Q2 Holdings Inc (QTWO) 2018 Q4 法說會逐字稿

Good morning. My name is Emily, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q2 Holdings Fourth Quarter Results Conference Call. (Operator Instructions) Thank you. Bob Gujavarty, VP Investor Relations, please go ahead.

Welcome to the Q2 Holdings conference call for the fourth quarter and year ended December 31, 2018. I'm Bob Gujavarty, VP of Investor Relations, and with me today on the call are Matt Flake, our 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 yesterday afternoon. If you have not, it is available on the web -- on the Investor Relations section of our website. A quick reminder, the Q2 will be hosting a Investor Day in New York on February 28. If you'd like to attend, we request you RSVP in advance of the event. But those of you who cannot attend, the event will be webcast and a replay will be available on the Investor Relations section of our website.

Before beginning, we must caution you that today's remarks, including statements made during the question-and-answer session, contain forward-looking statements. These statements are subject to numerous important factors, risks and uncertainties, which cause actual results to differ from the results implied by these or other forward-looking statements. Also, these statements are based solely on present information and are subject to risks and uncertainties that can cause actual results to differ materially from those projected in the forward-looking statements. For additional information, please refer to our filings with the Securities and Exchange Commission and the risk factors contained therein and other disclosures. We do not undertake any duty to update any forward-looking statements.

During this call, we'll be referring to both GAAP and non-GAAP financial measures. We believe that non-GAAP measures are representative of how we internally measure the business, and they're reconciled to GAAP in the tables attached to our press release, which is available on the Investor Relations portion of our website.

The nonrevenue financial measures we'll discuss today are non-GAAP unless we state the measure is 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. Since we expect our future stock-based compensation expense to have a significant impact on our future GAAP financial results, a reconciliation is not available on a forward-looking basis without unreasonable effort.

Let me now turn the call over to Matt Flake.

Thanks, Bob. Today, I'll share some highlights from the fourth quarter and full year 2018. I'll then turn the call over to Jennifer to provide a more detailed look at our 2018 financial results as well as guidance for the first quarter and full year 2019.

We ended the year with a strong fourth quarter, generating revenue of $67.2 million, up 30% year-over-year and 11% sequentially. Revenue for the full year was $241.1 million, up 24% year-over-year. We added more than 400,000 users in the fourth quarter, ending the year with 12.8 million users on our digital banking platform, a 23% increase year-over-year.

2018 was a record-setting year for Q2. We added approximately 2.4 million users to our digital banking platform, completed 2 strategic acquisitions and closed the year with our largest bookings quarter ever. With the acquisition of Cloud Lending, we also grew our footprint globally, and we now have close to 1,200 employees in locations from Bangalore to Austin.

I believe these results and others I will discuss shortly, reinforce the demand for digital transformation across the financial services industry and that our approach resonates with the market. These results also emphasize the importance of maintaining our focus on providing best-in-class service to our customers while we continue to grow.

Now, I'll review our results from the quarter and year in greater detail.

Our sales performance this past quarter was a record for highest bookings in a single quarter. 2018 also represented a record in total bookings for the year. We believe our strong bookings for the quarter and year were the result of an improved economic environment and continued sales execution. In the fourth quarter, we saw continued sales momentum from the platform sales team, tying the record for new customers signed in a single quarter, including the addition of 2 Tier 1 banks, a $30 billion bank located in the Midwest and a $9 billion bank located in the Northeast. Both institutions added our retail and small business digital solution, while the bank in the Northeast also added our corporate solution. The digital banking platform team's success came from strong performance in the bank space combined with continued positive momentum in the credit union space. I'm pleased with the performance of the sales team, and I congratulate them on a solid year of execution.

Following suit with our digital banking platform team, our cross-sales team also had a solid finish to the year, signing a record number of renewals in 2018. As I said before, renewals provide continued visibility into our future revenue and validate our customers' belief in our strategic direction. I'd like to highlight that the majority of growth from our current customers came from the adoption of our corporate Q2 SMART, Centrix and Biller Direct solutions. As I look ahead to 2019 with the addition of the lending, leasing and digital-onboarding capabilities from our recent acquisitions, I am confident that we will continue to see strong performance from our cross-sale team. Our Q2 Open team continued momentum in 2 key areas: sales and expanding the number of financial institutions participating in our bank of record program. Starting with sales. The Q2 Open team signed 6 new clients in the fourth quarter, including a CardSwap contract with a top-5 credit union. The adoption of CardSwap by this client is further validation of our Q2 Open strategy and financial institutions' desire to provide more Fintech-like products to their account holders.

