Alkami Technology, Inc. (ALKT) Earnings Call Transcript & Summary

Okay. Well, good afternoon, everyone. Welcome to Day 1 of the Barclays TMT Conference. My name is Saket Kalia. I cover SMID Cap software here at Barclays. Very happy to have with us the team from Alkami. We've got Alex Shootman, Chief Executive Officer; as well as Bryan Hill, Chief Financial Officer. We've got about 30 minutes here together. Maybe we can take just the first 20 or 25 minutes for some fireside chat here with the team. But I'd love to make this interactive. So if you have any questions, just pop up your hand and get a mic going around and would love to take any questions here from the audience. So with maybe all of that as a framework, Alex, Bryan, thanks so much for being with us here today.

Thanks for having us.

Thanks for having us.

Yes, pleasure. So I think this is our first conference together here, certainly in person, hopefully the first of Alkami. The folks here in the audience know, but Alkami completed their IPO early last year. You now have several successful public orders under your belt. Maybe for those of us in the room that aren't as familiar with the story, Alex, maybe you can give us just an overview of the business and the market you compete in? And then, maybe Bryan, you can add some color just on the business model as well as some of the highlights from the last quarter that you were most proud of. Does that make sense?

Yes, sure. As you all know, all financial institutions have to have a great digital presence. It's no longer a nice to have, it's a have to have. In the United States, there's about 285 million digital seats available. So think of that as the overall market that we could address. And I say digital seats because that's our primary pricing protocol. About 1/3 of those seats are served by a half a dozen megabanks and about 4 or 5 gigantic credit unions. So a megabank would be Citibank or Bank of America. One of the gigantic credit unions would be a USAA or a PenFed. There's about 185 million digital seats available for us or other companies to sell into across 8,000 financial institutions that are not those major institutions. The top 2,000 of those are about 85% of the market. Half of the market are banks, half of the market are credit unions. And so what happens for all of these institutions is that a company like a Capital One can spend $700 million, $800 million, $900 million a year building their digital banking platform. And these other institutions have to compete with Capital One and Capital One's digital capabilities. And basically what those institutions do is buy Alkami to be their white label digital banking platform. That's what we do for a living.

Yes, absolutely.

And just from a financial model perspective, Alex touched on this some, but the revenue algorithm is pretty simple. It's the number of registered users or seats, multiplied times revenue per user. And we gain digital users each year, either through selling new logos or the fact that our clients are growing. So our clients are adding about 12% to 13%, 14% additional accounts each year that convert to a digital user. The market itself is growing at a pace of, call it, mid- to high single-digit growth. And then on the revenue per user side, it's truly a go-to-market motion that's land and expand. And we have a client services team that will then sell additional product into our installed base once we land those clients. So how we're performing compared to how the market is positioned is as follows. We have just under 14 million digital users. It was 13.7 million at the end of October, and that compares to a market that we're going after of about 185 million. So we're pretty thinly penetrated. And then, the revenue per user opportunity is about $58 and presently we're at $16. That's the company average. Now, the new sales cohorts that we've added in the last couple of years, we're seeing increased adoption and higher revenue per user in those cohorts, so kind of $18 to $20 depending on the year that you're looking at. So the top line revenue model is pretty -- it's a high visible, highly predictable model. About 95% of our revenue is recurring in nature. And then, for the rest of the income statement, our target operating model is to achieve 65%-plus gross margin, and we're going on a path of about 200 basis points per year on average. So some years it might be 100 basis points, other years 300 basis points of margin expansion, but an average of about 200 basis points. We're extremely efficient from a sales and marketing point of view. So 15%, 16% of our revenue today is allocated to the sales and marketing motion of the company. And then, where we're a little bit high is in R&D. Presently we're at 27%, but we feel that we can drive that down to a 20% level over the next several years. And then, for G&A, we're currently at 22%, and we'll ultimately drive that down to 10%. So a target operating model of top line growth, 25%-plus; gross margin, 65%-plus over time; and then an adjusted EBITDA margin of 20% plus over time. Presently, we're not profitable. But what we've stated publicly is, we'll be profitable in Q4 of 2022 for adjusted EBITDA.

