Spok's (SPOK) CEO Vince Kelly on Q1 2016 Results - Earnings Call Transcript

| About: Spok Holdings, (SPOK)

Spok Holdings, Inc. (NASDAQ:SPOK)

Q1 2016 Earnings Conference Call

April 28, 2016 10:00 ET

Executives

Vince Kelly - President and Chief Executive Officer

Shawn Endsley - Chief Financial Officer

Hemant Goel - President

Operator

Good morning and welcome to Spok’s First 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 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 first 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 2015 Form 10-K, our first 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 will turn the call over to Vince.

Vince Kelly

Thanks, Shawn and good morning. We are pleased to speak with you today regarding our first quarter operating results and what we believe was a solid quarter for Spok and a good start for 2016. During the quarter, we made further progress toward our goal of transitioning Spok to a growth model and long-term provider of critical communications solutions.

Our performance in the first quarter was consistent with our expectations. We were very pleased as we saw continued reduction in the decline of our paging units and wireless revenue. Software sales were in line with the prior year quarter, but down sequentially from the typically more robust fourth quarter. Software maintenance bookings and related revenue, which is recurring in nature, continued to grow. We are not yet at the point where our software revenue growth overcomes our paging revenue erosion on a year-over-year basis, but we believe we are on plan and tracking with our strategy.

For the first quarter, we saw strong performance in the number of key operating measures, including operating expense management, cash flow and subscriber retention. We achieved these results as we increased our investment in our business by enhancing and upgrading our product development team and tools as well as our sales infrastructure and management. We believe these investments will yield significant future benefits in the form of our improved integrated communications platform, Spok Care Connect as well as higher future bookings levels supported by an enhanced and upgraded sales team.

Overall, we continue to operate profitably, enhance our product offerings and further strengthen our balance sheet with strong cash levels and no debt. Our ability to generate healthy cash flow has allowed us to execute against our capital allocation strategy, make key strategic investments and return nearly 80% of our operating cash flow to our stockholders during the quarter in the form of dividends and share repurchases. Shawn and Hemant will provide details on our financial performance and operating activity shortly, but before that I want to review some other key results for the first quarter.

First, bookings of $15.1 million in the first quarter included $9.5 million of maintenance renewals, a record high. Software backlog was $36.8 million at March 31. Though we are not satisfied with our operations bookings levels in the first quarter and continue to focus on generating activity through the remainder of the year, we are encouraged as bookings included sales to both new and current customers, with existing customers adding products and applications to expand our portfolio of communication solutions. Customer demand remains strong as for upgrades to call center solutions, healthcare applications to increase patient safety and improved nursing workflows. Also, our pipeline of qualified sales leads continued to grow as a result of excellent work by our sales and marketing team to broaden awareness of the benefits of our software solutions.

Overall, we continue to see growing demand for our software solutions for critical smartphone communications, secure texting, emergency management and clinical alerting. Though domestic markets performed well in the first quarter, we did see sluggishness in our international markets of both EMEA and APAC. However, we continue to expand our international presence during the quarter as well as widen our focus beyond healthcare in such market segments as public safety, business, hospitality, education and government services.

We are already seeing results from our sales and marketing efforts. During the quarter, we partnered with the organizations across industries and geographies such as medical solutions and services in Saudi Arabia, the Polk County Sheriff’s Office in Florida and VCU Health in Virginia to offer critical communications support. Combined with our strong team, solid financial platform and industry leading products and services, Spok is positioned to build on this momentum and stimulate sustainable growth. Second, wireless subscriber and revenue trends continued to improve. Our annual rate of paging unit erosion for the quarter improved to a record low 6.2%, while the quarterly rate improved to 1.7%, a 400 basis point improvement from the year earlier period. In addition, our annual and quarterly rates of wireless revenue erosion improved.

Also, contributing to slower wireless decline was a more stable ARPU, or average revenue per unit. In the first quarter, ARPU averaged $7.77 virtually unchanged from the prior quarter. We were pleased to see the continuation of these positive trends, especially in our top performing healthcare segment, which now comprises approximately 80% of our paging subscriber base. Third, consolidated operating expense in the first quarter, excluding depreciation, amortization and accretion was down nearly $2 million from the year earlier quarter and improved approximately 3% from the fourth quarter. Shawn will provide more detail on this in a few minutes, but I am pleased to report these results and the benefits we are seeing from our continued expense management initiatives.

