Q2 Holdings, Inc. (QTWO) Q2 2015 Earnings Report, Transcript and Summary

Good afternoon. My name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q2 Holdings First Quarter 2015 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Bob Gujavarty, Vice President of Investor Relations, you may begin your conference.

Welcome to Q2 Holdings Earning Call for the first quarter ending March 31, 2015. I am Bob Gujavarty, Vice President of Investor Relations and with me today on the call are Matt Flake, our President and CEO, and Jennifer Harris, our CFO. As a reminder, today’s conference call is being broadcast live via webcast. In addition, a replay of the call will be available on our website following the call. By now, you should have received a copy of our press release that was distributed this afternoon. If you have not, it is available on the Investor Relations section of our website. Let me also highlighting our participation in JP Morgan TMT Conference in Boston on May 20. Please remember that certain statements made during this call, including those concerning our business and financial outlook for the second quarter and full year 2015, the alignment of our business, product and strategic direction with our customers needs, our growth opportunities and expectation, our long-term financial target, anticipate improvement in revenue, adjusted EBITDA, gross margins, operating margins and other financial measures, the strength of our financial position and the confidence that inspire in our customers and prospects, our ability to implement and support customers both large and small, the integration of additional users is a result of Umpqua acquisition of Sterling Bank, our ability to continue signing contract with Tier 1 prospectus and the competitive advantages from supporting Tier 1 institution, the competitive advantage and market acceptance of our single platform solution. Our sales pipeline across all of our target markets including continued growth for Tier 2 and Tier 3 institution, our ability to implement new customers, our ability to successfully implement new product innovation, the demand for person-to-person payment solution and the anticipate success of our partnership with Acculynk and our ability to continue to achieve the target revenue growth our forward-looking statements. These statements are subject to a number risks, uncertainties and assumptions described in our SEC filings, including our Annual Report on Form 10-K for the year ended December 31 2014, filing with the SEC on February 12, 2015 and our Quarter Report on Form 10-Q for the quarter ended March 31, 2015, which we anticipate filing with the SEC on/or before May 11, 2015. Should any of these risks or uncertainties materialize or should any of our assumptions prove to be incorrect, our actual results could differ materially and adversely from those anticipated in these forward-looking statements. These statements are also based on currently available information and we undertake no duty to update or correct this information except as required by law. Cautionary statements regarding these forward-looking statements are further described in today’s press release. During the call, we will be referring to both, GAAP and non-GAAP financial measures. We believe that non-GAAP financial measures are more representative of how we internally measure the business and they are reconciled to GAAP tables attached to our press release available on our Investor Relations website. The non-revenue financial measures we will discuss today are non-GAAP unless we state the measure as a GAAP number. Any non-GAAP outlook we provide has not been reconciled to the comparable GAAP outlook, because among other things we cannot reliably estimate our future stock-based compensation expense, which is dependent on our future stock price. With that, thank you for joining us, and I will turn the call over to Matt Flake.

