Earnings Call Transcript - ICE Q4 2020

Operator, Operator

Good morning. My name is Kate, and I will be your conference operator today. At this time, I would like to welcome everyone to the Intercontinental Exchange Fourth Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Please note, this event is being recorded.

Warren Gardiner, Investor Relations

Good morning. ICE's fourth quarter 2020 earnings release and presentation can be found in the Investors section of 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 2020 Form 10-K and other filings with the SEC. In our earnings supplement, we refer to certain non-GAAP measures, including pro-forma revenues, adjusted income, EPS, operating income, operating margin, expenses, effective tax rate and debt-to-adjusted EBITDA. We believe our non-GAAP measures are more reflective of our cash operations and core business performance. You will find a reconciliation to the equivalent GAAP term in the earnings materials and an explanation of why we deem this information to be meaningful, as well as how management uses these measures in our Form 10-K. 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 terms. With us on the call today are Jeff Sprecher, Chairman and CEO; Scott Hill, Chief Financial Officer; and Ben Jackson, our President. I'll now turn the call over to Scott.

Scott Hill, CFO

Thanks, Warren. Good morning, everyone, and thank you for joining us today. I'll begin on Slide 4, with some key highlights from 2020, and a summary of our strong fourth quarter results. Earnings per share of $4.51 were up 16% year-over-year on record revenues of over $6 billion. Free cash flow totaled a record $2.4 billion, and we returned nearly $2 billion to shareholders through buybacks and dividends. We also used some of that cash in our strong credit profile to make the important strategic acquisition of Ellie Mae in September, an acquisition that was nearly 3% accretive to our full-year 2020 earnings per share. Our fourth quarter results were an exclamation point on a great year. Earnings per share totaled $1.13, up 19% year-over-year. Net revenues totaled approximately $1.7 billion, a 14% increase on a pro-forma basis. While we've now transitioned to new segment reporting, I'll mention that fourth quarter data services revenues totaled $595 million, which was at the high end of our guidance range and up 6% year-over-year. For the full year, despite the challenges brought on by the pandemic, our data sales teams focused on serving our customers, delivering data services revenues that grew 5% over the prior year, one of the top of our guidance entering the year.

Benjamin Jackson, President

Thank you, Scott, and good morning to everyone on the call. Please turn to Slide 9, where I'll begin with some of the highlights and key initiatives across our Global Energy business. While inflation, economic growth and geopolitics will always influence volume trends in a particular quarter or year, we are focusing on investing in the structural growth opportunities that exist across Global Energy markets. Investments that have been critical to the 7% average annual revenue growth we have generated across our energy and environmental network over the last five years.

Jeffrey Sprecher, CEO

Thank you, Ben, and thank you all for joining us this morning. Please turn to Slide 12. Over two years ago, and in collaboration with Starbucks and Microsoft, among others, we seeded a venture within ICE called Bakkt. Our vision was to leverage our collective core competencies to build a regulated ecosystem that would support the full lifecycle of a digital asset, and through efficiency gains and greater transparency, a platform that would have strong network effects within a nascent but rapidly growing asset class.

Rich Repetto, Analyst

Yes. Good morning, Jeff, Scott and Ben. Congrats on the great year. I guess the question is on the recurring revenue. Thanks for the breakout and transparency on that, Scott. So I get the impression you said at the SIP revenues, what I didn't understand is how - what's recurring in the mortgage side, and it looks like you're about - almost half year revenues recurring now overall if I have calculated accurately?

Scott Hill, CFO

Yes, Rich, you picked up on it exactly right. We did want to continue to give transparency in our guidance on those elements of our business that are recurring, and the leisure to predict in some of the volume based business. And you're exactly right that if you add up the total of the recurring guide, it's around mid-point, $830 million of revenue, which is just less than half of the overall business. If you look at it, we've given you that detail on a pro-forma basis historically, and if you do the math on the guide in the first quarter, those recurring revenues are growing 7% to 9%. So, very strong performance in a very stable part of our business right out of the gate, obviously led by a strong performance in the mortgage business, which has picked up customers, picked up volume from existing customers, but then also the data business, which again, despite the pandemic, as I said in my remarks, the sales team did a remarkable job and put us in a position where ASV was nearly 6% entering this year. So we feel very good about those recurring businesses and we intend to continue to give you each quarter our perspective on what we expect those revenues to be. You asked specifically about the recurring nature of mortgage bit, so I'll let Ben give you a little color on what's driving that great performance.

