OTC Markets Group's (OTCM) CEO Cromwell Coulson on Q2 2016 Results - Earnings Call Transcript

| About: OTC Markets (OTCM)

OTC Markets Group Inc. (OTCQX:OTCM) Q2 2016 Earnings Conference Call August 4, 2016 8:00 AM ET

Executives

Cromwell Coulson - President & CEO

Bea Ordonez - CFO

John Byers - Corporate Controller

Dan Zinn - General Counsel

Operator

Good day and welcome to the OTC Markets Group’s Second Quarter 2016 Conference Call. Today's event is being recorded. At this time I would like to turn the conference over to Dan Zinn, General Counsel. Please go ahead, sir.

Dan Zinn

Thank you, Operator. Good morning and welcome to the OTC Markets Group second quarter 2016 Conference Call. With me today are Cromwell Coulson, our President and Chief Executive Officer; Bea Ordonez, our Chief Financial Officer; and John Byers, our Corporate Controller.

Before we begin today's call, I would like to review the Safe Harbor statement. This conference call may contain forward-looking statements about the Company's future plans, expectations, and objectives concerning, but not limited to, the Company's expected financial results for 2016. Words such as may, will, expect, intend, anticipate, plan, believe, could, and estimate, and variations of these words and similar expressions are intended to identify as forward-looking statements. These forward-looking statements are not historical facts and are subject to risks and uncertainties that could cause the actual results to differ materially from those predicted in these forward-looking statements. These risks and uncertainties could include, but are not limited to, the risk factors described in the Risk Factors section of the Company's Annual Report for the year ended December 31, 2015. The Company does not intend and undertakes no obligation to update its forward-looking statements to reflect future events or circumstances.

A note on non-GAAP financial measures as well. In addition to disclosing results prepared in accordance with GAAP, the Company also discloses certain non-GAAP results of operations, including adjusted EBITDA and adjusted diluted earnings per share that either exclude or include amounts that are described in the reconciliation table of GAAP to non-GAAP information provided at the end of our second quarter earnings press release. Non-GAAP financial measures do not replace and are not superior to the presentation of GAAP financial results, but are provided to improve overall understanding of the Company's current financial performance. Management believes that this non-GAAP information is useful to both management and investors regarding certain additional financial and business trends related to the operating results. Management uses this non-GAAP information, along with GAAP information, in evaluating its historical operating performance.

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. For the past year, I’ve led off each of these calls by talking about our mission and our strategy. Our mission is to create better informed and more efficient financial markets. We fulfill that mission by executing our strategy for operating world-leading securities markets. We share information widely through open networks that foster greater transparency. We connect broker dealers, organize markets and inform investors. We deliver elegant, reliable and cost effective subscription based solutions for a future that is online data driven and social.

The central ideas within our mission and strategy, along with our core values, guide us in every decision we make and ultimately determine the direction of our company as we work to build our franchise to be a great place where people work and to create enduring value for our shareholders. And most importantly, value for our user community, our subscribers and our clients across our business lines. The two central ideas is that we are extremely proud of our accomplishments over the years, but understand in order to truly fulfill our mission, we have to execute our strategy very day through every product we introduce and every interaction with our clients and our community.

Following the heels of record results in 2015, we have seen slower revenue growth during 2016. The second quarter we continued to focus on executing our strategy and take the necessary steps to continue to invest in our people and products to protect our franchise and support our long term growth. Internally, our investment in technology solutions and focus on resilience and reliability, allowed us to continue our record of 100% uptime of our core OTC Link ATS systems during trading hours. We have a strong, dedicated technology team that collaborates with the business and our user community to remain vigilant about system uptime while developing new features and functionally to benefit our subscriber base.

Our technology and broker dealer compliance teams have also concentrated on our responsibilities under the SEC’s regulation SCI. we are if not the smallest, but one of the smallest SCI entities, which shows in many ways how as a small company, we’ve become such a critical piece of the infrastructure, but also the importance of the ongoing investments made in our systems to allow us to maintain reliability while offering elegant, reliable and cost effective new features and functionality to our broker dealer subscribers.

The most important new event that took place this quarter was that Vermont recognized the OTCQX Best Market and Washington, Wyoming, Iowa and Rhode Island have recognized OTCQX and the OTCQB venture market as electronic securities manuals under each state’s blue sky manual exemption. A sixth state, Alaska, has included OTCQX and OTCQB as recognized securities manuals in proposed rules scheduled to be finalized in October. This is an enormous milestone for OTC markets, a recognition by securities regulators that our data driven market standards represent a genuine benchmark for issuers in terms of the transparency they provide their investors for efficient second and informed secondary trading.

