OTC Markets Group (OTCM) Q2 2019 Earnings Call Transcript

OTC Markets Group (OTCM -0.02%)
Q2 2019 Earnings Call
Aug 08, 2019, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the OTC Market Group second-quarter 2019 earnings conference call. [Operator instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Dan Zinn, general counsel. Go ahead, please.

Dan Zinn -- General Counsel

Thank you, operator. Good morning, and welcome to the OTC Markets Group second-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 result 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 -- President and Chief Executive Officer

Thank you, Dan. Good morning, and thank you, everyone, for joining this call. Our second quarter saw continued investments in our people, platform and products. We added to our team with targeted hires early in the year, expanded our sales capabilities and integrated the newly acquired Qaravan and VIC businesses into our product suites.

These new services provide valuable performance analytics, competitor data, complex and compliance tools for community banks and enhance our suite of investor outreach solutions for our corporate clients. We are fortunate to be undertaking these efforts from our new corporate headquarters at 300 Vesey Street in New York City. Our state of the art facilities have allowed us to expand our events capabilities, including hosting a series of market bell-ringing ceremonies for companies and our partners. We have also increased the use of our conference spaces and added greater capacity to provide video and audio solutions to enhance the way companies dynamically connect with their investors through online media and distribution channels.

During the second quarter, we hosted a number of live issuer events and virtual investor conferences, reaching more than 6,000 investors. We remain focused on better serving the needs of our clients and executing our mission and strategy. Our mission is to create better informed and more efficient financial markets. We fulfill that mission by executing our strategy, which is 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. During the second quarter, we shifted gears from completing the two acquisitions and executing our office move in Q1 to the hard work of integrating those acquisitions, building the sales process and rolling out new products.

This includes our Canari compliance UI and the Qaravan CECL product, all the while continuing to support our core product suite and making new enhancements that deliver greater value to our subscribers. In that context, we began adding subscribers to our Qaravan Pro service during the quarter and launched the Qaravan CECL solution for firms to better meet the new accounting standards that are set to impact public and nonpublic banks in the coming years. The virtual investor conferences business hosted seven events with 79 companies using the online platform to efficiently reach more investors. The early momentum for this business highlights the potential demand for dynamic investor communications tools as companies seek to engage a wider range of investors across multiple media platforms and online distribution channels.

While companies, investors and market data users are all vital components of our community, serving the needs of our broker-dealer subscribers remains at the center of our business. As of August 1, our OTC link ECN grew to 47 subscribers. Our goal continues to be optimizing the broker-dealer experience on both of our ATSs by providing reliable and efficient trading platforms and offering our subscribers the data-driven services to support their competitive demands and broker-dealer regulatory requirements. We again achieved 100% uptime of our core OTC Link ATS systems during regular market hours.

Dedication to system's reliability and sustaining the culture of compliance remain top priorities for our team. Our regulatory goals remain consistent, to meet our SEC and FINRA compliance obligations as the operator of two SEC-registered ATSs, one of which is subject to regulation FDI to gain regulatory recognition of our OTCQX and OTCQB markets and to advocate for and support initiatives that can facilitate small company capital formation. In addition to our ongoing regulatory compliance, we added Kentucky and North Dakota to our Blue Sky map, bringing our total to 36 states in which securities on our OTCQX market are eligible to be exempt under Blue Sky secondary trading loss with OTCQB securities exempt in 33. We look forward to continuing to work with regulators to add more states.

We also had 13 companies graduate from our markets to a national securities exchange listing during the second quarter, making 25 such graduates during the first half of 2019. These numbers continue to highlight our role as the world's most successful venture market. Bea will cover our financial results in greater detail in a few moments. I would like to highlight that our second-quarter results saw a 6% 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.

Finally, I'm pleased to announce that on August 6, our board of directors declared a quarterly dividend of $0.15 per share, payable in September. This dividend reflects our ongoing commitment to provide superior shareholder returns. With that, I will turn the call over to Bea.

