Spok Holdings Inc (SPOK) 2013 Q3 法說會逐字稿

Good day, everyone and welcome to USA Mobility's Third 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; MyLe Chang, Controller and Colin Balmforth, President of the Company's Software subsidiary, Amcom Software.

At this time for opening comments I'll turn the call over to Mr. Endsley. Please go ahead, sir.

Good morning. Thank you for joining us for our third quarter investor update. Before we discuss our operating results, I want to remind everyone that today's conference call may include forward-looking statements that are subject to risks and uncertainties relating to USA Mobility'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. USA Mobility'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, there are subjected to risks and uncertainties. Please review the risk factor section relating to our operations and the business environment in which we compete contained in our 2012 Form 10-K, our Third Quarter Form 10-Q, which we expect to file later today, and related Company documents filed with the Securities and Exchange Commission.

Please note that USA Mobility assumes no obligation to update any forward-looking statements from past or present filings in 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 third quarter operating results and what we believe was another excellent quarter for both our wireless and software businesses.

On the wireless side, we ended the quarter ahead of our key operating goals for total revenue, cash flow, EBITDA, average revenue per unit, or ARPU, and operating expenses. In addition, our wireless sales force exceeded plans for subscribers including gross additions, while our annual rate of revenue erosion improved to an all-time low.

Our software business also achieved excellent results with increased bookings and record high backlog and a growing pipeline of prospective accounts. At the same time, we were able to operate profitably, maintain strong consolidated cash flow margins, once again return capital to our stockholders in the form of cash dividends.

Shawn will discuss our financial results in more detail in a few minutes but first I want to review a few key highlights of the quarter.

Number one, subscriber and revenue trends in our wireless business continued to show solid improvement in the third quarter with the rates of paging unit and revenue erosion either achieving or near record lows. Our annual rate of subscriber erosion was 8.9%, down from 10.2% a year earlier. Our annual rate of revenue erosion improved to a record low of 10.6% and our quarterly rate declined to a two-year low of 1.9%.

In addition to another strong performance by our wireless sales force, we believe these positive results were due in part to several other factors including the benefit of selling our wireless products in conjunction with our software solutions and a continuing recognition among many customers, particularly in the healthcare space, that paging remains the most reliable and cost effective form of wireless communications.

Number two, our software business also posted excellent results for the quarter as bookings increased from the prior quarters with record year-to-date performance, while our backlog reached a record high of $43.8 million at September 30th.

In addition, Amcom's pipeline of sales prospects continued to grow thanks to the outstanding work of our software sales and marketing team.

Sales in North American markets continued to come primarily from the healthcare sector but also include new accounts in public safety and government agencies. We also continued to expand our international sales efforts in Europe, the Middle East and Africa, as well as the Asia/Pacific region.

Number three, we continue to reduce operating expenses in our wireless operations consistent with our long-term business plan. While consolidated operating expenses excluding depreciation, amortization and accretion, declined 2.9% from the year earlier quarter, operating expenses for wireless declined 7.5% from the year ago.

Going forward we expect operating expenses in our wireless business will continue to decline and will be offset in part by incremental investment in our software business as we continue investing in our transition to a more software-based business model. While we've already integrated many overhead functions between our wireless and software businesses, we expect to identify additional cost savings and related operating synergies as we move forward.

In fact, a growing number of customers use both our wireless and software services and increasingly look to us as a single-source provider of unified communication solutions. I want to give you an example of that. Every year US News and World Report does a ranking of the best hospitals in America and then they put out -- they do that ranking in honor roll.

So this year they evaluated 4,806 hospitals and 18 hospitals that qualified for this honor roll and it's based on quality. And if you look at the 18 hospitals, all 18 of those hospitals are customers of our Company. 16 of the 18 hospitals are customers of our wireless business; 17 of the 18 hospitals are customers of our software business and that means the overwhelming majority have both.

And what we're hearing from these customers and number one is John Hopkins, number two is Mass General. Number three is the Mayo Clinic. Number four is Cleveland Clinic. It goes on and on. It's the who's who of quality hospitals in this nation.

