Q2 2022 Q2 Holdings Inc Earnings Call
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More than 80 syntax and over 250 banks and credit unions, representing more than 50% of our digital banking customer base leverage the innovation studio today.
And in our Investor day presentation in December we talked about how we believe this business will expand our total addressable market over time by bringing in technology partners that allow us to extend our platform and address opportunities outside of our current solution set.
During the quarter, we finalized an agreement with rocket mortgage the single largest mortgage provider in the country.
And adding their solution to Q2 innovation studio will provide our bank and credit Union customers with the option to embed rocket mortgage into the digital banking platform to offer to their account holders.
This gives customers fast easy access to our best in class digital mortgage solution that can help them enhance an existing mortgage lending practice or launch a new one altogether.
And for rocket mortgage this is a valuable opportunity to expand and diversify their go to market strategy by adding a large turnkey distribution channel.
We are excited to add a market leading brand like rocket to our ecosystem and believe this partnership will help Q2, and our customers providing additional best in class digital lending experience and then additional opportunity to generate noninterest fee income.
And helix on the net new side are most notable win in the quarter was with a large lending company that represents our first major deal in this vertical we are seeing alternative lenders increasingly look for ways to improve engagement and better monetize their existing customer basis, and our helix platform enables them to build differentiated experiences.
The drive new sources of revenue into their business models.
As we continue to expand into new industries, we believe wins like this should help our sales efforts in these verticals moving forward.
Another notable deal during the quarter was a progressive community bank seeking to launch a digital only brand alongside their traditional business.
This financial institution evaluated several options and determined that helix was the right product fit for their strategy.
We believe that over time, and increasing number of traditional financial institutions could start to pursue digital strategies to focus on their target market and differentiate themselves, which would open another segment of the market.
Overall, I'm pleased with our emerging businesses activity from the quarter, including the impact that innovation studio has had on the business just a year end.
Across emerging businesses, we're continuing to sign strategic deals launch new programs and drive adoption.
And with partnership additions like rocket mortgage we believe innovation studio is becoming a differentiated ecosystem in which our customers partners and Q2 all can benefit.
Thank you and with that I'd like to pass the call over to David to discuss our financials.
Thanks, Jonathan and the second quarter, we continued our focus on operational execution across the business.
Revenue results came in towards the high end of our guidance range and adjusted EBITDA results exceeded the high end of our guidance range.
I'll begin by reviewing our results for the quarter and conclude with updated guidance for the third quarter and full year 2022.
Total non-GAAP revenue for the second quarter was $145 million, an increase of 13% year over year and 5% sequentially.
The year over year and sequential growth for the quarter was primarily driven by an increase in subscription revenue, resulting from customer go lives.
As well as organic growth.
Service base pass through revenue associated with our helix business also contributed to the year over year and sequential revenue growth observed in the quarter.
As expected the sequential growth was also driven by seasonal increases in usage based revenue attributed to helix customers that was related to tax season.
Transactional revenue represented 13% of total revenue for the quarter.
<unk> grew 14% in the prior year period, and consistent with the previous quarter.
Transactional revenue dollars in total had a sequential increase driven by our helix business, which offset a decline in traditional bill pay.
Annualized recurring revenue or <unk>.
<unk> grew to $615 5 million up 17% year over year, and 4% sequentially the year over year and sequential growth was primarily from net new and cross sell bookings.
In addition, the sequential growth in the quarter also benefited from increased usage based revenue from our helix solutions.
While <unk> can have limitations as a key performance indicator. We believe it serves as a better barometer for net new and cross sell bookings given that our backlog metric can be an origin, Italy impacted by the seasonality of renewal activity.
We ended the quarter with approximately $1 4 billion in backlog and an 8% increase year over year and a sequential decline of approximately $19 million.
The year over year increase in backlog was largely the result of net new bookings over the past four quarters. In addition to renewal opportunities, which were concentrated in the fourth quarter of 2021.
As we previously mentioned in some quarters, we will have fewer renewal opportunities, which will impact sequential backlog growth.
As expected the number of in target renewal opportunities remained lower in the second quarter, but.
But we continue to deliver net new and cross sell bookings as evidenced in the sequential dollar growth of our ending balance.
