Bakkt, Inc. (BKKT) Earnings Call Transcript & Summary

[Audio Gap] Joining us our CFO, Karen Alexander;, General Counsel and Corporate Secretary, Marc D’Annunzio; and Chief Sales and Marketing Officer, Mark Elliot. Thank you all for joining us today.

Yes. Great to be here.

Good to be here. Thank you.

Great. So I want to start with the #1 question from investors and that's, what exactly is Bakkt today? The company has gone through a number of transitions since being built by ICE a few years ago. So what is Bakkt today? And where is Bakkt going?

Well, I'll take that, Andrew. Thank you. So you're right, we have been through some pivots and transitions since originally being founded by ICE. And really the way I'd characterize where we are today is in the sweet spot, in our view, of where the market is going. Our goal, our vision really is to be the best supporting actor, best supporting actress in the evolving crypto space. We've all seen the challenges that pure-play consumer-facing crypto companies have faced, and at the same time, traditional financial services companies, investment shops and even consumer brands have all been looking for ways to explore and deliver crypto strategies and solutions, especially to attract the next generation. And so we view ourselves as a core crypto infrastructure play behind the scenes, enabling them to deliver great crypto experiences and get the brand halo effect with, again, this new younger audience who is increasingly looking for new and exciting ways to engage with crypto.

Okay. Great. So let's move to the broader crypto market and the impact of recent events around the banking sector on your business. We've written about how bullish we believe these events are for the sector with Bitcoin and crypto market cap up about 50% since the failure of Silicon Valley and Signature Bank. What is your view of the driver of this behavior? And have you seen an increase in activity across your businesses?

Sure. Yes, I'll take that one, too. Look, it's pretty clear that with some of the recent bank failures, we are seeing Bitcoin rally as consumers look for alternative solutions to store funds. And while the government obviously has done quite a bit to help bank depositors with recent events, there's definitely still a lot of concern about future potential risk in the financial sector. The way we're seeing that impact us is, we have seen some increased interest in crypto specifically around our crypto custody solution. There's been a material increase in the number of inbound calls and inquiries we've received, especially as concerns around security, regulation, trust, compliance have really helped differentiate our platform and solution from some of the competitors. And at the same time, we're seeing general interest from institutions just looking to diversify their custody partners. So just to put a finer point on it, inbound calls have basically doubled from Q3 of last year, even more so for some of the crypto-specific solutions. And most of that increase has come from financial services outside of traditional finance or banking partners. In particular, we're definitely seeing more engagement come from fintechs. I think our acquisition -- pending acquisition of Apex Crypto certainly has helped with that from a brand perspective, but also large investment funds who have been increasingly inquiring about our Crypto Custody solution as they prepare for what seems to be increasingly a turnaround in the crypto marketplace.

Interesting. Okay. I definitely want to talk more about custody a little later on the discussion. But now I want to focus in a bit on the business and the Apex Crypto acquisition, which really should be transformational to your business, when, and if it closes. Investors have been asking for more disclosure on how this business is currently doing, particularly after you disclosed last quarter that Apex earned $9 million -- $9 million paid out of a $45 million target in Q4. So can you provide us with an update on how the business at Apex is doing?