What we're hearing from these hospitals when they have both our wireless solutions and our software solutions is they want to look to us as a single-source unified communications provider. They don't want to call, hey we want to talk to your wireless people; hey we want to talk to your software people. They call the Company; they want to talk to us. So it bodes well for our strategy. It bodes well for the future and it's just another example of how we're being viewed at by this fantastic customer base.

Moving on, number four, consolidated EBITDA was $13.4 million for the third quarter compared to $17.8 million in the year earlier quarter while consolidated EBITDA margin was 27% versus 32.2% a year ago. The decrease in EBITDA and EBITDA margin largely reflects the decline in software revenue that has been deferred in the backlog.

As noted, we expect this impact to reverse itself once our remediation process is complete as early as the fourth quarter.

EBITDA for wireless in the third quarter totaled $13.8 million representing a solid margin, 37.3% against 39.3% for the year earlier quarter.

Number five, finally we again generated sufficient free cash flow during the quarter to return capital to stockholders in the form of cash dividends. Our most recent quarterly dividend of $0.125 per share was paid on September 10 and our Board of Directors has declared our next quarterly dividend of $0.125 per share be paid on December 10.

With regard to our stock buyback program, no shares were purchased under the program in the third quarter. As a result, approximately $17 million of the authorized $25 million remains available for purchases under the program as of September 30th.

Since the program's inception, we have repurchased a total of 6,268,504 shares of our common stock at an average price of $9.53 per share. Including the September dividend, we have now returned the total of $474.6 million in capital to our stockholders over the last eight years including $414.8 million in cash dividends and distributions, $59.8 million in share repurchases.

Overall we were pleased with our operating performance and progress in the third quarter in the first nine months of 2013. We met or exceeded most of our key operating goals, generated significant free cash flow, reduced expenses, expanded our services and geographic reach and returned capital to stockholders.

As a result we believe we are well positioned to build on that success in the fourth quarter and beyond.

I'll comment further on our recent operating performance and related business activities in a few minutes but first our Chief Financial Officer, Shawn Endsley, will review third quarter financial results. Shawn.

Thanks, Vince. Overall we are pleased with our third quarter financial results and the continued progress we made toward meeting our long-term goals. Both our wireless and software businesses performed well continuing the positive momentum we established earlier this year.

Further improvement in the rates of subscriber churn and revenue erosion combined with reduced operating expenses and a stable ARPU contributed to strong cash flows and continued high margins in our wireless business. At the same time, our software business reported increased bookings and the backlog reached a record high.

Looking first at our wireless business, we ended the quarter with 1,408,000 units in service, a net decrease of 37,000 units. This compares to unit declines of 35,000 in the second quarter and 37,000 in the third quarter of 2012. Total net churn rate for the quarter was 2.6% compared to 2.4% in the second quarter and 2.3% in the year earlier quarter.

The annual rate of unit erosion improved to 8.9% in the third quarter from 10.2% in the year ago quarter.

Revenue from wireless totaled $37.1 million in the third quarter versus $41.4 million in the third quarter of 2012. The annual rate of revenue erosion improved to a record low of 10.6% compared to 14.6% in the year earlier quarter, while the quarterly rate improved to a two-year low of 1.9% versus 3.1% a year ago.

Paging revenue, which represents approximately 95% of wireless revenue, totaled $35.1 million for the quarter, a decline of 10.4% from the year earlier quarter.

While paging revenue continues to decline, the annual rate of erosion has continued to improve in each of the last four years from 16.6% in 2010, 14.5% in 2011, 13% in 2012 and 10.4% in 2013.

Healthcare represented 78.4% of direct gross placement. We experienced a unit (inaudible) of 1.9% in the third quarter. Healthcare, which contributed $23.5 million of direct paging revenue in the third quarter, now represents 74.8% of our direct units in service and 69.4% of direct paging revenue and we expect those percentages will increase over time. As such, we are encouraged by the stability in this part of our business.

Total paging ARPU was $8.22 in the third quarter, [equal] to the prior quarter due to a modest uptick in indirect ARPU. Going forward, however, we expect ARPU will continue a slow downward trend, as our direct subscriber base continues to shift toward larger accounts that benefit from volume pricing.

Overall though, price levels in our paging business remain relatively stable.