Bea Ordonez -- Chief Financial Officer

Thank you, Cromwell, and thank you all for joining the call. I will now spend a few minutes reviewing our results for the second quarter of 2019. Any reference made to prior-period comparatives refers to the second quarter of 2018. For the second quarter of 2019, OTC Markets Group generated $15.7 million in gross revenues, up 6%, with all three of our business lines delivering quarter-over-quarter growth.

Strong sales and increased uptick of our produce, as well as an improved retention, all contributed to this, our 10th consecutive quarter of top-line growth. Our corporate services business generated revenues of $6.7 million, up 9%. Revenues from our OTCQX market were up 11%, in line with the higher number of companies on the market. Strong sales in 2018 and for the year to date, together with an uptick in our renewal rate from 91% to 94% for the current year, all contributed to this increase in the number of companies on the market from 365 to 421 companies as of June 30, 2019.

The number of companies on our OTCQB market has trended down slightly, with 916 companies on the market, down from 922 as of the prior-period end. We saw a decline in the number of companies joining during the second quarter, with 38 joins, down from 53 during the prior-year period. Our voluntary nonrenewal rate has remained flat, while compliance-related downgrades have also largely remained constant. Notwithstanding the slight contraction in the number of OTCQB companies, the full-period impact of price increases introduced for 2018 drove a 9% increase in related revenues.

Market data licensing revenues was $6.1 million for the quarter, up 4%. We saw a 3% increase in revenue from professional users, consistent with an increase in reported users across our redistributors. Additionally, new sales of our data file product, and particularly, our suite of compliance analytics product, drove a 20% increase in related revenues. Following our acquisition of Qaravan in February, we have continued to focus our efforts on integrating and enhancing Qaravan's technology and suite of product on implementing an effective outbound sales process and on developing a strong pipeline of potential subscribers.

During the second quarter, we saw four sales of our Qaravan Pro service, and as noted, launched the Qaravan CECL solution. OTC Link generated revenues of $2.9 million. Revenues from our OTC Link ECN were up 46%. And together with a 10% increase in revenue from quotes on our OTC Link ATS, drove a 4% increase in quarter-over-quarter revenues overall.

Our OTC Link ECN continues to gain traction, and we have a strong pipeline. As we onboard new subscribers, we hope to be able to grow revenues from this offering. During the second quarter, operating expenses increased 15% to $10.4 million. The primary driver of the increase in our expense base was a 15% increase in our compensation costs, a result of head count increases and the impact of salary raises.

Our head count has increased from 91 as of June 30, 2018, to 99 as of June 30, 2019. This includes first-quarter hires made pursuant to our acquisition, as well as hires in London and New York to expand our international sales efforts and grow our trading services business. Annual salary increases drove a roughly 6% increase in our base salary expense. The increased cumulative value of our prior-year stock awards has also contributed to the increase in compensation costs.

We continue to operate in a competitive hiring environment, especially in respect of technology talent. In this context, we carefully evaluate our overall compensation structure against our peers to ensure that we remain competitive, as well as to reward and incentivize performance. On a quarter-over-quarter basis, our IT cost increased 19%. Increased technology support costs related to our recent 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. We are also in the process of upgrading certain hardware and other infrastructure at our data centers. During the second quarter, we incurred close to $100,000 in incremental data center costs related to this asset. These incremental costs will be ongoing through the completion of the project, which we currently anticipate will be during the fourth quarter of 2019.

Finally, in terms of our discussion of expenses. As previously disclosed, in late March, we completed our move to new offices in downtown New York. During the second quarter, our run rate occupancy expenses were $153,000 or 34% higher than the prior-year period, reflecting a roughly 10% increase in the amount of space occupied, and on a cash basis, an 18% increase in the amount paid for rentable square foot. For the second quarter, income from operations was $4.4 million, down 11% while net income for the quarter was $3.6 million, also down 11%.

This, of course, reflects the investments made in personnel, as well as the uptick in our technology and occupancy costs. We made those investments with an eye to the long term and remain focused on delivering sustainable earnings growth. Cash flows from operating activities for the second quarter amounted to $4.6 million, an increase of 6%. While net income decreased 11% in the current quarter, adjustments to reconcile net income to operating cash that is noncash items, principally, depreciation increased by 51%.