Yes, I'd be happy to take that one, Andrew. So we're making strong progress getting to the close of Apex Crypto. So we're very excited to have [indiscernible] joining us. We've been really focused also on working with our counterparts at Apex Crypto to across various functions to ensure a spin of a transition as we can to really release the synergies of the combination. So getting to the deal itself, if you remember the structure of the deal, it included a $55 million cash component upon close, and then the ability to earn stock consideration of up to $145 million, depending on how they performed relative to various revenue targets, starting with Q4 2022, I think, going through '23 and '24. And we're really happy with how this was structured from our perspective because you think about a negotiation between buyer and seller. These targets were effectively the seller's case, but we think that they're aggressive. Frankly, I'd be thrilled if I get to the point where I can pay 100% of them, but they're aggressive, and they are after a negotiation process. And to the extent that Apex Crypto's platform doesn't achieve those. We would reduce those proportionately. But that certainly doesn't mean that if we -- if they don't hit 100% of the earnout target, that's necessarily a cause of concern. It's just where they are relative to what is a very aggressive target on the top end. So as you mentioned, we saw them earn about $9 million of the $45 million that they have the potential to earn in Q4. And when you think back in what happened in Q4, that's obviously a really tough environment for the entire crypto industry, just given the FTX turmoil. And really, we saw reductions in transaction volume across the board. So if you think about Q4 trading volume, if you look at -- Apex was down around 20%, that's really right on path with what we saw with the competitor crypto trading volume coming out of places like Coinbase and Robinhood from what they've disclosed. So we're actually very happy that they were able to perform the way that they did in a very tough environment, and they certainly did not out -- yes, they were certainly not an outlier to what the larger space saw. When we thought about those targets, again, we -- the fuller net was based on an aggressive settler target. We had in the back of our minds that they wouldn't achieve all of that. They ended up getting about 65% of the revenue that we underwrite, not necessarily as their top side case. So you think about it, they've got 65% of what we thought they would get. We ended up paying 20% as an earn-out. So we think that, that structure works very well for us in terms of we're paying for performance in a way that really scales to providing that consideration. We continue to talk to them in Q1 2023. And similar to what others have seen, we are seeing green shoots in what the markets are doing overall in Q1. So January, I think all the players saw a substantially higher month-over-month trading volume from January versus December. Apex saw that as well, and it really held tight in February. Also looking at to [ Mark's ] point in terms of -- market interest is still there. They signed 4 new clients since we announced the acquisition, and 2 of those were after -- we talked about our earnings release a couple of weeks ago. So as I look again towards '23 and '24, again, the full earn-out targets are based on very aggressive revenue growth percentiles. So for instance, in 2023, they would have to increase revenue 175% from 2022 levels to earn the fuller amount. In 2024, they have to increase then that robust 2023 level by another 50%. So you -- so the other side to the extent that they don't achieve at least 25% of that growth, we wouldn't pay any earnout. Again, I'd be happy to be in a position where I paid all the earnout because those growth targets are pretty exceptional, but if I wouldn't look at not paying the full growth target as a sign of weakness. There -- in all circumstances, it points to growth in revenues, which we think is an incredible story for our shareholders.

Great. And you said, 4 new clients since the acquisition. I believe you guys said 2 on the calls. Has there been 2 since the call? Or...

Yes. So 2 as of March 9 and then another 2 since we [indiscernible] shared earnings a couple of weeks ago.

That's great.

Yes.

It's interesting. It's good to see that the business is still kind of growing as the transition is -- or potential transitions happening here. Great. And Apex, looking at SEC filings, Apex was profitable in 2021. According, they tend to lease back and had to file numbers. At the current run rate, is Apex still profitable?

Yes. Obviously, we've been staying close to them and looking at their year-end results. 2022, again, was another challenging year relative to what everybody saw in 2021. And I think Apex again performed in line with what the broader market saw. If you look at gross revenue, that their gross revenue came in at about 2/3 reduction compared to what they had in 2021. But it's important again to note that the larger marketspace saw that as well. So I think Coinbase was down 66%. Robinhood was down 50%. So we're seeing them. They are not underperforming peers relative to what everybody saw in the space in 2021 or 2022 rather. When you look at their expense base, they did spend more on their platform as they look to build out their service capabilities. So their expenses went up for various reasons related to personnel and general and admin costs. But when we looked at the deal, we're not taking all of those [indiscernible] So even though their expense base resulted in a loss in 2022, it's important to note that when we take over the business, we're taking over a subset of people and a subset of processes that we think have synergies to our business. So -- and how we run our crypto space. So we wouldn't expect their expense base in 2022 to be indicative of how they would be integrated into our business. So again, we're seeing -- we're really thrilled about what we're seeing in 2023, so far in terms of the January bounce back. And then happy to have them in soon so we can start realizing those cost synergies.

Got it. Great. And I mean, just in the current regulatory environment, I mean how confident are you in achieving the 2Q '23 close date for the transaction? And are there any capital requirements from the regulators related to the transaction?

