Spok Holdings, Inc.
Q3 2014 Earnings Call Transcript

Published: 2 Nov 2014

[Operator:]

Good morning. Welcome to Spok’s Third Quarter Investor Conference Call. Today’s call is being recorded. Online today, we have Vince Kelly, President and Chief Executive Officer; Shawn Endsley, Chief Financial Officer and Colin Balmforth, President of the company’s Operating Company. At this time for opening remarks, I would like to turn the call over to Mr. Endsley. Please go ahead, sir.

[Shawn Endsley:]

Good morning. Thank you for joining us for our third quarter 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. Please review the risk factors section relating to our operations and the business environment in which we compete contained in our 2013 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, Shawn, and good morning. We’re very please to speak with you this morning about our third quarter results, which clearly were among the strongest we reported in many years. Indeed, in our first full quarter under the Spok's name, the company grew organically for the first time in our recent history as revenue, operating cash flow and EBITDA, increased from the prior quarter. In addition to this important milestone, our software bookings reached an all-time high for the second straight quarter. Software revenue increased substantially from the year-earlier quarter and our backlog remained near a record high. At the same time, wireless trends continued to improve as we ended the quarter ahead of our key operating goals for total revenue, gross placements and pager churn. Overall, we met or exceeded virtually all of our operating goals, enhanced our product offerings, expanded our market reach, strengthened our balance sheet and once again return the capital to stockholders in the form of cash dividends. Shawn and Colin will provide details on our financial results and operating activity shortly, but first I want to review some key results for the quarter. Number one, consolidated revenue increased to $49.8 million, an increase from both, the year earlier and prior quarter. Our software revenue more than offset the decline wireless revenue. In short, Spok got bigger on an aggregate basis, not smaller. While, we expect it will take more time for the company to grow consistently on an annual basis, we believe this is a noteworthy achievement in Spok's evolution as we continue to reposition the company for long-term growth. Number two, software revenue increased 34.4% from the year-earlier quarter to $15.9 million while bookings reached to record high $20.4 million versus $17.3 million a year-earlier. Also our backlog rose to $42.1 million at September 30th from $40.2 million at June 30, and our pipeline of sales leads increased substantially due to the excellent work or sales and marketing teams combined with wider recognition of our portfolio of software solutions. Demand for our solutions remained strongest in North America, specifically among hospitals and healthcare organizations, where we sold solutions for critical smartphone communications, secure texting, clinical alerting and emergency notification to both, new and existing customers. We also continued to expand our international sales efforts plus broadened worldwide focus beyond healthcare in such market segments as public safety, hospitality, education and government services. Number three, wireless subscriber revenue trends also improved. Gross pager placements rose from the year-earlier quarter while gross disconnect increased Overall, our quarterly rate of unit erosion improved to 1.9%, the lowest rate in more than 10 years. In addition, the quarterly rates of wireless revenue erosion improved to 2% to 2.4% in the second quarter. Healthcare again was our best-performing market segment with the highest rate of gross placements and lowest rate of disconnect. We also completed a major transaction with the cellular provider during the quarter. Our cellular activations in revenue reached their highest level in more than two years, Number four, operating expenses, excluding depreciation, amortization and accretion of $37.5 million, increased from $36.3 million in the year-earlier quarter due primarily to several one-time expense items. Nonetheless, we continued to manage operating expenses prudently, especially as we continue to make investments in those key areas that support our strategy for long-term growth. Number five, strong operating results generated EBITDA or earnings before interest taxes, depreciation and amortization and accretion of $12.6 million for the third quarter, representing margin of 24.7%. This compares to $13.4 million in the year-earlier quarter and $11.7 million in the prior quarter a margin of 27% and 23.9%, respectively. As noted previously, we expect to see some modest margin compression going forward as our ability to reduce recurring expenses to [clients] and we continue to invest in our future. That said, we expect to keep margins at a comparable level for the foreseeable future. Number six, we again generated sufficient free cash flow during the quarter to return capital to stockholder in the form of cash dividends. We paid our regular quarterly dividend of $12.5 per share on September 10th, and have now returned a totaled of $$426 million to our stockholders in cash dividends over the past 10 years. Also, our Board of Directors declared our next regular quarterly dividend of $12.5 per share to be paid on December 10th. We did not make any additional purchases under our stock repurchase program during the quarter. As a result, we still have $15 million of repurchase authority remaining through the end of this year. As noted in our press release, our Board has extended our share repurchase plan through the balance of 2015, with an additional $15 million authorized. I will provide more clarity on our capital allocation strategy in a few minutes. Number seven, finally, as you know, we announced the new corporate name Spok in early July as part of the worldwide rebranding strategy. We are very pleased the successful launch and positive feedbacks we received today on our new identity and plan to expand our name recognition and brand awareness even further over time. Overall, we are very pleased with our operating performance and progress in the third quarter and expect to finish 2014 on a very positive note. We met or exceeded the majority of our key operating goals, achieved record results, expanded our services and geographic reach, generated significant free cash flow, returned capital to stockholders and successfully introduced the new name in corporate brand. In short, we made enormous strides toward our goal positioning the company for the future. I'll make some additional comments on our operating performance and related business activities as well as our revised capital allocation strategy in a few minutes, but first, Shawn Ensley, our Chief Financial Officer, will review financial highlights of the quarter. After that, Colin Balmforth, President of our operating company, will comment on third quarter sales and marketing activities, Shawn.

