OTC Markets Group Inc.

Thank you for standing by. Welcome to the OTC Markets Group second quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you will need to press star 1-1 on your telephone. You will then hear an automated message advising you that your hand is raised. To withdraw your question, you can press star 1-1 again. Please be advised, today's conference is being recorded. I would now like to hand the conference over to your speaker today, Dan Vinh, General Counsel. Please go ahead.

Thank you, Operator. Good morning, and welcome to the OTC Markets Group's second 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.

Thank you, Dan. Good morning, everyone. Thank you for joining us today. I will discuss at a high level our financial results for the first half of 2023 and review our progress on our strategic initiatives. I will also highlight our areas of focus for the remainder of this year. Overall, gross and net revenues continued to increase this quarter, with each up 5%. Expenses remained elevated, leading to decreases in net income, earnings per share, and operating margin during the second quarter and the first six months of the year. Our acquisitions of Blue Sky Data Corp. and Edgar Online last year continue to be the greatest drivers of change in our financial and operating results. We gained revenue from each business and incurred expenses to acquire and operate that. The Blue Sky products and team are fully integrated into our platform and we continue to expand coverage and increase the client value proposition. Edgar Online, which closed last November, is still in the early stages of our stewardship. Robust data platform building or turnarounds are always multi-year projects. Onboarding the team, technology and subscriber base to operate within our ownership is a key milestone. This work will put us in a strong position to reconnect with customers, optimize the operations and commercialize future opportunities. The acquisition added several non-recurring transitional expenses that will decline as the year progresses. as well as ongoing operating costs. Over the next few years, we will thoughtfully integrate and carefully invest in the platform based on customer demand, operational efficiency, and competitive opportunities. In the first six months, financial markets saw a risk-off environment with lower overall market activity and trading volumes across the industry these dynamics highlight the strength of our diversified business model there are over 12 000 securities quoted across our otcqx otcqb and pink markets a key metric that many find surprising is that 75 of these securities are adrs and foreign ordinaries of international issuers generating almost 85% of the overall dollar volume on our markets in the first six months. We have become the market that connects the world's leading global companies with U.S. investors. Our expense drivers remain consistent, led by increased headcount, technology operating costs, and the edge or online technology transitions. Blue Sky Data Corp and Edgar Online are each part of our market data licensing business. As a result, market data led our business lines with 20% revenue growth in the second quarter and 23% growth for the first half of the year. Revenue from OTC Link and corporate services each declined for the quarter and six-month periods. Corporate services revenues were 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 news service, or DNS. Voluntary renewal rates for the OTCQX and OTCQB markets remained similar to prior years. The decrease largely stems from a combination of slower new sales and a subset of companies no longer able to maintain compliance with each market's rules and standards, each in line with broader economic trends. OTC link revenue decreased during the second quarter and the first half of 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 obligations seriously, including those under SEC regulation SCI, and we value the trust our subscribers place in us to operate our