Intercontinental Exchange, Inc. (NYSE:ICE) Q2 2023 Earnings Call Transcript

Intercontinental Exchange, Inc. (NYSE:ICE) Q2 2023 Earnings Call Transcript August 3, 2023

Intercontinental Exchange, Inc. beats earnings expectations. Reported EPS is $1.43, expectations were $1.37.

Operator: Hello, and welcome to today’s ICE Second Quarter 2023 Earnings Conference Call and Webcast. My name is Bailey, and I’ll be the moderator for today’s call. All lines will be muted during the presentation portion of the call with an opportunity for questions-and-answers at the end. [Operator Instructions] I would now like to pass the conference over to our host, Katia Gonzalez, Manager of Investor Relations. Katia, please go ahead.

Katia Gonzalez: Good morning. ICE’s second quarter 2023 earnings release and presentation can be found in the Investors section of the ice.com. These items will be archived and our call will be available for replay. Today’s call may contain forward-looking statements. These statements which we undertake no obligation to update, represent our current judgment and are subject to risks, assumptions and uncertainties. For a description of the risks that could cause our results to differ materially from those described in forward-looking statements, please refer to our 2022 Form 10-K, second quarter Form 10-Q and other filings with the SEC. In addition, as we announced last year, ICE has agreed to acquire Black Knight. The transaction is still pending regulatory approval and we expect to close in the second half of this year.

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In connection with the proposed transaction, ICE has filed with the SEC a registration statement on Form S-4 to register the shares of ICE common stock to be issued in connection with the transaction. The registration statement includes a proxy statement of Black Knight that also constitutes a prospectus of ICE. Please see the Form S-4 filing for additional information regarding the transaction. In our earnings supplement, we refer to certain non-GAAP measures. We believe our non-GAAP measures are more reflective of our cash operations and core business performance. You’ll find a reconciliation to the equivalent GAAP terms in the earnings materials. When used on this call, net revenue refers to revenue net of transaction-based expenses and adjusted earnings refers to adjusted diluted earnings per share.

Throughout this presentation, unless otherwise indicated, references to revenue growth are on a constant currency basis. Please see the explanatory notes on the second page of the earnings supplement for additional details regarding the definition of certain items. With us on the call today are Jeff Sprecher, Chair and CEO; Warren Gardiner, Chief Financial Officer; Ben Jackson, President; and Lynn Martin, President of NYSE. I’ll now turn the call over to Warren.

Warren Gardiner: Thanks, Katia. Good morning, everyone, and thank you for joining us today. I’ll begin on Slide 4 with some of the key highlights from our second quarter results. Second quarter adjusted earnings per share totaled $1.43, up 8% year-over-year, driven by total net revenues of $1.9 billion. This marked the best second quarter on our company’s history and it was on top of 14% adjusted EPS growth in the second quarter of 2022. Second quarter adjusted operating expenses totaled $756 million, $7 million below the low end of our guidance range, and up 2% versus the prior year. Higher SG&A, including an increase in spend related to an uptick in IPO activity late in the second quarter, as well as higher D&A and rent, both of which were driven by handful of lease write-offs as we consolidate our real estate footprint was offset by higher capitalized labor and lower professional fees.

This strong performance helped to drive an adjusted operating margin of 60% and a 5% increase in adjusted operating income to $1.1 billion, which was on top of 14% growth in the second quarter of 2022. Looking to the third quarter, we expect adjusted operating expenses to be in the range of $760 million to $770 million with the year-over-year increase driven by additional compensation and technology expense, as well as roughly $10 million of FX. As a result, we now expect the full-year adjusted operating expenses will be between $3.04 billion and $3.06 billion, and towards the lower end of our guidance range. Moving below the line, adjusted non-operating expense totaled $84 million in the quarter, improving sequentially due to higher cash balances as we build consideration for our acquisition of Black Knight, as well as higher interest rates on those cash balances.

