Spok Holdings, Inc.
Q3 2017 Earnings Call Transcript

Published: 28 Oct 2017

[Operator:]

Good morning, and welcome to Spok's Third Quarter Investor Call. Today's call is being recorded. On line today, we have Vince Kelly, President and Chief Executive Officer; Mike Wallace, Chief Financial Officer; and Hemant Goel, President of Spok's Operating Company. At this time, for opening comments, I will turn the call over to Mr. Wallace. Please go ahead, sir.

[Mike Wallace:]

Thank you, and good morning. Thank you for joining us for our third quarter 2017 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 related 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 on assumptions that the company believes to be reasonable, they are subject to risks and uncertainties. Please review the Risk Factors section relating to our operations and the business environment in which we compete contained in our 2016 Form 10-K. Our third quarter Form 10-Q, which we expect to file later today; and related documents filed with the Securities and Exchange Commission. Please note that Spok assumes no obligation to update any forward-looking statements from past or present filings and conference calls. With that, I'll turn the call over to Vince.

[Vince Kelly:]

Thanks, Mike, and good morning. We're pleased to speak with you today regarding our third quarter operating results and what we believe was a solid performance for Spok. We are seeing the benefits from investments that we are making to enhance and upgrade our product development team and tools as well as our sales infrastructure and management. We believe these investments will yield significant future benefits with respect to our integrated communications platform, Spok Care Connect and our overall growth potential. During the quarter, we saw strong performance in a number of key operating metrics, including revenue growth, cash flow and expense management. We also made further progress towards transitioning Spok to a long-term growth model by delivering industry leading clinical communications solutions, noteworthy in the third quarter, with a more than 3% increase in total revenue from the prior quarter, as our software revenue growth outpaced the less-than-anticipated decline in our wireless revenue. This represents the second consecutive quarter of total revenue growth for Spok this year. Also in the third quarter, cash flow generation allowed us to execute against our capital allocation strategy while adding to our cash balances. The third quarter revenue was up more than 11% from the prior quarter as a result of a 25% increase in operations revenue and a more than 99% revenue renewal rate on maintenance contracts. Maintenance revenue of $9.7 million was up slightly from the prior quarter and more than 4% from the prior year. Similar to Spok's wireless revenue stream, software maintenance revenue is a recurring revenue stream that provides the company with a more stable revenue base. This quarter, nearly 80% of our revenue streams were recurring in nature. This strong revenue base provides us with the ability to make key investments on our business to enhance long-term stockholder value while executing on our capital allocation strategy. Overall, we continue to operate profitably and enhance our product offerings. We are excited about the momentum that our team generated in the period and remain confident as we head into the fourth quarter. Mike and Hemant will provide details on our financial and operating performance shortly. But before that, I want to briefly highlight a few key results for the third quarter. First; software bookings of $18.3 million were in line with prior year levels and included $9 million of operations bookings, up from $8.5 million in the year earlier period. Additionally, our software backlog of $46.9 million at September 30 was up on both the sequential and year-over-year basis and represents an historical high. We're encouraged as bookings included sales to both new and current customers with existing customers adding products and applications to expand their portfolio of communications solutions. We continue to see