I can take that one, Andrew. So we are very confident that we're going to close that transaction imminently. It's been a bit of a process. As you're probably familiar, both we and Apex, are broadly regulated across many different states. And one of the realities of that framework is that you need to get a lot of approvals in order to get transactions like this close. So we've been working very hard on that. And again, I think we're very close to the finish line and expect to close it imminently. With respect to capital requirements, Apex Crypto is itself a regulated business. It has a BitLicense similar to back to marketplace, the consumer-facing entity that we operate, and our trust company where we custody the crypto that we make available on our platform. So as a function of that regulation, each of those entities has its own capital requirements by virtue of the supervisory agreements that they have with New York DFS. We're prohibited, I think, from sharing details of exactly what those capital requirements are and how they're calculated, but obviously, we've looked at the capital requirements that Apex has that we're going to inherit when we close that transaction, and we're confident that, that we'll be in a good position to maintain them.

Okay. Impact has also announced some of its own crypto partnerships with a number of regional banks, but activations have been on hold for some time now. Given the recent events around the regional banks and the failure and shutdown of some of the crypto-friendly institutions and kind of off-ramps, do you still believe you can get these bake activations done soon?

Yes. Let me take that one. So look, there's no question, regional community banks have pushed back their activations, and they're looking for additional regulatory clarity before they implement crypto strategies. Right now, banks don't see the potential risk worth of reward of implementing a crypto strategy. That being said, we've worked closely with the platform partners and our announced community banks to substantively complete all the integration work needed to go live in a timely manner, including in most cases, responding to detailed regulatory threats for additional information around crypto and consumer protections, which we're actually very well suited to address. We're very optimistic that once market conditions approve and regulatory clarity comes, given all the integration work we've done, we'll be able to move quickly to activate those capabilities. And in addition, we still have several ongoing direct conversations with banks who want to pursue a crypto strategy at some point. So we feel good about where we are, given the environment we're in, and when the sun comes out, we'll be ready.

Okay. And let's shift to capital and your capital position post the Apex acquisition. So Bakkt has about $240 million in cash and is expecting about $100 million in cash burn this year, not including the $55 million for the Apex acquisition when it closes. So the plan has always been to become EBITDA positive by the end of 2024. Is this still an achievable target?

Yes. We've always expected -- said that we've expected to become EBITDA positive in that original takes timeline framework that was set out before the lease back. So thinking about where we are now with the $240 million of cash, cash equivalents and available securities, we think we have the liquidity to fund our roadmap. And remember that $240 million does not include any restricted cash that we hold for Bakkt Trust in particular. So you think about $240 million relative to the cash burn, our expectation of $105 million to $115 million, the $55 million that we have for the acquisition of Apex Crypto, we don't see the need to raise capital in the near-term foreseeable future. We do expect can be looking at the free cash flow utilization of 105 to 115, that's down 25% to 30% since 2022. And it really reflects some of the decisions and the tough decisions and the discipline we have in terms of trying to manage our expense base as best as we can and control everything that's within our control while navigating the timeline for activations that we're seeing that [ Mark ] just talked about. And so if you think about the free cash flow utilization in a little bit more detail, one of the biggest things that has brought that down is, some of the rightsizing of headcount, that is going to save us $36 million in free cash flow utilization. $29 million of it is going to come in 2023 and then an additional $7 million is going to come in 2024. That utilization also includes approximately $13 million that we set aside for deal costs to close Apex Crypto. And it also includes roughly, let's call it, $2.3 million to $2.7 million of cash related to the restructuring that I mentioned before. So if you think about those as nonrecurring then from a free cash flow utilization perspective, we're really down 35% to 40% from 2022 levels. To sum it up, we expect that we're going to continue to increase revenue and take advantage of the opportunities that Mark has described while improving and managing our cash flow utilization to be prudent and to make sure that we're there as the market opportunities present themselves.

Got it. And if you were to raise or need to raise capital to time in the future, do you believe you could raise capital in a nondilutive way of necessary, ICE owns more than 60% of the company? And I often get asked, how invested is ICE because ICE provide backing. If necessary, the company run to raise more capital?