Turning to our software business, revenue for the third quarter declined 7.9% to $12.6 million compared to $13.7 million in the third quarter of 2012. As previously noted in our earnings release, the decrease was due in part to a deferral of revenue recognition resulting from our material weakness from mediation.

Of the $12.6 million, $7 million was maintenance revenue and $5.6 million was operations revenue. Maintenance revenue includes ongoing support of the software application while operations revenue includes software licenses, professional services and equipment sales.

As noted in our press release, software revenue in the third quarter was in part negatively impacted by the remediation process regarding a material weakness in the design of internal control over software revenue recognition that we disclosed last April.

In a nutshell, to remediate the material weakness we have implemented staffing and organizational changes, adopted new revenue recognition processes and controls, conducted revenue recognition training programs and implemented standardized global contracts. The new revenue recognition controls require the Company to deliver all services, installation, training, consulting before operations revenue can be recognized.

Through the third quarter we also deferred revenue for 90 days until the warranty period had expires. This ensured no revenue was recognized until all services related work is complete.

Our new processes and controls will be required to have operated for a sufficient period of time to provide reasonable assurance as to their effectiveness. We expect to remediate the material weakness in the fourth quarter and lift the deferral for the 90-day warranty period.

Therefore, certain software revenue that previously would have been recognized in the third quarter will now be recognized in the fourth quarter.

Bookings for the quarter increased 10.4% to $17.3 million from $15.7 million in the year earlier quarter, as our sales force continued to convert its growing pipeline of sales leads into executed contracts. Bookings are all purchase orders received during the quarter and represent future revenue.

As a result of the excellent bookings performance, the backlog reached a record high of $43.8 million at September 30th, up 10.8% from $39.6 million at June 30th and up 21.2% from $36.2 million the year earlier.

The total backlog at September 30th included $26.9 million from new operations and maintenance orders and $16.9 million in future maintenance and other recurring revenue.

The current backlog consists of all purchase orders received from customers not yet recognized as revenue. We expect to convert this backlog into revenue in future quarters as our revenue recognition criteria are met.

On a consolidated basis, total revenue for the third quarter was $49.7 million versus $55.1 million in the year earlier quarter, a decline of 9.9%.

Third quarter operating expenses, excluding depreciation, amortization and accretion, decreased to $36.3 million from $37.3 million a year ago. Of the total, wireless expenses declined to $23.3 million from $25.1 million a year earlier. While software expenses increased to $13 million from $12.2 million. The decrease in operating expenses for wireless again reflected continued expense management in our wireless business, while the increase in operating expenses for software primarily reflected investment for growth in that business.

Companywide headcount at September 30th was 652 full-time equivalent employees including 355 for wireless and 297 for software compared to a headcount of 676 a year earlier with 396 for wireless and 280 for software.

Going forward, we will continue to adjust staffing levels as necessary to meet our long-term business goals, continuing our efforts to eliminate overhead redundancies and extract cost efficiency.

Consolidated EBITDA for the third quarter was $13.4 million or 27% of revenue compared to $17.8 million or 32.2% of revenue in the year earlier quarter.

Third quarter EBITDA included $13.8 million from wireless or a margin of 37.3% and negative EBITDA of $0.4 million from software, due primarily to the lower software revenue. A schedule reconciling operating income to EBITDA has been included in our earnings release.

Net income for the third quarter was $5.8 million, or $0.26 per fully diluted share, compared to $8 million, or $0.56 per fully diluted share in the third quarter of 2012.

Turning to the balance sheet, the Company ended the quarter with a cash balance of $83 million. We expect to use a portion of that cash in connection with quarterly cash dividends and future capital allocation decisions, which Vince will discussion further.

I would also note that our existing credit facility remains in place and provides us with approximately $40 million in borrowing capacity for potential acquisitions and related investment opportunities.

Finally, with respect to our financial expectations, we are maintaining our previously announced guidance for full-year 2013. To reiterate that guidance, we currently expect consolidated total revenue to range from $195 million to $213 million, consolidated operating expenses, excluding depreciation, amortization and accretion, to range from $150 million to $152 million and capital expenses to range from $8.1 million to $9.7 million.