growing demand for our software solutions for contact center, critical to secure smartphone messaging and clinical alerting. All of these are part of our Spok Care Connect integrated communications platform. Second, wireless subscriber revenue trends continue to stabilize. Our annual rate of paging unit erosion for the quarter improved 30 basis points to 5.4%. As a result of lower than anticipated unit erosion and relatively stable ARPU levels or average revenue per unit, over the past several quarters, wireless revenue on a trailing 12-month basis is down only 8% from last year. As a result of all of this, our 2017 revenue is trending above the midpoint of the guidance range that we provided at the beginning of the year. Next; operating expenses, excluding depreciation, amortization, accretion and research and development costs, were essentially flat on both an annual and sequential basis. Our ability to align and prioritize our expenses in support of our long-term vision has helped Spok to partially offset the increase in our research and development expenses over the past year. These R&D expense increases support the investments we are making in our sales and product platform. This effort will put us at the very low end of our guidance range from 2017 operating expenses. Mike will provide a bit made detail in a few minutes. And finally, we generated free cash flow in the third quarter, contributing to our ability to return capital to stockholders in the form of our regular quarterly dividend while adding approximately $3 million to Spok's cash balances. I'll comment further on our capital allocation strategy later in this call. But before I turn the call over to our CFO, Mike Wallace, to review the financial highlights, let me briefly talk about a couple of other developments during the quarter and share how the Spok team lives our mission on a daily basis. First, I'm proud to give you an example of Spok's industry leadership in recently assisting the Federal Communications Commission in an investigation in the spoofed robocalls. In late 2016, our company complained to the FCC that robocalling campaigns were disrupting our network. Using information provided by Spok to identify the source of the calls, the FCC's Enforcement Bureau was able to subpoena call records. Based on these records, FCC investigators verified more than 82,000 health insurance telemarketing calls made during that time that used falsified caller ID information. These co-op [ph] became the basis for an $82 million fine that was levied against the perpetuators. While sometimes it feels that we're swimming against the tide as the frequency of these annoying calls appears to be on the increase, I'm proud to report that both our technical and legal teams are taking a proactive leadership role in doing our part to improve the situation. Next, I'd like to take a moment to talk to you about the recent devastation resulting from the hurricanes this year and Spok's role in supporting healthcare institutions and emergency service responders in the affected regions. Our thoughts and prayers go out to anyone impacted by these storms. While they left a path of destruction resulting from the rain and flooding, our network and our coverage zones held up extremely well. Due to the simulcast nature of our network, high powered transmitters and Spok's best in class engineering team and satellite control, we were virtually 100% functional. I'm proud of the service that we provided to our customers during these catastrophic events. Finally, I'd like to take a brief moment to remember the recent violence and tragedy in Las Vegas. Again, our thoughts and prayers go off to all the victims and their families. While the entire Spok family is saddened by these events, we're glad that, again, our teams were able to support both our hospitality and healthcare customers to solve volume spike in the aftermath of the violence. Again, our systems performed well and we were able to handle the increased volumes, while supporting our customers in their time of need. And with that, I'll turn the call over to Mike Wallace, our Chief Financial Officer.