We expect renewal opportunities will remain low in the third quarter before increasing in the fourth quarter, which is in line with the seasonality we have observed historically.
Gross margin for the second quarter was 51, 3% down from 51, 9% in the second quarter of 2021 and roughly in line with 51, 4% from the previous quarter the.
The year over year decline in gross margin was attributable to direct costs associated with third party products included in our solutions and increase in the mix of pass through revenue and incremental delivery resources.
The sequential decline in gross margin was also driven by an increased mix of lower margin pass through revenue associated with some of our helix customers.
Total operating expenses for the second quarter were $67 4 million or 48% of revenue compared to $57 9 million or <unk> 46, 6% of revenue in the second quarter of 2021, and $65 7 million or <unk> 48, 9% of revenue in the first quarter of 2022.
Year over year percent of revenue increase was predominantly driven by increased head count concentrated within R&D and sales and marketing travel related expenses and marketing programs and events.
A sequential decline in operating expenses as a percent of revenue was driven by lower expenses associated with reduced payroll taxes. Following our Q1 annual bonus payout and annual equity vesting.
Lower benefit expenses and an increase in capitalized software impacting R&D.
Adjusted EBITDA was $9 7 million.
<unk> from $9 9 million in the second quarter of 2021 and up from $8 $1 million in the previous quarter.
Our adjusted EBITDA results, which exceeded the high end of our guidance were driven partially by lower benefits expenses, resulting from reduced claims activity for health care.
In addition, we've continued to rationalize facilities to align with our flexible working environment.
Given the macroeconomic backdrop and uncertainty we intend to continue to proactively seek out efficiencies in the business and prioritize investments in a manner, which we believe will allow us to drive long term value to the business.
We ended the quarter with cash cash equivalents and investments of $399 $3 million down from $413 7 million at the end of the first quarter.
Cash used in operations for the second quarter was $9 $8 million.
Driven largely by an increase in accounts receivables associated with the timing of some large annual invoices for some of our bigger customers.
We generated negative free cash flow in the quarter of $16 $2 million the.
The normalization of working capital timing in the second half of the year is expected to result in positive cash flow from operations and free cash flow over this period.
Let me wrap up by sharing our third quarter guidance and reiterating our previously provided full year guidance.
We forecast third quarter non-GAAP revenue in the range of $145 8 million to $147 $8 million.
We are reiterating our full year non-GAAP revenue guide to the range of $577 5 million to $581 $5 million.
Representing year over year growth of 15% to 16%.
We forecast third quarter, adjusted EBITDA of $6 2 million to $8 2 million.
And reiterating our full year 2022, adjusted EBITDA guidance of $41 4 million.
$44 $4 million representing.
Representing 7% to 8% of non-GAAP revenue for the year.
As a reminder, the customers associated with bookings in the back half of 2021.
Our scheduled to be implemented in the back half of this year.
As we've seen historically large installations can bring some near term expense pressure, which is reflected in our third quarter adjusted EBITDA guidance.
Once those customers are installed and begin revenue recognition, we expect to see revenue and EBITDA acceleration exiting the year, which is reflected in our full year guidance.
In summary, we delivered better than expected adjusted EBITDA results for the second quarter and reiterated our full year guidance for both revenue and adjusted EBITDA.
Looking ahead, we will be closely monitoring the impacts of the broader macroeconomic conditions on our customers, while placing an emphasis on prudent cost management to optimize the long term value of the business and helped drive EBITDA accretion as we exit the year.
With that I'll turn it back over to Matt for closing comments.
Thanks, David in conclusion, the first half of the year was highlighted by broad based product adoption in our digital banking and lending solutions as well as the announcement of key programs and partnerships for our emerging businesses.
Mowing is to engage in strategic vertical we haven't previously served.
While we're excited about what's going on inside the business. We are also monitoring the potentially challenging macro economic environment and the impact it may have on our customers and our operations as we begin planning for the year ahead, we will continue to closely monitor market conditions and proactively adjust as conditions warrant while prioritizing.
<unk> long term value for our stakeholders.