mission-critical systems efficiently and effectively. Based on the shifting trends across our business lines, For the second quarter, corporate services represented approximately 43% of our overall revenue, market data licensing accounted for 39%, and OTC Link accounted for 18%. Antonia will cover our financial results in more detail in a few moments. Throughout the year, I have discussed our five strategic initiatives for 2023. First, coming together as one team on one platform to build the value of one share. Earlier this year, our technology infrastructure and market data teams successfully completed the time-constricted move of Edgar Online's applications from a legacy physical data center to a cloud environment. As I've said, our daily work is on retaining enterprise clients and transitioning the current technology to a robust cloud environment. Once the team has addressed some pressing technical debts and done basic cloud optimizations, we will be able to shift our attention to the future. With the Edgar Online team meshing into the fabric of OTC markets, we are able to begin cross-training, providing support, and identifying what new levers to pull to improve the technology, enhance the products, and exploit commercial and competitive opportunities for our expanded data set across our business lines. Second, commercializing our role as a regulated market operator and delivering visible client value. Our investment in our regulatory efforts this year has led to our approval to conduct digital asset securities business and achieving blue sky recognition for our markets in north carolina the 40th u.s jurisdiction on our blue sky map third prioritizing client-facing application development and improving our data all of our work integrating the blue sky and edgar online data is setting the stage for new products to fuel our clients businesses and compliance engines In combination with our existing OTC equity data, we can expand the depth of services we offer, cover more securities, more companies, digitalize disclosure, and further distribute useful financial information. Fourth, improving OTC link functionality and reducing operational exposure and business risk. In early May, We received FINRA approval to permit digital asset security to be traded by broker-dealers on OTC Link ATS. While not an immediate revenue generator, we see a long-term opportunity as more digital assets move into entities regulated by the SEC and FINRA. Over the past several months, that approval has allowed us to begin discussions with firms across the industry, from broker-dealers to custodians to exchanges and ATSs. As lawmakers and regulators deepen their engagement in the digital asset space, we remain focused on providing value to brokers seeking to trade a wide spectrum of securities and to issuers wishing to demonstrate compliance and provide disclosure to the market. 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 capitalists, our last strategic initiative is creating strong net revenue growth and delivering sustainable profitability that increases long-term per share earnings. Our results in the second quarter and for the first six months of the year continue to show good top line growth. We are conscious of the impact of rising expenses on the value of each OTC markets group share. Our investments in recent acquisitions, as well as in our existing products and services, provide the fuel in the form of data. Our focus is to commercialize the data and add new capabilities that drive sustainable revenue growth that translates into greater operating profits and long-term earnings per share. I look forward to reviewing these initiatives and our strategic direction throughout the remainder of the year. In closing, I'm pleased to announce that on July 31st, our Board of Directors declared a quarterly dividend of 18 cents per share, payable in September. This dividend reflects our ongoing commitment to providing superior shareholder returns. With that, I will turn the call over to Antonia.