[Mike Wallace:]

Thanks, Vince. Before I review our financial highlights for the third quarter, I would as always, encourage you to review our third quarter Form 10-Q, which we expect to file later today, since it contains far more information about our business, operations and financial performance than we will cover on this conference call. As Vince noted, we were pleased with our overall operating performance for the third quarter and are confident in the momentum that our team is building as we finish the year. In addition to the substantial progress we made toward meeting our long-term business goals, we saw a solid sequential and year-over-year improvement in a number of key operating metrics. Revenue contribution from both software and wireless, combined with focused expense management, helped increase our quarterly operating cash flow, EBITDA and operating margins, as we continue to invest in our business for long-term growth. We also maintained an already strong balance sheet and continue to operate as a debt free company at quarter end. In the interest of time today, I will not review our third quarter performance on a line by line basis, since much of that information is contained in our news release, schedules and federal filings. If you have any specific questions about our quarterly financial results, I would be glad to address those during the Q&A portion of this call. Instead, I would like to focus this morning on four key areas that I feel will give a better idea of the drivers of our third quarter performance. These include revenue generation, expense management, balance sheet items, and finally, our financial guidance for the remainder of 2017. With respect to revenue for the third quarter, total revenue was $43.6 million, up more than 3% from the prior quarter. As Vince pointed out, this was our second consecutive quarter of sequential total revenue growth, and it exceeded our second quarter sequential growth of approximately 2%. Third quarter revenue performance was driven primarily by solid software operations revenue, which include license revenue, subscription and professional services and continued strong maintenance revenue renewal rates from our software companies and a lower rate of anticipated paging unit erosion that favorably impacted wireless revenue. Wireless revenue continues to exceed expectations and compares favorably to the guidance range that we outlined at the beginning of the year. Year-to-date, wireless revenue was down less than 8% from 2016 and at the low end of the anticipated attrition range that was included in our revenue guidance. Wireless revenue totaled $25.1 million in the quarter, down only $500,000 or 2% in the entire quarter. This solid retention reflects another strong performance by our sales team to again generate significant wireless gross additions while minimizing churn and maintaining stable unit pricing. Third quarter software revenue of $18.5 million was up more than 11% from revenue of $16.7 million in the prior quarter. Again, this performance exceeded the 7% sequential increase we saw in the second quarter. As I've noted on previous calls, our software operations revenue is now generally recognized on a ratable basis and totaled nearly $8.8 million in the second quarter, up nearly 26% from $7 million in the prior quarter. Maintenance revenue, the other component of software revenue, increased slightly from the prior quarter to $9.7 million in the third quarter and was up more than 4% from $9.3 million in the prior year period. The increases reflect our continuing and solid maintenance revenue renewal rates in excess of 99% from our installed software solution base. Turning to operating expenses. We reported consolidated operating expenses, which exclude depreciation, amortization and accretion, of $37.5 million in the third quarter. This compares to $36.1 million in the year ago period. The increase in our operating expense base over that time frame is primarily due to the planned investments in our Spok Care Connect platform, primarily in the research and development category. Net of those planned investment costs, operating expenses totaled $32.5 million, flat to the year ago period. The leverage of our operating platform continues to yield cost efficiencies across the business, including cost of revenue; service, rental and maintenance and in certain areas of sales and marketing. This performance is the direct result of our expense management initiatives but, importantly has not come at the expense of our business operations as we continue to upgrade processes as well as human capital. Turning to headcount. We continue to adjust our employee levels to meet anticipated demand levels as well as make the necessary additions to support our investments in the Care Connect platform. Our full time equivalent employees, or FTEs were 599 at September 30, 2017, versus 587 FTEs at December 31, 2016, and 598 FTEs at September 30, 2016. While these total show a flat number of FTEs over the past year, they represent incremental R&D staff for our software business in our Eden Prairie facility and the build out of the Care Connect platform. Those increases have been largely offset by leveraging other areas within the company. Turning to the balance sheet and other financial items. Cash totaled $110.1 million at September 30, 2017, a nearly $3 million increase from the June 30 balance and down $15.7 million from the prior year end. Included in the year-to-date net reduction in cash balances from the beginning of the year was the use of nearly $23 million to fund dividend payments and share repurchases and $7 million spent to purchase property and equipment. This was offset by approximately $14 million of cash generated by operating activities over the nine-month period. We expect to continue to use a portion of our cash in connection with our quarterly dividends going forward. We exited the quarter with no debt outstanding and continue to operate as a debt free company. Vince will comment further on our capital allocation strategy shortly. Looking at our deferred tax assets, or DTAs, we had nearly $72 million in DTAs at September 30, 2017, and no valuation allowance. These DTAs allow us to shelter virtually all of our regular federal taxable income, although we are required to pay a minimum amount of federal alternative minimum tax. Our DTAs primarily consist of net operating losses that will expire in the years 2021 through 2029. Based on the availability of these DTAs, we do not expect to pay a significant amount in federal income taxes for the foreseeable future. Also during the quarter, we completed our research and development income tax credit analysis, which resulted in a cumulative credit of $1.3 million and had the re-impact of reducing our effective tax rate for the third quarter to 4.4% and year-to-date effective tax rate to 24.2%. Going forward, we will continue to benefit from this tax credit based on our respective levels of research and development investment in the future. Finally, with respect to our financial guidance for 2017, as a result of the solid performance we saw in the third quarter, we are maintaining the 2017 guidance range that we provided at the beginning of the year. However, based on our year-to-date performance, we believe that we will come in at or above the midpoint of the revenue range and the low end of the expense range. Those ranges include total revenue of $161 million to $177 million; operating expenses, excluding depreciation, amortization and accretion, of $153 million to $159 million; and capital expenditures to range from $8 million to $12 million. I would remind you once again that our projections are based on current trends and that those trends are always subject to change. We look forward to presenting our expectations for 2018 when we release our 2017 fourth quarter results. With that, I will turn the call over to Hemant Goel, who will update you on our third quarter sales and marketing activities. Hemant?

