $5.0 million in Q2 versus $0.1 million, and $2.0 million for the first half versus a $2.6 million loss. These measures exclude material items, including stock compensation, acquired-intangible amortization and the partnership termination charge; they do not replace GAAP results.
Liquidity, cash flow and debt
- At June 30, cash and cash equivalents were $376.3 million, investments $12.7 million and restricted cash $3.5 million. The company described cash, cash equivalents and investments of $388.9 million as its principal liquidity.
- Operating cash flow was negative $27.2 million for the six months, compared with negative $18.7 million in 2019. Capital expenditures were $14.8 million; investing cash flow was positive $4.4 million.
- Financing cash flow was positive $299.0 million, mainly from the May 2020 stock offering, which generated approximately $311.2 million net proceeds to Q2. The company sold 4.24 million shares; existing shareholders sold another 0.50 million shares.
- Convertible notes had $546.2 million aggregate principal outstanding: $230.0 million of 0.75% notes due 2023 and $316.3 million of 0.75% notes due 2026. Their combined balance-sheet carrying amount, net of discounts and issuance costs, was $435.9 million.
- Q2 stated that available liquidity and operating cash flow were expected to meet cash requirements for the next 12 months, based on current operations and assumptions about COVID-19 impacts.
- Remaining performance obligations were $1.2 billion at June 30; Q2 expected to recognize approximately 47% within 24 months and another 40% in months 25–48.
Material changes and unusual items
- Gross margin declined 2.9 percentage points year over year in Q2. GAAP operating and net losses widened; the net-loss margin increased to 39.9% of revenue from 22.3%.
- A $13.2 million strategic partnership termination charge was recorded in Q2. Q2 paid $5.6 million in May 2020, with $7.6 million due in the third quarter of 2021.
- Q2 recorded a $0.7 million charge for vacating its San Mateo facility. It also finalized Cloud Lending contingent consideration at $21.2 million; $3.0 million remained payable at June 30 and was paid in July.
- In May, Q2 completed its public offering at $76.50 per share, increasing outstanding shares and providing substantial new capital. The filing reports 53.4 million shares outstanding at June 30.
- Q2 adopted the expected-credit-loss standard in January 2020, recording a $0.3 million cumulative adjustment to accumulated deficit. COVID-related uncertainty prompted higher credit-loss reserves; at June 30, allowances were $0.6 million for accounts receivable and $0.3 million for contract assets.
Outlook, management commentary and risks
Management said COVID-19 could accelerate demand for digital financial services, and Q2 reported increased digital activity and cross-selling to existing customers. At the same time, new-customer deals, especially enterprise lending and portfolio-management sales, were delayed; implementations and revenue recognition were also affected. PPP solutions supported Q2 bookings and revenue, but management expected Cloud Lending bookings to fall from Q2 levels if the program did not continue.
Management expected sales across solutions to be slower than normal in the quarter ending September 30, 2020, citing COVID-19 uncertainty, the upcoming election and typical summer seasonality. It expected COVID-19 to negatively affect revenue, gross margins and operating cash flows, and had reduced 2020 hiring and limited investment mainly to essential support, delivery and infrastructure roles. The company planned to operate virtually at least through the remainder of 2020. It did not provide numerical financial guidance in the supplied filing text.
Key risks include uncertain customer spending, payment delays or requests for extended terms, customer insolvency and churn, implementation delays, credit losses, service capacity and cybersecurity risks amid higher digital usage and remote work, and potential impairment of goodwill or acquired intangibles. Q2 reported no material legal proceedings and no goodwill impairment following its COVID-triggered review. The 2023 notes became convertible at holders’ option for July 1–September 30, 2020; the 2026 notes were not convertible at June 30. Management cautioned that the pandemic’s longer-term impact could not yet be estimated.
Important facts for investors to verify
- Whether slower new bookings, delayed implementations and customer payment-term requests persist, and how they affect revenue, margins, collections and operating cash flow.
- How much Q2 revenue and bookings growth depended on PPP-related activity and the PrecisionLender acquisition, versus organic subscription, user and transaction growth.
- Whether rising service and infrastructure costs, acquired-technology amortization and stock-based compensation continue to pressure GAAP margins and losses.
- The company’s cash consumption and liquidity relative to $546.2 million of note principal, lease obligations and other contractual commitments; also monitor the 2023 notes’ conversion status and potential settlement effects.
- The assumptions behind credit-loss reserves and goodwill/intangible-asset impairment reviews as economic conditions and customer credit quality evolve.
- The effect of the May equity offering on share count and dilution, and the reconciliation of non-GAAP operating income and adjusted EBITDA to GAAP results.