Period-over-period changes in assets and liabilities also contributed to the increase in cash generated by operating activities. During the second quarter, we used operating cash flows to fund leasehold and technology investments at our new corporate headquarters, as well as the necessary upgrades to our data centers. The total spend amounted to approximately $1.1 million. We ended the quarter with $24 million of cash on hand, a strong balance sheet with no debt and benefit from a subscription-based revenue model, which generates predictable recurring cash flows.

We continue to operate an investor-focused capital allocation policy, which returns cash in the form of dividends and through stock buyback. During the second quarter, we returned a total of $1.7 million, up 8%. We were pleased to announce our 43rd consecutive quarterly dividend. In closing, during 2019, we have made some significant investments in the people needed to grow sales and better serve our subscriber base, in technology-enabled businesses that are additive to our suite of product and can deliver future revenue growth and in the facilities and infrastructure that will allow us to continue to deliver reliable, cost-effective technology solution.

We remain focused on delivering sustainable earnings growth and on building on our track record of providing strong return for our shareholders. With that, I would like to thank everyone for their time and pass it back to the operator to open up the lines for questions.

Questions & Answers:

Operator

Thank you. [Operator instructions] Your first question comes from Chris McGinnis, Sidoti and Company. Go ahead, please.

Chris McGinnis -- Sidoti and Company, LLC -- Analyst

Good morning. Thanks for taking my questions, Chris. Chris, I just wanted to ask a little bit around OTC Link and just the way your growth you're seeing now with tougher comparisons in the back half of the year with growth. Is this level of growth where you think we should stay after the year? Or do you think you have the ability to continue to drive maybe a higher rate? Thanks.

Cromwell Coulson -- President and Chief Executive Officer

Thank you, Chris, for that question. It is -- establishing the OTC Link ECN business has been a process for us, which is learning, getting the system up. And then once we had a suite of functionality to attract users, then it's rolling it out and getting more connections from other firms. And that process is -- takes time.

It's an enterprise sales-type process and then building. And then once you have buy-in, getting actually into the development to kind of and around the connectivity. So that said, our pipeline looks good, and -- but we don't make any predictions on when it will come or how it will come, but we are aggressively pushing to bring on more subscribers. And we think there is a good opportunity to grow the business.

And as we build the network effect to -- for firms to add new features.

Chris McGinnis -- Sidoti and Company, LLC -- Analyst

OK. Thanks for that. And I know a number of new products and service has been offered lately. Just going through the queue of the investor conference that you mentioned, longer term, that should be incremental to earnings.

Just wondering, you talked about seven conferences, 6,000 investors reach, how does that change over time as you think about it and as that starts to be incremental for earnings? Thanks.

Bea Ordonez -- Chief Financial Officer

Sure, Chris. Look, again, we acquired this business in the early part of the year. So it's definitely gonna be both the learning experience and for us, about building the value proposition from that business. And I think that comes in a few ways.

One is to continue to build that investor database, that group of investors that you could reach through this product. Because that's the value, obviously, that we bring to issuers who want to use that product, to give them an audience for their message, to give them an audience for what they want to say to the market. So we reached 6,000 investors with our conferences in Q2, we had 10,000 unique views either live or of replayed events. And that's a nice metric, but we are confident that we will continue to grow that.

So I think, as I say, in terms of growing that revenue base, one is to grow the investors, two is to make the product -- suite of product, widely available to that pool of issuance that we serve and really to sort of prove that value proposition, to continue to talk about it, to continue to offer it to our issuers and to others and to work in partnership with some of the folks who have used this historically, people like Deutsche Bank and so on, who have hosted events through this product. So early days, somewhat, it was only a sort of early part of the year acquisition. We've clocked about $165,000 of revenues year to date, and we certainly hope to grow that with a view to making that business accretive to earnings in that sort of 12 to 18-month time frame.

