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Spok Holdings Inc. (NASDAQ:USMO)

Q2 2014 Earnings Conference Call

July 31, 2014 10:00 AM ET

Executives

Vincent D. Kelly – Chief Executive Officer

Colin Balmforth – President

Shawn Endsley – Chief Financial Officer

Analysts

John Noell – Kensington Growth Partners LP

Operator

Good day and welcome to the Spok’s Second Quarter Investor Call. Today’s conference is being recorded. Online today, we have Vince Kelly, President and Chief Executive Officer; Shawn Endsley, Chief Financial Officer and Colin Balmworth, 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 E. Endsley

Good morning. Thank you for joining us for our second 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 second 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.

Vincent D. Kelly

Thanks, Shawn, and good morning. We’re delighted to speak with you this morning about our second quarter results, recent activities and business outlook. Our second quarter results were very strong relative to our plan and we believe we are well positioned for the balance of the year.

In addition, as you know, we announced the new corporate name Spok, earlier this month as part of the company wide rebranding strategy. We are very pleased with the successful launch and positive feedback we received today on our new identity in [LaSalle] (ph).

Spok is proud to be a leader in critical communications for healthcare, government, public safety and large enterprise market segments. We deliver smart, reliable solutions to help protect the health, well-being, and safety of people around the globe. More than 125,000 organizations worldwide rely on Spok for workflow improvement, secure texting, paging services, contact center optimization, and public safety response. When communications matter, Spok delivers. Our core value includes customer approach in everything we do. What we do matters, our solutions improve communications in critical situations. We are committed to innovation and offering new solutions for future growth and we are accountable to each other, our customers and our shareholders.

Turning to the second quarter, we set an all-time record for software bookings, while software revenue increased from the year earlier quarter. Our backlog is also near record high at June 30. Our wireless trends improved as we ended the quarter ahead of our key operating goals for total revenue, gross placement and pager churn. On a consolidated basis, we were able to exceed our operating goals, strengthen our balance sheet, advance our long-term business strategy and once again return capital to stock holder in the form of cash dividends.

Shawn will provide a financial overview shortly, but first I want to review some key results for the quarter. Number one, Software bookings for the second quarter increased 21.3% to a record high of $19million from the year earlier quarter. In addition software revenue were 7.4% at $15.6 million at the prior year’s quarter. While our backlog totaled $40.2 million at June 30. Also our pipeline of sales prospects increased substantially during the quarter due to the efforts of our dedicated sales and marketing team, along with wider recognition of our software solutions.

Demand for our software solutions remain strongest in North America, specifically among hospitals and healthcare organizations where we sold solutions for critical smartphone communications, secure testing, clinical alerting and emergency notification to both new and existing customers. We also continue to expand our international sales efforts during the quarter, as well as broadened our worldwide focus beyond the healthcare and specialty market segment, public safety, hospitality, education and government services.

Number two, Wireless subscriber and revenue trends also improved during the quarter. Gross paid replacements increased from the first quarter, while gross disconnect decreased. Overall, our quarterly rated unit erosion improved to 2.1%, the lowest rate of net unit loss was in fixed quarters. Also our quarterly rate of Wireless revenue erosion improved to 2.4% versus 6.2% a year earlier. These improvements in wireless trends are credit to the talent and commitment of our entire sales team.

Number 3, operating expenses excluding depreciation, amortization and accretion declined 1.6% in the first quarter. Going forward, we will continue to manage our operating expenses as efficiently as possible, however, we may incurred to one-time expenses on occasion such as our current re-branding program as we make selected investments to support our strategy for long-term growth.

Number 4, strong operating results generated EBITDA for earnings before interest, taxes, depreciation and amortization and accretion of $11.7 million for the second quarter, representing a margin at 23.9%. As I’ve noted on previous calls, we expect our operating margins will near of somewhat overtime as opportunities to reduce recurring expenses declined and we continue to invest in our future.