Shifting to the tax rate. As the increase in the UK tax rate became effective in April of this year, we confirmed our ability to make certain U.S. tax elections, which primarily led to a second quarter adjusted tax rate of 22%. As a result, we now expect to be around the low end of our 24% to 26% guidance range for both the second half and full-year. Now let’s turn to Slide 5, where I’ll provide an overview of the performance of our Exchange segment. Second quarter net revenues totaled $1.1 billion, up 9% year-over-year. Transaction revenues of $736 million were up 12%, driven by 33% growth in energy revenues. This strong performance included 52% growth in global natural gas revenues, driven by a record quarter for both TTF volumes and participation, as well as 9% growth in our environmental revenues.

In addition, we continue to see robust trends across our global oil business, particularly our crude oil benchmarks, Brent, Murban, Dubai, WTI, and Midland WTI, with ADV up 26% year-over-year in the second quarter, and open interest as of the end of July, up 21% year-over-year. Importantly, this is helping to drive strong open interest trends across our global commodity futures and options complex, including 15% growth in global energy and 21% growth in Ags. Recurring revenues increased by 2% year-over-year, including 6% growth in exchange data services, which was once again driven by double-digit growth in the number of customers consuming our global energy and environmental data. This was partially offset by our Listings business, where capital markets activity through much of the first half was relatively muted.

However, the IPO markets started to open up towards the end of the quarter with the NYSE acting as the backdrop for 91% of total capital raised in the second quarter. In addition, the NYSE continues to lead the industry with a total of 12 operating companies transferring from other exchanges so far this year, representing a combined market cap of roughly $100 billion. Turning now to Slide 6, I’ll discuss our Fixed Income and Data Services segment. Second quarter revenues totaled $546 million, up 6% versus a year-ago. Transaction revenues increased by 23%, including 17% growth in ICE bonds, and 25% growth in our CDS Clearing business. Excluding the impact of the Euronext migration, both recurring revenues and ASV grew by 4%, driven by strong growth across our analytics, desktop and feeds offerings.

Within Desktops, we continue to see strong demand from energy and environmental focused customers, as well as continued robust growth in our ICE Chat offering with the number of users has grown at a 15% CAGR over the last five years to nearly 120,000 at the end of 2Q. This growth has been driven by the investments we have made to reduce friction across the workflow, including the development and refinement of a proprietary large language model within ICE Chat. And as a result of these enhancements, through the first half of this year, we have seen a nearly 60% increase in energy volume executed through our ICE Chat platform. Lastly, within our consolidated feeds business, investments we have made to elevate and enhance our offering continues to pay dividends, evidenced by double-digit revenue growth and a number of wins both in the quarter and first half driven by displacement of larger multi-asset class incumbents.

This collective performance is a key driver of our other Data and Network Services business, which increased by 7% in the second quarter and 9%, excluding the impact of Euronext. In our Fixed Income Data and Analytics business, similar to the last few quarters, we experienced an extended sales cycle within our End of Day Pricing business. Somewhat offsetting was a return to year-over-year growth in our Index business, driven by growth in ETF assets under management to record $526 billion as of the end of 2Q. Let’s go next to Slide 7, where I will discuss our Mortgage Technology segment. Second quarter Mortgage Technology revenues totaled $249 million. Recurring revenues, which account for nearly 70% of segment revenues totaled $164 million and helped to drive outperformance versus an industry that experienced nearly 40% decline in origination volumes.

While data and analytics recurring revenue grew double digits year-over-year, and nearly two-thirds of our Encompass customers up for renewal during the quarter did so at higher minimums, growth was offset by those electing to renew at lower levels as well as reduced spend on ancillary products such as our CRM and marketing solutions, which tend to be utilized by customers that are more refi focused. Importantly, the vast majority of these customers not only remain on the Encompass and ICE Mortgage Technology platform, but have also signed multi-year contract renewals. While macro conditions appear to be stabilizing and year-over-year pressure on forward-looking application volumes appears to be moderating, evidenced by a mid-teen decline in July applications compared to a nearly 30% decline in 2Q and a nearly 50% decline in the first quarter, current cyclical pressures are now likely to drive our recurring revenue growth into the low single-digit range for the full-year.

