OTC Markets Group Inc

OTC:OTCM

Earnings Call Analysis

OTC Markets Reports Steady Growth Amid Challenges

OTC Markets Group saw a steady performance in the third quarter of 2023, with gross and net revenues growing by 4%. However, a 12% rise in expenses has led to a dip in operating margin. Net income and earnings per share had a slight uptick, thanks to a lower effective tax rate. Corporate Services, Market Data Licensing, and OTC Link contributed 42%, 41%, and 17% to total revenue, respectively. Strategic initiatives are underway to optimize data technology, expand market acceptance, develop client applications, integrate digital asset trading, and create sustainable profitability. Reflecting confidence in their strategy, the Board declared a special dividend of $1.50 per share and a regular dividend of $0.18 per share, payable in December.

Financial Overview

The company saw a continued increase in both gross and net revenues by 4% this quarter. However, the operating expenses also rose by 12%, which led to a decrease in operating margin both for the third quarter and year-to-date. Revenues less transaction-based expenses increased by 5%, with total gross revenues reaching $27 million. Interestingly, despite the general narrative of OTC Markets being for smaller companies, the company has over 2,600 listed securities with over $238 billion traded in dollar volume, emphasizing its strength and global reach.

Divergent Business Line Performances

The business saw varied performance across its three main revenue streams. Market data licensing stood out with a revenue growth of 22% for the third quarter, driven by subscriber growth and price increases. In contrast, revenues from OTC Link decreased by 10% and Corporate Services by 3%, due to a combination of factors like a lower number of companies on the OTCQX and OTCQB markets and decreased usage of the company’s disclosure and new services.

Strategic Initiatives and Dividends

The company is making progress in its strategic initiatives, such as enhancing its regulated market operator role and focusing on client-facing application development. There is also an ongoing push to improve the functionality of OTC Link and responsibly manage the company's exposure to operational and business risk. Moreover, to create shareholder value, the Board of Directors declared a special dividend of $1.50 per share and a quarterly dividend of $0.18 per share, which highlights a commitment to returning value to shareholders despite short-term challenges in achieving net revenue growth goals.

Influence of Edgar Online Acquisition

The company's recent earnings figures reflect the full quarter impact of the Edgar Online acquisition, completed in November 2022. This acquisition has contributed to the significant 22% increase in market data licensing revenue. Nonetheless, the acquisition has also brought about an increase in operating expenses, particularly in compensation and IT infrastructure costs.

Operational Efficiency and Profitability

Despite top-line revenue growth, the increase in operating expenses prevented the company from reaching their short-term profitability goals. However, their commitment to operational efficiency and financial stewardship aims to ensure sustainable financial results that will increase the value of individual shares over the long term.

Earnings Call Transcript 2023-Q3

[Operator]

Good day, and thank you for standing by. Welcome to the OTC Markets Group Third Quarter 2023 Earnings Conference Call and Webcast. [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, executive]

Thank you, operator. Good morning, and welcome to the OTC Markets Group Third Quarter 2023 Earnings Conference Call. With me today are Cromwell Coulson, our President and Chief Executive Officer; and Antonia 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 2022 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.

[Robert Coulson, executive]

Thank you, Dan. Good morning, everyone. Thank you for joining us today. I will discuss at a high level, our financial results for the third quarter of 2023 and review our strategic initiatives for the remainder of this year and heading into 2024. Overall, gross and net revenues continued to increase with each metric up 4% this quarter. Expenses remained elevated, up 12% during the quarter, leading to decreases in operating margin for the third quarter and the first 9 months of the year. Net income and earnings per share increased slightly this quarter due to a reduction in our effective tax rate. Antonio will cover our financial results in more detail in a few moments.

Our acquisitions of Blue Sky Data Corp and Edgar Online continue to be drivers of change in our financial and operating results. The Blue Sky product is now fully integrated into our platform and we are focused on ways to expand coverage, streamline operations and address future needs for our subscribers. The optimization of Edgar Online remains in its early stages.