'23.

'23. Let's say, '24. I mean, '23.

Maybe one last thing just in terms of why we like the market. Bryan talked about a little less than 14 million users with Alkami. 185 million users that we can go after, Alkami is the fourth largest provider, the largest provider has about 20 million users. So a pretty fragmented market that we can go after with a lot of headroom.

Yes. Yes, absolutely. Great summary, by the way, guys. That was very helpful. Alex, maybe starting from a high level building on some of that. Can you just talk about how your customers are coping with the macro environment currently? How is it affecting them? And why do they still need to lean on Alkami despite some of the macro headlines out there?

Yes. Well, what our customers tell us is, my digital branch is my most important branch. In fact, research that we've done and other people have done have shown that the #1 decision criteria for a consumer or a business selecting a new primary financial institution is the quality of their digital experience. And this is nothing that we have to tell our customers, they all understand it. So what is attractive to us about Alkami is, we're not selling something that people want to have, we're selling something that people have to have. The second thing about this is, it's a 100% replacement market. So we're not going to a customer and saying, you need to create new budget for this offering. We're going to a customer who has experienced delivering a poor digital experience to their customers, and we're saying Alkami is a better offering for your customers. Yes, how our customers are reacting? So far -- and this could change, anything could change -- so far, we haven't seen a drop off in demand, a company like Alkami gets steady demand. And let me tell you why. The contracts that our customers have and our prospects have are 5-, 6-, 7-year contracts. So if you work backwards from the time that they would go live with Alkami, and an onboarding cycle for Alkami might be 9 to 12 months. So they would probably create a buffer of maybe 5, 6 months. So they would work back from when their contracts expiring to 18 months before that when they want to sign a new agreement and then their buying cycle might be 6 or 9 months. So somebody is in a buying cycle with us right now, they've got a time line that they're working on that they have to adjust to. And I think that time line and the need to create -- to provide a good digital experience is why to date we have not seen a falloff in our customer interaction.

Yes. Yes, absolutely. Bryan, maybe a follow-up for you. I mean -- and you hit a lot of this in your prior answer just around this, being what I would call a very straightforward subscriber base model based on registered users and RPU. Maybe you could just -- one of the things I just want to make sure we double-click on is just the visibility that you have in the model. You've got factors like backlog, you've got churn, you've got growth from your existing base. Can you just kind of touch on those and kind of how that helps you as a CFO, just get good visibility into the next 12 months?

Yes. The visibility we have is really pretty remarkable. A lot of it ties into what Alex has just explained is the long-term contract aspect of this. And if a prospect is making the decision to move off of their existing platform, they have to start that process early. So what that means is, in any given 12-month period, I effectively have a full year of implementation sitting in backlog. So the visibility I have is that I know for one of our growth levers, which is new logos adding users to our platform, I know 12 months of implementation that is about to occur. Let me give you an example. At the end of Q3, what we had discussed was, we have 40 new logos in our implementation backlog so that we've already signed a contract represents 1.7 million digital users and approximately $43 million of ARR when combined also with add-on sell implementation backlog that we have. So incredible, incredible visibility for the next 12 months of implementation. Then given that we have a gross retention rate of 97%, the renewal success that we have is very, very high as well. So that provides even further visibility into the next -- really multiple years. And then when you look at what's happening in terms of new business that we're adding, the renewal success, that kind of combines with the remaining contractual backlog. And now, we're close to $1 billion. So we've crossed over $750 million of contractual backlog that we'll recognize over the next 4 to 5 years.

Sure. I think we've got a good sense of the market and the model. Alex, I want to dig in a little deeper and hit on 2 strategic priorities that you talked about since becoming CEO, which are gaining share with banks and growing add-on sales. Maybe strategically, can you just -- can you just tell us why those are important and how you feel like Alkami is doing in both those areas?

