Q2 Holdings, Inc.

Good morning. My name is Phyllis and I will be your conference operator today. At this time, I would like to welcome everyone to the Q2 Holdings second quarter 2021 financial results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. At that time, if you would like to ask a question, please press star one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I would now like to turn the call over to Josh Yankovich, Investor Relations. Sir, please begin.

Thank you, operator. Good morning, everyone, and thank you for joining us for our second quarter 2021 conference call. With me on the call today is Matt Flake, our CEO, and David Mihawk, 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 will 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 quarterly report on Form 10-Q 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 this call are based on assumptions only as of the date discussed. Investors should not assume that these statements will 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 8K filed with the SEC yesterday afternoon. Let me now turn the call over to Matt.

Thanks, Josh. I'll start today's call by sharing our second quarter results and highlights from across the business. I'll then turn it over to David to discuss our financial results in more detail, as well as guidance for the third quarter and updated full year 2021. In the second quarter, we generated non-GAAP revenue of $124.2 million, up 26% year-over-year and 6% sequentially. We also added over 500,000 users sequentially, resulting in a year-over-year increase of 16%. That brings us to more than 18.8 million total registered users on our digital banking platform. Overall, we had an encouraging quarter of activity across the business. We signed key deals across our product lines, announced an important new offering that we believe will build on our competitive advantage in the market, and we continued to execute at a high level in delivering our solutions. Although we continue to see uncertainty around the timing of purchasing decisions, we believe that a return to more normalized living and working conditions will help the market improve, which we are already beginning to see by an increase in customer evaluations of digital solutions and growth in our pipeline. So we're pleased that we're seeing expansion in the number of opportunities across all areas of our business. And as we look ahead to the back half of the year, we're optimistic that overall deal activity in the space will begin to return to pre-pandemic levels. We also saw a resurgence in M&A activity within the banking space in the first half of the year, which we view as a positive for our business. Of the 22 mergers or acquisitions announced in the first half that involved a Q2 digital banking customer, we were on the acquiring side in all but one instance. This reinforces a belief we've long communicated that because we tend to partner with financial institutions that are strategically looking to grow and are forward-thinking around digital transformation, Q2 customers are often on the acquiring side of M&A transactions. If the acquiring company rolls the new entity onto their existing digital banking solution, these events can result in incremental users being onboarded without going through a typical sales or implementation process. While the timing of revenue from M&A is difficult to predict, we are optimistic that this recent M&A activity in the industry will benefit our business, which we find especially encouraging considering the industry-wide slowdown in decision-making we saw during the pandemic. We also view it as a testament to the quality and breadth of our customer footprint. Transitioning to our sales performance in the quarter, we signed key net new and expansion digital banking deals, achieved broad-based success within digital lending, and continued to build momentum in the banking as a service arena. On the digital banking front, we won a highly strategic credit union deal in a competitive scenario. This credit union has a sophisticated internal product team, so finding a provider with a strong base platform and the ability to extend that platform was a priority. Our Innovation Studio solution, which I'll discuss in more detail shortly, was a key differentiator for this client as it provides them the flexibility to personalize the digital banking platform according to their own timeline and member feedback. In the past, we've discussed a growing trend in credit unions increasingly expanding into business banking, and our end-to-end digital banking platform has put us in a competitive position to capitalize on this shift. That was the case in this deal. where the combination of our platform's retail experience and our feature-rich commercial suite was another important selection criteria. We also continued to generate meaningful expansion opportunities across our customer base. A good proof point from the quarter was a $3 billion credit union that renewed their existing retail digital banking agreement, while also adding our corporate banking solutions. We believe examples like these demonstrate the growing value of our broad solution portfolio and our ability to leverage that breadth to deepen relationships with existing customers. We had several banner wins on the lending side of the business in the second quarter, and I'm pleased with our traction, especially in North America. With the events of the last 18 months, we're seeing financial institutions put an increased emphasis on streamlining their internal lending processes in order to provide a more competitive borrower experience. And our loan origination solutions are a natural fit for lenders looking to digitally transform their capabilities. The first deal I'll highlight was a loan origination win with an enterprise top 30 U.S. bank. This is an important deal from a strategic standpoint as it helps demonstrate the quality and scalability of our origination solutions in the enterprise segment. We also believe this will add momentum to our North American sales efforts. It also gives us a foothold with this bank, and we're optimistic that this initial relationship will create expansion opportunities for us. As an example, this bank also made the decision to purchase our ClickSwitch solution in the quarter, which is intended