Alkami Technology, Inc. (NASDAQ:ALKT) Q3 2023 Earnings Call Transcript

Alkami Technology, Inc. (NASDAQ:ALKT) Q3 2023 Earnings Call Transcript November 1, 2023

Operator: Hello and welcome to the Alkami Third Quarter 2023 Financial Results Conference Call. My name is Betsy and I will be your operator for today’s call. [Operator Instructions] please note this event is being recorded. I would now like to turn the conference over to Steve Calk. Steve, you may begin.

Steve Calk: Thank you, Betsy. With me on today’s call are Alex Shootman, Chief Executive Officer; and Bryan Hill, Chief Financial Officer. During today’s call, we may make forward-looking statements about guidance and other matters regarding our future performance. These statements are based on management’s current views and expectations and are subject to various risks and uncertainties. Our actual results may be materially different. For a summary of risk factors associated with our forward-looking statements, please refer to today’s press release and the sections in our [indiscernible] Form 10-K entitled Risk Factors and Forward-Looking Statements. This is made during the call today are being made as of today and we undertake no obligation to update or revise any forward-looking statements, also unless otherwise stated, financial measures discussed on this call will be on a non-GAAP basis.

We believe these measures are useful to investors in the understanding of our financial results. A reconciliation of the comparable GAAP financial measures can be found in our earnings press release and in our filings with the SEC. I’d like to now turn the call over to Alex.

Alex Shootman: Thank you, Steve and good afternoon, everyone. The third quarter was another good quarter for Alkami as we grew revenue 27% once again ahead of our expectations. In addition, we achieved positive adjusted EBITDA 1 quarter sooner than we committed and we are adding and keeping users at a better pace than any other digital banking provider. Over the last 12 months, we added 3.2 million Digital users to our platform. And as we approach the end of 2023, we do not expect to lose a single client off of our digital banking platform this year. Q3 marks another quarter of progress in our plan to build Alkami into a primary provider of digital technology to banks and credit unions with healthy growth, solid profitability, a strong culture and satisfied clients.

One of the questions many of you asked me is how our clients are navigating a very dynamic macro environment. During September and the first week of October, I slept in 18 different beds as I traveled the country meeting with clients and prospects and gained a perspective on how regional banks and credit unions are thriving in today’s environment. In addition, last week, we hosted a dozen prospects at our headquarters for exchange with members of our client advisory board and got to listen to those executives discuss their current strategies and tactics. Every conversation on the [indiscernible] and in our headquarters started with some variation of the following narrative. [indiscernible], in all my years of this business, I have never seen such a rapid change in monetary and fiscal policy.

The meetings evolved into discussions on the volatility in interest rates, the rising cost of deposits, the speed at which they’re rebalancing deposits and loans and most interestingly, the need to dust off playbooks they’ve not used since the mid-2000s. I had one CEO tell me, Alex, we have always talked about driving card usage and attracting direct deposits but we really hadn’t focused too much on it. She went on to say none of my staff were here the last time we had to drive deposits and we were having to teach strategies and tactics we have not used in years. I asked each CEO of this changed the way they thought about digital banking. And to a person, they told me that digital banking is a mandatory innovation in this environment. From digital onboarding to analytics to drive card usage to tactics to encourage direct deposits and technology to fight fraud [ph].

They were continuing to invest in digital banking and even something as routine as CD rollovers is on their mind. One CEO told me Alex, we all offered short-term CDs and these products will roll over in 2024. We don’t have enough people to handle them manually. We have to use digital capabilities to meet the demand. In addition to the personal meetings I conducted, we surveyed 215 FIs in September to assess their overall digital maturity by asking a series of questions related to digital adoption and investment priorities. We found the most digitally mature organizations which also reported higher revenue growth than their peers are much more likely to say that digital banking is more important than branches or call centers. In addition, they are also much more likely to say that their top investment priority is improving customer experience technology.

As one bank responded put it, from the top of the organization all the way on to the lowest levels, there’s a constant reminder if there’s an opportunity, digitize it. Amidst all this change, our clients are proving to be resilient. While the U.S. banking industry deposits contracted 4.8% year-over-year as the FDIC reported in June, when we evaluate our clients’ data, we’ve seen almost a 1% increase in deposits since early July. Also since July, their user counts have increased and the percentage of users with uninsured deposits remains virtually unchanged. Our clients’ strategic use of digital banking and their ability to compete in this environment mirror the demand we are seeing in our new client wins and additional products being purchased by our current clients.

