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Spok Holdings Inc  (NASDAQ:SPOK)
Q3 2019 Earnings Call
Oct. 24, 2019, 10:00 a.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Good morning, and welcome to Spok's Third Quarter Investor Call.

[Operator Instructions] On line 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.

Michael Wallace -- Chief Financial Officer

Good morning. Thank you for joining us for our third 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 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 2018 Form 10-K; our third 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 for past or present conference calls.

With that, I'll turn the call over to Vince.

Vincent D. Kelly -- President and Chief Executive Officer

Thanks, Mike, and good morning. I'll be speaking to you today regarding our third quarter operating results. We believe we have established a solid base as we prepared to demonstrate our new innovative cloud-native and integrated communication platform to our customer base next week at our annual user conference, Connect 19.

Our third quarter results were encouraging as we saw strong performance momentum in a number of key operating metrics with both sequential and year-over-year improvements. I will provide more color on our results and progress, then our CFO, Mike Wallace, will cover our financial performance. I'll come back later to discuss our capital allocation plans and outlook, and then we'll take your questions.

Here's a brief overview of our results for the quarter and the first nine months of 2019. Throughout the third quarter, we continue to see improvements in both wireless unit and revenue trends, as well as a record level for our software revenue backlog. Third quarter performance was supported by continued strong software maintenance renewals and improved operating expense levels. Plus, our sales team turned in a strong operations bookings result, beating plan for the quarter.

Spok also returned $14 million of capital to our stockholders through the first nine months 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 and are leveraging our decades of experience in critical healthcare communication to deliver a cloud native platform that will bring the latest in communication technology to the market. Our teams remain on target to meet our development goals for the year.

Early in the quarter, we were excited to announce that for the seventh consecutive year, all 21 adult hospitals named to US News & World Report's 2019 to 2020 Best Hospitals Honor Roll use Spok clinical communications solutions to facilitate care collaboration and support exceptional patient care.

We believe this recognition enhances our industry-leading reputation and provides momentum as we welcome more than 120 customers next week to Connect 19, Spok's annual user conference for healthcare professionals. At Connect, we will bring together some of the industry's leading innovators who are pushing the boundaries to advance and improve healthcare communications.

This year at Connect 19, we are particularly pleased to demonstrate what we believe is a game changer in healthcare communication technology. Our new cloud native platform is an entirely new animal in healthcare communications with substantially more potential and capabilities. I want to make it clear that we have built a cloud platform, not a suite of products running in the cloud.

Yes, we have much to do to extend the platform to address many of the use cases that our legacy solutions support today, albeit in a very different way. We are not moving existing technology to the cloud as others have done or are trying. We have created a new cloud platform built from the ground-up expressly for the cloud.

As Spok moves its communication technology to the cloud, this conference provides our customers an opportunity for live demonstrations and access to resources that will help them get the most out of their Spok investment now and into the future. Our collaboration with hospital leaders at these conferences and throughout the year has helped us create an enterprise platform that positions healthcare providers for success today that supports some of the faster, smarter clinical communications for the future.

Now before I turn the call over to Mike to provide additional details on our financial performance in the third quarter, I want to briefly review some key results. First, third quarter software bookings exceeded $20 million for the second consecutive quarter.

Third quarter bookings included $9.8 million of operations bookings, up from $9.2 million in the prior quarter. Our related software backlog at September 30 was a record 42.6 million, up on both year-over-year and sequential basis by 17.2% and 7.2%, respectively.

Additionally, we continue to see a more than 99% revenue renewal rate on software maintenance contracts. Similar to our wireless revenue stream, software maintenance revenue is largely recurring in nature and provides the company with a more stable revenue base. Throughout the first nine months of 2019, approximately 80% of our revenue base is recurring in nature.

Second, wireless subscriber revenue trends continued to exceed our expectations. While we don't talk about this a lot, we work very hard on these results. Spok posted solid results for wireless products and services in the third quarter. The net decline in paging units totaled 22,000 and was down from the prior year quarter. Additionally, ARPU, or average revenue per unit, was up from the prior quarter.