From the start, we anticipate that this integration would involve a significant effort and then putting the operations on stable commercial footing would take place over several years. Notably, the Edgar Online acquisition added ongoing operating costs as well as certain nonrecurring transitional expenses. As with each of our business lines, our ongoing investments in the Edgar Online business will be strategic and based on client demand, operational efficiency and competitive opportunities.

In the first 9 months, financial markets saw a risk-off environment with lower overall market activity and trading volumes. Our performance in this economic environment highlights the strength of our diversified business model. Today, there are over 2,600 securities of companies with over a $1 billion market cap traded on the OTC market.

They traded $238 billion in dollar volume through the end of Q3, an 88% of overall dollar volume. International company ADRs and ordinary shares, including those billion-dollar companies, are now 77% of the securities quoted and over 85% of the dollar volume. These numbers contradict a standard narrative that OTC Markets is primarily for smaller companies or speculative petty stocks. It is a testament to the work our people have done building our platforms and processes, but today, our regulated markets connect the world's leading global companies with U.S. investors and that global reach factors heavily into the opportunities we pursue as part of our strategic plan.

With respect to our 3 business lines, market data licensing again led the way with revenue up 22% during the third quarter. This increase was due to the contribution from Edgar Online and organic growth. For the first 9 months of the year, market data is up 23%. Revenue from OTC Link is down 10% during the quarter and Corporate Services is down 3%.

Corporate Services revenues remained impacted by decreases in the number of companies on the OTCQX and OTCQB markets as well as a reduction in companies using our disclosure and new service or DNS. Voluntary renewal rates for the OTCQX and OTCQB markets remain similar to prior years. The decrease largely stems from a combination of slower new sales and downgrading companies that are unable to maintain compliance with each market's rules.

We have never shied away from flagging risk based on disclosure, stock promotion, bankruptcy and other potential public interest concerns to inform investors, enforcing the financial and governance standards of OTCQX and OTCQB is important to the integrity of these markets. The revenue we lose when we reject unqualified companies or remove those that fail to meet our ongoing financial standards ultimately support the value for companies that qualify for OTCQX and OTCQB.

OTC Link revenue has decreased throughout the year, primarily due to lower message and trading volumes across our ATSs. While we do not control trading volume, we continue to prioritize subscriber growth to expand our networks. The reliability and uptime of our core trading platform remains a top priority. We take our regulatory obligation seriously including those under SEC Regulation SCI, and we value the trust our subscribers placing us to operate our mission-critical systems efficiently and effectively.

Based on the shifting trends across our business lines, for the third quarter, Corporate Services represented approximately 42% of our overall revenue. Market data licensing accounted for 41% and OTC Link accounted for 17%. Throughout the year, I have discussed our 5 strategic initiatives for 2023. First, coming together as one team on one platform to build the value of one share. During the third quarter, we worked to retain enterprise clients and optimize the Edgar Online technology in a robust cloud environment.

We have made progress in reducing the number of outside consultants we originally hired to facilitate the technology transition. As we finish this stage of technology work, we will shift our attention to optimizing operations and unlocking the value of these robust data sets.

Second, commercializing our role as a regulated market operator and delivering visible client value. We regained momentum in our Blue Sky initiative this year with 40 U.S. jurisdictions now recognizing our markets under the Blue Sky manual exemptions. We must continue to engage with the 14 remaining jurisdictions and ensure that Blue Sky coverage for companies and investors in those states that can meet those high standards. We also have significant work to do in commercializing our role as a qualified interdealer quotation system under SEC Rule 15c2-11.

Third, prioritizing client-facing application development and improving our data. As our business and our company have grown over time, there can be a temptation to focus all of our energy on protecting the house and maintaining existing systems. It is management's job to ensure that we have the capacity to develop new features and useful functions for our clients, specifically leveraging the throes of data we have at our disposal. It is well within our reach to expand the depth of services we offer, digitalize disclosure and further distribute useful financial information to our subscribers.