Thanks Bob, and thanks to all of you joining us today for our first quarter earnings call. I am pleased to share with you are start 2015 highlighted by our continuing strong revenue performance, driven by new customer go lives and are dedicated to excellent customer service and share some business details on today's call before turning it over to our CFO Jennifer Harris who will take you to our financial results in detail share our outlook for the second quarter. We are pleased to announce another quarter of strong revenue growth in the first quarter we generated total revenue of $24.2 million leading the high-end of our guidance of $23.8 million and up 44% year-over-year. I am particularly proud of record user growth in the quarter we added more than 800,000 users up 50% year-over-year and almost 20% sequentially and exited the quarter with 5.2 million registered end-users on the platform. We also took steps to continue to strengthen our balance sheet completing a follow-on offering of the company stock in February the rate approximately $32 million for the company. Customers and prospect alike are encouraged by our strong financial position in our ability to partner with them for the long-term. The first quarter saw the organization continuing to execute, I would like to some time on the call today to talk about our delivery execution because the ability to install and support customers large and small is an area of strength for Q2 and critical to our business. As I mentioned we added 800,000 users in the quarter, with a perspective that more users than we had in the system total for the first six years of the business. We’re pleased with the scale of the business and believe this reflects the capability of our single platform architecture. I am especially proud to announce the implementation of international Bank of commerce or IBC Bank during the quarter and more than $12 billion bank with large retail and commercial customer bases we signed IBC Bank in the second quarter of 2014 and completed their representation in the first quarter. For Q2 this is one of the largest customers we take on live in the success of IBC Banks implementation is another proof point of our ability to deliver these large institutions. The bank was impressed with both the pace of migration to the new system and the number of users to migrate and has already begun reaping the benefits of operating from a single platform. I’d also I give a quick update on the Umpqua Bank they recently completed their back-office migration to integrate Umpqua and Sterling. Nearly all of the Umpqua users are live on the system today and we look forward to integrating the Sterling users in the future. The success with IBC Bank and the progress with Umpqua gives me continued confidence in our ability to execute in the Tier 1 space. We believe installing and supporting customers of this size extends our competitive advantage in the marketplace. On the sales side our single platform continue to resonate with banks and credit unions and am pleased with our pipeline covered in all of our target markets. In addition to our recent Tier 1 successes the bread and butter of this business has historically been in the Tier 2 and 3 space and we continue to grow in the market. During the first quarter we signed Tier 2 Bank in the Southeast that shows the Q2 platform to replace the core providers online banking solution provided a much lower cost in our platform. This particular bank had already been successful on driving utilization of the digital channel with 80% of all transactions coming through online and mobile, but felt that consolidating from multiple products on the Q2 single platform would equip them with the superior customer experience and more holistic security strategy and consistent branding across the digital channel. I believe is when is a great example of the scalability of the platform and its ability to serve the needs of institutions large and small in virtually any stage of their digital strategy. Last quarter I mentioned our growing momentum in the credit union space we had a partnership with [NAVTEQ] and sign some credit union customers and we real to continue that momentum in the first quarter adding multiple credit union across the country. I’d like to talk about one of those wins in particular. A leading credit union in the West chose Q2 after an exhaustive search for new virtual banking solution. This is a competitive situation were Q2 display system providers we compete against frequently. This credit union required flexible solution that would both exceed the high expectation of their members while helping grow as a commercial business. The key component of the credit unions growth strategy and made the decision to purchase the Q2 platform for its ability to provide a modern consistent experience across devices and with retail and commercial functionality all on the same platform the credit union will be able to land and expand commercial business. Due to his reputation for delivering the poor and service was also mentioned is a key driver for their decision to convert the Q2. I believe these wins are representative of what we continue to perform favorably. The advantages of our single platform architecture continue to resonate with banks and credit unions. In our commitment to delivery the system up time and support help us provide superior customer experience. Now I would like to talk a little bit about the product specifically version 4.0 the platform which provides customers with a modern user experience and robust mobile commercial functionality. In November we referenced that we had 10% of our end-user based live on 4.0. Today I am pleased report that we have nearly 50% of our end-user based on 4.0. This is the most rapid pace of adoption for any version of our platform today the administrating our ability to innovate on our products and successfully help our customers realize their benefits. I'm excited to announce the new partnership on the product side as well. During the quarter we partnered with Acculynk a leading person-to-person payments provider that serves over 7000 issuers and 70 million cardholders. To bring integrated person-to-person payments on to the platform there's a considerable demand for P2P solutions in our market $8 billion were exchanged via P2P in 2014. And we believe are integration with Acculynk enhances our payment solutions to meet the needs of our customer base. Finally we’re committed to providing a superior customer experience and I am proud to report that for the ninth straight quarter. Since we began tracking this metric our customer satisfaction rating across implementation projects for new and existing customers is over 90%. This company was founded abroad more than great technology and we believe this metric captured our dedication to superior customer service and support a core tenant of our past success and our growth strategy going forward. In closing I’d like say were of to a strong start 2015. We've been a public company now for just over a year and in our short history due to has been characterized by great execution, meeting or exceeding commitments and 30 and top line growth. Going forward we will drive to continue executing against those standards. With that, I’d like to hand the call over to Jennifer discuss our financial performance.