Number 5, finally, again that our goal generating sufficient free cash flow during the quarter to return capital to stockholders in the form of cash dividends. We paid our regular quarterly dividend of $0.125 per share on June 25 and have now returned the total of $423 million to our stockholders and cash dividend over the past 10 years. Also our board of directors has declared our next quarterly dividends of $0.125 per share being paid on September 10th. During the quarter, we did not make any additional purchases under our stocking repurchase program as a result we still have $15 million of repurchase authority remaining through the end of this year. I will comment further on a capital allocation strategy in a few minutes.

Overall, we're very pleased with our operating performance and progress in the second quarter and believe we’re well positioned for a solid second half of the year. We met or exceeded the majority of key operating goals, expanded our services and geographic reach, generated significant free cash flow, and return capital to stockholders. At the same time, we continue to make significant progress toward our long-term goal, of structuring the company for sustainable growth.

I'll comment further 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. Shawn?

Shawn E. Endsley

Thanks, Vince. Before I review our financial highlights for the quarter, I would again encourage you to review our second quarter Form 10-Q, which we expect to file later today, since it contains far more information about our business operations and financial performance that we will cover on this call. As Vince noted, our operating performance for the second quarter was consistent with our previously announced financial guidance for 2014, strong Wireless and Software revenue combined with continued expense management contributed to solid cash flow, EBITDA and operating margins. Overall, we believe this was another quarter of solid results as we continue to transition our corporate business model to focus on global critical communication.

I planned to limit my comments this morning to four areas that may be of interest to you. They include, number one, a review of how we now report certain items in our financial statements following the consolidation of our business operations earlier this year. Number two, an update on how software revenue reported for the second quarter was impacted by the internal control remediation process we completed in 2013. Number three, a review of selected items impacting our statement of income and number four, a brief review of the balance sheet and other key financial items in the second quarter. If you have specific questions about any of these issues or related financial matters, I would be glad to address them during the Q&A.

With respect to how we report certain results in our financial statements in 2014 following the consolidation of our Wireless and Software businesses on January 1st, we will report only one operating segment, our consolidated operations. However, we will continue to breakout revenue for Wireless and Software. As previously noted, our business operations are now unified under one company with a single brand identity.

We believe this operating structure one integrated sales force, one set of overhead and one platform for future acquisitions not only eliminates operational redundancies but maximizes the opportunities for us to pursue profitable revenue growth. With regard to Software revenue, we reported $15.6 million in Software revenue for the second quarter, up from $14.5 million in the year earlier quarter, but down slightly from $15.8 million for the first quarter of 2014.

As I mentioned during our first quarter investor update in May, there are two one time events that contributed to the slight decline in quarter-to-quarter Software revenue. First, we recognized approximately $1 million in Software revenue in the first quarter for two large projects, both of which were larger than our usual project size and favorably benefitted our first quarter software operations revenue.

Second, our internal control remediation process, which we completed in 2013 far that we defer certain Software revenue recognition into the completion and the professional service period relating to software arrangements, which effectively satisfied all the churns of our contract. The process also provided us the ability to reliably estimate the service periods, which allows us to recognize revenue from those accounts on a ratable basis. The net effect with the delay or ability to recognize certain Software revenue into 2014. Going forward however we expect the remediation process will not impact Software operations revenue in the third and fourth quarters. In short, due to the remediation process Software revenue results to someone uneven over the first two quarters of the year.

Therefore, we believe in more accurate way to look at those results is on a year-to-date basis, were total Software revenue increased to $31.3 million for the first six months of 2014 from $28.8 million in the first half of 2013 or an increase of 8.7%. With regard to selected items impacting our statement of income in the second quarter, we incurred approximately $0.5 million in one time expenses for our rebranding efforts. These expenses are included in selling and marketing expenses in our statement of income.

Turning to the balance sheet and other financial items the company generated $10.5 million in cash. During the second quarter, from operating activities and ended the quarter with the cash balance of $97 million. We expect to use a portion of that cash in connection with quarterly cash dividends, 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.