[Shawn Endsley:]

Thanks, Vince. Before I review our financial highlights for the quarter, I would again encourage you to review our third quarter form 10-Q, which we expect to file later today as it contains far more information about our business operations and financial performance than we will cover on this call. As Vince noted, we were pleased to report excellent operating results for the quarter, results that were consistent with our previously announced financial guidance. An increase in software revenue combined with solid wireless revenue along with discipline expense management, contributed to strong cash flow, EBITDA and operating margins. Our balance sheet also improved during the quarter as our cash balance at September 30th exceeded a $106 million. This morning, I will highlight several items regarding our third quarter financial performance. They include first, a review of certain items impacting our revenue. Second, a review of selected items impacting our expenses, and third a brief review of the balance sheet and other key financial items. If you have specific questions about these or other financial issues, I would be glad to address them during the Q&A. Our wireless revenue for the quarter declined only 2% from the second quarter of 2014. This decrease reflected the performance of our sales teams in generating wireless gross additions and management of our direct quarterly average revenue per unit or ARPU, which declined only $0.01 in the quarter. We were pleased with this performance in a very competitive wireless marketplace. During the third quarter, we also benefited from a large cellular transaction. In addition to helping increased our cellular activations to their highest level in more than two years, the deal helped generate $350,000 in third quarter cellular revenue. Our cellular revenue is a small component of our total wireless revenue. It continues to be an additional source of revenue that helps offset the continued decline of wireless revenue. Our software revenue reflected increases in both, operations and maintenance revenue from both, the second quarter of 2014 and the third quarter 2013. Software operations revenue is now generally recognized on a ratable basis, an increase from $5.6 million in the third quarter of 2013 to $9.1 million in the third quarter of 2014 or 63.3%. The increase primarily reflects successful installations of higher dollar value project in 2014. Maintenance revenue, the other component of software revenue was $7.8 million in the third quarter of 2014, increasing 11.6% from the third quarter of 2013. The increase reflects our continued maintenance renewal rates in excess of 95% from our installed solution base. For the quarter, total revenue was $49.8 million an increased from both, the second quarter of 2014 and the third quarter of 2013. With regard to selected expense items impacting our statement of the income in the third quarter, we incurred approximately $1 million in one-time expenses related primarily to our rebranding efforts and severance. Approximately $0.3 million was incurred for one-time rebranding expenses that are reflected in selling and marketing expenses. Approximately $0.5 million of several expenses was incurred in the quarter related to the management of our headcount to meet our strategic requirements. Finally, there were approximately $0.2 million in miscellaneous other one-time expenses that has been reflected in our statement of income. The remaining level of our operating expenses reflects our investments to grow software revenues and booking and to support the wireless infrastructure and revenues. Our capital expenditures for the third quarter were approximately $1.3 million and were incurred primarily for the purchase of pagers and infrastructure to support our wireless customers. We do not expect any significant changes to our capital expense requirements for the remainder of 2014. Turning towards balance sheet and other financial items, the company generated $13.9 million in cash from operating activities during the third quarter compared to $10.5 million in the prior quarter and ended the quarter with a cash balance of $106.9 million. We expect to use the portion of that cash in connection with quarterly cash dividend as well as potential share repurchases over the balance of 2014. I would also note, that we continue to have no debt outstanding and our existing credit facility remains in place unused and provides us with approximately $40 million in borrowing capacity for acquisitions or related investment opportunities. Vince will comment on our capital allocation strategy in a few moments. With respect to other financial items, we expect to pay minimal federal alternative minimum income taxes as we use our available deferred tax assets to shelter our taxable income. We evaluate the carrying value of our deferred tax assets each quarter based on our estimates of future taxable income and will adjust that carrying value as appropriate. Finally, with regard to our financial expectations, we are maintaining the previously announced financial guidance for full year 2014 that we provided earlier this year. To reiterate that guidance, we currently expect total revenue to range from $183 million to $201 million. Operating expenses, excluding depreciation, amortization and accretion to range from $147 million to $156 million and capital expenses to range from $7 million to $9 million. Finally, I would remind you once again that our projections are based on current trends and that those trends are always subject to change. With that I will turn it over to Colin Balmforth, who will update you on our recent sales and marketing activities, Colin?