For example, as part of one renewal in Q3, the client added 12 new products, including data and analytics, advanced business capabilities, biometric security and card capabilities that allow them to provision digital cards. They’re not alone. We continue to see earlier client cohorts add functionality. Our 2018 and 2019 cohorts are now at 2x their initial ARR and our 2020 cohort is already at 1.8x initial ARR. In addition to adding products, our clients continue to grow digital users faster than the overall market. In 2023, we will add more new clients and digital users to our platform than any year in our history. Our pipeline going into 2024 is the strongest ever and we continue to deliver on the commitments we made to our clients and our investors.

To our clients, we committed to invest in expanding our product portfolio so they can compete with the digital capabilities of mega banks. Over the last 6 years, we’ve invested over $0.25 billion in R&D. And Alkami has consistently spent the most on R&D as a percent of revenue compared to other large companies in our market. While this percentage will moderate as revenue grows, we will continue to grow R&D to keep our platform modern and competitive. The technology we deliver today includes fraud protection, digital account opening, advanced card services, commercial business banking capabilities and payment solutions. At the time of our IPO in 2021, our new clients on average used 34% [ph] of our product portfolio. And today, new clients on board with over 50% of our product portfolio.

This demonstrates we are not just delivering new products but also developing the right new products. We committed to our clients that we would continuously deliver a world-class user experience for their end users. Today, we consistently hold one of the highest ratings in the App Store that may be more importantly by far the app that is most rated in our space. One of the biggest commitments we make to our client is when we convert them from their legacy system to Alkami. This is nontrivial, as there are integrations to their back-office core systems, dozens of connections to third parties and thousands of customer accounts to convert. And usually, the entire user base moves to the Alkami platform on launch date. Our experience in launching new clients is a significant and sustainable competitive advantage.

Among the many clients we launched in Q3, we accomplished a first for Alkami. We launched 3 clients in a single day. So it’s not just about launching the client. It also has to be a great experience for our clients and their end users. Jerry Agnes [ph], who’s the President and CEO of Elevations Credit Union told me, Alex implementing Alkami for our new digital banking platform has been better than any other conversion I’ve experienced. Over 88% of our members converted to Alkami with no assistance or intervention from our staff and our members are thrilled with the new platform. A digital banking platform must have trusted availability and performance because our clients and users rely on it for — during critical life moments. We committed to continuously evolving our digital platform and over the last 6 months, have made great progress in transitioning to an event-driven architecture with advanced tools for observability and automation.

We are now using auto scaling and we support 0 downtime upgrades. All of this while driving efficiency through transitioning to technologies such as [indiscernible] and Linux. Keeping our commitments to our clients has allowed us to keep our commitments to shareholders. We have consistently delivered on our growth targets while being prudent with our investments and expenses. We have delivered on a commitment to be adjusted EBITDA positive and we have confidence in the longer-term revenue gross margin and adjusted EBITDA guidance we have provided. In closing, we are proud of the results we delivered in the quarter and pleased with the progress we’ve made in 2023. I am confident in the long-term prospects for Alkami to be an indispensable technology platform for the financial services industry, a great place to work and a reliable partner for the investment community.

And now, I’ll hand the call to Bryan to take us through the numbers.

Bryan Hill: Thanks, Alex and good afternoon, everyone. During the third quarter of 2023, Alkami crossed several major milestones. First, we achieved our first quarter of positive adjusted EBITDA. This occurred 1 quarter earlier than originally expected at the beginning of 2023. Second, we increased the digital users on our digital banking platform by 1 million during the quarter. This represents the largest quarterly increase in company history, bringing us to just under 17 million digital users. And third, Alkami’s remaining purchase obligation or contract backlog reached $987 million, representing 3.6x our live ARR and 31% higher than a year ago. These achievements, combined with our 2023 financial performance, evidence outcoming success and unique position to capitalize upon the strong secular trend of digitization in the banking industry.