Cromwell Coulson -- President and Chief Executive Officer

And Chris, I think the bigger picture for us is if you look at company disclosure, there's what I call, the flat disclosure, which is financials, quarterly reports, 8-K-type events, press releases. Those are expensive and slow to produce. So -- but the more fluid disclosure from earnings calls to investor conferences that you can do online is much lower stress to produce for the management teams, and more compelling for them to be able to tell their story and also a great way for investors to really see who are the people in these companies which matters so much. So building those tools, the VIC business is a starting point, but it's an exciting one because it allows us to create additional channels for communication that are not as painful as the flat regulatory disclosure.

It is much more dynamic and interactive.

Chris McGinnis -- Sidoti and Company, LLC -- Analyst

Yes. That makes a lot of sense. And then just one last question. Maybe just explain a little bit of the difference between Blue Sky exemptions between a QX and a QB and why are there different number of states? Thanks.

Dan Zinn -- General Counsel

Sure. Chris, this is Dan. Thanks. So it stems from, really, the earliest adopters.

Vermont was the first state that granted an exemption by rule, and when coming on, all of these states take some time to learn about us and our market. And there are a few states that have felt more comfortable with OTCQX than OTCQB, that's the difference of those three states. We continue to work with them to talk about the disclosure. Really, the similarities between those markets are the disclosure standards and the fact that all companies have audited financials and quarterly reports and material news reports.

And all of the things that are really the backbone of that manual exemption that NASAA puts out. So as states get more comfortable, we've seen it over time, the later states are typically granting exemptions to both markets. And we'll continue to try to normalize that number. But for us, it's just important that they have to recognize what we're doing on a higher level, and then we'll sort of be able to fill in as we go.

Cromwell Coulson -- President and Chief Executive Officer

And Chris, this is Cromwell. Just some states, be their Blue Sky rules is strictly disclosure-driven. And other states have more merit review from looking at the corporate governance requirements, the independent audit committee requirements that we've got on OTCQX. And they see from a Blue Sky exemption that they are not gonna just make it only disclosure-based.

And that's a real difference between all the U.S. states. So I would also expect that as the states that we haven't gotten yet, some of the tougher state securities regulators will be more comfortable with the higher standards that we built, which are based on long-standing corporate governance best practices with OTCQX of requiring outside directors and independent audit committees, and [Inaudible]

Chris McGinnis -- Sidoti and Company, LLC -- Analyst

Thank you. I appreciate that. Those are all my questions for now. And good luck in Q2, Q3.

Operator

Thank you. Your next question comes from Andrew Mitchell, Edison. Go ahead, please.

Andrew Mitchell -- Edison Investment Research -- Analyst

Thank you. I'd like to start by asking about the -- you referenced the SEC concept release. I wonder if you could just give some sort of headline thoughts on that. I'm assuming that looking at the list of issues they've raised to be discussed, that this would be likely be sort of clearly upside from an OTC markets perspective.

But are there any potential threats? Are there any possible changes might give rise to?

Dan Zinn -- General Counsel

Thanks, Andrew. I think we look at it more as an opportunity to be able to put some of our regulatory agenda, put pen to paper on it for not only the SEC but of all the folks who are interested in the comment process there. The concept release itself, its targeted focus is on exempt offerings and how to harmonize that process and whether there need to be changes in how issuers are doing that initial capital raising. But it also, as you read through it, talks about secondary markets, what happened after those initial raises, which is often where we come in.

It references us with respect to what we've been doing with the states and how state law interacts with the federal law and whether changes need to be made there. So we're certainly gonna comment on those aspects of it. We're also gonna use it as an opportunity to maybe point out some additional improvements that can help the process from start to finish, from initial issuance and what kind of information is available to transfer agents and brokers and clearing firms, all the way through the secondary trading process and how brokers and others can feel comfortable working with these securities. So it really is, I think, more of an opportunity than identifying threat.

We will certainly take our claim to being the largest venture market in the world, the most successful venture market in the world and everything we do with exchange graduates and the like. And make sure that when the SEC is making these decisions, even thinking just about exempt offerings, but really considering what the downstream process is gonna be like for investors.