With regard to other financial items, we currently have growth deferred tax assets of $143.2 million with an offsetting valuation allowance of $119.3 million. The availability of these deferred tax assets ensures that we will pay minimal several Federal income taxes for the foreseeable future. Ignoring the valuation allowance these deferred tax assets would allow us to shelter approximately $363 million of taxable income. The availability of these favorable tax asset use is a consideration as we evaluate acquisitions and other opportunities to invest for internal growth.

Finally, with respect to our financial expectations, we're maintaining the previously announced financial guidance for full year 2014 that we provided in March. 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'll turn it back over to Vince.

Vincent D. Kelly

Thanks, Shawn. Before we take your questions, I want to comment briefly on several other items that may be of interest. First, provide some additional perspective on our recently announced corporate name change of rebranding program.

Second, briefly update our current capital allocation strategy; and third, review our business outlook over the balance of the year. With respect to our recent name change to Spok which we announced on July 8, we are very excited about this new chapter in our company’s history. As many of you know, the paging side of our business firmly known as USA Mobility Wireless and the Software side firmly known as Amcom Software both had strong and respected brands in a respected markets.

Indeed, both of these entities with the product that numerous mergers and acquisitions over the years, our reach was associated with the specific product line, mostly pagers and operator consoles and either reflected the evolving global focus about the company truly represents to the marketplace today and integrated provider of critical communication on a worldwide basis. As we thought about this internally over the past year, we concluded that we needed a brand identity that would reflect our singular mission, as well as one that would be easily recognized and respected by customers in both domestic and international markets.

Additionally, we wanted to assure then that we now provide a number of technologies not just one or two, that are specifically designed to improve their communication challenges. In short, we wanted to ensure that all customers and potential customer clearly understood what we did and how our product and services could improve their workflow activity and operating results. We think our new name Spok effectively depicts many elements of our current business and long-term goal.

Like the spokes of a wheel remain suggest movement, strength, reliability and speed. It’s often integral part of a smoothly functioning haul. The name Spok also conveys the concept of a completed communication, which for all is the heart of our business.

Turning to our capital allocation strategy, we continue to evaluate all options for deploying capital, with a dual goal of achieving sustainable business growth, while also maximizing long-term stockholder value. Among those options, as previously discussed our potential software related acquisitions that could expand the depth and breadth of our current applications and service capabilities.

Towards that end, the Board and management continue to evaluate various acquisition opportunities. Although, we have identified a handful of teams that need some of our stated criteria to date we have not found a strategic target, which we believe is a reasonable value. Nonetheless, we continue to evaluate viable candidate we believe we will find the strategic fit for us at some point. In the meantime, we will remain disciplined in our approach.

As for other users of capital, we expect to continue paying our quarterly dividend of $0.125 per share and $0.50 annually for the foreseeable future based on our current projections for operating cash flow. We believe the current dividend rate provides an appropriate yield on our common stock. Also, with respect to our repurchase program we may buyback additional shares of our common stock from time-to-time and paying on a stock price to market conditions.

Finally, I would note that the Board may consider additional options for deploying capital going forward recognizing that the company continues to generate strong operating cash flow with a cash balance of just under $100 million at June 30. Those options might include special dividends and further share repurchases balanced with opportunities to invest in product development where we see opportunities to serve our customers with unique solutions to serve our critical communications’ need.

In the meantime, we will continue to manage our balance sheet prudently by maintaining ample liquidity to support our working capital needs. And, as usual, we will keep you updated on all capital allocation decisions.

At this point, I’ll ask Colin Balmforth, President of our Operating Company, to comment briefly on our second quarter sales and marketing activities. In addition, Colin will provide an update on what we see as a principle growth driver going forward. Colin?

Colin M. Balmforth

Thank you, Vince, and good morning. Following a strong first quarter this year, our sales and marketing teams delivered a new quarterly record for the second quarter – Software bookings of $19 million. Included in these figures was 74% increase in new business from the second quarter in 2013. While we appreciate the record efforts of our sales and marketing teams, we also recognize the customer decisions and preferences and impact the timing of purchasing decisions each quarter.

