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

Welcome to today's fireside chat with Bakkt. I'm John Roy, your host. I work for Water Tower Research, and I cover technology here. So today, I'm joined by Gavin Michael, CEO; and Karen Alexander, CFO of Bakkt. I should mention that Bakkt's safe harbor statement is on their website, if you would like to see it. So with that, I'm so glad to speak to you -- speaking with you both again. How are you doing?

We're doing well.

We're very well, John. Yes. Great to be back. Thank you very much.

Thanks for joining us again. So maybe you could give us what are the key strategic highlights that came out of the earnings call for the second quarter.

So let me take that one. I think at the beginning of the year, we had a set of strategic highlights for -- and focus areas for the company. And I think as we've gone through Q2, you can see that we're making strong progress, again, executing on those key priorities. We've expanded our platform through the acquisition of Apex Crypto, we're activating and broadening the client network. And we're being prudent with our capital allocation. We're seeing strong traction with new custody and crypto trading clients. We're building new strategic alliances with some very prominent players as our capabilities and best-in-class infrastructure just continues to resonate strongly in the market. I'm excited that we're expanding into international markets alongside our clients with Latin America expected to launch in the fourth quarter and other markets like the U.K., European Union, Hong Kong and Australia to follow. And we're focused on delivering solid results for our existing loyalty clients as we work together to grow their transaction volume. And then I think the last point is that we continue to manage our expenses. We're seeing improved gross profit margins. And as part of our Q2 update, we updated our full year operating cash flow outlook to improve approximately 20% from where we started at the beginning of the year. So I think when you look at the company's performance through the second quarter, you can see that progress. But importantly, you can see our focus as well. We laid out a set of priorities at the beginning of the year, we continue to deliver against those priorities, and we're excited by the progress that we've made through this last quarter.

That sounds good. So speaking of performance, maybe you can give us an overview of the financial performance of the quarter. So like what were some of the positives. And can you improve from here?

John, I'm happy to take that one. So obviously, one of the things I was most excited about was to be able to report Apex Crypto in our results for the first time. We closed that transaction on April 1. And if you look at that performance and think back to what happened in the second quarter, it was a tough quarter for the market. So the market in general was down on a crypto-trading volume, about 40%, but we outperformed the market. So we were down 25%. So it's obviously -- it's never great to be down, but we look at where we were relative to market performance, and I think that showed the durability and some of the things that are unique about the customers that we acquired through the acquisition and the fact that they tend to be more resilient even through some of the trading costs. When you also yet look at the results, one of the things that we were also happy to report is the progress that we're making with operating expenses. As Gavin alluded to, you're starting to see real benefit from the discipline that we've put into place, and I think we were talking about for the past couple of quarters. SG&A is down 23% year-over-year. Comp and benefits is down 21%. So we're obviously focused on activating the partnerships that we've signed and signing new ones. And so when I think about, call it, room for improvement or things that we know the market expects from us, I think continuing to see those activations and then starting to really show our investors the proof points out of the opportunities that we have on the custody side are the things that we're going to continue to focus on delivery.

Great. Now you revised guidance. Hopefully, you can walk us through that. And where does that leave us on the cash position at the end of the year? Do you need to raise?

Yes. So yes, look, I'll walk you through them in pieces. So on the revenue side, you think about our business, the loyalty business, we expect to come in relatively consistent with 2022. The one thing if people though recall in the 2022 performance, that was a very strong transaction revenue year coming off of a post-COVID rebound. So the fact that the loyalty business continues to operate at that level is where we're seeing that net revenue expected to come in at the end of the year, let's call it roughly $55 million. The range that we provided for revenue really comes into the crypto side of our business. So the low end of the range, we're really looking at the market trading dynamics that we saw in the first half of '23. And assuming that those remain pretty steady throughout the remainder of the year, we are factoring in international expansion. As you heard us talk about last week and as Gavin just mentioned, with ibex and some of the opportunities that we have internationally, we expect to start seeing that in Q4. And then the range between the low end and the high end, really, the delta there is how quickly we can ramp up international. So we see international as a great momentum maker into '24. And it's just going to be a matter of timing for the second half of the year in terms of what you'll see there. On the cash flow side, as Gavin mentioned, I was really happy to report that we are taking down our free cash flow utilization outlook. So I took it down by $10 million to $15 million, which is the 20%, that Gavin referenced. And what you really look at that -- when you look at that numbers, you're going to see second half free cash flow utilization down a good 70% to 80% compared to where we were in the first half of 2023. And then if you compare that to our cash position, we're going to -- at that rate, we'll end the year with approximately $80 million-ish of cash on our balance sheet. And so you think about where we are from a capital position perspective, you're going to continue to see the benefits from the cost cutting that we did earlier in the year. So even on the comp and ben, we're going to have another $7 million reduction in 2024, which is the full year effect of the decisions that we took earlier this year. And then you're seeing us continue to improve margins. So the -- we're absolutely still working for us being adjusted EBITDA breakeven by the end of 2024.

