Spok Holdings, Inc.
Q4 2020 Earnings Call Transcript

Published: 18 Feb 2021

[Operator:]

Good morning, ladies and gentlemen, and welcome to the Spok 2020 Fourth Quarter Investor Call. Today's call is being recorded. On line today, we have Vince Kelly, President and Chief Executive Officer; Mike Wallace, Chief Operating Officer and Chief Financial Officer. At this time, for opening comments, I'd like to turn the conference over to Mr. Wallace. Please go ahead, sir.

[Michael Wallace:]

Good morning. Thank you for joining us for our 2020 fourth quarter and full year investor update. Before we discuss our operating results, I want to remind everyone that today's conference call may include forward-looking statements that are subject to risks and uncertainties relating to Spok's future financial and business performance. Such statements may include estimates of revenue, expenses and income as well as other predictive statements or plans, which are dependent upon future events or conditions. These statements represent the company's estimates only on the date of this conference call and are not intended to give any assurance as to actual future results. Spok's actual results could differ materially from those anticipated in these forward-looking statements. Although these statements are based upon assumptions that the company believes to be reasonable, they are subject to risks and uncertainties.

[Vincent Kelly:]

Thanks, Mike, and good morning, everyone. Thank you for joining us on today's call. Before I get started today, I just want to acknowledge that we are still in the midst of a global pandemic. Many of us have been sick, lost loved ones, have been otherwise adversely impacted by this crisis. And most of us are still waiting for a vaccine for the world to return to some sense of normalcy. The pressure and stress have fallen disproportionately on health care clinicians and staff. At Spok, we understand that and appreciate the sacrifices and commitment that caregivers continue to exhibit in the service of their fellow humans. We want to thank them for what they do each and every day. We were encouraged with our performance in the fourth quarter of 2020 and believe that the momentum generated by our team in the second half of the year positions Spok for sustained improvement in 2021 as we continue to market and sell our new cloud-native and integrated communications platform, Spok Go. Despite the many challenges that we encountered last year,as the result of a once-in-a-century global pandemic, our team was able to stay on task and focused breaking a 5-year record for selling new console licenses, helping our existing customers set up remote call center capability during the initial onset of COVID, and booking Spok Go deals in the second half of the year while building the pipeline into 2021. But before we get into the details of the quarter and the full year, I want to underscore where we are strategically with respect to our business plan and outlook. As we enter the new year, we believe we are poised to positively impact the healthcare landscape through our strategy of offering an integrated, cloud-native platform for mobility, clinical alerting, workflows, and contact center solutions. The Spok Go platform announced early last year was developed on the foundation of a single, best-in-class architecture built on a cloud-based, software-as-a-service or SaaS delivery model. Clearly, we were challenged with rolling out a new platform right as the pandemic struck. In fact, the timing of COVID-19 could not have been worse for our plan to introduce a new solution. However, we don't believe that changed the long-term potential for Spok Go. Sales and revenue will ramp up over time as the pandemic recedes, and the vaccines are more widely distributed. Based on customer feedback and our evaluation of the competitive environment, we believe we are on track for long-term success and value creation that will reward all our constituents.

[Michael Wallace:]

