OTC Markets Group Inc. (OTCQX:OTCM) Q3 2022 Earnings Conference Call November 15, 2022 8:30 AM ET
Company Participants
Daniel Zinn – General Counsel
Cromwell Coulson – President & Chief Executive Officer
Antonia Georgieva – Chief Financial Officer
Conference Call Participants
Steve Silver – Argus Research
Daniel Baldini – Oberon Asset Management
Operator
Good day, and thank you for standing by. Welcome to the OTC Markets Group Third Quarter 2022 Earnings Conference Call and Webcast. 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.
I would now like to hand the conference over to your speaker today, Dan Zinn, General Counsel. Please go ahead.
Daniel Zinn
Thank you, operator. Good morning, and welcome to the OTC Markets Group Third Quarter 2022 Earnings Conference Call. With me today are Cromwell Coulson, our President and Chief Executive Officer; and Antonio Georgieva, 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 2021 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, everyone. Thank you for joining us today. I want to start by congratulating our team on closing the acquisition of the EDGAR Online business from Donnelley Financial. I’d also like to formally welcome our new EDGAR Online colleagues to the team.
EDGAR Online has a long history of providing company disclosure and financial information, structured data sets and insights. This acquisition expands our reach to cover the full complement of U.S. public companies, adding SEC reporting data to the issuer data we currently provide to our disclosure and news service. As a long-time EDGAR Online customer ourselves, we value its data and analytics products.
The enterprise customer base includes regulators, exchanges, brokerage firms, data distributors and financial portals that rely on EDGAR Online’s mission-critical SEC data and compliance tools. EDGAR Online services are embedded into our issuer compliance and disclosure digitalization process.
This high-quality data allows our team to build automated tools that track a company’s compliance with disclosure, financial standards and regulatory reporting requirements. By bringing these vital services in-house, we protect our existing operations and have an opportunity to expand our data offering and distribution channels.
Along with our purchase of the EDGAR Online business, we are bringing in a team with deep technological and operational expertise. These skills are useful for building our platform, supporting public companies’ disclosure distribution, streamlining data-driven market standards and allowing broker/dealers to automate business processes.
From a financial perspective, we acquired a business for approximately $3.5 million that currently is not cash flow positive. We understand, as fiduciaries, we must work to turn this business into a net financial gain for our shareholders, both by expanding the current revenue base and by being commercially sound business owners.
Over the longer term, we have an opportunity to use our ownership of the data, domain knowledge and commercial skills to enhance our client offering. It is a different playbook than our Blue Sky data acquisition, where we consume their subscriber base and expertise into producing a higher-quality product from our technology platform.
Our goal is to become a competitive supplier of tailored SEC data and analytics for regulators, broker-dealers and data distributors. I am excited to see our team execute on this opportunity. We look forward to sharing more about the integration of the EOL business into our market data offering and our technology platform.
Our overall business continued to grow during the third quarter. In keeping with the trend from the first half of the year, the year-over-year rate of revenue growth slowed following last year’s record results. Transaction-based revenues declined in the OTC Link business, although this market volume-driven trend began to moderate in the third quarter due to changes in year-over-year comparatives.
Our Corporate Services business delivered strong revenue results this year, showing double-digit growth for the quarter. The market data business line also grew during the third quarter, strengthened by increases in pro user licenses and the impact of a full quarter of revenue from the Blue Sky data acquisition earlier this year.
Our overall revenue mix looks similar to the first half of this year, with Corporate Services and Market Data subscription revenues, balancing out lower OTC Link transaction fees. Expenses outpaced our revenue growth, which resulted in our operating profit margin contracting this quarter. This similarly impacts our net income and earnings per share.
We continue to thoughtfully invest in our people and platform. Antonio will cover our financial results in more detail in a few moments.
