OTC Markets Group (OTCQX:OTCM) Q3 2019 Results Earnings Conference Call November 6, 2019 8:30 AM ET

Company Participants

Dan Zinn – General Counsel

Cromwell Coulson – President and Chief Executive Officer

Bea Ordonez – Chief Financial Officer

Conference Call Participants

Chris McGinnis – Sidoti & Co

Andrew Mitchell – Edison Investment Research

Operator

Ladies and gentleman thank you for standing-by and welcome to the OTC Markets Group Third Quarter 2019 Earnings and Webcast Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator instructions]. Please be advised that today’s conference is being recorded. [Operator Instructions].

I would like to hand the conference over to your speaker today, Dan Zinn, General Counsel. Sir, please go ahead.

Dan Zinn

Thank you, operator. Good morning and welcome to the OTC Markets Group Third Quarter 2019 Earnings Conference Call. With me today are Cromwell Coulson, our President and Chief Executive Officer; and Bea Ordonez, our Chief Financial Officer. Today’s call will be accompanied by a slide presentation.

Our earnings press release and the presentation are each available on our website. Certain statements during this call and in our presentation may relate to future events or expectations, and as such, may constitute forward-looking statements. Actual results may differ materially from these forward-looking statements. Information concerning risks and uncertainties that may impact our actual results is contained in the Risk Factors section of our 2018 Annual Report, which is also available on our website.

For more information, please refer to the Safe Harbor statement on Slide 3 of the earnings presentation.

With that, I’d like to turn the call over to Cromwell Coulson.

Cromwell Coulson

Thank you, Dan. Good morning, and thank you everyone for joining the call. In the third quarter, we continued to grow our revenues across all our business lines. Bea will cover our financial results in greater detail in a few moments. Briefly, I would like to highlight that our third quarter results saw a 7% top-line revenue growth with operating income down 11%, due in large part to our investment in staff and the impact of increases in IT and occupancy costs. We completed the refresh of our primary and backup data centers, which was the second of our two large capital investment projects for 2019. I’m especially proud that our engineering teams executed this complex infrastructure upgrade ahead of schedule, while delivering 100% uptime of our core OTC Link ATS systems during regular market hours.

This is after a busy first half of the year, consumed with our other large projects we completed, moving our headquarters to 300 Vesey Street. Dedication to system reliability is an integral part of our firm’s culture. To thrive in the regulatory environment in which we operate and to better serve our subscribers’ needs in the future, we must continue to enhance our functionality while sustaining the culture of compliance and reliability. To stay competitive over the long-term, our engineering teams must always seek to proactively build a better technology platform.

This quarter, we successfully posted a number of investor conferences company bell ringing ceremonies and industry events at our new offices. We are expanding the use of our headquarters for a future that is online, data-driven and social. Our Virtual Investor Conferences business leverage the enhanced audio and digital tools around this space, allowing us to deliver cutting-edge technology that connects companies and investors. Our modern multiuse space in New York City’s financial district is well on its way to becoming a center of our community, as well as a studio to create dynamic multimedia that can easily be shared online.

Building our OTCQX and OTCQB premium services allow companies to succeed in our markets without the wait of a national exchange listing. While we had 14 companies graduate from our markets to a national securities exchange listing during the third quarter, this marked 39 such graduates through the first three quarters of 2019. I want to be clear tough our goal is to build a longer runway for public companies in our role as the world’s most successful venture market that allows them to grow larger on our markets.

We also use the third quarter and the start of the fourth quarter to lay the groundwork for several key initiatives that will drive our business forward in the coming years. Just last week, we announced a strategic alliance that will provide companies with access to the North Capital Investments Technology platform, which can enable cost effective, online capital raising, using expanded Jobs Act Exempt offerings. This initial foray into helping companies attract capital reflects industry trends indicating that raising growth capital has moved to the private markets. The key roles of public markets are to provide secondary trading to seasoned shares, and as equally importance, the ongoing trend, business transparency and market discipline the sustainable companies required to be successful over the long-term.

Many of our core ideas for building better public markets are outlined in the comments we recently provided to the SEC’s concept release on harmonization of securities offering exemptions in September. Our comments discussed our perspective on modernizing regulations. These improvements to the capital markets would support small company capital formation, fix the behind the scenes aspects of share issuers and public trading, enhance the disclosure required of company inspires affiliates and other powerful market participants when they’re buying or selling.

We look forward to working with the SEC as they consider taking action in these vital areas.