[Colin Balmforth:]

Thank you, Shawn, and good morning. After another record-setting quarter this year, our sales and marketing teams helped us close a solid third quarter with software bookings of $20.4 million. Included in this figure is a 72% increase in new logo business from the third quarter in 2013. While new customers are an important part of our growth, our long time customers continued to return and invest in upgrades to their existing applications as well as add new products and expand their portfolio of communication solutions. Q3 included notable upgrades for a number of our call center customers.. One example is a large southeastern health system with more than 20 acute care nursing care and hospice facilities were added to Spok's clinical alerting solution. The health system needs to consolidate several of its call centers and is focused on centralizing the management at critical alerts such as code calls, panic alarms, fire alarms and medical gas interruptions. Their decision was driven by the need to integrate these critical alarms for multiple locations with a call center to increase its patient safety and enhance operational efficiencies. We continue to meet our goals for gross additions to our paging services. As I have mentioned in the previous calls, there are also many positive collaboration efforts among sales representatives. Our cross-selling efforts brought in 17 deals during the third quarter, representing more than $1.5 million in bookings. I also talked before about our five pillars for growth. They represent Spok's strategy for meeting our long-range objectives. I would like to update you on our progress in each area. Our first pillar is the midmarket healthcare space, which we define as hospitals with 200 to 600 beds. We are very proud to have a majority of large healthcare institutions in the U.S. as our customers and we continue to see the midmarket as a growth opportunity for new customers, We were pleased to add 13 midmarket accounts in Q3. One example is the 200-bed hospital in Texas that selected our full Spok council's suites to enhance that call center. This hospital wants to automate their call handling and on-call calendars, make on calls schedules available for a web portal and improve the code calling process. They will also be using our solutions in the transport center to coordinate patient transports throughout the facility. We expect to expand on our success in the midmarket with new technologies and solutions. Our development team is making progress with a Software-as-a-Service, SaaS capabilities that will allows us to offer hospitals in a small and midmarket space, products and solutions that enhance the communications while reducing information technology cost of ownership. For the international pillar, we continue to expand our presence outside the U.S. Spok's attendance of three important healthcare events (Inaudible), the United Kingdom and Singapore generated more interest in our solutions. Indeed in the Asia-Pacific region, we were in the midst of our 2014 mobility and healthcare seminar series. The series has been well received and is growing both, size and reputation. Healthcare remains a strong international segment for us. Two mid-sized hospitals in Australia, both were console customers who are implementing a secured texting solution contacted us with additional services to help facilitate expanded options throughout our enterprise. We are experiencing success in other markets as well. One recent win includes a largest casino in the Philippines that added Spok's alerting solution. They want to efficiently monitor gaming machines and provide faster response to customer services and when equipment needs attention. This leads me to our third pillar for growth. In the area of vertical markets, we have also made significant progress beyond hospitality public safety has seen tremendous growth and continues to be our fastest-growing market. Our Public Safety customers rely on our products to support the emergency call handling at the 911 dispatch centers. Because our solutions dependability, which has been verified by extensive testing to acquire quite Joint Interoperability Test Command [certification]. The government sector and U.S. military locations remain an important part of this growth. Combined with municipal sales, we had 28 public safety software deals this quarter as compared to 19 in Q2 and eight in the first quarter. Regarding progress in the innovation pillar, our physician advisory board recently joined us in San Antonio for Spok's Annual Connect Conference. Their discussions as well as conversation with customers and our 350 strong Spok's directions user group continue to provide us insight into clinical workflows. This information allows us to further improve our products such as Spok mobile with additional functionality that will better help our customers improve patient care and provider efficiency. Our customers are adding more and more mobile products to their enterprise suites, because they help busy clients to do their jobs more effectively. Sales of the mobile app are up 63.6% over Q3 last year. One of our planning considerations includes an option for innovation expansion in our software and technology development centers. We are evaluating a number of potential addressable markets to competitive landscape and our ability to holistically service these markets. Under our fifth and final pillar, mergers and acquisitions, as Vince mentioned, we are still evaluating potential acquisitions adjacent to our core space. At this point, we have not identified any targets that meet all of our criteria. In closing, I want to provide an update on our marketing activities, in the first 90 days at Spok, we saw over $4 million impressions resulting from the announcements of new identity. Social media activity, for example on Twitter and LinkedIn, has increased by 45%,. In addition, looking at our website, organic search traffic is up by 43% with paging services among our most popular destinations. Overall, we had a highly successful launch for our new unified brand. We continue to see a positive return for our ongoing marketing investments in e-marketing campaigns, webinars and website improvements. We launched three popular e-Briefs on prominent healthcare topics. These materials are used to help drive our lead generation and marketing activity achieved another record for identifying qualified leads in a single quarter. In Q3, leads were up by 53.3% over Q3 last year and up by 13.3% over Q2 of this year. Our marketing teams has also been busy coordinating the Connect Conference I mentioned earlier held this year in San Antonio. This conference is a great learning opportunity for customers and a chance for us to strengthen our customer partnerships. Overall, I am very pleased with our results in the third quarter, we look forward to continuing this positive momentum in the last three months of the year. With that, I will pass it back over to Vince. Vince?

