Q2 Holdings, Inc. Q4 FY2024 Earnings Call

Good afternoon. My name is Aaron, and I will be your conference operator for today. At this time, I'd like to welcome everyone to the Q2 Holdings Fourth Quarter and Full Year 2024 Financial Results Conference Call. I will now provide operator instructions. And with that, I would like to turn our call over to Josh Yankovich, Investor Relations.

Thank you, operator. Good afternoon, everyone, and thank you for joining us for our fourth quarter and full year 2024 conference call. With me on the call today are Matt Flake, our CEO; Jonathan Price, our CFO; and Kirk Coleman, our President, who will join us for the Q&A portion of the call. This call contains forward-looking statements that are subject to significant risks and uncertainties, including, among other things, with respect to our expectations for the future sales operating and financial performance of Q2 Holdings and for the financial services industry. Actual results may differ materially from those contemplated by these forward-looking statements, and we can give no assurance that such expectations or any of our forward-looking statements will prove to be correct. Important factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in our periodic reports filed with the SEC, copies of which may be found on the Investor Relations section of our website, including our annual report on Form 10-K for the full year of 2024 and subsequent filings and the press release distributed this afternoon regarding the financial results we will discuss today. Forward-looking statements that we make on this call are based on assumptions only as of the date discussed. Investors should not assume that these statements will remain operative at a later time, and we undertake no obligation to update any such forward-looking statements discussed in this call. Also, unless otherwise stated, all financial measures discussed on this call will be on a non-GAAP basis. A discussion of why we use non-GAAP financial measures and a reconciliation of the non-GAAP measures to the most comparable GAAP measures is included in our press release, which may be found on the Investor Relations section of our website and furnished with our Form 8-K filed today with the SEC. We have also published additional materials related to today's results on our Investor Relations website. Let me now turn the call over to Matt.

Thanks, Josh. I'll start today's call by sharing our fourth quarter and full year results and highlights from across the business. I'll then hand the call over to Jonathan to discuss our financial results in more detail and provide guidance for the first quarter and full year before I conclude with a look ahead to 2025. In the fourth quarter, we delivered results above the high end of our guidance, generating non-GAAP revenue of $183 million, up 13% year-over-year and up 5% sequentially. We also generated adjusted EBITDA of $37.6 million, representing 20.6% of non-GAAP revenue, an improvement of approximately 630 basis points of adjusted EBITDA margin over the prior year quarter. We closed out the year with outstanding sales execution in the fourth quarter, posting the best bookings quarter of the year and the second strongest bookings quarter in company history. Our bookings performance was powered by a balanced mix of net new and expansion wins, highlighted by seven total Tier 1 and enterprise deals and was the best cross-sell as well as the best renewal quarter in company history in terms of total bookings. In particular, we view the renewal success as a strong indicator of customer satisfaction, the strength and differentiation of our platform and the overall value we're delivering for customers. Our fourth quarter sales performance underscored a great year for our business. We capitalized on a favorable demand environment with very strong sales across the board. We help customers address a wide range of challenges and opportunities across retail, small business, commercial and fraud management, leading to a record year of renewal activity, and we delivered consistently strong financial results that have us well on pace towards our three-year framework. After a record bookings year in '23, we followed it up with another strong year of well-rounded sales performance. Overall, we signed 25 total Tier 1 and enterprise deals, our most ever in a single year. And within digital banking, we drove significant volume in the Tier 2 and 3 space as well. In fact, we signed nearly twice the number of digital banking deals in these segments as in the year prior. Our ability to compete effectively in both areas is a testament to the breadth of functionality we have across retail, small business and commercial use cases and the reputation we've built in the market over the last 20 years. Complementing our success with new and expanded relationships, we also achieved a record-breaking year for renewals with bookings from renewals up 80% year-over-year. This solid execution demonstrated the resilience and growth of our customers in a challenging market environment as well as their reliance on and confidence in our technology to support their strategic initiatives. Also, there's no question that Q2 Innovation Studio is playing a large role in our sales success. Innovation Studio continued to be a valuable differentiator in net new sales, being cited as a key reason we won more than 90% of our deals in 2024. Throughout the year, customer and partner adoption also reached new levels, leading Innovation Studio bookings to more than double year-over-year. On the relationship pricing front, we signed a number of meaningful new customers in the Tier 1 and enterprise segments to continue to expand and renew our existing relationships. We've talked about the ability for these products to price the entire commercial relationship, not just loans. And that was key throughout the year in a volatile rate environment as new and existing customers purchased modules to price non-lending products like treasury services. We enter 2025 with solid momentum and are optimistic about the demand environment in the year ahead. Our risk and fraud solutions had a tremendous year as well. Thematically, fraud is one of the most pressing topics on the minds of virtually all of our customers. Because of the vital role our technology plays, our customers look to us to help them manage fraud across the retail and commercial account holder life cycle from authentication to in-app behavior to payments and more. In 2024, our solutions helped mitigate more attempted fraud against our customers than ever before. And from a bookings growth standpoint, our fraud solutions are one of the fastest-growing solution sets. Given the heightened priorities being placed on mitigating fraud in our end market, we expect to continue to see healthy demand for these solutions, and we believe we're in a great position to help our customers rise to the challenge in 2025 and beyond. A key driver of our sales performance throughout the year was the breadth of our platform, which gives us a natural expansion opportunity with existing customers. And because we spent 20 years building a strong customer base, that opportunity is significant. Take our commercial customer set, for example. While ACHs and wires were in our first lines of code back in 2005, we spent more than 10 years investing heavily in building out our commercial functionality and user experience. As a result, we've been successful delivering and supporting some of the largest and most sophisticated financial institutions in the country. Today, we have more than 60 Tier 1 financial institutions that utilize our commercial digital banking solutions. The result of significant innovation, investment and sales success. But that means we still have approximately 50 Tier 1 digital banking platform customers that do not use our commercial functionality today, representing a meaningful expansion opportunity to cross-sell commercial digital banking, and that's just one example. This dynamic powered our record year of renewal and expansion success and is a key reason we did such a high volume of Tier 1 and enterprise deals. Because of this single platform dynamic, we continue to expect expansion to play an increasingly important role in 2025 in addition to our continued momentum on the net new side. In summary, we delivered strong financial results in terms of growth and profitability in 2024. We significantly outperformed our expectations in the first year of our three-year financial framework and successfully reached our Rule of 30 goal on a total revenue basis in the second half of the year. Before I hand the call over to Jonathan, I'd like to take a moment to recognize the announcement of an addition to our Board of Directors. I'd like to take this opportunity to welcome Andre Mintz to the Q2 team. Andre brings a wealth of experience in global privacy, cybersecurity and financial technology, having held senior roles at Meta, Newport Group, Red Ventures and Microsoft among others. His expertise in data protection and compliance, particularly in the financial services sector, will be invaluable to Q2, and we're excited to add his perspective to our Board. Andre officially joins the Board on March 1. I'll now hand the call over to Jonathan to cover our financial results in more detail and provide an updated outlook for 2025.