to help the bank become the primary financial institution for their retail customers. In addition to our loan origination success, we continue to build traction with our loan pricing, data, and sales coaching solutions. A representative win in the quarter was with the Tier 1 Top 100 U.S. Bank, which not only purchased our loan pricing solutions, but also opted to add our Centrix risk management products. Another example of our product breadth creating additional opportunities for us. This bank is looking to utilize our technology to create a competitive advantage and will use our loan pricing solutions to empower the relationship managers with valuable pricing data and coaching. allowing them to design more profitable, competitive loans in real time with their borrowers. We also signed a loan pricing agreement with an existing Tier 1 digital banking client. This is our expansion model in action. Our goal has always been to win a customer, run successful projects with them, and earn more of their business over time. Given the breadth of our product set today, we're now in a position to partner with our customers on both sides of the balance sheet, no matter where they are in their digital transformation journey. So when this client expressed an interest in providing loan pricing data to their commercial lenders, we were in a great position to partner with them on this initiative. Our banking as a service team also had a solid quarter of activity, partnering with FinTechs in new verticals that are driving innovation in financial services. One such win in the quarter was with NYDIG. a leading technology and financial services firm dedicated to giving U.S. consumers far easier access to buy, sell, and hold Bitcoin. This is an exciting partnership for us on multiple fronts. First, as a banking as a service client, they'll leverage our vast platform to power their new payroll offering for corporate customers, aimed at giving U.S. employees the ability to allocate a portion of their paycheck to investing in Bitcoin, the first such offering in the country. And beyond our banking as a service relationship, we announced a collaboration to make NYDIG's custodial functionality available to Q2's digital banking customers as well, which will give our financial institutions customers the ability to offer Bitcoin services to their account holders. Expanding on innovation, we formally announced the Q2 Innovation Studio in the quarter, the culmination of years of hard work from our teams and input from our customers. Built on our award-winning SDK, the Innovation Studio allows our customers to extend and personalize their digital banking platform, either with in-house developers, outside development partners, or a library of pre-integrated fintech partners. Traditionally, financial institutions have been dependent on their vendors to deliver new products, third-party integrations, or custom functionality. As the pace of change continues to accelerate in the industry, Q2 Innovation Studio empowers our clients to rapidly design, develop, and distribute innovative solutions to their account holders. And the initial feedback from our customers has been extremely positive. As the Chief Product Officer for Stanford Federal Credit Union put it, we feel very empowered. For our size, our ability to execute on our vision is a differentiator. With Innovation Studio, Q2 has developed a true partner approach. We are also seeing a strong reception from partners for whom our network of customers and end users provide a potentially valuable and rapidly accessible distribution channel for their products. Although we just formally announced Q2 Innovation Studio, we already have more than 25 fintech and development partners leveraging it today. And as that number grows, the value the Innovation Studio can deliver to customers will grow as well. By leveling the playing field and empowering our customers with equal access to technology, we believe the Innovation Studio is a powerful contributor to our mission. And with its ability to help customers differentiate and deliver innovation rapidly, we believe Q2's Innovation Studio will give us a meaningful competitive advantage, more engagement opportunities, and drive high levels of customer satisfaction for years to come. Shifting to product delivery, our teams continue to execute at a high level during the second quarter. One go-live event from the quarter was particularly noteworthy, a coordinated launch with six financial institutions all owned by the same holding company that is one of our largest digital banking clients. This launch was a tremendous effort from our team, and I believe our track record in delivering solutions to sophisticated customers with complex environments continues to set us apart from competitors. So when you combine our delivery execution with the expansion of the product portfolio and key wins on the sales side, we're pleased with the quarter and feel we're in a strong competitive position as we enter the back half of the year. With that, I'll hand over the call to David to walk through our financial performance. Thanks, Matt. And good morning, everyone. As we hit the halfway mark of the year, we're pleased with our execution and effectively bringing deals to revenue and our ability to deliver organic growth in the business. which has helped yield strong overall revenue growth exceeding the high end of our guidance. We continue to grow investments in our solutions, support, delivery, and people while driving efficiencies, which have resulted in adjusted EBITDA also exceeding the high end of our guidance. I'll begin by reviewing our results for the second quarter of 2021 in more detail and conclude with updated guidance for the third quarter and full year 2021. Total non-GAAP revenue for the first quarter was $124.2 million, an increase of 26% year-over-year and up 6% sequentially. Both the year-over-year and sequential increase in revenue was largely the results of growth in subscription revenue, driven by new customer go-lives and organic user growth. In addition, the year-over-year increase was also due in part to go-lives associated with cross-sold products. Year-over-year and sequential revenue growth also benefited from the contribution of Quick Switch, which we acquired on April 1st. Transactional revenue represented 