With the durability of our business model. We believe we are well positioned to weather a potentially tougher climate ahead and that financial institutions have a lot of reasons to continue to prioritize the digital transformation with a proven partner like Youtube. Thank.
Thank you and with that I'll turn it over to the operator for questions.
Thank you at this time I would like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad will pause just a moment to assemble the roster.
And we will take our first question from Andrew Schmidt at Citi.
Hey, guys. Good morning, Thanks for taking my questions here.
Good morning, Andy Good morning.
Good morning, guys.
I wanted to ask about the direction of air growth as we head into the back half obviously as it relates to the pipeline of deal execution in fourth quarter is a big quarter, but if you could talk about just directionally do you expect for <unk>.
Kind of exiting in the back half of next year, how that might influence your confidence in achieving the acceleration in revenue growth that you've outlined for 2023 framework there any thoughts there would be helpful. Thanks a lot.
Hey, Andrew sure happy to go over that with you.
As you know there are something that we began disclosing last year and we hope you found it useful metric and as we go through the end of this year one of the things that we are absolutely anticipating as one.
A lot of that activity that we saw in the second half of last year in regards to the bookings strength as well as the first quarter and second quarter of this year is we see that second half of last year manifest itself in go lives in the second half of this year. So Q3 is actually going to be the largest go live quarter that we've had in a while in fact more than the entire first half of this year.
So as a result, what youll see is that revenue ramp in Q4, because you have a full quarter of those go lives in Q4.
They are our number that youll see going through the year, we expect that to continue to grow sequentially as we get to Q3 and Q4. So you can model that out effectively now one thing that we are monitoring closely is M&A.
We talked a lot about how encouraged we are by the activity. There. If you look over the last 18 months over a 150 of those opportunities have involved the Q2 customer and we're on the winning side of that of our customers on the winning side of that and over 90% of them.
But the regulatory approval process has been longer than we've anticipated with dozens of these are now hung up in the approval process and most of them on the larger opportunities to have more revenue attached to them. So it's something that we're going to continue to monitor closely as we go through the next six months.
So the M&A environment, while you might be on the winning side you could see some lumpiness.
These deals come through in the conversion happens at some point, let's call. It next year.
It sounds like later this year or next year, that's the right way to think about it on the conversion front with M&A.
Yes, Andrew this is that that is accurate and the other thing that gets held up and these opportunities big or small is if you're in the middle of waiting for approval. We are waiting for a conversion. It freezes your ability to buy new products. So that you can cross sell gets hit a little bit too.
But the bigger point is the hold up in these larger banks that were waiting to get approval on.
So we can get the conversion and then get them up and running and that obviously adds to organic growth to the business. It gives us much more cross sell opportunity is there.
It become a bigger bank or credit.
Got it that's helpful. Matt Thanks for the clarification, if I could just sneak just one more in.
The obvious question on the macro backdrop.
Just you had some comments about being cautious so I just wanted to be clear are you seeing anything in the decision making process or in the customer base that leads you to believe that.
There is a slowness in decision, making process or the deal cycle is slowing or is it just.
Being proactive on our front just to chase just being prudent.
So that should it occur just curious about that aspect. Thanks a lot.
Yes. It is.
Is being prudent I think if you look at the data the first half of the year demos are up Rfps are up the activity is up I felt good about the sales pipeline I feel good about the pipeline in the back half of the year I think whether it's tier one or tier two or tier three bank or credit union lending or digital banking.
We have a lot of great opportunities out there the challenge with the macro environment is if you talk with the Ceos of banks and credit unions, it's a pretty simple formula inflation stays up rates.
Our rates continue to rise if unemployment goes up you're going to have charge offs and charge offs hit.
A bank or credit Union in the cost becomes something they have to manage on those and so no matter how important digital transformation is the.
The profitability of the entity matters is obviously paramount. So those are the things that we're watching closely but with that said, we're seeing as I said the demos are up rfps are up.
The sales cycle year over year is actually.
The timeframe is down somewhat just on a.
Maybe a tactical piece the quarter over quarter, which two or three deals a trend doesn't make but we had a little bit of an elongated sales cycle.
In the second quarter close some of those deals already and we have more that are that are coming but I don't I don't want to say that we have an elongated sales cycle at this point yet.