Our history of organic growth stems from our focus on providing unique value to our clients. With the acquisition of Blue Sky data and EDGAR Online this year, we are applying that same principle to a new avenue of strategic growth opportunities. Each of these businesses provides a unique data set that is deeply valuable to our clients’ trading, compliance and business processes.
As we grow however, we must continue to drive through an unrelenting commitment to serving our clients. For example, in a year where trading volumes have normalized, our OTC Link team has focused on adding subscribers, strengthening compliance and building operational efficiency that will better serve the subscriber base.
Security and uptime of OTC Link ATS, our core SCI regulated trading system will always be a top priority. And during the third quarter, we again delivered consistent, reliable service to our broker-dealer community. We know our subscribers demand our best and our team’s focus on quality, reliability and regulatory compliance is a key aspect of our culture.
OTC Link ECN, once again, ended the quarter with more than 100 subscribers, showing continued client growth and demonstrating the value of the business model. We will continue to invest in this critical trading tool as it gains users. Our subscribers also rely on our publicly available compliance determinations under SEC Rule 15c2-11. The EDGAR Online services are vital to our 2-11 compliance process.
And as we bring those services under our purview, we can enhance this critical monitoring role for our industry and offer additional value for companies to go public.
Our OTCQX best market continued to grow this quarter, ending with a record 609 companies. The OTCQB venture market closed another quarter with more than 1,200 companies, allowing our premium markets to provide these companies with efficient access to U.S. investors.
Our market data licensing business experienced another increase in the number of professional users and enterprise licenses during the quarter, while the number of non-professional users declined in line with lower retail investor activity.
On the regulatory front, our efforts to gain Blue Sky recognition for our OTCQX and OTCQB markets regained momentum over the past several weeks with Puerto Rico becoming the first U.S. territory and South Carolina, the 38th state to recognize our markets. We intend to drive towards recognition in all 54 U.S. jurisdictions.
Throughout 2022, we pursued four strategic initiatives structured around serving our clients and shareholders. First, drive sustainable revenue growth across each of our business lines that increases long-term per share earnings power.
Second, commercialize our enhanced regulatory status under Rule 2-11 to create new opportunities for public companies and broker-dealers.
Third, advocate for additional regulatory recognition of our markets to increase the value of being public. Fourth, pursue corporate development efforts to grow and diversify our product suite and client base. These initiatives are reflected in many of the topics we have discussed on these calls throughout the year, and we will continue to work towards them in the months ahead.
In closing, I am pleased to announce that on November 10th, our Board of Directors declared a special dividend of $1.50 per share and a quarterly dividend of $0.18 per share, each payable in December. These dividends reflect our ongoing commitment to providing superior shareholder returns.
With that, I will turn the call over to Antonio.
Antonia Georgieva
Thank you, Cromwell, and thank you, everyone, for joining our call today. I would like to start by recognizing our entire OTC Markets team for their sustained focus and dedication to serving our subscribers, maintaining our systems and delivering on our strategic priorities. As I discuss our results for the quarter ended September 30, 2022, any reference made to prior period comparatives will refer to the third quarter of 2021.
Turning to Page 12. OTC Markets Group benefited from its diversified business model and revenue streams against the backdrop of increasingly challenging economic environment. Our Corporate Services business saw continued customer demand for our premium OTCQX and OTCQB markets, while market data licensing benefited from the additional revenues from the Blue Sky Data Corp acquisition and the sustained demand from professional and enterprise clients, offsetting a decline in non-professional users. OTC Link experienced continued moderation of trading activity on our markets impacting its transaction-based revenues. We generated $25.9 million in gross revenues, up 3%, as compared to the prior year period, while revenues less transaction-based expenses were up 5%.
In our OTC Link business, gross revenues declined 18%, primarily as a result of lower trading volumes and consequently, lower transaction-based revenues. We executed approximately 32,000 trades per day on OTC Link ECN and OTC Link NQB in the third quarter of 2022, down 17% from approximately 39,000 in the prior year quarter.