There are no changes to the breakouts between the wireless and software businesses that were previously provided. I would also remind you that our projections are based on current trends and that those trends are always subject to change.

With that, I'll turn it back over to Vince.

Thanks, Shawn. Before we take your questions I want to comment briefly on our third quarter sales and marketing activities, as well as update you on our current capital allocation strategy. With respect to sales and marketing activities, both our wireless and software sales teams performed very well during the quarter.

On the wireless side our sales team recorded 44,000 gross pager placements compared to 49,000 in the third quarter of 2012, again demonstrating continued demand for paging services despite long-term trends toward alternative wireless platforms. Notably our wireless sales team won three new hospital accounts during the quarter, including a large southwest medical center. They also completed two in-house paging systems conversions with existing customers.

Our wireless sales team also deserves a tremendous amount of credit for reducing the annual rate of revenue erosion to an all-time low of 10.6% for the third quarter, as well as reducing the quarterly rate of revenue erosion to a two-year low of 1.9%. In addition, our wireless team continued to play a major role in minimizing the rate of direct net unit charge.

With regard to cross selling, our wireless team collaborated with their software counterparts to close six transactions during the third quarter including three major contacts in our accounts for Amcom. As we look at long-term trends in wireless, we believe many of our accounts, especially in healthcare, continue to be relatively stable notwithstanding the significant increase in alternative technologies such as smartphones, tablets, WiFi and secure text messaging platforms. We attribute the stickiness of these customers to the cost and reliability of paging as well as our continued investment in Amcom's unified communication solution.

While some of our competitors have resorted to competing strictly on price at the expense of maintaining their networks and servicing their customers, we have chosen to compete on service and invest in our vision for the future. As a result, we believe we can sustain the bulk of our core wireless subscriber base for the foreseeable future. We also believe over the longer term paging subscribers will continue to migrate toward an integrated communications that combine secure smartphone messaging with traditional paging products. Toward that end, we're now providing customers with a range of options to help them solve their communications challenges depending on their specific needs.

This includes a variety of software solutions through our mobile connect secure smartphone communications platform combined with our core paging products. Based on current trends, we believe the best communications system going forward will incorporate both pagers and smartphone solutions. Accordingly, our goal is to help our customers successfully navigate this process.

Turning to our software business, our Amcom sales and marketing team also made significant headway during the quarter with increased bookings and a record high backlog at September 30th. North American sales continued to come, primarily from healthcare, as well as from public safety and government agencies. In public safety we were awarded a contract for four military bases to improve their emergency call handling and response. We also added our first hospital on a military base.

Overall, our top selling solutions for healthcare in North America included secure texting and critical alerting, as well as healthcare console and other call center solutions.

Software accounts added during the quarter included a sizable healthcare system in Oklahoma which selected Amcom earlier this year for a full suite of clinical call center services and recently added 3,000 licenses of our secured texting application to help clinicians reach each other faster. Similarly. A long-term customers continues to regularly add to the numbers of uses it has for our mobile connect solution as its rollout plan proceeds. These customer wins illustrate how hospitals often test the waters with secure smartphones texting, then move into larger rollouts once their clinical staffs see the value first hand.

Another solid win was a New York based healthcare organization, a group of multiple facilities that expanded the scope of our console upgrade to include clinical alerting and secure texting. The key variable landing this account was our ability to provide an integrated enterprise wide system, this factor essential to our success and one of the many reasons we are selected over our competition, which often offers only standalone solutions. In fact, most competitor applications are unable to bring key pieces of information together when needed such as a doctor's on call schedule along with the right contact information for use with secured texting.

Looking at Amcom's international sales, we continued to see positive traction (inaudible) export of proven North American solutions to both the EMEA countries, that is Europe, Middle East and Africa, as well as customers in the Asia/pacific region. For instance, hospital within the United Kingdom's National Health Service selected Amcom's operator console to improve efficiency, customer service and time sensitive communications.

Likewise, a long-time hospital customer in Australia, which had used only clinical alerting, is now up and running on our full healthcare console solutions. Also, a large hospital in the Asia/pacific regions recently signed up for our web-based staff directory along with clinical alerting, secure texting app in order to coordinate patient care across their entire organizations.

