Spok Holdings, Inc.
Q4 2021 Earnings Call Transcript

Published: 17 Feb 2022

[Operator:]

Hello, everyone, and welcome to Spok Holdings’ Fourth Quarter Earnings and Strategic Plan Call. I’m joined by Vince Kelly, President and Chief Executive Officer; as well as Michael Wallace, Chief Financial Officer and Chief Operating Officer. I would like 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 the 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 2021 Form 10-K and related documents we expect to file 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 will turn the call over to Vince.

[Vincent Kelly:]

Thank you. Let’s turn to Slide 3, and good morning, everyone. Thanks for joining us for this important update. Today, we will share with you how we plan to deliver significant shareholder value with our new strategic business plan. As stated in our press release this morning, our plan will prioritize in maximizing free cash flow and returning capital to shareholders while at the same time continuing to explore alternatives to our ongoing strategic review process. I’ll start by reviewing the agenda for today’s call. The order will be as follows. We’ll start with a high-level overview of our fiscal year 2021 results. Next, we’ll review a summary of our new strategic business plan. This will include our capital allocation decisions and prioritization of returning capital to shareholders. Then we’ll cover our current outlook for 2022 and 2023. And finally, we’ll conclude with a wrap up in Q&A session. Turning to Slide 4. As mentioned, before we begin our discussion of the new strategic business plan for Spok, I’d like to take a few minutes and provide a recap of our 2021 financial performance, which we reported earlier this morning. I encourage you to review our 10-K when filed as it contains significantly more information about our business operations and financial performance than we will cover on this call. For fiscal year 2021, we achieved our previously communicated full year financial guidance for revenue, adjusted operating expenses and capital expenditures. Total GAAP revenue for fiscal year 2021 was $142.2 million, consisting of wireless revenue of $78.8 million and software revenue of $63.3 million. With respect to wireless revenue, 2021 performance was driven by a lower level of pager unit churn on a year-over-year basis. In fact, net pager churn declined during the year averaged 4.3%, another record low. As a result, wireless revenue for 2021 remained solid declining only 5.7% compared to the prior year. These continued strong trends in our wireless business are being driven by the combination of solid gross additions from our sales organization, continued minimization of churn with existing customers and stable unit pricing. Furthermore, in future periods, we expect our new GenA pager, which was announced in November 2021 to be a significant factor in minimizing churn and maintaining average revenue per unit. For software revenue, 2021 performance of $63.3 million represented a 2% decrease from 2020. Given the slow adoption of Spok Go, due in part to the pandemic and its impact on our customers’ resources, virtually all software revenue is related to our legacy Care Connect suite solutions, a relatively flat revenue performance in 2021 on a year-over-year, resulted from a combination of several factors, including number one, the fact that our focus has been on bringing Spok Go to market rather than our Care Connect suite solutions, and this is going to change going forward. Number two, hospital customers, our largest segment, have continued to struggle with significant burnout and resource constraints due to the pandemic. U.S. healthcare system has lost between 15 to one in six healthcare workers. Nursing staffs have been significantly depleted. On average, it takes four to five years to train a nurse. We expect these resource constraints to last well into the future. And while we’ve had success over the past year, selling our Care Connect suite solutions, our ability to demonstrate, sell and install our completely new cloud native clinical communication solutions Spok Go was severely impacted. Number three, our software maintenance revenue is a critical source of our reoccurring revenue stream. 2021 software maintenance revenue was $38 million versus $38.6 million in 2020, or 1.6% lower. As we’ve discussed previously, maintenance revenue being flat slightly down is in line with our expectations, given gross churn and uplift levels remaining consistent with prior years, combined with less net additions to bookings, primarily due to our 2021 focus on Spok Go versus our Care Connect suite. For the full year 2021, adjusted operating expenses, which excludes depreciation, amortization, accretion, goodwill and capitalized software development impairment charges and severance and restructuring charges and includes capitalized software development cost total $154.3 million. Additionally, we incurred approximately $2 million in costs related to our strategic alternatives review process. Expense management going forward will be a major focus as we align expense levels with market demand for our products. In 2021, both operating expenses and adjusted operating expenses were up from the prior year levels. However, the year-over-year comparisons are difficult given the timing of furloughs, CARES Act reimbursement, costs related to our strategic alternatives review process, and other costs. Despite this for 2021, we reported adjusted operating expenses of $154.3 million up from $147.3 million in the same period a year ago. Adjusted operating expenses were higher largely as a result of the following three items. One, we incurred approximately $3.8 million of higher payroll and related costs in 2021 as compared to the same period a year ago. Employees incurred two weeks of furlough last year as opposed to five in 2020. We also experienced