Spok Holdings, Inc.
Q4 2015 Earnings Call Transcript

Published: 26 Feb 2016

[Operator:]

Welcome to the Spok's Fourth Quarter Investor Call. Today's call is being recorded. On line today we have Vince Kelly. President and Chief Executive Officer; Shawn Endsley, Chief Financial Officer and Hemant Goel, President of the Company's operating company. At this time for opening comments I will turn the call over to Mr. Endsley. Please go ahead, sir.

[Shawn Endsley:]

Good morning. Thank you for joining us for our fourth quarter and 2015 year-end 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 on assumptions that the Company believes to be reasonable, they are subject to risks and uncertainties. Please review the risk factor section relating to our operations and the business environment in which we compete contained in our 2015 Form 10-K 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:]

Thank you, Shawn and good morning. We're pleased to speak with you today about our fourth quarter and 2015 operating results. We're encouraged by our performance as we met or exceeded the majority of our key operating metrics for both the quarter and the full year. We achieved these results as we continued to make key investments in our business to enhance and upgrade our operating platforms and sales infrastructure. We believe that these investments in our systems and people position us well for the future. We saw double-digit increase in our fourth quarter software revenue from the prior quarter. Higher fourth quarter and full-year software revenue is due in part to a continuing trend of very strong renewal rates on software maintenance contracts which provides a stable recurring and profitable revenue stream for Spok. Demand remains strong in our domestic markets for upgrades and installations of call center solutions in healthcare applications. Additionally we posted solid results for our wireless products and services in the fourth quarter and for the full year. Gross disconnects improved on both a quarterly and annual basis. As a result, annual net pager losses declined to a near historical low. Overall we continued to operate profitably, enhance our product offerings and further strengthen our balance sheet. Our ability to generate healthy cash flow levels allowed us to execute against our capital allocation strategy, make key strategic investments and return the majority of our cash flow to our stockholders in excess of our commitment to return $26 million. Shawn and Hemant will provide details of our financial performance and operating activity shortly but first I want to review some of our key results for the fourth quarter and 2015. Number one, continued demand for our software solutions and wireless services resulted in consolidated revenues of $189.6 million for 2015, a decline of approximately 5% from 2014. Consolidated revenue increased to $47.3 million in the fourth quarter from $46.2 million in the third quarter. Our increase in the fourth quarter software revenue again more than offset the modest decline in wireless revenue. Although we're greatly encouraged by the revenue performance we saw in the fourth quarter, we expect it will take more time for the Company to grow consistently on an annual basis. Nonetheless, we believe our recent quarter-to-quarter revenue performance is another positive step positioning Spok for sustainable long-term growth. Number two, software revenues increased more than 4% to a record high of $70.6 million in 2015 from 2014. Total bookings in the fourth quarter totaled $18.5 million and were up nearly 11% from the prior quarter. In addition, our backlog remained healthy totaling $38.7 million at year-end while our pipeline of marketing qualified sales leads also remained strong. Demand for our solutions remains strongest in North American markets specifically among hospitals and other healthcare organizations where we sold solutions for critical smartphone communications, call center management, secure texting, clinical alerting and emergency notification to both new and existing customers. However, while domestic markets performed well, we saw some sluggishness in our international markets, in particular in both EMEA and APAC in the second half of the year. Number three, wireless subscriber and revenue trends continue to improve in 2015 as we again exceeded our expectations for gross additions, net unit churn, revenue and ARPU. Our year-over-year rate of paid and unit erosion improved to a record low of 6.6% for 2015 and in the fourth quarter fell to a near record low of 1.6%. Our year-over-year rate of wireless revenue erosion was 10.1% for 2015, down again from the prior year. We were pleased to see the continuation of these positive trends impacting our wireless revenue. We were especially pleased to see these positive trends continue in our top performing healthcare segment which now totals nearly 80% of our direct paging subscriber base. Healthcare remained our best performing market segment in the fourth quarter with the highest rate of gross placements and lowest rates of unit disconnects. Number four, consolidated operating expenses which exclude depreciation, amortization, accretion and impairment, decreased 3.1% to $150.6 million in 2015 from 2014. Annual expenses were in line with the midpoint of the guidance range we had provided earlier in the year. Fourth quarter operating expenses declined approximately 12% to $37.4 million from the year ago period. Shawn will review details in a few minutes but essentially the lower year-over-year operating expenses reflected a cost structure that is fully aligned with the demand levels we saw during the year. We continue to manage operating expenses closely, especially as we continue to make investments in areas that support our strategy for long-term growth. I'll talk more about our operating goals in a couple of minutes. Number five, consolidated EBITDA or earnings before interest, taxes, depreciation and amortization, was $9.9 million in the fourth quarter, up approximately 14% from the prior year quarter. This represented a consolidated EBITDA margin 20.9% in the period, up 400 basis points from the prior year. Consolidated EBITDA was $39.1 million for 2015 compared to $44.8 million in the prior year and our consolidated EBITDA margin was 20.6% versus 22.4% a year ago. Going forward we expect our EBITDA margin will contract reflecting the impact of the investments we plan in our sales teams, product development and our operations platform and infrastructure. We expect these investments to pay dividends in the future as we continue to make progress on our unified communications and work flow collaboration platform. Number six, finally we again generated healthy levels of free cash flow in 2015 retuning a total of $28.3 million to our stockholders in the form of cash dividends and share repurchases. During the year the Company paid quarterly cash dividends to stockholders totaling $13.3 million. Also, our Board of Directors declared our next regular quarterly dividend of $0.125 per share to be paid on March 30th. In 2015 the Company repurchased 897,177 shares of common stock under our stock buyback program for approximately $15 million. Over the past decade we have generated nearly a billion in free cash flow, paid nearly $500 million to our stockholders in cash dividends and repurchased nearly $80 million of our common stock. In 2016 we continue to remain focused on returning value to our shareholders through our capital allocation strategy. So overall we're pleased with our operating performance in the fourth quarter and the Company's substantial progress in 2015. We met or exceeded our expectations on a number of key operating measures including revenue levels, operating expense management, cash flow and subscriber retention. We achieved these results as we continue to invest in our business. We believe that these investments in our systems and people position us well for the future. We also moved closer to our goal of transforming Spok into a company with a clear path for long-term growth. We're proud of this record of achievement and look forward to continued success in 2016. I'll make additional comments on our operating performance and related business activities in a few minutes but first, Shawn Endsley, our Chief Financial Officer, will review financial highlights for the quarter and then Hemant Goel, President of our Operating Company, will also comment on our fourth quarter sales and marketing activities. Shawn?