Our software marketing team is currently gearing up for Connect 13, our Annual User Conference, which will be held next week in San Diego. This is a popular annual event and we expect another good turnout this year. In addition, we continue to interact with our customers and industry leaders through our growing user group, Amcom Directions, as well as our new Physician Advisory Board through which we receive feedback from leading physicians on our product development initiatives.

Now, briefly review our capital allocate strategy, we continue to evaluate how best to deploy our capital resources to support sustainable business growth and maximize stockholder value. This is particularly true as we pursue our stated business strategy to evolve from a pure paging carrier to a software based provider of unified communication solutions. As I've noted previously, we continue to explore acquisitions and related business opportunities. In doing so, we expect to allocate additional resources to expand the depth and breadth of our software applications, service capabilities and market penetration.

I can't tell you today exactly when we might finalize such a transaction. However I can say we continue to evaluate opportunities while maintaining our discipline with respect to value. We will keep you posted on our progress quarterly and update you when appropriate.

With respect to other uses of capital, we've once again continued our quarterly dividend of $0.125 per share, or $0.50 annually. We believe the current dividend rate provides an appropriate yield on our common stock plus it allows us to retain strategic capital as we reposition the Company for the future.

Finally, despite the absence of purchases in recent quarters, we believe continuation of our stock repurchase plan beyond year end may also represent an other opportunity for us to return capital to our stockholders in the short-term as we continue to transition to a sustainable business model for long-term growth. Our Board will continue to evaluate our capital allocate strategy with respect to acquisitions, dividends and share repurchases in order to support our stated goal of creating long-term value for shareholders.

In summary, we again made substantial progress during the third quarter and through the first nine months of the year. Our wireless software businesses met the majority of their individual performance goals. At the same time we generated significant free cash flow, reduced expenses, expanded our service and continued the integration of our wireless and software companies while returning capital to stockholders. As a result, we believe we are well positioned to achieve a solid performance over the balance of the year and remain on track to complete over time our transition to a software oriented and fully integrated unified communications business.

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

Operator?

Thank you, sir. (Operator Instructions). Okay we'll take our first question from Brent Morrison with Zuma Capital Management.

Can you guys just briefly summarize the remediation efforts and kind of what was the SEC's main focus? It looked like it was the recognition of maintenance revenue in the backlog. Can you just kind of summarize that for me?

Actually yes we're happy to summarize it. It was not that. So the software revenue recognition rules are very specific. They're very involved and they really require the Company to change a lot of the ways that we had historically done business, including how our contracts work and specifically how we account and when we account and recognize revenue. We had been using the completed contract method and under the completed contract method you're required to completely finish all the work, even though you might have done a bunch of the work and even though you might have collected all the cash before you recognize any revenue.

So we went through a process last year with the audit that went all the way back to the time of acquisition and we really kind of had to restate every quarter rolling forward. It did require us to make changes in our 2011 financial statements, which we did in our comprehensive 10-K we filed at the end of the year, really didn't have an impact on 2012.

And it hasn't had an impact on 2013 other than the fact that since we have not yet remediated we have this process where not only do we need to complete all the work, but we wait an extra 90 days on top of that for the warranty period to run before we recognize the revenue. So if you think about it all the work that we did in the third quarter to install software and get customer acceptances and wrap up, while under a normal completed contract methodology would have recognized in the third quarter, all of that gets deferred into the fourth quarter. So you constantly have this kind of [white] shift exercise going on.

Now, having said that, we expect to remediate in the fourth quarter so the fourth quarter obviously would be a heavy revenue quarter and it will probably be more accurate to look at the third quarter and the fourth quarter together and average the two. But we expect that to get behind us and then next year in 2014 we actually are going to move to a ratable methodology of recognizing revenue where we'll take a look at a contract and we'll say that contract is going to take us nine months to implement and we'll recognize the revenue ratably over nine months.

It's all doable. You have to have the right controls in place. We've brought in software revenue recognition people on the staff, experts. We've positioned them up where we do our software accounting in Minnesota. We brought in Ernst & Young who provides the actual guidance that a lot of companies follow on software revenue recognition. They're our internal auditors and they've worked with us on reworking this up.

