Q2 Holdings, Inc.

My name is James and I will be your conference operator today. At this time, I'd like to welcome everyone to the Q2 Holdings first quarter 2021 financial results conference call. All lines have been placed on mute to prevent any background noise. And after the speaker's remarks, there will be a question and answer session. Thank you. I'd now like to begin the call and turn it over to Josh Yankovic, investor relations. Sir, please go ahead.

Thank you, operator. Good morning, everyone, and thank you for joining us for our first quarter 2021 conference call. With me on the call today is Matt Flake, our CEO, and David Mihot, our CFO. This call contains forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of Q2 holdings. Actual results may differ materially from those contemplated by these forward-looking statements, and we can give no assurance that such expectations or any of our forward-looking statements prove to be correct. Important factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in our periodic reports filed with the SEC, including our most recent annual report on Form 10-K and subsequent filings, and the press release distributed yesterday afternoon regarding the financial results we will discuss today. Forward-looking statements that we make on the call are based on assumptions only as of the date discussed. remain operative at a later time, and we undertake no obligation to update any such forward-looking statements discussed in this call. Also, unless otherwise stated, all financial measures discussed on this call will be on a non-GAAP basis. A discussion of why we use non-GAAP financial measures and a reconciliation of the non-GAAP measures to the most comparable GAAP measures is included in our press release, which may be found on the investor relations section of our website and in our Form 8-K filed with the SEC yesterday afternoon. Let me now turn the call over to Matt.

Thanks, Josh. Today, I'll share some highlights from the first quarter of 2021. I'll then turn the call over to David Mihawk, our Chief Financial Officer, for a more detailed look at our first quarter financial results, as well as guidance for the second quarter and updated full year 2021. In the first quarter, we generated non-GAAP revenue of $117 million, up 25% year-over-year and 7% sequentially. We added approximately 600,000 users in the first quarter, a year-over-year increase of 19% that brings us to more than 18.3 million total registered users on our digital banking platform. The first quarter was an encouraging start to the year with key success stories across the business. On the sales side, we saw an improvement in net new decision-making activity during the quarter, along with continued expansion success with existing clients. I'll discuss a number of key wins later in the call. We also had a major banking as a service client launch, which I'll expand on in a moment. And we saw yet another wave of record digital engagement enhanced by the latest round of stimulus payments in January. Our technology combined with the preparation and execution of our teams puts us in a great position to handle the increased volume as well as the continued growth in digital engagement we expect to see moving forward. I'll turn to sales highlights. In the first quarter, we had broad-based sales success, generating more net new bookings than any single quarter in 2020, which I believe indicates an improving buying environment. We had a number of noteworthy net new and expansion wins in the quarter, including several enterprise and tier one wins across the portfolio. I was particularly impressed with the breadth of deals we signed, which I believe demonstrates that the market is responding favorably to our digital transformation story. I'll start with the enterprise customer segment, where we continue to see traction with our loan pricing, data, and sales coaching solutions. We had two such wins in the quarter with the top 25 and top 50 bank in the United States. The top 25 bank worked with us to develop a new loan pricing module and cited the depth and flexibility of our loan pricing solutions as key drivers of their decision to partner with us. The Top 50 Bank provides a great example of our land and expand strategy coming to bear. This bank first became a customer in 2019 when they purchased our corporate banking suite. In 2020, they added our treasury onboarding solution. And in the first quarter of 2021, they purchased our loan pricing, data, and sales coaching solutions. This bank aims to grow their commercial portfolio aggressively. They initially selected Q2 because they sought a partner that could help digitally transform their entire commercial customer lifecycle. The purchase of our loan pricing data and sales coaching solutions is the next step in that vision, and it will help enable their commercial lenders to leverage data to design better loans, become more efficient in how they operate, and I believe ultimately improve the profitability of their commercial relationships. While this is a clear example of a customer partnering with us for a broad set of digital transformation initiatives, stories like this are becoming increasingly common, and they demonstrate that our strategy and product portfolio are resonating in the market