Spok Holdings, Inc. (NASDAQ:SPOK)
Q2 2016 Earnings Conference Call
July 28, 2016 10:00 AM ET
Vince Kelly - President & Chief Executive Officer
Shawn Endsley - Chief Financial Officer
Hemant Goel - President
Good morning and welcome to Spok’s Second 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 Spok’s operating company.
At this time for opening comments, I will turn the call over to Mr. Endsley. Please go ahead, sir.
Good morning. Thank you for joining us for our second quarter 2016 investor update. Before we discuss our operating results, I want to remind everyone that today’s conference call may include forward-looking statements that are subject to risks and uncertainties relating to Spok’s future financial and business performance.
Such statements may include estimates of revenue, expenses and income, as well as other predictive statements or plans which are dependent upon future events or conditions. These statements represent the Company’s estimates only on the date of this conference call and are not intended to give any assurance as to actual future results.
Spok’s actual results could differ materially from those anticipated in these forward-looking statements. Although these statements are based on assumptions that the company believes to be reasonable, they are subject to risks and uncertainties.
Please review the Risk Factors section relating to our operations and the business environment in which we compete contained in our 2015 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.
Thanks, Shawn, and good morning. We’re pleased to speak with you today regarding our second quarter operating results and what we believe was a solid performance for Spok. We are beginning to see the benefits from the investments that we have made to enhance and upgrade our product development team and tools, as well as our sales infrastructure and management. And while we still have more work to do in that regard, we are off to a good start.
During the quarter, we saw strong performance in a number of key operating metrics and made further progress towards transitioning Spok to a growth model and long-term provider of critical communications solutions.
In general, our performance in the second quarter was consistent with our expectations and the seasonal trends we typically experience during the year. We were very pleased as we saw continued reduction in the decline of our paging units and wireless revenue to record low levels.
Software revenue was in line with the prior quarter, and we believe we are well positioned for the second half of the year. Our software bookings improved nearly 33% from the prior quarter, and our backlog was up nearly 7.4% over the same period.
In the second quarter, we also saw strong performance in a number of other key operating measures, including solid improvements in operating expense management and cash generation. We believe that continued investments will yield significant future benefits in the form of our improved, integrated communication platform, Spok Care Connect, and an enhanced and upgraded sales team.
Overall, we continue to operate profitably, enhance our product offerings and further strengthen our balance sheet. Our ability to generate healthy cash flows allowed us to execute against our capital allocation strategy, returning capital to shareholders, while adding more than $5 million to our cash balances. Shawn and Hemant will provide details on our financial performance and operating activities shortly. Before that, I want to highlight the key results for the second quarter.
First, software bookings of $20.1 million in the second quarter included $9.9 million of maintenance renewals, a record high. Operations bookings totaled $10.2 million for the second quarter, representing the first time in the past year that they exceeded $10 million. And our software backlog grew nearly $40 million at mid-year.
Bookings included sales to both new and current customers, with existing customers adding products and applications to expand their portfolio of communications solutions. Customer demand remained strongest for upgrades to call center solutions, healthcare applications to increase patient safety and improved nursing workflows.
Also, our pipeline of qualified leads continue to grow both in terms of quality and size, the result of the 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 smart-phone communications, secured texting, emergency management, and clinical alerting. Also, we continue to widen our focus beyond healthcare in such market segments as public safety, business, hospitality, education and government services
Spok continues to build an industry-leading reputation that’s generating activity and momentum at the conferences we attend. Early in May, we were also pleased to publish the results of a customer study demonstrating how Spok customers are achieving notable improvements in staff efficiency and patient care coordination workflows throughout their organizations using Spok Care Connect solutions. Please visit our website to see these customer success statistics in our new infographic, the ROI of Communication Technology.
Second, wireless subscribers and revenue trends continue to improve. Our annual rate of paging unit erosion for the quarter improved to a record low of 5.5%, while the quarterly rate improved 900 basis points from the prior quarter to 0.8%.Our Healthcare segment increased by 1,022 units in service in the second quarter. In addition, our annual and quarterly rates of wireless revenue erosion improved.
Also, contributing to slower wireless declines was a stable ARPU, or average revenue per unit. 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.
We’re encouraged by the slower than anticipated rate of wireless paging unit revenue erosion. And let me point out that while many physicians want smart devices and secure messaging is a natural fit for them, they also want to keep pagers because they have long trusted them and want to separate their personal smart-phone communications from their work communications arriving on a pager.
Also, in a true emergency situation such as severe weather or an event involving rapid deployment of first responders, cellular networks tend to get overloaded and message delivery can fail or be interrupted. If an organization utilizes only smart-phones, communications can be at risk.