I am also excited about extending the network of financial institutions participating in our bank of record program. This program allows us to scale the pipeline for our Q2 Open product portfolio and has generated approximately $750 million in deposits to community financial institutions since its inception. Extending this network creates greater capacity and flexibility in offering solutions, such as deposit products and debit card functionality for the rapidly growing demand from Fintechs and brands. As I have mentioned before, we feel that there is a growing opportunity in helping financial institutions partner with Fintechs for mutual benefit.

I am also encouraged with the way our Q2 Open pipeline continues to progress. And I look forward to sharing updates with you throughout 2019.

Moving on, I'd like to share some updates on our recent acquisitions of Gro Solutions and Cloud Lending. We closed the acquisition of Gro in November of 2018. We pursued Gro because many of our customers expressed the desire to simplify and improve the onboarding experience. The Gro solution addresses this need by offering a more streamlined, online shopping card experience complemented by targeted marketing capabilities.

As a result, we believe our customers will be better positioned to increase deposit and loan acquisition from retail and commercial customers. I would like to add how impressed we were with the level of product innovation and the sales momentum they created for a team of their size in just 3 years. We are also enthusiastic about the sales opportunities Gro offers. As customers, we'll be able to consume the solution as part of our digital banking platform or as a standalone offering.

I'd like to share a few updates on Cloud Lending. As a reminder, Cloud Lending offers a SaaS, end-to-end lending and leasing platform. Their solutions help lenders close more loans, close them faster and provide a better experience to borrowers throughout the process. Results from the fourth quarter of 2018 support my optimism about the opportunities Cloud Lending represents to our customers and Q2. Cloud Lending team signed 5 new customers, including a $25 billion bank located in the Northeast and one of the largest independent leasing companies in the United States.

Cloud Lending pipeline continues to grow heading into 2019. And although we have more work to do, we have made meaningful progress on our integration efforts, which will be a continued focus in the coming year.

On the operations front, I want to compliment our teams on all they accomplished in 2018. We ended the year with 2 billion logins on our digital banking platform from 12.8 million account holders.

Logins increased approximately 70% year-over-year while our account holder base grew 23% the same period. This means engagement with our digital banking platform grew at a rate 3x greater than the user base. We find these metrics encouraging as we believe increased engagement translates to account holder loyalty. These accomplishments required a lot of work by our team. And I want to thank them for all their vital contributions to Q2's success.

I'd like to wrap up my comments by setting the stage for what I believe will be a year where our bookings success will translate to accelerated revenue growth in 2019. Our pipeline looks strong, and our sales organization continues to improve their ability to convert prospects to customers. We intend to leverage our strategic acquisitions and investments to add new customers and expand our relationships with existing customers across the globe.

As we enter 2019, we are positioned to deliver what I believe will be the most comprehensive digital transformation platform in the financial services industry. Our customers will benefit from our expanded portfolio of solutions that will help them grow both their deposits and their loans as we, and they, continue to address the challenges and opportunities created by the persistent innovation and evolution of the financial services industry. In addition, enabling partnerships between financial institutions and Fintechs makes us a highly distinctive partner to financial service providers of all kinds.

I will now hand it over to Jennifer to go through our financial results.

Thanks, Matt. I'll review our fourth quarter and full year results before finishing with guidance for the first quarter and full year of 2019. Total revenue for the fourth quarter was $67.2 million, an increase of 30% year-over-year and up 11% from the previous quarter. Revenue for the full year 2018 was $241.1 million, up 24% year-over-year. The sequential and year-over-year growth was driven by the strong Q2 digital banking platform user growth combined with approximately $2 million of revenue generated by Cloud Lending and Gro Solutions during the period from acquisition through the end of the year. Transaction-based revenue represented 17% of revenue in the fourth quarter and 16% of revenue for the full year 2018, consistent with both the previous quarter and the prior year. As Matt mentioned, we posted record bookings in the fourth quarter. The strong performance from the sales team combined with the record renewals and contract extensions executed during the quarter contributed to the committed backlog of over $870 million at the end of the year, up approximately $95 million from the third quarter.

The acquisition of Cloud Lending and Gro Solutions added approximately $12 million to the total backlog. Our revenue churn for the full year 2018 was 5%, essentially flat with the 4.9% in 2017. And I expect churn to remain in that same range for 2019. The churn driven by M&A activity during the year was roughly half of the total. Our Q2 platform installed customer count at the end of the year was 401, up from 382 at the end of 2017.

The growth in customer count was concentrated in the back half of the year as we experienced an accelerated pace of customer go-lives and saw less M&A activity among our customers. Our trailing 12-month revenue retention rate for 2018 was 114%, down from 122% in 2017.