Cromwell Coulson -- President and Chief Executive Officer

And Andrew, this is Cromwell. The other point I'd like to say is it is a fantastic concept, really. It's very well written. Kudos to the SEC staff and Jay Clayton for getting these ideas out there, because these ideas are gonna be worked on for the next five to 10 years by securities regulators.

So nothing is gonna move quickly, but it's really getting out into the public debate and the opportunity of making markets and capital formation work in between the private markets and the public markets. And for those, we do -- we are a very competitive bridge between those two places, and we're also a great destination for smaller companies. So for us, it's gonna allow us to really start working on where the areas and securities regulation that needs to be modernized so investors have better information, and capital markets are more transparent and efficient. And those really line up into the things we've been working with private market forces for a long time.

So we look at it as a great opportunity to be in the room with regulators talking about how to create better informed and more efficient markets.

Andrew Mitchell -- Edison Investment Research -- Analyst

So thanks very much. A couple of questions on just trends in client numbers in OTCQX and QB. OTCQX seems to be going well, and particularly, traction on the international companies. I think you indicated that Cannabis companies are an important element recently.

I'm just wondering, I mean, presumably looking ahead, you'd expect a broader, sort of, type of -- or the type of companies to flow through. And then on OTCQB, where the trend was less positive. I mean, is that really, as far as you can tell, primarily a reflection of market confidence that you note the reduction in Form 211?

Bea Ordonez -- Chief Financial Officer

Sure, Andrew. So I'll talk about OTCQX first. I mean, look, we've had some good tailwinds in this market for a while, which is encouraging. You highlighted two of them.

I think, in general, there are more and it is a broad and diverse market, and that bodes repeating, both in terms of the industries that these companies are engaged in and the geographical location and so on. But as with any market, there are seasonal forces and cyclical things that drive a particular sector to be more or less important over time. Historically, mining and resource companies might've been a significant driver of growth. And right now, we're seeing certainly growth on the global side, which is something we are both very happy about and also striving for, hence, our office in London, hence our efforts to really position ourselves as a great alternative for global issuers to access the U.S.

capital market. Cannabis is a driver, look, it's a growing sector that has a lot of investor interest, and we continue to see that interest driving issuers to the market here and even Canada, as well as elsewhere, and driving investors to want to look at that sector. So we're seeing that growth as well. And there are other areas, as we look at some of the biotech companies in Europe, other markets and submarkets globally that produce sort of technology-type issuers and sectors that are very well suited to benefit from access to the market and the very cost-effective access that we can provide through an OTCQX listing.

In terms of OTCQB, look, it was a very small contraction quarter over quarter. There can be some significant seasonality around some of the trends there, it can be from the filing deadlines around calendar year filers, driving both companies and issuers in general to be sort of less focused perhaps on the process of applying and much more focused on their SEC filing obligations and so on. So we can see adds and dips and pick up --

Operator

This is your operator. I think we have just had a technical issue there.[Technical difficulty]

Sorry for the interruption today. Please go ahead then.

Bea Ordonez -- Chief Financial Officer

Hi, Andrew, it's Bea. I was in full flight, but I have no idea. We had some technical difficulties and got disconnected from the conference host. So maybe you could tell me, Andrew, at what point you lost us?

Andrew Mitchell -- Edison Investment Research -- Analyst

Yeah. I think you were just highlighting the sort of seasonal bumpiness in the QB, which -- new companies arriving and so on that might affect that.

Bea Ordonez -- Chief Financial Officer

Got it. Great. OK. So you heard everything on QX.

So I wasn't speaking for too much longer. So yeah, on QB, as you know, I think seasonal bumpiness is a good way of talking about it. And with these sort of absolute numbers, it doesn't take a lot of bumpiness to show. Sort of, in percentage terms, a somewhat significant variance.

And we do see it sort of fluctuate from time to time. On the 211s that you noted, again, yeah, I think it's a factor of sort of the market as a whole, of how brokers are operating within that market, where they see opportunity, where they see investor demand, in particular companies, where they're at in terms of the number of names they might already be making a market in and so on. And all of those factors can drive sort of the up and down of 211 filings quarter over quarter. So I think all of those things can contribute.