[Vince Kelly:]

Thank you, Colin. Before we take your questions, I want to comment briefly on several other items that may be of interest. First, update you on our revised capital allocation strategy. Second, review our business outlook over the balance of the year. Third, give you some information about our upcoming Analyst Day and investor meeting we will host on November 20th in New York. With respect to our capital allocation strategy, we have evaluated several options for deploying capital that will allow us to meet our principal goal of achieving sustainable business levels while maximizing long-term stockholder value. I would add that we been particularly mindful of our asset allocation choices in recent months as the company has continued to generate strong operating cash flow and our cash balance surpassed $100 million at September 30th. While circumstances can always change and the Board retains the option to make changes in the future, we thought now is a good time to provide more clarity around our current plan. As previously discussed, we expect to reserve capital for potential software related acquisitions that would expand and enhance our current applications and services capabilities. As you know, the Board and Management have evaluated numerous acquisition opportunities in recent years. Today, however, we still have not identified a candidate that meets all of our stated criteria and is available with what we regard a reasonable value. Even so, we continue to pursue viable candidates and believe we ultimately will find a strategic fit. In the meantime, we remained very disciplined in our approach. Regarding other uses of capital, we expect to continue paying our quarterly dividend of $12.5 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 share repurchase program depending on the stock price and market conditions. We have now repurchased any shares for some time under the buyback program, which extends through the year end although $15 million remains authorized for purchase under the current plan. As I previously mentioned, the board has now extended our share repurchase plan through 2015. We are announcing today that it is our tent to distribute approximately $26 million in 2015 to our shareholders through a combination of our recurring dividend, our share repurchase plan and special dividends. Finally, based on our outlook for the business, we believe this level of distribution still allows for various other options for deploying capital from time-to-time. These options might include an acquisition, special dividend and a tender or certain number of shares or investing in product development opportunities that provides unique solutions to our customers' critical communications needs. We will keep you fully informed if and when any further decisions are made. In the meantime, we will continue to manage our balance sheet prudently by maintaining ample liquidity to support our capital needs. Turning to our business outlook for the balance of 2014 and beyond, we are very optimistic about our future. We believe we are currently on track to report strong results for the fourth quarter full year 2014, and look the carrier that positive momentum into 2015. A year ago, we still have some important integration work to be done. Our two operating subsidiaries were still functioning separately, our customers were bit unsure about who we were and if we had the resources and staying power to best serve them and we felt we were lagging in some of the momentum we had expected. Since the beginning of 2014, however, we have made enormous strides to remedy these shortcomings. On January 1st, we fully integrated our software and wireless subsidiaries. In July, we have redefined our mission as a global provider of critical communication solutions adopting a new name, brand and aggressively communicating these changes to customers and prospective customers. Throughout the year, we recruited a number of highly qualified business executives around our already solid management team. We have also made a significant investment in our selling and marketing functions, as well our research, development and professional service teams. The net result of these and numerous other investments over the past year as a more effective organization, one that generates a new level of confidence and competence, in fact, we believe we have a solid platform in place that not only can produce a sustainable growth, but one that that overtime can fulfill our long-term strategic goal of becoming a growing provider of critical communication solutions on a worldwide basis. Key to accomplishing net objective of course is both, internal and external growth. Internally, we will continue to redeploy capital to accelerate the development growth and expansion of our critical communication solutions and services worldwide. This includes developing products and services, extending our sales reach within in beyond the existing markets segments, extending our sales in the new geographic regions and promoting our brand in key global markets. At the same time, we will continue to leverage the value of our wireless infrastructure to meet our customers' need as well as our cash flow capital formation requirements. Beyond that, as I noted earlier, we will continue to explore acquisition opportunities in the critical communication space that can both, accelerate our revenue growth as well as help utilize our valuable tax assets. None of this will be easy. In fact, it will take a lot more hard work. However, I believe the progress we have made over the past year has created a strong foundation for our future. Finally, I want to extend an invitation to all of you to attend our Analyst Day Investor Meeting scheduled for November 20th in New York. As many of you know, we have not held this kind of Analyst Meeting for a number of years. However, the company's business focus has evolved over the past few years, we felt this was the right time to give the investment community an opportunity to learn more about Spok's day-to-day operations as well as our long-term business strategy. In addition to those of us on today's call, other members of the senior management will make brief presentations and be available to answer your questions, including those responsible for product development, information technology, global sales and marketing. We are very excited to be hosting this meeting and hope to see some of you there. Further details on the meeting, including the time and location were included in yesterday's earnings release. We have also posted meeting details on our website. In summary, we were very pleased with our operating results for the third quarter and first nine months of 2014. We believe, we were well-positioned to report excellent results for the full-year. We met or exceed the majority of our key performance goals, extended our sales capabilities, extended our reach in key geographic and vertical markets, strengthened our balance sheet and continued to operate the company profitably. We also successfully changed our corporate name and launched the global brand strategy. Going forward, we look for even further progress as we continue to aggressively execute our business plans and pursue additional opportunities to create value for our stockholders. At this point, I will ask the operator to open the line up for your questions. We ask you to limit your initial questions to one and a follow-up and after that we will take additional questions if time allows. Operator?