But it's something we're monitoring and so we're just trying to be prudent with the information we put out there. This is.
18 years of doing this now and so we've been through multiple cycles and our customers are not riverboat gamblers and they are going to be very and thats why they have been able to sustain for more than 100 years in this in this world. So we're just we know them well and we're just paying attention to it and just want to make sure we're being prudent with our shareholders.
Got it. Thank you for the comments I appreciate it guys. Thanks, Andrew Thanks Ann.
We will go next to Alex Skyler at Raymond James.
Thanks.
Maybe following up on that Matt just the idea of the kind of optimism coming out of the.
Back half of the year the pipeline was up two X last quarter in terms of later stage opportunity or are you still seeing that kind of growth through the second quarter here.
Yes, I would say we are.
Still see and as I said the pipeline continues to grow obviously.
The first half of 'twenty, one was not a great first half for anybody so.
Comps are Greg if you look at it over the last.
Four quarters, we continue to see.
Prudent and demos in Rfps and activity in the marketplace. Our products are resonating well, whether it's a retail products, our commercial products or our lending products digital acquisition risk and fraud. All of those are landing very well with our prospects and customers.
Okay, Great and then maybe a follow up.
Jonathan.
Looking into the quarter I am curious in terms of pipeline impact there on the macro as far as the contenders concerning the application.
Is that kind of continued marketing behind some of the products that are already booked.
Yeah, no. It's a great question I would say the one thing we've seen over the first half of this year from an existing customer perspective is a shift in the mindset towards the profitability of their program. So it's not that they're not marketing I think marketing events within our best clients will still be episodic and they will have big pushes throughout any year, but what.
They are really focused on in a more challenging consumer backdrop looking forward is how they're more profitable which means they are driving engagement with our most active users figuring out how to drive profitability overall as the program. So again it doesn't mean, they're not going to spend on marketing as much. It just means that as less of a focus adding the next incremental user.
Ensuring that the current basis is as engaged and profitable as possible.
And as far as demand and the outlook looking forward for helix.
The pipeline is strong as we talked about in the script. The reality is is that these wins are opening up new verticals for us which is exciting because it gives us an anchor into some of these verticals in our reference more opportunity to grow and leverage so.
It's a different world with Fintech and brands as they evaluate this than the traditional financial institution.
But the desire to embed financial services is there and the opportunities are exciting for us. So we're just trying to keep our heads down and execute.
Okay, great color. Thank you all.
Thanks, Alex Thanks Al.
Our next question comes from Pete Heckmann at D. A Davidson.
Okay.
Hey, good morning, Thanks for taking my questions.
Just kind of want to follow up and follow through on these numbers, but we're certainly with <unk>.
Nice.
Growth here in the last four quarters.
Kind of running high teens to low twenties.
Yes.
That's encouraging.
Acknowledging some of the uncertainties for macro but it.
It certainly appears that based upon the activity you're seeing assuming that continues in the back half.
Is it fair to say that the probability that we should get some revenue acceleration.
From this year's levels in 2023.
Yes, one of them.
The things that we're doing right now and this is the case every year in August as we're getting ready to kick off our FY 'twenty three planning process and right now the macro economic environment is changing rapidly it's uncertain as everybody understands so we're going to be going through this process over the course of the coming months and making sure that we understand.
All of these variables at a much more intelligent level just based upon the inputs that we're getting and then we'll be able to assess 23 projections.
Much better for you as we get towards the end of the year and into next year.
Okay, Okay, and then shifting over to the digital lending part of the business.
Nice job on the Australia tier one bank this quarter can you talk about I.
And I guess three four years you've owned.
This business.
We're really as the growth come from.
And how much have you expanded that footprint either at a number of institutions and thinking a little bit about domestic versus international growth.
Yes, Thanks, Pete I think if you think about the cloud lending acquisition, which we made in.
The fourth quarter of 18.
The expansion has been a multiyear.
Multiple layers of expansion so the consumer small business leasing all of those areas to grow and I think that.
25%, 30% and then are the other thing we've done with the tools as the product is we've made it part of our commercial banking solutions, So business account opening.
