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Q2 Holdings (NYSE:QTWO) Misses Q3 Revenue Estimates, Stock Drops


Full Report / November 07, 2022
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Banking software provider Q2 (NYSE:QTWO) fell short of analyst expectations in Q3 FY2022 quarter, with revenue up 14.2% year on year to $144.7 million. Guidance for the next quarter also missed analyst expectations with revenues guided to $149.4 million at the midpoint, or 5.18% below analyst estimates. Q2 Holdings made a GAAP loss of $27.7 million, improving on its loss of $31.5 million, in the same quarter last year.

Q2 Holdings (QTWO) Q3 FY2022 Highlights:

  • Revenue: $144.7 million vs analyst estimates of $146.7 million (1.37% miss)
  • EPS (non-GAAP): $0.10 vs analyst estimates of $0.04 ($0.06 beat)
  • Revenue guidance for Q4 2022 is $149.4 million at the midpoint, below analyst estimates of $157.5 million
  • Free cash flow was negative $3.86 million, compared to negative free cash flow of $11 million in previous quarter
  • Gross Margin (GAAP): 46.1%, up from 45% same quarter last year

Founded in 2004 by Hank Seale, Q2 (NYSE:QTWO) offers software as a service that enables small banks provide online banking and consumer lending services to their clients.

Small, regional and community banks often lack the resources required to manage their own tech infrastructure, making it difficult for them to compete with polished offerings of large national banks. Q2’s cloud-based platform provides them with mobile apps and websites that have the same functionalities big banks offer and allows them to put their own branding on it.

Q2 then handles all the regulatory compliance and security and provides banks with data-based insights on their customers, allowing them to offer more personalized products and better customer service.

Consumers these days are accustomed to frictionless digital experiences from online shopping to ordering food or hailing a cab. Financial services firms are notoriously risk averse in adopting modern software, often lacking the resources or competency to develop the digital solutions in-house. That drives demand for software as a service platforms that allows banks and other finance institutions to offer the digital services without having to run or maintain them.

Q2 and companies like nCino (NASDAQ:NCNO) or Alkami (NASDAQ:ALKT) are offering them a chance to keep up with the bigger players in the market.

Sales Growth

As you can see below, Q2 Holdings's revenue growth has been strong over the last two years, growing from quarterly revenue of $103.8 million in Q3 FY2020, to $144.7 million.

Q2 Holdings Total Revenue

This quarter, Q2 Holdings's quarterly revenue was once again up 14.2% year on year. But the growth did slow down compared to last quarter, as the revenue increased by just $4.44 million in Q3, compared to $6.23 million in Q2 2022. We'd like to see revenue increase by a greater amount each quarter, but a one-off fluctuation is usually not concerning.

Guidance for the next quarter indicates Q2 Holdings is expecting revenue to grow 13.2% year on year to $149.4 million, slowing down from the 21% year-over-year increase in revenue the company had recorded in the same quarter last year. Ahead of the earnings results the analysts covering the company were estimating sales to grow 19.2% over the next twelve months.

Profitability

What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Q2 Holdings's gross profit margin, an important metric measuring how much money there is left after paying for servers, licenses, technical support and other necessary running expenses was at 46.1% in Q3.

Q2 Holdings Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.46 left to spend on developing new products, marketing & sales and the general administrative overhead. While it improved significantly from the previous quarter this would still be considered a low gross margin for a SaaS company and we would like to see the improvements continue.

Cash Is King

If you follow StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. Q2 Holdings burned through $3.86 million in Q3,

Q2 Holdings Free Cash Flow

Q2 Holdings has generated $7.96 million in free cash flow over the last twelve months, 1.44% of revenues. This FCF margin is a result of Q2 Holdings asset lite business model, and provides it with at least some cash to invest in the business without depending on capital markets.

Key Takeaways from Q2 Holdings's Q3 Results

With a market capitalization of $1.52 billion Q2 Holdings is among smaller companies, but its more than $395.6 million in cash and positive free cash flow over the last twelve months give us confidence that Q2 Holdings has the resources it needs to pursue a high growth business strategy.

We enjoyed seeing Q2 Holdings’s improve their gross margin materially this quarter. That feature of these results really stood out as a positive. On the other hand, it was unfortunate to see that Q2 Holdings's revenue guidance missed analysts' expectations. Overall, this quarter's results could have been better. The company is down 5.64% on the results and currently trades at $24.89 per share.

Is Now The Time?

Q2 Holdings may have had a bad quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. Although Q2 Holdings is not a bad business, it probably wouldn't be one of our picks. Its revenue growth has been solid, and analysts believe that sort of growth is sustainable for now. Unfortunately, its gross margins show its business model is much less lucrative than the best software businesses.

Q2 Holdings's price to sales ratio based on the next twelve months is 2.3x, suggesting that the market has lower expectations of the business, relative to the high growth tech stocks. In the end, beauty is in the eye of the beholder. While Q2 Holdings wouldn't be our first pick, if you like the business, the shares are trading at a pretty interesting price point right now.

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