with even some of the largest, most sophisticated financial institutions. In addition to our success with loan pricing solutions, we saw good activity on the loan and lease origination side. One of our existing enterprise customers, a top 20 financial services provider in the world, extended their PPP agreement with us in the quarter. While on the leasing front, we signed a new agreement with the financing arm of a major automaker. I'm encouraged by our lending success in the quarter. And with government lending beginning to slow down and businesses beginning to reopen more broadly, I believe the improving economic environment will begin to serve as a tailwind for our digital lending business. We had several noteworthy wins in the Tier 1 space as well. On the digital banking front, we signed a comprehensive agreement with an $8 billion bank. The bank selected Q2's digital banking platform for retail, small business, and corporate banking, while also adding digital account opening and a robust set of fraud and risk management solutions. This win was another great example of a competitive process where the bank cited the breadth of our portfolio and the ability to deliver an end-to-end experience as key drivers of their decision to partner with Q2. And we are in active discussions to develop a joint roadmap with this customer that will expand our relationship to other aspects of the portfolio over time. Additionally, we had two Tier 1 banks select our digital acquisition and onboarding solutions, one for digital account opening and one for treasury onboarding. This end-to-end digital acquisition and onboarding suite, which includes account opening, treasury onboarding, and now click switch, solves for a key aspect of the overall customer lifecycle and is becoming a more common requirement in digital banking deals. As these two deals demonstrate, our digital acquisition and onboarding solutions are positioning us well for standalone, net new wins, giving us yet another avenue for a land and expand strategy. We also had success in the Tier 2 and 3 space, highlighted by two significant credit union wins, one for retail and small business, and one for retail banking with a credit union that chose us for the strength of our end-user experience. Our digital banking success across customer segments supports my view that as we've expanded into new products and markets, we continue to compete favorably in the digital banking space. Our focus on user experience, our strong track record of innovation and product delivery, and the breadth of problems we can solve for our customers from retail to SMB to corporate and from deposits to lending are why we continue to win deals with institutions of all sizes in this market. In looking at our overall sales performance, I was pleased with the improvement in the deal activity we saw when compared to the fourth quarter of last year. The variety of the deals we signed in the quarter, combined with the robust state of our pipeline across the business, gives me confidence that we'll continue to see improvements in sales activities moving forward. I mentioned that we saw exciting momentum from our banking as a service group in the quarter, and I'd like to provide a few updates on the work that the team has been doing. During the first quarter, Q2 Bass achieved a major milestone by supporting the launch of Credit Karma's Money Spin program. Credit Karma successfully launched a savings product with Q2 a little over a year ago and expanded the partnership with the addition of this checking account and debit card program in Q1. As part of this launch, we also partnered with Credit Karma to validate and release a number of new features. These types of feature enhancements enable our clients to meaningfully differentiate themselves and unlock new use cases and verticals for our vast sales organization. We're grateful to the Credit Karma team for all the hard work leading up to this launch and are thrilled to play a role in supporting their program. We believe client launches like this will become increasingly significant over time as the revenue driven by transactional activity within our clients' programs represents meaningful potential upside relative to the size of the initial agreement. Going forward, we expect these client launches and ultimate end-user utilization to represent a growing portion of Banking as a Service's overall revenue contribution to the business. On the operations side of the business, we saw strong levels of usage and engagement yet again. Partially driven by the latest round of stimulus payments, we transacted more than $420 billion in the first quarter, representing 47% year-over-year growth, and about as much as we have transacted in all of 2016. Now that we're a quarter into the new year, we continue to see the acceleration of digital engagement brought on by the pandemic, which we believe will endure. I'm proud of the way our teams have responded and the critical role they've played in supporting our customers in their greatest time of need. This is a strong reminder of the talent process and technological maturity required to operate at scale in this industry. With the widespread technology refresh financial institutions are undergoing following the pandemic, we're in our strongest position