Good afternoon. My name is Kellie and I will be your conference operator today. At this time, I would like to welcome everyone to the Q2 Holdings Second Quarter Results Conference Call. [Operator Instructions]. Bob Gujavarty, you may begin your conference..

Welcome to Q2 Holdings' earnings call for the second quarter, ending June 30, 2015. I'm 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.

Please remember that certain statements made during this call -- including those concerning, our business and financial outlook for the third quarter and full-year 2015; our ability to continue signing larger financial institutions and successfully implement them and the competitive advantages resulting therefrom; the shift in financial institution purchasing model from single vendors to multiple vendors and Q2's ability to benefit from this shift; our growth opportunities and expectations; our long-term financial targets and ability to achieve them; our ability to timely implement customers, large and small; anticipated spending to address our growth; anticipated registry user growth; benefits of the 2015 NAFCU Services Innovation Award; anticipated benefits and financial impacts of the Centrix acquisition; anticipated improvement in financial measures; and the competitive advantages of and market acceptance of our single-platform solution -- are forward-looking statements.

These statements are subject to a number of risks, uncertainties and assumptions described in our SEC filings, including our annual report on Form 10-K for the year ended December 31, 2014, filed with the SEC on February 12, 2015 and our quarterly report on Form 10-Q for the quarter ended June 30, 2015 which we anticipate filing with the SEC on or before August 10, 2015.

Should any of the 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 this information except as required by law. Cautionary statements regarding these forward-looking statements are further described in today's press release. During this call, we will be referring to both GAAP and non-GAAP financial measures.

We believe that non-GAAP measures are more representative of how we internally measure the business and they reconcile to GAAP on the 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'll turn the call over to Matt Flake..

Thanks, Bob and thanks to all of you for joining us today for our second quarter earnings call. During today's call, I'd like to share some business details with you before turning it over to our CFO, Jennifer Harris, who will take you through our financial results in detail and share our outlook for the third quarter and full year of 2015.

We're pleased to announce another quarter of meeting or exceeding forecasts. In the second quarter, we generated total revenue of $26.3 million, beating the high end of our guidance of $25.8 million and up 37% year over year.

We ended the quarter with 5.7 million registered users, as we added nearly 500,000 users in the second quarter, up 44% year over year and almost 10% sequentially. We continued to execute during the second quarter by signing new customers in all tiers and successfully implementing customers previously signed.

I'd like to take a moment to discuss a few of our wins from the quarter before sharing some highlights from across the organization.

During the second quarter, the sales organization executed across all of our target markets, the quarter was characterized by strong performance in the tier one space, but I'd like to remind investors that the foundation of Q2's business is built on success with tier two and tier three financial institutions.

That continues to be the bedrock of Q2's success and we will continue to pursue broad-based growth across the tier one, tier two and tier three financial institutions. With that, the sales highlights from the quarter included the addition of two tier one financial institutions.

The first was First Republic Bank, a $51 billion bank headquartered in San Francisco, California. The addition of First Republic demonstrates our continued expansion up market and our ability to meet the needs of more complex financial institutions. I'm extremely proud of the team and all the effort that went into this win.

During the quarter, we also signed a top-25 credit union based in the Midwest which chose Q2's platform to replace its current solution. This credit union required a responsive, innovative partner that would help push its technology forward and cited our track record of innovation as a key driver for its selection of Q2.

We believe that financial institutions large and small are increasingly moving away from the model where financial institutions purchase all their solutions from a single vendor, traditionally their core service providers, to a model that instead is open to segregating their front-end systems from their back-end systems.

We believe our industry-leading, single-platform solution is well positioned to benefit from this change, as evidenced by our continued growth in the tier two and tier three markets, as well as the seven tier one institutions we've signed since our initial public offering.

We believe Q2 is well positioned to continue to execute on its target annual revenue growth rate of 30-plus-percent for the foreseeable future. I'm pleased with our execution and momentum on the net new side of the business and this momentum will require some incremental investment to bolster our implementation teams.

