Nasdaq, Inc. (NDAQ) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the AxiomSL Ratable Revenue Recognition Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ato Garrett, SVP, Investor Relations Officer. Please go ahead.

Good morning, everyone, and thank you for joining us today to discuss the change to AxiomSL on-prem subscription revenue recognition to ratable. On the line is Sarah Youngwood, our Chief Financial Officer; and Matt Moon, AVP, Investor Relations. After prepared remarks, we will open the line for Q&A. The press release and presentation accompanying this call can be found on our Investor Relations website. I'd like to remind you that we are making forward-looking statements on this call that involve risks. A summary of these risks [ is ] contained in our press release and a more complete description in our annual report on Form 10-K. Also, please note that we will discuss our financial results on a pro forma basis and with year-over-year growth rates, which means that we are showing results versus the prior period as if we own the Calypso and AxiomSL for all of 2023, excluding the impact of FX as well as the $34 million non-GAAP adjustment that will be made to our third quarter results related to this change and to be described in greater detail later in this call. References to organic growth exclude the impact of FX, acquisitions and divestitures. And with that, I will now turn the call over to Sarah.

Thank you, Ato, and thank you all for joining us this morning. Before we kick off our teach-in, I would like to acknowledge, joining us today regarding the leadership transition at financial crime management technology. This is an extraordinary business. I am super happy with the succession planning that we had in place, and I look forward to continuing to partner with Jeremy and Stephanie. With that, today, we're confirming a change in how NASDAQ recognizes on-prem subscription revenue for AxiomSL. Importantly, the financial impact of this change are consistent with what we had previously described in our second quarter earnings call. Let's start on Slide 3. We finalized the business combination accounting for Adenza during the measurement project, and NASDAQ is changing its methodology for AxiomSL on-prem software contracts to ratable. The change reflects the frequent and ongoing mandatory update of its regulatory reporting software, which are critical to the utility and value of the product for the client. Now that will recognize 100% of AxiomSL on-prem subscription revenue ratably, that is evenly over the contract term whereas Adenza had previously recognized approximately 50% of AxiomSL's total contract revenue upfront and the remainder over the contract term. As we mentioned in the second quarter call, the updated revenue recognition enhances our financial reporting and will not change the Adenza medium-term growth outlook nor our ability to achieve it this year. Subscription revenue will now more closely align with the ARR and cash economics of AxiomSL on-prem subscription contracts. This changes began in the third quarter of 2024. Looking ahead to 3Q '24 results, NASDAQ will [ return ] a onetime noncash GAAP revenue reduction of $32 million. This adjustment reflects the net impact of the accounting change on AxiomSL revenue since November 1, 2023, when we closed the acquisition. The $32 million net decrease consists of the following: A $34 million decrease related to the November and December 2023 period, which will be excluded from our non-GAAP 3Q '24 results. This is partially offset by a $2 million increase related to the January through June 2024 period, which reflects a year-to-date cumulative adjustment. As a reminder, AxiomSL revenues were more closely aligned with the ARR and cash economics of its on-prem subscription contracts, and these changes only relate to AxiomSL on-prem subscription revenues. There are no changes to professional services revenues, and therefore, changes in those growth rates will still contribute to the difference between ARR growth rate and total revenue growth rate. Additionally, there is no change to the revenue recognition for cloud-delivered AxiomSL license agreement, which is already recognized on a ratable basis over the contractor. Moving to Slide 5, which shows historical AxiomSL revenue by quarter under ratable. Let me start by saying that ARR, which is our most relevant metric, as well as cash flow do not change. As you can see, 2023 revenue is $28 million lower which represents $0.03 of EPS and 30 basis points of operating or EBITDA margin for 2023. 2Q '24 gross leverage remains unchanged at 3.9x. As we look ahead, in a growing business, if we keep the proportion of on-prem working the same and everything else equal, we would expect that the impact of the change each year with the lower revenue in immediate period upon signing a contract versus the prior accounting treatment, even though each contract will be neutral over the contract project. This is due to the spreading of the contract value over the multiyear life of the contract versus the prior year method, [ always looks to sign, like], 50% of the contract value upon signing and the fact that each year would have increasing amount of renewals. I now want to spend a moment discussing the impact of the change in 2Q '24. As you recall, AxiomSL had ARR growth of 14%. And we said that subscription revenue growth under ratable would be generally in line with ARR growth. Subscription revenue is ended at 14% in line with ARR growth. We have mentioned that in the prior year, subscription revenue growth will be partially offset by a year-over-year decline in professional services fees. This was due to the timing of bookings and upgrades as well as the proportion of cloud bookings. As a result, we communicated that revenue growth under ratable revenue recognition in the quarter would have been in the low to mid-single digits. And for 2Q '24, AxiomSL revenue growth under ratable is indeed up 4%. 