Thank you, Cromwell, and thank you all for joining our call today. I would like to start by thanking our entire OTC Markets team for their unwavering commitment to delivering reliable service and support for our subscribers, advancing the integration of the EDGAR Online acquisition, and continuing to drive our business forward. During the second quarter of 2023, the various macroeconomic factors that impacted our business earlier in the year continue to affect certain of our business drivers, including the number of companies subscribing to our corporate services offering. In addition, our results reflect a full quarter impact of the EDGAR Online acquisition, which closed in November of 2022. As I discuss our results for the quarter ended June 30, 2023, any reference made to prior period comparatives will refer to the second quarter of 2022. Turning to page 7 for review of our second quarter revenues. We generated $27.2 million in gross revenues, up 5% compared to the prior year period. Revenues less transaction-based expenses were up 6%. OTC Link's gross revenues were down 6% compared to the prior year period. OTC Link ECN and OTC Link NQB saw a 4% decline in transaction-based revenues, while transaction-based expenses decreased 8%, primarily due to lower trading volumes on OTC Link ECN and OTC Link NQB. OTC Link APS saw a 20% reduction in revenues from messages, and a 34% decline in QAP1 statement fees, respectively, also due to reduced trading activity on our market. Against this backdrop of declining volumes, our team continued to grow the number of subscribers, and LDC Link ECN finished the second quarter with 104 subscribers, up from 101 at the end of the prior year period. OTC Link ATS has 88 subscribers unchanged from June 30, 2022. Trading volumes are highly unpredictable and could vary significantly period to period. Revenues from our market data licensing business were up 20% quarter over quarter, primarily due to the full quarter contribution of Blue Sky Data Corp and Edgar Online, which we acquired in 2022. Excluding the impact of the acquisitions, market data licensing revenues were up 4%. Pro user accounts were up 3% with the corresponding revenues up 2%. Revenues from internal system licenses, delayed data licenses, and other data services increased 11% due to growth in subscribers and price increases for certain licenses. Revenues from market data connectivity fees increased 58% as a result of pricing adjustments. Offsetting these increases was a 29% decline in revenues from non-pro users, driven by a 26% reduction in period and non-professional user counts. 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 our markets fluctuate. and we may experience a further decline in the future. Our preservatives revenues decreased 2% in the second quarter. OTCQX revenues were up 5% benefiting from incremental price increases effective for 2023 and a slightly higher average number of companies on the OTCQX market, despite a lower ending number of subscribers. OTCQB revenues declined 3% and DNS revenues decreased 7%, respectively, due to a lower average number of subscribers, offsetting the impact of pricing adjustments. In the second quarter, we added 23 OTCQX companies compared to 43 new sales in the prior quarter. We had 587 OTCQX companies as of June 30, 2023, compared to 594 as of June 30, 2022. For the annual OTCQX subscription period beginning January 1, 2023, we achieved a 95% retention rate compared to 96% in the prior year. On OTCQB, we added 49 new companies in the second quarter, compared to 64 in the prior year period. and had 1,191 OTCQB companies at the end of the quarter, down from 1,227 at the end of June 2022. We had 1,553 pink companies subscribing to GNS and other products at the end of the second quarter, down 4% from 1,617 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 six months of 2022 began to reverse in the third quarter of 2022 and remained at lower levels during the first six 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 non-renewals in the case of OTCQB and DNS. Turning now to expenses on page 11. On our quarter-over-quarter basis, operating expenses increased 16%. The primary drivers of expense growth were an 18% increase in compensation and benefits a 46% increase in IT infrastructure and information services costs, and a 25% increase in depreciation and amortization. The increase in compensation and benefits reflects higher headcount, including employees from Edgar Online, annual base salary increases, and an increase in cash and stock base incentive compensation, partially offset by lower commission. Compensation and benefits comprise 63% of our total operating expenses during the second quarter compared to 62% in the prior year period. IT infrastructure and 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. Depreciation and amortization increased primarily due to amortization charges related to intangible assets and software added in connection with the Blue Sky Data Corp and the Edgar Online acquisitions, respectively. Turning to page 12. In the second quarter, income from operations and net income declined 10% and 6%, respectively. Operating profit margin was 31.4%, compared to 36.7% in the prior year quarter. In addition to certain GAAP and other measures, management utilizes adjusted EBITDA, a non-GAAP measure which excludes non-cash stock-based compensation expense. Our adjusted EBITDA was 10.4 million in the second quarter, and our adjusted daily earnings per share were 86 cents, down 3% and 2% respectively compared to the prior year period. Cash flow from operating activities amounted to $4.7 million compared to $7.1 million in the prior quarter. Free cash flows for the quarter were $4.4 million compared to $6.4 million in the prior quarter. Going to page 13. During the second 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 proven stewards of shareholder capital, 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.