As a result, quarterly wireless revenue was down a record low 1.4% from the prior quarter. We were pleased to see the continuation of these more stable trends, especially in our top-performing Healthcare segment, which now compromises approximately 82% of our subscriber base.

In addition to our financial performance, progress was made in several other key areas, including product development, sales strategy and key strategic partnership agreements. During the quarter, we added nearly two dozen new customers to the Spok family.

Let me highlight a few of our six-figure deals for you. First, a large Canadian healthcare system needed to replace end-of-life paging terminals and a proprietary messaging gateway software. Spok successfully won the bid to do so with new paging terminals and Spok Healthcare Console software. When live, the health system will have as many as 22 operators at a time in their respective contact centers facilitating paging and messaging to a massive amount of end users, with the entire organization also having the opportunity to use Spok's Smart Web as well.

Today, for the organization, it has over 15,000 in their largest zone for Code Blue response team and on-call physicians. Paging volumes are as high as 30,000 transmitted messages per 24 hours. We're excited about our relationship and the downstream opportunities following our initial deployment of this healthcare system.

The next deal is a private non-profit organization in the southern United States that performs more than 7,600 surgeries, 45,000 breast procedures and needs more than 55,000 pap screens per year. It is the largest delivery service in the state and was the first area hospital to achieve nursing magnet status. This hospital has used Spok solutions for more than 10 years.

Recently, our Southeast Spok team went into action and presented a plan to enhance and improve their critical communications. We executed a multi-year additional software licensing and maintenance agreement in September. The result is a renewed collaboration and a happy customer. These are just a couple of our examples for our activity level in Q3. And that momentum has continued into the fourth quarter.

In the first week of October, we signed a deal with a northern state's largest healthcare system for inpatient admissions and net patient revenue. It operates as a non-profit health system with eight hospitals, 145 outpatient locations, nearly 5,000 physicians of more than 38,000 employees.

This organization has been a valued Spok customer of multiple solutions for 10 years. 2017, they announced a switch to one of our competitors rather than upgrading their Spok solutions. That competitor failed to execute on planned site migrations due to the health system's complex needs.

The Spok team stayed close during this sensitive time, which proved key to the renewed partnership. The organization executed an upgrade contract with Spok in early October and will leverage Spok for their enterprisewide contact center consolidation effort.

Again, I'm proud of our team and the work they have accomplished as we prepare to demonstrate our new cloud native and integrated communication platform to our customer base next week at our annual user conference. We are excited. As a team, we'll be able to leverage the momentum we generated from our user conference when we continue introducing our new platform to the marketplace in March at the HIMSS Global Health Care Conference.

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


Michael Wallace -- Chief Financial Officer

Thanks, Vince.

Let me give you a little more detail on our financial performance in the third quarter. I would again encourage you to review our third 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 believe that our performance in the third quarter of 2019 has helped to form a solid base as we prepare to fully introduce our improved cloud native and integrated communication platform to our customer base next week at our annual user conference.

Key drivers of our financial performance during the quarter were a second consecutive quarter of more than $20 million in software bookings that resulted in a record high backlog level, software maintenance revenue renewal rates, which continue to exceed 99%, stable ARPU rates, and strong performance in gross additions and disconnects impacting units and service, which resulted in the continued positive trends in wireless revenue attrition.

Lastly, continued disciplined operating expense management has also allowed us to absorb the impacts of our planned investments in product research and development expenses. Over the next few minutes, I will review key areas, which drove our third quarter financial performance. They include, first, a review of certain factors impacting third quarter revenue. Second, selected items, which influenced third quarter expenses; and thirdly, a brief review of the balance sheet and cash flow statement.