But overall, it was a very small contraction. And in the context of price raises last year, we're very comfortable and happy to see that our voluntary nonrenewal rate has stayed very constant versus that. It show sort of the stickiness of the product and the value that it should see in that product. And overall, we're seeing that it's -- we established a good product fit in that sense.

Andrew Mitchell -- Edison Investment Research -- Analyst

OK. Thanks very much. The point you're making about the 211 and broker dealers that likely make this -- wondering that probably applies to the reduction in the things like new erosion in the number of Link ATS participants in the quarter? Or is there any sort of particular company circumstances that have led to that reduction of sevens and 90?

Dan Zinn -- General Counsel

Yeah. Andrew, this is Dan. I think you should think about those things on separate tracks. The determination for a firm to file a Form 211, where a company is gonna be based on a number of maybe internal factors at the broker-dealer, what's going on the regulatory environment, what types of issuers are potentially in line for that kind of filing in a given quarter, whereas the other numbers you're citing with respect to subscribers are really the result of the continued long-term trend that we're seeing of some consolidation in the market.

We still are in a place where firms that are active in the OTC equity space continue to be subscribers to our ATSs. It's just the question of seeing where that goes in terms of the industry generally. But again, those things are really both important, but you should think about them separately.

Andrew Mitchell -- Edison Investment Research -- Analyst

Yeah. Sure. And the final question was the -- you cited the -- I think one of the reasons for the capex in the quarter that looked relatively high from my perspective, you cited the investments -- ongoing investment in the data centers. On a medium-term view, I mean, presume that that wouldn't have changed, that would be running at a somewhat lower level on an annual basis.

Bea Ordonez -- Chief Financial Officer

I'm sorry, Andrew. I don't quite follow it. Is your question, would we expect this to recur on an annual basis or ---

Andrew Mitchell -- Edison Investment Research -- Analyst

Effectively that -- whether your longer-term view of likely capex trend has increased perhaps because of the opportunity to spend money sort of profitably or is it the timing of -- spend on data centers and so on has meant that it's running a bit higher than maybe we are, so I might have expected.

Bea Ordonez -- Chief Financial Officer

Right. Now it's very much the latter. And I think we touched on this in our Q4 discussions when we close out 2018. But again, there's some lumpiness in that capex.

If you look at sort of the overall trend, there's a level of maintenance capex that you can discern just from sort of our financials over the years. And then there's sort of lumpiness that occurs every now and then around specific needs or project 2019, and I think we did flag this going into 2019 certainly. We knew we had to move, and that that was gonna entail some very significant capex spend on leasehold and other improvements. And we also knew that we had a data center refresh around just hardware and infrastructure i.e.

switches, servers and so on. That is something that, obviously, we don't do annually, but which, as we sort of go through the life cycle of that kind of equipment, we get to a point where it's a project that needs to be undertaken. So that hit this year. We're gonna sort of power through that project.

And when we come out the other side, we'll be in a much better place. And we should be looking at sort of closer to maintenance levels of capex on a go-forward basis.

Andrew Mitchell -- Edison Investment Research -- Analyst

Thanks very much.

Operator

Thank you. There are no further questions at this time. I would like to turn the floor back over to Cromwell for closing remarks.

Cromwell Coulson -- President and Chief Executive Officer

Thank you all for joining today. I hope you'll take the time to read through our quarterly report in more detail. We appreciate the opportunity to share insight into our performance and the trends and risks we expect to impact the company prospectively. We are excited to continue to execute our strategy and build shareholder value over the long term.

On behalf of the entire OTC Markets Group team, thank you for your support.

Duration: 39 minutes

Call participants:

Dan Zinn -- General Counsel

Cromwell Coulson -- President and Chief Executive Officer

Bea Ordonez -- Chief Financial Officer

Chris McGinnis -- Sidoti and Company, LLC -- Analyst

Andrew Mitchell -- Edison Investment Research -- Analyst

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