As a result, gross revenues from OTC Link ECN and OTC Link NQB saw a 26% decline, which was partially offset by a reduction in transaction-based expenses of 22%. Revenues from messages on OTC Link ATS and from Cap 1 statement fees decreased 20% and 64% respectively, contributing to the overall decline in OTC Link revenues.
These were partially offset by growth in subscription-based revenues from our consolidated audit trial reporting service and our connectivity services. OTC Link continued to attract new subscribers finishing the third quarter with 105 subscribers on OTC Link ECN and 88 subscribers on OTC Link ATS, up from 90% and 85% respectively, at the end of the prior year period.
As a reminder, trading volumes are highly unpredictable and could decline further. Furthermore, changes in our broker-deal subscribers’ trading behavior would also impact the transaction-based revenues and transaction-based expenses that OTC Link generates.
Our market data licensing business saw an increase in gross revenues of 6% with the full quarter benefit of the acquisition of Blue Sky Data Corp., which closed during the second quarter of 2022. Market data licensing revenues were flat to the prior year period excluding the impact of the acquisitions.
A 2% increase in pro user accounts produced a corresponding 2% growth in revenues from professional users. Revenues from internal system licenses, delayed data licenses and other data services increased 18% and revenues from broker-dealer enterprise licenses increased 14% due to growth in subscribers.
Offsetting these increases was a 46% decline in revenues from non-pro users, in line with a 49% decline in period-end non-professional user accounts.
Historically, and in the normal course of business, we have seen significant changes in the number of non-professional users as market volumes and retail participation in the U.S. equity markets fluctuate and we may experience a further decline in the coming months.
Corporate Services revenues increased 12% in the third quarter. As a result of the enhanced current information requirements under Rule 15c2-11, in effect since September of 2021, a significant number of companies sought to join our OTCQX and OTCQB markets.
The higher number of corporate services subscribers resulted in an increase in OTCQX revenues of 5%, while OTCQB revenues increased 18%. Contributing to the growth were also incremental price increases for our OTCQX and OTCQB marketeers that became effective January 1, 2022. Revenues from DNS and other products increased 11%.
In the third quarter, we added 36 OTCQX companies compared to 55 new sales in the prior year quarter, and finished the period with 609 OTCQX companies, up 9%. On OTCQB, we added 93 new companies in the third quarter, compared to 116 in the prior year period and had 1,245 OTCQB companies at the end of the quarter, up 17%.
We had 1,570 companies subscribing to DNS and other products at the end of the third quarter, up 1% from 1,556 at the end of the prior year period. Our DNS offering experienced a significant increase in subscribers during the prior year period in connection with the effective date of the amended rule 15c2-11 in September of 2021. This growth continued after the effective date including during the first six months of 2022.
In the third quarter of 2022, the number of DNS users declined to a level similar to the one we had at the end of the prior year period. The month-to-month variability in DNS subscribers is driven by non-renewals, corporate events and compliance downgrades.
Turning to Page 13, on a quarter-over-quarter basis, operating expenses increased by 13%. The primary drivers were an 11% increase in compensation and benefits and a 68% increase in professional and consulting fees. The increase in compensation and benefits expense reflects higher headcount, annual base salary increases and an increase in accrued incentive compensation.
Compensation and benefits comprised 64% of our total operating expenses during the third quarter, compared to 65% in the prior year period. Professional and consulting fees increased primarily due to higher spending on external consulting services to support our web-based applications, databases and security initiatives, partially offset by lower regulatory and clearing costs, as a result of reduced trading volumes on OTC Link ECN.
Turning to Page 14, our income from operations declined by 7%, as compared to the prior year period. Operating margin for the third quarter was 35.9%, compared to 39.5% in the prior year quarter. Net income declined by 5%, while our diluted earnings per share decreased by 3%.
In addition to GAAP and other measures, management utilizes adjusted EBITDA, a non-GAAP measure, which excludes non-cash stock-based compensation expense.