Pagers still work in these scenarios because we use a separate simulcast network and satellite control redundancy. As a result of these dynamics, we believe that migration from wireless pagers will continue to occur at a slower pace.
Third, consolidated operating expenses in the second quarter, excluding depreciation, amortization and accretion, continued to improve on both an annual and sequential basis. Shawn will provide more detail on this in a few minutes, but I’m 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 $8.9 million, or nearly 20% of revenue, in the second quarter, 900 basis point improvement from the EBITDA margin in the second quarter of 2015.
Of course, margin levels will fluctuate over time reflecting our level of investment in an aggressive hiring program in the areas of product development and sales. However, longer term, we are focused on transitioning to a sustainable and profitable growth model.
And finally, again we generated sufficient free cash flow in the second quarter to return significant capital to 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 more than 65,000 shares of common stock under our stock buyback program. I’ll comment further on our capital allocation strategy later in the call.
All-in-all, the Company posted solid operating results in the second quarter, and we look forward to further progress throughout the second half of 2016. I’ll 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. After that, Hemant Goel, President of our operating company, will comment on our second quarter sales and marketing activities. Shawn?
Thanks, Vince. Before I review our financial highlights for the second quarter of 2016, 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 than we will cover on this conference call.
As Vince noted, we were pleased with our overall operating performance for the second quarter, and we remain focused on executing against our business plan as we enter the second half of the year. In addition to the substantial progress we made for meeting our long-term business goals, we saw solid sequential and year-over-year improvement in a number of key operating metrics.
Revenue contribution from both software and wireless, combined with focused expense management, helped maintain solid operating cash flow, EBITDA and operating margins for the quarter, as we continued to invest in our business for long term growth. We also added to our already strong balance sheet and continued to operate as a debt-free company at quarter-end.
In the interest of time today, I will not review our second quarter performance on a line-by-line basis, since much of that information is contained in our news release schedules and federal filings. If you ask specific questions about our quarterly financial results, I would be glad to address those during the Q&A portion of this call.
Instead, I would like to focus this morning on four key areas that I feel will give you a better idea of the drivers of our second quarter performance. These include, number 1, a review of certain factors that impacted second quarter revenue, number 2, a review of selected items that impacted second quarter expenses, number 3, a brief review of certain balance sheet items, and finally number 4, our financial guidance for 2016.
With respect to revenue for the second quarter, total revenue was $44.6 million, in line with revenue levels in the prior quarter. Second quarter revenue performance resulted primarily from continued strong maintenance renewal rates from our software customers and a lower rate of second quarter paging unit erosion that favorably impacted wireless revenue.
As anticipated, total second quarter software revenue of $16.8 million was essentially flat to the prior quarter software revenue of $17.2 million. As I’ve noted on previous calls, our software operations revenue is now generally recognized on a ratable basis, and totaled $7.7 million in the second quarter compared to $8.1 million in the prior quarter.
Maintenance revenue, the other component of software revenue, increased nearly 9% to $9.1 million in the second quarter from $8.4 million in the prior-year period. It was also up slightly from the prior quarter. The increase reflects our continuing maintenance renewal rates in excess of 99% from our installed software solution base.
Wireless revenue continues to exceed expectations, as we saw quarterly pager unit erosion slow to a record low 0.8%. As a result, wireless revenue totaled $27.8 million, down only 1.1% from the prior quarter. This solid retention reflected another strong performance by our sales team to, again, generate significant wireless growth additions, while minimizing churn and maintaining stable unit pricing. Note that the financial tables that we included in the earnings release include an additional schedule detailing the components of our software and wireless revenue.
Turning to operating expenses, we reported consolidated operating expenses, excluding depreciation, amortization and accretion, of $35.8 million in the second quarter. Second quarter performance reflects a more than 8% improvement from the prior year and a more than 1% improvement from the prior quarter, as we continue to manage our expenses to meet the changing nature of our business.
These reductions have not come at the expense of our business operations. As Vince pointed out, we continue to invest to enhance and upgrade our product development t0eam and tools, as well as our sales, infrastructure and management.
Of the year-over-year and sequential declines in operating expenses, the sharpest improvements can be attributed to a decline in cost of revenue expense, as we implement greater efficiencies in our operating platform.
Cost of revenue expense reflects costs for both internal and external implementation services, as well as third-party hardware and software purchased for customer implementations. Last year, we focused our expense management initiatives to rebalance the use of these third-party services and have used internal implementation employees to manage this cost.