As I told you at the end of 2017, the 2017 revenue retention rate without the benefit of our 2 largest customers was approximately 112%. On that basis, our revenue retention was up slightly year-over-year. As a reminder, this metric compares revenue of all installed customers at the end of the previous year with the revenue from that same group of customers at the end of the current year.

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 52%, down slightly from 52.7% in the fourth quarter of 2017 and down from 53.8% in the previous quarter. For the full year 2018, gross margin was 53.3%, up from 52.5% for the full year 2017. Both the sequential and the year-over-year decline in gross margin was due to the acquisition of Cloud Lending and Gro Solutions and their related purchase accounting adjustments.

The total operating expenses were $34.6 million, up 34% from the year-ago period and up 18% from the previous quarter. Both the year-over-year and sequential increase in operating expenses were driven by headcount additions and their related benefits in overhead. As we ended the year with 1,190 employees, up from 844 at the end of 2017, approximately 160 employees were added based on the acquisition of Cloud Lending and Gro Solutions in the fourth quarter.

Adjusted EBITDA was $3.1 million, down from $4.1 million in the fourth quarter of 2017 and $5.7 million in the previous quarter, both as a result of the Cloud Lending and Gro Solutions acquisitions. Adjusted EBITDA for the full year 2018 was $19 million or approximately 8% of revenue, up from $10.2 million in 2017, an 86% year-over-year improvement.

We ended the quarter with cash, cash equivalents and investments of $177.3 million, down from $298 million at the end of the third quarter. Cash flow from operations for the fourth quarter was $8.5 million. And we generated free cash flow of $7.3 million, which was offset by approximately $130 million paid for the acquisition of Cloud Lending and Gro Solutions.

Let me wrap up by sharing our first quarter and full year 2019 guidance. We forecast first quarter revenue in the range of $70 million to $71 million, and full year revenue in the range of $305 million to $309 million, representing 27% to 28% year-over-year growth. We forecast first quarter adjusted EBITDA of $1.2 million to $1.8 million and $20 million to $22 million for the full year 2019. I expect approximately 75% of the annual adjusted EBITDA to come in the back half of the year.

In summary, 2018 was another solid year for Q2 as we delivered strong bookings and significantly expanded our product portfolio, setting the stage for accelerated revenue growth in 2019.

Margins will be depressed in the first half of the year as we absorb the acquisitions and the related purchase accounting adjustments but should improve in the back half of the year as the impact of the purchase accounting adjustments become less significant.

Now let me turn the call back over to Matt for his closing remarks.

Thanks, Jennifer. It is clear to me that our business continues to gain momentum and is quickly evolving to better enable our customers to prosper in a highly competitive market. I expect 2019 to be another year of solid execution, growth and best-in-class customer service.

In closing, I would like to thank the Q2 team for a record-setting year, our partners for their help in reaching this achievement and, most importantly, our customers for the privilege to serve them. Thanks again for joining us this morning.

And with that, I'll turn it over to the operator for questions.

(Operator Instructions) And our first question comes from the line of Sterling Auty from JPMorgan.

So I think the biggest -- I think the biggest difference in 2019 relative to Street expectations is in the EBITDA. It does appear that it seems to be the acquisitions that are doing that. I want to make sure that, that's correct. And more specifically, when you look at TheStreet models versus, kind of, what you give in guidance, is the biggest difference in gross margins? Or is it in the OpEx line? And what do you think changes in the second half to show that improvement that you mentioned when you gave guidance?

So when we gave guidance at the end of last year, we said we thought the floor would be $20 million, but that guidance was also prior to the acquisition of Gro that we closed at the end of November. So I'm actually quite happy that we were able to absorb the Gro acquisition and still keep the low end of our range of that $20 million floor. I would say that the majority of that is all related to the acquisitions. As I mentioned before, Q2 standalone, prior to those 2 acquisitions, was tracking to meet, kind of, where the analysts were. So it's all related to those acquisitions. And as far as where it's adding gross margin or OpEx, I would expect gross margin next year to be relatively flat in the first half of the year, given the investments that we're making as well as the impact of the purchase accounting adjustments on the revenue and see some moderate improvement in the back half of the year once those purchase accounting adjustments become less significant. For the full year basis, I would expect gross margin improvement somewhere in the 100 basis points range.

And our next question comes from the line of Tom Roderick from Stifel.