Our adjusted EBITDA was $10.7 million in the third quarter of 2022 and our adjusted diluted earnings per share were $0.88, each declining by 2%. Cash flows from operating activities amounted to $9.2 million in the quarter, compared to $10 million in the prior year quarter and free cash flows were $9.2 million, flat from the prior year period.
Turning to Page 15, during the third quarter of 2022, we returned a total of $2.1 million in the form of dividends, a slight increase of 1% over the prior year quarter. We remain focused on our strategic initiatives on enhancing the value of our products and services to issuers and broker/dealer subscribers, on growing our business and delivering long-term value to our stockholders.
With that, I would like to thank everyone for your time and pass it back to the operator to open the line for questions.
Question-And-Answer Session
Operator
[Operator Instructions] Our first question comes from Steve Silver with Argus Research. Your line is open.
Steve Silver
Good morning, and thanks for taking the questions. I was hoping if you could provide any color around the expectations for investments in the EDGAR business. Just trying to get a sense as to the timeframe for expected investments, whether it be quarters or spread out over a longer period of time in order to maximize the benefits of that acquisition?
Cromwell Coulson
Thank you, Steve. This is Cromwell Coulson. And the way we look at the EDGAR Online acquisition is, I don’t know if you watch many of the Restomod videos, where they find an old car in a barn and they take it out of the barn – they buy it, take it out of the barn and then they go through and figure out which stuff needs to be restored; which stuff should get updated with newer technology that either cost less or performs better or hopefully both.
And I look at the EDGAR Online project as one, we had to buy the car; two, we have to pay to move it out of the barn, we have to be out of the data center in the first half of the year. And so, we are moving it from being in a datacenter to moving it to a cloud provider and there is a cost of doing that for which we have outside consultants, because I am not an expert on putting something on a truck and moving it over and then we’ve got the carrying costs of the business as we work to take it to be a financially successful business.
Our goal is not to have this be a cost center. We don’t know fully because we upped what we paid and bought from them a year ago as part of our 2/11 project. So we are big believers in the quality of the data. We’re not sure how deeply embedded it is into all of our other clients – the clients’ operations, but we’re going to know over the next 12 months and we’re also going to be looking through the business, figuring out are there some easy wins on how to operate it?
Are there some opportunities to build – to sell the same data sets to others, to add data sets they have and/or to mix in with some of our data sets? So – but we don’t know. This is not like Blue Sky where we could say this is our plan and run straight ahead till you’re done. And this is one where we are going to get to one point, and we’re going to have to figure out the next one.
And – but it has good optionality and we’re going to – and it’s purchasing on an installment sale where there is one is the capital purchase, but then there is coming out of our earnings. But I don’t – as a shareholder don’t really care how we pay for something, whether it comes out of expenses. And my view is, we are going to have a really good idea where we stand in about two years.
And that’s when you’re going to be able to rate us, are you good commercial operators, and have you turned this into success in which the two ends of success are, do you have products that clients value, so they will pay an amount that it costs more than for you to produce? And two, are you bringing in producing it, are you bringing back returns to shareholders?
Steve Silver
Okay. Great. That’s very helpful. And one last one for me. The nine month results on adding clients to OTCQX and QB have been very, very strong, given everything that’s going on in the macro environment. I was just trying to get a sense as to if there are any trends you are seeing just in terms of the rate of new clients being added to the platforms?
And also, I noticed that international was a little lighter. Just trying to get a sense as to the current state of the macro environment affecting new clients listing on QX and QB.
Antonia Georgieva
Thanks, Steve, for the question. Our sales vary typically from quarter-to-quarter. They are not linear. We, as you pointed out, had a pretty strong first nine months of the year. However, we are mindful of the economic conditions in various parts of the world and the increasing strains on businesses, which could conceivably impact our sales efforts and the addition of new clients.