Thank you. As a reminder, to ask a question at this time, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. One moment while we compile our Q&A roster. Our first question is going to come from the line of Steve Silver with Argus Research. Your line is open. Please go ahead.

Good morning, and thanks for taking my question. I've got a bigger picture question about the macroeconomic impact on the company. In past economic cycles, have you been able to identify any economic signals that may have foreshadowed a return of retail and nonprofessional participation into the market? I'm just trying to get a sense of as lower inflation begins to work its way through the system and some of the recession talk has calmed, whether you see this as a potential catalyst over the coming quarters or whether you might think that the higher interest rate environment is a little more limiting here. for both retail and for borrowing costs that might be impacting QX and QB compliance, as well as DNS subscription. Thanks.

Thank you for the question, Steve. I wish I had those superpowers. I would be running a risk-on business of a prop trading business instead of a transaction processing business if those superpowers existed. I'm You know, I look at it, I'm very lucky that markets were much more cyclical in the 60s, 70s, 80s. And you would see these trends go where everybody was fantastically smart, making tons of money. And then everybody was incredibly depressed and except only half the firms were still around. And the main goal is you'll do fine in the good times. Just make sure you have a business where you survive through the slow times. And, you know, when we first went to take this business electronic, the mentors at the large NASDAQ market makers who wanted to drive this business forward, both from a technology, from a connectivity and connectivity, and then a regulatory improvements approach. you know, came from that world of carefulness. And so usually when people are pretty depressed and it looks bad, it gets a bit worse. And then, and then when it feels really terrible, it starts to get a little bit better and you live in. And, you know, so, so I see every one of our business lines has some cyclical clients, parts of skews, and then some, and then some skews that are stickier that will, that stay around. And that part is the upside of the cyclical ones is they explode up based on the economic cycle and you look like a genius. Then the upside, the stickier ones are they're much harder to sell. They're these enterprise firms that you're having to bring on. And it's across all of our business lines, whether it's bringing on a new electronic trading firm into one, two, or three of our ATSs, whether it is – but that market participant is going to be sticky until they go out of business. When it's signing up a larger mid-class global company or a community bank is – those are long sales cycles, but it's a sticky business, and market data – You know, we have some businesses which are very sticky, and then we have some parts which we've been grinding out past is you can see of individual, you know, SKUs that they're more cyclically tied. But it's fine. And, you know, we just want to run a business with an acceptable margin that we can keep moving forward and be careful. And we also don't have the volatility of, of a business that's all about the cycle. I mean, I don't know how I'd sleep at night if I was a car dealership with a lot full of cars at some parts of the different cycles that I've seen over the last 30 years. So does that answer it? I know you wanted special expertise, but I'm not. I just put it into our perspective. I built this business with a philosophy that I didn't want to put our clients, our shareholders, and my fantastic colleagues at OTC Markets in danger that if we mistime the cycle, we're gone.

No, that makes perfect sense. And obviously, visibility is very limited. So congratulations on the continued execution in some challenging markets.

Yeah.

Thank you. Thanks.

Thank you, and one moment for our next question. Our next question is going to come from the line of Brendan McCarthy with Sudoti. Your line is open. Please go ahead.

Great. Good morning, and thanks for taking my question. I'm wondering if you can comment on the QX and QB markets, the sequential decline there. And I know you mentioned the decrease stems from lower new sales and compliance downgrades. Is there a specific industry or sector, those downgrade they're coming from? Or is it primarily international companies there?

It's, I would say, Brendan, thank you for the question. It's really a flux of you've got companies coming on. In this environment, they don't move as rapidly. But then you also have, and we see it in the exchanges too. We see it on international exchanges. It's at the the the the less well capitalized end of the spectrum so there's a real flux that's going down and you know a company doesn't meet qx they move to qb a qb company doesn't it doesn't meet qb they they move to our our dns service and this is not just Going to us, I mean, last time I looked, NASDAQ had 700 companies that were not in compliance with their listing standards for various reasons. So this part of the cycle is it's painful to watch things happening that you have no control because we can't say, oh, you don't meet our standards. Stay around anyway. on our premium markets, or capital is becoming more careful. But over the long term, every time we've come out of one of these cycles, and I'm going to make myself sound really old, but each cycle, whether it was the 2001 cycle or the 2008 cycle, each one of these cycles, I can't even say that the COVID cycle was hard for financial markets rather than just two weeks. But we've come through each one stronger. And that's the part is you have to be careful going in, but keep investing in the business, improving the platform, because there's a shakeout as capital consolidates around more businesses that are more capital-friendly.

And, Brandon, I will point out that we're still very pleased with the voluntary renewal rates we have been observing for QX and QB. They have remained consistent with our historical experience and at a solid level. But the economic environment is challenging for some of our companies that are younger or less capitalized, as Pramod pointed out, and will have to live through the cycle. and come out on the other end strong.

And that puts, you know, as I spoke about the dollar volume and number of securities that is ADRs and international securities, global markets are growing. More companies are going public around the world. More investment opportunities are taking place. And they will, you know, hopefully, because I have children, this trend will go forward for a long time of globally capitalism and public markets improving, you know, consistently improving and growing. So that's, you know, that's our long-term bet. Short-term, we don't control a lot of the levers that drive that.