It's all going to be behind us. it's an interesting thing because most of the work and in the case of these contracts have been done, most of the cash has been collected, so we've incurred the expenses and we've collected the money but we're not getting to recognize the revenue until we wait for this 90-day warranty period so we're all anxious to get that done. We've spent a lot of time in the second quarter training people, putting new policies and procedures and systems in place. That did I think distract a little bit our Professional Services Group because they're having to learn a whole new set of rules to operate under and that's the Group that does the installs.

Nevertheless they maintained a very high utilization rate and we think that it bodes well for what's going to happen in the future. We did do some testing on July and August transactions. We found zero exceptions to our rules. Obviously we've got to do more testing on the September and then through the fourth quarter in order to get our auditors to agree with us that it's time to remove that material weakness. But it's something that's in process. It's something that we are going to do right. We are going to get right and then we're going to maintain that correctness going forward. I hope that answers what you were getting at.

Yes thanks. Good job; thank you. That helps a lot. So I guess that alleviates the software question so let's talk about cross selling. Caused you guys have talked about that; that was the main kind of motivation for buying Amcom and you mentioned a lot. Could we put some numbers to work? Like what kind of dollar pipeline do you see in cross selling potential with your current customer base and further with the pipelines?

Well, like we said, we did six deals in this last quarter. We haven't quantified the dollar amounts and I don't have that material available but what I will tell you is these customers, it's almost everything we're doing now from a wireless standpoint and a software standpoint is a cross sell. I mean most of these big customers already have both of our services so really what we need to do is we need to move more midmarket to some of the smaller healthcare accounts in particular that have wireless services that don't yet have Amcom software.

We still think there's a lot of potential there and we think there's a lot of opportunity there and we're going to continue our focus there. I think you're going to see for 2014 much more integration of our Company, of our systems, of our management, of our sales initiative, of our marketing approach, though I think the lines going to blur between gee is this a cross sell because the wireless people brought this particular piece of software sale in or the software people actually sold some paging and we're going to be commissioning and paying sales reps to do both. So really I don't think it makes a lot of sense to try to keep those separate going forward.

Well, why has that been -- why has that taken so long? It seems like that's the low hanging fruit if you have them as a wireless customer they're going to be seasoned. Why wouldn't you offer the Amcom software solution right away? It seems like it's such a no brainer.

Yes absolutely, we do and we have, but keep in mind these software solutions on average go for about $140,000 apiece. They're a capital budget item and the lead time or the cycle time on these things is 12 to 18 months so I agree with you 110%. We absolutely have and we had a pretty darn good quarter in the third quarter with respect to that initiative and we expect that to improve over time going forward.

I see, I see, okay. And then the last question is about EBITDA margins. It's 27% versus low thirties in the past and you've always kind of warned us that hey, these EBITDA margins aren't sustainable. Would you say that the 27%, high twenties kind of range, is more sustainable?

I think in general if you look at the businesses [separately] the paging business will get harder and harder over time to maintain the margins that it has, simply because as the revenue comes down even though it's coming down at a slower pace every quarter, it gets harder and harder to rationalize the network and take cost out. I mean if you look at our network right now, over half of our technical network the transmitters are private use agreements. They're basically straight. It's hard to get more than 50% of your network being free, so the margins on the paging side will come down over time.

The margins on the software side will go up over time. We made a conscious decision over the past two years to invest in our software business and actually spend more money, particularly in the areas of sales and marketing and product development. So we actually reduced the margin over there. Over time that margin will become enough. Over time that the paging margin will be going down, whether we can maintain 27% over the next multiple amount of years, I can't guarantee that but I would expect that we will have strong margins for the foreseeable future.

Okay. All right, that's all I have. Thank you.

(Operator Instructions). And, Mr. Kelly, it looks like we have no further questions.

Yes there doesn't appear to be any further questions so I just want to thank everybody for your participation today. Like I've said before, we have good things going on at his Company. We are very excited about our prospects in the future and we look forward to talking to you next quarter after we release our fourth quarter operating results.

Thank you very much, everyone, and have a great day.

And that does conclude today's call. We thank everyone again for their participation.