Yes. We obviously can't speculate on what ICE will do in the future, but they remain a great partner for us, and we look forward to continuing to have a great working relationship together. They -- their [ 66% ] ownership has remained relatively consistent. They haven't actually sold any shares. So the difference comes in the denominator or not, the numerator of what they own. You think about it strategically. We've got a couple of tie-in puts with them that are very important. They have a CEO in our Board. And then we have the tri-party agreement, which our custody services support their physically delivered Bitcoin's future product. I would reiterate that with the liquidity position that we have, we don't have any near-term plans to raise capital, but we would obviously continue to monitor market conditions, and we'll be opportunistic if that opportunity presents itself and makes sense. We're in a kind of a unique position in that we have been kind of balance the potential dilution that would come from a capital raise to our shareholders with the fact that we have a relatively small amount of [indiscernible] because of that large ICE position. So trying to make sure that we keep that balance is something that we're evaluating as part of our overall capital market strategy.

Okay. Great. Let's shift to the regulatory front and we'll start with custody. So the SEC is focused on separating custodial functionality from exchange functionality, which is in line with how Bakkt currently operates. Can you discuss the path the SEC has discussed on digital assets custody and if this benefits back?

I'd be happy to, Andrew. So obviously, there's a lot of scrutiny on all aspects of crypto, I think, powered largely by some of the events that have happened over the last several months. And I think it's unearth the reality that some companies, frankly, took some shortcuts in the way that they were organized and conducted their business. We set up our platform, as you mentioned, with separate exchange and custody functionality, number one, because that's what more traditional financial sort of frameworks look like, but we believe it's important to institutions and to our partners and ultimately to consumers because that helps assure that participants in our ecosystem that their crypto is safe as a starting proposition and with the platform that they're transacting on is set up for their protection. So broadly, we agree with the statements that Chairman Gensler has made around the importance of separating these 2 functions. We think that, along with lots of other things that are being discussed are really an important sort of predicate for restoring some of the trust and transparency that frankly has taken a pretty big hit over the last several months.

Right. And do you believe that can meet the revised definition of qualified custodian proposed by the SEC?

We do. It's obviously a proposed rule at this point, open for comment. We're likely to submit comments as part of that process. But I think we were encouraged to see that state-chartered trust companies like our Bakkt Trust company, which is chartered and regulated by New York DFS, has an avenue to continue to be considered a qualified custodian. We think that's a really important feature. And as I said, I think our business structure provides us with a competitive advantage in that regard.

Interesting. Okay. And you got to mention competitive advantage. How does Bakkt differentiate itself in terms of custody from some of the large players in the space? And when do you expect this business to be a revenue driver for Bakkt?

And I could take that one. When it comes to custody, security is really the key differentiator. You think about -- you're dealing with billions of dollars in assets that can be irrevocably transferred, you really can't sacrifice security. So you think about that relative to our heritage with ICE. The way that we think about being in a regulatory compliant security-first mindset, that's the foundation of how we were built from day 1. If you think about the fact that just starting with physical security, cold storage is in a highly secured bank-grade vault 24/7 armed security. But this security is just a part of it. So you think about operational security and that's also critical to a custody platform, and that's where we've focused a lot of attention anywhere from how the private keys are generated and secure to how transactions are signed. This all relies on human processes, and we've worked very hard to ensure that we've got a highly skilled team and robust processes in place. Yes. The other thing I would mention is the custody is protected with a $125 million insurance coverage across both the warm and cold wallets. We have a bank level compliance program with robust asset, anti-money laundering into our customers' processes. We have a sophisticated cybersecurity program and that leverages, frankly, allow the same technology and protections that defend the New York Stock Exchange. So if you're looking for a long-term exposure to crypto knowing that you're coins are safe and secured with world-class security, with a qualified custodian, held in a separate trust, this is all a very valuable proposition. So we know that how critical it is for us to continue to invest in it, and we're continuing to do so. We're going to upgrade to a modern security check -- modern architecture to just be able to be more agile to meet our B2B2C partner and institutional client needs. That includes things like automating hot wallets to enable the promising withdrawals and the ability to support an increased range of tokens and protocols, and eventually, get yield-generating offerings such as staking. We expect to start seeing custody ramp up later in the year. As Mark mentioned, a lot of it is just taking advantage of the inbounds that he's seeing since Q4. So we feel good about our position and our ability to offer a product that meets the needs of the market right now.

Got it. Okay. Great. And back to also, you recently acquired a small broker called Bumped Financial. From a regulatory perspective, how does this acquisition help back?