Sales to existing customers remain solid. Q2 included notable operates for a number of our long time (indiscernible) customers. Many of them also started new applications to their solutions throughput, demonstrating the trust they place in our products. One example is Southwest Health System with three hospitals and more than 100 clinics that added Spok’s clinical alerting. The health systems seeks to increase patient safety and enhance operational efficiencies. Their decision was driven by the need to create a more comprehensive alarm management system specific to their nursing workflows. We continue to meet our goals for gross additions in our paging services.

As I’ve mentioned in previous calls, there are many positive collaboration efforts among the sales representatives. This cross-selling effort brought in 11 more deals during the quarter. I’ve also excelled before about our five pillars for growth. They represent folks’ initiatives for meeting our long range objectives, and I would like to update you on our progress in each area.

Our first pillar is the mid-market healthcare space, which we define as hospitals with 200 to 600 beds. We continue to see the mid-market as a growth opportunity for new customers, which we added 12 accounts in Q2. Our development team is making progress with our software-as-a-service; SaaS capabilities that will allow us to offer hospitals in the small and mid-market space, problems that enhance the communications, while reducing information technology cost of ownership.

In Q2, 400 bed hospital on the East Coast added two-stroke products to that portfolio, and plus its additional licenses for a secure texting application. This hospital required solutions to help increase safety, quality of patient care and staff efficiency.

It’s worth noting that in this institution, the clinicians were big forced behind addition of more application licenses, because of the workflow improvements, the solution generates. To be international fellow, we continue to expand our presence outside the U.S. We’ve been hiring new talents, including our Regional Vice President for our EMEA team.

In the APAC region, we kicked off our 2014 mobility and healthcare terminal series. The series has been well received, and it’s growing in both size and reputation. Healthcare remains a strong international segment for us and strategic partnerships are an important part of that success.

A recent win includes a hospital in eastern Australia that upgraded its clinical alerting solution. combined with the assets of one of our global partners, this hospital not only purchased an upgrade, but it also added two new solutions to build on its messaging system and leverage key integrations between Spok and our partnered solutions.

In the area of vertical market, we’ve also made significant progress. Public safety is seeing tremendous growth and is our fastest growing market. In Q2, we won fixed sizable new deals in the government sector, supporting multiple U.S. military locations.

Combined with municipal sales, we had 19 public safety software deals this last quarter, compared to eight in Q1, and three in the second quarter of last year. In Q2, we also participated in five competitors focused specifically on the public safety sector. Our presence of these shows has generated 100 of leads.

We’re making strength under our innovation pillar. Two physician executives from Stanford University have joined our Physician Advisory Board and we were in the process of recruiting a Chief Nursing Officer to provide an additional clinical perspective.

Our user group Spok Directions celebrates its first-year anniversary this month and the group is now 300 members strong, representing 175 organizations.

Both forums have provided a significant product input including direction on our mobility strategy. As a result, Spok plans to release a new suite of mobility solutions under the Spok Mobile brand later this quarter. Our customers continue to add mobile products to their enterprise suites, because the health busy clinicians do their jobs more efficiently. Sales of the mobile apps are up 70.6% over Q2 last year.

Another innovative product is our Test Results Management Solution. This was recently purchased by a hospital in the Midwest where the Radiology department wants to replace their manual notification process and keep a complete audio trail of messages.

One of our planning considerations includes an option for innovation expansion in our software and technology development center. We are evaluating a number of potential addressable markets, the competitive landscape and our ability to holistically service those markets.

Under our fifth and final pillar, Mergers & Acquisitions, as Vince already mentioned, we are still evaluating potential acquisitions adjacent to our cost base. At this point, we’ve not identified any target to meet our criteria.