[Shawn Endsley:]

Thanks, Vince. Before I review our financial highlights for the fourth quarter and 2015 I would again encourage you to review our 2015 Form 10-K 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 fourth quarter and 2015, along with the substantial progress we made toward meeting our long-term business goals. Revenue contribution from both software and wireless combined with focused expense management helped maintain solid operating cash flow, EBITDA and operating margins for the quarter as we continue to invest in our business for long-term growth. We also strengthened our balance sheet recording a cash balance of $111.3 million at December 31st, 2015 and continued to operate as a debt-free Company at year-end. As a result of this performance, we believe we're well positioned for another successful year in 2016. In the interest of time today, I will not review our fourth quarter income statement on a line-by-line basis since much of that information is contained in our news release schedules and federal filings. However, to the extent you have specific questions about our quarterly financial results, I would be glad to address them during the Q and A portion of this call. Rather, I want to focus instead this morning on four specific areas. These include number one, a review of certain factors that impacted fourth quarter revenue; number two, a review of selected items that impacted fourth quarter expenses; number three, a brief review of deferred tax assets and the status of our valuation allowance along with other balance sheet items and number four, our financial guidance for 2016. With respect to revenue for the fourth quarter, total revenue was $47.3 million, up 2.5% from the prior quarter. The growth from the prior period was due to a nearly 11% increase in software revenue to $18.6 million which was partially offset by a 2.2% decrease in wireless revenue to $28.7 million. Total fourth quarter software revenue reflected increases from the prior quarter in both operations and maintenance revenue, while maintenance revenue was up from the prior year period as well. As I have noted on previous calls, our software operations revenue is now generally recognized on a ratable basis and increased slightly to $9.6 million in the fourth quarter from $9.4 million in the first quarter of 2015. The increase was driven in part by some projects completed in the fourth quarter for which the average contract value was higher than in previous quarters. This uptick in project size also resulted in an increase in the ratable revenue recognized during the period. Maintenance revenue, the other component of software revenue, increased 12% to $9 million in the fourth quarter versus $8.1 million in the first quarter of 2015. The increase reflects our continuing maintenance renewal rates in excess of 99% from our installed software solution base. Wireless revenue for the fourth quarter remained solid declining only 2.2% from the third quarter of 2015. This solid retention reflected another strong performance by our sales team to again generate significant wireless gross additions while minimizing churn and maintaining stable unit pricing. Note that we have included an additional schedule detailing the components of our software and wireless revenue in our earnings release. Turning to operating expenses, we reported consolidated operating expenses excluding depreciation, amortization and accretion of $37.4 million for the fourth quarter compared to $42.6 million in the fourth quarter of 2014. For 2015 operating expenses totaled $150.6 million versus 155.4 million a year ago and we're slightly above the midpoint of our guidance range of $145 million to $154 million that we had established. Our operating expenses in the fourth quarter of 2015 decreased approximately $5.2 million from the fourth quarter of 2014. Of that decline nearly half can be attributed to a declining cost of revenue expense. Cost of revenue expense reflects the cost of both internal and external implementation services, including travel, as well as third-party hardware and software purchase for customer implementations. In 2015 we focused our expense management initiatives to rebalance use of these third-party services and have used internal implementation employees to manage this cost. The remaining expense reduction of approximately $2.7 million in the fourth quarter 2015 includes lower G&A expenses