You'll likely see some of this investment come in the back half of this year in order to support our pipeline and the timely implementation of new customers. As I mentioned earlier in the call, we continued to execute on taking new customers live on our single-platform solution.

Our delivery efforts during the quarter included the implementation of two of our tier one signings from last year, American Airlines Credit Union and Trustmark National Bank. American Airlines Credit Union is a top-50 credit union that serves a large, mobile membership base.

We signed American Airlines Credit Union in the second half of 2014 and were able to complete their implementation during the second quarter. Trustmark, a leading bank in the southeast with $12 billion in assets, went live on the platform in the second quarter, as well.

They are excited about our execution on their implementation and they are pleased to be seeing a significant increase in virtual banking interactions as a result of consolidating online and mobile onto a single platform.

Our implementation success in the quarter gives me continued confidence in our ability to execute across our markets and I believe extends our competitive advantage in the marketplace, helping us build momentum in selling to institutions of all sizes.

We've added more than 1.2 million registered users in the first half of this year, but I will caution you that the back half of this year is seasonally slower in terms of customer go-lives. And therefore, we don't expect to sustain this pace in the second half of 2015.

With that said, I am confident you're going to continue to see strong user growth in 2016.

Since becoming their preferred partner for online and mobile solutions last year, the National Association of Federal Credit Unions has been a great partner to us and I'd like to thank them for recognizing us as a winner of their 2015 NAFCU Services Innovation Award at their conference in May.

The NAFCU Services Innovation Award is one of the industry's most recognized award competitions for credit union solutions. We're honored to receive this recognition for innovation from NAFCU. It signifies our commitment to delivering innovative products to our customers and we believe it will strengthen our momentum in our target markets.

There's a lot of innovation in the credit union market and I'm proud that Q2's virtual banking platform was chosen amongst the competition. Finally, we're 11 years into this business and we're proud to have grown Q2 organically to more than $100 million in projected annual revenue.

Last week, we entered into a new stage in our growth, having announced the acquisition of Centrix Solutions, the financial services software company that provides scalable products and services that assist financial institutions with fraud management, risk mitigation and compliance. Q2 has partnered with Centrix since 2007.

As part of this partnership, Q2 has resold the Centrix product, as they are complementary to our own. I'm excited to welcome the group of passionate and talented individuals to Q2 and I believe the addition of Centrix further equips us to capitalize on the large market opportunity ahead of us.

In closing, I'd like to say I'm proud of a very strong second quarter for Q2. We executed well across the organization, expanded our customer and user base and won the NAFCU Innovation Award. I'm proud of everything we accomplished in the quarter and I'm excited about where we're going.

With that, I'd like to hand the call over to Jennifer, to discuss our financial performance..

Thanks, Matt. Let me start by reviewing our results for the second quarter. I will then finish by providing updated guidance for the third quarter and full year 2015, as well as some comments around the impact of the Centrix acquisition. We're pleased to have delivered second quarter revenue that exceeded the high end of our guidance.

Total revenue for the second quarter was $26.3 million, a year-over-year increase of 37% and a sequential increase of 9%. This revenue overachievement along with strong subscription revenue growth drove both the sequential and year-over-year increases.

Our revenue overachievement in the second quarter was enhanced by a non-recurring services engagement related to a core processing conversion for one of our largest customers.

While services revenue grew as a result of the core processing conversion, subscription revenue benefited from user growth, as we added nearly 500,000 registered users during the quarter. User growth was a combination of new customer go-lives in the quarter and organic user growth within our existing customer base.

Transactional revenue continued to increase in absolute dollars while declining to 20% of total revenue, down from 21% of total revenue in the first quarter and down from 23% of total revenue in the year-ago period.

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 47.1%, up from 45.8% in the first quarter and 44.2% in the year-ago period.