1Q '24 had similar revenue trends with subscription revenue growth of 15% and 16% ARR growth. Again, partially offset by a decline in professional services fees due to the same factors. Moving to Slide 6 and looking at the remainder of 2024 on a pro forma basis. We continue to be pleased with the momentum of the business, both in terms of upsells and new clients. And we maintain our expectations for combined 2024 AxiomSL and Calypso ARR and revenue growth to be consistent with our medium-term growth of the range of mid-teens and low to mid-teens, respectively. With the change we expect regtech subscription revenue growth to be generally in line with ARR growth, that is stable with strong performance. However, negative view on new growth in AxiomSL professional services fees in 3Q '24 and full year 2024, will continue to have an impact on total regtech revenue. And we expect overall 2024 regtech revenue growth to be towards the low end of its medium-term revenue growth outlook of high single to low double digits with 2Q '24 being a trough and sequential improvement in year-over-year revenue growth in 3Q '24 and 4Q '24. The remaining subdivision and division board outlooks on both a medium-term basis and the comments provided regarding 2024 remain unchanged. Specifically, for capital market technology, our revenue growth expectation for the full year of 2024 remains unchanged from the [ outset ] we provided in 2Q, i.e., in line with our medium-term outlook of high single to low double digits. We also added on the second quarter call that overall, for the second half of 2024 we expect more normalized growth across the products within the division versus the first half of the year with consistent overall year-over-year growth rate across both quarters. This is an important point that I would like to [ supply ] for your model. Additionally, for financial client management tech, we continue to expect the business to deliver mid-20s revenue growth over the medium term. Moving to Slide 7. I will now share a few illustrative examples of how this all works in practice using a few educators to make the point. We compare revenue recognition and ARR for AxiomSL on-prem subscription contracts under the new methodology versus the old methodology. Assuming a deal with a $12 million total contract value or TCV and a 3-year term starting on January 1 of the first year, we would recognize $4 million of revenue in each year under the new methodology. Under the old methodology we will have recognized 50% of the TCV upfront on the [ project ], with the balance recognized over the contract life. So $8 million in year 1, consisting of the 50% or $6 million upfront versus $2 million recognized in the year, $2 million in year 2 and $2 million in year 3. However, under both methodologies, ARR remained unchanged at $4 million for each year. Although the change will reduce revenue growth volatility for AxiomSL, revenue and ARR growth may still divide for a few reasons, as outlined on Slide 8. Professional services, fees, which account for roughly 20% of combined AxiomSL and Calypso revenue can create a difference between total revenue growth and ARR growth, depending upon the number and quantum of upgrades implemented. We touched on this earlier in the presentation on Slide 5 when examining the actual performance for the first half of 2024. For the roughly 80% of revenue from subscription, growth can differ from ARR growth due to contractual rent and guaranteed uplift, booking linearity and contract exploration or client churn. Let's go to an example of how each factor would impact the base case example we discussed earlier with, again, a contract that has a TCV of $12 million and a 3-year term. On Slide 9, we consider the impact of the contractual ramp or guaranteed uplift of $250,000 per year. You can think of this simply as a $6 annual pricing increase. In this example, the client has built $3.75 million in year one, $4 million in year 2 and $4.25 million in year 3. The contract renews for 3 more years, in year 4 with $4.5 million invoiced that year, $4.75 million in year 5 and $5 million in year 6. ARR will track this amount billed in each year, which will also equal the cash flow in each year. However, revenue will be recognized evenly over the contract term, resulting in $4 million of revenue for each year of the initial contract and $4.75 million of revenue for each of the renewed contract. So ARR growth at a consistent $250,000 per annum, which is 5% to 7%, while revenue growth is 0 in year 2 and 3 and increases in the renewal year to 19% to then come in at 0% in years 5 and 6. Continuing with booking linearity or contract expiration churn on Slide 10. Starting with linearity. Let's assume that our $12 million contract with a 3-year term knocks out on December 30 of the first calendar year of the contract. In the first calendar year, even if the contracts starts at the very end of the year, ARR will be $4 million, while revenue would be close to 0. In the second calendar year of the deal, ARR would remain at $4 million, while revenue would be also $4 million. You can see that calendar year 2 revenue and ARR would also divert simply because of the timing of when the contract started. Moving to calendar year 3, revenue and ARR would remain at $4 million, respectively, reflecting 0 both for both in the year. In calendar year 4, however, we will see the impact of contract expiration. That is should the contract not renew at the end of the term for December 30 of the calendar year 4, revenue would accrue for pretty much the full year, amounting to approximately $4 million while ARR will be $0. You could see similar effects if the client churn meets contract. So once again, while ARR and AxiomSL revenue growth were more closely aligned under the new revenue recognition methodology. ARR and revenue may not align due to the growth rate of professional services fees that is inherently excluded from ARR, contractual rent and guaranteed uplift, booking linearity and contract expiration or client churn. Before we take your questions, I want to reiterate that this is a positive change for investors, which enhances our financial reporting, while more closely aligning subscription revenue with the ARR and cash economics. Taking a step back, we continue to see sustained momentum across our business as we execute on our 2024 priorities, integrate, innovate and accelerate. As our first and second quarter results have shown, we are achieving strong performance driven by our solutions businesses and the power of our diversified platform. Before opening up the line for questions, we would greatly appreciate it if you could keep your questions to this accounting change. And with that, I will open up the line to Q&A, and we look forward to seeing you at the Goldman Sachs Tech and Barclays conferences next week.