Benjamin Jackson, President

Hi, Rich. We saw this. So the first thing to start with is on the mortgage side of the business. When someone subscribes to come onto our network, they're getting our full platform and our network services as part of that. So there is a base level of subscription fee that someone's paying to be a part of that and that's really what that recurring revenue piece is. And when we analyze the deal, one of the exciting things that we saw under the covers here and that I've talked about in terms of the different addressable markets that we can go after here with this business, out of that $10 billion addressable market, $4 billion alone is just in the origination side and automating that whole origination process. And we had seen that Ellie Mae had increased market share, 38% to 44% in a pretty short period of time, and we had conviction that they're going to continue to grow market share in that space. I'm pleased to say that under the covers what we've seen in terms of sales performance, and I even highlighted this on the last quarterly earnings call back in October, that the sales results have been phenomenal in terms of selling new versions of our loan origination system into new customers and then also cross sales of our products into the customer base. And to go into that even a little bit further, in Q3 and Q4, the company set all-time records in terms of bookings on the Encompass Loan Origination System. So Q3 and Q4 are the two highest quarters ever in the company's history. Q4 across the entire Ellie Mae product set was the largest bookings quarter ever in the company's history. So all of that are real tailwinds. Scott gave the guidance to the Q1 recurring revenue for the business as well and why we feel really strong about the businesses ability to grow that recurring revenue base regardless of volume environments.

Alex Kramm, Analyst

Yes. Hey, thank you. Just to follow on that mortgage discussion just now since you gave some recurring revenue guidance, etc. Can you just give us an update how you feel about your outlook for the full year in general? It's a two-part question. One, obviously, you gave an 8% to 10% outlook that you're comfortable for 2021 you said when you closed Ellie, but that was just flatly and now you're obviously running ahead. So, one, how should we be thinking about that guidance going forward now and how should we really hold you accountable now that you're obviously talking about pro forma numbers, you're integrating the business, so how should we think about it from a combined ICE plus Ellie mortgage outlook for the year? Thanks.

Benjamin Jackson, President

Thanks, Alex. It's Ben. So obviously, fourth quarter blew away all industry estimates in terms of volume. So you got to set that aside. And when we did this deal, we were very clear that we saw this as a long-term growth trend and that we are convinced that on an annual basis, we can grow this business and this business will grow 8% to 10% per year on average over 10 years. And underneath the covers, as I just referenced in the answer I gave to Rich, if you look under the covers of what's happened with that business since we've acquired it, sales strength has been very strong. So I mentioned a couple of the Encompass records that we saw over the last couple of quarters. Also another in that, $4 billion of the $10 billion addressable market, another $4 billion of that $10 billion addressable market is around data and analytics. And we also saw record sales of our AIQ platform, so record bookings of the analyzers that are automating that origination workflow in the fourth quarter. We continue to see strength across Encompass as well as AIQ in January, and we're ahead in January than where we thought we were going to be in terms of our model. What this means is that, as we're hitting these types of sales results and sales records for the company, it obviously means there's going to be more recurring revenue into the business. It means it's going to be more customers on the business. There's going to be more loans that are on the platforms that are now on our network loans that we did not interact with before. And more loans on our network interact with the third parties on the network that we have and for the efficiencies that we provide to people, ordering services like our flood report or credit report of that network, we monetize that, charge a service fee for the efficiency that we're providing. So all of these we see as significant tailwinds into the business that gives us confidence that we can grow regardless of volume environment over a long period of time with that 8% to 10% guidance.

Mike Carrier, Analyst

Hi. Good morning and thanks for taking the question. I just wanted to get an update on the data outlook. And I guess, mostly on the equity side, you've just given some of the changes with the SEC on the data rule. Just wanted to see how you think about if that can impact the business, how you guys are thinking about it? Whether it's from a product standpoint, new competition coming in to the industry, I mean, how you are, let's say, to navigate?