Fourth, consolidated EBITDA or earnings before interest, taxes, depreciation and amortization was $9.1 million or 20.1% of revenue in the first quarter compared to $9.9 million or 20.9% of revenue in the fourth quarter. Margin levels will fluctuate over time, reflecting our level of investment and aggressive hiring program in the areas of product development and sales. However, longer term, we are focused on operating profitably once we have stabilized our revenue stream and pivot to a sustainable growth model.

And finally, again, we generated sufficient free cash flow in the first quarter to return significant capital to our stockholders in the form of cash dividends and share repurchases. During the quarter, the company paid cash dividends to stockholders totaling $2.6 million or $0.125 per share. We also repurchased nearly 292,000 shares of common stock under our stock buyback program. Over the past decade, we have now returned nearly $0.5 billion to our stockholders in cash dividends and repurchased approximately $80 million of our common stock. I will comment further on our capital allocation strategy shortly.

All-in-all, the company posted solid operating results in the first quarter and we believe this provides us strong base to build on for 2016. We achieved the majority of our key operating goals, generated significant free cash flow, expanded our services and geographic reach while returning capital to stockholders. We also made further progress toward our goal of transforming Spok into a company with a long-term growth trajectory.

I will make some additional comments on our business outlook in a few minutes, but first Shawn Endsley, our Chief Financial Officer will review the financial highlights of the quarter. And after that, Hemant Goel, our President will comment further on our quarterly sales and marketing activities. Shawn?

Shawn Endsley

Thanks, Vince. Before I discuss the financial highlights for the first quarter, I would again encourage you to review our first 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 with our overall operating performance in the first quarter. Continued operating expense management and software maintenance renewal rates that exceeded 99%, coupled with the lower levels of churn in both paging units and wireless revenue enabled us to maintain positive cash flows and a strong balance sheet. We also continued to make steady progress towards our long-term business goals. Overall, we believe we are off to a solid start in 2016.

This morning, I will review four key areas that influenced our first quarter financial performance, they include; number one, factors related to first quarter revenue, number two, selected items that influenced first quarter expenses, number three, a brief review of the balance sheet including deferred tax assets and finally, number four, an update on our financial guidance for 2016. As usual, if you have specific questions about these items or any of our quarterly financial results, I will be glad to address them during the Q&A portion of this morning’s call.

With respect to revenue for the first quarter, consolidated revenue totaled $45.4 million. Of the total, software revenue contributed $17.2 million, while wireless revenue comprised $28.2 million. Our software revenue represents 37.9% of our total revenue in the first quarter 2016 compared to 36.2% of total revenue in the first quarter 2015, reflecting the continued transition of our revenue base. First quarter software revenue reflected an increase of nearly 13% in maintenance revenue to $9.1 million compared to the first quarter of 2015. Software operations revenue totaled $8.1 million in the first quarter. And as I have noted on previous calls, software operations revenue is now largely recognized on a ratable basis. The increase in maintenance revenue reflects our continuing maintenance renewal rates in excess of 99% from our installed software solution base and the increase in new name accounts with attached maintenance contracts during 2015. Wireless revenue was $28.2 million for the first quarter, down only 1.9% from the fourth quarter of 2015. The strong performance of our sales team, solid retention and stable ARPU contributed to our wireless revenue results. Please note the additional schedule that we have included in our news release detailing the components of our software and wireless revenue.

Turning to operating expenses, we reported consolidated operating expenses which excludes depreciation, amortization and accretion, of $36.3 million in the first quarter compared to $38.1 million in the year earlier quarter and $37.4 million in the fourth quarter of 2015. Cost of revenue expense in the first quarter of 2016 totaled $8 million or 17.7% of revenue. This is down from $8.8 million or 18.3% or revenue in the prior year period. Cost of revenue expense reflects the costs associated with the implementation of our solutions, including third party installation and third party hardware and software to meet our customer commitments. As noted in previous investor calls, we typically increased the use of more expensive third party implementation services and third party hardware and software in the fourth quarter to meet customer requirements. While we continue to use third party implementation services and third party hardware and software in the first quarter, we continued to manage these expenses and these efforts are favorably impacting our margins.

