Spok Holdings, Inc. (NASDAQ:SPOK) Q1 2019 Results Earnings Conference Call April 25, 2019 10:00 AM ET
Vincent Kelly - President & CEO
Michael Wallace - Chief Financial Officer
Conference Call Participants
Ben Natter - Kent Lake
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; Mike Wallace, Chief Financial Officer.
At this time, for opening comments, I will turn the call over to Mr. Wallace. Please go ahead, sir.
Good morning, and thank you for joining us for our first quarter 2019 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 2018 Form 10-K, our first quarter 2019 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, Mike, and good morning. We are pleased to speak with you today regarding our first quarter operating results from what we believe is a good start for 2019. First quarter results were in line with our seasonal expectations as we saw strong year-over-year performance in a number of key operating measures, including software revenue and wireless subscriber retention.
We achieved these results as we continued to invest in our business by enhancing and upgrading our product development team and tools as well as our sales infrastructure and management.
As we previously outlined, we believe these investments will yield significant future benefits in the form of what we believe is a game changer for future health care communication technology, the next evolution of our first of its kind Cloud Native enterprise communications platform, Spok Care Connect.
We believe our efforts will result in an industry-leading real-time Cloud Native solution that will provide hospitals the most security, agility, breadth and depth of services. In the first quarter, we continued to operate profitably and as a debt-free company while enhancing our product offerings.
We executed against our capital allocation strategy by continuing to make key strategic investments in our business while returning cash to our stockholders during the quarter in the form of dividends and share repurchases.
We were particularly pleased with our record high level of software revenue. Additionally, we continue to see a more than 99% renewal rate on software maintenance contracts.
Similar to our wireless revenue stream, software maintenance revenue is a largely recurring revenue stream that provides the company with a more stable revenue base. In the first quarter, approximately 78% of our revenue was recurring in nature.
Now before I turn the call over to Mike to provide additional details on our financial performance, I want to briefly review some key results for the first quarter. First, software revenue of $19.2 million included a near record high level of maintenance revenue, and our related software backlog at March 31 was up more than 4% from the prior year quarter.
In looking at our Q1 bookings results, it's important to note that this number would have been materially higher had a large seven-figure deal we were counting on closed in the last week of March rather than as it turned out in April, despite our best efforts to get it over the line of the quarter end.
However, we’re encouraged as bookings included sales to both new and current customers with existing customers adding products and applications to expand their portfolio of communication solutions.
Second, wireless subscriber revenue trends continued to improve and remained strong. Spok posted solid results for wireless products and services in the first quarter. Gross pager placements of 27,000 were up from the prior year quarter, while gross disconnects of 37,000 were down nearly 15% from the year-earlier quarter.
And as a result, net pager losses were 1% in the first quarter, nearly half of the prior year Levels. Wireless revenue decline in the first quarter was 2.1%, contributing to the continued low wireless revenue decline with a more stable ARPU or average revenue per unit.
In the first quarter, we averaged $7.32, down slightly from the prior year quarter. We were pleased to see the continuation of these positive trends especially in our top-performing Healthcare segment, which comprises nearly 82% of our paging subscriber base.
Third, we continued to demonstrate disciplined expense management. Mike will provide more details in a few moments. But I'm pleased to report that in the first quarter, adjusted operating expenses, which exclude depreciation, amortization and accretion, were down on both a sequential and year-over-year basis, with improvements in most expense categories.
In addition to our financial performance, we made progress in several other key areas, including product development, sales strategy and key strategic partnership agreements. During the quarter, we closed 12 six-figure deals and one deal that totaled $1.2 million. We also added more than a dozen new customers to the Spok family.
While this new customer was a large public hospital in Australia, it provides care to more than 0.5 million people through a range of services, including acute inpatient and day services, outpatient services, women's and children's services, pediatrics and pathology. This $1.2 million deal was the first time we saw an enterprise solution in Australia.