Thanks, Vince. Before I review our financial highlights for the fourth quarter and full year 2020, I would again encourage you to review our 2020 Form 10-K, which we expect to file later today, since it contains significantly more information about our business operations and financial performance than we will cover on this call. As Vince noted, 2020 was a challenging year for Spok from both a management and operational perspective as we continue to feel the profound impact that the global pandemic has had on our business and our customers. However, we believe that the operating environment continues to strengthen, and we were generally pleased with our overall performance in the fourth quarter as it clearly demonstrates the continued improvement from the first half of last year. As such, we believe that Spok's performance over the last 2 quarters of 2020 provides us with momentum as we head into the new year. While we are not satisfied with revenue levels last year, significant progress is made in meeting our long-term business goals. Sustained levels of software revenue in the second half of 2020 and continued record low attrition of wireless revenue, combined with continued focus on expense management, resulted in net cash provided by operating activities of $26.2 million. This was partially offset by investing activities of $14.8 million, specifically for capital expenditures and capitalized software development costs during the year. Spok was able to achieve this performance as we continue to return cash to our shareholders in the form of quarterly dividends of $9.8 million while also investing in our business for long-term growth. Our balance sheet remains strong with a cash, cash equivalents and short-term investment balance of $78.7 million at December 31, 2020, and we continue to operate as a debt-free company. We believe this provides us a solid financial platform as Spok is well positioned to execute against our long-term goals in 2021 and beyond. In the interest of time today, I will not review our fourth quarter and full year 2020 income statement on a line-by-line basis since much of that information is contained in our earnings release tables and SEC filings. However, to the extent you have specific questions about our quarterly financial results, I would be to glad address them during the Q&A portion of this call. Rather, I want to focus this morning on 4 specific areas. These include revenue, operating expenses, a brief review of our balance sheet and our financial guidance for 2021. With respect to revenue in the fourth quarter of 2020, total revenue of $37.5 million was in line with the prior quarter and down from $39.5 million in the fourth quarter of 2019. Full year 2020 revenue of $148.2 million was down 7.6% from revenue of $160.3 million in 2019. However, nearly 40% of the year-over-year decline was due to the expected erosion of the wireless revenue portfolio with the balance due to the impacts of the pandemic on our software business. Looking at software revenue. Total fourth quarter revenue of $17.2 million showed continued sequential improvement and was up from revenue of $16.9 million in the prior quarter and slightly lower than the revenue of $17.9 million in the fourth quarter of 2019. The decrease in software revenue for the quarter on a year-over-year basis was primarily due to lower license and associated equipment revenue. This was a result of lower software operations bookings and the mix of those bookings being more heavily skewed towards professional services. On average, professional services are recognized over 6 to 12 months as work is performed, whereas license bookings are generally recognized in the same period they are sold. And equipment bookings are recognized several months thereafter, both upon transfer of control to the customer. Regarding professional services revenue, again almost exclusively related to our legacy products, revenue was slightly down with the fourth quarter of last year but increased steadily during 2020 as our ability to access our hospital customers to perform implementations were impacted by COVID restrictions and travel prohibitions, primarily in the second and third quarters. However, we have been pleased by our team's ability to adapt and determine methods to deploy our solutions almost entirely on a remote basis at this point. And lastly, software revenue in the fourth quarter was supported by maintenance revenue of $9.9 million. This included approximately $250,000 of catch-up revenue discussed in last quarter's earnings call from a government renewal that was delayed. This drove an approximately 4% increase in revenue compared to the quarterly average in the first 3 quarters of 2020. Maintenance continues to provide a foundation under our legacy software business and is significant to maintain as we ultimately transition existing customers of our legacy products to Spok Go over the next several years. For the full year 2020, we saw the same dynamics just mentioned play out with respect to software revenue. We saw significant improvements in all categories of software revenue during the second half of 2020 as compared to the first half and the onset of the pandemic. However, we were not fully operating at pre-pandemic levels during the fourth quarter of 2020 and fully expect to see some level of continued impact from the pandemic as we enter 2021. Also included in software revenue in the fourth quarter, albeit small, was $41,000 in subscription revenue from our cloud-native Spok Go platform with bookings of $255,000 in total contract value, or TCV, with annual recurring revenue, or ARR, of $55,000 and average contract life of 2.3 years. In aggregate, Spok Go bookings for 2020 were $1.1 million in TCV with ARR of nearly $300,000 and an average contract life of approximately 2.7 years. In conjunction with our Spok Go transactions, the company provides minor implementation services by our professional services group, especially when compared to our legacy on-premise business model, and that is included in the respective total contract value. These implementation revenues are included in the services line of our detailed revenue tables. Wireless revenue for the fourth quarter remained strong, declining by only 2.5% from the prior quarter. And for the full year, wireless revenue was down a record low 5.2% from 2019. These results reflect another impressive performance by our sales team to again generate wireless gross additions while minimizing churn and maintaining