All other operating expenses in the first quarter totaled $28.3 million and were approximately $1.1 million less than the first quarter of 2015. This decrease primarily reflects lower payroll and related expenses during the quarter resulting from lower headcount. With regards to headcount, full-time equivalent employees or FTEs, decreased to 595 at the end of the first quarter, compared to 600 FTEs at December 31, 2015 as we continued to adjust employee levels to meet the changing requirements of our business. Looking ahead, we expect recurring payroll and related expenses will reflect the level of our investments to grow software revenues and bookings and to support the company’s goals for wireless revenues and infrastructure.

Finally, with regards to the income statement, please note that our tax rate was up this quarter versus last year. The first quarter 2016 income tax expense was $2.7 million, an increase of $300,000 from the $2.4 million of income tax expense for the same period in 2015. The increase in tax expense and the effective tax rate was caused primarily by two factors; a decrease in the state effective tax rate on December 31, 2015, which results in a lower valuation of the DTAs and foreign losses which were not recognized in computing the overall effective tax rate. Since we are uncertain whether foreign losses will provide a benefit at year end, we are required to exclude them from computing the effective tax rate at March 31, 2016. Our capital expenses in the first quarter were approximately $1.4 million and were incurred primarily for the purchase of pagers and infrastructure to support our wireless customers. We do not expect any significant change to the level of our capital expense requirements for the balance of 2016, which reflect the guidance range that we have provided last quarter.

Looking at our deferred tax assets or DTAs, we had approximately $127.5 million in DTAs at March 31, 2016, before recognition of our valuation allowance of $45.8 million. This resulted in an estimated recoverable amount of deferred income tax assets of $81.7 million. These DTAs allow us to shelter virtually all of our regular federal taxable income, although we are required to pay a minimal amount in federal alternative minimum tax. Our DTAs primarily consist of net operating losses that will expire in the years 2021 through 2029. Based on the availability of these DTAs, we do not expect to pay a significant amount in federal income taxes for the foreseeable future.

Turning to the balance sheet and other financial items, the company generated $9.5 million in cash from operating activities during the first quarter of 2016, giving us the ability to execute against our capital allocation strategies, continue to make strategic investments in our business and add to our cash balances. We ended the quarter with a cash balance of $111.9 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 also ended the quarter with no debt outstanding and continue to operate as a debt free company. Vince will comment on our capital allocation strategy in a few moments.

Finally, with respect to our financial guidance for 2016, based on our performance in the first quarter, we are maintaining the guidance we previously provided, which projects consolidated total revenue to range from $174 million to $192 million, consolidated operation expenses excluding depreciation, amortization and accretion of $153 million to $159 million and capital expenditures to range from $6 million to $8 million. Finally, I would remind you that our projections are based on current trends and that those trends are always subject to change.

With that, I will turn the call over to Hemant Goel, who will update you on our first quarter sales and marketing activities. Hemant?

Hemant Goel

Thank you, Shawn and good morning. Our sales and marketing teams delivered software bookings of $15.1 million, down 14.8% from Q1 in 2015. However, an all-time record number of qualified marketing leads and strong tradeshow activity reflect the forward momentum we expect to create as the market recognizes the value of our enterprise critical communications platform. Maintenance renewal rates remain strong at more than 99% and clinical alerting was one of our best performing solutions with sales up 28.5% over Q1 2015. This quarter, we welcome more than 35 new customers to the Spok family, primarily in the healthcare and government sectors. However, our largest six figure deal of the quarter came from an existing hospitality customer in the Southeast. This long time customer trusts our solutions to support the comfort and safety of their patrons. This deal is an expansion project as well as the addition of a new hotel.