The year-over-year improvement was attributable to growth in higher-margin subscription revenue and an increase in services margins related to the previously mentioned core processing conversion.

The sequential improvement was primarily attributable to a combination of the higher-margin services revenue and a continued shift of development resources from customer support and implementation activities to forward software development, thereby reducing the allocation of development resources classified as cost of sales.

I would point out that the conversion was completed in the second quarter and was responsible for approximately half of the sequential increase in gross margin. Turning to operating expenses, we continued to invest in our business, with particular focus on research and development as we look to accelerate our product road map.

Total operating expenses were $15.7 million, up 32% from one year ago and up 10% from the previous quarter. Sales and marketing expenses were $6.6 million, up 14% year over year and up 13% sequentially.

The year-over-year increase was primarily due to investments in headcount and marketing programs, while the sequential increase was driven by higher spending for our customer conference held during the quarter. Research and development spending was $4.6 million, up 72% year over year and up 15% from the previous quarter.

The increased R&D spending, both year-over-year and sequentially, largely reflects increased headcount to support an expanded product road map.

We also continued to see a shift of resources from customer support and implementation activities to forward software development, thereby reducing the allocation of development resources classified as cost of sales and increasing the research and development operating expenses.

General and administrative expenses were $4.5 million, up 31% from a year ago and up approximately 2% from the previous quarter. Both the year-over-year and sequential increases were largely a result of higher headcount-related spending and costs associated with operating as a public company.

Adjusted EBITDA was negative $2 million, down from negative $2.5 million in the second quarter of 2014 and down slightly from negative $2.1 million in the previous quarter.

The sequential improvement was driven primarily by the higher than anticipated revenue and gross margin which was partially offset by increased headcount and our annual customer conference. We ended the quarter with cash, cash equivalents and investments of $118.5 million, down slightly from the previous quarter.

The company generated approximately $3 million in cash flow from operations during the quarter which was partially offset by $1.9 million of capital expenditures and a $2.2 million payment related to equipment financing.

The increase in operating cash flow was driven predominantly by the collection of customer deposits in advance of implementation and other services being performed which resulted in deferred revenue of $43.4 million at June 30, up from $39.6 million at March 31.

Also contributing to the increase in operating cash flows is the decrease in our day sales outstanding, to 24 days, down from 27 days in the prior quarter and 26 days in the year-ago period. Let me wrap up by sharing our third quarter and full-year 2015 guidance.

We forecast third quarter revenue in the range of $27.4 million to $27.8 million and we're raising full-year revenue to a range of $107.4 million to $108 million, representing 36% to 37% year-over-year growth for the full year.

We forecast third quarter adjusted EBITDA of negative $2.5 million to negative $2 million and negative $9 million to negative $8 million for the full year 2015. The projected sequential decline in adjusted EBITDA is the result of increased investments in implementation to support tier one go-lives and the impact of annual merit increases.

As Matt mentioned, we're seeing momentum in the tier one market and these customers typically require a longer implementation. To ensure we have the capacity to support these larger customers, we will add incremental resources in the second half of the year.

We will also continue to make select investments across the R&D organization to accelerate our product road map. Finally, I'd like to outline the impact of the Centrix acquisition to our financial guidance.

Centrix derives its revenue from a combination of subscription fees for access to the use of their software solutions, term-based license fees and related implementation and maintenance fees. Therefore, their revenue model is very similar to ours, as is the length of their contracts.

They have not been able to obtain standalone value for their implementation fees and thus they are recognized ratably over the term of the underlying subscription.

Additionally, because Centrix has not established vendor-specific objective evidence of fair value for the maintenance and related services associated with their term licenses, the entire arrangement consideration is recognized monthly over the software license term once all of the revenue recognition criteria are met.

Therefore, their revenue model is very similar to ours and the substantial majority of their revenue is recognized ratably over the term of the underlying agreements once implementation is complete. Centrix has historically posted revenue growth rates consistent with our 30-plus-percent top line growth.