Great. Now when we take a look at the crypto transactions, I mean, the take rate there, maybe you can walk us through a little bit of that? And then what should we think about that rate going forward?

Yes. It's a great question. And obviously, when you look at our statement of operations, we've got some big numbers on there because as I mentioned last week on the call, we actually report crypto revenues -- crypto services revenue on a gross basis, and that's an accounting phenomenon because from an accounting perspective, we act as a principal in the services that we provide. And so if you think about the economics of crypto trading, you've got gross crypto revenues, which is basically the gross proceeds from the purchases and sales of crypto into -- back and forth into cash and coin. We typically have a spread on those of about 100 basis points. Then when you look at below the revenue line, you'll see a crypto cost line. That is really primarily the cost of providing the crypto -- basically net of the spread. And then it also includes some, for instance, blockchain fees and the like. But it's mostly the difference, that 100 basis points between the rate that we charge to the customer and the cost of fulfilling that trade. The line that you'll see after that at the segment operations is what we call execution, clearing and brokerage fees, which is a very long way of saying, this is the rev share that we give to our partners. As we've talked about a lot, we are a B2B2C model. So we're partnering with partners like Weibel, they are basically serving as our introducing broker. So we're giving them a share of that spread. When you do the math on all of that, you can either get in dollar terms or on basis point terms, the take rate, what drops out at the bottom line to us in terms of the contribution of those trading activities. Insofar the second quarter, it was about $1.3 million, which translates to about 38 bps. That amount, if you look historically at how Apex -- Apex' results looked over time, it's always been somewhere in that 30 to 40 bps range. It could change because every partner is different in terms of how we do the rev share, for instance. We have partners where we have a tiered structure, which we think works well for both of us because the more their customers trade as they go into higher tiers, the more rev share that they could take from us. So you could see a change over time depending on the -- what the partner wants to do in terms of the spreads that they charge and then what we do with rev share, but we have a pretty good track record of being in the, let's call it the mid- to upper 30 basis point range.

Great. That gives a good kind of clear picture on where you think things are headed. But let's talk about custody for a second. I got a couple of investors who have been asking me, why was it back to more in the Bitcoin ETFs. And maybe we could talk about the custody situation. Gavin any thoughts here?

I think, John, we've been fortunate that clients are proactively reaching out to us because there's this interest in the secure, trusted, institutional-grade custody platform that we've built. And honestly, the influx of client interest has been even more pronounced as we've seen the disruptive events in the crypto markets, which are really highlighting the difficulty in storing digital assets and importantly, the need for multi-custodian access. So whilst we're signing up new custody clients, and we're focused on using this momentum when we look at initiatives like the ETF products that are happening, we see that as just opening up the market for us. So I would say that many of the relationships that you've seen in those environments are ones that have been in market for a while. But the focus on this multi-custodial access and diversifying the custody relationship and us continuing to build on our custody solution with the ability to do private key backup is really giving us enormous opportunity in a wide range of client opportunities, including those that you mentioned.

Right. So custodies commoditizing there? It doesn't really sound like it. And maybe give us an idea of what the revenue and potential on costs look like?

Yes. Yes, I can definitely speak to that a bit. So if you think about custody just the core of what it is, it is a service, and it's really a backbone product where we earn fees as a percentage of assets under custody. Sometimes there's some minimums in there that give us a floor, but it's pretty straightforward ASA model. But to Gavin's point, and one of the things that we mentioned last week is we talk about our custody solutions, as solutions plural, it's not just taking and holding the assets, but we're really looking to expand those services. So we've already been talking about the OpEx solutions that we're providing, disaster recovery, the future road map that we have to start supporting more assets and things like institutional staking and open loop. What that does over time is that really diversifies the revenue profile because you're going to have a mix of revenue that's based on assets under custody. You're going to have some that are based on a platform or fixed fee structure. So I think disaster recovery is one of those examples. And when you compare that to what we've built so far, we've built a lot of this infrastructure already. And we've got a team, a development team that we feel size now not only to complete the near-term road map but also to add these features over time. So we don't see our fixed -- we don't see our cost going up on a variable basis, like the incremental variable costs for bringing in, for instance, a new custody customer is minimal. You're really going to see leverage as we add those custody customers to basically -- they could be serviced primarily out of our fixed cost base. And we feel like we've got the right tech team to continue to build out those capabilities without having to add incremental variable costs. So I think you're going to really see the -- yet again the leverage coming out of that part of the product and what we've built as it grows.

Great. And maybe we could transition just a hair to the new collaborations with Plaid and Fireblocks. So maybe you could walk us through a little bit more on the details on what those are and what that's really going to bring to back and maybe a little bit of color on revenue potential.