Healthcare remains an important part of our growth, comprising 77% of overall bookings in the U.S. for Q1. While much of that business represents customers who are expanding their enterprise communications and adding more of our services and solutions, nearly a fifth comes from new hospitals and health systems that have never worked with us before. These organizations join a prestigious list of customers that includes all of U.S. News and World Reports 2015-2016 Best Hospitals Honor Roll. These 15 adult hospitals and 12 children’s hospitals rely on our solutions to help them provide the best care. Among our new customers is a midsized regional hospital in the Northwest. This facility is replacing their existing contact center solutions, because staff needs a console that supports robust search capabilities, locations and staff contact information. This hospital selected Spok because of our contact center solutions healthcare-centric features and integration options, our excellent track record for customer support and our enterprise capabilities that make us a single source for critical hospital communications.

Our customers also recognize the value of their partnership with us as well as our ability to offer comprehensive solutions and services that differentiate us from competitors. A good illustration of this is a large health system in the Southeast that recently engaged our consulting services team. They were already a customer using many components of our enterprise critical communications suite. We are now working with them to apply industry best practices throughout their campus that further improve their workflows and enhance the overall effectiveness of our solutions. This consulting engagement was a 6-figure deal that demonstrates customer trust in our expertise as well as commitment to the vision of a unified enterprise solution.

As part of our strategic direction for the long-term, our professional services group has been working hard to offer customers an even better implementation experience. This group’s educational materials, such as Spok Mobile adoption and best practices guides, are helping our customers to develop their mobility strategies and drive adoption of our secure messaging app by the mobile care team, including physicians. The professional services group has rolled out a new methodology that includes unified site information and comprehensive checklists to enhance enterprise transitions at customer locations.

Healthcare comprises the largest percentage of our business, but public safety is an additional growth opportunity with a dedicated sales team. Public safety customers around the world rely on our solutions to support emergency call handling at their 911 dispatch centers and the solutions dependability has been verified with ongoing Joint Interoperability Test Command certification. Spok’s reputation for that dependability was a contributing factor in the success of one of our largest facilities of the quarter. An international military base selected our emergency dispatch and caller location solutions to support the safety and security of their personnel.

Looking at customers and prospects outside of the U.S., international bookings in Q1 were below our expectations, but our experience indicates that this will not be a trend. We see a trend of healthcare organizations in Europe, the Middle East and Africa placing greater emphasis on communications solutions and applications as well as more movement towards adopting U.S. based practices. This was a fourth year of participating in Arab Health, the largest healthcare event in the Middle East. Conversations in our booths revolved around unified communications across the entire hospital, not just individual departments showing that our enterprise-wide solutions approach also resonates internationally. With our expanding relationships with key healthcare service providers and partners in the region, we see EMEA as a strong market that will gain momentum in the coming years with good growth opportunities.

In the Asia-Pacific region, there continues to be a lot of interest in secure messaging and clinical messaging capabilities, especially our Critical Test Results Management solution, or CTRM. Media attention on one of our customers in Australia using CTRM has created new interest in the unique workflows that Spok and [indiscernible] achieved. This interest was also evident from the record registration for our clinical center design architecting for productivity webinar with partner Cisco Australia. We are confident this market is ready for our mobile solutions and our integrated platform to unify critical communications and we remain focused on strengthening the Spok brand internationally.

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 and activities in these areas, which include digital demand generation campaigns, webinars, educational e-briefs, videos and website improvements, help us drive leads and fill the sales pipeline. In Q1, the contribution these efforts made to the sales pipeline increased 27% over the first quarter in 2015.

Marketing is also responsible for planning and coordinating Spok’s presence at a large number of tradeshows throughout the year. The most notable show the first quarter was HIMSS held in Las Vegas in March. This event is one of the largest healthcare conferences in the U.S. and a great opportunity for us to demonstrate our capabilities. Qualified leads identified at the exhibition booth during the show more than doubled from HIMSS 2015 and the caliber of conversations we had made it clear our brand recognition is growing and our enterprise communications approach is resonating. Lastly, our social reach has shown significant growth. Quarter-over-quarter, our following has increased 66%. Engagement with our audience is up 80% and unique views of our blog more than tripled.