Turning to headcount. We continue to adjust our employee levels to meet anticipated demand levels as well as the changing requirements of our business, including investments in our product development staff. Our full-time equivalent employees, or FTEs, were 597 at June 30, 2016 versus 600 FTEs at December 31, 2015, and 608 FTEs at June 30, 2015. These employee levels will continue to change as we execute against our business plan.
Our capital expenses in the second quarter of 2016 were approximately $1.5 million and were incurred primarily for the purchase of pagers and infrastructure to support our wireless customers. Through the first half of the year, capital expenses totaled approximately $3 million, and we do not expect any significant changes to the level of our capital expense requirements for the second half of 2016.
Turning to the balance sheet and other financial items, the Company generated approximately $20 million in cash from operating activities in the first half of 2016. Of that amount, Spok returned more than half to our stockholders in the form of cash dividends and share repurchases. Of the remaining operating cash, 50% was used to purchase property and equipment, and the remaining $5.8 million has been retained for future use as part of the June 30, 2016 cash balance of $117.1 million.
We expect to use a portion of that cash in connection with quarterly cash dividends, as well as potential share repurchases in the remainder of 2016. We exited the quarter with no debt outstanding and continue to operate as a debt-free company. Vince will comment further on our capital allocation strategy shortly.
Finally, with respect to our financial guidance for 2016, as a result of the solid performance we saw in the second quarter, we are maintaining the 2016 guidance range that we provided last quarter. That includes total revenue to range from $174 million to $192 million, operating expenses excluding depreciation, amortization and accretion, to range from $153 million to $159 million, and capital expenditures to range from $6 million to $8 million. 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 the call over to Hemant Goel, who will update you on our second quarter sales and marketing activities. Hemant?
Thank you, Shawn, and good morning. During the second quarter of this year, our sales and marketing teams delivered software bookings of $20.1 million. This represents a 32.8% increase over Q1 and includes a consistently high maintenance renewal rate in excess of 99%. We also welcomed more than 30 new customers to the Spok family, primarily in the healthcare and government sectors.
I will start by sharing our largest six-figure deal of the quarter. It came from a government customer looking for a secure, reliable way to monitor 911 calls across more than 160 locations around the U.S.
Our solution’s dependability has been verified with ongoing Joint Interoperability Test Command, or JITC certification, and Spok’s reputation for that reliability was a contributing factor in the success of this deal. This opportunity was also made possible through strategic partnership with another IT company. The Spok team worked closely with this ally to design an enterprise-wide emergency assistance solution that will meet the needs of this customer.
Healthcare remains an important part of our growth and our largest segment, comprising 82% of overall bookings in the U.S. for Q2. Many of these are current customers returning to upgrade their systems, and expand their Spok infrastructure. For example, a customer in the Northeast is adding a secure messaging app to their solution set so physicians can coordinate care effectively via text messages without putting protected health information at risk.
And one-fifth of our Q2 Healthcare bookings were hospitals and health systems that have never worked with us before. Among the new customers joining Spok in Q2 is a small acute care hospital on the West Coast. This facility recently completed construction of a new building and seeks to upgrade their contact center.
As they look to have communications across the hospital to assess the project, they realized they needed a solution that would support more than just call handling for their operators. They saw the value of our integrated solution suite offers beyond standalone departmental applications to help support evolving communications technology. This hospital selected us for their console platform, because they recognized Spok as a long-term partner as they build out their clinical communications infrastructure.
It is common for our customers to see us not just as a vendor, but also a trusted partner that can support them now and into the future. A community hospital in the Eastern United States responding to a request from their nursing staff engaged our consulting services team to assess their clinical workflows and make recommendations.
The hospital’s leadership wants to ensure that any new solutions will work with their existing IT infrastructure, allow for growth and be sustainable long-term. Spok’s unified enterprise communications platform resonated with this customer and they are working with us to solidify their communication foundation and expand.
Our Consulting Services Group continues to gain momentum and has seen a 70% growth in engagements over past year. Consulting is one part of our highly skilled professional services group, which is an important part of our long-term strategic direction to give our customers an exceptional experience and set them up for success.
Satisfaction scores with our continually improving processes have increased 7 points year-over-year, and we have been able to improve project profitability by 5% in the same time period. In addition, 90% of our project managers are now PMP certified.
Looking at customers and prospects outside of the United States, international bookings in Q2 were below our expectations, but our experience indicates that this will not be a trend. We see healthcare organizations in Europe, the Middle East and Africa placing greater emphasis on communication solutions and applications, as well as more movement towards adopting U.S.-based practices.
With our expanding relationships with key healthcare services providers and partners in the region, we see EMEA as a strong market that will gain momentum in the coming years with growth opportunities.