[Hemant Goel:]

Thank you, Mike, and good morning. As previously outlined, our sales and marketing team delivered software bookings in the third quarter totaling $18.3 million. This performance was in line with prior year levels. Our momentum continues, and we believe our strategy is resonating with customers. Market recognition for the value of our enterprise healthcare communications platform is increasing, demonstrated by the level of conversations we have with customers and prospects, the volume of activity we see on our website, and most notably, by the stories behind our quarterly bookings. During the quarter, we welcomed nearly 20 new customers to the Spok family, primarily in the healthcare sector. Healthcare remains a key part of our growth and primary focus, comprising nearly 88% of overall bookings in the US for third quarter. Nearly a quarter of that business came from new hospitals and health systems that have never worked with us before. Among our new customers this quarter is a regional health system in Southern Canada. This customer has chosen Spok to replace manual on call scheduling processes and multiple disconnected applications in the contact center with an integrated communication platform. Their vision is a single solution with real-time information and single quick call transfers, getting staff subservice access to schedules and helping call agents provide a more efficient and streamlined service. This customer has selected Spok because of interoperability with other solution providers and our proven reputation for delivering value at other hospitals and health systems in the area. I'd also like to take a couple of minutes to highlight how one of our healthcare customer is improving its patient care coordination and performance metrics substantially using the Spok Care Connect platform. Our mid-size, Mid-Atlantic community hospital with over 3,000 employees and serving more than 1.5 million patients a year has seen a sharp reduction in cold call activation from minutes to seconds. The hospital also embeds Spok on-call scheduling into its ordering screen to make it easier for physicians to call their colleagues about a case when placing a consult. Spok complements the EHR or electronic health record, streamlining these workflows, which means improved response time for better care coordination and a quieter hospital environment for patients. Spok Care Connect also supports mass notification for the hospital, which allows them to quickly notify staff, whether it be all staff or a specific group, during emergency events. This technology is used for rallying the rapid response team and activating critical codes. Each of these examples demonstrate the strategic enterprise level investments hospitals are making with Spok. These customers are working with us to improve the reliability of their communications and capture the value that our unified healthcare communications platform makes possible. On a final note, earlier Vince mentioned the impact of recent hurricanes in the Southeast. I'd like to highlight Spok's responsiveness and concern for both customers and noncustomers that were caught in the devastation. One example was for a large Florida-based regional health system. Seeing that Hurricane Irma was heading towards the Florida coast and knowing that their in-house system had been failing during critical times, we contacted the hospital and offered to supply them with pagers at no charge, so they had a reliable means of reaching staff should their in-house system fail again during the storm. They immediately accepted our offer, and overnight Spok provided 100 units for their leadership team and key staff. We provisioned the units to be bound together by an emergency group all call number and we worked with the hospital as they built the numbers into their global database. The units were used throughout the storm without issue and are still in use today. I'm pleased to report that based on our actions, we are now actively engaged with the hospital, acquiring all their paging business, which totals approximately 2,000 units, and look to have this all completed in the next few weeks. Spok's team also supported all our customers and facilities in the path of the hurricanes. Our teams provided the customers with instructions on how to gather paper records should they need them in the event of power outages. The records were to aid in contact information as well as scheduling information. Throughout the storms, our teams tracked the hospital that had to evacuate or shut down and continued to offer help where we could. The teams ensured that our customers continue to have paging capabilities throughout the storms. Spok's concern and responsiveness in disaster situations has won us increased credibility as both a leader in critical communications and as a company willing to lend support in times of need. We are proud of our levels of response and the support we gave our customers and noncustomers during these tragedies. Before turning things back over to Vince, I would want to provide a brief update on our marketing activities. Ongoing investment and activities in these areas help us drive leads and fill the sales pipeline. These efforts are providing to be highly effective. The percentage of mobile use has more than quadrupled over the past year, and our website traffic overall has more than doubled over that period, largely driven by stronger rankings in search engines. Additionally, our social reach and audience engagement continues to show significant growth. Marketing is also responsible for planning and coordinating Spok's presence at a large number of trade shows throughout the year. In late September, we participated in the Becker's Hospital Review Third Annual Health IT and Revenue Cycle Conference in Chicago. With more than 3,000 participants, Spok senior management participated on speaking panels and continued to enhance our reputation with hospital C-suite. We generated more than 160 new leads from the conference, a sharp increase from last year. I'd also like to highlight our recent Connect conference. Last week, Spok welcomed leaders from more than 100 hospitals to Connect 17, our annual conference for healthcare professionals. The event took place in New Orleans, providing a setting for healthcare clinicians, IT experts and C-Suite executives to explore the challenges and opportunities of using communication technology to improve patient outcomes. Our Connect conference brought together some of the brightest minds in the industry to think big, envision the future of healthcare communications and pave the way to get there. Our collaboration with the hospitals through these conferences is essential to assist us in creating an industry leading technology platform and furthering our reputation as an industry top leader. These conferences and trade shows we attend continue to be valuable opportunities for us to grow our brand and showcase the benefits of our integrated platform, Spok Care Connect. Looking forward, we expect continued market demand for our integrated communications, especially in health care. Our investment in research and development is ongoing to support the industry shift away from a point solution strategy to the unified platform and continued focus on our Professional Services business, or PSG, provides a solid base to contribute to Spok's revenue performance by addressing our customers' needs and accelerating implementation times. We continue to position this business for scalability and growth. In short, our customers continue to reinforce that an enterprise wide communication platform fulfills their needs, increases efficiencies and ROIs and is the right strategy for Spok to provide. With that, I'll pass it back to Vince.

