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

Good afternoon, ladies and gentlemen, and welcome to the Alkami Technology Third Quarter 2024 Financial Results Conference Call. [Operator Instructions]. This call is being recorded today on Wednesday, 30th of October 2024. I'd like to turn the conference over to Steve Calk, Vice President of Investor Relations. Steve, please go ahead.

Thank you, operator. 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 in the sections in our latest 10-K entitled Risk Factors and Forward-Looking Statements. Statements made during the call are being made as of today, and we undertake no obligation to update or revise these 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 would now like to turn the call over to Alex.

Thank you, Steve. I am pleased to report another quarter of outstanding performance. In the third quarter of 2024, Alkami grew revenue 27% and expanded adjusted EBITDA to over $8.3 million, both ahead of our expectations. We added 9 new digital banking clients, including 3 banks and launched 12 clients on the Alkami platform, which ties a previous record number of client launches in the quarter. In addition, during the quarter, we were recognized by several third parties as we continue to establish ourselves as the leading digital banking platform. FI Navigator listed Alkami as the top digital banking provider and credit union market share based on the number of enrolled mobile users. We were named as a 2024 fintech top solution provider by IDC and included on CNBC's 2024 world's top fintech companies list. Tearsheet named Alkami Best Banking App and Alkami became the first digital banking solution company to be certified by J.D. Power for providing clients with an outstanding mobile banking platform experience. User experience extensibility, availability and broad functionality are reasons why clients have selected Alkami. More recently, our ability to create value with our data technology is becoming a differentiator for Alkami. With our data and marketing products included in approximately 60% of our new client wins in '23, moving to over 70% so far in 2024. These products have also generated over 20% of our add-on sales to date in 2024. During this call, I'd like to spend a few minutes describing why data is becoming a differentiator and a growth driver for Alkami. Digital banking has been a service platform for consumers who did not want to go into a branch to manage their money. It also served to reduce cost for a financial institution by shifting interactions from human to digital. Today, we are seeing our market accelerate the adoption of digital revenue-generating strategies in addition to using digital banking as a service channel. As these financial institutions implement digital revenue efforts, they are realizing that data is the oil that makes the revenue engine run. For example, our research shows that -- deploying modern data capabilities along with predictive AI, grow 2x faster than FIs that don't apply these technologies. Our market knows they have relevant data to drive revenue strategies, but their data is challenged to access and analyze. For instance, in our 2024 Deloitte Banking and Capital Markets survey, 92% of FI data users and leaders say that data is unavailable or takes too long to retrieve. And over half responded that when the data is there, they don't have the technical capabilities to make use of it. Data must be cleansed, maintained, normalized and curated. Alkami's data and