of $1.6 million as we implemented greater efficiencies in our back office and approximately $900,000 in lower sales and marketing expense reflecting lower year-over-year total revenue. We continue to adjust our employee levels to meet the changing requirements of our business including investments in our product development staff. Our full-time equivalent employees or FTEs, were 600 at December 31st, 2015 versus 587 FTEs at December 31st, 2014. Depreciation, amortization and accretion decreased in both the fourth quarter and full-year 2015 compared to the same periods in 2014, primarily due to lower amortization expense associated with our intangible assets. As you may remember, due to our rebranding in 2014, we had revised the amortization period for the intangible assets associated with the AMCOM name which resulted in increased amortization expense in 2014. Our capital expenses for the fourth quarter of 2015 were approximately $2 million and were incurred primarily for the purchase of pagers and infrastructure to support our wireless customers. For the full-year capital expenses totaled $6.4 million, slightly below the midpoint of the guidance range of $5.5 million to $7.5 million that we had said at the beginning of the year. We do not expect any significant changes to the level of our capital expense requirements for 2016. Looking at our deferred tax assets or DTAs, we had approximately $129.8 million in DTAs at year-end before recognition of our valuation allowance. These DTAs allow us to shelter virtually all of our regular federal taxable income. However, we're required to pay a minimal amount in federal alternative minimum tax which we expect to be approximately $444,000 for 2015. The 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 of in federal income taxes for the foreseeable future. The DTA valuation allowance adjusts the total balance of the DTAs to the amount that we expect to realize in the future based on the analysis of our future operations. Based on the applicable accountings guidance, the Company determined in the fourth quarter that more of the deferred income tax assets are recoverable in future periods. Using this analysis, fourth quarter income tax expense included a benefit of $68.4 million to adjust the DTA valuation allowance to reflect the amount of DTAs that are expected to be realized. The impact was included in net income for 2015 of $84.2 million or $3.98 per diluted share compared to net income of $20.7 million or $0.94 per diluted share for the previous year. Excluding the income tax benefit associated with the DTA valuation allowance, full-year 2015 net income would have totaled $15.9 million or $0.75 per fully diluted share. On a comparable basis in 2014 net income also included a favorable income tax benefit of $5.1 million for reduction in the DTA valuation allowance. Excluding this benefit full-year 2014 net income would have been $15.7 million or $0.71 per fully diluted share. Turning to the balance sheet and other financial items, the Company generated $38 million in cash from operating activities during 2015. Of that $38 million we returned 76.2% to our stockholders in the form of cash dividends and share repurchases. Of the remaining cash 14.6% was used to purchase property and equipment, principally pagers. The remaining 9.2% or $3.5 million, was retained for future use as part of the year-end cash balance of $111.3 million. We expect to use a portion of that cash in connection with quarterly cash dividends as well as potential share repurchases in 2016. We ended the year with no debt outstanding and continue to operate as a debt-free Company. Vince will comment further on our capital allocation strategy shortly. Finally, with respect to our financial guidance for 2016, we currently expect consolidated total revenue to range from $174 million to $192 million with wireless revenue of between $101 million and $111 million and software revenue between $73 million and $81 million, consolidated operating expenses excluding depreciation, amortization and accretion of $153 million to $159 million and capital expenses to range from $6 million to $8 million. Finally, I would remind you once again that our projections are based on current trends and those trends are always subject to change. With that, I will turn the call over to Hemant Goel, who will update you on our fourth quarter sales and marketing activities. Hemant?