stable unit pricing. Our wireless business, along with the maintenance component of our legacy software business, continue to provide a cornerstone as they represented, in aggregate, more than 82% of total revenue in 2020 and allow for the ongoing development efforts of the Spok Go platform. Turning to operating expenses. For the full year 2020, adjusted operating expenses, which exclude depreciation, amortization, accretion, goodwill impairment and includes capitalized software development costs, totaled $148 million, down more than 6% from $158 million in the prior year. This performance primarily reflects increased efficiencies and expense reductions in general and administrative costs as well as the impact of employee furloughs. Year-over-year reductions in all expense categories was critical in our ability to drive positive free cash flow in an extraordinary year by all measures while continuing our Spok Go development spend at levels expected prior to the pandemic. Similar to previous years, during the fourth quarter of 2020, we performed our annual assessment of goodwill as of October 31. Based on that assessment, using a short-term moving average of our stock price and given the decline in the market value of Spok's common stock that resulted in a 52-week low in mid-October, it was determined that the carrying value of the business exceeded the estimated fair value of the company, resulting in an impairment. However, this impairment in no way reflects management's confidence and the future value of the business. This assessment is based on the company's market value as of a particular point in time. Now unfortunately, that point was in October. And as previously mentioned, the price of Spok's common shares hit a 52-week low. With the recent increase in Spok's market value over the past several months, had the assessment been performed using our stock prices during 2021, it is likely that no impairment would have been necessary. Additionally, in the fourth quarter, we completed our annual assessment of the recoverability of our deferred income tax assets which represent the tax benefits of future tax deductions. This assessment is required to determine whether it is "more likely than not," but all or some portion of the deferred income tax assets will be realized in future periods. Based on the cumulative pretax book income loss incurred by the company over the 3-year period ended December 31, 2020, albeit quite small, and the uncertainty created by COVID-19, our ability to consider our projections for future profitability and growth were significantly limited. Thus, we were required to record a valuation allowance to reduce net deferred income taxes as the realization did not meet the more likely than not criteria under the accounting guidance of ASC 740. We did not record a valuation allowance during 2019. However, given the traction we are beginning to see from sales of the Spok Go platform, our outlook continues to remain strong. We believe Spok Go is set to meet a significant need in the health care marketplace and will create significant value for shareholders in the coming years. For a more detailed explanation of how the estimated fair market value of the company is derived to determining the goodwill impairment charge and the criteria for creating the valuation allowance for the recoverability of the deferred tax assets, please see Notes 6 and 9 in our 2020 10-K, which, again, we expect to file later today. Nonetheless, the assessment of goodwill resulted in a $25 million noncash impairment charge in the fourth quarter, and the valuation allowance for the deferred tax asset reduced earnings by an additional $22.1 million. Excluding the impact of these charges, which we believe is a more appropriate way to view our results since these are noncash charges that did not result from operations, adjusted earnings per diluted share were $0.02 and $0.15 for the fourth quarter and full year 2020, respectively. Next, our capital expenditures for the fourth quarter of 2020 were approximately $0.6 million and were incurred primarily for the purchase of pagers and infrastructure to support our wireless customers. For the full year, capital expenses totaled $3.5 million, down from $4.8 million in 2019, reflecting the decreased capital needs to support the Spok Go platform development. We believe that we are past the major portion of our CapEx requirements to support our strategy and that levels should generally remain flat over time. And lastly, to our financial guidance for 2021. While there remains significant uncertainty and challenges with respect to the markets and customers we serve due to the pandemic, we have seen increasing visibility over the second half of 2020 and therefore providing guidance as is typical with our fourth quarter earnings release with the goal of providing investors with our views on 2021. We have included an additional schedule, detailing the components of our annual guidance for this year. Included in that guidance are Spok's expectations for software and wireless revenue generation in 2021. We expect total revenue to range from $132.2 million to $147.2 million. Included in that total, we expect software revenue to comprise $58.2 million to $67.2 million, which is consistent with 2020 levels at the midpoint of the guidance range. More than 90% of this software revenue guidance is expected to be driven by our legacy software solutions as bookings of Spok Go and the related subscription revenue continue to ramp through 2021. As our legacy on-premise bookings are replaced by Spok Go bookings in the coming years, our revenue recognition will also transition from more immediate recognition characteristics through ratable recognition over time associated with the subscription revenue model. Finally, Spok expects adjusted operating expenses, which exclude depreciation, amortization and accretion and the addition of capitalized software development cost, to range from $142.7 million to $150.7 million as compared to adjusted expenses of $148 million in 2020. Finally, we expect capital expenses to range from $2.7 million to $6.7 million. I would remind you once again that our projections are based on current trends and that those trends are always subject to change, especially as we continue to gain further insight into the potential easing from the impacts of COVID-19. With that, I will turn the call back over to Vince, who will make some closing comments before opening the call up to your questions. Vince?