So couple of things to kind of parse through as I think about, Matt, your comments on record bookings quarter, really positive commentary, a couple big Tier 1s. And most specifically, I'm trying to wrestle through the backlog disclosure, where even when I strip out the $12 million you gave, Jennifer, from the acquisitions, it still looks like it's up 10% sequentially. So I guess, the 2 questions I'd have on that is: Number one, how would that sort of sequential jump in backlog compare to historical levels? And of course, sort of the underlying question there is, the 2 Tier 1s and the record bookings. Can you provide a little bit of more qualitative assessment of that relative to sort of historical Q4 seasonality? And then the second part of that, Jennifer, for you, I know it's way too early to think about 2020, but as we roll out our numbers and try to put some parameters around it, how would you suggest the cadence of that shakes out? Last year, we had a pretty good sense that things were going to accelerate because of the deployments of the Tier 1s coming out of '18 into '19. That is indeed happening. How would you suggest we sort of look at 2020 on a qualitative basis with revenues accelerating from this year? Should they come back to a normal level or stay at the heightened level that we'll be exiting the year at?

Thanks, Tom. So first on the backlog. The majority of the backlog, as you mentioned, was driven by the Q2 platform business with about a little over 10% of the increase coming from the acquisitions that we made during the quarter. And within the Q2 platform business, a large majority in Q4 actually came from our strong quarter of renewals and extensions. We had several long-term renewals and some extensions that added about 2.5x more during the quarter from renewals than we had in any of the other quarters in 2018. So hopefully, that gives you a little bit of color there. And then on 2020, obviously, the first half year-over-year compares in 2019 are going to be relatively easy, given the 2018 numbers. So I would expect the year-over-year compares to moderate next year and not be as high as they are exiting the year. So 2020, I would expect more in that, mid-20 -- 20% to 25% range probably most quarters.

And our next question comes from the line of Brian Peterson from Raymond James.

So one for Matt and then maybe one for Jennifer, if I could, but I just want to -- the retention metric, it was 115% I believe. Just trying to understand, how we should think about that metric going forward? And what it -- what that's going to look like from upsell in terms of new products and then users? And just a clarification on the tax rate. That was a little bit different than I modeled this quarter. Any help on how we should be looking at that going forward?

So our trailing 12-month revenue retention was 114% year-over-year. And that's -- the last couple of years, we've been at 122%. But if you remember, at the end of last year, we told you that with no large Tier 1s going live in 2017, it made it for a tough year-over-year because we had 2 of our very largest Tier 1s go live in late '16 and impact that number. So we told you on the Q4 call last year that had we not have -- if we stripped out the impact of those very large 2 Tier 1s, last year's number would have been about 112%. And we expected this year to be consistent with that. So 114% is, I think, where we were expecting and I would expect go forward, given what I know today, that it's going to remain somewhere in that mid- to low double-digit teens. So 112% to 114% would be my expectation go forward. And then on the -- what's the second part of the question?

It's actually…

The tax, yes, the tax. Yes, we did have a onetime tax benefit in Q4 related to the acquisitions. Approximately $3 million of that benefit that was recorded in Q1 is a onetime, resulting from the valuation or the large valuation that was presented to the non-goodwill intangibles related to the CLS and Gro acquisitions. Because of that large value there, deferred tax liabilities actually exceeded their deferred tax assets that were primarily NOLs. And so we had to reverse part of our valuation allowance against that.

Our next question comes from the line of Pete Heckmann from D.A. Davidson.

Jennifer, in terms of your full year 2019 guidance, can you give us kind of a run rate revenue for the 2 acquisitions? And then on a gross basis -- and then -- what -- given the deferred revenue write-down, what amount would be included in your 2019 guidance?

Yes. So I can tell you that on Q4, we said that we expected the CLS acquisition to contribute in the low double-digit millions after the purchase accounting adjustments to 2019. I still think that's the right number. And Gro is much smaller than CLS. We acquired them on November 30, and so they contributed about $100,000 to revenue in December of 2018. And so their impact to 2019 after purchase accounting adjustments is going to be very small.

Our next question comes from the line of Brett Huff from Stephens.

Quick one on some of the card-related activity in the business you're doing with places like Acorn (sic) [Acorns] and the Q2 Open. Can you give us a more detailed update on that in terms of those wins that you signed? Kind of what was the nature of those? Any update there, we -- we're fairly focused on that and think there's real value there, so wanted to get some more intel on that.