Thanks, Matt. We're pleased to announce fourth quarter and full year results that outperformed our guidance, and we delivered strong results across several key metrics, which demonstrated continued execution of our profitable growth strategy. We've seen robust growth in our subscription-based revenues, advances in our operational efficiency and noteworthy improvements to our cash flow generation. Furthermore, we believe our record backlog and solid subscription ARR growth positions us well for continued success in 2025 and beyond. With that, let me start by discussing our financial results in more detail and conclude with guidance for the first quarter and full year 2025 as well as providing an update to our three-year financial framework. Non-GAAP revenue for the fourth quarter was $183 million, an increase of 13% year-over-year and up 5% sequentially. Total non-GAAP revenue for the full year was $696.5 million, up 11% from the prior year. The year-over-year and sequential increases for the quarter were primarily driven by subscription-based revenues, resulting largely from the delivery of new customer go-lives and additional solutions with existing customers. In addition, our sequential revenue growth benefited from an increase in one-time professional services work in the fourth quarter. Our subscription revenue growth for the full year was 16% and represented 79% of our total full year revenue. Based on the strength in subscription-based bookings we observed throughout 2024, we would expect the mix of subscription revenue to continue increasing as a percentage of our overall revenue mix in 2025. For the full year, our services and other revenues declined by 11% year-over-year. As we've mentioned previously, this downward trend is largely attributable to a decrease in our professional service revenues, which tend to be more discretionary in nature. Given the consistent pattern we've observed throughout 2024 coupled with our strategic emphasis on pursuing higher margin growth opportunities, we expect similar trends within our services segment to continue for the foreseeable future. Total annualized recurring revenue, or total ARR, grew to $824 million, up 12% year-over-year from $735 million at the end of the fourth quarter of 2023. Our subscription ARR grew to $682 million, up 15% year-over-year from $594 million in the prior year period. In anticipation of the tough year-over-year comparison against our largest bookings quarter in company history, we previously communicated expectations of subscription ARR growth in the fourth quarter of 12% to 14% year-over-year. On the back of the bookings success in the quarter, we were able to exceed that range and delivered 15% annual subscription ARR growth in the fourth quarter. Our year-over-year subscription ARR growth was largely driven by bookings from net new customer wins as well as cross-sold solutions with existing customers. Our total ARR growth continued to be pressured relative to our subscription ARR growth by the decline in professional services based revenue we previously discussed. Our ending backlog of over $2.2 billion increased by $189 million sequentially or 9% and $387 million year-over-year, representing 21% growth. The year-over-year and sequential increases were driven by bookings success across new cross-sell and record renewal activity. Our renewal performance was strong in both the fourth quarter and the full year 2024. The fourth quarter of 2024 marked our strongest single quarter ever for renewal bookings, culminating in 2024 as the best year for renewals in company history. For the full year of 2024, the total dollars added from renewals increased by 80% from the prior year. And in the fourth quarter alone, we renewed 10% of our entire digital banking customer base. As we have mentioned previously, the sequential change in backlog may fluctuate quarter-to-quarter based on the number of renewal opportunities available within that quarter. Our trailing 12-month total net revenue retention rate for 2024 was 109%, up from 108% in 2023. This rate reflects the continued strength in subscription-based revenue from our existing customers, offset by the expected decline in discretionary services-based revenue as we previously indicated. When looking only at our subscription-based revenues, our subscription net revenue retention rate ended the year at approximately 114% compared to 112% in 2023. Our revenue churn for 2024 was 4.4%, improving from 6.1% in 2023. As expected, heading into the year, we observed a reduction in overall churn, and our digital banking churn was well below 5% as we experienced record renewal strength. Gross margins were 57.4% for the fourth quarter, up from 56% in the prior year period and from 56% in the previous quarter. Both the year-over-year and