And finally, I will review our financial guidance for the remainder of 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 third quarter of 2019, total GAAP revenue was $39.5 million. This compares to $39.5 million in the second quarter of 2019 and $42.5 million in the prior year period. Through the first nine months of 2019, GAAP revenue totaled $120.7 million. This compares to revenue of $126.2 million in the first nine months of 2018.

On a GAAP basis, third quarter software revenue of $17.6 million compares to revenue of $19.2 million in the third quarter of 2018 and reflected a slight increase from the second quarter of 2019. Through the first nine months of 2019, software revenue totaled $54.2 million, a slight decline from the revenue of $55 million in the prior year period.

Software revenue performance was driven by a nearly 4% year-to-date increase in software maintenance revenue from 2018 as maintenance continues to perform at record levels. This was offset with a 7.7% decline in software operations revenue driven by a lower mix of software license bookings where we are able to recognize revenue immediately and lower associated shipments of equipment when compared to 2018. While the mix of our software bookings has changed from the third quarter of 2018, we continue to meet virtually all of our established software bookings goals through the third quarter of 2019.

Now from a wireless revenue perspective and also contributing to the year-to-date performance were stable levels of pager unit churn and solid ARPU rates. As a result, wireless revenue for the first nine months remained strong, declining at a record low 6.5% from the prior year period.

Turning to operating expenses. We continued to maintain our focus on creating efficiencies in our expense base in order to offset some of the planned increases in product research and development. During the third quarter of 2019, we reported adjusted operating expenses, which excludes depreciation, amortization and accretion of $39.8 million, up slightly from $39.2 million in the prior quarter, but down from $41.3 million in the year earlier quarter.

The increase in operating expenses from the prior quarter was driven primarily by an increase of $600,000 in research and development costs as we continue to work on the latest version of our software platform. However, in comparison to the year ago period, operating expenses in aggregate declined $1.4 million or 3.4%, largely driven by a decline in general and administrative expenses as we continue to implement efficiencies across the organization to offset the higher research and development costs.

For the first nine months of the year, research and development costs totaled $20.4 million. This represents a 14.4% increase from the same period in 2018. While up from the prior year, the rate of increase is down substantially from the 29.6% year-over-year increase we saw in the first nine months of 2018. We believe this overall trend will continue as we are now past the initial portion of our investments in research and development for our next-generation software platform, and those expenses should approach a more steady-state level.

Our capital expenses in the third quarter were approximately $1.4 million. Through the first nine months of 2019, capital expenses totaled $4.2 million. 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.

Now turning to the balance sheet and other financial items. Through the first nine months of the year, Spok generated approximately $3.4 million of EBITDA, or earnings before interest, taxes, depreciation and amortization. This, along with cash on hand and the positive impact of working capital items, was used to fund the quarterly dividends of $7.4 million, share repurchases of $6.6 million and the aforementioned capital expenses of $4.2 million. We ended the quarter with a cash balance of $79.2 million, down approximately $8.1 million from December 31, 2018.

Finally, based on our year-to-date performance and expectations as we roll out the next version of our software platform, we are reiterating the guidance ranges that we had previously provided. To summarize, we expect total revenue to range from $156 million to $174 million. Included in that total, we expect software revenue to comprise $75 million to $85 million.

Also, Spok expects adjusted earnings -- adjusted operating expenses, 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 Kelly for some closing comments before we open the call to your questions.


Vincent D. Kelly -- President and Chief Executive Officer

Thanks, Mike.

Before we open up the call for your questions, I'd 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. 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 multi-faceted capital allocation strategy includes dividends and share repurchases, as well as key strategic investments that include augmenting our product development and operating platform infrastructure.

Our strategy also includes the potential for acquisitions that are both strategic in nature and that are accretive to earnings. However, as we have said before, after looking at a lot of opportunities over the past several years, we've made the decision essentially to build versus buy. This is not to say we would never do an acquisition in the future, but for now, none are currently targeted.