increased healthcare costs, as many individuals delayed wellness visits and medical procedures with lockdowns in place during 2020. Our average employee compensation costs increased, particularly for software engineering talent. The healthcare technology market continues to see low unemployment, as well as tougher competition for employee recruiting and retention, combined with the market’s adoption of a remote working environment. This has broadened the reach of many larger companies with which we compete for talent. Number two. 2020 included approximately $1.3 million of one-time savings related to refundable tax credits for employee retention, taken under the CARES Act. And number three, as mentioned previously, we incurred approximately $2 million in costs related to our strategic alternatives review process. Each of the items described above with the exception of the $2 million of process costs were reflected in our financial guidance. Additionally, in the fourth quarter of 2021, we recorded an impairment charge of $15.7 million related to capitalized research and development costs associated with Spok Go. Finally, our balance sheet remains strong with a cash, cash equivalents and short-term investment balance of $59.6 million as December 31, 2021. We continue to operate as a debt-free company. To turn to Slide 5. And I’d like to now provide an update on our previously announced strategic review process. As you’ll recall, the process commenced last year, whereby the Board in partnership with management and our financial and legal advisors, began evaluating alternatives to maximize shareholder value. After a comprehensive and rigorous process, the company today is announcing a new strategic business plan, one that prioritizes maximizing cash flow over the long-term and returning capital to shareholders. Consistent with our announcement this morning, our Board of Directors has unanimously approved this business plan, which we will begin to implement immediately. The plan includes maximizing revenue and cash flow generation from our established Spok Care Connect suite, including Spok Mobile and our wireless service offerings. As a reminder, our company has an excellent track record of driving revenue from these business lines and enjoys a significant market leadership position in narrowband personal communication services, i.e., paging and hospital call center solutions. Additionally, we plan to invest in a targeted and limited manner, these important and valuable franchises in order to continue our longstanding relationships with a nation’s leading healthcare providers. While this has been a difficult decision, the company will be discontinuing Spok Go and intends to eliminate all associated costs. Ultimately, the ongoing challenge of the COVID-19 pandemic has made an untenable for the platform to gain significant traction with customers or for our business to continue operating with our current levels of costs and personnel. Given the environment in which we operate with respect to both the health of our customer base and the challenges in software engineering talent retention and acquisition, we believe this is the best path forward for Spok and our shareholders. With that being said, we will continue to work closely with existing Spok Go customers to ensure that this transition is as smooth as possible. Our new strategic business plan also includes expanding on the company’s already disciplined expense management by streamlining our management structure, rationalizing external cost, reducing capital expenditures, and consolidating offices. Proceeding down this course involves some very hard decisions. We will be trimming our management team by roughly one half, and we’ll be reducing our workforce by approximately one-third over the course of the next 60 days. We are not taking these steps lightly. However, after careful deliberation, given the challenges that we have talked about, we believe this is the right decision. I’d also like to note that our review of strategic alternatives remains ongoing. While this process has not yet resulted in a transaction, the Board remains open to all potential alternatives to maximize value. Let’s look at Slide 6. Turning now to the company’s plans to prioritize returning capital to our shareholders, Spok will be increasing our regular quarterly dividend by 150% from $0.125 per share, or $0.50 annually to $0.3125 per share, or $1.25. annually. This increase dividend was approved by our Board and a quarterly dividend was declared with the record date of March 16, 2022, and a payment date of March 30, 2022. Based on our new business plan and our view of the future, we believe we can continue to pay this level of dividend for the foreseeable future and expect to be able to fund the majority of it from cash flow from operations in 2023 and beyond. This new level of dividend represents a significant and recurring yield on Spok shares going forward. As always, the declaration and payment of future dividends are subject to the Board’s discretion and will depend on financial and legal requirements and other considerations. Additionally, the Board has also authorized a share repurchase program of up to $10 million of the company’s common stock. This authorization allows the company to return capital to shareholders by opportunistically repurchasing the company’s shares. We’ll continue to evaluate opportunities to repurchase shares as Spok transitions throughout our strategic pivot underway during 2022. And finally, on the subject, we’ll continue to evaluate our capital allocation strategy with a goal of maximizing shareholder value while continuing to provide critical communication services to our very important healthcare communications customers. I’ll now turn the call over to Michael Wallace, our Chief Financial Officer and Chief Operating Officer, who will review our financial outlook for 2022 and 2023. Mike?