However, we expect the revenue contribution from Centrix to be limited in 2015, due to the timing of the transaction as well as the purchase accounting adjustments we expect to take in regards to the deferred revenue balance on their books as of July 31.

We do expect the acquisition to be accretive to gross margins based on the reduction in our costs from the ongoing sales of Centrix products and we also believe it will be accretive to operating margins in 2016 as we fully integrate the business.

Given that we just closed the acquisition last week, we have some work to do to finalize the allocation of the purchase price and book all the related purchase accounting entries.

However, even with a fairly significant haircut to the deferred revenue balance acquired at July 31, we believe that the Centrix acquisition will contribute approximately $4 million in revenue to our 2016 financials, with the largest impact being in the second half of the year once the impact of the deferred revenue adjustment becomes minimal.

In summary, the second quarter was marked by strong growth in registered users, significant customer wins and continued improvement in gross margin and adjusted EBITDA. While we expect the pace of these margin improvements to moderate in the near term, we're on track to deliver meaningful year-over-year margin improvement.

Now, let me turn it back over to Matt for his closing comments..

Thanks, Jennifer. We're pleased with our execution and delivery, continued end users growth and strong sales momentum in all of our target markets. These are encouraging signs and suggest to me continued success. The Centrix acquisition is a significant milestone for the company.

We believe adding their products will help us expand our total addressable market, while also being accretive to gross margins and potentially accelerating our revenue growth. I think the market is continuing to shift, as financial institutions undergo a widespread technology refresh and demand for industry-leading front-end solutions grows.

Q2 is well positioned to capitalize on this shift and we fully intend to continue attacking the market and investing into the business in order to do so. With that, let me turn it over to the Operator for questions..

[Operator Instructions]. Your first question comes from the line of Terry Tillman from Raymond James. Your line is open..

This is Brian Peterson, in for Terry. Matt, just wondered on your comments on the net adds -- or the lives on the platform in the back half of the year. Obviously, you're already up above 2014 levels in the first half.

But I'm just curious, is it implementation capacity? Or, is it customer desire? Why wouldn't those kind of continue at the current pace in the back half and shift more into 2016?.

Brian, it's really about seasonality. If you think about the summer eats into some of your -- people try to get it done before August, before they go on vacation. And then, if you don't get implementation in before Thanksgiving, typically you're going to roll to next year. And you saw the seasonality in it this year.

We did about $800,000 in the first quarter. So, it's seasonality and we've talked about it in the past..

And just maybe a broader perspective on the product road map? As you move a little bit more upstream into tier ones, just curious, does that change the decision on build versus buy, just given that some of the larger customers might look to buy more product from you?.

Not really. We know we're going to continue to build the products that we're really good at. So, that would be designing beautiful products, mobile technology, commercial offerings, security products, as well as some of the analytics things that we do.

But the Centrix acquisition is an example of a place where those guys have deep domain expertise, have done some really complicated work flows and we wanted to buy that because it was a lot better than to try to go and build it, from all the man-years they put into it.

So, we'll keep with the same discipline we've had, but we will always look at buy, build or partner from a decisioning process on product..

[Operator Instructions] Your next question comes from the line of Peter Heckmann from Avondale. Your line is open..

Jennifer, I was hoping to get from you -- I may have missed it because my call dropped for a moment -- but did you quantify the non-recurring services revenue related to the core conversion in the quarter, both on the revenue line and the gross margin line?.

We did not quantify the impact of it. On the revenue line, we said it was a significant portion of our overachievement. And we said that the improvement quarter over quarter on the gross margin came from about half from that non-recurring impact..

And then, totally acknowledging what you're saying as regards to financial institutions looking at best-of-breed solution providers, but we did notice a couple of weeks ago that it looked like there was potentially a competitive take-away by one of the large core providers, being a competitive win on core as well as virtual banking [indiscernible] that we believe is one of your tier one customers.

Would that be something that is counter-trend and more of a data point than anything you would suggest it would be, something of a trend?.