Fourth, improving OTC Link functionality and reducing operational risk and -- operational exposure and business risk. In early May, we received FINRA approval to permit digital asset securities to be traded by broker-dealers on OTC like ATS, while there remains intense debate about what may qualify as a digital asset security. We see a long-term opportunity as more digital assets move into entities regulated by the SEC and FINRA.

Our FINRA approval has allowed us to start developing plans to help facilitate regulated broker-dealer trading in these assets in a lawful and compliant manner. A fully integrated solution requires connections between broker-dealers, custodians and trading platforms. More regulatory and industry-wide work remains to be done and we will continue to provide updates on our progress.

Finally, because we operate as owners and catalysts, our final strategic initiative is creating strong net revenue growth and delivering sustainable profitability that increases long-term per share earnings. Our results thus far this year show top line increases. However, the corresponding rise expenses has kept us from reaching our goals in the short term.

As managers of a public company, we have 3 important roles to play. First, we must be good stewards of the business to serve clients and help our colleagues succeed. Second, we must act as sharp commercial operators in managing our resources carefully. And third, be fiduciaries for the shareholders to deliver sustainable financial results that will increase the underlying value of each individual share.

We have invested in acquiring and developing a deep pool of data across the OTC enlisted markets. We must engage with our clients and thoughtfully commercialize that data by adding new capabilities that drive sustainable revenue growth, we will generate greater operating profits and drive long-term earnings per share.

In closing, I am pleased to announce that on November 6, our Board of Directors declared a special dividend of $1.50 per share and a quarterly dividend of $0.18 per share, 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, executive]

Thank you, Cromwell, and thank you, everyone, for joining us today. I would like to start by thanking our entire OTC Markets team for their continued commitment to supporting and servicing our subscribers, integrating our acquisitions and driving our business forward. As I discuss our results for the quarter ended September 30, 2023, any reference made to prior period comparatives will refer to the third quarter of 2022. As a reminder, our results reflect a full quarter impact of the Edgar Online acquisition, which closed in November of 2022.

Turning to Page 7 for a review of our third quarter revenues. We generated $27 million in gross revenues, up 4% compared to the prior year period. Revenues less transaction-based expenses were up 5%. The OTC Link's gross revenues were down 10% compared to the prior year period. OTC Link ECN and OTC Link in NQB saw a 12% decline in transaction-based revenues and a commensurate 12% reduction in transaction-based expenses primarily due to lower trading volumes.

Our OTC Link ATS on our OTC Link ATS revenues from messages declined 19% and QAP One Statement fees decreased 30%, respectively, also due to reduced trading activity. Against this backdrop of declining volumes, our team continued to grow the number of subscribers to OTC Link ECN with 108 subscribers at the end of the quarter, up from 105 at the end of the prior year period. OTC Link ATS has 87 subscribers compared to 88 on September 30, 2022.

Trading volumes are highly unpredictable and could vary significantly period to period. Revenues from our market data licensing business were up 22% quarter-over-quarter due to the contribution of the November '22 acquisition of Edgar Online as well as subscriber growth and price increases for certain licenses. Pro user counts were up 11%, with the corresponding revenues up 9%.

Revenues from internal system licenses, delay data licenses and other data services increased 9% and revenues from market data connectivity fees increased 85% in both instances due to subscriber growth and price increases for certain licenses, partially offsetting these increases with a 24% decline in revenues from non-Pro users, driven by a 22% reduction in period-end nonprofessional user count. Historically, and in the normal course of business, we have seen significant changes in the number of nonprofessional users as market volumes and retail participation on our markets fluctuate, and we may experience a further decline in the future.

Corporate Services revenues decreased 3% in the third quarter. OTCQX revenues were up 1%, with incremental price increases effective for 2023, offsetting a reduced number of companies on the OTCQX market. OTCQB revenues were declined 6% and DNS revenues decreased 5% respectively due to a lower number of subscribers offsetting the impact of pricing adjustments.