yet to support our clients. Another theme we're hearing from customers coming out of 2020 is that they and their account holders want innovation rapidly. More than a year into working remotely, I'm incredibly proud of our performance in innovating and delivering for our customers. In the time we've been remote, we've released substantial new innovation to our customers. We continue to shorten the time it takes to deliver incremental products to our customers and are delivering a record number of those enhancements. As I've often said, digital transformation is no longer optional. It's critical. When you consider the increasing demand for stability, security, and innovation, I believe we're in a highly differentiated position that balances those needs for our customers. On the subject of new products, we completed our acquisition of ClickSwitch in early April, and I'm excited to share a bit about the rationale behind the transaction. With the increasing focus on digital account opening in the past 12 months, we've continued to hear a theme from our customers. One of the most critical steps in onboarding a new consumer is acquiring their direct deposit. This is essential for driving deeper engagement, revenue generating activity, and cross-sale opportunities. But the process remains manual and time consuming for account holders. As a result, less than half of all new checking accounts are fully activated within the first 90 days of opening the account. ClickSwitch automates direct deposit setup for account holders via direct integration with thousands of employers, easing the burden for account holders and helping financial services providers create more engaged and profitable consumer relationships. We believe ClickSwitch offers substantial value as a standalone solution, and that it will also further differentiate our digital banking and banking as a service offerings. Furthermore, ClickSwitch helps enhance our digital acquisition and onboarding solutions by helping clients not only digitally acquire new account holders, but drive deep, meaningful engagement through the process. We're excited to welcome the ClickSwitch team to the Q2 family, and we're already hard at work to bring the two companies together from selling to supporting to innovating. Before I hand the call over to David, we recently announced an addition to our board of directors, and I'd like to take this opportunity to welcome Lynn Tyson to the Q2 team. Lynn brings a wealth of experience in leading enterprise companies through major transformation. Having held senior roles at Ford, PepsiCo, and Dell, among others, we're excited to add her perspective to the B2 board. Lynn replaces Charles Doyle as he resigns after having served on our board of directors since 2011. I speak for all of Q2, and I thank Mr. Doyle for his substantial contributions. Our company would not have been able to accomplish what we've accomplished without his insights, and I appreciate his guidance over the past 10 years. So again, welcome to Lynn, and thank you, Mr. Doyle. With that, I'll hand the call over to David to walk through our financial performance. Thanks, Matt, and good morning, everyone. I'm pleased to report that we're off to a strong start to 2021. As Matt said, we're building on the business momentum we started to see in the fourth quarter, and we're excited to see increased customer new buying activity combined with strong execution, resulting in solid financial outcomes. I'll begin by reviewing our results for the first quarter of 2021 and conclude with updated guidance for the second quarter and full year. Total non-GAAP revenue for the first quarter was $117 million, an increase of 25% year-over-year and up 7% sequentially. Both the year-over-year and sequential increase in revenue was largely a result of growth in subscription revenue, driven by new customer go-lives and organic user growth. In addition, the year-over-year increase was due in part to go-lives associated with cross-sold products. Transactional revenue represented 14% of total revenue for the quarter, consistent with the prior year period and up from 13% of total revenue the previous quarter. The sequential increase in the mix of transactional revenue from the prior quarter was driven by pay revenue resulting from new customer go-lives and a moderately increasing contribution of interchange revenue associated with the BAS business. In terms of backlog, we ended the quarter with approximately $1.3 billion in total backlog, a 10% increase year-over-year, and a sequential increase of $2 million. The year-over-year increase in backlog, which is largely a result of bookings added through renewal and expansion opportunities with our existing customers over the past 12 months. As Matt mentioned, in the first quarter, we saw an improvement in the net new buying environment as the total dollars added from new customer bookings was higher than in any quarter of 2020. We also continued to see strong retention across all of our lines of business and continued success in cross-sell opportunities. As the buying environment continues to improve, we expect that the contribution mix of net new bookings as a percentage of total bookings will be higher than what we observed last year. 2020 was an unusually strong year in terms of