With console, mobile, messenger, critical test results management and test and development environments, this hospital will be our showcase site for the Asia-Pacific region. The hospital is also contracted for five years in maintenance.
On the wireless side, we closed the deal with an existing customer during the quarter that was a major pickup for us. This heath system is a research and teaching hospital in the Western United States serving as a referral center for the region and surrounding states.
The organization is adding Spok-encrypted alphanumeric pagers and deployed 2,175 units in March. Due to our strong relationship with the organization and alignment with Spok Mobile, the help system chose to end its 20-year relationship with one of our major paging competitors and keep its important facet of its communication solutions with Spok.
Spok continues to build an industry-leading reputation and is generating sales momentum at the conferences we attend. Thus far in 2019, we generated tremendous activity from trade shows and positioned Spok as a thought leader in our industry.
At the American Organization for Nurse Executives, AONE, Conference earlier this month, our Chief Nursing Officer, Dr. Nat’e Guyton, presented a sunrise session to nurse leaders entitled How to Leverage Technology to Prioritize Care Delivery.
We believe the combination of Spok's strong team, solid financial base and broad depth of our products and services positions us to capture the opportunity in the health care sector and stimulate sustainable growth.
I'll make some additional comments on our business outlook in a few minutes, but first, Mike Wallace, our Chief Financial Officer, will review the financial highlights for the quarter. Mike?
Thanks, Vince. Let me give you a little more detail on our financial performance in the first quarter. I would again encourage you to review our first quarter 2019 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. Key drivers of our financial performance during the quarter were strong levels of software services revenue, software maintenance revenue renewal rates, which continue to exceed 99%, and the lower than anticipated levels of churn in paging units and wireless revenue churn.
Continued operating expense management has also allowed us to continue to absorb the impacts of our planned investments in product, research and development expenses. Overall, we believe we are off to good start in 2019.
I will review 4 additional key areas which drove our first quarter financial performance. They include: one, a review of certain factors impacting first quarter revenue; two, selected items which influenced first quarter expenses; three, a brief review of the balance sheet; and finally, an update on our financial guidance for 2019.
As usual, if you have specific questions about these items or any of our quarterly financial results, I will be happy to address them during the Q&A portion of this morning's call.
With respect to revenue for the first quarter of 2019, total GAAP revenue was $41.8 million compared to $43.1 million in the first quarter of 2018. We were particularly pleased with our ability to generate record high levels of first quarter software revenue as well as the continued slower erosion in our wireless business.
Total first quarter software revenue of $19.2 million reflected a nearly 2% increase from the first quarter of 2018 with software services revenue and maintenance revenue growing by more than 28% and 8%, respectively, from the prior year quarter as we continue to refine and enhance our processes specifically related to the implementation of our software solutions.
Additionally, as noted earlier, the maintenance revenue continues to increase reflecting our maintenance revenue renewal rates in excess of 99% and providing a reliable and reoccurring revenue and cash flow stream.
Wireless revenue for the first quarter remained solid, declining only 6.8% from the prior year quarter. This continued performance in our wireless business is being driven by the combination of solid gross additions, the minimization of churn with existing customers and maintaining stable unit pricing.
Turning to operating expenses; we continue to maintain our focus on creating efficiencies in our expense base in order to offset some of the planned increases in our product research and development category.
During the first quarter, we reported adjusted operating expenses, which excludes depreciation, amortization and accretion, of $38.3 million, down from $39.8 million in the year-earlier quarter and down from $40.5 million in the prior quarter.
The year-over-year decline was driven largely by lower cost of revenue, selling and marketing and general and administrative expenses and offset by slightly higher research and development costs.
Specifically in the first quarter of 2019 regarding research and development, costs totaled $6.2 million. While up approximately 8% from the first quarter of 2018 or approximately $400,000, the spending level was down nearly 7% from the prior quarter.
From quarter-to-quarter, we expect to continue to see fluctuations in research and development costs as we continue to build out the Care Connect platform. But as discussed previously, an overall moderating growth rate in research and development spend as we move forward. Our capital expenses in the first quarter were approximately $1.3 million and we’re in line with the guidance we provided for 2019 during our year-end conference call.