Scott Hill, CFO

Hey, Mike. It’s Scott. I'll address this, and then Jeff can add if he wants. As I understand your question, you’re inquiring about the recurring revenues in the Exchange business, particularly related to exchange data, and what revenue impact we expect from ongoing discussions with the SEC. The answer is that we expect none. We are in discussions about proposed changes, but at this moment, we have not observed any impact and do not anticipate any. Consistent with what we've communicated over the past two to three years, we do not expect this line of business to generate significant growth nor decline much; it is likely to remain stable. We have provided some historical data on recurring revenue, and if you look at the third and fourth quarters, as well as the guidance for the first quarter, they fall within the same range. Therefore, we do not foresee any changes that would impact our revenue this year. We have also previously stated that any changes that might occur will likely take two, three, or even five years to materialize, not immediately. So, the bottom line is that we do not expect any real impact on that revenue segment for us this year.

Ken Hill, Analyst

Good morning. I wanted to return to a smaller segment of the mortgage business related to data analytics. I believe the current run rate is approximately $70 million annually, but as you noted, there is an opportunity set of around $4 billion in the addressable market. Could you elaborate on the infrastructure or processes you're implementing to develop this area and share your long-term vision for it?

Benjamin Jackson, President

Thanks, Ken. This is Ben. This is an area where we have invested significantly. When we considered the acquisition of Ellie Mae, our enthusiasm was particularly focused on this aspect. The data and analytics division, especially the AIQ business acquired by Ellie Mae a few years back, is central to this. The core of this business is about automating the manual tasks involved in the origination workflow. In the past, we noted that it costs approximately $8,000 to process a mortgage, with $5,200 of that attributed to manual processing. We believe that, through our AI solutions, there is a substantial opportunity to achieve at least half of that in savings, or around $2,600 per loan through automation. This includes tools like credit analyzers and income analyzers, which streamline the comparison of credit report information with our underwriting requirements for the specific products that customers are applying for. We can automate a significant portion of the manual processes, making it one of our fastest-growing sales items. In fact, we achieved a record in new sales of this product in Q4. Regarding the $4 billion addressable market, it’s straightforward to quantify. If we consider a conservative estimate of $2,600 in savings per loan and apply that to about 10 million loans annually, along with our approximate 50% market share in the loan flow, the potential revenue grows rapidly. As our customers experience these benefits, we are able to monetize them effectively.

Brian Bedell, Analyst

Great. Thanks. Good morning everyone. To explore the mortgage recurring revenue further, the guidance of $122 million to $127 million has a relatively wide range. Ben, could you share the factors influencing the lower and higher ends of that range? Also, I believe you provided guidance on the recurring revenue for fixed income for the entire year, but I am unclear about the guidance for Mortgage Technology's recurring revenue. Do you have any insights on that? Additionally, I would like to hear about the advancements in obtaining more real-time mortgage production data. I know you are working on this, so could you provide an update on the progress?

Scott Hill, CFO

That question had three parts, so let me address them. First, a $5 million variance on a projection of over $100 million isn't actually that significant. It's about the customers we have and those we expect to bring on board. If you look at our historical data for recurring Mortgage Technology revenue in the fourth quarter of 2019, it was $92 million, then $95 million, $100 million, $108 million, and $119 million. We've achieved consistent quarterly growth due to factors we've discussed, including acquiring more customers and customers increasing their seat counts. We anticipate continued growth throughout the quarter, whether that translates to an addition of $1 million or $3 million on a projection of over $120 million, it seems reasonable to guide that way. It's less about a $5 million variance and more about a $2.5 million range. We're optimistic about it. Regarding our data business, particularly in fixed income recurring revenues, we expect growth around 5% to 6% for the year based on a 5.7% annual subscription value. This ASV represents essentially all of the revenue in that segment. We believe that predicting 5% to 6% growth is a sound outlook for fixed income recurring revenue. As for updates on mortgage data and its collaboration with the sales team, I'll pass that to Ben to share his insights.