Part of our Q2 catalysts announcement, which is the onboarding of customers we've used that tool.
And that way so it's been it's been a transformational transaction and then once you put precision lender into the lending side of the business. We now have the ability to price the relationship onboard the customer and expand their utilization of the products within whether it's for lending or deposit so.
It's transformed our business as far as the different segments in the World. Obviously, we've talked about the struggles in Europe .
Some of that has just been whether it's the pandemic and now you have inflation recession and you have the war that's going on over there and everything thats tied to that.
Obviously, Australia has been a.
Strong market for us and we're happy about the results that we've got out of there but.
The lending solutions that we have continued to mature and grow and we have I would say that the team has been methodical and disciplined in how they build the products out and we feel like we're a really good position to capitalize on the digital transformation is happening on the lending side of the business as well.
Alright, thanks for the feedback.
Thanks Pete.
Yeah.
We'll go next to Parker Lane at Stifel.
Yeah, Hi, guys. Thanks for taking the question, but the digital only brand deal on the helix side, it's pretty interesting in the quarter could you provide some context, maybe on the scale of that opportunity in terms of how many banks are going down that direction, how large that opportunity could be what you expect over the next few years. Thanks.
Clearly you are talking about the helix deals Parker, yes, correct, just how many other banks are considering going with the digital only brands presence.
Yes, it's interesting we've seen more and more of it throughout 2022 I think what's interesting is you have sort of this bifurcation between the executive financial institutions and the sales organizations that are very focused on strategically growing the business and the digital only brand is a great vehicle for them to target certain demographics weather.
Millennials or the like or even national strategy through the digital only channel.
But operationally its a different core than what theyre used to with the traditional cores that power the financial institution that they are used to so understanding.
The box that you're operating within from a core perspective is really the challenge that these banks have to overcome and we like where helix sits in that equation and we're seeing all over the market the strategic value of a cloud based core coming more and more to the forefront whether its in this use case or it's in the embedded finance use case that helix is largely focused on with <unk>.
<unk> brand. So it's exciting it's opening up a new market and I think we're going to see more and more opportunities with regional community financial institutions launching these digital only initiatives. It's just a question of making sure that the operational side of their house and the strategic side of their house are aligned on what the capabilities are in a digital only scenario.
Got it very helpful. And then David could you provide some more color on the decline of traditional bill pay during the quarter or was that simply seasonality.
Secondarily, how should we think about the impact of the transactional business and more uncertain economic times.
Yes, Mark it's something that we're monitoring really closely the bill pay business was.
Was certainly something that was below what we expected and that's for the first half in total so we're going to continue to monitor that in the second half.
And obviously as we enter into next year, it's going to be something that's going to be a key variable as we work through that planning process that I talked about earlier in regards to FY 'twenty three.
Got it thanks again guys.
Thanks.
Our next question comes from Brian Mcnamara BPH.
Okay.
Yes, Hi, this is Matt van Vliet.
So I guess looking at <unk>.
Some of the digital only banks that you announced on the digital lending side maybe.
Then parkers question.
When youre looking at those banks is there any difference in terms of pricing out the solutions or the number of total users expected or maybe even just the build of those deals coming through than a normal.
And mortar related digital banking.
Deployment, and how youre thinking about some of those opportunities coming through the pipeline.
Yes, Matt it's a good question I think when you think about it.
Startup bank and there hasn't been many and for a while a long time ago. We used to do you have to it's a partnership where you go in and we've got to evaluate the ownership is in the structure of them and then there is it's a multi tiered kind of a year give them time to grow you can't charge and too much at the beginning.
Betting on this together a little bit and so.
It can.
If you get the right group it can be a great deal for both of us and so it is a different construct than when you go to an existing bank that has 50000 users or credit unions 50000 members and they're signed on Youre going to convert them over and you have a minimum that's tied to that so it does have some different dynamics to it but one of the things about these de Novo banks, if you think about.
We're on both sides of the balance sheet, we have the technology to be able to offer them everything from pricing the relationship to onboarding the relationship because they have to onboard every single new customer.