In addition to the concept release on Harmonization of exempt securities offerings, in September, the commission proposed amendment to Exchange Act Rule 15c2-11. This rule governed the publication of quotes on systems such as OTC Link ATS. To put proposed amendments to rule 2-11 will attract many perspectives to have the potential to greatly impact all aspects of our public markets, from companies to our broker dealer subscribers to investors.

The proposed amendments to Rule 15c2-11would require among other things that current information about a company be publicly available in order for that company to become or remain the subject of publicly — of public market maker quotes. The proposal recognizes our disclosure standards for OTCQX, OTCQB and current information companies, and will allow brokers and others to rely on our designations to determine whether these companies are eligible to be quoted by market makers.

The proposal would also allow our OTC Link ATS to initiate quotation in these companies on its own. There are a number of other critical elements to the SEC’s proposal that need to be addressed and additional complexities that must be worked through. A key challenge is how to safely handle trading in shares of dark or distressed companies, this balances protection for mainstream investors, efficient trading for professional investors and the property rights of minority investors.

Since the SEC staff asked over a 130 questions in that proposal, we believe they want to the roles, responsibilities and overall market efficiency right with this rule modernization. We of course intend to submit lengthy comments to provide our perspective regarding the impact of the proposal on investors and market efficiency. Improve the workability of the regulations and address the areas in which additional guidance from the SEC or FINRA is required to allow any resulting rule to work in practice. Outside of the SEC’s current rulemaking concept releases, we remain focused on gaining regulatory recognition for our OTCQX and OTCQB markets.

At the state level, we continue working with NAFTA and individual state regulators towards our goal of achieving nationwide blue sky exemptions. Securities on OTCQX market are exempt in 36 states, with OTCQB securities exempt in 33.

At the Federal level we are actively engaged with members of Congress on legislative solutions that would allow qualified OTCQX and OTCQB companies to gain margin eligibility and more efficiently offer employee stock ownership plans. In September, we traveled to Washington D.C. with members of the OTCQX Advisory Council to meet with lawmakers and discuss these important issues impacting small public companies in the United States.

Finally, I’m pleased to announce that, on October 4th, our Board of Directors declared a special divestiture of $0.65 per share and a quarterly dividend of $0.15 per share, each payable December. These dividends reflect our ongoing commitment to provide superior shareholder returns.

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

Bea Ordonez

Thank you, Cromwell and thank you all for joining the call. I will now spend a few minutes reviewing our results for the third quarter of 2019. Any reference made to prior period comparatives refers the third quarter of 2018. For the third quarter of 2019, OTC Markets Group generated $15.8 million in gross revenue, up 7%, with all three of our business lines delivering quarter-over-quarter growth. Our Corporate Services revenues were up 8%. Revenues from our OTCQX market were up 16% in line with the high number of companies on the market.

Strong sales in 2018 and for the year-to-date, together with an uptick in our 2019 renewal rate from 91% to 94%, all contributed to an increase in the number of companies on the market. The number of companies on our OTCQB market has trended down slightly. Year-to-date, we have seen a decline in the number of companies joining the market, with 159 new sales during the nine months ended September 30, 2019, down from 198 new sales. On a year-over-year basis, our renewal rate has remained constant at roughly 94%, while compliance related downgrades have also remained largely consistent.

Notwithstanding the slight contraction in a number of OTCQB companies, the full period impact of price increases introduced for renewing customers for 2018 drove a 4% increase in related revenues. Market Data Licensing revenues were up 6%. New sales of our Data File products, particularly our suite of Compliance product drove a 19% increase in related revenues.

On a year-to-date basis we’ve seen 15 new uses of our premium Compliance Analytics product. Our suits of Compliance products are now integral to the processes of almost every major bank, broker dealer and clearing firm that is active in the OTC space. We also saw a 15% increase in revenues from broker dealer enterprise licenses, a factor of new sales in the second quarter. Following our acquisition of Qaravan we have continued to focus our assets on integrating Qaravan’s data products and on developing a strong pipeline of potential subscribers.

In October we made quarterly bank call report data available on our OTC Markets’ website and during the third quarter, we closed four sales of our Qaravan Pro service and three sales of our CECL which we launched in May of this year. OTC Link revenues were up 6%. Revenues from our OTC Link ECN were up 49%, and was a primary driver of the increase. Our OTC Link ECN continues to gain traction. And as we on-board new subscribers, we hope to continue to grow revenues from this offering.

During the third quarter operating expenses increased 17%. The primary driver was a 15% increase in our compensation costs, which make up roughly 64% of our total expense base. Our headcount has increased from 89 as of September 30, 2018 to 101 as of September 30, 2019. This includes highest made pursuant to our acquisitions of the Qaravan and the Virtual Investor Conference businesses, hires in London and New York to expand our sales efforts and additional hires to support our product development efforts. On our quarter-over-quarter basis our IT cost increased 20%. Increased support costs related to our 2019 acquisitions drove some of this increase.