Sure. So obviously, Bumped Financial is a registered broker-dealer, and there are lots and lots of discussions happening both at the legislative and at the regulatory level in terms of which federal regulators ought to be regulating the crypto space and in what way. Obviously, there's a lot of attention these days around which coins could be deemed to be securities. And if they are deemed to be securities who's authorized to transact in those coins, and so we thought as though having a proactive approach to have a broker-dealer and voluntarily sort of put ourselves in privity, if you will, with the SEC would be helpful. Obviously, those discussions continue to evolve. So it's a little early to make a solid prediction in terms of how that will ultimately play out. But again, I think as we highlighted a couple of minutes ago, we don't run from regulation, and I think we welcome the ability to have those discussions with regulators to ultimately come out at a better answer for this space.

And Marc, I guess just one more on regulation. And just bigger picture, given the recent events around the banking sector and we saw the USDC stablecoin depeg. And really, the traditional banking system acted as the single point of failure and crypto has acted quite well throughout this whole kind of banking crisis. So do you think this brings regulatory clarity sooner to the space? Or do you think this prolongs any regulatory action?

I think the disruption in the banking space -- I mean, technically, I view that as an issue that is separate from what has gone on in crypto. As you saw with some of the bank failures, they were sort of orthogonal to the crypto space, right? It had much more to do with customer concentration issues, reserves that were held in sort of illiquid securities and the like. But that being said, obviously, there's been a lot of attention paid to crypto companies, their ability to bank, their ability to maintain those relationships. As Mark highlighted a couple of minutes ago as well, the bank regulators, especially at the federal level, are also now involved in terms of making sure that the banks that they regulate engage in crypto in a safe and secured way. And so obviously, there are a lot of people asking a lot of questions about the space. At a high level, I think we welcome that. I think we believe that the questions largely are good. We think that we have good answers to those questions, and we think that in the same way that partners and users care about aspects of the crypto platform that matter that banks and their regulators ought to care about those answers as well in terms of how does the exchange conduct business? How does it represent itself to customers? How does it safeguard crypto? And again, we believe ultimately that we have good answers to all of those questions, and fundamentally, that ought to illuminate a path for banks to be involved in the space in a way that satisfies their risk parameters and I think does not create systemic risk.

Okay. Makes sense. Just to close out with a couple of questions. Switching to the rewards and benefits platform a little bit. You just announced an interesting deal with Caesars Casino Rewards to provide crypto access to their loyalty customers, and you've announced in the past similar programs with other well-known brands as well. So can you talk about this particular partnership? And when do you expect the crypto activation to go live?

Yes, sure. I'll take that one. So we're really excited about our partnership with Caesars Entertainment. This has been a conversation we've been having for them -- with them for a while. And the strategic alliance we have will enable Caesars' customers to have access to back crypto rewards, allowing them to redeem crypto rewards points -- I'm sorry, Caesars Rewards points for cryptocurrency. But in addition, we are and we'll continue to collaborate with and are working with Caesars on several other crypto use cases jointly over time. And look, despite the current environment, this partnership really demonstrates that companies are still thinking about how crypto fits into their business model. We believe crypto is not going anywhere, and we're going to continue to see businesses invest in these kind of capabilities. And this really was a natural fit, both Bakkt and Caesars are at the cutting edge of innovation and customer engagement. And from day 1, we felt really good symbiosis in our conversations with Caesars. So again, we're working on getting Caesars Rewards live. We're targeting this year -- later this year, but again, we're also working to build new offerings and other crypto solutions to Caesars customers down the line as well. And again, there's a real natural fit here. Our data shows, for example, sports betters have 2x favorable opinion of Bitcoin in the general population. 66% of Caesars Sportsbook users have interacted with Bitcoin in the last year, and so we're expecting to activate this later this year. And again, this is really just the beginning of what we think will be a multiyear, very fruitful, ongoing partnership with Caesars.

Interesting. Okay. And I mean just thinking about the space and are there any other industries where you think Bakkt's underpenetrated in terms of having your rewards platform in place and offering these crypto rewards like you with Caesars and some of your other partnerships?