We have an opportunity to work with state regulators across the country to build on these first six states and really provide for companies blue sky for secondary trading across the country. This is going to be a multi-year lift but is really important and you can tell the history of NASDAQ was when the state regulators started to recognize for blue sky NASDAQ. That was an important milestone. It will take more time than we want to, but it will be faster than the path of NASDAQ’s and we think this is really important and it validates our model.

OTCQX and OTCQB are designed to give innovative and entrepreneurial companies the public markets they need today so they can grow for tomorrow. We continue to work with state securities regulator across the country to achieve this important designation in every jurisdiction and every state and there’s a couple of other districts. And our interactions have been very positive with the individual states and with NASDAQ. So we’re optimistic that this is an important start of lowering the cost and complexity of demonstrating compliance with blue sky through the OTC checks market.

We have consistently said that being public shouldn’t be painful and that is particularly true in the current climate for capital raising. In June, we filed a partition for rule-making with the SEC to extend regulation A+ to SEC reporting companies. Experts from across the industry are on record in support of this proposal and we look forward to continuing to work with regulators, legislators and market participants on this and other practical solutions for smaller companies. Reg A+ and crowdfunding are tailor made for online capital raising. These disruptive technology driven platforms are an exciting opportunity to expand access to capital and lower the cost of raising capital for small companies.

This is not something that is going to happen instantly the United Kingdom is five years ahead of us in crowdfunding and the numbers have growth strongly, but they start out small because this is a completely new way to raise capital. The skillsets of the advisors, the capabilities of the electronic platforms, and the knowledge of the user community is all new and it is not developed. So we see this as in three years is going to be important to our markets and in five years, is going to be huge. We have positioned our markets to be the leading destination for Reg A+ and crowdfunding companies in the next five years and in the future. And we’re going to do that the same way that the online capital raising platforms are going to be disrupting the phone-based private placement market is by being online data driven, social and of course, lower cost and more user friendly through the use of technology and better integration.

In the second quarter we had eight companies graduate from our markets to a NYSE or NASDAQ listing, maintaining our position as the global leader in exchange graduates. As Congress and the SEC continue to discuss the role of venture markets in the US, we are actively participating in the discussion and speaking with law makers and market participants about the kind of changes that would benefit the companies on our markets. We really see there’s two points, in part we can do, part regulators can do, part the Crowdfunding industry could do. Number one, companies need lower cost, wider access to capital. We’re only going to solve that by using technology.

Number two, we need to make it less painful for small companies to be public. It’s too complicated. It’s too costly, some that’s driven by regulation, but some that has been driven by blue chip stock exchanges imposing blue chip standards on companies that are not in the S&P 500. We are building our markets, not for companies that are in the major indexes. We are building our markets to put the information on the screen for investors to be able to analyze value and trade the securities in an informed manner through online or institutional brokers. By doing that, our markets are about letting the market participants decide the merits of an investment, and using the power of the internet and technology to lower the cost of information distribution.

Whether through the regulatory process for our own operations, we are looking to remove unnecessary cost and complexity while providing trust, reliability and competitive choice to market participants. In that vein, we continue to evaluate and revise our OTCQX Best Market rules to reduce unnecessary complexity while supporting informed and efficient trading markets. OTCQX we’re looking how can we use data driven qualitative standards that are efficient to execute for companies is -- and part of it is common sense corporate governance to build on established best practices which will be implemented by the end of the years. Continuing penny stock standards are also coming in through the end of the year. This is allowing us to deliver for companies that benefits the public trading, including visibility, liquidity valuation and trust at less than half the cost and burden of a NASDAQ listing.

With OTCQB, we charge less than a quarter of NASDAQ’s lowest price. OTCQX and OTCQB are tailor made for the next generation of small company Crowdfunded offerings. Our data driven market standards focus on publicly available company information so that market participants can easily analyze value and trade securities. So results within our business lines have remained largely in line with the first quarter results. OTC Link ATS continues to experience a decline in revenues as a result of industry contraction as well as a very slow market environment can start the year.

Consolidation continued as one of our largest subscribers, Citigroup’s automated trading desk shut down its equity market making business as part of a sale to another large subscriber. We have continued our technology initiative during the first half of the year to support the system and other changes necessary to allow subscribers to quote Tier 2 NMS securities on OTC Link ATS in the coming months. This will be a multi-year project. We will be slowly working to build this project, but it is something that to build the liquidity, providers will take on.

Our broker dealer network face model allows our subscribers to compete directly with one another on pricing execution quality. The competing dealer model is the cornerstone of how our platform creates a superior investor information and trading experience via online and institutional brokers in the US and global securities. While most large cap stocks have natural liquidity via standing order books, smaller companies need the liquidity provided by broker dealers trading in the market. Similarly, global securities need cross border electronic [arbiters] providing continuous liquidity. The competing market makers on our trading systems provide liquidity as a service and are a key component of the capital market landscape for these smaller and global companies.