As I said in my opening comments, half of the financial institutions in the United States are banks, half of the financial institutions are credit unions. There really were 2 disruptors that came into the industry. If you think about -- we're in about the third cycle of digital banking. The first cycle was, put up a web front end to your bank so that you can see your balance, right? And then people wanted to do some things functionally and the legacy core providers started offering some functional capabilities. Those legacy core providers had challenges in terms of how fast they could deliver functionality and how easy it was to integrate things into their platform. And this created an opportunity for 2 different disruptors, 1 was Q2 and 1 was Alkami. Q2 is a couple of years ahead of Alkami, and Q2 got their start primarily in the bank market. Alkami, we got our start primarily in the credit union market. What happened a few years ago is that our credit union -- largest credit union's customers, one of our credit union customers is the largest SBA loan originator in the United States. They started coming to us and saying, we're going after the business banking market and we need you to build us some capability. So we started building that capability for them and got to the point where we had a very competitive commercial banking offering. And so we decided to focus on the bank market because that basically opens up a second half of a SAM, if you will, for us. If the entire TAM for us is 185 million digital seats, [ half banks ] have credit unions and we've been one of the dominant providers in a credit union. If we're a dominant provider in the bank market, then essentially, we kind of double our SAM, if you will. So that's the focus on banks. We're doing well. We've signed more bank new logos through 3 quarters than the entire year last year. So we're very happy with the performance in the bank market. From an add-on sales perspective, as Bryan talked about, the math on Alkami is really simple. How many seats do we have and what's the RPU? And when you look at our product portfolio, we've got about 30 products in 8 product areas with a theoretical revenue per user of $58. And I think we reported just a little under $16 per user. We've got customers that -- or current customers that have much higher RPU. And so it doesn't take a lot of rocket surgery if you're in my position or Bryan's position to say, wow, we can create a lot of shareholder value if we increase our RPU and doing that by dedicating energy into selling into the base.

Yes, absolutely.

And the add-on sales motion is important because it's a shorter sales cycle and it's a much shorter implementation cycle. So the speed from invoice from closing the deal to revenue recognition is very much shorter. And then, on the bank side of the market, what's cool about banks is, the banks that we have in backlog today to implement, which is about 16, we have 5 live, we have about 16 to implement, the average RPU across those banks in our backlog is $30. So we have a company average of $16 -- just under $16 today, we're selling new business at around $20 and banks represent $30 per user.

So really -- I mean, just to put a bow on this, I mean, really targeting the banks more, you open up a SAM to your point. But then also -- you also add higher-value subscribers, aren't you?

Higher value subscriber at a higher gross margin, all those things.

Absolutely. Absolutely. Alex, I'd love to maybe shift to the competitive environment a little bit. You mentioned Q2. But actually, I wanted to touch on maybe some of the more legacy providers. How open are you ripping and replacing their solution for online banking? And do you see the change in just the -- maybe the velocity of replacements in the coming years?

Yes. The primary competition continues to be legacy providers, right? So if you look at who we compete with, basically what happens is, somebody says to themselves -- I'll give you an example. We announced this that in early October, we had closed a couple of bank customers. I talked to the CEO of one of the banks that decided to go with us and said, why are you going to spend money with Alkami? And he said, here's what happened. We had a merger of equals. And half of our user base came on to a platform that was not the experience that they were used to, and they were very vocal about it. We were going to improve our digital experience, but this caused us to accelerate our digital experience quite a bit. And so that's the kind of thing that we're hearing from the customers from their legacy vendors is, there's 2 things that they're looking for when they replace a legacy vendor. One is, I have to deliver a better user experience. All of my customers or all of my members are used to a modern experience in everything else that they do. And that's been Alkami's hallmark is that user experience is a strength. We have the highest app score in the industry. Our app score tends to be 4.8 out of 5. So they're looking for that, but they're also looking for the ability to plug new products into the platform. One of the things that's happened to all these financial institutions is the $200 billion that we all poured into venture capital funds for digital financial innovation over the last couple of years has created a bunch of brand-new products that their customers want to use. And so to your point, we're being successful replacing legacy software, and it's because their customers have a new expectation that the legacy software can't fulfill.

Absolutely. Bryan, maybe for you. One of the things I feel like the team has talked about a little bit increasingly in the last couple of quarters has been contract renewals. It feels like we just got more and more of those kind of coming up. What happens at a contract renewal for Alkami? Is it -- we had 100 before, we're at 100 now? Or what's unique about your contract renewals maybe from a revenue perspective and a gross margin perspective?