Benjamin Jackson, President

Yes, as I mentioned in the script, there we have identified some early opportunities on the data side. As you can imagine, there is an absolute treasure trove of information and data sets that are within the Mortgage Technology business segment across all the businesses that are in there. You have the merge business in there, you have Simplifile, and you have the Encompass system and the Ellie Mae business in there. Some of the areas that we're looking to leverage the data sets, the power of the datasets in there are simple things like, when you're going through a mortgage origination process, one of the most common areas where you'll see errors is very late in the process when you get to the closing. What happens at the closing is that you have to compare the original estimates of what your closing fees are going to be at the closing table from what the original estimates were that were provided 60 plus days ago. If those numbers are off by any amount, not even a material amount, it could be zero tolerance, 10% tolerance, you have to go back through the entire origination process again. What we found is Simplifile has all of that information. They know exactly what the closing requirements are, what the fees are in every jurisdiction around the US. We managed all of that reference data for the clients in the closing process. Pulling that type of information, all the way up front to the origination process, and then combining that with our artificial intelligence expertise and automation expertise that we have in our AI tools is able to create a significant amount of more efficiency and a higher quality loan asset that's going to be less subject to errors as you get to the closing table. A lot of these capabilities in the artificial intelligence area and how to leverage this type of information and data is directly coming from the expertise that we have on the data side of the business.

Jeffrey Sprecher, CEO

Let me bridge a wider point, which is that we've been building a technology base in the mortgage space, and it's a very active market. We have a solid platform and commodity. The Ellie Mae business we acquired has proven to be a valuable asset since we took ownership. It's important to recognize that much of the growth acceleration stems from our vision of an end-to-end platform managed by ICE. In today's society, many platforms we engage with raise the question of whether we are actually their customers. They provide services that seem to cater to us, but the reality is that the true customer might be the entity buying the data or the individual giving up data in exchange for free access. We are currently witnessing examples of individuals who believe they are customers of these free services, but in truth, they do not generate any revenue for the provider. The revenue is derived from a different source. As we promote our vision, we are engaging in conversations with key players in the mortgage industry, and it's resonating. The data that you asked about, along with the way Artificial Intelligence will interact with that data, is an area where ICE has built decades of trust within the financial services sector concerning data management, ownership, and protection. This positions us well as we continue to engage in broader societal discussions regarding data privacy and rights.

Alex Blostein, Analyst

Great. Good morning everybody. Jeff, a question for you around maybe some of the regulatory things, potentially might be on the comp, but really was hoping to get your perspective on everything that's going on in the retail trading side of the equation. It feels like the concept of payment for order flow has come up a bunch of times in the past, I don't know if this time is going to be any different, but curious to kind of get your perspective on how things might evolve and whether or not with 50% of volumes now trading off exchange, could there be an opportunity for the lit venues to grab some of that market share back?

Jeffrey Sprecher, CEO

That's an excellent question, and it's something we've been contemplating over the past week. When we acquired the New York Stock Exchange, we made it clear that we believed the market structure in the US equity sector was flawed and needed a comprehensive review. We attempted to propose a significant overhaul that we discussed with many industry stakeholders, but we were not successful. The previous SEC invested a considerable amount of time overseeing industry consortiums responsible for managing infrastructure, rather than assessing if the entire infrastructure functioned appropriately. As Scott mentioned, this infrastructure somewhat hinders the industry and limits innovation. With the new SEC Chair, once Chairman Gensler is confirmed and takes office, we will have someone with experience in the derivatives sector and a strong understanding of market structure. The SEC plays a dual role as both an enforcement and consumer protection agency, as well as overseeing market structure. Traditionally, the heads of the agency have been lawyers more accustomed to the enforcement side. There is an opportunity for a new perspective with the incoming Chair, which could allow for a discussion on a significant reform, which we would support. This could mean that we might have to cede some of our unique advantages if others are willing to do the same, aiming for a more innovative and transparent regulated market that fosters growth in our capital markets.

