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Spok Holdings, Inc. (NASDAQ:SPOK)
Q2 2019 Earnings Call
Aug. 1, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning and welcome to Spok's Second Quarter Investor Call. Today's call is being recorded. Online today, we have Vince Kelly, President and Chief Executive Officer, and Mike Wallace, Chief Financial Officer. At this time, for opening comments, I will turn the call over to Mr. Wallace. Please go ahead, sir.

Michael W. Wallace -- Chief Financial Officer

Good morning. Thank you for joining us for our second 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 and 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 day 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 factor section relating to our operations and business environments in which we compete, contained in our 2018 Form 10-K and our second 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.

Vincent D. Kelly -- President and Chief Executive Officer

Thank you, Mike, and good morning. We're pleased to speak with you today regarding our second quarter operating results and what we believe is a good start as we enter the second half of 2019. Our performance in the second quarter of 2019 was in line with our seasonal expectations. During the quarter, we saw strong performance in a number of key operating measures, including solid growth in year-over-year software bookings levels, both sequential and year-over-year improvements of subscriber retention, increased software backlog levels, and continued strong operating expense management. We believe our year-to-date results provide a solid base and position us well as we enter the second half of the year.

Overall, we continue to generate positive EBITDA, totaling $3.8 million in the first half of 2019, up from $3.6 million in the year earlier period. We also returned nearly $7 million of capital to our stockholders through the first half of the year in the form of dividends and share repurchases and enhanced our product offerings through our continued investments in our integrated communication platform Spok Care Connect.

We continue our substantial investment in our development team by leveraging our decades of experience in critical healthcare communication to deliver a cloud-based platform that will bring the latest in communication technology to the market. As previously outlined, we believe these investments will yield significant future benefits in the form of our improved integrated communication platform, as well as high future bookings levels supported by our enhanced and upgraded sales team. Our teams remain on target to meet our development goals for the year.

As we further our transition, we were pleased to see first-half software revenue grow year-over-year, with each quarter up from the prior year. 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 from our legacy premise-based software solutions. Through the first six months of 2019, over 75% of our revenue base is recurring in nature.

Now, before I turn the call over to Mike to provide additional details on our financial performance, I wanna briefly review some key results for the second quarter. First, on a GAAP basis, software revenue of $17.4 million was up 2.5% from the prior year quarter, and our related software backlog at June 30th was $39.7 million, up more than 6% from the prior quarter, and up over 9% from the second quarter of 2018. Our sales team will continue to be laser focused on generating activity throughout the remainder of the year. Additionally, we expect to be selling our new cloud-native platform by year end, including a pilot program to incent early adopters.

Second, wireless subscriber and revenue trends continue to exceed our expectations. Spok posted solid results for wireless products and services in the second quarter. Gross pager placements of approximately 35,000 units were up sharply from the prior quarter. As a result, net pager losses declined to approximately 5,000 units in the second quarter, half of the level of net pager losses in the prior quarter and matching the historical low for this metric. We were pleased to see the continuation of these more stable trends, especially in our top-performing healthcare segment, which comprises approximately 82% of our paging subscriber base.

Spok continues to demonstrate disciplined expense management. Mike will review the specifics for the quarter in a few minutes; however, let me point out that as we continue to make the necessary investments in our product development and sales and marketing infrastructure to support to the evolution of the Care Connect platform, we saw operating expenses drop nearly 4% on a year-over-year basis in the first half of this year. I'm proud of what our team has accomplished in this area, and we remain focused in looking for opportunities to make our platform even more efficient from a cost perspective.

Finally, in addition to our financial performance, progress was made in several other areas, including product development and sales strategy. During the quarter, we added more than two dozen new customers to the Spok family. Several of those customers are in Australia, signaling our continued growth and commitment to the Asia Pacific market.

Let me take this opportunity to highlight a couple of new customers that joined the Spok family last quarter. First, we signed a seven-figure deal with Australia's largest public health system. The system, which operates multiple local health districts, recently selected an Enterprise Imaging IT solution and chose Spok to help collaborate its medical imaging and information across multiple locations. The hospital's taken part managing a joint volume around $3 million imaging exams per year. This customer signed a multi-year deal for Spok to deliver test results for all of its sites.