As we have outlined in the past, we are undergoing a transition from a wireless company to a provider of software solutions, 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 integrated communication platform will be a game changer in our chosen markets. I'm happy to report that we're on track with our development efforts and rollout plans, and look forward to taking advantage of what we believe is a large market opportunity for this technology.

Our capital allocation policy for the remainder of the year includes our recurring quarterly dividend of $0.125 per share and capital investments in our business. Part of that capital allocation strategy has also included share repurchases. In the third quarter, we repurchased 401,342 shares and exhausted the current $10 million buyback authorization. Our Board of Directors will continue to evaluate our capital allocation strategy, and we will communicate our plans to you each quarter when we report earnings.

Finally, with regard to our key goals and business outlook, we believe our activities and investments thus far have positioned us to be successful in the fourth quarter and next year. Our business goals for the year remain unchanged. They include accelerating development of our products and services, building a stronger infrastructure, aligning resources and focusing where most needed and driving software revenue growth while managing wireless revenue declines.

Finally, we are very excited about our future in supporting our customers' missions. For most of us, we want our work to have meaning. We want to know that we're doing something useful that will both reward shareholders, but also provide greater meaning to society and our caregiver customers.

For us at Spok, we have chosen a path that will help solve the communications challenges in healthcare. And we believe what you will see and experience over the coming quarters and years will show you that Spok is leaning into the future, and we're making a difference.

Right now, we're turning cutting-edge ideas into a great product. This is not easy. There are a lot of steps in between and it takes time, but we're not skipping steps and we're not taking any shortcuts. We're relentless, and we're being stubborn with our vision because we're taking an idea and turning it into a successful product that customers care about, that will really improve patients' lives. And it's hard work and hard work that has to be done right.

Recently, we had a third-party software development consulting team from Silicon Valley come in and perform an assessment of our engineering team doing this work. Here's just some of the feedback they gave me after their work, "Great focus on execution. We think the team is surprisingly good. Not just good for the Minneapolis area, not a tech mecca, but we would rate them well against many of our Silicon Valley teams."

Again, it's not easy. It doesn't happen overnight, but we believe we're on the right track and look forward to future success as we bring our new cloud platform to market and continue to enhance it every four months and the years ahead. We look forward laying out our financial guidance for 2020 when we report our fourth quarter and full-year results in February.

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


Questions and Answers:


[Operator Instructions] Our first question comes from Vivian Zhang with Diamond Equity Research.

Vivian Zhang -- Diamond Equity Research -- Analyst


Vincent D. Kelly -- President and Chief Executive Officer



Vivian Zhang -- Diamond Equity Research -- Analyst

Hi. Thanks for taking my question. Hi. My question is can you update us on the type of acquisition opportunities you are seeing in the future and what kinds of acquisitions investors can anticipate? Thank you.

Vincent D. Kelly -- President and Chief Executive Officer

Okay. Well, thanks for the question. In terms of acquisitions, we've looked at a lot of companies in clinical communications space over the last three years to four years. We've looked at over 70, actually. Most of them shared common characteristics. They're very small. They don't have critical mass and they're what we would consider point solutions. At Spok, we're offering an integrated communications platform.

Now, we don't have any in our targets right now. We continue, obviously, to get information memorandums and get asked to take a look at companies, and we do so because every time you do, you learn something. But right now, unless it would be a service line that we think we're not able to build quickly ourselves or partner with somebody to integrate to, I don't think there's an acquisition anytime in the near term for Spok. That could change. It could change next year.

Our main focus right now is getting our new cloud native platform out there. It's already being received very well by the large customers that we've shown it to. We've had huge medical institutions and teaching institutions look at what we're doing and say, when can I have it? And so we think our time and our resources is best suited focusing on delivering that to the market and not doing acquisitions. So again, I don't want to say never because you never want to say never. But I think for now, for the balance of 2019 and probably for the totality of 2020, we're not going to be doing an acquisition. I hope that answers your question.

Vivian Zhang -- Diamond Equity Research -- Analyst

Got it. Thank you. It's a good gesture [Phonetic]. Thank you.