sequential increase in gross margin were driven by an increasing mix of higher-margin subscription-based revenues and increased efficiencies within our delivery and support functions. Gross margins were 56% for the full year, up from 54.5% in the prior year, representing a 150 basis point improvement. This margin expansion was driven by an increasing portion of subscription revenue in our overall mix, coupled with enhanced operational efficiencies from our global workforce. Total operating expenses for the fourth quarter were $75.4 million or 41.2% of revenue compared to $74.8 million or 46.1% of revenue in the fourth quarter of 2023 and $72.6 million or 41.5% of revenue in the previous quarter. The year-over-year and sequential improvement in operating expenses as a percent of revenue was derived from increased scaling across all operating expense categories, with G&A showing the biggest year-over-year improvements. We ended the year with 2,483 total employees, up from 2,315 total employees at the end of 2023, with the majority of additional resources onboarded within our delivery and customer support functions. Total adjusted EBITDA was a record $37.6 million, up 62% from $23.2 million in the prior year period and up 15% from $32.6 million in the previous quarter. Full year adjusted EBITDA was $125.3 million, up 63% from $76.9 million in the prior year, with adjusted EBITDA margins up by approximately 570 basis points as we continue to mix towards higher-margin revenue streams and drive operational efficiencies across the business. We ended the quarter with cash, cash equivalents and investments of $447 million, up from $408 million at the end of the previous quarter. We generated cash flow from operations in the fourth quarter of $43 million, driven by improved profitability and favorable seasonality. For the quarter, we also generated free cash flow of $37 million, resulting in free cash flow for the year of $107 million. This represents an 85% conversion rate as a percentage of adjusted EBITDA, which is well above our previously set targets. This better-than-expected conversion rate was attributable to increased focus on profitability across all business units, streamlined operational processes and effective working capital management. Let me wrap up by sharing our first quarter and full year 2025 guidance. We forecast first quarter revenue in the range of $184 million to $188 million, resulting in full year revenue in the range of $772 million to $779 million, representing year-over-year growth of 11% to 12% for the full year. We forecast first quarter adjusted EBITDA of $36 million to $39 million and full year 2025 adjusted EBITDA of $165 million to $170 million, representing 21% to 22% of revenue for the year. In addition to this current year guidance, we are also updating the three-year financial framework we set last year for 2024 through 2026 with our revised targets as follows: we are lifting the average annual subscription revenue growth from approximately 14% to approximately 15%. As previously communicated, we anticipate full year 2025 subscription revenue growth of at least 15%. And while the growth outlook for 2026 will be dependent on execution throughout the year, our early expectation is that subscription revenue growth for 2026 will be approximately 13%. Additionally, we are increasing the average annual adjusted EBITDA margin expansion to approximately 360 basis points as compared to the midpoint of the prior range. And finally, we are increasing our full year 2026 free cash flow conversion target from greater than 70% to greater than 85%. As indicated by the targets in this updated framework, we are focused on eventually achieving and exceeding a subscription revenue Rule of 40 as a sustainable long-term objective. We are updating this framework based on our strong first year performance and our belief in our ability to execute against these targets over the next two years. Furthermore, our business model provides us with a high level of visibility. And when coupled with our robust pipeline, it has further informed these updated targets, positioning us for strong subscription revenue growth. In conclusion, we delivered better-than-expected results for the fourth quarter. We've updated our previous three-year financial framework to raise our average subscription revenue growth, average annual adjusted EBITDA margin expansion and free cash flow conversion targets and believe we are well positioned to continue capitalizing on the demand we are seeing in the market while executing against our profitable growth strategy. We're excited about the momentum we've built and are confident in our ability to continue delivering strong results in 2025 and beyond. With that, I'll turn the call back over to Matt for his closing remarks.

