Banking software provider Q2 (NYSE:QTWO) reported results in line with analysts' expectations in Q2 FY2023, with revenue up 10.1% year on year to $154.5 million. However, next quarter's revenue guidance of $155 million was less impressive, coming in 1.2% below analysts' estimates. Q2 Holdings made a GAAP loss of $23.6 million, improving from its loss of $25.2 million in the same quarter last year.
Q2 Holdings (QTWO) Q2 FY2023 Highlights:
- Revenue: $154.5 million vs analyst estimates of $154.2 million (small beat)
- EPS: -$0.41 vs analyst expectations of -$0.36 (14.4% miss)
- Revenue Guidance for Q3 2023 is $155 million at the midpoint, below analyst estimates of $156.9 million
- The company reconfirmed revenue guidance for the full year of $624 million at the midpoint
- Free Cash Flow of $3.73 million is up from -$3.19 million in the previous quarter
- Gross Margin (GAAP): 47.8%, up from 44.8% in the 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 decent over the last two years, growing from $123.6 million in Q2 FY2021 to $154.5 million this quarter.
This quarter, Q2 Holdings's quarterly revenue was once again up 10.1% year on year. However, its growth did slow down compared to last quarter as the company's revenue increased by just $1.52 million in Q2 compared to $6.47 million in Q1 2023. While we'd like to see revenue increase by a greater amount each quarter, a one-off fluctuation is usually not concerning.
Next quarter's guidance suggests that Q2 Holdings is expecting revenue to grow 7.08% year on year to $155 million, slowing down from the 14.2% year-on-year increase it recorded in the same quarter last year. Ahead of the earnings results announcement, the analysts covering the company were expecting sales to grow 9.58% over the next 12 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's left after paying for servers, licenses, technical support, and other necessary running expenses, was 47.8% in Q2.
That means that for every $1 in revenue the company had $0.48 left to spend on developing new products, sales and marketing, and general administrative overhead. Despite trending up over the last year, Q2 Holdings's gross margin is poor for a SaaS business. We have no doubt that shareholders would like to see its improvements continue.
Cash Is King
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. Q2 Holdings's free cash flow came in at $3.73 million in Q2, turning positive over the last year.
Q2 Holdings has generated $45.4 million in free cash flow over the last 12 months, a decent 7.75% of revenue. This FCF margin stems from its asset-lite business model and gives it a decent amount of cash to reinvest in its business.
Key Takeaways from Q2 Holdings's Q2 Results
Sporting a market capitalization of $2.08 billion, Q2 Holdings is among smaller companies, but its more than $280 million in cash on hand and positive free cash flow over the last 12 months puts it in an attractive position to invest in growth.
This was a mainly in-line quarter for Q2, with decent cash flow. On the other hand, its underwhelming revenue guidance for next quarter was disappointing. Overall, the results were mixed. The stock is flat after reporting and currently trades at $34.26 per share.
Is Now The Time?
When considering an investment in Q2 Holdings, investors should take into account its valuation and business qualities as well as what's happened in the latest quarter. We cheer for everyone who's making the lives of others easier through technology but in case of Q2 Holdings, we'll be cheering from the sidelines. Its revenue growth has been weak, and analysts expect growth rates to deteriorate from there. And while its strong free cash flow generation gives it re-investment options, unfortunately 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 12 months is 3.0x, suggesting that the market does have lower expectations of the business, relative to the high growth tech stocks. While we have no doubt one can find things to like about the company, and the price is not completely unreasonable, we think that at the moment there might be better opportunities in the market.
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