Dan Zinn - General Counsel, OTC Markets Group Cromwell Coulson - President and Chief Executive Officer Bea Ordonez - Chief Financial Officer

Chris McGinnis - Sidoti & Company Andrew Mitchell - Edison Investment Research

Thank you, operator. Good morning and welcome to the OTC Markets Group second quarter 2018 earnings conference call.

On 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 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 2017 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 will turn the call over to Cromwell Coulson.

Cromwell?

Thank you, Dan. Good morning and thank you everyone for joining the call.

I will cover some important second quarter milestones and discuss our initiatives tied into our mission and strategy. Our mission is to create better informed in 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.

Our mission, strategy, and company values guide us as we focus on improving our technology platform in our data driven products providing value to our clients, creating growth opportunities for our team, and delivering long-term value for our shareholders. For the second quarter we again delivered solid 7% growth in top-line revenue broadly in line with our performance in the first quarter and in 2017.

All three of our business lines contributed to this growth. Notably our corporate services business achieved its first ever $6 million revenue quarter.

This is a clear demonstration of the value our OTC-QX and OTC-QB markets offer to companies and their shareholders. Bea will cover our results in more detail in a few moments.

On the regulatory front we continue to focus on gaining additional regulatory recognition for our markets, advocating for rule modernization and of course, being a strong voice for small company capital formation. Since our last call, we had Minnesota to our blue sky map.

With Minnesota OTC-QX is now exempt from secondary trading rules in 31 States while OTC-QB is exempt in 28. Michigan, Oklahoma, and Missouri are also in the process of adopting rule proposals recognizing our OTC-QX and OTC-QB markets.

On a national scale, NASA the National Organization of State Securities Regulators released a proposed model rule recognizing OTC Markets Group and the securities manual with respect to all OTC-QX and OTC-QB companies. NASA's support of state regulators recognizing our premium markets for providing investors with current information about securities is an important step towards our goal of national blue sky recognition.

Our success in the regulatory arena is a direct result of our corporate services teams' hard work to build better public markets. While we incentivize company disclosure across all securities the data-driven standards of OTC-QX and OTC-QB create efficient, transparent, and cost-effective public trading.

It works for companies, brokers and investors. In that light our transfer agent verified shares program which brings transparency and reliability to companies share data also reach a new milestone that during the quarter.

22 transfer agents now participate in the program providing investors with current share information on over 85% of domestic OTC-QX and OTC-QB companies. Our stock promotion in [indiscernible] continue to gain acceptance across the industry and our compliance efforts have garnered positive coverage for the financial press.

In keeping with our disclosure based philosophy we want to maximize market forces by increasing the data available in every security traded by broker dealers. These flags provide valuable transparency into areas of risk.

It can impact market pricing and investment decisions. We continue to see impressive growth in the number of clients using our enhanced market data products including the stock promotion file and compliance analytics products.

These tools provide broker-dealers, investment managers and compliance professionals with the data they need to streamline processes, identify operational risk and better address market wide challenges.

We recorded another quarter of 100% up-time of our core OTC-link ATS systems during trading hours. We are able to publicly announce this achievement every quarter because of the dedication of our entire team.

Systems reliability remains a top priority. Finally, I'm pleased to announce the last week our board of directors declared a quarterly dividend of $0.15 per share payable in September.

The announcement of our 39th consecutive quarterly dividend and increased to $0.15 per share reflects our ongoing commitment to providing superior shareholder returns. With that I will turn the call over to Bea.

Thank you Cromwell and thank you all for joining the call. I will now spend a few minutes reviewing our results for the quarter ended June 30, 2018.

Any reference made to prior period comparatives refers to the second quarter of 2017. I will start on Slide 7 of the earnings deck.

For the second quarter of 2018, OTC Markets Group generated $14.8 million in gross revenues up 7%. Our corporate services business generated revenues of $6.1 million representing 42% of the total revenues an up 7% versus the prior period.

Revenues from our OTC-QX market were up 5% with stronger year-to-date sales and a decline in the number of downgrades partially offset by an increase in exchange graduates and a small decline in our renewal rate for 2018 all contributing to an increase in the number of companies on the market. In respect to our OTC-QB market strong sales during 2017 and reduced churn in the second half of 2017 resulted in a higher number of companies on the market at the beginning of 2018.

While on quarter today and year-to-date basis we have generated moderately weaker sales and experienced an increase in the number of downgrades. Overall, we have seen an increase in the number of companies on the OTC-QB market as of June 30, 2018.

This coupled with price increases for new and renewing subscribers drove an 11% increase in related revenues. Market data licensing revenues were $5.8 million for the quarter representing 39% of the total and up 6% versus the prior period.

Price increases affected the 2018 and impacting certain end of day pricing and data file products coupled with increased usage of our data file products including our suite of compliance products with the primary drivers of a 21% increase in related quarter-over-quarter revenues. Revenues from non-professional users of our market data were up 7% while revenues from professional users were flat versus the prior period.