Capital expenses are incurred primarily for the purchase of pagers and network infrastructure to support our wireless customers as well as the necessary infrastructure to support our software business.
We do not expect any significant changes to the level of our capital expense requirements for the balance of 2019 and expect to be within the guidance range for the year. During the quarter, the company generated approximately $3.5 million in EBITDA, or earnings before interest, taxes, depreciation and amortization, up on both a sequential and year-over-year basis.
This, along with cash on hand, was used to fund the quarterly dividend of $2.7 million, share repurchases of $1.8 million and the previously noted capital expenses of $1.3 million. We ended the quarter with a cash balance of $81.8 million, down approximately $5.5 million from December 31, 2018.
Before I review our 2019 financial guidance, from a balance sheet perspective, I'd like to point out the approximately $17 million increase in noncurrent assets as well as the corresponding increase in our current and noncurrent liabilities this quarter.
This gross-up of our balance sheet represents the valuation of right-of-use operating leases related to ASC 842. On January 1, 2019, we adopted ASC 842 using the modified retrospective approach with a cumulative effect adjustment to our opening balance of retained earnings as of January 1, 2019.
Results for the reporting period beginning after January 1, 2019, are presented under ASC 842, while prior period amounts are not adjusted and will continue to be reported in accordance with our historical accounting under ASC 840. For additional details, please refer to the Notes section in our Form 10-Q, which we expect to file later today.
Finally, with respect to our financial guidance for 2019, based on our performance in the first quarter, we are maintaining the guidance we previously provided, which projects consolidated total revenue to range from $156 million to $174 million, including software revenue of $75 million to $85 million; adjusted operating expenses, excluding depreciation, amortization and accretion, of $155 million to $165 million; and capital expenditures to range from $3 million to $7 million.
I will remind you that our projections are based on current trends, and those trends are always subject to change. With that, I'll turn the call over to Vince who will update you on our business goals for 2019. Vince?
Thanks, Mike. Before we open the call to your questions, I'd like to comment briefly on several items. First, I want to update you on our current capital allocation strategy. Second, I want to talk about some recent key management additions. And finally, I want to briefly review our key goals for 2019.
With respect to our current capital allocation strategy, our overall goal is to achieve sustainable profitable business growth while maximizing long-term stockholder value. Towards that end, the outpatient capital remains a primary area of focus.
Our multifaceted capital allocation strategy includes dividends and share repurchases as well as key strategic investments that include augmenting our product development, operating platform and infrastructure. It also includes the potential for acquisitions, as we have discussed in the past.
Even now, we have not been satisfied with valuation expectations for most of the targets we have reviewed, we'll continue to explore select M&A opportunities and conduct business due diligence as appropriate.
However, for now, we have concluded that the build path, while taking a bit longer, is far superior to the bypath due to our ability to create an integrated state-of-the-art Cloud Native architecture for the future that we believe will result in an industry-leading platform for clinical communications and collaboration.
Additionally, as we’ve previously stated, we remain committed to paying our $0.125 per share of quarterly dividend this year and make additional share repurchases as appropriate. We'll continue to invest in our company to benefit the future and create long-term stockholder value.
We're a company in transition, and our management and board believes that financial flexibility over the long term is important to the success of our strategy. We review our capital allocation posture on a quarterly basis and remain comfortable that we are striking a reasonable balance in serving the longer-term interest of stakeholders.
We'll continue to evaluate our capital allocation strategy and communicate our plans to you respect to dividends, potential share repurchases and other uses of capital each quarter when we report earnings.
With regard to management, we've recently upgraded our team with two very important additions. First, we brought on a new CIO, Chief Information Officer, Tim Tindle, to replace our former CIO, Tom Saine, who we tragically lost in an airplane accident last August.
Tim comes to us after 15 years at Harris Health System, a $1.5 billion a year integrated system system and academic medical center that also happens to be a Spok customer for both wireless and software.