[Vincent Kelly:]

Thank you, Mike. With respect to our key goals and business outlook, let me take a few moments to outline our outlook and strategy for 2021. As we've talked about in the past, about 5 years ago, we embarked on a transformation that was a tidal shift in our strategic direction for health care, our largest customer segment. This strategy pivot signaled a very intentional move from offering our customers point solutions or single-product solutions for call center software, alarm management and secure messaging to offering them a cloud-based, single, integrated communications and collaboration platform called Spok Go. Our decision to make this shift and focus on the Spok Go platform resulted from many reasons, including customer needs, as our health care customers were telling us they needed a more unified approach to communications across their enterprise; the large potential market opportunity as we further penetrate the multibillion-dollar health IT communications market; business simplification as we've been offering our customers many different products and multiple versions on several different platforms; and competitive positioning as we concluded that no one else offered a single, integrated, cloud-native platform for health care communications. In many respects, 2020 was the most challenging year for Spok in our history from both a management and operational perspective. The impact that this unprecedented pandemic has had on our customers has been profound, both in terms of the stress that is put on the doctors, nurses and hospital administrators as well as the financial impact that it has had on the health care industry in general. Already thin margins at these organizations were further challenged by shifting resources to deal with COVID-19, thus altering investment decisions. This has clearly impacted our customer spending priorities and ability to focus on a new platform solution over the short term. However, we expect that to change over the course of the new year. I'm particularly proud of our Spok team and their ability to adapt and change under these circumstances. Our core foundation of clinical communications is strong. We're proud of the work our employees have done in support of this mission. We have accomplished so much together since we became Spok. We are laser-focused on making Spok Go the leading clinical communication and collaboration platform in the health care industry. So with that as a background and with respect to our 2021 guidance, this year, we continue our commitment in investing to address near-term opportunities and to achieve long-term organic growth. We believe these investments are critical in supporting our strategy to enhance our industry-leading clinical communication and collaboration platform and drive long-term stockholder value. Included in total operating expenses, we believe that R&D expenses, excluding the impact of capitalized software development, will continue to flatten in 2021 and approach a more steady-state level. For 2021, we expect a relatively small portion of our R&D spend to be for legacy solutions and the majority to be on our new Spok Go platform, reflecting our continued investment in the future. With respect to our capital allocation strategy, our overall goal has been to achieve sustainable business growth while maximizing long-term stockholder value through our multifaceted capital allocation strategies, which has included both dividends and share repurchases as well as key strategic investments to improve our operating platform and infrastructure in order to drive long-term organic growth. We are also open-minded to potential acquisitions and partnerships that could provide additional revenue streams. For 2021, we're committed to continue paying our $0.125 per share quarterly dividend while keeping an eye on profitability. We will continue to evaluate our capital allocation strategy on a quarterly basis and communicate our plans to you with respect to dividends, share repurchases and other uses of capital each quarter when we report earnings. We are focused on the huge opportunity in front of us in clinical communications. From a business configuration and strategy perspective, we believe we're strongly positioned at the moment. We have created a long-term organic growth engine, Spok Go. We maintain a source of strong recurring revenue in our paid and service line. We run the largest paging offering in the world and have integrated its operations deeply with our software operations while continuing to enhance our paging platform and user devices. We believe with these two assets going for us, our best financial results are ahead of us and Spok's future is bright. At this point, I'll ask the operator to open the call for your questions. . Operator?

[Operator:]

. We'll take our first question from Ryan Vardeman with Palogic.

[Ryan Vardeman:]

So, did I hear right that 90% of the revenue projected in 2021 is going to be from the legacy solution? So, with the $58.2 million to $67.2 million in guidance, can I assume that 10% of that will be from Spok Go?