Thanks Matt. Let me review our financial results for the first quarter before finishing with updated guidance for the second quarter and full-year 2015. We have pleased to have delivered first quarter revenue that exceeded the high end of our guidance. Total revenue for the first quarter with $24.2 million an increase of 44% year-over-year and up 9% from the previous quarter. Our increased revenue in the first quarter was the result of strong growth in subscription revenue. Subscription revenue benefited from record user growth as we had over 800,000 registered users during the quarter. User growth was driven primarily by new customer go lives in the quarter, while also benefiting from organic growth in our existing customer base. The strong user growth increase subscription revenue as a percentage of total revenue and therefore positively impacted gross margin. Transactional revenue increase in absolute dollars they declined to 21% of total revenue in the quarter, down from 22% of revenue in the previous quarter and down from 24% of revenue in the first quarter of last year. As a reminder Tier 1 customers typically do not purchase bill pay from Q2 and therefore to the extent revenue growth is from Tier 1 customers the transaction revenue will continue to decline as the percentage of total revenue. As we turn to gross margin and operating expenses, please note that unless otherwise stated, all references to our expenses and operating results are on a non-GAAP basis. Gross margin was 45.8%, up sharply from 42.8% in the fourth quarter and 40.1% in the year ago period. The year-over-year improvement was primarily attributable to growth in subscription revenue and increase productivity of headcount and data center investment. The sequential increase was due to a combination of improved product mix and a shift in timing of resources and capital investment. Turning to operating expenses we continue to invest in our business with particular focus on research and development to continue our pace of rapid innovation. Total operating expenses were $14.3 million, up 28% from one year ago and up 13% from the previous quarter. Sales and marketing expenses were $5.9 million up 10% year-over-year and up 4% sequentially. The year-over-year increase was primarily due to investments in headcount by the sequential increase was driven by higher spending on T&E and sales automation tool. Research and development spending was $4 million, up 52% year-over-year and up 23% from the previous quarter. The increase R&D spending both year-over-year and sequentially largely reflects increased headcount to support our expanded product. Research and development spending in the quarter was also contacted by a shift of resources from customer support and implementation activities to forward software development, thereby reducing the allocation of development resources classified at cost of sale and contributing to the improvement in gross margins referenced earlier. General and administrative expenses for $4.4 million up 39% from a year ago and up 18% from the previous quarter. The increase with the result and the associated payroll taxes as well as higher spending on professional services, including our year-end audit. We continue to expect to pace of G&A spending growth to moderate and to decline as a percentage of revenue in 2015. Adjusted EBITDA was negative $2.1 million down from negative $3.4 million in the first quarter of 2014 and down slightly from negative $2.2 million in the previous quarter. The improvement was driven primarily by the higher revenue and gross margin. We ended quarter with cash, cash equivalent and investment of $119.7 million, up from $88.9 in the previous quarter. The increase was driven by approximately $34 million in proceeds from a combination of our equity offering in February and the exercise of stock options during the quarter. Partially offset by cash flow from operations for the first quarter of negative $2.6 million and approximately $440,000 of capital expenditures. Our deferred revenue on March 31 with $39.6 million, up from $36.7 million in the previous quarter. The increase in deferred revenue reflects customer deposits collected during the quarter, partially offset by revenue recognized during the quarter for services engagement. I'd like to remind you that we build a majority of our customers for their subscription fees on a monthly basis and collect customer deposits in advance of implementation. And therefore we do not believe it meaningful to look at deferred revenues and indicator of future revenue. I would also point out that we signed two Tier 1 customers at the end of 2014 and those deposits were collected in the first quarter of this year boosting the deferred revenue balance. Our day sales outstanding for the quarter with 27 day down from 31 days a year ago, but slightly from 20 days in the fourth quarter of 2014 are consistently low DSO is the function of our monthly billing and a high credit quality of our customers. Let me wrapped up by sharing our second quarter and full-year 2015 guidance. We forecast second-quarter revenue in the range and $25.4 million to $25.8 million and we are raising full-year revenue to arrange of $105 million to $107 million representing 33% to 35% year-over-year growth for the full-year. We forecast second-quarter adjusted EBITDA of negative $3 million to negative $2.4 million and negative $10 million to negative $8.5 million for the full-year 2015. The projected sequential decline in adjusted EBITDA is the result of our client conference that occurs in the second quarter of each year. We expect headcount addition across the organization and the client conference to moderate the pace of adjusted EBITDA improvement in the second quarter. However revenue growth and improved margin should combine to deliver improvements in the back half of the year. In summary the first quarter clearly demonstrated the leverage in our business record user growth drove strong revenue performance and resulted in significant gross margin expansion and improvement in adjusted EBITDA. We remain committed to our long-term financial targets and believe we are poised to deliver on 30 plus percent revenue growth, annual gross margin expansion and improvement in adjusted EBITDA. Now let me turn it back over to Matt for his closing comments.

Thanks Jennifer. We’re pleased with the progress of the business and I would like to close by sharing that we recently hosted our annual client conference in Austin. Year-after-year this event is an opportunity for us to meet face-to-face with our customers and with over 400 Bank and credit union attendees. I would like to report that we had record participation from customers, partners, and prospects of this year's conference. The overwhelming message for customers with that we remain strategically aligned. The conference left the company and the attendees energized and optimistic about the opportunity ahead of us. With that, let me turn it over to the operator for question.

Thank you. [Operator Instructions] Your first question is from Sterling Auty with JPMorgan. Your line is open.

Hi, guys. Its Jackson on for Sterling. One question from us the user edition one that they come in the quarter was mostly front end or back end loaded.