[Operator:]

Yes, sir. Thank you. (Operator Instructions). We do have one in queue. We have Josh Paulson with Claragh Mountain Investments.

[Josh Paulson:]

Yes. Good morning and thanks for taking my questions. I was wondering if you guys could talk a little bit more about your backlog for software operations, with the new revenue recognition method on a ratable basis. How are you modeling future recognition of that current $42 million backlog?

[Vince Kelly:]

Shawn, you want to ahead and take that?

[Shawn Endsley:]

Yes. Essentially that backlog includes both, our maintenance renewals and our operations. We implement that over a specified period as normally either the longer the maintenance or the implementation period. To the extent we implement faster than that, we than both have a catch up revenue amount. At this point, we expect that most of that will be recorded in 2015 over the entire year.

[Josh Paulson:]

Great. Thanks.

[Operator:]

(Operator Instructions) Mr. Paulson has re-queued. Please go ahead, sir.

[Josh Paulson:]

Thanks for taking the next question. I was wondering also if you could provide detailed on the average sale price for your software solutions in general or by sector if possible as well as the high and low range. For example, in yesterday's results you mentioned 28 new accounts for your public safety sector. I am trying to get a better understanding of how this impacts top-line revenue for software sales in general?

[Vince Kelly:]

Colin, you want to take about the average sale price of our solutions?

[Colin Balmforth:]

Yes, I would be happy to talk that, Josh. The overall averages that we record typically for new logo sales around $111,000 the public safety deals have been slightly higher than that Josh, so we have been running those at closer to about $150,000, but they do vary in size quite considerably. Our new logo transactions have increased as I mentioned earlier and our six-figure deals have increased the year-over-year as well, so just to give you a little bit color on that. We had 46 transactions this last quarter to six-figure deals. In Q3 2014, we had 24 six-figure transactions and that also relates to about 33 in Q2 2014.

[Josh Paulson:]

All right. Great. Thanks guys and congrats on the quarter.

[Vince Kelly:]

Thank you. Okay. That’s all the questions that I seen in the queue, so we will probably wrap up now. I don't see no one else joining the queue, so thanks everyone for joining us this morning. We look forward to seeing some of you at our Analyst Day in New York on November 20th. And speaking to all of you again after we release our fourth quarter and full year results early next year. Thanks again, everyone, and have a great day.

[Operator:]

Ladies and gentlemen, that does conclude today's conference. We do thank you for your participation. You may now disconnect. Have a great rest of your day. Thank you for calling.