Yes, Brett, so on the Open side, we had a solid quarter obviously. I think if you look at the difference in each quarter as they grow, the deals are getting larger. So I would say they're moving from what, if you're trying to compare to the platform side of the business, they're moving from like Tier 3 deals to Tier 2 deals. Keep in mind, they come to revenue faster and they're higher margin. And if I look at the collection of deals that we won in the quarter, there is a combination of some direct bank deals. There is like, obviously, the CardSwap deal that we did with the large credit union. And then there is the Fintechs that sign up just to use the CorePro system to run deposits through their -- through one of our broker of record banks. If I look at the pipeline moving forward, I see that trend continuing. I see the deals getting larger, more prominent Fintechs and also more direct banks for some of our existing customers and even some banks that aren't customers. So I think that trend's going to continue. I would say that at Investor Day on February 28, we're going to dive a little deeper into the Open application and what's happening there. So that's a -- that would be a good time for us to go a little deeper into it. But I'm very pleased with the activity on the Open side, the execution and the interest that we're seeing, not only from Fintechs but from our banking and credit union customers.

Brett, I'd just also add on CardSwap in particular. That's a monthly subscription fee plus transaction per swap. The monthly transaction fee is fairly small. And the per swap fee, unlike our bill pay and mobile remote deposit capture, which tend to be recurring, is typically not recurring because that only takes place when an account holder or an end user actually has to change their debit card. So it's a fairly small number.

Our next question comes from the line of Brad Berning from Craig-Hallum.

Congrats on all the deal activity. I wanted to follow up on the renewals. You guys talked about, obviously, a large amount of renewals. Can you talk about pricing versus content? What kind of pricing growth are you seeing in some of the contracts? And how did that contribute to the growth in the backlog as well?

So I would say, Brad, that what we're seeing is we've come out with a lot of new innovation over the last couple of years. And many of these clients have been customers now for 5 years and have grown their account holder base significantly. And so we've been able to include new features and functionality that they didn't previously have into the renewals. And that helped offset some of the pressure that we got from customers to get volume discounts on their increased user base. So I think we've done a really good job at maintaining our renewal base and, in some cases, growing it depending on the number of the new products that they add.

Our next question comes from the line of Matt Hedberg from RBC Capital Markets.

This is actually Matt Swanson on for Matt. Matt, as your product portfolio grows, have you had to make any changes kind of in the go to market or how your sales force is telling the story? And when you look out at the pipeline, could there be any changes in the length of sale cycles?

Yes, Matt, so we are constantly trying to educate the sales force and the relationship management team on the product set, how it ties together, with the meaning it can provide to our customers whether it's a Fintech, an all-finance, a lending, leasing or deposit-oriented institutions. So there's a lot of energy that goes into that. And Tom Sheehan and Pete [Van Sistine], who run those organizations, really try to coordinate with the product team and the learning and education group to make sure that they're up to speed. So that's an ongoing process, one that we've got to continue to get better at, but it is something that is one of the challenges that we are always trying to get better at based on the deals that we've done. As far as the pipeline, I don't see any reason why the time to close deals would change the banking and credit union side of the business. We've covered that many times before. They have a cycle which they go through to make a decision. And I think that will be the same. And then the Fintechs and the other ones are all -- there shouldn't be any change. If anything, the more of these deals we get done and the more people that we can show we're up and running and in production, the easier it would be to close them. So there shouldn't be any change in timing of closure.

And our next question comes from the line of Mayank Tandon from Needham & Company.

Matt, just maybe few thoughts on competition. Obviously, you're doing really well. It's not showing up any slowing in your activity. But I would love to get some thoughts on some of the upstarts in the market and if they're nipping at your heels and any competitive pressures you're seeing today versus maybe 6, 12 months ago that you want to all out.

Yes. Thanks, Mayank. For the competitive environment on the platform side of things, it's still -- you've got the big guys that are out there that are trying to innovate and push us out, and then you have the upstarts, as you reference them. See them mostly on the retail side of the business. And we don't win them all, but we try to do the best to win the deals that make sense for us and fit with our margin profile and our strategic direction. We really want to win deals. There are certain customers that we target or prospects that we target that we really want -- we think they are a good fit for our ecosystem. And -- so we are doing a good job on winning those. Obviously, with the bookings quarter and year that we had, we're doing very well in the market place. On the lending side, Cloud Lending, that's mostly -- upstarts or newer companies. There's really no large player in there. We're just trying to maintain discipline around how we sell these, how we deliver them and how we support them because we think we've got a long view on that opportunity, and we want to make sure we get it right. So -- and then the Open side, it's -- we really -- on the -- at least with Fintechs, we really feel like we're the leader out there in the story we can tell, whether it's with Acorns or MoneyLion, Capital. And then our bank of record program, it's very unique. So we have different competitive environments now based on some of the products that we have. But we continue to deepen our product offering. We're going to continue to integrate those to bring a very compelling story to whoever the prospect is. And so that's the focus, but feel really good about it.

Our next question comes from the line of Joseph Vafi from Loop Capital.

I was wondering if all of the large Tier 1s that were signed exiting last year have moved into production and that's reflected in growth rate now, or there is still some of the Tier 1s from about a year ago that have yet to go live.