marketing solutions have these four characteristics at scale. Our data platform contains 29 million deposit accounts with 20 billion historical transactions and about 20 million new transactions are added each day. FI's early in their data journey can use these data capabilities to close the gap against megabanks who are already investing in data technology and data science teams. FIs starting on a path to predictive AI can use one of our 12 AI models to generate revenue, improve engagement or retain customers with models built for the compliance requirements of our industry. And FIs that need marketing technology in addition to data and models can use Alkami's full funnel market stack that covers digital channels including the digital banking channel, web and e-mail and measures ROI for each campaign. Alkami offers 3 plans within our data and marketing solutions, data insights, predictive AI and full funnel marketing. These plans are designed to meet the needs of the regional and community FI market and help these institutions achieve their growth strategies such as driving new deposits, loans and noninterest income. In 2023 alone, Alkami's data and marketing clients generate $4.5 billion in CDs, $525 million in money market accounts and $391 million in savings accounts. In addition, our clients use these capabilities to generate $1.8 billion in home equity loans, $1.7 billion in mortgages, $1.4 billion in consumer auto loans and $983 million in commercial loans. It's been exciting for me personally as I've sat through executive meetings in which we show clients revenue opportunities with the live data, including for deposits, we can identify transfers where investment dollars are going, trial deposits show when new accounts are opened elsewhere or track tax refunds, so that the FI can keep those in their institution. For lending, we can identify where our account holders pay their mortgage, auto loan and credit cards. Merchant processing, commercial lending and payroll can all be identified and placed in the hands of commercial relationship managers to new drive business opportunities. Beyond our current capabilities, we see a future in which we can combine our data technology with digital banking to provide real-time revenue opportunities. For instance, if an FI's customer attempted to digitally move money from the FI to a brokerage account, the FI could insert a targeted offer for a high interest rate account complete with the pre-approval and instant account activation. Or if their customer tried to establish a new bill payment for a recurring subscription, the FI could prompt the customer to use a rewards-based debit card instead, generating new interchange revenue and transforming bill payment from a cost item through revenue source. The more FIs reduced friction and revenue generation, the more they worry about fraud. And we've also run successful experiments in which we use our data scale to provide real-time insights into proactive fraud detection. The success of our data and marketing solutions to date, combined with an increased awareness within our market and the power of data to drive revenue activity, gives me confidence that our data capabilities can be a long-term differentiator and growth driver for Alkami. In closing, Q3 2024 was another quarter in which Alkami demonstrated continued execution towards our target operating model and the long-term goal we have to be the #1 digital banking platform. I'll now hand the call to Bryan to take us through the numbers.