[Hemant Goel:]

Thank you, Shawn and good morning. Our sales and marketing teams delivered software bookings of $18.5 million, up 10.5% from Q3, while annual software bookings are down 5.7% over 2014. The annual bookings in 2014 reflected significant federal government activity that was not replicated in 2015. However, our new customer bookings, along with another quarter of 99% maintenance renewal, are driving healthy maintenance revenue numbers. Secure text messaging remains one of our best performing solutions with sales up 42% over 2014. In Q4 we welcomed more than two dozen new customers to the Spok family and more than 170 for the full year. Healthcare bookings overall in the U.S. are up 4.9% over 2014 and new customer bookings are up 88% for the year. These are hospitals and health systems that have never worked with us before. These new Spok family members join a prestigious list of customers that includes all of U.S. News and World Reports 2015-2016 Best Hospitals Honor Roll. The 15 of those hospitals and 12 children's hospitals rely on our solutions to help them provide the best care. Our healthcare customers are an important part of our future growth as they continue to expand their enterprise communications and add more of our services and solutions. We also maintain a number of strategic partnerships with companies that have complementary products and services and work together to offer customers joint solutions. For example, a healthcare system on the East Coast was upgrading their communication network at multiple locations. Working with that network vendor we're able to concurrently provide console software upgrades for several of their hospitals and a new installation of another preparing this customer to expand with additional applications such as secure texting. Our customers also recognize the value of their partnership with us and our ability to offer comprehensive communications solutions that differentiate us from point solution competitors. A good illustration of this is an integrated health system in the Midwest that included us in their evaluations of secure text messaging applications. Already a customer for our console solution, they were impressed to learn about Spok's full integration with a database for on call and group messaging capabilities and this was the deciding factor for them to select our software. This health system will become a significant Spok mobile enterprise customer. They also purchased our web solution, crisis management communication tool, additional console licenses and a test system. This is the largest six-figure deal of 2015. As part of our strategic direction for the long-term, our Professional Services Group has been working hard to offer customers an even better implementations experience. The year-over-year ratings were very good or excellent on both installation surveys have risen 7 points and our Consulting Services Team has seen a 41% growth in annual bookings. Our satisfied customers include a small regional hospital in California that recently installed Spok Mobile. This customer is giving staff the ability to securely text and share images containing patient data which also reduced overhead announcements for a quieter hospital. The project teams experience and the mobile expertise of our Consulting Services Team were key factors in the success of this implementation. Healthcare comprises the largest percentage of our business but public safety is an additional growth opportunity with a dedicated sales team. In 2014 we recorded significant federal government public safety bookings that were not applicated in 2015 but we will continue to enhance these solution offerings in the coming months and cultivate strategic partnerships that increase our reach in this sector. Public safety customers around the world allow our solutions to support emergency call handling such as 911 dispatch centers and our solutions dependability have been verified with Joint Interoperability Test Command, JITC certification. Our domestic operation is essentially a key plan this year but looking outside of the U.S. international bookings were below our expectations. However, we see a trend of healthcare organizations in Europe, the Middle East and Africa placing greater emphasis on communications solutions and applications as well more movement upward towards adopting U.S. based practices. The decision cycle for purchases is taking longer due to the global economic slowdown. Yet our relationships with key healthcare centers providers and partners in the region are expanding and we see EMEA as a strong market that will gain momentum in the coming years with good growth opportunities. In the Asia Pacific regions economic headwinds throughout Asia have heavily affected consumer spending across all industries in 2015 though there continues to be a lot of interest in our Secure Text Messaging app, Web and Critical Test Results solutions. We're confident this market is ready for our Mobile Solutions and our Integrated Platform [indiscernible] critical simplification and we remain focused on strengthening the Spok brand internationally. Throughout 2015 Spok participated in 16 international trade shows including RM Health, HENS Asia Pac, [indiscernible] and NHS England Health and Care Innovation Expo. These events enhance international brand awareness and generate qualified opportunities for our Spok team to build regional world partnerships that further increase our worldwide exposure. Before turning things back over to Vince, I want to provide an update on our marketing activities. Our Marketing Team is responsible for expanding our global content development, lead generation and event planning efforts. Ongoing investment in activities in these areas which include digital demand generation campaigns, webinars, educational eBriefs, videos and website improvements, help us drive leads and fill the sales pipeline. In 2015 the amount of closed business that originated from qualified marketing leads was up 47% over last year. Our social reach is also growing. Quarter-over-quarter our following has increased 15% engagement with our audience is up 14% and unique views of our backlog are up 74%. Marketing is also responsible for planning and coordinating Spok's presence at a large number of trade shows throughout the year. The most notable show of the fourth quarter was our own Connect 15 Conference held in Nashville in November. This Conference is a great opportunity for us to strengthen our customer partnerships, share our product roadmap and inspire trust and loyalty in our brand. In 2015 over 95% of survey respondents graded the Conference either very good or excellent and the top two reasons for attending were networking and learning more about Spok's direction and solution updates. Looking forward to 2016 we expect strong market demand for better communications, especially in healthcare and our making investment in these certain developments to further enhance a unified communications and collaboration solutions. With that, I'll pass it back over to Vince.