Yes, Jackson this is Jennifer. So they came on throughout the quarter, but a significant portion of them went on at the end of the quarter as we brought some of those guidelines that we expected to happen early in Q2 and to the end of Q1.

So does that actually pool your expectation for the second quarter user editions to that – if that coming down at all or I guess how was this quarter shaping up in terms user edition.

It really bounces around it depends a lot on the timing of the banks and their organizational readiness to go live it is currently pulling down what we thought would be Q2 editions because we had we pulled some of them into Q1 its too early in the quarter to tell whether working to be able to pool in any from Q3 or whether any that are scheduled to go live at the end of Q2 might push for some reason on the bank side. But I wouldn't expect the pace of growth that you Q1 again in Q2.

Fair enough and then one more you mentioned Umpqua I think that almost all of their users are live there is another chunk that are coming soon. How large is that the second wave of users compared to the first.

We don’t disclose the number of users that are - the bank intends to use and that is scheduled for sometime in the back half of 2015 or first half of 2016. So it's really their schedule and they can drive they had a lot of technology changed since the Internet banking conversion as well as the core conversion on the back end. And so we never they're ready to do that conversion will be ready to go, but we don't disclose the amount in the number users.

Okay thanks guys.

Thanks, Jackson I appreciate it.

Your next question is from Tom Roderick with Stifel Nicolaus. Your line is open.

Yes, Matt [indiscernible] for Tom. Thanks for talking my question. The first one you announced the new peer-to-peer payment product how that one be priced and available for your customers relative to say bill payer or some of the other offerings that you have.

Hi, Matt, good question. Partnership with Acculynk for the P2P is going to be priced at a there's a the slight imitation fee to get up and running and then as a per payment fee that the financial institution will pay and they usually charge sometimes they charge to that back to their – some of it to their customers and we take a percentage of that as well.

Okay and then on the - the rapid implementation of version 4 that you saw here in the first quarter. Are you expecting to get done with the whole thing and maybe sooner than expected or was this potentially some assertive delays going into the end of the year is banks don't want to take on version conversion. And then you can accelerated here in the first half of the year.

Yes, I think on the earnings call in the fourth quarter I think I’ve talked about we anticipated about 50% adoption in 2016. So were clearly ahead of schedule I think you'll see especially after the client conference and being able to talk to the other customers that were there you'll see us ahead of schedule it's hard to say 100% I don't think you'll hit 100% in 2016. But I would think the majority of our customers would be on the system by the end of the year.

2015 just to clarify.

Yes, 2015 I am sorry.

Okay and then follow up on one of the other questions there that you had a pretty big chuck of the users come on near the end of the quarter. Just in terms of kind a high level quantity could you give us may be a little more color just so we can kind understand how much impact they had on this quarter versus you know having a full quarter in 2Q.

Because his Matt discussed in his script one of those we brought on a bit earlier than anticipated with IBC which has a relatively large user base and they did come in late in the quarter, but they also tend to be fairly significant amount of revenue and so the impact to the current order and what probably a good portion of the overachievement from the analyst consensus, but was already baked into Q2 because we had had them fairly early in Q2 going live. So I don't expect a big impact or big overage from the time in Q2.

One last one for me, obviously the user conference talk about is very successful how do you think about one played out in terms of looking at maybe the Tier 1 pipeline this time and just kind of whereabouts that after you had such a strong year last year.

Yes, thanks I think the only things we’ve talked about Matt is the important to the marketplace the banks of delivering our application in production and so when you think about Umpqua and IBC and we’re making tremendous progress on the other Tier 1s, those of the questions that our perspective Tier 1s - are those of the questions that they asked is tell me about words in production where I can see running. And so are overachievement on the delivery of the software to our existing Tier 1 customers plus we have a lot of customers of grown up to be Tier 1s means a lot. So the client conference we did have some Tier 1 prospects that were the there and they were able to kind have unfettered access candidly to the Tier 1s that are customers there and I think it is going play pretty well. We had more Tier 1s in the pipeline would never had to have more RFPs from Tier 1 then we've ever had in our brand awareness is growing adding $30 plus million the balance sheet done her as well. So I feel a lot of momentum there and we’re really excited about how the products performing in that space as well.

All right, thanks great quarter.

Thanks Matt.

Thanks Matt.

Your next question is from Richard Davis with Canaccord. Your line is open.

Thanks very much, I was a call back but security is a big topic these days do you have update on kind of customer demand and functionality on that front and also this to any discussion on the competitive environment especially as you kind move up market you kind move into a slightly different part of the sandbox. Thanks.