Yes. I'll touch on all those points. So Alkami has been in existence for a little over 13 years. And if you consider we average about 6 years in our average contract, so we're just now having clients come up for the first renewal, many of them. And so to-date, we've renewed about 30 clients representing about $30 million of ARR, but 11 million of those have happened through October of this year. So it is accelerating, as you indicated. What happens at renewal is a couple of things, the way our contracts are structured, clients sign up for a minimum commitment, and that's in terms of users and that minimum commitment increases each year as they proceed through a contract. And so at the time of renewal, we're resetting the minimums and we're establishing new minimum increases for the new term, and then we're also selling additional product. So what we experienced through the first 30 renewals was about a 10% uplift in run rate ARR with about 1/3 of that coming from increased minimums and price increases for the new term, and the remaining 2/3 is coming from selling new product at the time of renewal. Now, the team that does this is the same team that also focuses on cross-sell. So what we suspect will happen is through the cross-sell initiative, we'll start seeing some acceleration of renewals because when you're selling more product at that point, it's most likely more advantageous for the client to just reset the contractual term. So we should see some acceleration of that. This year, in total, we'll have somewhere between 15 and 20. And next year, it just increases beyond that. And we have a very, very high instance of renewing our clients. Again, our gross retention is 97%. On the gross margin side of this, something interesting happens. We have structurally built in our contract gross margin expansion at the point of renewal. And so what that means and how that happens is, our professional services revenue as well as our implementation costs for a new logo is amortized over the life of the initial contract. And today, that effort is happening at a gross profit loss. And so you're effectively amortizing a loss over the life of that first contract. When that contract renews, a couple of things happen. One, the revenue is replaced by the increase of minimum that's happening as you work your way through the contract. So what revenue you're losing upon renewal that was deferred and amortized, you replace that now with subscription-based revenue, which is a great day. And then, the cost and the loss goes away. So we have a 300 basis point to 500 basis point gross margin expansion at a unit economic level at the point of each renewal. And we're just still in the early innings of renewals. So some companies like Q2 and others, they've already been through several renewal cycles. So they've already experienced that gross margin low. We're just now starting to experience it.

Yes. That's really interesting. Alex, maybe we can just dive into the add-on sales a little bit, which, again, clearly is becoming a bigger driver for Alkami. Without getting into too much detail, can you just maybe help us rank order some of the biggest products in terms of customer adoption for add-on sales and maybe why you think they are?

Yes. I mean, first of all, we've got some tailwinds on this, right? Because it's not that Alkami's out in the market saying you should buy more products. What's happening in the market is that once again, these financial institutions are having to offer a broader range of products and services to their customers. 10 years ago, people didn't try to use chat in terms of interacting with their financial institution, they called into a call center to talk to their financial institution. And so what's driving this for us, and then I'll talk about the key areas, the customer -- there's more products out there. The customer is driving more choice, and the products drive real operational improvement for the financial institution. If I just take chat as an example, if there's call center avoidance in terms of implementing a chat capability, well, the financial institution wants to do that. Or if you take a credit union who right now is trying to generate deposits, right, they've gone from having too many deposits to not enough deposits, they'll say to themselves, I want to go after businesses so that I can generate deposits and then we have the opportunity to upsell our business banking capability. Across the 8 product areas, the product areas that have performed best for us are things associated with fraud and security, things associated with money movement and things associated with kind of customer care and customer interaction. Those have been the best -- and it makes a lot of sense if you think about it because all of those can create either revenue lift or cost avoidance for the customer.

Yes, yes, absolutely. Alex, maybe -- and actually, before I do that, just we've got about 6 minutes up. Any questions here from the audience before I maybe move to profitability?

And just real quick, one more add to what Alex was saying.

Sure.