In the third quarter, we added 28 OTCQX companies compared to 36 new sales in the prior year quarter. We had 595 OTCQX companies as of September 30, 2023, compared to 609 as of September 30, 2022. For the annual OTCQX subscription period beginning January 1, 2023, we achieved a 95% retention rate, relatively unchanged from 96% in the prior year. On OTCQB, we added 46 new companies in the third quarter compared to 93 in the prior year period and had 1,166 OTCQB companies at the end of the quarter down from 1,245 at the end of September 2022. We had 1,496 Pink companies subscribing to DNS and other products at the end of the third quarter, down 5% from 1,567 at the end of the prior year period.

During the prior year quarter, we saw a significantly higher number of DNS subscribers in connection with the amendments to Rule 15c2-11 becoming effective in September 2021. This elevated number of DNS subscribers during the first 6 months of 2022 began to reverse in the third quarter of 2022 and has remained at lower levels through the first 9 months of 2023. The month-to-month variability in subscriber numbers is driven by new sales, offset by the impact of compliance downgrades and corporate events as well as voluntary nonrenewals in the case of OTCQB and DNS.

Turning now to expenses on Page 11. On a quarter-over-quarter basis, operating expenses increased to 12%. The primary drivers of expense growth were an 11% increase in compensation and benefits and a 35% increase in IT infrastructure and information services costs. The increase in compensation and benefits reflects higher headcount, including employees from Edgar Online, annual base salary increases and an increase in stock-based incentive compensation, partially offset by lower commissions.

Compensation and benefits comprised 63% of our total operating expenses during the third quarter compared to 64% in the prior year period. IT infrastructure information services costs increased primarily as a result of the acquisition of Edgar Online as we added the technology, data services and data center costs supporting the Edgar Online platform.

Turning to Page 12. In the third quarter, income from operations declined 5%, while net income increased 3% with a lower effective tax rate and interest income earned offsetting the decline in operating income. Operating profit margin was 32.7% compared to 35.9% in the prior year quarter.

In addition to certain GAAP and other measures, management utilizes adjusted EBITDA, a non-GAAP measure, which excludes noncash stock-based compensation expenses. Our adjusted EBITDA was $10.5 million in the third quarter and our adjusted diluted earnings per share were $0.87, each down 1% compared to the prior year period. Cash flow from operating activities and free cash flow for the quarter each amounted to $7.9 million compared to $9.2 million in the prior year quarter.

Turning to Page 13. During the third quarter, we returned a total of $2.1 million to investors in the form of dividends, unchanged from the prior year period. We remain focused on growing our business operating as prudent stewards of shareholder capital and delivering long-term value to our stockholders.

With that, I would like to thank everyone for your time and passing back to the operator to open the line for questions.

[Operator]

[Operator Instructions] Our first question is going to come from the line of Steve Silver with Argus Research Corporation.

[Steven Silver, analyst]

Congratulations on being able to continue returning capital to shareholders through the special dividend even during these uneven markets. It's really a testament to the performance of the team. I guess my first question, in the disclosure on a quarterly basis, there's been discussion about how the OTC Link subscriber base or the addressable market is a little bit more limited at this time in terms of future growth.

Curious as to whether you could put any parameters around the continued growth opportunity in the subscribers for the market data licensing among professional users that seems to be the largest source of growth right now. Just curious to see what -- how you see that pipeline moving forward.

[Robert Coulson, executive]

Thank you for the question. We as you know, don't make forward predictions. Our view is the more content we put on our network of securities trading, the more connections we make out, the more we're going to sell data. And I don't we've been making -- connecting to more international broker dealers, more international market data systems. And improving the quality of securities traded on our markets. And so those are the levers that we look to do.

[Antonia Georgieva, executive]

And Steve, as a reminder, the members of OTC Link platforms could only be U.S. domicile and registered broker-dealers, while our market data could be consumed by those subscribers as well as foreign broker-dealers. So the opportunity for the market data sets is broader than the subscriber base to OTC Link, even though, of course, there is a connection between the two.