However, these same cyclical conditions and the need to reexamine legacy cost structures continues to attract customers that have not traditionally utilized the ICE Mortgage Technology platform. As an example, the top five bank that elected to replace their in-house solution with Encompass as their system of record for the retail channel last quarter has now also signed on as an Encompass customer for their correspondent channel. In addition, CrossCountry Mortgage, a top 15 lender and Encompass user, signed on to utilize our analyzers and what was one of the largest data and analytics deals in our history, following JPMorgan’s adoption of our Analyzer suite last year. While these wins will take time to implement and are therefore not expected to impact our 2023 recurring revenues, it’s a clear example of the increasing need for workflow efficiencies.

And we expect there to be continued momentum through the balance of this year and into 2024. Moving to Slide 8. In summary, it was a record first half. We delivered revenue, operating income, earnings per share and free cash flow growth. We continue to make strategic investments across our business and future profitable growth opportunities. And we are well positioned to meet the evolving needs of our customers and create value for our shareholders. I’ll be happy to take your questions during Q&A, but for now, I’ll hand it over to Ben.

Benjamin Jackson: Thank you, Warren, and thank you all for joining us this morning. Please turn to Slide 9. Amidst the dynamic macro environment we’ve witnessed in the first half of 2023, our customers continue to rely on our leading technology, mission-critical data and transparent and accessible markets to manage their risk. Across our commodities markets, average daily volumes increased 17% in the quarter and were up 7% when compared with the first half of 2022, including a 16% growth in energy and a 27% growth in our agricultural portfolio in the second quarter as customers respond to changing weather patterns given the El Nino conditions and its impact on commodity supplies. In energy, the globalization of natural gas and the evolution towards cleaner energy are trends that we began investing in over a decade ago.

And today, cleaner energy sources, including global natural gas and environmentals, make up over 40% of our energy revenues and have grown double digits on average over the past five years. This strong performance has contributed to an average annual growth rate of 8% in our energy platform over that period, growth that is a direct result of staying close to our customers, understanding their evolving risk management needs and expanding the breadth of the content that we offer across our energy network. In our oil markets, ICE’s Brent benchmark, the largest crude oil futures and options market in the world, has undergone its latest evolution with the addition of Midland WTI into the Brent basket, creating a new Midland exposure for the oil market to manage.

Reflecting this dynamic, ICE Midland WTI reached record volumes during the quarter, along with a series of open interest records in July. In addition, commercial customers continue to demand more additional, more precise hedging tools and that we are in a unique position to provide, given their correlation to our benchmark contracts such as Brent. This trend is best illustrated by the continued growth of our other crude and refined products line, up 17% in the first half and up 33% in the second quarter. In our natural gas markets, driven by a record-setting quarter in our TTF gas benchmark, revenues were up 32% in the first half, including 52% growth in the second quarter. In addition, open interest trends in our global gas complex remained strong through July, up 16% year-over-year, including a 34% increase in our TTF complex and a 15% increase in our North American gas business.

Importantly, because we have built a global platform that spans benchmarks across North America, Europe and Asia, we are well positioned to continue to benefit from both the near-term volatility and the long-term secular growth trends occurring across these markets. In our environmental markets, as we look out over the longer term, corporates and market participants remain committed to environmental policy to reduce carbon emissions. This is illustrated by continued growth in active market participants, up 9% year-over-year. Importantly, because we offer one of the broadest suite of environmental products across the carbon cycle, we remain excited about our position to serve customers as they navigate the journey to cleaner energy and as the demand for transparent pricing in carbon grows.

Some recent examples of customer-led innovation include the launch of futures on Washington State’s carbon program, along with soon-to-be launched futures on Alberta’s carbon program, which is expected to go live in the third quarter. In summary, as the energy evolution continues to introduce new complexities, uncertainties and volatility to energy markets, our global environmental markets alongside our global oil, gas and power markets provide the critical price transparency and risk management tools that will enable participants to navigate this evolution. Moving to our Fixed Income and Data Services business. Our comprehensive all-weather platform continues to generate compounding revenue growth, up 9% in the first half. This growth was underpinned by both recurring and transaction revenue growth, a testament to the strategic diversification of our business and our ability to deliver growth through an array of macroeconomic environments.