Yes. Joseph, I can tell you that all of the Tier 1s that were signed in 2017 are live in some form or fashion. I think we mentioned several times last year that a few of those decided to do phased rollouts. And so there is still approximately 3 of those deals that are not fully live yet that we expect to go live here, hopefully, by mid-2019 on their full production system. And the deals that were signed in 2018, the majority of those are also set to go live during the back half of 2019. But they're back-half loaded.

Our next question comes from the line of David Hynes from Canaccord.

Two quick ones, if I could. Matt, for you, just on the breadth of the platform, right, you have retail, corporate lending, you have a bunch of apps around the edges. Does it feel like you now have all the major pillars in place? Or is there more you'd like to add as you think about, kind of, the scope of problems you're trying to solve for your customers? And then second, for Jennifer, the $12 million from acquisition contribution, the backlog, should we think of those deals coming on with the same multiyear duration? Or help us frame, maybe, what that $12 million looks like on an ARR perspective.

So [DJ], on the platform side, I do feel like we have the 2 major areas, which are the deposit side and the lending side. Now there is so many different trails you can go down on each one of those. And that's going to be left to us to build. Some of those, whether it's an asset class on the lending side or a feature -- commercial feature on the deposit side to help a corporate run their business. So we -- there is a lot of road map for us to get through. We have -- I probably had 30 to 40 customers in Austin since January 1 this year. Met with them. And they have a list of stuff that they want us to do obviously. So there is a lot of work to be done, but that's really the opportunity for us. We don't sit in a room and spitball our product road map. We actually talk to our customers and prospects and try to find out what they want and then roll that into the road map. So we -- they have a list of stuff for us to do, and we will tackle that by building it, partnering with people or even potentially buying it. But right now, I really feel good about where we are with the product set. Obviously, we talked about the success on the cross-sell side. And then you add Cloud Lending, and Gro Solutions to it, and it becomes even more of an opportunity for our relationship management team. And then we can win it on the net new side. So a lot of work to be done. But I feel good about where we are. And this opportunity continues to grow as the pressures of Bank of America, Wells, Chase continue to push down on community and regional financial institutions as well as Fintechs.

And, David, on the backlog of the $12 million. Obviously, the majority of that is Cloud Lending as we said that Gro was very small. Cloud Lending had annual contracts. So all of the backlog related to Cloud Lending will roll off in the next 12 months. Whereas, Gro did have, on average, about 3-year contract. So there is a smaller amount that goes out into the future. But if you look at the overall backlog number of just over $870 million, a little less than 50% of that would be recognized in the next 24 months.

Our next question comes from the line of Terry Tillman from SunTrust Robinson.

Matt, Jennifer and Bob, I have a 2-part question. The first part, Matt, for you is just, you framed it well in terms of just the operating environment, improving, and plus, you have the strategic new product additions. But as we're moving into 2019, or as we're in '19, versus when we were entering 2018, could you just maybe delve a little deeper in the Tier 1 pipeline or sales activity in terms of just framing it whether it's the number of opportunities or the size or strategic nature of them? How does that differ versus heading into '18? And then I had a question on cross-selling.

Yes. So Terry, I would say that this is our sixth quarter of signing a Tier 1, and then we've also -- if you listened to the commentary, there's been consistent performance on the credit union side. I see -- and then the bank piece has really picked up, especially since 2017 -- '16, coming off of a rough '16. So from a pipeline perspective, all of the categories, whether it's Tier 1, Tier 2, Tier 3, on the area we focused on, Q2 Open, the environment is just -- it's very positive. I think our marketing footprint has gotten much better, and we're getting in front of more people now. We have more case studies whether it's on the open side, obviously, Cloud Lending, we're building those case studies, but there is -- the quarter we just had, whether it's a $25 million bank or one of the largest leasing companies in the country, are big wins for us considering that we closed the transaction in the middle of October. And so when I look across the pipe, it continues to grow. And whether it's the dollar amount of the pipeline or the deals. And obviously, it's a good environment, but we're also watching closely to see what happens based on what's going on in the world. But I just -- I couldn't be more positive on the execution of the sales and the relationship management team in 2018, and look forward to continue the execution there. And then you had a question on the cross-selling side -- cross-sell side, you said? Yes, you may have gotten dropped, Terry. See if you can jump back in the queue if you want.

Our next question comes from the line of Arvind Ramnani from KeyBanc Capital Markets.

This is [Brian] (inaudible) sitting in for Arvind. So as the company has changed quite a bit in the past 12 to 18 months. You've obviously added a number of Tier 1 customers and expanded the offering. Have you had to reprioritize how you've focused on selling back into your customer base versus trading that off for adding new customers?