[Michael Wallace:]

Yes. Ryan, it's Mike. You're correct. I mean it's probably a little bit more than 90%. But until the Spok Go bookings continue to ramp, and then as you're aware, with a subscription model, it will obviously take time for that revenue to make its way through the P&L. For the majority of 2021, the overwhelming amount of revenue on the software side is going to continue to come from our legacy products. So I would say that it's about 90% to 95% would come from our legacy products.

[Ryan Vardeman:]

Okay. So, kind of on the low end then, if you're using 5%, maybe just under $3 million maybe of Spok Go revenues. So, I mean I'm still trying to understand what the opportunity is that you guys see. You say the outlook remains strong. What are you kind of forecasting the annual recurring revenue to be from Spok Go by the end of the year and how big is the opportunity over time?

[Michael Wallace:]

Yes. I mean, as far as ARR is concerned, yes, we're not going to publish that at this point. I mean we're still at the very early days as it relates to Spok Go. As we continue to report each quarter and get more visibility into that, we will certainly share that with investors. Vince, do you want to take the overall opportunity question?

[Vincent Kelly:]

We've looked at a lot of data, a lot of statistics in terms of the size and the scale of the potential market. It's huge. We're not -- it's in the billions. We're not the only one going after it. Yes, there's other competitors going after it, but there's plenty to be had for all of us. We think no one has the type of solution that we have in terms of what we've created will Spok Go, and there's going to be a long-term winner. Our luck probably could not have been worse to be rolling this thing out right as the pandemic struck because it's hard to get folks' attention. We've taken a look on a number of industry consultants, and we've looked at a lot of data in terms of what hospitals and healthcare systems have focused on in 2020, in dependency of this pandemic in terms of spending, and they’ve focused on things like anesthesia and respiratory equipment, patient monitoring and vital signs equipment, medication administration, lab equipment. Where we are, health care, IT, and enterprise software is kind of fifth on the list. And of that, if you look at the amount of institutions that have delayed capital budgets are uncertain right now, that's about 47%. So, almost half of the potential market is off the field in terms of rolling out a new cloud-based platform in 2020. However, the conversations that we've had with CIOs, the conversations that we've had with innovation partners like the Mayo Clinic partner we just announced indicate that there is a big need for what we're doing. Our Board member, Dr. Bobbie Byrne, who's at Advocate Aurora, indicates there's a big need for what we're doing and what we've created. So our goal is to continue to invest in this platform, continue to manage the business well, continue to pay the dividend, and then as we come out of this pandemic grow the Spok Go sales. And when you grow those bookings, generally, you're looking at a 3-year TCV. So, you're going to be essentially amortizing that booking into revenue ratably over a 36-month period. So, it's going to have less impact on revenue in the short term than the booking will. But over time, that will build a very nice recurring revenue layer.

[Operator:]

. We'll take our next question from Richard Dearnley with Longport Partners.

[Richard Dearnley:]

I got distracted when you were talking about R&D, the 40-ish percent of sales R&D going forward, now that Go is a go product. Could you just talk about where your R&D is going now? And what kind of spending levels are you thinking about for '21 and then the future, please?

[Vincent Kelly:]

Mike, do you want to take that or do you want me to? I'm happy to.

[Michael Wallace:]

Yes, yes. I'll go ahead and start off. Right now, from an R&D perspective, as we have been socializing in the last couple of years, we expect it to level off at kind of current levels, which, today, is, call it, about $27 million to $28 million on a gross basis, so not including the capitalization of software development. So the cash spending on R&D is about $27 million to $28 million. And as Vince mentioned, the majority of that, call it 75% to 80% today is being spent on Spok Go with the balance being spent on our legacy products to keep them in the marketplace until we're able to fully make the transition to Spok Go. With that said, our expectation is over the next several years, and we don't like to give guidance after this upcoming year, but we feel pretty comfortable that things will -- from an R&D perspective, we'll be fairly flat with the levels that you're seeing today. Vince, I don't know if you want to add anything else.