[Michael Wallace:]

Thanks, Vince, and good morning, everyone. Turning to Slide 7. So as Vince went through our 2021 results and took you through the strategic pivot that we are embarking on today, I would like to take some time to give you our thoughts for the balance of this year and looking into 2023. And before getting into specifics, I think it is important to highlight for everyone that fiscal year 2022 will be the transition year for Spok, given the implementation time required to execute our strategic shift to a cash flow model. However, we do anticipate that this transition will be completed by the end of 2022. So turning to our guidance for 2022 and be reminded the figures I’m going to discuss today are included in our guidance table in the earnings release. We expect total revenue to be in the range of $126 million to $139.2 million, of which we expect wireless revenue to range between $71.6 million to $77 million, where the midpoint reflects an annual revenue attrition rate of approximately 5.7% when compared to 2021, consistent with our recent trends. Software revenue is expected to range from $54.4 million to $62.2 million, where the midpoint reflects annual revenue attrition of approximately $5 million from 2021. Given that, it is important to understand where this decrease in total software revenue from 2021 is coming from and why. First, we have assumed an intentional reduction in services revenue to better align with our current backlog and to drive a higher rate of net cash flow in alignment with the shift in our strategic business plan that Vince mentioned – previously mentioned. Services has not historically driven meaningful cash flow on a standalone basis, but has been viewed as an opportunity to expand our licensed footprint through customer engagement as well as to fulfill upgrade obligations under our maintenance contracts, which is to – which is critical to maintaining our existing customers. Second, an anticipated low point in Care Connect suite bookings in 2022, which will impact license and equipment revenue, which typically has revenue recognition immediately as we focus solely on Care Connect suite across the organization and bolster our Care Connect suite product line through directed R&D spend at levels consistent with previous years in the $7 million to $9 million range annually without the dilutive effects from Spok Go initiatives. And third, for maintenance revenue to contract by approximately 3% on a year-over-year basis, primarily due to the lower net additions provided by bookings in 2022 that I just discussed, as we expect customer churn and annual uplift rates to remain consistent with past years. Turning to adjusted operating expenses. We expect adjusted operating expenses for the full year of 2022 to be in the range of $118.8 million to $128.6 million. As noted in our earnings release, adjusted operating expenses exclude severance, restructuring costs, depreciation, amortization and accretion. And regarding the one-time costs, I will speak to those specific costs on the next slide. But first, as it relates to adjusted operating expenses, the reduction from the $154.3 million in 2021 to the 2022 midpoint of $123.7 million, or approximately $30 million lower is as follows

[Vincent Kelly:]

The Slide 10 – and thank you, Mike. Before we open the call up for questions, I’d like to comment briefly on our business as we move forward. This slide provides an excellent visual of the quality of our healthcare provider customers, which includes some of the top hospitals in the country. For the ninth consecutive year, Spok has partnered with all 20 of the best adult hospitals. And in eight of the past nine years, the company has also provided solutions to all the best children’s hospitals. All these hospital systems rely on Spok to solve complex healthcare communications challenges and provides secure and reliable care team communications, which has been especially important with the rise of COVID-19 variants. We look forward to continuing to provide outstanding support to our customers as we make our business transition. Turning to Slide 11, I’d like to wrap up with a quick recap of our business. For starters, we continue to remain committed to our mission to be a strategic partner of choice for enterprise grade communications and patient care coordination. This commitment has allowed Spok to create a significant market position with longstanding relationships with the nation’s leading healthcare providers. Spok has a best-in-class paging network, currently the largest in the United States, which continues to generate strong results. And we now have a new exclusive alphanumeric messaging device in our GenA product. Additionally, Spok continues to provide a valuable and critical service to our customers. It’s delivering important information to care teams, when and where it matters the most to improve patient outcomes. As previously discussed, our Spok Care Connect solutions provide a suite of products with potential for new license sales in a valuable maintenance stream. Maintenance continues to provide a foundation under our legacy software business and is important to maintain as we quickly transition to focus on cash flow generation. Finally, I’d like to close by reminding you Spok continues to demonstrate a very predictable revenue base with over 80% of our revenue being recurring in nature, coming from either our legacy wireless offerings or software maintenance contracts. At this point, I’ll ask the operator to open the line for questions. Operator?