Thanks, Alex, and good afternoon, everyone. In the third quarter, we continue to outperform on the top line and profitability. We achieved total revenue of $85.9 million, representing year-over-year growth of 27%. Subscription revenue also grew 27% and represented over 95% of total revenue. We increased ARR by 24% and exited quarter at $342 million. We currently have approximately $46 million of ARR and backlog for implementation. The majority of which will occur over the next 12 months. We implemented 12 new clients in the quarter, bringing our digital banking platform client count to 266 clients. Also, we have 36 new clients in our implementation that representing 1.3 million digital users. We exited the quarter with 19.5 million registered users on our digital banking platform, up approximately $900,000 sequentially and up $2.6 million or 15% compared to last year. Over the last 12 months, we implemented 37 financial institutions supporting 1.2 million digital users. In addition, our existing clients increased their digital user adoption by 1.4 million users. As a reminder, because of the long-term nature of our clients, we had 3 to 4 quarters ability into upcoming client attrition. We expect churn of less than 1% for the full year 2024, all of which occurring in the fourth quarter. Over the long term, we modeled digital banking ARR churn at 2% to 3% per year. We ended the quarter with an RPU of $17.54, up 8% compared to a year ago driven by add-on sales success and the addition of new clients who came to onboard with a high average RPU. We are seeing broad-based demand across our product portfolio. Our 2024 new sales performance continues to outpace 2023. Year-to-date, we signed 23 digital banking platform clients, including 8 banks, and our add-on sales effort represented approximately 46% of 2024 new sales. In addition to add-on sale, our client sales team is responsible for client contract renewals. We expect to renew over 30 client relationships in 2024. During the first 9 months in '24, the 26 client relationships and in total, increased the ARR run rate, 16% at the time of renewal, outperforming prior year cohorts. And finally, our remaining performance obligation was just under $1.3 billion, representing 3.7x our ARR and up 27% compared to a year ago. Now turning to gross margin. For the third quarter of 2024, we delivered non-GAAP gross margin of 62.8%, representing a 400 basis points of expansion compared to the prior year. We achieved gross margin expansion through continued improvement in our hosting costs and platform investments as operating leverage across our operations. As a reminder, our 2026 gross margin objective is 65%. Moving to operating expenses. For the third quarter 2024, operating expenses of $46 million or 53.6% revenue represented year-over-year operating leverage of 490 basis points. We drive operating leverage across each operating expense [indiscernible] primarily in R&D, where we continue to realize operational scale while investing in our platform. Investment focus areas include initiatives to drive quality and cost efficiency of the platform, expand our product offering, improve extensibility and enhance the product market fit of our commercial banking offering. As for non-GAAP sales marketing expenses, we continue to achieve a high level of sales team productivity and go-to-market efficiency. For the last 12 months, we increased ARR $67.1 million, while investing $48.5 million in sales and marketing, representing an efficiency ratio of 1.4:1. We believe this ranks among the very best in SaaS in terms of sales and marketing efficiency. Our adjusted EBITDA in the third quarter was $8.3 million, better than the high end of our expectations. Our adjusted EBITDA margin for the quarter was 9.7%, when combined with our revenue growth rate, results achieving a rule of 36. Our operating strategy of balancing revenue growth and profitability will continue and we expect to achieve a Rule of 40 on a run rate basis as we exit the fourth quarter of 2025. As we are now approaching 2025, I want to provide some additional color on the path to our 2026 adjusted EBITDA margin target of 20%. As we previously mentioned, during 2023, we began to build a base of offshore talent through a third-party outsourcing model. This has been a positive experience for us, allowing us to expand engineering capacity during a period of rapid growth while focusing on profitability. We are now preparing to transition these activities to a captive offshore subsidiary model. We expect to invest in this capability starting in the fourth quarter of 2024, continuing throughout 2025, with the goal of completing the transition during 2026. We do not anticipate any impact on our 2026 financial targets, although we do expect to see a positive impact on margins beyond 2026. During 2025, the incremental investment to effect the transition will represent approximately a point of margin for the year. We are very excited that we are maturing as an organization and we look forward to the positive operational and financial impact this can have as we scale the business beyond 2026. Related to our balance sheet. We ended the quarter with approximately $101 million of cash and marketable securities. Our revolving credit facility remains undrawn and provides $125 million of borrowing capacity. In the third quarter, we produced operating cash flow of $11 million and free cash flow of $8.7 million. Now turning to guidance. For the fourth quarter of 2024, we are providing guidance for revenue in the range of $89 million to $90 million, which represents total revenue growth of 25% to 26%. For adjusted EBITDA, we are providing fourth quarter guidance in the range of $8.5 million to $9 million. For full year 2024, we are providing guidance for revenue in the range of $333.2 million to $334.2 million, representing total revenue growth of 26%. We are also providing adjusted EBITDA guidance of $25.2 million to $25.7 million. In closing, I am very pleased with our continued progress. Our team delivered a strong quarter with profitable growth, continued operating leverage and a level of go-to-market efficiency that places us among the very best performers in SaaS. And with strong industry tailwinds combined with our multiple growth drivers, we have a clear path to our longer-term operating and financial targets. With that, I'll hand the call to the operator to take your questions.