As opposed to an existing financial solution that has already has the customer base. So we have a lot of tools through digital acquisition and Onboarding that make it kind of a no brainer to go with us on the digital side.
Okay very helpful. And then as you look at the large deployments both from the second half of last year and maybe more importantly, some of the tier ones you've signed earlier this deal.
Year do you feel like there's any concerns that they might.
Sort of drag along the process or extend out the project timelines given the macro uncertainty.
Or do you feel like Theyre, all pretty well staged in and to your point on second half of 'twenty to getting some of those late 'twenty one deals into the revenue stream.
Yes.
The ones that we signed last year.
All the <unk>.
The net new to US go lives are on track I would reiterate with David's comment was we have dozens of.
Customers that skewed to the larger side that are on the M&A front that are just being held up by the regulatory environment, They're just not.
Theres not a proving them right now and so those delays.
Extend out and that's one of the things that we're monitoring closely but as far as the net new side you signed it last year. You cited this year. We're on track to delivery team is doing an amazing job of delivering in Q3 and Q4, we've got some big go lives, but no delays there.
Alright, great. Thanks for taking the questions. Thanks, Matt.
And we will go next to Terry Tillman at Trust.
Great. Thanks for taking the questions. This is Robert on for Terry.
Just starting off you were talking about being prudent on expenses I was actual employee head count trending and are you seeing more stable retention now or still the great resignation with difficulty in keeping top talent still highly prevalent.
Hi, Robert.
I would say that we put a lot of time and energy into our culture and the sustainability of this and in our employees. If you look at our.
Attrition rates are voluntary attrition rates.
Five points below whatever whatever youre seeing in the software industry right now and so I think youre seeing a stabilization of employees and you're also seeing a.
The wage inflation has flattened out somewhat.
Really happy with the deal.
The retention that we have.
And also the engagement of our employees around our mission so.
Feel good about that right now.
That's great to hear and then just one follow up if I may more on the macro front, how would you compare and contrast demand across tier one banks tier two banks and then the fin techs you serve.
Yes.
Yes, the concerns are similar on the tier ones into the tier twos.
Keep in mind, we have quite a few enterprise customers as well through precision lender.
Rates going up creates a more.
Plex lending environment, and so precision lenders a tool that should should come into play there, but the sentiment between tier ones and tier twos is similar to what I said earlier, which is what's going to happen with inflation, what's going to happen with rates unemployment and how are those going to ripple through the business.
Whether it's having.
Off loans.
How you have to adjust that and so they're just being prudent with their decision making.
Okay, Great I appreciate the color. Thank you. Thanks, Rob appreciate it every day.
We'll go next to James Foster at Morgan Stanley .
Hi, It's Michael Hartshorn town for James Thanks for taking my question.
Maybe just help me unpack that rocket mortgage process in general I imagine that process was highly competitive. So just help me understand like how you were able to win that relative to others.
Yes. Thanks for the question no I mean look it's a long time in the making and it's a great brand for us, but we really want that on the back of the differentiation of our software development kit in the platform and the openness and the ability and easy to work with it.
This was a process where both sides saw the strategic benefits and for US all of the innovation studio thesis is around how do we bring optionality for our banks and credit unions to drive adjacent or relevant products into their client base and rockets, a great brand for that especially in the backdrop that we're operating within.
And they did a lot of diligence and they talk to our existing partners. They reference call reference calls were done with existing partners prospect partners to understand what it's like to work with us how easy it is and.
Im really pleased with the deal and the opportunity in the early adopter universe of banks and credit unions that we're already talking to.
Sure.
Again, I think its timely from the standpoint of in a rising rate environment, and a world where a lot of the regional community banks have big refinance portfolios. That's an area of home lending thats going to be challenged over the foreseeable future and so the opportunity to pivot that into or sidecar that into another business, where its fee income.
The management of the paper and the process is all done by our best in class digital provider that has a brand like rocket I think it's going to be exciting. So we're really pleased with that one and we have many others. We signed north of 15 partners again in the quarter and so we're just continuing to build an ecosystem and give these banks and credit unions access to more innovation.
Great. Thanks, Jonathan and then maybe on <unk> backlog can you help me sort of decompose the backlog composition geographically so how much do APAC and Europe comprise and have you seen any elongation of sales cycles in Europe , specifically like we've seen from some other SaaS names.