In the United States, we secured a major agreement with the West Coast not-for-profit healthcare system, operating 23 hospitals and 160 clinics. A former Spoke customer, the healthcare system had switched to one of our competitors for their contact center solution two years ago with disappointing results. The customer came back to Spok, has executed a four-hospital upgrade to Spok Care Connect, Version 1.9, and is working toward an enterprisewide consolidation of all of their console solutions.

Spok continues to build an industry-leading reputation and is generating sales momentum. In the last quarter, we strengthened our position as an industry thought leader at the conferences we attended where key Spok executives made presentations and facilitated focus groups. Also, for the seventh consecutive year, we are proud and honored to report that all of the adults hospitals named to the U.S. News and World Report's 2019-2020 Best Hospitals Honor Roll used Spok clinical communication solutions to facilitate care, collaboration, and support exceptional patient care.

I'll make some additional comments on our business outlook shortly. But first, Mike Wallace, our Chief Financial Officer, will review the financial highlights for the quarter. Mike?

Michael W. Wallace -- Chief Financial Officer

Thanks, Vince. Let me give you all a little more detail on our financial performance in the second quarter. I would again encourage you to review our second 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 second quarter and believe that our year-to-date performance positions us to take advantage of the typically increased activity in the second half of the year. Key drivers of our financial performance during the quarter were sustained levels of year-over-year software operations revenue, software maintenance revenue renewal rates, which continue to exceed 99%, and lower levels of churn in wireless paging units. Lastly, continued discipline in our operating expense management has allowed us to absorb the impacts of our planned investments and product research and development expenses and generate positive EBITDA.

Over the next few minutes, I will review key areas which drove our second quarter financial performance. They include, 1.) A review of certain factors impacting second quarter revenue, 2.) Selected items which influence second-quarter expenses, a brief review of the balance sheet, and finally, I will review 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 second quarter of 2019, total GAAP revenue was $39.5 million, compared to $40.6 million in the second quarter of 2018. Through the first six months of 2019, GAAP revenue totaled $81.3 million, compared to revenue of $83.7 million in the first half of 2018. While total revenue was down slightly on a year-over-year basis for the periods noted, we were again pleased with our ability to generate a year-over-year increase in software revenue and minimize wireless revenue erosion.

Specifically, for software revenue, total second-quarter performance of $17.4 million reflected a 2.5% increase from the second quarter of 2018, with year-to-date software revenue up similar from prior year levels. This performance was driven primarily by a nearly 7% year-over-year, year-to-date increase in software maintenance revenue, and we continue to refine and enhance our processes, specifically related to the implementation of our software solutions to drive higher services revenue.

With respect to wireless revenue, first-half performance was driven by lower level of pager unit churn on both the sequential and year-over-year basis. As a result, wireless revenue for the first half of 2019 remained solid, declining only 6.7% from the prior year period. This continued performance in our wireless business is being driven by the contribution of solid gross additions, 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. For the second quarter of 2019, we reported consolidated operating expenses, which excludes depreciation, amortization, and accretion of $39.2 million, down from $40.3 million in the year-earlier quarter. We achieved a $1.1 million year-over-year improvement, despite a $630,000 increase in research and development costs over the same period by finding ways to cut other costs across the organization.

While research and development costs are up from the prior year period, I'd like to highlight the moderate rate of increase I have been discussing in previous quarters, as we approach a more steady-state level in that category. In the second quarter of 2019, research and development cost totaled $6.8 million, representing a 10.2% increase from the second quarter of 2018, but down sharply from the 32.5% year-over-year increase we saw in the first quarter of 2018. On a year-to-date basis, research and development costs totaled approximately $13 million, up from $11.9 million in the first half of 2018. While first-half R&D expenses were up 8.9% from the prior year, again, this was a sharp reduction from the $35.9 percent year-over-year increase we saw in the first half of 2018.