Great. Thank you. That's very helpful. And I know you mentioned the voluntary renewal rate. I guess what is that or how is that defined specifically?

So, for QX, as you know, we renew once per calendar year in the usually fourth quarter of the year preceding the renewal cycle. The rate is measured as renewals versus those who are up for renewal. and that was 95% for the renewal year starting January 1st, 2023. That was compared to 96% the year before. For QB companies, similarly, we measure it as percent of actual renewals versus those that are after renewal, but those renewals happen every month on the anniversary of when companies have joined our QB market, so it's more of a rolling basis. And there we have had 90% plus renewal rates for quite a while.

And, Brendan, maybe sometimes it's easiest to understand in contrast to what it's not. So think about voluntary renewal rates as those who remain in compliance with the standards of each market, who are choosing whether to renew, as opposed to those who are noncompliant. And to Cromwell's point, we are forced to remove from the markets. That's really the difference.

Got it. That's very helpful. Thank you. One more question. I know I actually asked this question last call, and I know it's, you know, difficult to answer, but regarding the integration of DOL, I guess, you know, what, you know, as far as the timeline, what percentage are you able to, you know, quantify what percentage you are through the federal integration process?

So integration is a big word. You know, I would much more like this year, it's really about shifting and stabilizing the status quo of the business within our core technology operational environment. It is, you know, EOL is not the majority of revenue for market data. And it takes a lot of work to do this move, go through, have quick conversations of retaining, discussing. And we've got a small team on the ELL team of developers, and we've put a lot of resources corporate resources across of moving, setting things up, going through it. It's been fantastic for people to learn and understand it. But we're very early days. There's a bunch of different levers to make these products, all of these different data sets successful. But the commercial and the competitive forces, we don't fully know yet. So we're going to learn. We're going to hopefully get pulled forward by some of the clients, and then the opportunities to mix our two data sets. And then finally, there's a lot of interesting technology pieces. But we don't know which pieces are there. You know, the EOL platform has run very well for 20-plus years. Some of the pieces don't need to change. other pieces instead of using core proprietary technology there's great advantages we can pull from using competitive commercial products that are coming out or a lot of these products to do it are even commodity every cloud service provider has it and but that how we do it it takes time on the developers to remove and refactor and use the new products. Internally, I talk about when you're restomodding a car, you just make sure the axle's in good shape. You're probably going to make sure the engine block is not rusty and it's big enough for what you want to do, but you're going to replace the carburetors with a modern fuel injection system and you're going to make sure the body is in good shape. So those are the pieces we're going to do. But this is really going to be, you know, a three to five-year project. We're not rushing. We're not trying to chop away every expense because we don't really know where the best levers are going to be. And if we execute really well, As we commoditize some of the data sets of used commodity technology to automate some of the data sets, there's other interesting data sets that these teams who have the business understanding can start collecting. But it's really going to be pulled by customers and what's the competitive opportunity and where do we have skills, and that's early days. Anybody who comes in with just a blind vision that they're not going to change as this moves along, this deal won't work that way. Blue Sky, on the other hand, is a fantastic deal that we quickly integrated. We transferred all the clients, and we're expanding the coverage. and the value to clients. But those kind of deals are much harder to find. And the strength that we get from EOL is going to let us buy other ones. But we're not going to rush.

Got it. That makes sense. That's all from me. Thanks for taking those questions. Thank you, Ben.

Thank you. And I'm showing no further questions at this time. And I would like to hand the conference back over to Caramel Coulson, Chief Executive Officer, for any further remarks.

Thank you, operator. I want to thank each of you for joining us today. I would encourage you to read our full second quarter report and the earnings press release. Links to both are available on the investor relations page of our website. On behalf of the other team, we look forward to updating you on key initiatives that continue to shape the integrity and competitiveness of the public markets.

This concludes today's conference call. Thank you for participating. You may now disconnect.