[Steven Silver, analyst]

That's helpful. Great. And then one quick question just about the OTCQB and QX member base. It's been very resilient given all the unevenness around the markets. Can you put any color around in terms of the reduction of the number of companies on the 2 platforms, whether most of them are just in terms of compliance or whether you've seen maybe a higher proportion of companies ceasing operations given the current client?

[Robert Coulson, executive]

So there's compliance and there's financial distress, which is really a compliance issue, too. Because if a company is financially distressed, it really -- it shouldn't be on our OTCQX market. And I think the interesting dynamic is we're doing a very good job internationally and taking our message of the things we do for international companies, which is digitalized and distribute and normalize their disclosure and make it so there's no blank screen or empty machines under their U.S. symbol.

And then there's the other side is share their compliance, governance and being lawful securities under U.S. securities law rather federal or state for brokers to trade for investment advisers to advise on to go into the solicited investable market. And so that's where we've done really well. I mean, I think if you've read some of our recent blog posts, you've seen that a lot of the very speculative domestic issues are on the exchanges today.

There's lots of penny stocks that keep doing reverse splits listed on the exchanges. And that's a -- and that takes away from -- we used to see companies that would get delisted from the exchanges much earlier in their cycle. But by the time smaller U.S. companies that may need to focus on their operations and struggle, they just keep doing reverse splits, which -- and effectively issue more shares to debtors, which is effectively going through bankruptcy. And that has kind of changed the dynamic of things sliding down on the domestic side.

[Operator]

And our next question is going to come from the line of Brennan McCarthy with Sidoti.

[Brendan Michael McCarthy, analyst]

Great. Just to start off, I noticed interest income becoming a bigger part of the picture this quarter compared to the same quarter last year. I guess can you just talk about your strategy as far as capital allocation and cash on the balance sheet. I noticed short-term investments as a new line item on the balance sheet. How can investors think about just this interest income going forward?

[Antonia Georgieva, executive]

Thanks for the question, Brendan. Obviously, as the economic environment has changed and interest rates have increased. We have reacted appropriately to take advantage of the opportunities to earn additional income on the corporate cash. In terms of our capital allocation strategy, it has remained quite consistent over the past of the company. And as you know, it is mostly focused on paying quarterly dividend and again, a special dividend this quarter as well. In terms of interest income, we remain -- how investors should think of it. We certainly remain very focused on driving our operating income, first and foremost, our sales and keeping our costs under control. But given the opportunities, we will continue to take advantage of the ability to earn financial income on our cash.

[Robert Coulson, executive]

And yes I think -- this is Cromwell. At a high level, one of my favorite books that I think every public company CEO should read is the outsiders. And it's a good coverage of some successful outperforming companies that we're thoughtful about investors' capital. And there are some parts that I disagree with. They make a hero of the CEO when these organizations, it's everyone in the organization being aligned within the culture of being stewards commercial and fiduciaries is -- and I also -- they put too much into what shows up in the financial reports as capital allocation versus resource allocation.

And you can break not many public companies are great at providing capital returns over the long term. And that's something we aspire to is -- and you can look at it 2 different ways. There's one way to build of businesses from organic growth that create capital over the long term and grow in a positive, profitable manner is -- and I think we've done that pretty well. And when we've been focused on that organic growth side, we have thought of ourselves, in many ways, the way Buffett will buy very good companies that serve their clients well and he sucks all the capital out.

So he takes away capital allocation from the management and pulls it up to where he's got a superior skill and he allocates out there. We luckily have some great shareholders. So we push out on dividends.

Is -- the second part is, can we get to the second stage now that we have some scale to be able to deploy capital efficiently in acquisitions. That's a very hard game. We have started small places where if we make a mistake, and we will make mistakes as we learn how to do this, is we won't blow up or sink the ship.

And so that's the part where I would like to over time be a good organization of adding in profitable opportunities. But if you look at the news side is the old bulls on the hill of Buffett is building up all this cash. He's not out there buying things. And it's good for us to use this time to focus on our operations, focus on shifting making our business more competitive.