[Vincent Kelly:]

You got it spot-on. I was going to say 80% to 75% of what we're spending today of that $27 million numbers on Spok Go, and the 20% to 25% is on our legacy solutions. And that will stay about there for 2021. That will change over time going forward. Obviously, more will be spent on Spok Go in the future and less on the legacy solutions as we make the transition.

[Richard Dearnley:]

Right. Okay. And is the goodwill write-off strictly a matter of the stock price?

[Michael Wallace:]

Yes. So yes. I mean the driving factor in that analysis is the stock price. And as I stated in my prepared comments, we do that analysis each year at the end of October. That's our cadence, and that happened to be when we are at a 52-week low. Obviously, we were close, anyways. But as I said, if we looked at the share price in the first 6 weeks of this year, there likely would have been no impairment. So, I hate to be on these calls and blame anything on accounting, et cetera, but this is kind of one of the vagaries of accounting. It does not impact our view in any way, shape, or form on the outlook for the business and our projections. So...

[Richard Dearnley:]

Okay. I had thought that the goodwill was the outlook for -- I mean the impairment was related to the outlook for revenue and -- as contemplated revenue and earnings from the asset, not the stock price.

[Michael Wallace:]

Yes. No. I mean you -- there's a number of ways you can look at goodwill impairment. That is one component of it. But the largest piece, the largest driving factor of that analysis is the share price to drive the market value as being, if you will, in a public company the most readily available determinant of value on a given date. So while your projections are a component of it, they carry far less weight than the actual share price.

[Operator:]

. We'll take our next question from George Melas with MKH Management.

[George Melas:]

I'm fairly new to the story, so I'd like to ask you a fairly sort of broad question which is about the legacy solutions or a number of point solutions. The Spok Go is primarily sort of a communication platform that can unify a number of its solutions on top of that. Can you talk about the transition from one to the other? How are your customers, particularly the customers that are existing legacy customers, how do they implement the communication platform and then basically use it for the various functionality of the point solutions that they already have?

[Vincent Kelly:]

Sure. Let me take that. Yes. I think I understand your question. So look we've sold 5 in the second half of 2025, 5 Spok Go solutions. Two of them were brand new. So that's obviously a much easier sale. Three of them were to legacy customers that had existing software. And what you have to do in really both cases is it's a communications platform that can do a lot of things. You can add workflows on it. It keeps on-call scheduling. You can do critical test results management. There's other workflows and service lines you can layer on to it. But you have to integrate with the platforms that are out there right now. Our legacy solutions are primarily in 3 categories. The first category would be contact center solutions, so we run the hospital call centers. The second category, our messenger solution is kind of an alerting -- clinical alerting solution. And the third category is just kind of mobile in general. Encompassing in all that is also our on-call schedule offering. So you can go to an existing customer. We can sell the Spok Go platform. We integrate that platform to a gateway with their contact center solutions. The platform replaces the critical alerting part. It replaces the on-call scheduling part. It replaces the mobile part, and we build on that into the future while integrating with their contact center solution. If they're a new customer and they're not an existing customer, then we disintegrate with what they have, whether it's their EHR, what other systems they would like to integrate with, to do their clinical communications. The biggest advantage of Spok Go is that we keep the directory, which is kind of the hospital hub, if you will, the source of truth in terms of where everybody is. So if you want to know somebody's in campus, west campus, Floor 6, Ward A, who's on-call, we keep all that data. How do they want to be reached? Do they want to be reached by a mobile phone app? Do they want to be reached on a pager, et cetera, so we keep all that data. And so that's really what the platform does, and it does that very elegantly, and it does that with the ability to scale with AWS is our partner on that. And that's different because it's cloud than the existing solutions that we sold over the years, which are legacy based, which are on-file servers that are installed in customers' data centers. I hope that helps provide some clarity.

[Operator:]

Ladies and gentlemen, there's no further questions in the queue. I'd like to turn the call -- go ahead.

[Vincent Kelly:]

Yes. Thanks, everyone, for joining us this morning. We look forward to speaking with you again after we release our first quarter results in April. So everyone, have a great day, and stay safe.

[Operator:]

Ladies and gentlemen, this concludes today's conference. We appreciate your participation. You may now disconnect.