Thanks, Jonathan. As we kick off 2025, I continue to have tremendous confidence in the future of the business. 2024 was a great bookings year across the board, highlighted by another year of Tier 1 and enterprise success, record performance in Tiers 2 and 3 and a solid year for our relationship pricing solutions, all of which is powered by a highly differentiated solution set. We also had a record year for renewals, which we believe validates our roadmap and reinforces our customers' trust in us as a strategic partner in their digital transformation. Even with all the booking success, our pipeline remains strong, and gives us good visibility into continued sales momentum, particularly in the first half of 2025. We expect the demand environment to remain positive and with our improved win rates in 2024 compared to the prior year, we believe we're well positioned to build on our sales success from the last several years. With our strong financial performance and progress towards our three-year framework, we believe we're in a great position to continue to deliver value to customers, employees and shareholders in 2025 and beyond. Thank you. And with that, I'll hand it over to the operator for questions.

I will now open the call for questions. Our first question for today comes from the line of Terry Tillman with Truist Securities.

Matt, Jonathan, Kirk and Josh. Congrats on the strong bookings in the fourth quarter. Two questions. I won't guarantee they're single parters. But the first one is a multipart on this with Wells Fargo that I think you all press released: is this relationship pricing? And how meaningful is the proportion of the total PrecisionLender business relationship pricing? And are there potential synergies with just commercial digital banking deals?

Kirk, your team did it. Do you want to talk about the success of it and we can...

Yes. Thanks, Terry. This is a really exciting opportunity for us. This is a deal we talked about in this call a year ago in terms of the win that we had in the fourth quarter of '23. Getting something that's live in under a year is really a testament to both teams. It also points to the deployability of that product, something we've been focused on. This puts us at about nine of the 15 largest banks in North America using PrecisionLender and so we look forward to building on that.

And Terry, just on the second part of your question, it's Jonathan, just to be clear, the relationship pricing terminology really is how we're thinking about the PrecisionLender business as a whole. So the color we've given historically about PrecisionLender, when we say relationship pricing, that is that business — how we're talking about it and really based on the fact that we're not just pricing loans with that solution, we're looking across the entire relationship the institutions have on the commercial side. So hence, the reference to relationship pricing.

And as far as the commercial digital banking side of the business, we haven't found a lot of crossover from a product perspective. But having a master agreement with a lot of these customers, whether it's for digital banking or for PrecisionLender, them understanding the way we treat our customers, how we respond to the company, there's some intangible value to that. It's open doors for us, and we've been able to win, and we're also seeing expansion opportunities within existing customers for the product. There are not a lot of synergies between the two from a product perspective.

Okay. And just a follow-up, it's going to be simpler. People always are intrigued by big deals. It's the people really hang our hat on that. But as you look into '25 and you said strong pipeline, how would you characterize the reliance potentially on large Tier 1 enterprise deals versus the volume and velocity Tier 2, Tier 3? Does it seem much different than potentially what happened in '24?

Yes, Terry, if you remember, coming off of '23, we had, I think, four of the top 10 biggest deals in the history of the company. We told the Street that we were looking at probably skewing more towards Tier 2 and the volume, which we said in the earnings call: we signed more Tier 2, Tier 3s in '24 than we did in '23. But we still did 25 Tier 1 and enterprise deals, which I believe is a record as well. If I look at '25 and the pipeline ahead, I think you're still going to see a steady flow with the Tier 2s and 3s. I don't want to front-run it, but these are probably back half, but I think you're going to see us get back to some of those larger enterprise deals above $25 billion in assets as the year develops, but we'll still have success in the Tier 1 space, $5 billion to $25 billion as well. So it's a pretty balanced pipeline right now, which feels good going into the year. But there's a lot of work and execution that has to get done. These things are not easy to get done whether it's a Tier 3 or enterprise. I'm fully confident in the sales and success team to execute.

Our next question comes from the line of Alex Sklar with Raymond James. Your line is live.