[Operator Instructions] Your first question comes from the line of Alexei Gogolev from JPMorgan.

This is Elyse Kanner on for Alexei Gogolev. My question is about where do you currently see the AI adoption curve? And what will it take for customers to become more comfortable incorporating AI-based solutions and how dependent is this on industry regulation?

Thanks for the question. The adoption curve is -- well, first of all, AI has been used in the financial services industry for a long time. So if you thought about, you would activate your card to a voice response unit, some of those things in terms of natural language processing have been used for quite a while. But in terms of using it for predictive models around revenue generation, we're in the early stages. And what it's going to really take, as I mentioned in the prepared comments, is for the customers to be able to cleanse and normalize and manage their data. These customers are using the best data you have to run AI models as transactional data. And these customers have that information in their mobile banking application and in their core, but getting all of that to a state where they can run the models against it, is the first big step for them.

Got it. And then my second question would be, what do you think drove the really strong ARR uplift at renewal?

What we're seeing now is there's just a greater appetite for more innovation and technology through the platform. And so on average, if you look at our client base, they average between 13 and 14 products. And then when you analyze the new sales cohorts that are coming in, they're averaging around 19 products. So what we're renewing today or clients that typically have somewhere between 9 to 14 products. But for them to be on par with where new sales cohorts are coming in, they need more innovation. They need to be more in the 19, 20 to 22 product level. So it's really the cross-sell opportunity that's occurring at the time of renewal.

And I would like to add to that, and we've mentioned this on a couple of calls is that several years ago, we started building out a client-facing account management team. That account management team has now been in place for a couple of years. And because of that, they're able to establish relationships and execute strategic workshops with our clients where they lay out a multiyear digital transformation journey, which leads to strategic adoption of the products that Brian was just talking about.

Your next question comes from the line of Patrick Walravens from Citizens JMP.

This is Austin Cole on for Pat. Congrats on the results. So I recognized some of the kind of longer-term demand drivers don't really change day-to-day, right? But with the kind of 50 basis point rate cut and some of the long yields rising. I mean, what impact do those things have on your business? And are you feeling any change in kind of the attitude from clients?

What I would say is the demand for digital banking has remained consistent from a low interest rate environment to a high interest rate environment, to the recent interest rate changes. So this is a long-term market sector transformation in which the customers aren't making decisions to accelerate the investment one quarter or decelerate it another quarter. The main difference that we see is the products that they add on based upon the interest rate environment. So are they adding on products like an instant account verification to try to be able to drive deposits or if this market changed a little bit and their balance sheets were able to change and they could make more loans. Then are they going to be buying products that help more with loan generation. But the summary is the long-term change in investment isn't impacted by short-term interest rate changes. The mix of add-on products sometimes changes. And that's good for us because we've got products that are useful for either side of that equation.

Your next question comes from the line of Chris Kennedy from William Blair.

Brian, can you talk about the long-term savings opportunity for the offshoring and I understand that 2026 and beyond, but can you frame the opportunity there at all?

Well, we're excited about the opportunity. I mean, presently, we have maybe 110 to 120 FTEs that are coming through this third party and they're exclusively engineering. And one of the secrets to our success has always been the best platform wins. And so there's the desire to continue to innovate through the platform, create new products, provide innovation to the end market. Well, to do that profitably, we have to find areas in which we can do that at the right price point. And so engineering is definitely an area where this is going to benefit us. And also, this is going to benefit us within gross margin and cost of sales because over the longer term, there will be opportunities for some of our post-sale operations, to offshore some of those listed growth in those areas that then the cost curve. So we're extremely excited. The adoption within the company has been great. The results that we're seeing in productivity has been really very good as well, and we think that will only improve as we move more to a captive model versus a third-party outsourced model.

Great. And then just a follow-up on the data platform and the opportunity. Can you talk about how open banking in the U.S. will impact that opportunity?

Yes. This is Alex. I think the rate and pace of open banking is still pretty much unknown. So the customers right now -- we just see a directive that was handed out a week or so ago from the CFPB. The investments that the customers are making right now in data really have nothing to do with open banking. And so if open banking were to accept that might provide more tailwinds in terms of the data investment. The investment that the customers are making right now in data is really realizing that the advantage some of the mega banks have in terms of the investments they've made in their data platform and their models. And since that tends to be the competition focus on the most. Their current investment is about current capabilities with the current market conditions and really doesn't have thing to do at this point in time in open banking. Like I said, that might be an increasing tailwind for us, but the rate and pace of that, when I talk to customers is largely unknown.

Your next question comes from the line of Jeffrey Van Rhee from Craig-Hallum.

This is Daniel on for Jeff. Just in terms of -- you've discussed the mindset, obviously, with interest rates of FIs changing towards attracting deposits. Just any additional thoughts on how that's been translating into new logos and additional add-on products?