[Operator Instructions] Our first question comes from the line of Brian Bedell with Deutsche Bank.

This is really helpful. Maybe just on that churn rate for AxiomSL, how would you characterize that churn rate for the business currently and how it's been trending over time? And then maybe if I could just ask a second part on the professional services fees component as well, how volatile do you expect that to be?

There is really nothing notable to discuss on the churn. So I would just go with the comments that we've given you in the previous earnings calls, where we are seeing that those are businesses that are in very, very good shape from that point of view. And in terms of professional services fees for AxiomSL, that is a topic that we had raised in the second quarter earnings call. It's the same factors. You've got really the -- some lumpiness, and that's the general item for professional services by definition. They are always more lumpy. But here, you have some timing that just related to the timing of booking, some of the timing that's related to upgrades. And then you have a continuous path towards cloud, which, in general, when you don't have a customizable [ card ] platform, which is a good thing, actually, like AxiomSL, that actually means that the more you go towards cloud bookings, the less professional services fees you have and the more subscription revenues you have.

So on that 20% contribution from professional services, do you see that going down over time if you're building the book of cloud-based software? Or do you expect that to be more like a normalized rate?

For now, that's a good rate. So that's still a very good approximation. And if that -- it is possible that in extreme, if you had 100% AxiomSL cloud, which we're not about to be at, you would certainly have less professional services fees, but that's something that's not going to happen overnight.

[Operator Instructions] Our next question comes from the line of Michael Cyprys with Morgan Stanley.

Just wanted to come back to Page 6 where you mentioned the regtech revenue guide to trend towards the lower end of the medium-term guide for 2024. I believe that's because of the negative growth you called out on the professional services fees on a year-on-year basis. But if you were to apply this accounting change to the historical period a year ago and '23, understandingly you did not own the business for most of '23, just curious how that growth rate would compare.

So if you look at it on -- in regtech for the year before, you would have been in the medium-term outlook. Also, so you would have gone from being really at a very high end to being more squarely in it. So you still would have seen the subscription revenue that would have been in line with the ARR, and we -- so that's a mid-teens ARR so that would have been a subscription revenue and you would have had professional services fees that would have been almost flat and that would have basically pulled it down a bit.