[Operator:]

At this time, we’ll be conducting a question-and-answer session. Our first question comes from the line of Amelia Roberts with Odeon. You may proceed with your question.

[Amelia Roberts:]

Hi there. Thank you for holding today’s call and taking my question. When you rejected the $12 offer almost two years ago, you said that it was not the right time due to disruptions in the debt and equity markets, but also indicated the very recent launch of Spok Go and its broad market potential for critical and hospital communications as a growth driver for future company performance. But now you are announcing that you will discontinue Spok Go. What do you now consider the growth driver for future company performance? And where will we start to see year-over-year revenue growth?

[Vincent Kelly:]

Thank you very much for your question. First of all, we are giving guidance today that doesn’t suggest revenue growth for 2022. We are very focused on our wireless business. But that is still attriting albeit attrits a little bit more slowly every year going forward, and our software business has been relatively flat. There’s opportunity for revenue growth that would be on the software business side. Last year, our revenue eroded 2% roughly from 2020 levels. And going forward, we expect it to be relatively flat. But there could also be opportunity there because our Care Connect suite, which is our hospital contact center solutions primarily, has not been our primary focus over these last couple of years, we haven’t put a ton of effort into it. We are the industry leader in that market. And so I think it’s anywhere in our business, there’s opportunity for growth, it’s going to be there. But we’re not forecasting that in our guidance today.

[Amelia Roberts:]

Okay, great. Thank you. And just to follow-up with that. Why would the Board agree to make significant changes to dividends and extend employment agreements, while still undergoing discussions with bidders for the company? And why would the changes announced today not reduce the chances of other bidders having interest in the company?

[Vincent Kelly:]

Well, I think the Board is importantly focused on the future. And while the process absolutely remains open, the Board is open minded to all potential alternatives to maximize value, we still have a business to run in order to get there. And it’s important to make this pivot because the outlook for Spok Go in this environment with all the pressure that these hospitals have had on their resources, we have found is a very difficult. We would have to continue spending at a very high level and hope over the next couple of years that things got better in the healthcare environment. And when we look around and we talk to CIOs and we see what’s going on with their resources, and how long we think it will take them to recover. We didn’t think continuing to spend $20 million a year in R&D on Spok Go going forward in the hopes that we would get $2 million, $5 million, $10 million of revenue out of it on an annual basis was a good trade. So we made a very difficult decision. As I said in my comments earlier, we did not take this decision lightly. We have an awful lot of good people that worked very, very hard to make this thing successful. It just didn’t happen. And so we’re left with a very tough slate of choices. The Board made the choices, we’re moving forward, and we’re going to do our absolute best to generate as much cash as we can. And we’re going to return that capital to our shareholders. When we look at our business plan, even with these what we think are conservative outlook, we can pay this level of dividend for a very, very long time. And we can find most of it through our free cash flow. And so that’s what our focus is going to be going forward and we think it’s going to be a very nice yield. And we think returning capital to shareholders in this environment, given all the things that are happening, given the challenges that we’ve had with recruiting and retention for engineering talent, given the challenges that we’re seeing with respect to M&A going on in the sector and very large competitors moving in. You’ve seen Oracle acquire Cerner, you saw Stryker acquire Vocera right after Vocera acquired Patient Safety. We saw a while ago Hillrom acquired Voalte, who is a competitor of ours only later for Hillrom to get acquired by Baxter, very large players moving into that clinical communication space. All these were factors in our decision to make the changes that we made. And we think going forward, running the company for cash flow, returning that cash to our shareholders, doing selective share repurchases, while keeping a completely open mind to other alternatives to maximize shareholder value is the right business plan at this point.

[Amelia Roberts:]

Okay, great. Thank you.

[Operator:]

Our next question comes from the line of Jason Kraft, private investor. You may proceed with your question.