Vincent D. Kelly -- President and Chief Executive Officer

Thank you. Next question?


Our next question comes from Scott Williams with Palogic.

Vincent D. Kelly -- President and Chief Executive Officer

Hi, Scott.

Scott Williams -- Palogic Value Management -- Analyst

Hey, Vince. How are you? Hey, Mike.

Vincent D. Kelly -- President and Chief Executive Officer

I'm well. How are you?

Scott Williams -- Palogic Value Management -- Analyst

Mike, the midpoint of the fourth quarter guide on software implies pretty large growth over '18 and '17. How do you retain confidence in that number?

Vincent D. Kelly -- President and Chief Executive Officer

Yeah. It's a good question. We decided that what we would do is keep the ranges that we set out at the beginning of the year. I think it's fairly evident from our results through the third quarter that while we expect to hit that range, fundamentally, we expect to be probably at the lower end of that range, between $75 million and $85 million. But without changing the range, we decided to simply leave it as previously stated.

Scott Williams -- Palogic Value Management -- Analyst

Okay. Vince, do you expect revenue growth in the software segment in 2020?

Vincent D. Kelly -- President and Chief Executive Officer

Absolutely. Yeah. We're going to give you guidance in February when we release earnings, but we absolutely expect not only revenue growth, but pretty significant operations bookings growth as well, both from selling our legacy solutions, which is essentially our 1.9 upgrade and selling our new Care Connect platform. And we'll have a lot more color on all of that because I know you guys are hungry for that. We have a lot more color on all of that in February when we give you our guidance.

Scott Williams -- Palogic Value Management -- Analyst

Okay. Fantastic. Thank you.

Vincent D. Kelly -- President and Chief Executive Officer

We've been at this a long time. You know what? Now it's time to show the results. So, we hear you loud and clear and you're going to see it.

Scott Williams -- Palogic Value Management -- Analyst

Okay. Thank you, both.

Vincent D. Kelly -- President and Chief Executive Officer



[Operator Instructions] Our next question comes from Paul Dwyer with Punch.

Vincent D. Kelly -- President and Chief Executive Officer

Hi, Paul.

Paul Dwyer -- Punch & Associates -- Analyst

Hi. Good morning, guys.

Vincent D. Kelly -- President and Chief Executive Officer

Good morning.

Paul Dwyer -- Punch & Associates -- Analyst

Just one quick question for you. On the share repurchase authorization, it sounded like you did not reup the authorizations. Does that imply you'll be out of the market and not buying back stock in Q4?

Vincent D. Kelly -- President and Chief Executive Officer

Yeah, that's what it implies. We did not -- we have -- we used it up, the basket, the $10 million basket that we had, we used up and completely exhausted in the third quarter. We look at that basket and the potential repurchase shares once a quarter at our quarterly Board meeting, and so we did not renew it for the fourth quarter. Again, we'll look at it when we meet in February. We'll get it again and see what we think.

Paul Dwyer -- Punch & Associates -- Analyst

Okay. Perfect. That's all I've got. Thanks, guys.

Vincent D. Kelly -- President and Chief Executive Officer

Thank you.

Michael Wallace -- Chief Financial Officer

Thank you.


[Operator Instructions]

Vincent D. Kelly -- President and Chief Executive Officer

Yeah. Operator, I don't see anyone else in the queue. So, we're going to sign off now. I want to just thank, everyone, for joining us this morning. We look forward to speaking with you again after we release our fourth quarter and full-year results in February. And everyone, have a great day.


[Operator Closing Remarks]

Duration: 29 minutes

Call participants:

Michael Wallace -- Chief Financial Officer

Vincent D. Kelly -- President and Chief Executive Officer

Vivian Zhang -- Diamond Equity Research -- Analyst

Scott Williams -- Palogic Value Management -- Analyst

Paul Dwyer -- Punch & Associates -- Analyst

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