[Vince Kelly:]

Thank you, Hemant. Before we take your questions, I want to comment briefly on several items regarding our expectations for 2016. These items include our expectations regarding profitability, an update on our capital allocate strategy and a review of our business outlook and key initiatives for 2016. First, with respect to our current goals for profitability, our target is to continue to maintain our profitability and generate positive operating cash flow as we invest for the future. We understand that our operating margins will be impacted both by declines in our wireless revenue and by the investments we're making for future growth. In 2015 we were focused on investments in our software solutions capability while maintaining our valuable wireless revenue stream. Last year we took steps to strengthen our leadership team as Hemant became President of Spok's Operating Company and more recently with the addition of industry veteran, Don Soucy, as Executive Vice President of Global Sales. This year we're undertaking a significant program to enhance our product development solution delivery capability which will result in an increase in R&D and other expenditures throughout 2016 and future periods while we position the Company to be an industry leader and long-term player in the critical communications space. We believe these investments will pay dividends in future periods as we continue on a path toward sustainable growth. Next, turning into our capital allocate strategy, in 2015 we returned $28.3 million into our stockholders in the form of dividends and common stock repurchases. This represented the majority of our cash flow and exceeded the commitment of $26 million we made to you at the beginning of 2015. The allocation of capital will continue to be a primary area of focus for us this year as the Company expects to generate strong operating cash flow and currently carries cash balances in excess of $111 million. As I've said previously, our Board and Management Team have spent a great deal of time over the past few years evaluating numerous acquisition opportunities that will enhance our software portfolio, service capabilities and market penetration. With our strong cash levels and healthy balance sheet we can be nimble in taking advantage of opportunities that exist in the marketplace when and if the price is right and valuation expectations are reasonable. We remain optimistic and will continue to review viable candidates that we believe could be a good strategic fit. As we continue our pursuit of acquisition candidates, I assure you we will remain disciplined in our approach. With regard to other uses of capital, we expect to continue paying our quarterly dividend, the $0.125 per share or $0.50 annually, for the foreseeable future based on our current projections for operating cash flow. In addition, we may buyback additional shares of our common stock from time to time under our existing $10 million share repurchase program. Between dividends and share repurchases we currently expect to return approximately $21 million to our shareholders in 2016. Finally, with regard to our business outlook and key initiatives for 2016, we believe our performance in 2015 and the investments that we're making provide a solid platform for additional progress this year and well into the future. Our goals in 2016 are simple and straightforward; number one, grow our software revenue and bookings profitably across all our geographies; number two, retain our wireless subscribers and revenue; number three, continue to invest in our people, products and infrastructure; number four, continue to evaluate acquisition opportunities. Key to accomplishing these objectives, of course, is managing a disciplined and balanced approach to both internal and external growth. Internally we will continue to redeploy a larger portion of our capital to accelerate the development, growth and expansion of our critical communications solutions and services worldwide. This includes developing new products and services, expanding our sales reach both within and beyond existing market segments, extending our sales in the new geographic regions, promoting our brand in key global markets. At the same time, we'll continue to leverage the value of our paging and related wireless infrastructure to meet our customers' needs as well as our cash on capital requirements. In addition, as I noted, we'll continue to explore acquisition opportunities. These are long-term goals that will not happen immediately. Indeed they will take a lot of hard work and time. However, I believe that we have the right team in place in order to execute against these objectives and take advantage of market opportunities that we see. Collectively we made enormous progress last year and we're confident that we can face the challenges of 2016 and create a model for long-term sustainable growth. Spok continues to build an industry-leading reputation. We're generating tremendous attention and high approval ratings at the conferences we attend. We intend to carry the momentum generated at these conferences into 2016 in order to stimulate long-term growth. We remain committed to our core values of putting the customer first, creating solutions that matter, innovations and accountability. Combined with our strong team, solid financial platform and industry-leading products and services Spok is well positioned for the future. Thank you for your continued support as we take this journey together. We look forward to updating you on our progress next quarter and along the way. At this point I'll ask the operator to open the lineup for your questions. We'd ask you to limit your initial question to one and a follow-up and then after that we'll take additional questions as time allows. Operator?

[Vince Kelly:]

Okay, it looks like there are no questions, so I just want to thank everybody for joining us this morning. We look forward to speaking with you again after we release our first quarter results in April. Everyone have a great day and thank you.

[Operator:]

Thank you for your participation. This does conclude today's program. You may disconnect at any time.