14% of total revenue for the quarter, consistent with the prior year period and previous quarter. Within transactional revenue, we're seeing an increasing contribution associated with the BAS business. which includes interchange as well as pass-through fees for debit transactions. This increase in revenue from the Bass business, combined with continued slowing growth in traditional bill pay revenue, has resulted in transactional revenue as a percentage of total revenue remaining constant. Turning to backlog, we ended the quarter with approximately $1.3 billion in total backlog, a 4% increase year over year, and a sequential decline of $15 million. The year-to-year increase in backlog was largely the result of bookings added through renewal opportunities with our existing customers, as well as the contribution of net new bookings. As I mentioned in last quarter's earnings call, we believe that backlog growth will be pressured in 2021, in part due to our proactive approach and success in 2020. in renewing existing customers, which resulted in fewer customers targeted for renewal in 2021 relative to 2020. We remain confident that net new bookings are going to be a bigger contributor to backlog this year compared to last, but we could continue to see pressure in the total backlog dollars due to the impact from fewer renewals in 2021. Gross margin for the second quarter was 51.9%, down from 53.9% in the second quarter of 2020, and down from 52.6% in Q1 of this year. The year-over-year decline in gross margin was primarily attributable to expenses associated with the addition of implementation resources, which continue to benefit our effectiveness in delivering solutions. We also increased investments focused on maintaining best-in-class security and uptime for our customers. The sequential decline in gross margin was also impacted by a higher mix of transactional pass-through revenue in the second quarter. Total operating expenses in the second quarter were $57.9 million, or 46.6% of revenue, compared to $48.3 million, or 48.8% of revenue, in the second quarter of 2020. and $54.9 million or 46.9% of revenue in Q1 of 2021. The year-over-year and sequential reduction in OPEX as a percentage of revenue were driven by efficiencies in supporting growth in our business with G&A showing the greatest decline in expense as a percent of revenue. R&D exhibited the most pronounced OPEX growth as we continue to invest in our solution. such as Banking as a Service and Q2 Innovation Studio. We feel strongly about continuing to invest in open solutions like these to benefit our customers, Q2, and ultimately expand our addressable market. Another driver of the sequential increase in R&D came from incremental headcount onboarded during the quarter related to the acquisition of QuickSwitch. Adjusted EBITDA was $9.9 million, up from $8.1 million in the second quarter of 2020, and flat sequentially. The year-over-year increase was largely attributable to maintaining a balanced approach to cost management, resulting in operating expenses scaling below the growth rate of revenue, which more than offset both the increased OPEX contribution from ClickSwitch as well as the decline in gross margin. We ended the quarter with cash, cash equivalents and investments of $411.3 million, down from $528.6 million at the end of the first quarter of 2021. This declining cash was attributable to the acquisition of Quick Switch and the repurchase of the majority of the remaining 2023 notes we announced during the quarter. In total, these transactions reduced our cash balance by more than $120 million. Cash flow from operations was $11.5 million in the second quarter compared to a use of cash from operations of $5.5 million in the first quarter. In addition to disciplined working capital management, the sequential improvement was due in part to the timing of payments for large vendor contracts. as well as our annual bonus payout and payroll taxes associated with stock vestings, which were both paid out in the first quarter. We incurred net capital expenditures of $8.3 million and generated free cash flow in the quarter of $1.7 million. As a reminder, in the third quarter, we will make the final payout of our termination agreement with Stone Castle, totaling approximately $7.6 million. Now, let me wrap up by sharing our third quarter and updated full-year guidance. We forecast third quarter non-GAAP revenue in the range of $125 million to $126.5 million, representing year-over-year growth of 19 to 21 percent. And we are increasing our guidance for full-year revenue to $497.5 million to $499.5 million, representing year-over-year growth of 22% to 23%. We forecast third quarter adjusted EBITDA of $6.2 million to $6.8 million. And we are increasing full-year 2021 adjusted EBITDA guidance to $33.2 million to $34.7 million. We delivered better than anticipated financial results in the second quarter through effective and timely delivery of our solutions to our customers. And we are increasing our guidance for both revenue and adjusted EBITDA for the full year. We continue to invest in strategic opportunities, which we believe will benefit our customers and create long-term value. we are able to fund a portion of these investments through operational efficiencies and have confidence in our ability to continue executing in the back half of the year. With that, I'll turn it back over to Matt for some closing remarks. Thanks, David. In closing, we continue to see signs of improved business momentum. We had important sales wins across our lines of business, adding strategic new clients in digital banking, loan origination and pricing, and banking as a service. while continuing to expand existing relationships and execute on cross-pollination opportunities we continue to further differentiate our solution portfolio with products like q2 innovation studio which enable financial institutions to design develop and distribute innovative solutions to their end users more quickly than ever before looking ahead we're encouraged that our market is beginning to improve We're engaged in more and more sales opportunities, creating a strong pipeline, and we expect prospect and customer decision-making timelines to improve through the end of the year. Thank you. And with that, I'll turn it over to the operator for questions.