Yes, just quickly on the.
The breakdown, so theres very little debt of the backlog mix that comes from Europe quite honestly.
And then in regards to the timeline of deals and decision, making I mean, I think Matt Matt covered it pretty extensively it's certainly something that we're monitoring closely but they have not come out of.
Some of the some of the delayed decision <unk> macroeconomic pressures that <unk> been dealing with for the last couple of years. So.
It's certainly an area of the world that we're going to continue to closely look at.
Great. Thanks very much.
Thanks.
We will go next to Bob Napoli William Blair.
Okay.
Hi, Good morning, guys. This is a deep chartering on for Bob Napoli. Thanks for taking our questions. Just wanted to ask on the competitive environment. If you guys are seeing any shifts in competitive intensity.
They are in the market for digital banking deals and I guess to tell that it sounds like innovation is the key reason for why customers are choosing to partner with Q2.
Is it starting to move the needle in terms of win rates.
So the competitive environment remains as I've said over the last several quarters retail digital banking is a competitive environment, especially as you work down the tiers.
Tier two tier three the credit Union side in particular lot of solutions out there we continue to fair well in those markets.
Our win rates in tier two and tier one are similar to what they've been historically and then tier three we've never really given the win rates. There theres just a lot more volume down there and I don't I don't have an indication there of any any any problems. We're a little more selective in that area as well so.
And then.
Innovation studio the breadth of our products Q2 catalyst all of those things are differentiators for us.
When you talk to the people that selected products.
Great. Thanks for that color and then just as a follow up on capital allocation and M&A could you talk about your current appetite given some of the compressed valuations in the market. It feels like corporate development might be opening up a little bit.
So I guess what types of assets or capabilities would you guys be most interested in.
And so from a market backdrop perspective, I can tell you that the second quarter was probably one of the quietest. We've seen in the last several years in terms of inbound activity, where we get calls around opportunities and assets in the market. So while we certainly expect in the back half of the year to start seeing what you referenced in terms of the market opening up and more corporate development.
Activity and opportunities we didn't see it yet in the second quarter and I think it's largely because of the lag between what's happened in the public markets and how that slowly translates into private sellers and so we do expect that will happen, though and as far as where we're going to be focused I wouldn't say that anything has changed I do think that we have the benefit now of Q2.
<unk> studio in some of our other partner in.
New product launches across the portfolio that give us more and more insight into end markets and the assets within those and how they perform in the hands of our customers.
So I think that's interesting, but as far as areas of interest across digital wealth digital insurance risk and compliance.
Segments, we've talked about in the past continue to be interesting I. Just think we have a much different lens into it now and new and more new segments are opening up and peaking our interest. We just we just have to see what comes to market and what makes sense.
Great. Thanks very much.
Thank you.
We'll go next to Charles Nabhan of Stephens.
Good morning, and thank you for taking my question I appreciate the color on the gross margin for the quarter, but I was wondering if you could walk us through some of the puts and takes for the second half of the year specifically in terms of how we should think about cadence as well as any any headwinds tailwind do you anticipate.
Yes, sure Chuck and I do think that the second half our gross margin profile will improve.
Improved slightly from the first half profile and one of the pressures that you see in Q3 is very specifically when we have these large implementations you typically do see some pressure on gross margins. So because we have such a high concentration of implementations. In Q3, you have a lot of those implementation resources and customer support resources that are hired.
That implementation side no longer capitalized.
End up hitting the P&L. So you do see some short term pressure, but obviously it gives us a nice long term lift after after winning these opportunities so that pressure exists. During Q3, you end up seeing an uptick in Q4.
We also believe that there's going to be as we exit this year less of a mix of the pass through as a total mix of the overall business. So if you remember we talked about that pass through business being higher some of it related to tax season activity. So as we get into Q4. The gross margins are pressured as much based upon that.
Lack of mix. So those are a couple of the key variables to keep in mind as we get into Q3, and then exit the year in Q4, but I would expect from a modeling standpoint youll see.
Increases in Q4 relative to Q3.
Got it and.