We think these companies and those market participants and investors wishing to trade them, will be better served by the diversity in choice of our dealer based network model that offers investors an informed and efficient trading experience through online and institutional broker dealers. We will continue to work with our community of broker dealers, companies and market participants the support smaller and global company public trades to build the next new network market.

Our market data business lines revenues maintained slow steady growth for the second quarter. We continue to be working to improve the efficiency of our sales and marketing efforts to grow our market share and expand our customer base and market data as we look to build on the momentum generated by the success of our compliance data file which is being used by more and more large broker dealers, clearing firms and regulators to remove and add risk controls on securities based on data points.

There’s been a lot of press about how tough the terminal business is. I think Bloomberg’s terminal growth I’ve heard through the grapevine, has stopped growing, but I think we have to look at our professional users as a small subset of the NASDAQ UTP professional plan. NASDAQ UTP plan has actually been bouncing a bit. There’s about 278,000 users. It bounced because the SEC issued a letter that said you couldn’t use NASDAQ basic instead for trading decisions. It got down as low as around 240,000 users. But at 278,000, our 21,000 professional users is just 7.5% of the NASDAQ UTP market. So for us, if we double our market share, we’re still just 15%.

We’ll need to figure out what is that next group of users, professional users who we know take tasks and how do we have them interested in our market data, our securities, our places. And that is again, that is not quarter to quarter process. That is a multi-year process, but it should be understood that it is a hard problem to solve, but it is an opportunity long term to develop value for the franchise. So we’re still going to continue in creating more high quality market data products.

Corporate services continued to grow revenues, based on a large part to the rapid growth of the OTCQB venture market during the second quarter last year, combined with improving retention rate within the OTCQX. Last year was a fantastic, transformative year of creating OTCQB as a venture market. This year, we’re building it out and market conditions for companies outside the S&P 500 have been challenging. And that not only affects our trading business, but it also affects new sales and corporate services retentions of less well-capitalized companies. There’s A+ and a minus is the old OTCQB, the quality check at the bottom wasn’t removing securities when they weren’t meeting standards is a good thing. But on the other side is, it’s going to be affected by the market dynamics and the financing windows.

We continue to sharpen our focus on retaining OTCQB companies and expanding the new sales pipeline for both OTCQX and OTCQB. For OTCQX, we’ve raised the annual fee for new companies this year to $20,000 a year. Existing companies that comes in at the beginning of next year. So what it shows is the new fees are sticking in new sales because we’re not seeing the fee as a blocker. We’ve added value across and we’re looking by the end of the year when the fees kick in, we will have added more value for OTCQX companies because we want to be less than half the cost of NASDAQ’s lowest fee and that’s a real competitive price to be in, but deliver most of the value up for public trading with a lot less of the pain is one of the key pieces we added with Morningstar research reports. And it’s a data driven research model and it shows stars based on valuation and we show the report and the stars for OTCQX companies and for OTCQB companies we show the stars and the report is an optional upgrade service.

This product is part of a future of having more third party analysis and more machine driven analysis in the space. By having Morningstar able to consume data on all of OTCQX and OTCQB companies, to do quantitative research valuations is, that’s going to make the companies on our markets more machine readable, more machine understandable as Wall Street and finance and industry in general continues to move to taking the best of man and machine. And as a market that has always been about putting information on the screen and making it useful electronically, we believe that we’re well positioned to help our broker dealers, subscribers and our companies move forward into that next world that is online data driven and social.

Before Bea discusses the details of our financials, I’m pleased to announce that on August 2, our Board of Directors declared a quarterly dividend of $0.14 per share payable in September. This is our 31st consecutive quarterly dividend and our fifth consecutive $0.14 quarterly dividend.

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

Bea Ordonez

Good morning. Thank you, Cromwell and thank you all for joining. I will now spend a few minutes reviewing the results of our operations for the second quarter of 2016. Any reference made to prior period comparatives refers to the second quarter of 2015.

For the second quarter of 2016, OTC Markets Group saw a 2% increase in gross revenue to $12.6 million versus $12.4 million in revenues for the same period last year. This increase was driven by growth in our corporate services business, which saw $400,000 or 10% increase in revenues, with this increase being partially offset by a decrease in revenue from our trading services business, which saw a $300,000 or 9% decline. The growth in our corporate services business line continues to be driven largely by the full period revenue impact of the growth in companies verified to trade on our OTCQB market during the first half of 2015. In the second quarter, the revenue impact of this was partially offset by a contraction in the ending number of OTCQB companies.

We ended the second quarter with 877 companies on our OTCQB market as compared to 955 companies at the end of the same period last year. This drop in the ending count of OTCQB companies, reflects the higher rate of compliance related downgrades we experienced on this market as compared to the OTCQX market. During the second quarter, we saw 65 downgrades for non-compliance with our market standards.