In the context of our continued obligations under regulation SCI, we also saw an increase in spend related to system security and reliability initiatives. During the third quarter we completed necessary upgrades and enhancements to the infrastructure of our data centers, requiring a total capital investment of roughly $700,000. In the second quarter, we incurred $104,000 in one-time operating costs related to this effort. The project as we noted was completed ahead of schedule and our fourth quarter data center costs will return to run rate levels.

For the third quarter income from operations was down 11% while net income was down 8% with a decrease in the company’s effective tax rate for the quarter partially offsetting the contraction in operating income. Cash flows from operating entities for the third quarter were up 5%. We ended the quarter with 26 million of cash on hand, a strong balance sheet with no debt and benefit of a subscription-based revenue model, which generates predictable recurring cash flows. We continue to operate and invest to focused capital allocation policy which returns cash in the form of dividends and through stop buybacks.

Year-to-date we’ve returned 6.6 million, up 10% over the prior year-to-date. We were pleased to announce our 44th consecutive quarterly dividend and our 8th consecutive special dividend. In closing during 2019 we’ve made some significant investments in the people needed to drive sales and better serve our subscriber base, in technology enabled products that can generate future revenue growth, and in the facilities and infrastructure that will allow us to continue to deliver reliable and cost effective technology solutions.

With that, I would like to thank everyone for their time and pass it back to the operator to open up the line for question.

Question-And-Answer Session

Operator

[Operator Instructions] And it looks like our first question comes from the line of Chris McGinnis with Sidoti & Company.

Chris McGinnis

If you could just start around the announcement of the alliance with North Capital, could you just maybe talked about, the opportunity there, how competitive that marketplace is and maybe why you selected to go in North Capital?

Bea Ordonez

Thanks for your question, Chris. Look, we — and Cromwell mentioned some of this in his talking points, we see a longer term trend, which is one of decline in the number of IPOs, from the high of say the late 1990s. And we spoke about the reasons alone, and then many fold. And we see a lot of media coverage around this, the increasing complexity of being public, the rising cost of going and being public, and really the ready availability of private capital. But really, when you look at that complexity and that cost, we look at some of the data that is produced, and recent survey showed that companies, they stratify it based on revenue. But if we look at companies with less than $100 million in revenues, one-time cost to go public averaged around $3.1 million, while the ongoing cost approached close to $2 million a year.

So, in that context, what we see is that the traditional public offerings, just really don’t serve the needs of small venture staged companies all that well, and those companies are the ones that really need capital to grow their businesses.

So, we’re seeing online capital raising tools beginning to take hold, I think we’ll continue to see those online tools gain traction. And the market here is large and reading that SEC concept release around the harmonization of Exempt Offerings, the amount of money raised in 2018 through those offerings was about 2.9 trillion and we compare that against the roughly 1.5 trillion that was raised in the public market. So what we really see here is companies raising more capital privately, availing themselves with those technology and those tools, it’s a very large addressable market. Yes, there are many players in this market but what we’re really looking for and what we were really looking for through this alliance is a technology platform that is out of the box, that is cost effective, that is fit for purpose for small and venture staged companies, and that can really integrate very smoothly, both with our own website so that we can sort of drive traffic, take advantage of the millions of page views that we see on our website, and drive potential investors who might be interested, and can also integrate with that company’s website.

And through that technology issuers can avail themselves a jobs act reggae type offerings, private offerings, and really managing a very seamless technology enabled way, all the aspects of the offerings, from compliance through to tracking and so on. So, look, again, from our perspective, it’s a super interesting space. It’s growing, it’s very relevant to the issues that we said, and we’re looking to solve it in the way that we try and solve other problems by serving up with technology solution at a cost effective price.

Chris McGinnis

I appreciate that color, and just touching on obviously 2019 is a year investment. Are we at a point I guess in Q4 you maybe have started to lapse in some of those investments and do expect operating leverage start to come back into the network or at this point as you start to get towards the end of the year maybe there is more room investment kind of given the success that you’ve had on the top-line?

Bea Ordonez

Look as we said, Chris, this has been a year of investment. We added hires and we did so sort of fairly early in the year, a lot of those hires came on-board in January. We made those investments we talked about in our infrastructure, in our new headquarters and so on. We talked a little bit in the first quarter and also in the subsequent quarters about some of those one-time cost that we incurred related to those efforts. I mean, all told, year-to-date there is probably close to 700,000 in one-time non-recurring costs related to our move, related to our data center refresh.