Yes. I think that -- not in the last 18 months. I think when you get to -- probably, 6 or 7 years ago, you're selling new deals, and that's fun because you're winning new deals and then customers come out the back end and they want to know what you're going to -- how you're going to continue to innovate. And that's what I call the kind of the indigestion of a startup. And that was 2010 or '11 that we went through that. We really had to build out a relationship management organization to address the existing customers. So it's not -- it's nothing new for us. I think it's continuing to evolve. As we think about these customers, one of the things we've noticed in the customer base is I mentioned we have a lot of customers that came in -- that have come to Austin in the last 40 days. They want to begin to have board-level conversations, Chief Strategy Officer conversations, not so much about the day-to-day operations of the products. So that's one of the things that we've really been having to bulk up our leadership team around getting out and talking with customers to drive strategy and how they're going to deliver this technology. And that's a good thing for us, but it does require more attention from the top, both on the bank side or the financial institutions side and our side. So it -- that's nothing new for us, but it is evolving as this becomes -- I think digital transformation is probably #1 or 2 on the board docket for most of these financial institutions today.

And we do have Terry Tillman back on the line for his second question.

Well, you guys are waiting with anticipation, aren't you?

Yes, so excited, Terry. We were going to ask you about SunTrust-BB&T deal. But I don't know if that's fair.

Yes, I don't think I should comment on that. So yes, the question, though, Matt, relates to you in terms of you guys are smart people, for sure. And then over the last couple of years, you probably test and learn a lot about cross-selling. And Centrix was a nice deal. You have had nice add-on. Corporate banking, I assume, was at least a double or triple. But like what have you learned from those prior products that you've added: the acquisitions or organic development? And being able to apply that to now Gro and, more importantly, Cloud Lending because what I'm getting at, and I want to kind of put your feet to the fire like you asked me that question, you did, is maybe you could accelerate the cross-selling of these newer products just because of some of the things you learned in the past and just how you execute with cross-selling.

Yes, Terry. I would say that the thing that we've learned -- Centrix was a little unique in that we had a deep relationship, and 30% of their customer -- our customers were their customers. And so we already had the technology integrated. But if you look at the Social Money or Q2 Open product, and if you look at like Cloud and Gro, the thing that we are doing, and we've moved some really talented people from the Q2 platform side to help execute this, is you have to plan the right way. You can't go out and start selling things until you know exactly how the product is going to integrate. You've got to make sure you've gone out and talked to customers about what they -- how they would like for it to work. And so I would say rather than rushing in and trying to sell one to everybody early and create a logjam around the delivery or the quality, is that we are putting a lot of energy into getting the product right. We may lose deals on some of these opportunities in the first 6, 12 months. But we believe in the long run, it will make a huge difference in our ability to deliver it more rapidly and with a higher quality and to deliver customer success. So the lessons learned -- if you think about Q2 Open, it's evolved from just a deposit-processing tool to Biller Direct to CardSwap. And that was patience but also a lot of people put energy into how we're going to deliver these products, and it's ongoing. So the energy that goes in on front end is where we're -- what we've learned and we're going to continue to do that. And I think it'll pay off for us in '19 and '20.

Our next question comes from the line from Tim Willi from Wells Fargo.

My question was about, I guess, sort of the margin outlook, and not necessarily near term, but going to some of the other questions where we talk about how the company has changed quite a bit, bigger banks seem to be more receptive and success there, more products, is there anything about how you think about the balance of investment versus revenue growth versus protecting or establishing market position that is different now than it may have been a year ago or 18 months ago? Just sort of curious about sort of any high-level thoughts around scale and R&D and investment and things like that.

I don't think there's any change from where we were at 12 months ago other than the investment that we're making to integrate these acquisitions. We have always been a company, even before we were public, who was conscious of growing the top line at a rate that allowed us to make improvements on the bottom line because that's what our customers and prospects expect. And so we've looked at these acquisitions in such a way that, yes, they're going to be dilutive to margins in 2019 and perhaps the early part of 2020. But we would expect exiting 2020 that they're actually then breakeven for us at the EBITDA line. And it will help us improve go forward because they're both deals that are implemented on a platform: one, on the salesforce.com platform; and the other, in the AWS cloud. And so we don't have the underlying data center structure and infrastructure costs, which will allow us to grow our gross margins even more over time as those become a larger piece of our revenue.

Our next question comes from the line of Brian Essex from Morgan Stanley.