Yes. Sure, John. Look, these are great new strategic relationships for us. It's providing us with access to a strong pipeline of prospective clients who are already inside the Plaid and Fireblocks networks today. With plant, it's a bilateral referral agreement. We will be a Plaid crypto trading solution provider for their clients who are interested in providing crypto solutions to their end customers. They have an extensive network of over 8,000 sort of fintechs that utilize their platform today. And so the agreement provides us with a strong pipeline of prospects for our crypto solutions, and it's bilateral in that whilst Plaid are referring customers to us for crypto, we'll also take advantage of their infrastructure to be able to refer clients of ours. We're looking for access to Plaid's extensive set of services, and we would then refer them on to Plaid. So we like this in that it is a bilateral agreement. With Fireblocks, it's a multifaceted agreement. We're going to provide disaster recovery services to Fireblocks' off-exchange customers. We'll also join Fireblocks qualified custodian network. So the way to think about it is with our relationship, every off-exchange customer will require a disaster recovery package. So again, tremendous opportunity for us in safeguarding these assets. And Fireblocks network has thousands of institutions using it daily. So it provides us, again, access to a strong pipeline of prospective clients. So these partnerships are really designed to expand our client base, expand our volumes and bring to us a set of targeted opportunities where there's interest in the assets and capabilities that we offer, whether that be our trading platform or our secured custody platform.

Great. It's just like some good collaborations coming forward here. So maybe we could talk about, obviously, Apex Crypto just closed, and it did do a lot of things -- good things for you guys this quarter. Maybe you could give us a view into what you think are the biggest revenue opportunities going forward.

Yes. I think what Apex Crypto gave us was capability to an advanced trading platform that covered well with our secured custody environment, together with our Fiat onramps. So what we announced last week is this continued expansion of our crypto trading clients and mostly in the fintech industry, and this isn't a direct result of the acquisition of Apex Crypto. We signed on new clients and we're engaged in a set of late-stage negotiations with an additional number of prospects. We're also making solid progress on the international expansion. We are actively working with the client base to execute a go-to-market strategy in markets with regulatory clarity. And again, our entry into those markets is through clients that already have an existing presence there, partners of ours who are seeing the regulatory clarity as providing them with an environment where there's a changing consumer sentiment that -- the positive sentiment that they want to take advantage of. So when we look at growth and look at the opportunities to continue to drive growth in the fintech and neobank space, we've demonstrated the ability to continue to capture more share. We're excited by the potential of that, both here in the U.S. but also growing internationally. And they're a direct result of the Apex acquisition.

Great. Well, when kind of when rubber meets the road here, can you give us a little bit of your view on the pipeline and where you are seeing transaction in signing new clients.

We're seeing traction in this new client activity. When we think about custody, for example, custody is really working well with prospects and sort of mining family offices, registered investment advisers and corporate treasury functions as well. The qualified sales opportunities for custody are up 10x compared to the first half -- in the first half of '23 compared to the second half of '22. So great momentum in establishing a pipeline of strong custody relationships. And as Karen mentioned, it's a great anchor product. It gives us a strong base from which we can build other services. So we're excited by the way the pipeline is shaping up for custody. In trading, we obviously continue to see that growth in the U.S., again, in that neobank, fintech space, great traction. And with the added pipeline coming in from Plaid, we're excited by what's happening here in the U.S. But as I said earlier, the international growth is very strong. And we like the markets where we see that increased regulatory clarity, and we like the fact that a number of our existing partners are looking to expand their operations into those markets and are using crypto as part of that expansion program -- expansion proposition. So again, when we look at the pipeline, really happy and excited with the growth that we're seeing in custody, excited by what we've signed with Fireblocks as a way to give us greater access and greater depth. But the diversity of opportunity across mining and family offices, the RIAs and the corporate treasury functions is really giving us a solid base together with then the trading platform growing both here in the U.S. and then using that as an expansion proposition into those international markets.

Well, great. Well, I think we need to leave it here because we're running out of time today. Gavin, Karen, thank you so much for joining me today in today's fireside chat. And investors, if you'd like to learn more about Bakkt, please visit their website or you could look at our WTR research on Bakkt at watertowerresearch.com. And thank you, everyone for joining us today.

Thanks, John.

Thanks, John.

Thank you. So now the views expressed in this fireside chat may not be necessarily reflective of the views of Water Tower Research LLC and are provided for informational purposes only. This fireside chat may not be distributed or reproduced without the written consent of Water Tower Research and should not be considered research nor a recommendation. WTR is an Investor Relations firm, not a licensed broker, broker dealer, market maker, investment banker, underwriter or investment adviser. Additional disclaimers can be found at watertowerresearch.com. Have a great day.