Areas in the future where we think we'll see continued traction with cross-sell would be digital account openings. That's a huge problem in this space, and there's very few service providers that can address that problem. And then, second is marketing and analytic products. And we acquired a company in April of this year, the name of the company was Segmint, and they provide kind of AI technology around all of the -- all the data transaction -- all the transactional data that's occurring at an account level within their financial institution. And it allows them -- this product offering allows them to create very micro customized offers for the actual individual. And so we think that's an area of great growth for us in the future as well. And where we're seeing just kind of some numbers around this real quickly, a client services team that's responsible for cross-sell created in 2019, and 2020 represented like 17% of our total contract value that we sold, 2021 was about 23%, 24% and through October, 34%. So we're seeing a lot of traction in this team and their ability to cross-sell.

And that's -- as we've been growing bookings, because our bookings trend...

Right, right.

It's -- I mean it's accelerating basically [ fortunate or ] unfortunate, yes.

Very interesting. I want to shift to profitability because I think that's another really important part of the story. Maybe before we go there, and I suspect this is somewhat related. Alex, I think you talked about a new platform, back-end platform for Alkami. Can you just remind us what that entails? And what percentage of the user base [indiscernible]?

So a couple of things that we talked about on the platform side. There have been 2 efforts. One effort is continuing to drive improved economics in the way that we consume cloud resources, which goes to the gross profit -- gross margin efforts. So there's 2 efforts that have gone around platform. #1, very fast-growing company, focused on growth, consumes a lot of cloud resources. Now let's make sure that we're optimizing the way that we consume those cloud resources because any optimization we do there goes straight to gross margin. What we're talking about in terms of new platform is, we deliver both a web application and a mobile application. What we deployed was a brand-new mobile platform. Historically, we wrote to iOS and Android. That was frustrating for our customers because they obviously have both in their base and keeping the experience exactly the same for both took a lot of engineering resources. So what we did is we replatformed everything onto a technology from Google called Flutter. And so we write our application to Flutter. It's exactly the same on iOS and Android. It's an improved software development kit as well. But for us, what it basically does is, it almost doubles our engineering throughput because we no longer have to built to both teams.

Got it. Got it. Maybe just a couple of minutes that we've got left, I really want to talk about profitability with you, Bryan. I mean, I think we said Q4 of '23 is that target for EBITDA breakeven. You correct me there if I'm wrong. I mean is there anything that you want to talk about just around the path to getting there? And then once we get there, where do we go in terms of long-term profitability. You may have mentioned some of this at the outset, but I just want to make sure we...

Yes. And I can touch base on those points again. So the key is to focus on gross margin. And so as we exit next year, it would be very important on where our gross margin level is. We provided some, not guidance, but just kind of some directional comments on that. We expect we'll be around a 60% gross margin in Q4 as we exit 2023. That's key for us and provides a great line of sight to our 65% goal. R&D, again, today, we have really spent a lot of money in R&D, and it was not the sacrifice of anything else. The thought process has been best platform wins. And as we scale the business, we'll continue to spend more and more dollars in R&D, but as a percent of revenue, it will go down. We're growing that at a slower pace than revenue, and we feel very confident that we can get to 20% at that for R&D as a percent of revenue. And we're also 100% domestic today. So there is this element of lower cost point opportunities for us that we haven't even begun to exploit that yet. And then, sales and marketing, it's a vertical market. We know who the buyers are. We know which systems that they're utilizing today that's providing their digital banking platform. We know when their contracts are going to renew. And so there's no need for us to oversaturate the market with sales and marketing personnel. So we will continue our sales and marketing efficiency at least at the 15% of revenue level and potentially even better than that. And then, I already touch based on G&A. I mean, there was a large ramp-up of G&A costs, whether it was audit fees, D&O insurance, personnel around SEC reporting, tax report. And it goes on and on, but that's an initial investment that you incur and then you just grow it marginally over time from things like merit increases and inflationary kinds of things, but it's just a scale game. And there's no reason why we can't scale the G&A line to 10% of revenue. And so longer-term, again, we are at a 20% plus adjusted EBITDA. We'll reset that because I don't think you stop there. But it's a gate that we need to go through. And once we go through that gate, we'll reset what the longer-term objective can be at that point.

Got it. Got it. Well, I couldn't think of a better place to end right there. Look forward to seeing that path as it unfolds.

Thank you.

Alex and Bryan, thank you so much for being with us here today. Really enjoyed it.