Ari Ghosh, Analyst

Hey, good morning everyone. Ben, just a quick one on Mortgage Tech. Even, you know on the origination tech revenue piece, just curious how we should think about the sensitivity to market conditions here, say, either like a backlog or do you have any visibility for a portion of these transaction-based revenues? Again, just curious, because I think you were embedding pretty conservative industry and refinance assumptions for the year and the outlook perhaps looks a little more favorable than it did three to four months ago? Thanks.

Benjamin Jackson, President

Thanks, Ari. I'll go through it. Regarding the business's ability to grow through different volume cycles, I'll address your question about volumes. What excites us about this business, and the results we've seen in the few months since acquiring it, have reaffirmed its capacity to develop in various volume environments. Firstly, we are consistently gaining market share, as evidenced by the sales results I've shared. Secondly, more customers lead to increased loan flow. With more loans processed through our network, an average loan interacts about seven times with different third parties. Each new loan creates multiple interactions with third-party service providers, for which we receive fees due to the efficiencies we deliver. The third point concerns automation, which offers significant potential; we have around 10 million loans and efficiency gains estimated at over $2,600 for each. The fourth area is the digitization of the closing process. We are uniquely positioned with the MERS and Simplifile assets, integrating these with our origination network via Encompass into an eClose room. We have several substantial releases this year, including a hybrid eClose offering in Q2, followed by a comprehensive eClose offering later in the year. We anticipate this will drive growth in 2022 and beyond. Concerning volumes, we have unique visibility since we are embedded in the origination platform and witness nearly 50% of loans originated in the US. We see these loans in the initial application stage for refinancing or purchases, giving us a 60 to 90 day preview of market conditions. While industry analysts provide estimates, these are often revised significantly after a quarter or two, making it challenging to predict mortgage origination volumes beyond that timeframe, similar to predicting US equity and oil market volumes. Based on the data from our platform, estimates from Fannie and Freddie for the next quarter or two closely align with our observations and expectations for volumes. However, forecasting beyond that is difficult. Despite this uncertainty, we remain optimistic that our business can grow, regardless of the volume environment.

Chris Allen, Analyst

Good morning guys. I just wanted to follow-on mortgage bit. I just wanted to ask, just in terms of the share gains that you're seeing, how much is coming from existing customers versus new customers? And any update in terms of penetration of the independent mortgage banks which I think, as you talked about in the past, is potentially a 20%, 25% share opportunity over the longer term?

Scott Hill, CFO

Sure. Thank you for the question, Chris. We are experiencing growth in every segment of our customer base. Independent mortgage bankers are performing particularly well, especially in the purchase market. In terms of refinances, we do see some volume going to larger banks due to existing banking relationships, but independent banks continue to grow in the purchase market. Our services extend to large banks, independent mortgage banks, correspondent banks, wholesale banks, and more. The sales strength I mentioned earlier is evident across our entire portfolio. On the volume side, much of our strength is in the purchase market, although we do engage with the refinance market as well. Compared to 2020, application volumes for refinancing and purchasing have risen significantly, with refinancing increasing more than purchasing. According to estimates from Fannie and Freddie, 30-year mortgages are currently around 2.7% to 2.9% for 2021, which indicates that about 20 million units are eligible for refinancing. We also notice a continuing demand in the purchase market, despite limited inventory. As vaccinations progress and the economy recovers, we anticipate strong pent-up demand for purchasing, which aligns with our market share that leans slightly toward purchase rather than refinance, providing us with an additional advantage.

Owen Lau, Analyst

Good morning, and thank you for taking my question. So on Slide 20, you disclosed that you have a 1.4% ownership in Coinbase. Could you please talk about the cost basis? Why did you make that investment and is there any synergy with ICE or Bakkt? Thank you.

Jeffrey Sprecher, CEO

Yes, that's a good question. As a company, we have never considered ourselves a private equity or venture firm, and we believe we should responsibly manage our shareholders' money. We have always believed in returning excess capital. However, we have invested in several businesses that are related to us, where we saw strategic advantages in having a relationship, either through partnerships or knowledge sharing. We invested in Coinbase during its early rounds to understand blockchain and the significance of digital currencies in payments. The company has performed exceptionally well, and our investment, although small in monetary terms, has likely increased in value. Similarly, we invested in Bakkt to further our understanding of blockchain technology. A few years ago, many were questioning whether blockchain would be used for clearing or if it would disrupt the traditional financial services industry, and we aimed to stay ahead of that technology. We also invested in Euroclear, a European custody solution that has relevance to us. Our company is performing very well, and as your question suggests, we do have several interesting assets that hold value, which we believe we can unlock for our shareholders over time as those partnerships and knowledge sharing develop.