Jonathan, first question maybe for you. You're taking up the TAM to $20 billion. It looks like kind of 15% TAM growth over the next couple of years. Can you just talk about some of the biggest drivers behind that market growth? And how we should think about the puts and takes for Q2's growth relative to those market levels?

Yes. So when I think about the changes, some of the areas that are clearly in there now that have evolved over the last couple of years in particular: we have a much clearer view of our opportunity set when we talk about our fraud products and Matt mentioned that at length in the call. We're really excited about the success to date and the opportunity set there. As we think about our Helix business, with the fabric opportunity, the ability to bring that product inside the financial institution landscape and capture the opportunity set there was another driver of that. And then the final thing is just as we've crystallized our entire commercial line of business across all the commercial products, including commercial digital banking and PrecisionLender and everything around that from a commercial standpoint. Those are the areas that have the fastest growth from a market perspective and that had the biggest impact on that change in TAM.

Okay. Great color there. And then maybe for Matt or Kirk, a lot of commentary in the prepared remarks about the progress selling that full digital banking platform across customers who had started with one of retail or commercial. You said 75%, I think, still don't use both. So can you just talk about what are the gating factors? Could that get up to 80%, 90% over time? What are the puts and takes there for adoption? And how are you going to market to those customers that are still only using one solution?

Yes. The comment here is we have 110 customers that are digital banking customers above $5 billion and 60% of them are only using one, either commercial or retail. The sales and success teams are locked in, going to cross-sell the other product into them. The single platform drives a lot of value. You provide a great customer experience. The financial institution is more likely to do business with you, and we've seen that play out. The challenge is these are big projects. They have to have the budget. They've got to be prepared for it and they have other priorities. But it's easier to get them live once you've got one of the products in there because you've got the integrations, you've got the network set up and everything else. It's a huge opportunity for us, and that's why we highlight it.

Our next question is from the line of Joe Vruwink with Baird.

When you think about your customers benefiting from deregulation, how do you think that plays into strategies that might end up involving your technology? And is there a right time frame to think about when that could manifest in bookings benefit above and beyond the strength you've already observed?

To some extent, the deregulation, when or as it occurs, will allow them operating efficiency, fewer people to have to follow all the regs. It will also hopefully help with their ability to transact if they need to do an M&A, pick up banks. All of that will be a tailwind for us. The energy behind the banking and credit union community is they are pretty optimistic about things as we sit here today. So all of it should be a tailwind for us. The direct correlation between deregulation and digital banking may not be immediate, but the fact that there's less burden on the financial institution, even if you take some of it out, their ability to focus and make these decisions and spend less time on regulatory things is a positive for us. It's less distracting for them. So overall, positive for Q2.

Okay. That's great. Just on the updated three-year average financial targets. I think you've done a nice job in structuring these where the out-year budgets embed a fair amount of conservatism. And obviously, that gets rolled up into an average calculation. I guess as you triangulate on that 2026 number and thinking about the 13% subscription growth, also the margin expansion, we're getting closer to the estimates consensus that are out there. I just wanted to maybe revisit your guidance philosophy and how you think about performance that could happen over the next 12 months, which still may be driving upside to what's embedded for 2026?

Yes. Thanks, Joe. So I'll take that. Our business model affords us a fair amount of visibility even looking forward two years. It wasn't long ago, in the third and fourth quarter of last year on those calls, where we talked about the shape of bookings and the mix leading us to a fair amount of larger deals that were going to go live in late '25 and into '26. So we do have a fair amount of visibility into '26. Happy to say, in addition to discussing Wells and a couple of other deals, we've actually gotten a couple of the bigger deals live faster than we anticipated on both the digital banking side and the PrecisionLender or relationship pricing side. So I think that's given us a more clear view of '25 and confidence in that number. But then as we think about '26, there's a fair amount of impact from the execution that we have here in the next 12 months, whether it be hitting our bookings plan or the mix and shape of those bookings that will impact 2026 above and beyond what we see today. So that's the kind of thing that could drive upside performance to the 13% that we talked about or the EBITDA implied guide in '26. And at the end of the day, as we think about modulating between investing to elongate that subscription revenue growth at these elevated levels, that's really what we're giving ourselves room to manage here as we get through '25 to ensure that we have that right balance, totally in line with our profitable growth strategy that we've been talking about for the last couple of years.

Our next question comes from the line of Adam Hotchkiss with Goldman Sachs.

To start, Matt, just on bank IT spend priorities in '25. There's a lot of talk about lending volumes picking back up, particularly on the commercial side and banks being a little bit more offensive in their thinking. Just curious how you think that impacts you guys, if at all?