It’s too early to tell. We haven’t seen those trends yet, but certainly mindful of the potential for less favorable economic conditions ahead.
Steven Silver
Okay. Great. Thank you so much for the color and congratulations on all the success.
Antonia Georgieva
Thanks, Steve.
Cromwell Coulson
Thanks, Steve. And just to add in, we had a regulatory change last year. And that created an immediate need. It was seen more on the lower end of the market. However, it created a regulatory role for OTC markets.
And that really put us in a better position to create commercial value for public companies and if you add in the things that we’ve been – the data tools that we’ve been acquiring, our long-term vision of really changing what it means to be public to offering a platform for companies to really own their own public market to be able to do the data and disclosure distribution, to demonstrate their compliance standards and share their corporate governance in an electronic, screen-based, automated world, the tools we have are increasing.
So, – but those are enterprise sales-type and – type projects with a big education component and that’s our opportunity to execute on or our opportunity to less slip away.
Steven Silver
Okay. Great. Thanks for the extra color.
Operator
Thank you. And our next question comes from Daniel Baldini with Oberon Asset Management. Your line is open.
Daniel Baldini
Hi, good morning. Thanks for taking my questions. Last month, you all had a press release that had a title ‘OTC Markets Group Introduces Fixed Income 15c2-11 Data Product.’ and there is thousands of fixed income securities out there. And I am just curious if you could talk about the opportunity for you all in providing this data.
Cromwell Coulson
Thank you, Daniel. This is Cromwell.
Daniel Baldini
Hi.
Cromwell Coulson
Look, there is tens of thousands of fixed income products and we’ve created a data product that within the areas the corporate securities that we have and we believe it’s a pretty good product. The industry is still pushing on the SEC. So the compliance date is approaching. What happens and how the SEC handles it? There has been some murmurs that may get pushed a bit.
However, we see the same problems exist in the debt market is that there is not a clear line for broker-dealers where the disclosure is and it’s actually a greater problem, because so many corporate bonds, investment advisers are – need to solicit orders out.
This is not the eTrade client searching in a chat room to find which IBM bond they want to buy. And that the requirement under both 15c2-11, which – and State Blue Sky Laws because these are the federal and state requirements. We believe we should be able to offer a good solution to the broker/dealer community that they are conducting business in a compliant manner, while also fitting it into more automated processes.
Daniel Baldini
Okay. Is there much of a revenue opportunity with this?
Cromwell Coulson
Not today. I mean, I think it’s one of those doors to come in on and where we’re pricing the product today is very competitive. It’s good value for clients and it’s good value for – it’s good value for us, but we’re going to find out what firms want to do and they have, so far, been moving around.
There is two competitor products, one out of Bloomberg, one out of Refinitiv, I believe, they are much – one out of ICE and they are much more expensive than ours. So, we should be able to offer to the trading community Costco type value.
Daniel Baldini
Okay. Great. And just to comment on this EDGAR Online, it seems we did – we have an EDGAR online – sorry, we have BAMSEC subscription and it’s $800 a year now and so, we were looking around a few weeks ago, and I thought, well, whatever happened to EDGAR Online? And I went to the website and it was awful.
You couldn’t find out what the product was and how much it costs and there wasn’t easy way to contact them. And BAMSEC had a good business when they were charging $3.25 and now they’ve raised it to $800. So if you can just imitate what BAMSEC does for a few hundred dollars less like you are doing with your debt product, you should have quite a nice business there with EDGAR Online? Anyway, so good luck with that.
Cromwell Coulson
Yeah, I mean we are hopeful it’s – where we choose to compete in the SEC reporting data space, we have to choose our niches. And that’s going to be – but that’s something – we don’t really know the competitive where each one of their products, the competitive value is, and can we be commercially successful there.
Daniel Baldini
Okay. Well, it would be nice to have an alternative to BAMSEC.
Cromwell Coulson
Yes. Great.