Kyle Voigt, Analyst

Hi. Good morning. So in the fourth quarter, S&P Global announced its acquisition of IHS. Just last week, we had the LSE Refinitiv deal close. Just give me size of these transactions. Can you just talk about the kind of broad competitive environment and landscape in your fixed income and data segment? How you would expect the environment to evolve as some of these competitors gain scale or add product breadth?

Jeffrey Sprecher, CEO

Sure. I'm glad to say that we recognized early the adjacency of data and information and analytics around risk management and moved relatively quickly to formalize our internal offerings and also make similar large acquisitions for us. This is really now probably half of our business in serving data and analytics. I use that number roughly, but it's somewhat how we think of the business. They are intertwined virtuous circle of risk management along with the data and information that it takes to manage our portfolio risk. It’s not surprising to us that others are making moves in that space. With respect to all the companies actually that you mentioned, we have some relationships with them, and, at times, we use some of their platforms and, at times, they use some of our platforms and data and indices. You've seen a movement of large exchange and data information groups advancing their own businesses, but also somewhat collaborating across the industry where necessary. We have a good relationship with the managers of all of those companies. Although in some areas we are fierce competitors, in other areas, we cooperate for the betterment of the industry.

Simon Clinch, Analyst

Hi, thanks for taking my question. I wanted to revisit the mortgage tech aspect. Regarding your comments about having just under 50% market share on the origination side, could you discuss how you see the competitive environment evolving in origination and where you believe that market share could go? Is there a natural limit to that market share for you in a typical scenario?

Benjamin Jackson, President

Thanks, Simon. Over the last decade, the mortgage space has remained remarkably analog. The market share I mentioned is closely followed by many homegrown systems, Excel spreadsheets, or disconnected systems. This gave us strong confidence in pursuing this transaction, as there is still a long way to go in gaining market share in origination alone. Additionally, we are in a unique position with a robust origination network that provides significant benefits to our customers by automating manual workflows. We also have a strong network for electronic closings. We believe the real potential in this deal lies not only in origination automation but also in our eClosing room, which will connect your loan underwriter with your attorney, settlement agent, title insurance provider, and others in a digital closing environment. This allows us to electronically finalize transactions, register them on MERS, securely store all related documents, and file them electronically at the local county courthouse through Simplifile. This is an impressive capability we are bringing to the market. We have already launched several key components due to our prior partnership with Ellie Mae. As mentioned earlier, we have critical functionalities in the pilot phase that will roll out in Q2 for our eClose solution. There is also another major set of functionalities planned for the second half of this year, which will contribute to significant growth for this business in 2022 and 2023.

Jeffrey Sprecher, CEO

Yes, just to focus on how we're thinking about mortgage right now, the real opportunity for us is to take the loan origination customers that were on Ellie Mae and get them to use the other services on our network. We find that the customers that use the entire network have a multiple of revenues for us beyond those that are simply using the loan origination platform. The market share, if you're looking at it solely in loan origination, we're looking at internally at the bigger total addressable market of end-to-end services that Ben just described. We've seen, and I've been involved, and Ben has been involved; actually, all three of us here have all been involved in helping Ellie close some loan origination system deals, where we've been able to articulate the end-to-end vision that has brought new customers to the platform for the loan origination system, but it is that full vision I think that is helping to increase the market share if you look only at loan origination. The bigger addressable market for us is taking those already loan origination customers and getting them to use the end-to-end network.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Sprecher at this time.

Jeffrey Sprecher, CEO

Thank you, Kate. I thank all of you for joining us this morning, and we'll look forward to speaking to you again soon. But in the meantime, I hope that you stay safe and that you and your loved ones stay healthy. And with that, we'll conclude the call and have a great day.

Operator, Operator

This concludes today's conference. You may now disconnect.