I hope lending picks up for the banks for their sake. But deposits are still at the center of what runs the bank and the discipline around acquiring deposits, wanting to use a commercial platform that's competitive with what Bank of America, Wells and Chase rollout is important. If you think about what happened in 2012 to 2022, a lot of these banks were signing the loans but weren't getting the operating accounts. Now they have a discipline around needing the operating accounts. So when loan volume picks up, you'll see more operating accounts come in, but they want to have a competitive commercial product to get that. We are squarely in the middle of that. If you look at our win rates and success over the last seven or eight years, especially upmarket in the commercial banking product, we are well positioned. So I think the lending environment picking up would be a tailwind to us as well.

Okay. Really helpful. And then just on that point, what's the barrier to you guys cross-selling commercial? I know it's obviously a much more complex product for financial institutions. So what's worked for you in the past and what gives you confidence on continuing to be able to do that with new FIs and existing customers going forward?

Some of it is we can point to our customer base: a large share of the most profitable banks use our platform and many of the top credit unions do as well. Banks look to other banks when they're making decisions, and we have more examples than anybody to point to the success and satisfaction customers get on the product. The challenge when moving a commercial banking system is the risk of moving their crown jewels to a new system; it's complicated and fraught with risk for those that haven't done it as much as we have. Nobody has done more of those modern conversions than us. We're able to lean on our track record, show product screens, and demonstrate the operating capability to convert files, wires and provide operational discipline. We've built that over time and continue to invest in it. Those are the things that differentiate us in the sales process and explain our bookings over the last couple of years. We'll continue to rest on that and be competitive.

Our next question comes from the line of Andrew Schmidt with Citigroup.

Good results here. I wanted to touch on the longer-term EBITDA outlook and similar to a question asked earlier, just outlook philosophy when it comes to the out year 2026. Maybe talk through, are there investments that are contemplated there? Is it more prudence when we think about the out year from an EBITDA margin perspective?

It's a little bit of both. There are definitely investments planned, especially in some product areas I mentioned before, whether it's fraud, Innovation Studio, fabric, commercial functionality where we need to continue to expand feature function and capabilities overall in those areas. We're also leaving ourselves room to make further investments as we see the year play out and we see opportunities across the business. So I feel good about our ability to achieve those targets. We're looking a couple of years out as we give color on 2026 today, but we have a lot of confidence in those targets. We do have planned investments in there, but we also need to be able to modulate between investing to elongate growth versus driving profitability for shareholders.

Absolutely. That makes a lot of sense, Jonathan. I appreciate that. And then maybe on the Tier 2, Tier 3 step-up, it's really great to see that. Can you talk about just the drivers there? Is it more shots on goal, win rates, combination of those factors? Can you elaborate on what's driving that uptick there?

I think it's a function of demand: these banks are trying to get the operating accounts. They need a modern product that works on mobile, integrates, and provides a single experience. Many banks are running legacy systems that don't meet today's needs. For us, we're able to walk in and present a product that's up and running, with hundreds of customers and a long track record. These commercial deposits are sticky and profitable, and that's what's driving demand. Win rates were slightly up from '23, and Tier 2s and 3s have been coming to us because they're looking for these modern products. I think that trend will continue in '25.

Our next question comes from the line of Charles Nabhan with Stephens.

Congrats on the quarter. I wanted to ask about free cash flow. It's good to see the increase to the cycle guide, and it sounds like a lot of that is attributable to working capital improvements and operating leverage. But I wanted to ask if there's been any changes to your expectations for CapEx spend? And then secondly, as a follow-up to that, I wanted to get some color around your capital allocation priorities, specifically, where you're investing in product, what's on the product roadmap? And if M&A is still part of the consideration?

Really pleased with the free cash flow conversion. The team did a phenomenal job improving conversion through under-the-waterline processes. We had phenomenal DSO performance, especially in the fourth quarter, which was a big part of it, on top of improved profitability. There is no change from a CapEx perspective; we remain a CapEx-light business and expect that to continue. From a capital allocation perspective, organically we're focused on product areas like fraud, Innovation Studio, building out the partner ecosystem, fabric and commercial functionality, and relationship pricing, especially on the treasury and deposit sides. Regarding M&A, our balance sheet strength and free cash flow generation provide optionality. We're seeing a lot to look at, but we haven't seen assets that meet our quality and valuation expectations. We'll be prudent and only pursue M&A if everything lines up strategically and financially.

Got it. Appreciate the color. And as a follow-up, I wanted to ask about professional services. It looks like that line was down about 11% in '24. And it sounds like the expectation is that it will be down at a similar rate in '25. I wanted to get your thoughts on the discretionary consulting piece and some of the assumptions underlying that outlook. Is that an area that could potentially come back over the next year or two as a result of deregulation and/or consolidation in the bank space?