As we look out into 2020, we don’t have significant hiring plans certainly outside of any potential acquisitions, but of course we evaluate our means on an ongoing basis. And as Cromwell noted, we ensure that we are well position to continue to deliver a 100% uptime, it’s critical to our mission and to make investments that we have to grow for the long-term. So, yes, I would hope and expect that we will start to see a little bit of advantage from that operating leverage in 2020 and beyond.

But really what we’re headed to do it, is to run the business for the long-term to invest prudently in areas where we think we can drive sales, drive growth, drive revenue, increase sort of efficiency and so on, and really to continue to do what we have always done in that context.

Operator

Thank you. [Operator Instructions]. Our next question comes from the line of Andrew Mitchell with Edison. Your line is open. Please go ahead.

Andrew Mitchell

Just first off on, if you can explain perhaps a bit more about the potential implications of that consultation on Rule 15c2-11, does that loosen-up or that push more companies into your high tiers of markets?

Dan Zinn

Sure. This is Dan and I’ll kind of give some background on it from a legal perspective and I think Cromwell may jump in from the business side as well. That 15c2-11 is a rule we work with for years and that really is the gateway to a company becoming public on markets, and broker dealer has to have certain information to file a form with FINRA in order to be able to publish a quote with that, and so any changes to that rule clearly is going to have a big impact on the way our operates and the way our broker dealer subscribers interact with us. One of those potential results I think is exactly what you mentioned, which is and a greater incentive for companies who want to be part of our higher tiers want to disclose more of those that are — maybe have limited information or no information now seeking to move up so that they can remain the subject of market maker quotations and have that liquidity option for their investors. They are also aspects of the rule that give us a greater control over a qualifying companies, it has incurred information from a regulatory perspective, and so we’re happy to see the SEC recognizing our disclosure standards and all the work that we do on the issuer compliance side to go through and review company and now allowing the rest of the industry really to rely on our determination because of the fact that we’ve developed to this point.

On the other side of that, of course, other companies that are not going to be able to meet the standard and that it may no longer be able to be the subject of market maker quotes on our market and we are developing solutions something we call the Expert Market to be able to address some of those needs for professional investors, while still giving effect to the SEC’s real philosophical goal here, which is the protection of the retail investors. So there are a lot of implications, I could probably answer this for 45 minutes, but I will cut it off there. And you will hear more about this from us as time goes on, the rule now is just in a proposal phase. And as we move into finagling our comment letter and then seeing what the SEC does as a result of our comments and others, we will continue to update everyone on our plans going forward.

Cromwell Coulson

And so Andrew we view the high level positively of the ability for the interdealer quotation system to be really driving the public disclosure of companies, we feel we’re much better addition than previous rule proposals. The second part is we completely agree philosophically with the SEC that if you’ve got a publicly traded security you should be making current information available or we should have some type of restrictions on mainstream investors being able to purchase those securities. And we also believe insiders, affiliates control persons should not be able to buy or sell securities if they are not making current information publicly available. And we probably believe that stronger than this proposal has shown and the hard part is, as we get into the practice there’s a lot of different players in this market, there’s a lot of different ways that things come through as the SEC talks about gatekeepers, we really want to talk about roles and gates.

And we want to have the entities who are closest to or can control a gate, be the ones who are responsible. So that’s going to be a lot of long discussions with the SEC. And we’re hopeful that we can craft a rule that really modernizes our markets going forward to be more competitive and better serve small companies, investors and our broker-dealer compliance.

Andrew Mitchell

And just — probably two. If I just think — thinking about this, but what I’d in relation be thinking of those that would be sort of perhaps sectioned off into an Expert Market or might not have trading available? Those indicators from your business perspective would not be substantial contributors to revenues.

Cromwell Coulson

There’s some revenue we might move, there’s some revenues we can gain by delivering value to the market. I don’t, how we made our money last year or 10 years ago is really the horizons. We type of look at is like we want to deliver value going forward. Now what I would say is, and if you look at SEC comment file, initially it’s been a bunch of sophisticated professional investors who invest in darker distressed companies, who are very scared that the SEC may destroy their property rights. And what I would say about the companies that are either not making disclosure available or shale companies with lot of assets, there are not dangerous company for professional or sophisticated investors. They have the skill sets to look at these securities and price fairly. The danger comes to the mainstream investor who just buys without looking at valuations or financials. And that, so that side is I think a gating approach is very appropriate rather than a married approach which says, these things are all bad. We’re going to draw a line around this neighborhood we don’t like and make it not exist.