OTC-link generated revenues of $2.8 million or 19% of total revenues for the quarter up 12% versus the prior period. Increased volatility and generally higher U.S.

trading volumes help drive a period-over-period increase in the volume of messages on our platform and a 14% increase in related revenues. Our OTC-link ECN contributed growth revenues of $227,000 for the quarter.

These increases offset reduced subscription based revenues resulting from continued those slowing contraction in the number of users of our OTC-link ATS. Launched in December of 2017 the services offered by our ECN are designed to be complementary to our existing offering.

Since launch we have added eight new subscribers enabled 27 of our legacy subscribers and had seen a consistent increase in trading volumes executed on the platform. Turning now to Slide 8.

During the second quarter operating expenses increased 9% to $9.1 million. The primary driver was a 12% increase in our compensation costs.

Increased headcount, annual salary raises, including an additional 3% raise awarded to all employees following the 2017 tax reform an increase in 2018 incentive bonuses is crude as well as an increase in stock compensation expense all contributed. Our information technology cost declined 5% in the quarter to $1.4 million.

The decrease is primarily related to the elimination of certain blue sky data costs as well as a renegotiation on more favorable terms of our contract with [Morningstar]. This was partially offset by an increase in software support costs for our OTC-link ECN and increased spend related to enhanced system security.

We saw a 49% increase in professional fees in the quarter largely related to one-time costs incurred in connection with evaluating and performing due diligence on a potential acquisition. We ultimately determined not to complete the acquisition in question.

While we continue to focus resources on organic initiatives a core component of our short-term to medium-term strategy involves evaluating potential corporate development opportunities and where appropriate committing capital and resources accordingly. Moving now to Slide 9.

For the second quarter income from operations was $5 million, up 4%. Net income for the quarter increased 28% a result of the increase in operating income combined with a drop in the company's effective tax rate from 36% in the prior period to 20% in the current quarter a result of tax reform legislation passed at the end of 2017.

In addition to certain GAAP and other measures management utilizes a non-GAAP measure, adjusted EBITDA which excludes non-cash stock based compensation. Adjusted EBITDA are increased by 2% to $5.8 million or $0.49 per diluted share.

You can find a reconciliation of our GAAP to non-GAAP results in our press release which is available on our website as well as in the appendix to the earnings presentation. Moving now to Slide 10.

Our subscription-based revenue model continues to produce strong and recurring operating cash flows. Cash flows from operating activities for the second quarter amounted to $4.4 million, an increase of $2.9 million over the prior period.

On a year-to-date basis cash flow from operations increased by $3.1 million to $6.2 million. We ended the quarter with $25 million of cash on hand and a strong balance sheet with no debt.

We continue to operate an investor focused capital allocation policy which returns cash to investors in the form of dividends and through our stock buyback program. Year-to-date we have returned $4.3 million representing 70% of our free cash flow for the same year to-date period.

We were pleased to announce our 39th consecutive quarterly dividend as well as an increase in that quarterly dividend from $0.14 to $0.15 per share. In closing we will continue to strategically deploy our cash flow and resources to invest in and enhance our product suite and grow our subscriber base both organically and potentially by strategic corporate development initiatives while always focusing on delivering strong capital returns to our shareholders.

With that I would like to thank everyone for their time and pass it back to the operator to open up the line for questions.

Good morning. Thanks for taking my questions and nice quarter.

If we could start maybe just around the blue sky recognition and how does the NASA change that for you going forward? How big of a development is that?

Can you maybe just expand on that a little bit more? Thanks.

Sure Chris. This is Dan and thanks for the question.

So it's big in that the rest of the states of the remaining states we haven't gotten yet really look to NASA for guidance in terms of what's accessible and what the baseline should be. So at this stage what's out there is a proposed model rule it's in a comment period.

Once NASA hopefully adopt that model rule then the individual states will have an opportunity to bring that into the fold of their own regulatory schemes and just from having worked on this for the past two years it's clear that there are a number of states that we're waiting for NASA to make some public statement about their acceptance of our market. So in that sense it's a really nice push forward.

The fact that it's going to be a model rule I think will ultimately lead to specific adoption of that rule but even more than that it's a public support of this initiative.

Great. And then second maybe just on the [Reg A] and does that being signed into law and now does that change that kind of end market for you and maybe just update us somewhere where [Reg A] is right now in terms of how you do that market overall?

Thanks.

Sure I think it hopefully changes that in-game force but a little bit of an indirect result. So right now the law is in place which was obviously a big first step and we're waiting to see exactly how the SEC implements that.

They need to go through some rule making processes on their side in order to bring this to fruition and then once you see this extended Reg A our feeling is what it has always been that on one hand it will allow a greater number of companies to partake in Reg A offerings which extends the pool and hopefully leads to more to those offerings winding up on our platform and then on another hand it also sheds a more positive light on Reg A as an offering tool because you'll see these may be more established companies or companies that have existing disclosure and existing history as public companies are taking it and so hopefully between those two there's a kind of a nice growth relationship and we see Reg A start to take off more. We will obviously report on what impact that has on our numbers going forward but again at the very least it's a nice baseline and first step towards really building that market.

Okay. Thanks Dan.

Appreciate that and then just one last question I'll jump back in queue. Just you mentioned possible acquisition.