Pete, I would say that --. It's PacWest, is the opportunity you're talking about. We hate losing any customer. With that said, I would remind everyone that PacWest is in all likelihood going to be running on our application through 2016. So, from a modeling perspective, they're going to have minimal impact coming out.

We're not changing any of our communicated churn numbers of less than 5% in those years. To provide a little color on that, why I think it's unique is if you look at PacWest, they've been a customer of ours for a long time.

They've gone from sub-$5 billion in assets to about $16 billion in assets over the last five to seven years and they've done that through acquisition. So, there is a consolidation at an enterprise level of not just electronic banking, but core processing and payments and all those different systems.

And so, the bank has to go and they've got a lot of really big decisions to make. And we just don't chase that kind of business. And so, at the end of the day, FIS and Fiserv are going to have those situations where they're going to be at an advantage. But not many banks go from sub-$5 billion to $16 billion in five years through acquisition.

So, there's nothing to worry about. I'm not worried about anything as far as that trend. We still win a lot of deals, as you can see from the press release..

And I think that the wins [indiscernible] public, the other tier ones, it's something that you can easily grow through. But just one last question and I'll get back in the queue.

As regards First Republic, given the real substantial size of that organization, give us some sort of sizing in terms of what you would expect to expense for implementation costs over the next, let's say, six quarters before bringing that one live in early 2017?.

Pete, you said the implementation cost?.

Correct..

Let me start off by saying First Republic was kind enough to allow us to share limited information on this signing, just due to the materiality of the contract. With that said, I'll honor there what we've agreed to do and I can't share the cost associated with it, with implementing them.

The timing of them, essentially we've communicated that tier one deals take about 12 months to deliver. These guys are going to be on the longer end of that. So, I would anticipate late 2016. So, if you're trying to model this, I don't see First Republic having much of an impact on revenue in 2016.

So, that's kind of all I can share on that from the relationship perspective..

And your next question comes from the line of Richard Davis from Canaccord. Your line is open..

This is Mark, on for Richard. Two questions for me. First, on Centrix, you've been partners for quite some time.

So, I guess, why was now the right time to bring them into -- and complete the acquisition? And then, second, just can you give us an update on your sales hiring and how you're tracking against your targets for the year?.

So, I'm glad you asked about Centrix. We have partnered with them since 2007. The timing came down to a couple of things. If you look at -- the first thing that we wanted to do was make sure that it was a great cultural fit and we've worked with them since 2007 and I've known a lot of that team since the early 2000s.

So, they're of the highest integrity. We know the product very well. So, we've resold one of the products since 2007 and less than -- just about 1/3rd of our customers use that product today. It's high quality and it's in high demand. If you think about the products also, they are around fraud mitigation, risk management and compliance.

Those are three very hot topics in all of the customers that we talk with or prospects that we talk with today. So, the product fit really well for us. And then, we've talked about these criteria.

We want to make sure we at least -- when we make an acquisition that somebody is going to expand our total addressable market or enhance our gross margins or help enhance our growth of 30-plus-percent that we've communicated. They met all three of those criteria, rather than one. And so, for us, it's a very low-risk acquisition.

Some of the why now? For them, I think that they got to see the impact of Q2 going public and what it meant to us, because they're in on a lot of deals with us. And the transparency in the balance sheet. And they started to run into some of those issues on their side which was all the due diligence that came down on them.

And they said, hey, you guys are winning a lot of deals. And I think they probably view us mutually as well from a great cultural fit. We have people up there in Lincoln today. We've been up there for the last couple of weeks. It's just a great team. We're excited about it. We think this is a tremendous opportunity with very low risk.

So, it was a great pickup for us. As far as the sales hiring, we're still on pace to hire the sales organization at about 30% adds on the sales side this year..

There are no further questions at this time. I would like to thank you for participating in the Q2 Holdings second quarter earnings results call. You may now disconnect..