Thanks Richard. Security update our security story bill seems to be unique in the marketplace behavioral analytics tied to mobile tablet desktop experience with appear to be the only vendor author that has a fully integrated from the ground up, system that we build our own we also partner with easy solutions which does outside of this browser authentication we sold a lot of that they have - they were very well received in our client conference easy solutions will beginning to sell quite a bit of that. So our security story seems to be unique and seems to help us close a lot of deals as I said in the past we lead with our chin when it comes to security and that the big differentiator when you talk to prospects. As far as other competitive market that there's no changes the same group of competitors whether its Tier 1, Tier 2 or Tier 3 is just different flavors other stuff and we still compete favorably in and all those bases.

Thanks Matt.

Thanks Richard.

Thanks Richard.

Your next question is from Terry Tillman with Raymond James. Your line is open.

Hi, this is Brian Peterson and for Terry. You mentioned a couple credit union wins this quarter on any perspective on if that’s coming [technical difficulties] or from some of your partners there and just curious on your sales force hiring efforts any update their.

Thanks Brian. The credit union this quarter NAVTEQ is a partnership to where we know that we signed in the third quarter is their helpful through as they were at our client conference help and so there are trusted advisor that helps us helps credit unions come to the decision. So in that sense there part of those decisions but they're there they come to us from our direct sales organization and in the other question. On the sales hiring we are continuing to add sales reps we think will add you somewhat in that in the about the 30% range, 30% growth in the sales spending and in 2015 I would say that there some seasonality to it if you think about a lot of sales reps try to finish out the year at the company there with get their commission checks and they join us in the second and third quarter. So I think you probably see lift in and sales spending in the back half of the year. But will continue to invest 3% penetrated we got a lot of opportunity in front of us to go get

Okay.

Thanks Brian.

On the gross margins you said with the shift in some of the resources in the R&D issue we continue would assume that's going to stay the same or we are going to seeing any more fluctuation there.

I think you're going to maybe be a little bit of fluctuation on a quarterly basis given the capacity that we have with implementation but I think now that we have the capacity built up and we’re continuing to hire ahead of that demand and implementations I do believe that the amount of debt resources that are focused on that. We will continue to stay at level such as they were in Q1 and we factored all of that into our forward guidance.

Okay thank you.

Thanks Brian, appreciate it.

[Operator Instructions] Your next question is from Spencer Bogart with Needham & Company. Your line is open.

Hi, guys two one of the sign last year. What percentage of their available user base is set the model that we can walk us through how they get rolled out through the year?

What percentage of their user could you add that question again Spencer.

Yes, available user based so how many of them are actually using the system now.

Let me we don't disclose number of users and individual bank let me talk about the customers and the status on which is we signed five last year we have delivered one of those in the first quarter which is IBC even my was sent to them at the end of the year we anticipate taking a parts of them of the of the three to we signed in the first half year live in the next two quarters. And then we anticipate the two we signed at the end of the year coming live at the end of 2015 or in the first quarter of 2016 depending on if we kind can get caught in the holidays at the end of year was a lot times can push the conversion. So that would be a better way to look at in the number of users.

Great. Thanks guys and could you give us an update on the treasury product which is rolled out last quarter and what type of respective are you seen in the market and how can you differentiate in deals.

Thanks for the question Spencer we obviously got the roll the treasury product out of the client conference and it was well received its a living breathing thing and the customer say keep giving more we more and more feature functionality. The think it was really interesting was a lot of customers if said we have never had access to technology like this without having to go by a standalone system pay a license and the service dollars. So we can just roll out Q2s platform and rollout this feature function as workflows for the larger customers just by binary platform that we don't have to – the cost associate with standalone products. So that was very well received and I think you're beginning to see you begin to see that treasury will have an impact on our bookings in 2015 and 2016 is it something that differentiates us as we put pressure our competitors to answer the questions around what’s you are going to do around treasury in those type solutions. So you are not going to see anything in 2015 - anything material 2015 is a revenue but in 2016 and 2017 and beyond you are going to begin to see the impact of our investment treasury. So thank you for the question.

So and just one for me. Let me think about the split between credit union versus bans in the quarter. How does that compare with what you are seening in the pipeline?

Well, I would say we’ve got lot of momentum in the credit union space, but we are still doing well on the bank side from the pipeline perspective the pipeline in all tiers and all sizes is growing and so Tier 1, Tier 2, Tier 3 there is growth in the pipeline and that's what sort I look at make sure the help of the business to make sure were begun to build deliver on the 30 plus percent top line growth for the foreseeable future.

Thanks for that color.

Thanks Spencer. End of Q&A

There are no further questions at this time and this will conclude today's conference call. Ladies and gentlemen you may now disconnect.