Can you just talk a little bit about is it, was a complimentary of the business and how was that complimentary of the business possibly is it more services maybe just expand a little bit on that as well. Thanks.

Sure, let me talk in more general terms in terms of our corporate development initiatives and objectives again on a more general basis. So as we've mentioned I think in a couple of the earnings calls while we remain focused on organic initiatives and see a lot of opportunity there in looking forward we're definitely interested in looking on bolt-on type technologies that serve our subscriber base or have products and technologies that we can add to our suite that cover some of the same sectors and some of the same sort of areas of the market that we serve currently.

So some examples of that are products and technologies that obviously serve the issue space in particular with a focus that might serve the small to medium cap issue of space that would be an example of an area that we're focused in. So the particular target company that we were engaged with fit that mode and we were engaged with them for some period of time and performed some evaluation work and due diligence and ultimately didn't proceed with that for a number of reasons but that is certainly as I said something that we will continue to focus resources on and really looking to how we can expand the suite of our products and really create sort of more value for that subscriber base, more value for the clients that we already serve.

Great. Thanks for that.

Appreciate and I'll jump back in queue.

Yes. Thank you.

Good morning. So two areas of question just further one on the proposed model rule.

Do you have a timeframe for that consultation period? And then on the second area on OTC-link ECN where the revenue run rate around a $1 million a year.

So just wondering whether it's sensible to talk about what level would give you profitability on that but then I notice you also reference that to gain market share you'd have to be more aggressive on pricing funding whether that was a sort of indication that was the nature of the market or that something you actually planning to do because you do seem to be gaining position there as you stand.

Thanks Andrew. This is Dan.

I'll start with the question related to blue sky and then and then pass it over to Bea. So the model rule again the proposed model rule is in comment until I believe Monday of next week at which point NASA will kind of go back and consider the comments and run through their internal process before putting this out there as adopted model rule from the NASA standpoint and then in terms of timeline it gets even more difficult to sort of put a number on it as states have different – every state as I've learned very well has a different process for how and when they adopt rules like that.

So it's an ongoing process. Again now we're focused on the fact that there is a public pronouncement from NASA and then as every time there's a milestone during this process hopefully that also sheds a little more light on it in and has states focused on this a little bit more.

Hi Andrew. Thanks for your questions.

So in terms of the OTC-link ECN I mean in terms of profitability what we're all readily already modestly profitable in terms of that business we don't necessarily analyze right down to the product offerings but in terms of direct costs incurred to support and run that business and gain that volume we're already profitable in that business. As I called out I think in the Q1 as we sort of noted it's a relatively limited market, the OTC space in general is a small slice of the overall equity volume done in the U.S.

and it's a relatively limited market that we are looking to capture with one very notable large competitor in this space at least in regard to that particular operating model, and again as we called out we feel we're going to need to price compete somewhat to continue to gain traction and participants typically in this space of this kind of volume and this kind of trading are rather price sensitive at least some of the larger ones who have significant volume. So we think strategically it make sense to be a little more aggressive where that's prudent and where we think they will gain us traction with those particular subscribers and when we think that and make that determination we stand ready to do that in terms of our overall pricing and are confident that ultimately that will drive gains and allow us to continue to capture some of that share.

This is Cromwell. I just like to jump in that for the ECN what it's really allowing us to do is be a bit more pluralistic about different types of market structures and broker dealers desire and how do we knit them together in an efficient manner with the large pools of dealer liquidity in the space and how do we serve other types of broker dealer needs as well but at the end of the day the 800-pound [gorilla] is going to be market makers in the types of securities that are traded on our markets and so by adding an anonymous order book, electronic order book functionality that integrates well with the dealer liquidity we're expanding the tools and strategies that broker dealers can use to access different types of liquidity and the ECN is giving us a great learning experience on how to support what broker dealers desire to see in the space.

All right. Thank you and right now thinking that your main competitors has not changed their fee regime?

Fees in that space often change Andrew and I believe while I don't have it in front of me that there was a recent change in our competitors’ pricing but you'll find that Cromwell's point about really providing a model that works for subscribers and their specific kind of trading flow that folks in the space more generally and more widely who operate that kind of pricing model do tweak that pricing on a fairly regular basis.

Okay. Thanks very much.

And our competitor there are significant differences in how the order books function. So I would say it's not an apples for apples comparison of the functionality for a broker dealer.

Okay.

Thank you everybody for calling in for this quarterly call. I would like to wrap up with the points that we've been developing our OTC-QX best market and OTC-QB venture market offer many years of really setting standards by getting feedback from the market, and these markets are developing and had developed to a new stage say their functionality is almost fully baked and with that what that means is that we're not going to need to be changing the standards that much.

We've developed a market that makes it efficient and effective for global and U.S. companies to be publicly traded without being overly burdensome to a company's finances or management time.

And that's super important. So with NASA recognition and the continued establishment of market participants viewing OTC-QX and OTC-QB as established public markets that are efficient and effective we've really got a competitive alternative to the high cost legacy exchange model and that's going to be a lot of just getting more use of the network.

So thank you very much for calling in and we look forward to serving you to going forward. Thank you.