Daniel Baldini
All right. Thank you.
Operator
Thank you. And I am showing no further questions at this time. I’d like to turn it back to Cromwell Coulson for closing remarks.
Daniel Zinn
And before we get there, and thank you, operator, there were a couple of questions that were actually sent in directly to us from an investor who couldn’t make a call today. I want to paraphrase those a little bit, one of the issues we’ve already covered, but for the other two, I will play investor and ask Cromwell the questions.
Cromwell, first question is regarding our recent hire in Singapore and just what we see as the opportunity in Asia and how we are looking at what the company side and other opportunities?
Cromwell Coulson
So, we’ve hired a salesperson in Asia, primarily focused on corporate services, but also getting our data into Asian brokerages and market data systems. And the opportunity we see for Asia is traditionally, Chinese companies have listed on one of the major U.S. exchanges.
And it’s been a challenge because, in the U.S., we have a disclosure-driven regime and we don’t have full compliance power back to China. And the trend around the world, in other countries has been companies going public on their local exchange and then having an ADR, some of them go to the New York Stock Exchange, some of them go to NASDAQ, some of them go to OTCQX.
And we believe that, that trend will get to China and either in Hong Kong or Singapore, depending on the companies, is – and they will still though want to have visibility to the U.S. And for investors, I actually believe that it will be better if these securities have local investors, because a very smart securities regulator told me once, the biggest problem is, when companies can raise capital only from foreign citizens, they don’t tend to get in too much trouble with their local regulators if they keep that offshore.
And that’s been one of the problems for – we’ve seen in the quality of disclosure and quality of operations and quality of being fiduciaries. Now, we hope that we will be able to have a compelling story the same way we have in Canada for companies listed on the Hong Kong Stock Exchange. And – but that is – it is an educational stage. It’s an enterprise sales process. The users need to learn how to use the product and generate value.
Daniel Zinn
Excellent, on behalf of the investor, thank you. And the last question was congratulations on the recent acquisitions. And then just a question about the general acquisition landscape as you see it and what our plans would be?
Cromwell Coulson
So, Blue Sky Data was a lot of work upfront and it’s pretty well integrated now and we are using their team to improve our data quality throughout our operations. So, that one, the capacity got used this year. And the management team really did a lot of work, took bandwidth of – so we shouldn’t say that, oh, it didn’t reflect our operations.
EDGAR Online was also a lot of work to bring in, but now we’ve got a lot of work to make it successful within our operations and a lot of learning. So, that one is going to take bandwidth too. We are not running around on a real housewife shopping spree, where you’re going to see us with five different bags in our arms.
We are still looking for acquisitions, which we think we can add in on a strategic basis and that we can earn a return for shareholders over the long term. That goes down to the rule is, over the next three to five years, can we increase the amount of Warren Buffett calls or owner’s earnings, I call it earnings power to one share?
And can we do that with buying businesses? So, but we’re in an interesting area where there is some interesting businesses, probably valuations are probably too high. There are some distressed businesses that are quite dangerous and EDGAR Online, we are a large customer for them. In fact, we are the largest, so we knew the quality of their data. We knew their people, their culture, their people are decent people, and we have a general idea of the usefulness. Other businesses that are distressed were a lot more blind. So we are going to be careful. But if there are opportunities, we are very interested because I think this part of the cycle is going to be interesting.
Daniel Zinn
All right. That concludes the investor questions. So now I’ll switch back and play the role operator and now I’ll turn it back again to you, Cromwell, for closing remarks.
Cromwell Coulson
Thank you, operator. I want to thank each of you for joining us today. I would encourage you to read our full third quarter report and the accompanying earnings press release. Links to both are available on the Investor Relations page of our website. On behalf of the entire team, we look forward to updating you on key initiatives that continue to shape the integrity and competitiveness of the public markets.
Operator
This concludes today’s conference call. Thank you for participating. You may now disconnect.
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