I know youre not going to give specific guidance in our 'twenty three but you did reiterate the 60% long term target.
So just curious if you could kind of give us a little color around that that tailwind and catalysts over the medium to long term specifically if youre you see a mix shift more towards.
Cross sell and cross sell activity, which has the higher incremental gross margin.
Yes long term if you think about some of the drivers we talked about.
One we have opportunities.
Opportunities to mix up in our business towards higher profit margin areas innovation studio is a great example of that Jonathan talked about laying the groundwork and the partners that we've signed up in the ecosystem that we're creating as that becomes a more meaningful part of our business 345 years down the road. That's a very high margin business on the helix business is going to continue to mix up.
Way from pass through towards higher margin transactional business over the course of the next three to five years, that's going to help the overall business and that obviously is a business that is going to grow at a premium to what we have overall and then we're going to have opportunities from a scale standpoint, and things like utilizing global resources in a more effective manner that are just going to help our.
Labor mix in our overall cost structure, when you think about our gross margins.
Got it I appreciate the color. Thank you.
Thanks, John .
And we will move next to Joe <unk> at Baird.
Great Hi, everyone at when you step back and look at the broader landscape over the past two years now and new system decisions that are getting made.
The level of activity has skewed proportionately more towards retail offerings and given some of the comments like the tier one win changing commercial expectations, maybe the industry is readying the shift back around and focusing on commercial and if that is happening.
I guess that dovetails, a little bit with the competitive landscape question is that type of shift something where Q2 actually stands out better by comparison.
Yes, Joe I think if I understand your question correctly.
Yes. The difference has been credit unions have largely been focused on consumer for forever.
And over the years, we have built a practice with credit unions of helping them build their small business capability out as well as some of them are beginning to move into larger midsized business offerings for commercial banks, which in 2004, when we started the business.
We were we built a platform.
Single platform for them that retail small business and commercial customers on the platform. So we're 18 years into building that product, but our commercial banking investment that we began to really make in 2012 and 13 before went public in one of the reasons. We went public in 2014 was to fuel and fund those offerings and so as you.
Look forward commercial banking has always been the cornerstone of small.
Tier one and tier two and tier three banks. The difference now is the need to be able to offer commercial banking solutions digitally and that's where whether it's a mobile phone or tablet or desktop we have.
We have a significantly lead in user experience and breadth of product as far as deposit and lending side of the house pricing relationship to Q2 catalyst product over anybody in this space. We have to continue to build out offerings for large corporates, which is where the legacy players have.
The product set there, but they don't have it in a modern technology form and so our position in the marketplace right now our investment in Q2 catalyst is highly differentiated when we sit down with a bank above.
A couple of billion that has larger commercial customers.
They are blown away by our offerings and they are and theres not many people that can come close to us without cobbling together solutions, they don't own their partnering with people. So our differentiation in the commercial space I anticipate it will continue to grow we're going to continue to invest in those areas and so I think whether it's <unk>.
Community Bank.
Our credit Union, we're in a very good position there because all the things that come with that or the experience and the conversion advisory services with how you use these tools that we've built over years and years of teams that work here. So.
Really differentiated for us in the marketplace, we anticipate that will continue to be a differentiator for us in 2023 and beyond.
Yes.
I guess, where I was going with that question I think your commercial product ends up really well when you look into the pipeline are you seeing proportionally more opportunities and.
Commercial than might have been the case over recent years youre kind of matching.
<unk> product.
Stronger market opportunity.
Yes, yes.
That is true as well if you think about it the consumer space not consumer retail digital banking upset is crowded, but the consumer space is crowded as well whether Jonathan side of the business with helix helix serves.
We have several customers that jumped into the space and have millions of retail accounts and debit cards that are out there and so you see credit unions and banks shifting to have more of a commercial focus because of their cost of capital the advantages of being in the market their ability to offer wires in aviation that type of stuff. So I think youre going to continue to see the pipeline skew towards more commercial offerings.
And we're well positioned for that.
Okay, great. Thank you.
Thanks, John I appreciate it.
And that does conclude the question and answer session and today's conference call. Thank you for your participation you may now disconnect.
Okay.
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Sure.
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