Matt, I just had one on Cloud Lending, the $25 billion deal in Northeast. How deep does that go into your organization in terms of origination through underwriting approval funding? Is that different than smaller deals? And then maybe to follow up on Terry's question in the pipeline, I know it's early days there, but any cross-sell and how the -- maybe get a sense of how the pipeline into Q2's install base with Cloud Lending might be shaping up?

Yes, so on the Cloud deal, it's a consumer lending product, and it's going to that -- it's one line of business that they're going to go through. So it goes all the way from the borrower signs up through closing the loan. That's all I'll say on that. And from a cross-sell perspective, the pipeline with Cloud, there is a tremendous amount of interest from our customer base, whether it's the customers that I've mentioned that come in or from what the field reps are saying out there talking to the existing customers. And also, we are beginning to present it as part of our platform, where we can show the -- some of the integration opportunities. And I think it represents what could be our largest cross-sell in the back half of '19. I think it's going to take a little time before it gets there. But as I mentioned, we're trying to plan appropriately and make sure that we can deliver on expectations. But keep in mind, we're still driving the Cloud Lending pipeline globally that was already there and enhancing it, signing the deals that we talked about in the fourth quarter. For me, it was a very strong indication that I think the customers and prospects like the fact that Cloud is no longer a small company that's owned by private equity and they're part of a company with a mission and willing to invest in the technology to make it scalable and just continue to enhance it. So I'm very optimistic about it. The North American banking opportunity with our customer base, our sales organization, our relationship management organization is ripe for us to go take this platform to the customers and begin to win a bunch of deals. So it should be a big part of cross-sells in the back half of '19. And I look forward to -- it could potentially be one of the -- the #1 cross-sell for us in '20.

Our next question comes from the line of Arvind Ramnani from KeyBanc.

Just wanted to -- can I ask you a follow up on these larger deals? How is your pricing and margins kind of expected to change as you kind of introduce kind of footprint at some of your larger accounts?

Yes, Arvind. So I think as we've mentioned before on the larger deals, we tend to get a little better pricing on the services component because those types of institutions are used to more like enterprise rollouts and paying for the implementation services. So while the subscription fee is probably a very similar margin, the services is typically, on an economic perspective, somewhere in the 20% or 20% to 25% gross margin, whereas, the smaller deals, the services component, on an economic basis, is closer to breakeven. The thing to remember there though is they tend to depress gross margins early on whenever you sign them because they do take longer to get to revenue, and we don't recognize any of that revenue until they go live. So they have an initial negative impact but, over the longer term, do have a positive impact.

Our last question comes from the line of Brad Berning from Craig-Hallum.

Just wanted to take your perspective on the engagement that you guys are seeing in the 70% growth. And as you think about your community and regional banks and bigger banks and then you also see the Fintech platforms through Q2 Open, how do you think about maintaining deposit account relevance on the community bank side in helping them from a product rollout standpoint to maintain engagement opportunities as they go forward and the competition from Fintech versus kind of the banking world heats up over the years ahead? Given your unique perspective to see both sides and help both sides, how do you think about your product road map to help them?

Yes, Brad. So I'll try to make it as simple as possible. I think at the end of the day, when you see a 70% increase, you see $2 billion logins, for us, what that means is more data of our customers to understand their customers. So how -- why somebody's logging in? What their cash flow looks like? What their spending habits are? And then you take that engagement, you begin to provide relevant offers or information to them. And that's where if you look at our Q2 SMART product, I think we closed 35 SMART deals in the fourth quarter, which is, obviously, a record for us. But that's what the engagement's bringing us is the data for the bank or credit union or the Fintech to be able to use that information to get to know their customer better, to provide better services or cross-sells. So the engagement is -- for us is nothing but a win because we get more data on the account holder. And then from there, we can begin to use more of that information to help them drive deeper relationships and maybe even -- make the client a borrower or a buyer of the product. So it's -- we're very excited about it. It's just more data for us to use.

And our next question does come from the line of Brian Essex from Morgan Stanley.

Just wanted to sneak one quick follow-up in for Jennifer, if I could. Just on the cash flow statement. It looks like we have a bit of a working capital drag for the year. And just want to understand how to -- how to get our arms around cash flow conversion going forward. And that will be it.

Yes. I think the investments that we're making in 2019 related to the Cloud Lending and Gro acquisitions, the retention payments around those as well as the possible earn-out payment related to Cloud Lending will keep us from probably being free cash flow positive in 2019. But then again, if there is an earn-out payment achieved at the June 30 milestone, that's a good thing for future revenue growth. So I think it's a good trade-off. But like I said, it will limit our ability to be free cash flow positive in '19. But I think you'll still see us generate cash from operations.

And there are no further questions at this time. This does conclude today's conference call. You may now disconnect.