The baked-in assumption is that we do not see a rebound in professional services. Is it theoretically possible over the next couple of years? Yes. But we have not seen an indication of that behavior from our financial institutions as we sit here in early 2025. Interest rates are not moving down as quickly as some had anticipated, and we're not seeing a pickup in discretionary spending. We still see the same pressures on deals in Q1 2025 where customers are careful about contract length, scope and in some cases pushing decisions. So the evidence in Q1 suggests continued pressure on discretionary services. That said, if demand comes back, we'll be selective about how we grow that business and focus on high-quality, long-term engagements.

Probably just to add that if the demand does come back, we're going to be very selective in terms of how we choose to grow that business back. We want to make sure we're doing so with high-quality, long-term intentions.

Our next question is from the line of Michael Infante with Morgan Stanley.

Hopeful color just on the renewal bookings growth of 80%. I know you have had some improvement on the pricing front versus historical trends. But if you had to apply some form of rough attribution or directional framework on how the mix of that bookings growth builds up between incremental cross-sell, attach, price and contract duration extension, I'm trying to think about some of the drivers of the FY '26 subscription revenue growth aside from the fact that the comps get tougher. I'm wondering if that is some assumption on normalization of some of the renewal dynamics, which obviously have been really strong.

I'll hit that. When we were coming into 2024 with a subscription growth expectation of 13% originally, a huge part of the progression toward what ended up being 16% for the year was the pull-in of out-of-scope renewals with favorable economics and really strong cross-sell performance relative to expectations. As we think about 2025 and into 2026, there's some persistence to our strategy around pricing and packaging on cross-sell and renewals, but when we laid out our plans for this year and started to think about next year, we're not assuming a significant level of out-of-scope renewals coming in every year beyond normal. Our history and data set helps benchmark that. Theoretically, more out-of-scope renewals would be upside. We're working off the data we have today for a full-year 2026 view. The average term and tenure of deals hasn't changed — we're still averaging 66 months — so the primary incremental driver historically has been out-of-scope renewals and their economics, plus cross-sell. Those are the drivers that could lead to performance above what we have provided for the 2026 outlook.

That's helpful, Jonathan. Maybe just on the terminal pricing structure within digital banking. I know this is primarily a user-driven model. I'm thinking through with the M&A acceleration contemplated, you obviously tend to be a beneficiary. But you have levers like contractual minimums, inflation escalators and cross-sell attach. How do you think about the conditions under which you would consider shifting the pricing model toward more of an asset-based or consumption model over time versus user-based? How far away might that be, if at all?

Just to clarify, digital banking pricing is driven by an end user base; there are tiers from an asset perspective, but the underlying driver is number of end users. That practice allows us to capture economics as financial institutions grow and get more digital adoption. We don't have a lot of products that work on a true seat-based model. As M&A occurs in the market, you're accruing more customers under a single logo, and that's a tailwind for us because combined user count relative to existing minimums can be negotiated, and that's an upside driver to the economics post-transaction.

As M&A occurs in that market, you're basically accruing more customers under a single logo, so that's part of the economics that help. That's a tailwind for us when there's a lot of M&A in our customer base.

Our next question comes from the line of Parker Lane with Stifel.

Matt, you called out the continued success of the fraud products. I was wondering if you could sort of break down the success along the lines of desire to deprecate legacy tools, improvements in your own capabilities there or just a greater emphasis on the part of the end market. What is contributing the most to the success you're seeing there?

Since the pandemic, utilization of digital banking products went through the roof and the weakest point is the end user. We're seeing account takeover, various types of fraud, and check fraud has gone through the roof as well. We have tools across authentication, in-app behavior monitoring, payments and file validation. We've invested heavily in machine learning tools since around 2008 and have products that stop fraud in many different ways. The single platform gives us a better view: we can aggregate data from millions of end users and commercial customers and use that data as a defensive tool. One system creates advantages over multiple disparate systems with multiple entry points and databases. Our platform design and how we work with customers are intrinsic differentiators. Unfortunately, fraud has increased with higher digital adoption, and our products are in high demand.

Got it. And one quick one for you, Jonathan. If I heard you correctly about roughly 10% of the digital banking base renewed in the quarter — just what share of that was out-of-scope renewals? I know you talked about that earlier, but didn't quantify it. Is that something you could quantify?

We don't quantify out-of-scope renewals externally because it isn't consistent quarter-to-quarter or year-to-year. What I will say is that both in the quarter and the full year, we saw more out-of-scope renewals than typical, and that was a driver of the results. Seasonally, Q4 is the strongest renewal quarter, and in addition to in-scope renewals that were part of the plan, the out-of-scope renewals on top of that led to a tremendous quarter. Ten percent in one quarter, given the length of these deals, is well above normal.