Metrics such as these demonstrate our commitment to expense management, while simultaneously investing in our future. We believe that this overall trend will continue, as we are now past the initial portion of our investments in research and development, and those expenses should approach that more steady-state level from a growth rate perspective.

Regarding capital expenses in the second quarter, they were approximately $1.5 million. For the first six months of 2019, capital expenses totaled $2.8 million and are in line with the guidance we provided. Capital expenses are incurred primarily for the purchase of pagers, 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.

Turning to the balance sheet and other financial items, through the first six months of the year, Spok generated approximately $3.8 million of EBITDA. This, along with cash on hand, was used to fund quarterly dividends of $5 million, share repurchases of $1.8 million, and capital expenses of $2.8 million. We ended the quarter with a cash balance of $77.7 million, down approximately $9.6 million from December 31st, 2018.

Finally, with respect to our financial guidance for 2019, based on our performance through the first six months of this year, we are maintaining the guidance we previously provided. We expect total revenue to range from $156 million to $174 million. Included in that total, software revenue will comprise $75 million to $85 million. Also, we expect adjusted operating expenses, again, which excludes depreciation, amortization, and accretion, to range from $155 million to $165 million and capital expenses to range from $3 million to $7 million. I would 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 back over to Vince for some closing comments before we open up the call for your questions. Vince?

Vincent D. Kelly -- President and Chief Executive Officer

Thanks, Mike, and good job. Before we open the call up for your questions, I'd like to comment briefly on a couple items. First, I wanna update you on our current capital allocation strategy, and second, I wanna review our key goals and business outlook for the remainder of 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 allocation of capital remains a primary area of focus. Our multifaceted capital allocation strategy still includes dividends and share repurchases, as well as key strategic investments that augment our product, development, operating platform, and infrastructure. Our strategy also includes the potential for acquisitions that are both strategic in nature and that are creative to earnings.

We're a company in transition and believe that financial flexibility over the long term is important to the success of our strategy. Spok is laser-focused on delivering the next generation of our software platform, and we believe that our cloud-based and fully innovative communication platform will be a game changer in our chosen markets. As I said at the start of this call, I'm happy to report that we are on track with our development efforts and rollout plan and look forward to taking advantage of what we believe is a large market opportunity for our technology. We will continue to evaluate our capital allocation strategy and communicate our plans to you each quarter when we report earnings.

Finally, with regard to our key goals and business outlook, we believe our first-half activities and investments have positioned us to be successful in the second half of 2019. In order to take advantage of the large opportunity in our chosen markets, our business goals for the year remain unchanged. They include accelerating development of our products and services, building a stronger infrastructure, aligning these sources and focusing where most needed, and driving software revenue growth while managing wireless revenue declines.

Last quarter, we were pleased to host our 2019 investor day in New York City. At that event, we were excited to give you an update on our business, have you meet the team, and most importantly, to provide a demonstration of our next-generation Spok Care Connect platform. For those of you that were not able to attend in person or via the webcast, the event and slide presentation are on our website. We believe that these presentations will give you a sense of the excitement level our team has with the introduction of our enhanced platform and the opportunity ahead of us. We will continue to update you as we make progress in our transition and appreciate your continued support.

...

At this point, I'll ask the operator to open the call for your questions. We'd ask you to limit your initial questions to one and a follow-up, and after that, we'll take additional questions as time allows. Operator?

Questions and Answers:

Operator

Thank you. If you would like to ask a question, please signal by pressing *1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, please press *1 if you would like to ask a question.

And we'll take our first question from Ryan Vardeman with Palogic.

Ryan Vardeman -- Palogic Value Management, LP -- Analyst

Hey, guys. Thanks for taking my question.

Vincent D. Kelly -- President and Chief Executive Officer

Hi, Ryan.

Ryan Vardeman -- Palogic Value Management, LP -- Analyst

It sounds like you're on track to start selling the Spok 2.0 in the back half of this year. How do you intend on pricing those platform sales, and what are some bookings goals between now and the end of the year on that?