renewals. While the macro backdrop driven by the pandemic caused a slowdown of net new opportunities, it also allowed us to drive a record number of customer renewals, as we believe existing customers clearly recognize the importance of their digital capabilities driven by our solutions and wanted to solidify the partnership with an extended contract duration. gross margin for the first quarter was 52.6 percent down from 53.1 percent in the first quarter of 2020 and up from 48.3 percent in q4 of 2020. as a reminder in the fourth quarter of 2020 we had a combined impact of approximately 370 basis points to our stated gross margin resulting from an accounting adjustment and contract asset impairment, which negatively impacted the prior quarter's gross margin results. The yearly decline in gross margin was primarily attributable to expenses associated with incremental implementation resources delivering customer go-lives. Absent the negative impacts in the prior quarter, the sequential improvement in gross margin was primarily a result of the continued growth in higher margin subscription revenue generated from new customers' lives. Total operating expenses in the first quarter were $54.9 million. or 46.9% of revenue compared to $52.8 million, or 56.3% of revenue in the first quarter of 2020, and $50.1 million, or 45.7% of revenue in Q4 of 2020. The year-over-year reduction in OPEX as a percent of revenue is an example of our ability to increase efficiencies across the organization and scale our operating expenses below the rate of revenue growth. The category of OpEx that exhibited the most pronounced growth year over year was R&D, as we continued to focus on investing in our products and capabilities to deliver these solutions to our customers in an accelerated manner. The sequential increase in OpEx was driven by incremental headcount onboarded during the quarter. associated with the timing of annual bonus commission payments and restricted stock unit and market stock unit vestings. Adjusted EBITDA was $9.9 million, up from a loss of $100,000 in the first quarter of 2020, and a positive $6.1 million in the previous quarter. The year-over-year increase was largely attributable to an increased mix of higher margin subscription revenue and effective scaling of operating expenses. The sequential increase was attributable to the negative impact from the accounting adjustment and contract asset impairment realized in the fourth quarter of 2020. We ended the quarter with cash, cash equivalents and investments of $528.6 million, down from $539.1 million at the end of the fourth quarter 2020. Cash flow used in operations for the first quarter was $5.5 million, driven largely by the timing of our annual bonus payout, restricted stock unit and market stock unit vestings, and the related payroll taxes. We incurred net capital expenditures of $6.1 million and generated negative free cash flow in the quarter of $12.4 million. Now let me wrap up by sharing our second quarter and updated four-year guidance. We forecast second quarter non-GAAP revenue in the range of $122 million to $123.5 million. representing year-over-year growth of 23% to 25% and four-year revenue in the range of $495 million to $498 million, representing year-over-year growth of 22%. We forecast second quarter adjusted EBITDA of $8.5 million to $9.1 million, and full year 2021 adjusted EBITDA of $32 million to $34 million. This guidance includes the expected contribution of click switch, which is required on April 1st. In fiscal 2021, we anticipate click switch revenue contribution to be low to mid single digit millions of dollars. and an adjusted EBITDA loss of low to mid-single-digit millions of dollars, recognized relatively roundly over the next three quarters. In closing, we continue to be encouraged by the market activity, customer receptivity of our solutions, and the associated financial benefits. We feel we're continuing to build a broad and diverse base of revenue with meaningful operating leverage that supports continued accretive growth going forward. And with that, I'll turn the call back over to Matt for his closing remarks. Thanks, David. In closing, we had a great start to the year in the first quarter. From a sales perspective, we saw steady sequential improvement in the deal activity, which I take as an indication of an improving buying environment. When you look at the breadth of wins we had across our teams, I believe it's clear that we're well positioned to enable broad-based digital transformation for banks, credit unions, and fintechs. We continue to innovate and deepen our solution set. We released key enhancements to our banking as a service offering supported by the launch of a major client program, and we couldn't be happier to add the ClickSwitch product and team to Q2. and we continue to operate the business at a high level in a remote environment, whether supporting record digital usage or continuing to deliver new products to our customers rapidly. I'm encouraged by the momentum we're seeing across our business. Our growing pipeline, improvements in the macroeconomic environment, and our pace of innovation put us in a great position to continue executing our strategy through 21 and beyond. Thanks, and with that, I'll turn it over to the operator for questions.