Interest rate volatility as well as continued efforts to build institutional connectivity across our platform contributed to a 51% increase in our ICE bonds business in the first half versus last year. In addition, we continue to see returns on past investments made in our other data and network services business, which is up 7% in the first half driven by strong growth across our analytics, desktop and feeds offerings. Turning now to our Mortgage business. In the second quarter, our Mortgage business once again outperformed a broader industry that experienced a nearly 40% decline in origination volumes. This continued outperformance is a result of executing against our strategy of leveraging our mission-critical technology and data expertise to accelerate the analog to digital conversion happening in the industry.

Part of that strategy is intentionally shifting more business to recurring revenue, particularly within our origination technology and data and analytics business. And during the second quarter, of the Encompass customers that came up for renewal, over 60% increased their base subscriptions. Importantly, where customers decline in subscriptions, the trade-off is a higher per-close loan fee, which will provide an uplift in transaction volumes when the market returns. In addition, we continue to have constructive conversations with customers as they seek greater workflow efficiencies. For example, the top five banks that elected to implement Encompass as their system of record for the retail channel last quarter has expanded their relationship with us, signing on as an Encompass customer for their correspondent channel.

And during the quarter, we had one of the largest data and analytics deals in our history with the signing of CrossCountry Mortgage to implement our analyzer offering. Importantly, increased workflow efficiency through continued electronification is a secular trend we believe will continue through a variety of mortgage origination environments. This trend gives us confidence that we can grow a business that today is only a fraction of the $10 billion addressable market that is in the early days of an analog to digital conversion. Our ability to capture this secular trend is illustrated on Slide 22 of the appendix. While origination volumes on the Encompass platform in the first half were comparable if not slightly below those seen in the first half of 2018, pro forma IMT revenues have increased over 50% with recurring revenues growing at a 14% compounded annual growth rate.

With that, I’ll now turn the call over to Jeff.

Jeffrey Sprecher: Thank you, Ben, and good morning, everyone. Thank you for joining us. Please turn to Slide 10. I’ll begin by touching on our pending acquisition of Black Knight. While we are unable to answer any questions on this call relating to the pending litigation with the Federal Trade Commission, I’ll briefly discuss our announcement to divest of Optimal Blue. On July 17, we announced that we entered into an agreement whereby contingent on the close of our acquisition of Black Knight, Constellation Software will acquire Optimal Blue for total consideration of $700 million. This consideration includes $200 million of upfront cash and $500 million in the form of a seller finance note, which we have committed to place into the market within six months following the transaction close.

We intend to provide additional performance details upon the closing of Black Knight, but it’s worth noting that we continue to target revenue synergies of $125 million and expense synergies of $200 million by year five. As a result of our agreeing to sell Optimal Blue, our federal trial was rescheduled to August 14. And we are in a dialogue with the FTC about potential resolution. The transaction with Constellation Software will keep Optimal Blue and the Empower loan origination system together under a single, highly credible owner. A related agreement will continue and expand our commercial relationship to facilitate Optimal Blue being made fully available to ICE’s customers on our open network. As the largest distributor of Optimal Blue via our network, we remain very excited about the value and efficiencies that the combined ICE and Black Knight entities will bring to the end consumer as well as to other stakeholders across the mortgage ecosystem.

Shifting to ICE’s strong results, please turn to Slide 11. In the second quarter, we grew revenues. We grew adjusted operating income, and we grew adjusted earnings per share, delivering the best second quarter and the best first half in our company’s history. These record-setting first half results reflect on the quality of our strategy and more importantly, on the execution of that strategy. We’ve deliberately positioned the company to have a mix of transaction and compounding subscription revenues, giving investors upside exposure while hedging our downside risk. We’ve intentionally diversified across asset classes and geographies so that we are not tied to any one cyclical trend or macroeconomic environment. We’ve placed the company at the center of some of the largest markets undergoing an analog to digital conversion.