Vincent D. Kelly -- President and Chief Executive Officer

So, the pricing, the rollout, the pilot program are something that we're in deep development right now. We're working with an outside consultant on that as well. I think when we did our Investor Day -- and thank you for coming -- Mike showed you an example of how a premise-based package solution looks and how that might look under a SaaS-based model. So, that work is all in process, and it's not complete yet, so we're not prepared to share that today. We're not gonna give specific booking targets for the new platform this year other than to reiterate the guidance that we gave at the beginning of the year and that Mike just reiterated a couple minutes ago in terms of where we see our revenue, our operating expenses, and our capex.

We are in the process. We have completed Release 2. We are in the process of working on Release 3, and as I said at Investor Day, we're gonna have three releases a year, one approximately every four months. And each time we do a release on that platform, Ryan, we'll be adding features and functionality. Obviously, that'll change the value for the platform.

Traditionally, in our business, our contact center solution, which if you look at all the hospitals out there in the United States, the hospitals that have 600 or more beds, the large hospitals, traditionally, we've got about half of those hospitals are Spok customers with our contact center solution, and so that contact center solution, if you think about it, was kind of the nucleus or the platform upon which we sold our other packages, including our messenger package, our mobile package, our critical test results package. All of those packages kind of pivoted off that contact center solution, and we sold all that as a premise-based model. You bought everything, it's over 20 servers, and a lot of software, and a lot of professional services. So, that was a model.

Going forward, the model looks very different. Our base platform is the cloud-native platform, which includes our mobile piece, but everything else, including the contact center, any clinical care, radiology and laboratory facilities management, cardiology, emergency medicine -- all of those functions are service lines that build on that platform. So, initially, we're selling the base platform. That base platform will have a workflow engine in it, it will have an on-call schedule in it, it will have a mobile piece in it, but that's all it has initially, and it will interface through a gateway to a premise-based contact center, and that's how that'll function.

As we do these releases every four months, we'll be adding these other service lines to the platform, so if you think about it, the actual value of the platform as we add the service lines, you're adding functionality, the actual value of the platform goes up. So, it's a bit of a complicated thing to put together, but I can assure you we are very focused on it. We're working on it right now. The customers that we went out and talked to have seen it. Our new CIO who came from Harris Health, which was the third-largest healthcare system in the nation, has said it's a game changer. Nobody is doing this. It'll make everything the hospital does more efficient. They'll get more utilization out of our their EHR from it. It's really something that we think is gonna be fantastic for our future, but it will build, and it will build slowly over time.

When you roll it out at first, you're not gonna have all those service lines built on that platform. You're gonna have the base platform and maybe the integration with the contact center solution. You'll have the mobile piece, and you'll have the on-call scheduling piece. By the way, our on-call scheduling piece, we think, is quite strong from Day 1 when we roll it out. So, we're gonna announce this and demo it at our Connect conference, which is our customer conference. It's coming up here in October. We are working on rolling this out on a pilot basis in September with some of our customers and creating a sales contest for it. And then at HIMS, we'll be talking about Release 1 of 2020 on that platform, adding even more functionality, but that's in the first quarter of 2020.

So, this thing will build over time. It'll get more attractive over time, and we'll continue to refine our thinking on pricing because, as you know, SaaS model is much different than a premise-based model. The interesting thing about this -- and again, it's gonna take time -- is I look at our company, and I look at our cost structure, and I look at where are things costing us money, we've got about 80 people in professional services that are necessary because they have to go out and install premise-based software, and due complicated maintenance, and layer solutions on top of solutions, and do upgrades, etc., every three years. You need a forklift upgrade, you're buying new hardware, new software.

We've probably got 25 sales engineers, and we've probably got 50 full-time equivalents writing code for that legacy software. So, just round number, you got 150 people there that are not inexpensive people, trust me, that [audio cuts out] will be able to come down. So, I've given the team a goal of what I wanna see over 24 months in terms of how I want that to be reduced, because when you build cloud software, you don't need any of that. So, the business is gonna change quite dramatically over time. It won't happen overnight, and the pricing will evolve with that transition. I know that's not exactly answering what you asked, but we're not gonna answer what you asked right now, so I added that little color to help you about how we're thinking about it.