In the Asia Pacific region, there continues to be a lot of interest in clinical messaging, especially critical test results management and our integrated platform to unify critical communications. This is evidenced by the strong attendance at our recent webinar, Enabling EMR Interoperability, presented in conjunction with HIMSS Asia-Pac.
Outside of healthcare in this geography, the team converted solid opportunities to booking in the hospitality sector. One of our largest deals of the quarter, a new resort and casino in Eastern Asia, will be using Spok to support their contact center. The resort’s parent company has high regard for our partnership and has made Spok a standard partner for their communication technology to help them provide exceptional services to guests.
Before turning 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 eBriefs, videos and website improvements, help us drive leads and build our reputation as a top leader in the industry.
Marketing is also responsible for planning and coordinating Spok’s presence at a large number of trade shows throughout the year. In Q2, Spok participated in a number of events for both healthcare and public safety. Qualified leads identified at these shows increased by 33% over last year. And the caliber of conversations made it clear, our brand recognition is growing and our enterprise communications approach is resonating.
Our social media reach is also continuing to grow. Quarter-over-quarter, our social following has increased 33% and unique views of our blog more than doubled from the second quarter last year.
Looking forward to the second half of 2016, we expect strong market demand for integrated critical communications, especially in Healthcare, and are making investments in research and development to further enhance our unified communications and collaboration solutions.
One of these investments is the addition of Dr. Nat’e Guyton as Chief Nursing Officer and part of our senior product strategy team. Dr. Guyton will work with nurses around the globe to implement best practices and help us continue to enhance our critical communications solutions for workflow improvements and better patient care.
With that, I’ll pass it back to Vince.
Thank you, Hemant, and thank you, Shawn. Before we open the line up to your questions, I’d like to comment briefly on a couple items. First, I want to update you on our current capital allocation strategy, and I also 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 through our multifaceted capital allocation strategy. That includes dividend and share repurchases, key strategic investments to improve our operating platform and infrastructure, potential acquisitions that can provide additional revenue streams and are accretive to earnings.
First, we expect to continue paying our quarterly dividend of $0.125 per share, $0.50 annually, for the foreseeable future based on our current projections for operating cash flow. In addition, we may buy back additional shares of our common stock from time to time under our share repurchase authorization and as market conditions allow.
As Shawn noted earlier, through the first six months of 2016, we repurchased approximately $6 million of our common stock. As a result, a little more than $4 million remains authorized for purchase under the current buyback plan which extends through year-end.
Next, as part of our capital allocation strategy, we have several options available to us to create shareholder value in addition to returning cash. One such option that we have discussed and that we are already executing on is to increase our product strategy and development-spend in growth opportunities, where we believe we can generate attractive returns for stockholders. As usual, we will continue to maintain ample liquidity to support our working capital needs.
Last, we’ve not yet identified the candidate that meets our acquisition criteria, primarily due to what we see as a continued environment of unrealistic valuation expectations and candidates with high cash burn rates and unrealistic projections.
We continue to review candidates that could be a good fit for our platform. However, as we’ve discussed in the past, we will remain disciplined in our approach, ensuring that any acquisition demonstrates both synergistic and strategic value for Spok. In the meantime, we will continue to weigh increases in our internal R&D expenditures against M&A opportunities.
Finally, turning to our key goals and business outlook. We’re encouraged by our solid operating results in the second quarter. 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.
Our business goals over the next few quarters are unchanged, and are simple and straightforward, designed to create long-term value for our shareholders. They include growing our software revenue and bookings profitably across all of our geographies, retaining our wireless subscribers and revenue by slowing erosion, investing in our people, products and infrastructure, and continuing our evaluation of acquisition opportunities that could be accretive to our business that accelerate our revenue growth and that use our viable deferred tax assets.
To accomplish these goals, we will deploy a portion of our capital to accelerate the development, growth and expansion of our critical communication solutions and services. This includes investment in new products and services, expanding our sales reach both within and beyond existing market segments, extending our sales into new geographic regions, and promoting our brand in key global markets.
In conclusion, there are many reasons we are confident in our future. Spok is proud to be working with more than 2,000 hospitals worldwide, including the best adult and children’s hospitals as defined by the U.S. News & World Report. We continue to build an industry leading reputation across several vertical markets. We remain committed to our core values, 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’ll ask the operator to open the call for your questions. We’d ask that you limit your initial questions to one and a follow-up. And after that, we’ll take additional questions if time allows. Operator?
Okay. Look, thank you for joining us this morning, everyone. We look forward to speaking to you again after we release our third quarter results in October. So everyone have a great day.
And that does conclude today’s teleconference. We thank you all for your participation.
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