Andrew Mitchell

And then our next question was on another subject. You highlighted the number of additions of international companies. I was just wondering whether you can you are able to judge from a sort of pipeline of potential companies whether those efforts made over time to attract more than a still coming through. So it’s a potential there as promising seen what has been delivered in this quarter.

Bea Ordonez

Yes, no, I think that’s right. This has been a focus of ours for some time and will continue to be a focus for us, through the rest of the year into 2020 and beyond. So we have more than 600 international issues on OTCQX and OTCQB markets, and those include some very big names from Roche to Adidas to Heineken. We just recently added Hugo Boss, and looking at the market, it’s obviously vast, right, both in terms of currently listed companies and in terms of the 1,500 or so public company or companies that go public globally each year. And we offer a very compelling value proposition to those non-U.S. issuers, who can trade on these overseas regulated exchange and who can then access the U.S. capital market with none of the complexity and regulatory burden that would be required if they were to go to a national exchange.

So yes, we do see tremendous opportunity here, but of course, the key is to be targeted in our sales approach and to align the client acquisition costs to a given sector, or geography to the opportunity that exists there. So, we try and do that certainly. We focus traditionally and historically in Canada. There’s obviously parallel in terms of how straightforward and seamless the trading and cross-border settlement process can be there. We see opportunities in Europe, our office in London, the thriving sort of venture market there and just in general the underserved SME market in Europe more generally. We’ve had events and so on in Tel Aviv whether it’s thriving technology, venture stage technology, sector developing, we see opportunity in places like Australia that has minerals and resource companies that are well suited to our markets.

So yes, we continue to see opportunity. We continue to carefully evaluate where that opportunity exists and to align our resources to capture it in the most cost effective way possible.

Cromwell Coulson

Andrew, this is Cromwell. This is an enterprise sale process. So it takes time but — and it’s hard. You have to walk through, you have to build up information around an advisory community. But long-term, companies want to control their information channels to their constituents. And the U.S. is the biggest pool of investors and the most diverse and the widest. So from a high level OTCQX and OTCQB products for international companies offer incredible value. And there’s a big market for us to chase down but it’s hard, every sales gets earned and you have to build every sale, you have to build every market. And so, that’s something which will increase the investments, we get better at it. Each local country has slightly different market practices and priorities. So, but it’s a great opportunity for us.

Andrew Mitchell

Excellent. And then just one final one. Just a follow up on the North Capital Investment Technology alliance. I appreciate it. It’s sort of material revenue source in the near-term. But does the agreement effectively provide you within introduction see when someone uses their technology or a bit more complicated than that?

Bea Ordonez

I mean, it’s a straight forward strategic alliance with our revenue-sharing arrangements in place, but as we say, this is not a material driver for us in the short-term. This is a problem that we are looking to solve for the issuer community. It’s a problem we hear from our QX Advisory Council about and we’re looking to provide technology-enabled solutions into that space. So, this is about being at service to our subscriber base.

Cromwell Coulson

And Andrew, this is Cromwell. What’s really important is the point I made earlier. The growth capital has moved to the private market and this is not just for private companies, it’s for public companies. So, smaller public companies whether on our markets or the exchanges are raising their capital privately. Platforms like North Capital empower companies to go direct to investors who want to hold their securities. The problem with the Jobs Act was the regulations were built, written before there was online capital raising business. So, they very painful to use. They don’t work. The industry has taken a long time to get — to move along. But our expectation is, over the next decade, online capital raising — so companies to raise capital directly to investors will become a more significant avenue, and the second piece is with that capital raising is going to make public markets more useful, because these companies will be raising money with online information, and its publicly available.

And if we can work through that chokehold, the two chokeholds are, one bringing the private companies into public transparency where they get business transparency and a discipline of markets. And number two already public companies better access to capital at not a large discount from their public market price. We can really improve the value public markets.

Bea Ordonez

Thanks.

Cromwell Coulson

Thank you, Andrew.

Operator

Thank you. And I’m showing no further questions at this time and I would like to turn the conference back over to CEO, Cromwell Coulson for any further remarks.

Cromwell Coulson

Thank you all for joining today. I encourage to read our quarterly reports in more detail. As always, we appreciate the opportunity to discuss our performance and how this may impact the company. We are excited to build our strategy and grow shareholder value over the long-term. On behalf of the entire OTC Markets Group team, thank you for your support.

Operator

Ladies and gentleman thank you for participating in today’s conference. This does conclude the program and you may all disconnect.

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2019-11-11