Tim has deep health care IT experience but also an entrepreneur's blood flowing through his veins. When he saw what we were doing with our Cloud Native fully integrated Care Connect platform, it resonated with him.
He told us, no one else in the industry is doing that, and he thought our strategy of building a fully integrated Cloud Native platform with state-of-the-art architecture, while not offering the instant gratification of an M&A approach, was the best long-term path to winning the endgame in clinical communications. We're delighted to have Tim on our team. He has already made us a better company.
Second, we've added Dave [Indiscernible] to lead our product development team. Dave has vast experience in health care information technology, including 14 years’ experience with Class 2 and Class 3 medical device technology, nine years with Cath Lab devices and five years with enterprise radiology software.
Dave too endorses our strategy and has already contributed to enhancing our product organization and market approach in a collaborative, organized and professional manner. We're pleased to have both of these experienced team players and industry-leading executives on board contributing to and enhancing our collective future.
Finally, with regard to our key goals and business outlook, we believe our first quarter activities and investments have positioned us well for a successful 2019. In order to take advantage of a large opportunity in our chosen markets, our business goals for the year are simple and are straightforward.
They include accelerating development of our products and services to facilitate the evolution of the spare Spok Care connect platform, further strengthening our infrastructure, aligning resources and focusing where we believe there is highest potential for growth and driving software revenue growth while managing wireless revenue declines. We do all of this with the ultimate goal of creating long-term stockholder value and fulfilling our commitments.
So wrapping up, Spok remains committed to our core values of putting the customer first, providing solutions that matter, innovation and accountability. We believe our past results and future plans reflect these values and beliefs.
Before I open the call up for your questions, again, I'd like to remind everyone that on May 15, we'll be hosting an Investor Day program in New York that will further expand on our strategy and plans with respect to our company and our Care Connect platform.
After a presentation from management, we'll be providing a product demo followed by a question-and-answer session. If you're interested in attending this event, please contact Al Galgano for details. His contact information is in the Investor Relations section of our website. And we hope you can join us.
At this point, I'll ask the operator to open the call up to your questions. We’d ask you limit your initial questions to one and a follow-up after than we’ll take additional question as time allows. Operator?
[Operator Instructions]. Our first question comes from Ryan [technical difficulty].
Sorry, I had you on mute. Thanks for taking my questions.
Last quarter, we talked about having about a $2.5 billion opportunity for this communication and collaboration software suite. Is that an annual subscription revenue do you think for the whole opportunity?
Hey, Ryan, it's Mike Wallace. The roughly $2.5 billion to $3 billion is on a -- if you look at it from an on-prem license type of market. It's about $1 billion if you look at it on an annual subscription basis. So depending on what multiple you get to that annual subscription revenue, you can back into what you think the size of the market is. But the sort of $2.5 billion to $3 billion on the low end that we use from a market-size standpoint is based on an on-prem perpetual license type of business model.
Great. And so is your 2019 expectation still on the no bookings for the Care Connect platform? Or are you expecting bookings this month?
We're going to be selling the Care Connect platform in the second half of this year. We have our big summer sales conference in July, mid-July. We're prepping all sales reps at that conference for that who will be selling it in the middle of the year. But I don't expect significant revenue in 2019 from that. We'll get some bookings. But in terms of revenue, I'm expecting that we'll start seeing revenue coming in 2020 for that, Ryan.
Great. And then in your prepared remarks, could you double click on some examples of the progress you've made in each product development and sales strategy?
Yes. We're actually going to give a demo of that and quite a lot of detail at our May 15 Investor Day. And I think I saw that you're signed up for that. So I think we'll probably just defer to that after about three weeks, and we'll show you guys where we are with that.
Okay. And then the dozen new customers to the Spok family, what products did they purchase?
They purchased a variety of products. I mean our primary product that we've sold historically has been our contact center solutions as well as our mobile solutions. But they also buy our learning solution, which is messenger. Many of them do the whole suite. So it's a combination of those but primarily contact center and mobile.