Finally, I want to provide a little detail on our marketing activities. Donna Scott joined our executive team in April as Senior Vice President of Marketing and helped meet the team through the successful launch of our Spok identity. During our first several days at Spok, we saw thousands of impressions across our social media platforms and gained many new followers. We’ve also garnered traditional media attention from a number of sources including our cover feature in the business section of the Minneapolis Star Tribune. We continue to see a positive return on our marketing investments.

In addition to driving the preparations to become Spok, out team maintained ongoing e-marketing campaigns, webinars and website improvements. In less than four weeks, from effectively zero brand recognition in the market for a new name, Spok, we achieved Page One success with our SEO, Search Engine Optimization. And we expect to lead generation marketing achieved an all-time record for identifying qualified leads in a single quarter. In Q2, leads were up 26.2% over Q2 last year and 11.6% over Q1.

Overall, I am very pleased with our results in the second quarter. We look forward to continuing this positive momentum in the second half of the year.

With that, I’ll pass it back over to Vince. Vince?

Vincent D. Kelly

Thank you, Colin. With regard to our business outlook for the balance of 2014, we are very optimistic about meeting our performance goal this year, as well as making significant progress toward our long-term strategic goal of becoming a growing global provider of critical communication solutions. The value of paging for critical messaging remains strong and should contribute to our cash flow and capital formation for some time to come.

We expect overall demand for paging to continue to decline over time. As a result, we will continue to redeploy the majority of our capital to accelerate the development, growth and expansion of our critical communications solutions and services worldwide. This includes internally developing new offering, expanding our sales leads both then and beyond existing market segments, extending our sales in the new geographic regions and promoting our new brand, Spok in key global markets. In addition, as I noted earlier, we will continue to explore acquisition opportunities in the critical communications base that can accelerate our revenue growth and help utilize our valuable tax assets.

In summary, operating results for the second quarter were strong and have positioned us well for our solid second half of the year. We never exceeded our primary performance goals, expanded our sales capabilities, extended our region key geographic and vertical markets, strengthened our balance sheet and continually operate the company profitably.

Going forward, we anticipate even further progress as we aggressively execute our business plan and continue to explore all opportunities to create additional value for our stockholders.

At this point, I’ll ask the operator to open up line up to your questions. We would ask you to limit your initial questions to one and a follow-up. After that, we’ll take additional questions as time allows. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator instructions) And we’ll take our first question from John Noell with Kensington Growth Partners.

John Noell – Kensington Growth Partners LP

Yes. Hi, guys. I just wanted to ask in the paging industry, are there any potential acquisitions out there that could still potentially make sense at the right price, or has the industry kind of shrunk or deteriorated to the point where that would make sense, almost any price levels just be easier for you to take their customers?

Vincent D. Kelly

It’s a great question that we look at it all the time, and just like any kind of M&A announcements that you do, it comes down for value. There are some other players out there. They are a lot smaller than we are. We pick up a lot of their subscribers on a monthly and quarterly basis, because frankly, we operate our systems better than they do, we can afford to. We saw the big jump that we had in our gross additions in the second quarter over the first quarter and a lot of that was takeaway.

So at some point, it might make sense, but again, you have to be careful, because there’s a lot of complexities associated with it. One of the issues that you have to consider is the actual, technical network infrastructure of the target, because depending on what frequency they operate on, if you purchase that company and then you try to integrate them, you might have to end up swapping out the pages, because if you want to have a very efficient long-term platform, kind of single skew if you will on a minimum number of frequencies, we can’t be maintaining multiple networks as the industry gets smaller.

So there are some out there, we’ve talked to some in the past. the valuations haven’t made a lot of sense are up. and so we’ve really kind of approached it from the standpoint of just selling and marketing and being in the marketplace with our technical networks and our sales expertise.

John Noell – Kensington Growth Partners LP

Thank you.

Operator

(Operator Instructions)

Vince D. Kelly

Okay. Look, I don’t see any more questions in the queue. And so we’re going to ahead and call for this morning. Thank you very much for joining us. We look forward to speaking with you after we release our third quarter results. And thanks again, everybody have a great day.

Operator

This now concludes the presentation. Thank you for your participation.

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