[Vince Kelly:]

Thank you, Hemant. Before we open the call up for your questions, I'd like to comment briefly on a couple of items. First, I want to update you on our capital allocation strategy and I also want to review our key goals and business outlook for 2017. With respect to our current capital allocation strategy, our overall goal is to achieve sustainable business growth while maximizing long-term stockholder value through our multifaceted capital allocation strategy that includes returning cash to our stockholders, key strategic investments to improve our operating platform and infrastructure and potential acquisitions that could provide additional revenue streams and broaden our portfolio of solutions. We expect to continue paying our quarterly dividend of $0.125 per share, $0.50 annually, for the foreseeable future. Through the first three quarters of 2017, Spok has returned approximately $23 million to our stockholders, including a special dividend that was declared in December of 2016 and paid in January of 2017. Next, as part of our capital allocation strategy, we're continuing our investments in product strategy and development where we believe we can generate attractive returns for stockholders as we pivot to a growth model in our software solution sales. As usual, we continue to maintain ample liquidity to support our working capital needs. Last, as we have previously outlined, while we remain open to the possibility of an acquisition, we've not yet executed for a variety of reasons. However, we continue to review candidates that could be a good fit for our platform and solution portfolio. We remain disciplined in our approach to ensure that any acquisition demonstrates both the synergistic and strategic value for Spok and is accretive in the short term. In the meantime, we will continue to weigh increases in our internal R&D expenditures against M&A opportunities. Finally, with regard to our key goals and business outlook, we believe our year-to-date performance and the momentum that we have generated positions us well for the fourth quarter and 2018. In order to take advantage of the large opportunity in our chosen markets, our business goals are simple and straightforward

[Operator:]

[Operator Instructions]

[Vince Kelly:]

Okay. Look, it doesn't look like there's any questions. And I know we had a bit of an unusual release this quarter and that we put our earnings results out Tuesday night instead of Wednesday night, the night before we talked to you. So we did answer some questions yesterday that were fairly generic questions. So I appreciate everybody's participation today. I appreciate any questions you want to get to me or Mike or Hemant with a follow-up. And look, we look forward to speaking with you again after we release our fourth quarter earnings in the first quarter of next year. Everyone, have a great day and a great fourth quarter. Let's all finish strong. Thank you.

[Operator:]

This concludes today's call. Thank you for your participation. You may now disconnect