Great. And then just a follow-up question. Just curious, what's the scope for implementing this change for the Calypso business, either in the near term or even over the longer term? Just curious how you're thinking about that.

Yes. So when you think about the Calypso business versus the AxiomSL business, one of the difference is really how frequent the regulatory updates are. So AxiomSL is a regulatory tech business as its name is putting it. And we get thousands, literally thousands of regulatory updates. And even the rail that transfer the information to the regulator are being updated fairly frequently in different regions. And so there is literally no value to the software without the update, and therefore, we are moving that to ratable because you can't really recognize what's valuable upfront because it is not valuable upfront. It's valuable over time as we provide the update. Calypso, at this point, in terms of like product has some value in terms of life of the software itself if you didn't do as many upgrades and the pace of upgrades is not as much. So products can always change over time, and we're a business that evolves our products for clients. But with the current product, Calypso continues to be an upfront recognition type of software.

Is there a day where that could evolve for Calypso's business? Is that something that you see in the range -- realm of possibilities over the longer term? Or not really?

So if you think of it in the short term, I would say no. In the longer term, it's a possibility that as the pace of change increases and how the product becomes more integrated between the software and upgrades and the pace of which, the upgrades, could change. You could see a change, but we're not talking about something that we expect at this point in the short term.

Our next question comes from the line of Michael Cho with JPMorgan.

I just had a follow-up to one of the -- I guess, the scenarios that you laid out, Sarah. I mean, I guess, just in general, for the renewals, I think maybe in Slide 9 in that scenario, you talked about how revenue uplift can happen in -- at the end of the contract, if there is a renewal and some price increase. So I guess, just in general, with the Axiom contracts, like, is there a typical annual inflator in terms of pricing when we think about kind of typical contracts for these -- for the Axiom clients?

Yes. So if you go back to our revenue growth formula for AxiomSL and Calypso combined, we say to usually think about it as you're going to have half of our revenue growth coming from the upsells and then the other half coming from the TPI or pricing increases as well as from the new logos. So since you have that, you could say the upsells as well as the pricing increase is becoming part of the -- what you put in at renewal. And so this is illustrative in terms of what the numbers are. But the point that I wanted to make in that example is that because of how you recognize the contract, you've got a $4 million per year for 3 years, $12 million. And then it jumps to $475 million since it's always the average of the 3 years versus in real cash flow in real life, in real ARR, it's very gradual because in this case, as an example, it's $3.75 million, $4 million, $4.25 million, $4.50 million, $4.75 million, $5 million. And so it was really to show that you could still see some minor differences. And so we're not talking about the type of differences that we had with the 50% upfront recognition. But I wanted to be sensitive to the fact that if you have enough of those differences, you could see 1 or 2 percentage points of ARR difference, and I'm not, like, calibrating it, but -- and it could also be 0 difference as it was, for example, 14% in the second quarter.

Okay. Great. And then just a quick -- I don't know if there's a way to read in this or categorize this, but when we think -- you've talked about some seasonality, maybe it's, like, 4Q seasonality with professional services with Axiom in the past. But in general, when we think about renewals of these contracts, going forward, for Axiom, I mean are there any kind of seasonality kind of considerations that we should just have in mind going forward in terms of quarterly seasonality for any of these contract renewals as an aggregate for AxiomSL?

Yes. So the timing of our bookings is not going to change. So you continue to have a lot of the bookings that happen in the last quarter. That is going to have much less of an impact under a ratable than subscription - than upfront treatment, but you will still have a little bit of seasonality in the fourth quarter versus what you had before, but less so than what you had before.

And I'm currently showing no further questions at this time. I'd now like to turn the call back over to the CFO, Sarah Youngwood, for closing remarks.

We really appreciate you taking the time to be with us today. And we've got a good program of conferences and [indiscernible] for next year and for next week, actually. So we'll continue to see you a bunch. Thanks. Bye-bye.

This concludes today's conference call. Thank you for your participation. You may now disconnect.