Ryan Vardeman -- Palogic Value Management, LP -- Analyst

I've been fairly consistent in asking for this, but we're four years into this development of this next-gen platform, and we don't really have any bookings targets that we can measure you by. The stock's trading well below what we paid for the software business plus what we've put into it. Clearly, the market is missing something, and so either you're wrong or the market's wrong. In the event that the market's wrong, I would love to be able to understand truly what the ROI targets are associated with the large investment that we've made. So, I think the sooner that you can help letting us understand those things, I think --

Vincent D. Kelly -- President and Chief Executive Officer

Ryan, thank you. You've been very consistent, and I appreciate your questions and understand it fully. We do think the market's wrong. We look at the value of the recurring revenue stream off of our paging business, and we get a very nice number long term. We look at the software business, and we're not gonna get valued and we're not gonna get appreciated until we actually show those bookings from the new platform, so right now, if you think about it, within Spok, there's essentially a start-up company. There's a start-up company that has no revenue, no bookings, and a lot of expenses.

We think from feedback we've got, not from each other sitting around the table saying how wonderful we are, customer we've shown these things to, we think we've got something that's gonna be a game changer and gonna be significant. We don't expect the market to give us value for that until they actually see sales and results. I just think that's just the way it's gonna work. And so, we know what we have to do. We are very frustrated with the stock price, but we're not losing our enthusiasm for what we're doing. We think our strategy is the absolute right strategy to create significant upside for our shareholders long term, as opposed to other strategies.

Everybody talks about different kind of things companies can do, go back to just milking your revenue streams for cash flow. We don't think that would give nearly as good a result as the investments we're making in our cloud data platform, but it is gonna take time to see those investments come to fruition, and I appreciate the frustration -- I'm frustrated myself. I'm a very large shareholder in this company.

And I do think we're doing the right thing, the management team thinks we're doing the right thing, we've got board support on this, and customer doing this. We're able to attract very talented programmers. We're able to track very talented leadership. Our sales team has seen the demos of our new product, and they are jazzed about it. We just attracted a very good, high-level chief medical officer that we'll be announcing that's joining us later this month who saw it and just loves it and thinks we're on the right track. So, we've got some good things going on, but I don't expect anybody to give us value for it until we actually -- you know, show me we deliver, and that's what we have to do, and that's what we're going to do. Thank you.

Operator

And as a reminder, that is *1 if you would like to ask a question.

Vincent D. Kelly -- President and Chief Executive Officer

Operator, I don't see any other -- there's one more. It looks like Ryan's got another question coming in the queue, so go ahead and put him back on.

Operator

And Ryan, your line is open.

Ryan Vardeman -- Palogic Value Management, LP -- Analyst

Thanks. So, what is the board's thought as it relates to capital allocation strategy going into 2020? Do you intend to continue the dividend?

Vincent D. Kelly -- President and Chief Executive Officer

Yes. Absolutely. The board's thought is consistent with what I said in my comments, and with respect to 2020, we will continue the dividend. We don't have any plan any time in the near future to cut that dividend.

Ryan Vardeman -- Palogic Value Management, LP -- Analyst

Thanks a lot. Good luck.

Vincent D. Kelly -- President and Chief Executive Officer

Thank you. Operator, that was all the calls that I saw in the queue, but Ryan, thank you very much for all your questions today, and thanks, everyone, for joining us this morning. We look forward to speaking with you again after we release our third quarter results in October, and everyone, have a great day.

...

Operator

And that does conclude today's conference. Thank you for your participation. You may not disconnect.

Duration: 28 minutes

Call participants:

Michael W. Wallace -- Chief Financial Officer

Vincent D. Kelly -- President and Chief Executive Officer

Ryan Vardeman -- Palogic Value Management, LP -- Analyst

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