Looking forward to the rest of 2016, we expect strong market demand for integrated critical communications, especially in healthcare and we are making investments in our research and development to further enhance our unified communications and collaboration solutions.

With that, I will pass it over the Vince. Vince?

Vince Kelly

Thanks, Hemant. Before we open up the call for your questions, I would like to comment briefly on a couple of items. First, I want to update you on our current capital allocation strategy. And second, I want to review our key goals and business outlook for 2016.

With respect to our current capital allocation strategy, our overall goal is to achieve sustainable business growth while maximizing long-term stockholder value. Towards that end, the allocation of capital will continue to be a primary area of focus for us. Our multifaceted capital allocation strategy includes dividends and share repurchases as well as key strategic investments that include augmenting our operating platform and infrastructure as well as potential acquisitions that provide additional revenue streams. As most of you know, we have spent substantial time over the past few years evaluating many acquisition opportunities to enhance our portfolio of software solutions. As such, we have reserved capital for one or more such acquisitions. Today, we have not yet identified the candidate that meets our acquisition criteria, primarily due to what we see as unacceptable valuation expectations. Nonetheless, we remain optimistic and will continue to review candidates that will be a good strategic fit. As we have discussed in the past, we will remain disciplined in our approach ensuring that any acquisition demonstrates both synergistic and strategic value for Spok as well as being accretive.

With regard to other uses of capital, we expect to continue paying in our quarterly dividend of $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 share repurchase authorization. As I noted earlier, we repurchased approximately 292,000 shares of common stock in the first quarter for approximately $4.9 million. As a result, a little more than $5 million remains authorized for purchase under the buyback plan, which extends through year end. We plan to return a total of $21 million in capital to shareholders in 2016 although the exact manner of distribution is yet to be determined along with the actual distribution dates.

I would also note that the Board may consider various other options for deploying capital from time-to-time. As part of our capital allocation strategy that I outlined previously, we have several options available to us to create shareholder value in addition to returning cash. One such option we have discussed and that we are already executing on is to increase our product strategy and development spend and growth opportunities where we believe we can generate attractive returns for stockholders. As usual, we will continue to maintain the ample liquidity to support our working capital needs.

And finally, with regard to our key goals and business outlook, we believe our first quarter activities and investments have positioned us well for another successful year in 2016. Our business goals for the year are simple and straightforward. They include growing our software revenue and bookings profitably across all geographies, retaining our wireless subscribers and revenue by slowing erosion, investing in our people, products and infrastructure and evaluating acquisition opportunities that are accretive to our business, can accelerate our revenue growth and use our valuable deferred tax assets. We are going to do all of this with the ultimate goal of creating long-term shareholder value.

To accomplish this goal, we reported a portion of our capital to accelerating the development, growth and expansion of our critical communications solutions and services. This includes investing in new products and services, expanding our sales reach both within and beyond existing market 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 paging and related wireless infrastructure to successfully meet the needs of our customer base as well as support the company’s ongoing cash flow and capital formation requirements.

And beyond that as I noted earlier, we will continue to explore external growth opportunities through the acquisition of companies or products that will enhance our portfolio solutions as well as potentially generate new avenues for sustainable growth. Spok continues to build an industry leading reputation. We remain committed to our core values of putting the customer first, creating solutions that matter, innovation and accountability. Combined with our strong team, solid financial platform and industry leading products and services, Spok is well positioned for the future.

At this point, I will ask the Operator to open the call for your questions and we would ask you to limit your initial questions to one and a follow-up. And again after that, we will take additional questions as time allows. Operator?

Question-and-Answer Session

Operator

Vince Kelly

Okay. So look I know it’s a real busy earnings week, since a lot of companies are putting their numbers out today. And I know folks and investors have a lot to focus on. We don’t seem to have any questions right now, but we are always available to take questions and you can always call Al Galgano, our Investor Relations professional and he can get back to you as well. So thank you very much for joining us this morning. We look forward to speaking with you again after we release our second quarter results in July. Everyone have a great day.

Operator

Thank you. This does conclude today’s call. You may disconnect at anytime and do have a great day.

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