We believe that the combination of these factors is what makes ICE an all-weather name that generates growth on top of growth. Looking to the second half of the year and beyond, we are positioned to capitalize on the secular and cyclical trends occurring across asset classes. And we remain focused on executing on the many growth opportunities that are in front of us, extending our track record of growth. Before I end my prepared remarks, I’d like to thank our customers for their continued business and for their trust. And I’d like to thank my colleagues at ICE for their contribution to our record second quarter, making this an unsurpassed first half result for our company. With that, I’ll now turn the call back to our moderator, Bailey. And we’ll conduct a question-and-answer session until 9:30 Eastern Time.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question today comes from the line of Dan Fannon from Jefferies. Please go ahead, Dan. Your line is now open.

Daniel Fannon: Thanks. Good morning. My first question is on the mortgage side. So curious as to what percentage of Encompass customers have gone through the renewal process. You’ve given some updates on the kind of renewal and what people have been doing. But curious about where you are in that full process. And then broadly looking forward on the mortgage side, there is an outlook that we’ve kind of bottomed in terms of activity. Looking at your guidance implies that we’re still going to have some pressures for the remainder of this year, but as you think about the overall macro backdrop, are you anticipating volumes here in the second half to start to recover?

Benjamin Jackson: Hi, Dan, this is Ben. And great questions. Thank you. In terms of the first part of your question of what percentage of the customers have renewed, so we started this process really a couple of years ago. We’ve had the Ellie Mae business now for three years, and we started talking about this just a couple of years ago. Most customers are on agreements that are around four to five years in duration. So we’re roughly halfway through that transition. In terms of how the business is doing from a longer term perspective, we feel great as we’ve been talking about on many of these calls, how we’ve been repositioning the ICE Mortgage Technology company to really unlock long-term growth potential. And underneath the covers, we’ve seen a lot of success towards that.

The evidence to that effect is that over the last several quarters, we’ve mentioned that we’ve had success renewing more than 60% of our customers at higher subscriptions. And even when we do see that 40% or so or less that are renewing at lower subscription fees, the trade-off there is that we’re getting a higher per-close loan fee on each of those. So when the market normalizes, that will be a tailwind towards our transaction revenues. The second thing is we have continued to see in the second quarter some headwinds from M&A consolidation and going out of business, although it’s been relatively small. I think the other thing that we’ve seen in the first half that were in some of our prepared remarks were that there are some ancillary products that roll up into our origination line item that are not Encompass that are more CRM and marketing-oriented platforms that are very targeted towards helping our lenders identify refi opportunities with clients.

And the refi environment continues to be very tough, obviously, with the rate environment where it is. Those contracts tend to be one year in duration. They’re user-based. And that is an area where the first half of this year, we saw some pretty significant headwinds towards subscription revenue. But we’re already seeing some small signs that, that’s turning. And when the market normalizes, we feel good about that coming back. In terms of offsets, we continue to have great sales success in the second quarter of this year on the back of Q4, which we mentioned was strong. Q1 was our best ever. Second quarter was our best second quarter in the last six years. We have 41 new clients come onto the Encompass platform. Now of those clients that come on, many of them are midsized clients that come on right away.

We start recognizing subscription revenue right away on those clients. There’s also a percentage of those clients that are significant large clients such as the large top five global bank that we had mentioned as well as the win with CrossCountry Mortgage in the D&A space. These clients take time to implement. And the way to think about those is that those will start to have an impact on subscription revenue come 2024. And then once those clients are implemented, there’s all kinds of new loans that are coming on to our platform and onto our system that we’ve never interacted with before that we’ll start getting additional transaction fees from as well as they interact and consume services off of our open third-party network and we get per-close loan fees from those loans as well.

So from a long-term perspective, we feel great about the positioning.

Operator: Thank you. The next question today comes from the line of Benjamin Budish from Barclays. Benjamin, please go ahead. Your line is now open.

Benjamin Budish: Hi there. Good morning and thanks so much for taking the question. I wanted to maybe follow up a little bit on the Mortgage segment. There’s a lot of dialogue around sort of the ongoing digitization and sort of similar to the question in terms of the contract renegotiation cycle. I kind of wanted to ask about the cross-sell some of your existing products like AIQ in particular. Just curious where you are in terms of the penetration of the current customer base and how far you think that can go?