[Unidentified Analyst:]

Hey, it’s . I got a few questions. So now, Board and management have come to terms with running the two business segments for cash. You’ve given some outlook in the guidance. But let’s get some color on this where you think the free cash flow margins of both segments could look like, say, on the run rate end of the year, next year, and you’ve given the guidance on some of the cost and the revenue, but let’s talk about what really matters the cash flow. So what are the free cash flow margin expectations on both segments?

[Vincent Kelly:]

Yeah, we didn’t provide guidance on free cash flow margin expectations. We said we’d cover the majority of the dividend through free cash flow next year and going forward. And that’s all the guidance we’re going to give regarding that today. We’ll take a look in the future if we want to give additional guidance around that, but not today.

[Unidentified Analyst:]

But, Vince, I mean, we’re in a different mode here, where you guys, just to be blunt, we hear a lot about maximizing shareholder value, maximizing free cash flow. There really is no – there really hasn’t been a track record in that. And the Board as well as management team has no credibility in saying something like that. So I think we’re in a mode where I think it’s incumbent on you guys to lay out what you think those margins are. A lot of us shareholders, we think we know. And you guys spent shareholder capital for the last seven months to come to conclusion that many of us realized the path you were heading down well before that. So I think we appreciate some of the transparency. But I think it’s incumbent on you guys to start laying out what you think these assets really can drive in terms of cash and on the pager business as well as the software?

[Vincent Kelly:]

Yeah, let me – two things respond to that. First of all, I want to correct your record, in terms of management credibility and being able to do this. We’ve generated $1 billion of free cash flow since we’ve been doing this, and we’ve returned the overwhelming majority of that to shareholders, okay? So what you’re really talking about is just Spok Go. And we run into a very tough scenario with Spok Go with respect to what this pandemic did. And so I think we made the right business decision. And I think we have a track record of filling up an enormous amount of cash, and you watch us will do so. I don’t know, Mike, if you want to comment on the margin.

[Michael Wallace:]

Yeah, a couple of things, Jason, on the free cash flow margin. As you said, you could back into a lot of the numbers. We have specifically said that we could cover a majority of that $1.25 annual dividend. We think that that number is going to be about 75% to 80%, which is about $1 a share at the end of the day. So that that translates to about a 15% to 17% free cash flow margin on the business. But we need to make this transition during this year. So those numbers can certainly change. And we hope that they would actually obviously go up.

[Unidentified Analyst:]

So you’re – so 15% to 17% in aggregate on the business towards the end of the year. Is – if you segment out – if we just listed the paging business, the paging business have higher free cash flow margins in the software business at the moment?

[Vincent Kelly:]

Yeah, we’re not – we don’t do segment accounting.

[Michael Wallace:]

And any other point, Jason, is that that 15% to 17% free cash flow margin is a run rate basis. So I think after we get through this transition on a run rate basis, which we think will certainly be at by the end of 2022, you would be at those free cash flow margins.

[Unidentified Analyst:]

And then just real quick as you brought it up, Vince, on the $1 billion of cash?

[Vincent Kelly:]

Yeah.

[Unidentified Analyst:]

…generate – you can generate all the cash in the world, but if it doesn’t – if you’re a publicly traded equity and it doesn’t reflect actual total shareholder returns, it doesn’t matter. And…

[Vincent Kelly:]

Well, I mean, $623 million or so off it has been returned to shareholders. And that’s money that’s like $30 a share something that they’ve gotten cash from us over the years. So yeah, and look, we said today – Jason, we said today, we’re taking out between, I think, midpoint $42 million of operating expenses on a run rate basis, that’s a lot of cost that’s being reduced. And I think each quarter going forward, you’ll see and it’ll be much more clear what the cash flow potential – what the margin potential of this company is, but it is something that we’ve done before to great success. It’s something that we’re very focused on right now. It’s unfortunate that we’ve come to this, but it is the best conclusion we have. And we also have an ongoing process I’ll remind you, so that’s keeping us a little bit busy, too.

[Operator:]

Ladies and gentlemen, we have reached the end of today’s question-and-answer session. I would like to turn this call back over to Mr. Vincent Kelly for closing remarks.

[Vincent Kelly:]

Thank you very much, everyone, for joining us today and thanks for your patience during this lengthy process. We appreciate your support and your interest in Spok. We look forward to updating everybody again next quarter. If you have any additional questions, please reach out to our Investor Relations team, and we’ll follow back up with you. Everyone, have a great day, and please stay safe and stay healthy.