Right. Thank you very much. Good luck.
Our next question comes from Ben Natter with Kent Lake.
Hi. I just wanted to ask about kind of what the outlook looks like for further operating expense or R&D or sales and marketing investment as you move through the rest of this year.
Yes. I mean we've taken our R&D expense, as you can imagine, up quite a bit over the last couple of years. We're at a level right now where I think we're pretty comfortable that, that thing is going to be relatively stable going forward. In other words, it's not going to be growing like it's been growing in the past. Yes, I think we had -- a few years ago, we're only spending about $13.5 million a year or so on R&D. And in 2017, that went up to over $18 million. And in 2018, it was up over $24 million.
And now we do not foresee increases like that. We brought on the staff we needed to bring on. We're actually making ourselves more efficient now in that area going forward. We're doing some outsourcing and consolidating some outsourcing opportunities. We've confirmed it has got a very good reputation and some of our leadership on the technology side have worked with in the past. So you're going to see that line item stabilize, and it will stay about where it is as we complete the Care Connect cloud-based infrastructure platform.
Okay. So I mean, it seems like your -- if you just annualize your operating or your sort of expense base, it seems like you're…
I think you're spot on.
What about -- I mean, so look, to what degree customers or sales cycles being impacted by Care Connect? I know you had perhaps one of the softest billings quarters you've had in a number of years. Is that related at all to customers saying I want to wait for the new platform?
No, it's actually not. We had a big quarter in the fourth quarter. What tends to happen is the first quarter from a seasonal perspective tends to be a little bit light. We've got a really nice pipeline for the second quarter. We just landed a very large seven-figure deal that I might have referenced that in my prepared comments, just another very large seven-figure deal and sales people have given us a very good solid pipeline for the balance of the quarter and for the rest of the year.
So I don't think you'll see that affect things as much. The rollout of our Care Connect platform in the cloud-based platform is going to take place over time, and it's really not going to start until the second half of this year. People aren't saying no because some of the upgrades and the technology that we're selling now are necessary in order to move to the cloud for our prospective CCS version 1.9 that we're selling out there right now. So I don't think it's going to hurt us at all. As a matter of fact, that might even help us.
Got it. So there's no pause or anything. It's just pure -- so you'll continue to be selling both platforms in the second half or just...
Oh, yes. Oh, absolutely. Yes. No, like Mike said, I think he reiterated our guidance. We're comfortable with our guidance.
Okay. And just one other question. I mean what has driven the sort of -- you had some increases in your accounts receivable over the last few years. What's primarily driven that?
Yes. I mean a part of it is the hospital sector is certainly slowing down in their payments these days. That's one. Second, we are selling a set of, which is a good thing, larger and more complex deals that tends to in some cases, stretch out the payment terms that we have historically been seeing a number of years ago. So all of those things -- and we have been increasing bookings not at the pace we would like but certainly increasing them over the years. So they all play into a function of AR increasing a bit.
Mike, excuse me. When did we -- I know at some point, we did a reclass too where we pulled credits out of AR, and it tended to bump up AR and intended to bump up AR and pump up AP. Was that in the first quarter?
Yes. So in the first quarter, there was about $2 million of credits that we reclassed into accounts payable. So if you actually look at our balance sheet, you'll see that accounts payable increased about $2 million. So…
That’s a one-thing…
That's a one-time thing, so that pushed up AR about $2 million.
Okay. Well, great. Thank you.
Thank you, Ben. From CFO, May 15 to Manhattan.
I’m in San Francisco. You’re guys are going to webcast there, right?
You can download.
Operator, I don't see any more calls in the queue. So we'll go ahead and wrap up. I just want to thank everyone for joining us this morning, and we look forward to speaking with you again in May at our Investor Day if you can make it and after we release our second quarter results, of course, again in July. Thanks for joining us and, everyone, have a great day.
Thank you, everyone. This concludes today's teleconference. You may now disconnect.