Yes. As I said earlier, the change in interest rate environment doesn't really impact the rate and pace at which we're closing new logos. If you go back a little bit to some of the comments that Bryan and I have made in the past. These contracts are 5, 6, 7 years. Our customer will have to make the decision to begin a conversion process a year before their contract is up for renewal, which means they'll start the decision cycle, maybe even a year before that. And so any change in interest rate that might happen in that decision cycle doesn't really change whether or not they're going to make a decision because they're making a decision for the next 5 to 7 years. The biggest impact that it has for us is the mix of add-on products that we sell. There's a certain set of products that are useful for a low interest rate environment and another set of products that are useful for high interest rate in products -- excuse me, high interest rate environment. And so we've seen that mix shift starting what that was almost 24 months ago when the interest rates started going up and it might shift back as the interest rates start going down.

And just on the credit union ad pace, in 2024, fairly similar to 2023. Should we expect credit union adds to remain relatively flat around this level of, call it, 30 credit unions a year just based on that regular cadence of credit unions that come up for renewal and the limited number of deals that could be pursued in any given year? Or should we be thinking of any ways that ad count should be showing acceleration?

Yes. You should expect the credit unions that we add from year-to-year to remain pretty consistent in the 25 to, call it, low 30 range. We're working towards the same rate and pace as it relates to banks as well, and we're showing some progress there. But a lot of it is framed by the structure and cadence of the market. As Alex just mentioned, 5 to 7-year contracts, we focus on the top 2,500 financial institutions, those top 2,500 financial institutions represent over 200 million digital users. And so there's a rate and pace in which those come market. And we continually win our fair share of credit unions, and we're starting to see more bats and more opportunities as it relates to banks, and we believe 2, 3 years out, we'll be at the same rate and pace with banks as it relates to credit units.

Next question is from the line of Adam Hotchkiss from Goldman Sachs.

I guess first to start, in your experience on some of these data-related add-on sales, how much education has to happen on your side of the equation to get FIs to understand the value and the security that you bring them here versus sort of proactively coming after the opportunity. I guess I'm just trying to understand how knowledgeable and educated some of these bank decision-makers are around the AI opportunity and the data opportunity.

Yes. It's been interesting to watch over the last 3 years. I would say 3 years ago, we would be in evangelical mode about data. And now almost every executive that I talked to knows that they have to become a data-first digital. So we're no longer in an evangelical mode in terms of, boy, you should think about the fact that data will drive personalization in the digital banking channel. These are all smart executives, and they all get it. So that change has happened in the last 3 years. We do have two different sides of the market. So we'll have a part of our market that is pretty sophisticated from a data perspective. They might have created their own data capability through something like a snowflake or something like that. They've got their own mark tech stack and what they want to do is figure out how to use Alkami's cleanse and curated data to feed into their data tech stack and then to be used into their marketing tech stack as well. And then we'll have another set of the market that it's just been hard for them to get that talent in their organization. And so they want essentially a shrink-wrapped capability where the data platform, the models that are already built right on top of those models and then has essentially a walled garden mark tech stack that sits right on top of the data and the model. So in summary, last 3 years has moved from an evangelical position to a position where the executives get it and they're asking us how we help. And the market is bifurcated between sophisticated customers that have built their own data tech stack and models and they want our data to feed it and customers that struggle getting access to that skill set and want a prebuilt capability for data models and market.

We're seeing it in our results as well. So if you look back a couple of years ago, where we were seeing success with our data products was really when a digital banking platform sale was occurring. So we would see maybe a 50% to 55% attachment rate. But when C-level executives and financial institutions were involved in making a decision, we tended to have more success in selling our data product. Now when you look at the attachment rate in 2024, we're closer to 75%. So that's good news. But what gets me excited is a couple of years ago, it was really hard from a client sales team go-to-market motion where their penetration point in the market generally is a bit lower than the C-suite to get traction with the data sell. We'll flash forward to 2024 now our data products are one of our leading cross-sell products back into our base. So not only we are seeing strong attachment at the point of a new client win, we're also now seeing some very nice progress in our client sales team cross-selling back into our base.