The OTCQB venture market is a market for early stage and developing companies. Given this, we expect to see this trend continue and expect to continue to see a high rate of turnover of companies on the OTCQB markets. Also a contributing factor to the overall drop in the ending count of OTCQB companies, was relatively sluggish performance in terms of new companies joining the markets. We are seeing one of the slowest 5 tier market since 2009 and yet despite these unfavorable market conditions, we added 63 new companies to the QB market during the second quarter.

Revenues from our OTCQX Best Market was flat versus the prior period. We ended the quarter with 383 companies on our OTCQX market, down from 398 companies on that market at the end of the second quarter of 2015. Again, difficult market conditions are contributing to sluggish performance in terms of new sales. We added 11 new companies to our OTCQX Best Market during the second quarter of 2016, which compared to the 28 companies which we added in the prior period.

We began to see an uptick in our IPO market activity towards the end of the second quarter and expect to benefit from these more favorable market conditions. Further, we remain very positive about the potential opportunity created by the new regulatory framework for online capital raising created by the job sec.

Our trading services business line recorded revenues of $2.7 million for the quarter, down 9% over the prior period. The decrees was primarily a result of the introduction in July 2015 of updated pricing, which had the effect of eliminating quote fees to securities traded on our premium markets, while increasing fees for quotes in other markets and for messaging. This pricing change has had the effect of reducing revenues from quote fees, with this reduction being only partially offset by an increase in message revenues.

Declines in quote volumes versus the prior period also contributed to the decreased revenues we saw in the second quarter. As Cromwell mentioned, we continue to see a decline in the number of market participants, from 120 at the end of June 2015 to 112 at the end of the current quarter. This decline is reflective of continuing pressure on the broker dealer industry resulting in continuing contraction and consolidation in the space.

Market data revenues were up 1% from the prior period to $5.3 million. As at the end of the quarter, we had almost 21,000 professional users of our market data and close 11,400 non-professional users.

Operating expenses for the quarter were up 3% to $8 million. As in previous quarters, the increase was primarily due to an increase in compensation and benefits costs, which were up 4% to $5 million. As a percentage of gross revenues, compensation and benefit costs increased to 39% during the three months ended June 30, 2016, compared to 38% during the same prior year period. This increase reflects the impact of annual compensation increases as well as additional headcount.

IT and infrastructure costs for the quarter were $1.4 million, up 20% over the prior year period and reflecting both the run rate impact of the significant investment we made in our core trading systems in 2015, as well as additional investments made this year since we have system monitoring and security.

Our income from operations for the quarter was $4.1 million, flat versus the prior period. And our operating income margin was 34%, down very slightly from the 35% we saw in the prior period.

Net income for the quarter increased 4% to $2.5 million, primarily due to a decrease in operating our effective tax rate for the quarter.

In addition to certain GAAP and other metrics, management tracks the non-GAAP measure adjusted EBITDA. Adjusted EBITDA excludes non-cash stock based compensation expense. Adjusted EBITDA increased 1% $5 million or $0.42 per adjusted diluted share from $4.9 million and again 42% per adjusted diluted share in the prior period. You can find a reconciliation of our GAAP to non-GAAP results in our press release which is available on our website.

During the second quarter, we generated cash flows from operations of $2.3 million. This was down $1.8 million over the same period last year, primarily because we saw a very significant influx of cash in the first half of 2015 from companies joining our OTCQB market.

In closing, the second quarter of 2016 demonstrates the resilience of our business model and our ability to generate consistent performance despite uncertainty and disruption in the financial and capital markets. We enjoy a unique position in the market with, complimentary business lines serving diverse sectors of the financial community. Further, we benefit from a subscription based recurring revenue model which produces consistent and predictable cash flows. We will continue to strategically and prudently utilize our cash flows to grow our business organically through investments in our people and technologies. It is through this continued investment in our people, in our technology and in our products that we will position ourselves to deliver consistent revenue growth.

As appropriate, we will continue to return cash to our investors in the form of dividends and through our stock buyback program. In that context, as Cromwell has already noted, we were pleased to announce yesterday a quarterly dividend of $0.14 per share of our class A common stock. This will mark our 31st consecutive quarterly cash dividend. For the six months ended June 30, 2016, we returned just under $4 million to our investors in the form of dividends and share buybacks, a net payout ratio of 65%.

With that, I’d like to thank everyone for their time and pass it back to the operator for questions.

Question-and-Answer Session

Operator

Cromwell Coulson

Thank you everyone for calling in. with that, we’ll just close the call.

Operator

This conclude today’s call. Thank you for your participation. You may now disconnect.

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