The customer success team really knocked it out of the park. This doesn't just happen in the fourth quarter — it's the work they put in across 2023 and 2024 to engage these customers, discuss other products and the value we provide to get those extensions. There's a lot of effort across the success, support and delivery organizations. This demonstrates how you treat customers and their willingness to sign longer-term arrangements. I'm really proud of the work that team did in 2024 and look forward to more in '25.

Our next question comes from the line of Dominick Gabriele with Compass Point.

I was curious if you could talk about pricing and competition for new deals versus renewals. You're having some profitability success. Do you believe you have pricing power given the demand for your products versus peers? Would you consider your products a premium product that banks are willing to pay extra for?

In '24, average selling prices were slightly down, more because of deal mix. Every deal is competitive; you see more pricing pressure on retail than on commercial, and we do capture a premium for our products. Some buyers purchase on price, but we play the long game. There are competitors we have lost deals to over the years and later won back. Commercial banking is not something institutions take a chance on; they need a fully functional system with operational discipline and execution, and we've built that capability. We don't give that away because there's tremendous long-term value and customers realize it. All deals, net new or renewal, are competitive, but our sales and success teams do a great job capturing value and communicating the benefits of a single, integrated platform, which includes faster feature rollouts and better data for fraud and cross-selling.

Yes, it seems to show up in the numbers. Then could you break down the year-over-year margin improvement in the long-term guide, the 360 basis points? How much is due to scale versus cost reductions versus product mix? Is any one of those an outsized benefit, or is it more balanced?

Broadly, the revenue mix shift toward subscription revenue benefits both gross margins and EBITDA margins. In '24 and '25, roughly speaking, about 60% of the improvement was driven by OpEx leverage versus 40% from cost of sales. As we move into 2026, that dynamic flips more toward gross margin improvement driven by things like cloud migration, with OpEx still contributing but to a lesser extent. So overall, mix shift is a key driver along with expense initiatives and operational focus, but the balance of OpEx and cost-of-sales contributions varies year to year.

Our next question is from the line of Marc Feldman with William Blair.

On Helix, in 2024 embedded finance and banking-as-a-service was a major regulatory topic. Under the current administration, do you think there's going to be any upside in demand for embedded finance products from your customers going forward?

On the fintech side, the market has shifted to where the most likely entrants need scale and need to work with committed banks because everything runs through a financial institution now. Middleware providers and highly distributed service models are concentrating around the top banks that know how to run a BaaS program end-to-end. From the financial institution perspective, when they think about the Helix opportunity they are more inclined to control the entire BaaS program and are looking for core alternatives to run those programs. Historically, Helix might have partnered with a bank of record to sponsor a customer, but now institutions want to do it themselves and need a core to run with. That's how I would characterize the change compared to '24. It sets us up well as a differentiated product in the space, but I wouldn't say administration changes have materially shifted the underlying dynamics.

Ironically, the attention in '24 highlighted our strengths, many of which are operational in nature. Banks are focused on operational integrity, and we think that will be good for us in the long run.

Got it. That's helpful. Second, Innovation Studio bookings doubled year-over-year. Is that driven by new customers adopting it, growing use among existing customers, partner activity, or some combination?

We haven't quantified it by component externally, but it's all of the above. Innovation Studio is a high-margin revenue stream because of net revenue treatment. It significantly impacts new wins and adoption by existing customers. Three years ago at GA, we had about 20 early adopter institutions; today over 400 of our 450 live digital banking customers use it in some fashion. We're seeing a two-sided marketplace with customers and products finding each other, and we're still in the early innings of driving bookings and revenue opportunity from Innovation Studio.

And we have the final question today from the line of Dan Perlin with RBC.

I had a question on the level of absolute dollar increases that we're seeing in the backlog. It increased sequentially $189 million, up from $78 million last quarter. I know it can be lumpy, but are deal sizes getting bigger as a result of the size of clients in your portfolio? Or is there just greater appetite for incremental spending in the current demand environment?

In any one quarter, the biggest driver of the backlog change will be renewals because they tend to have larger contribution given their term and size. The fourth quarter is seasonally our strongest renewals quarter, and the $189 million sequential increase was driven by renewals and some out-of-scope renewals. Deal size on the net new side matters, but the primary driver in a given period will be the renewal mix and out-of-scope renewals that get done in that quarter. There's upward pressure on average deal size overall, but renewals are the dominant factor in the quarter-to-quarter movement.

Thank you for your questions. With that, that will conclude the Q2 Holdings Fourth Quarter and Full Year 2024 Financial Results Conference Call. Thank you for attending. Have a great afternoon. We'll see you next time.