And especially as the dynamic change from -- with the 15c2-11 rule changes and with market volumes going just the wind at our backs and the waves at our backs and the tide with us is to going to learn how to actively swim upstream. And that part will be good for our organization. And matching, merging, mashing together the technologies, the people, the processes and not being happy with the status quo is important for us building a strong company for shareholders over the long term.

[Brendan Michael McCarthy, analyst]

Great. That's helpful. And then looking at the quarterly expenses, it looks like, from my perspective, total operating costs have actually trended downward both from a year-over-year growth perspective as well as a percent of revenue since the first quarter of this year. Just curious, do you think it's reasonable to say, maybe the worst of the integration costs are behind the company?

[Antonia Georgieva, executive]

As Cromwell said earlier, we do not give forward guidance on either revenue or expenses, but I would remind you that we did identify certain nonrecurring expenses that we incurred earlier in the year related to the integration. We had a transition services agreement. We incurred additional data center costs for a period of time while we were positioning the technology to a cloud environment. And of course, we did expect those to phase out as we continue with -- to progress. In terms of future expectations, again we do not provide forward guidance.

[Robert Coulson, executive]

Yes. I mean we had to hire consultants for the lift and shift. They stayed around too long. I think originally, we had something like 7 or 8 and we're now down to 1. And hopefully, the team will be able to onboard all those skills. So where we took on an EOL technology team who is smart engineers with good business honesty, they were complete novices outside the data center type environment and they have been learning by doing.

And it's hopefully been an incredible opportunity for them to learn a bunch of interesting things. They worked incredibly hard to do a bunch of work that is, you don't see from the outside world and really isn't diving into the cool new stuff in the future yet, but they've learned how to operate this.

And when I talk about stewardship of the EOL business is we've kept the data quality. So we can keep the clients. And so it can be relied upon. We knew EOL as a vendor because the data quality was so important for our data-driven compliance processes. And that has been a real important threshold. Now what we do and use interesting ways to expand the opportunities with that, I cannot tell you like how exactly that will move forward because there are variables, and there are competitive opportunities, but there's also competitive threats, is, but we will, hopefully, by the end of the year, be able to start thinking about those ideas. And -- but that's with using our internal resources.

[Brendan Michael McCarthy, analyst]

Understood. That's helpful. And then looking at the Market Data Licensing segment, I know you mentioned the bulk of growth there from a year-over-year perspective, driven by the past acquisitions. Just wondering if you can disclose the inorganic growth metric from quarter-to-quarter.

[Antonia Georgieva, executive]

So in prior quarters, you will find disclosure in our quarterly earnings call, identifying the percentage of growth that was attributable to the 2 acquisitions versus organic growth. I would say approximately half of the growth was inorganic versus organic this quarter.

[Brendan Michael McCarthy, analyst]

Okay. Okay. And last question for me. I'm just curious about the compliance downgrade process. What would you say is the primary factor driving the compliance downgrades. I'm sure it's inflationary pressure and the higher interest rates playing a big role. But just kind of curious as to your thoughts on what are the primary drivers there.

[Robert Coulson, executive]

I mean we're part -- it's part of the business cycle where when capital becomes tighter, the risk-off environment changes. And that said, there's opportunities in the data world because for us, being able to sell into the brokerage industry, a lot of the data points that we look at around companies that aren't on our markets because we track promotion. And we track promotion out to the broker-dealers and clearing firms, not only for OTC securities but listed securities.

And I can tell you when you look at promoted securities versus dollar volume, we -- our team has done a really great job improving market integrity. And there's a lot of stuff going on in exchanges, which nobody is looking at. And it puts our model against theirs. We believe that our role as a market operator with a lot of different types of securities and disclosure standards is to put the data out there, so investors can make their own decision.

Exchanges like to blind by the brand. And it's hard for them to talk about various risks of individual securities. And I believe our model is better for small capital formation in creating efficient pricing.

[Operator]

Thank you. And I would like to turn the conference back over to Cromwell Coulson for any further remarks.

[Robert Coulson, executive]

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 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.