Yes. I mean, look, we -- we're having ongoing conversations across in multiple industry verticals around crypto rewards. So whether that's quick service restaurants, whether that's nonfinancial services brands like Caesars, whether that's with financial services companies looking for ways to revamp their rewards programs. I mean some of these rewards programs have been around for decades, and we've got some studies that show the younger population don't see them as relevant for them as perhaps the generation before them. So there's a -- look, I think as regulatory clarity comes to the space, we'll see even more places where crypto rewards can come to life across multiple industry verticals. I almost feel like the -- it's almost limitless in some ways, but again, there are some areas where we've got some initial traction and ongoing conversations.

Okay. Great. I want to take a couple more minutes, a few questions from the audience. We'll leave most of those alone, but a couple -- and kind of on the regulatory front that I think are interesting. So just in terms of Apex one of the reasons for the acquisition was to expedite some of the new offerings like staking and the SEC recently had an action against Coinbase against their staking platform. So the question is just, does this change your views at all on some of the Apex capabilities and what you're going to try to roll out with Apex?

I think we've certainly taken note of the enforcement actions that have come up recently that do involve staking. We've -- I think as a general matter, we have long been pretty conservative about the way that we run the business in terms of the coins that we offer and the other services that we offer. So in some ways, it doesn't really change much in that we're still triangulating the way that we would offer staking, which would be a way that we're confident is compliant with existing guidance. So again, it's a little iterative. One of the realities of regulation by enforcement is that slowly defines the things that you can't do rather than give you a clear path for the things that you can. And so obviously, we're taking those new actions into account along with the details of the stacking programs that have come under scrutiny as we think about how we would launch our own solution.

Okay. Great. And just one more, just on engagement with the SEC, and question is, the Bakkt seems to have productive conversations with the SEC and other platforms, whether it's DeFi or less-regulated platforms, that difficulties having discussions with the SEC. So can you just comment on your discussions with the SEC? Do you think we're moving towards broad solutions for user -- for crypto usage, especially in the U.S., where we're seeing a lot of kind of regulation move overseas? Like do you think, in the U.S., we're going to see regulations soon where a lot of this kind of -- instead of moving to overseas regulation kind of following the path that's going on over there.

I certainly hope that we do. I don't want to predict the timing of how fast Congress will move on anything, but I do think that. And we've highlighted these themes as part of the meetings that we have regularly on Capitol Hill and with regulatory agencies, right, which is, number one, I think enforcement is an important part of a regulatory framework without question. It's not the only part. And so -- and along with bringing the sort of perceived bad guys to justice, a well-developed regulatory framework also provides guidelines for the good guys who want to follow the rules and want to do things the right way and gives them an avenue to really conduct their business in a transparent way. That's the piece here where I think, I think frankly, we could make some strides as a nation. And as you point out, some of this activity has moved overseas and will continue to move overseas, which candidly, I think, is a bad answer for the country. Leaving aside this company and obviously, we're in it for profit as well, but I think from a broader perspective, I think you can see with platforms like FTX that moving this activity -- ignoring this activity is not a solution. It will move elsewhere. It may move to places that are lightly regulated or not regulated at all And then when U.S. consumers engage with those platforms as they still can, then they're injured, lose their funds, et cetera. And so we believe at least that there is a better answer than that, and it ought to come in the way of increased clarity on the regulatory front. That could come from the regulators, that could come from Congress. It could come from both. And certainly, we think that as a practical matter, that will really benefit the space and will really help to restore a lot of the avenues of growth that we've previously seen.

Okay. Great. And we'll just do one more because you guys have discussed this previously. Is the Bakkt-Apex roadmap in the U.S. exclusively? Or do you plan to spend to other geographies as well?

Yes. And I can take that one. I think one of the things that we're excited about with the Apex client roster is that there's a lot of clients with an international presence. So we look forward to working with these clients, and there is a lot of interest in expanding internationally, and we're very excited as to be a part of it.

Great. Well, I think we can end it there. That was a ton of information. And I think it really kind of tells a really interesting story and particularly, in the space that we're particularly bullish on. And we think that Bakkt is in a good position to take advantage of kind of the change here that's happening and the growth in the sector. So Marc, Mark, Karen, I appreciate the time, and we'll talk soon.

All right. Thanks, Andrew.

Thank you.