Let me unpack an impressive quarter for you. For the third quarter of 2023, we achieved revenue of $67.7 million, representing growth of 27% which is slightly above the high end of our financial guidance. This was driven by balanced performance across our primary revenue drivers. We implemented 11 new clients in the quarter, bringing our digital platform client count to 229. So far in 2023, we have implemented 1.3 million users at just under $23 million of ARR, both which exceed the full year of 2022. Based on our near-term visibility, we expect to exceed last year’s implementation production by 35% and 30% for digital users and ARR. We now have 35 new clients in our implementation backlog representing 1.1 million digital users. We exited the quarter with 16.9 million registered users live on our digital banking platform of 3.2 million [ph] or 23% compared to last year.

Over the last 12 months, digital user growth continues to be driven by 2 areas. First, we implemented 39 financial institutions supporting 1.7 million digital users. Second, our existing clients increased their digital user accounts by 1.4 million users, demonstrating an ability to drive client growth and digital adoption during a more challenging economic environment. This underscores the importance of the digital channel. Over the last 12 months, we have not experienced any client churn from our digital banking platform and we expect the same for the full year 2023. We ended the quarter with an RPU of $16.28 which is 5% higher than last year, driven by add-on sales success and the addition of new clients who tend to onboard with a higher average RPU.

Subscription revenue grew 28% compared to the prior year quarter and represents approximately 96% of total revenue. We increased ARR by 29% and exited the third quarter at $275 million. In addition, we currently have approximately $42 million of ARR in backlog for implementation, most likely to occur over the next 12 months. We continue to see healthy demand across our product portfolio. So far in 2023, we have signed 23 new digital banking platform clients, of which 7 were signed during the third quarter. Our new client wins reflect solid representation from banks with 7 signed so far in 2023. We Presently, based on the strength of our sales pipeline and visibility into Q4 digital banking platform decisions, we expect the fourth quarter to be a strong quarter for new client wins.

Our add-on sales success continues to yield results, representing 33% of total new sales for the first 3 quarters of 2023. In addition to add-on sales, our client sales team is responsible for client contract renewals. During the first 3 quarters of 2023, we renewed 11 client relationships where we raised the ARR run rate 9% through a combination of new product sales and committed client growth. In total, we expect to renew over 20 clients during 2023. Now turning to gross margin and profitability. For the third quarter of 2023, non-GAAP gross margin was 59%, representing 190 basis points of expansion when compared to the prior year quarter. Improvement in our gross margin results from operating leverage across our post-sale operations, such as our implementation, client success and site reliability engineering teams, offset by a higher mix of revenue from our third-party IP partners.

We are scaling post-sale operations while delivering the previously mentioned higher level of output. As a reminder, our 2026 target operating model is a non-GAAP gross margin of 65% as we continue to scale our revenue. Moving to operating expenses. For the third quarter of 2023, non-GAAP R&D expense was $17.6 million or 26% of revenue, 240 basis points lower than the year ago quarter. Margin expansion was primarily driven by revenue scale as we’ve increased R&D expenses at a slower pace than our revenue growth. However, we are achieving operational scale while investing in our platform to drive future efficiency, best-in-class reliability and innovate new products and functionality. Our target operating model is to leverage R&D to 20% of revenue, while we continue to invest and expand our platform.

Non-GAAP sales and marketing expenses were $10 million or 15% of revenue, approximately 130 basis points lower than the prior year. We continue to achieve a high level of sales team productivity and go-to-market efficiency and matched by many high-growth SaaS companies. we expect to maintain or slightly improve our go-to-market efficiency as we scale the business and gain market share. Non-GAAP general and administrative expense was $11.9 million or 18% of revenue. In the prior year quarter, G&A was approximately 22% of revenue. The margin expansion is primarily attributable to revenue scale, as we closely manage G&A expenses; we expect to achieve further leverage as a percentage of revenue as we move towards our profitability objectives. Our adjusted EBITDA for the third quarter was $826,000 which is over $1 million better than the high end of our expectations and over a $5 million improvement when compared to the prior year quarter.

We are very pleased to have crossed adjusted EBITDA positive a quarter earlier than originally expected at the beginning of the year. We believe this demonstrates the leverage afforded by our financial model as well as the trajectory of our business. And as a reminder, we have established a 2026 adjusted EBITDA margin objective of 20%. We expect our path to 20% will occur at a pace of roughly 700 basis points of adjusted EBITDA margin expansion each year. Now moving on to the balance sheet. We ended the quarter with just over $178 million of cash and marketable securities and just under $83 million of debt. One final item on our third quarter results. In addition to crossing into positive adjusted EBITDA, we are reporting positive operating cash flow of approximately $3 million and free cash flow of $1.5 million.

Now turning to guidance. For the fourth quarter of 2023, we are providing guidance for revenue in the range of $70.5 million to $71.5 million, representing growth of 27% to 29%. And adjusted EBITDA of $2.5 million to $3.0 million. For full year 2023, we are raising our revenue guidance to a range of $264 million to $265 million, representing growth of 29% to 30% and an adjusted EBITDA loss of $2.1 million to $1.6 million. This compares to an adjusted EBITDA loss of $17.6 million for the full year of 2022. In closing, we remain confident that we are well positioned to continue on the growth path we laid out over 2 years ago. During the last year, the resiliency of our model has been tested by industry and macroeconomic factors and we have continued to deliver both for our clients and our shareholders.

We are carrying strong momentum into the fourth quarter and we look forward to delivering another great year in 2024. With that, I’ll hand the call to the operator for questions.

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Q&A Session

Operator: [Operator Instructions] The first question today comes from Bob Napoli with William Blair.

Bob Napoli: Thank you. Impressive [ph] momentum. Appreciate the guidance and the trends and EBITDA margin expansion which obviously begs the question to get the kind of growth that you have and the momentum you have while driving that operating leverage. What are you giving up on the growth side or on the technology development side expanding 700 basis points a year is pretty dramatic. So appreciate any color around that.

Alex Shootman: Bob, this is Alex. I don’t feel like we’re giving anything up in terms of our ability to grow the business in the future. We are — we’re pleased with a lot of the investments that we’re making in the platform and we’ve got a lot of visibility on how those investments turn into leverage as the company grows. And we’re also pleased with the leverage that we’re beginning to get out of the implementation teams and the productivity that we’re getting out of the implementation team. So we don’t feel like we’re giving anything up in terms of our ability to serve our customers and grow with the guidance that we’ve provided with you all.

Bryan Hill: And Bob, I’ll just add a couple of more comments to Alex’s statement. I mean the beauty of our financial model is it provides visibility that allows us to invest and know when to invest and where to invest. So what I mean by that is we can grow our research and development, our engineering team, our product management teams, just at the same pace as revenue and we’ll scale that organization. Sales and marketing. Again, we really have a best-in-class sales efficiency. We deliver about $1.60 in ARR for every dollar of sales and marketing spend. there are very few SaaS companies that you’ll find that are delivering a sales efficiency at that level. And then when you look at G&A, coming out of our IPO now, it’s been a couple of years.

We’ve really made the necessary investments within G&A. So now you’ll see some reasonable growth with the business between 7% to 9% a year over the next 3 to 4 years. And so we’ll continue to scale G&A at the level that we’ve been scaling it during 2023. I mean for the quarter, we are 10 percentage points or 1,000 basis points of adjusted EBITDA margin expansion which, again, that just speaks to the leverage in the model, the visibility that we have that allows us to invest where necessary.

Bob Napoli: Appreciate that. And then just a follow-up on the number of new customers that you’re adding, maybe has the win rate — I mean, obviously, you haven’t lost any customers. So has the win rate improved, what’s driving the, I guess, the acceleration in the customer additions? And what kind of success are you having with banks

Alex Shootman: Yes. Our win rate remains steady. We were pleased with the 7 new customers that we signed in the quarter and then the additional 4 new customers that we signed in the week or so after the quarter 2 credit unions and 2 banks. So we’re pleased with the new logos that we’re winning and our win rates remain high in the credit union space. I’ll say we’ve got a mixed blessing in the bank space. We are — the good news for us is that we are being invited to more opportunities and I think we may have mentioned this in the past earnings call, where we had high win rates in banks but we weren’t being invited to that many opportunities. So we are being invited to more opportunities that results for us right now is our win rate being slightly less in banks than it is in credit unions. But for us, that’s really a bit of good news because we wanted our participation rate in banks to go up.