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EX-32.2 - EXHIBIT 32.2 - Spok Holdings, Incspok-ex322_3q16.htm
EX-32.1 - EXHIBIT 32.1 - Spok Holdings, Incspok-ex321_3q16.htm
EX-31.2 - EXHIBIT 31.2 - Spok Holdings, Incspok-ex312_3q16.htm
EX-31.1 - EXHIBIT 31.1 - Spok Holdings, Incspok-ex311_3q16.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2016
 
¨
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                      to                     
Commission File Number: 001-32358
  
SPOK HOLDINGS, INC.
(Exact name of registrant as specified in its charter)

DELAWARE
 
16-1694797
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
6850 Versar Center, Suite 420
 
 
Springfield, Virginia
 
22151-4148
(Address of principal executive offices)
 
(Zip Code)
(800) 611-8488
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year if changed since last report)
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
¨
Accelerated filer
x
 
 
 
 
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
20,538,372 shares of the registrant’s common stock ($0.0001 par value per share) were outstanding as of October 21, 2016.
 




SPOK HOLDINGS, INC.
QUARTERLY REPORT ON FORM 10-Q
INDEX
 
 
Page  
PART I.
 
 
Item 1.
 
 
 
Condensed Consolidated Balance Sheets as of September 30, 2016 (Unaudited) and December 31, 2015
 
 
Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2016 and 2015 (Unaudited)
 
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended 
 September 30, 2016 and 2015 (Unaudited)
 
 
 
Item 2.
 
Item 3.
 
Item 4.
PART II.
 
 
Item 1.
 
Item 1A.
 
Item 2.
 
Item 6.
 




PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
SPOK HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
 
 
September 30, 2016
 
December 31, 2015
 
(In thousands)
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
122,461

 
$
111,332

Accounts receivable (less allowances of $1,194 and $1,286, respectively)
23,382

 
22,638

Prepaid expenses and other
4,293

 
5,352

Inventory
2,100

 
2,291

Total current assets
152,236

 
141,613

Property and equipment, net
13,672

 
15,386

Goodwill
133,031

 
133,031

Other intangible assets, net
11,810

 
14,964

Deferred income tax assets (less valuation allowance of $0 and $45,777, respectively)
77,795

 
83,983

Other assets
2,588

 
1,445

TOTAL ASSETS
$
391,132

 
$
390,422

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable and accrued liabilities
$
7,238

 
$
9,247

Accrued compensation and benefits
11,471

 
10,864

Deferred revenue
30,183

 
27,045

Total current liabilities
48,892

 
47,156

Deferred revenue
712

 
741

Other long-term liabilities
9,074

 
8,972

TOTAL LIABILITIES
58,678

 
56,869

Commitments and contingencies


 


Stockholders’ equity:
 
 
 
Preferred stock

 

Common stock
2

 
2

Additional paid-in capital
106,342

 
110,435

Retained earnings
226,110

 
223,116

TOTAL STOCKHOLDERS’ EQUITY
332,454

 
333,553

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
391,132

 
$
390,422



The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

2



SPOK HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
(Unaudited and in thousands except share and per share amounts)
Revenue:
 
 
 
 
 
 
 
 
Wireless
 
$
27,024

 
$
29,375

 
$
83,055

 
$
90,287

Software
 
18,331

 
16,806

 
52,322

 
52,002

Total revenue
 
45,355

 
46,181

 
135,377

 
142,289

Operating expenses:
 
 
 
 
 
 
 
 
Cost of revenue
 
7,639

 
7,871

 
23,167

 
25,816

Service, rental and maintenance
 
11,898

 
11,117

 
34,510

 
33,376

Selling and marketing
 
5,955

 
6,572

 
18,912

 
20,409

General and administrative
 
10,593

 
10,410

 
31,542

 
31,883

Severance
 
12

 
141

 
9

 
1,645

Depreciation, amortization and accretion
 
3,229

 
3,413

 
9,787

 
10,608

Total operating expenses
 
39,326

 
39,524

 
117,927

 
123,737

Operating income
 
6,029

 
6,657

 
17,450

 
18,552

Interest income
 
67

 
1

 
176

 
3

Other income
 
85

 
784

 
443

 
1,110

Income before income tax expense
 
6,181

 
7,442

 
18,069

 
19,665

Income tax expense
 
(2,123
)
 
(3,222
)
 
(7,116
)
 
(8,150
)
Net income
 
$
4,058

 
$
4,220

 
$
10,953

 
$
11,515

Basic net income per common share
 
$
0.20

 
$
0.20

 
$
0.53

 
$
0.53

Diluted net income per common share
 
$
0.20

 
$
0.20

 
$
0.53

 
$
0.53

Basic weighted average common shares outstanding
 
20,517,419

 
21,301,311

 
20,581,586

 
21,623,612

Diluted weighted average common shares outstanding
 
20,532,345

 
21,315,685

 
20,596,050

 
21,638,973

Cash dividends declared per common share
 
$
0.125

 
$
0.125

 
$
0.375

 
$
0.375





The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

3



SPOK HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
For the Nine Months Ended September 30,
 
 
2016
 
2015
 
 
(Unaudited and
in thousands)
Cash flows provided by operating activities:
 
 
 
 
Net income
 
$
10,953

 
$
11,515

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation, amortization and accretion
 
9,787

 
10,608

Deferred income tax expense
 
6,188

 
6,989

Amortization of stock based compensation
 
2,067

 
1,497

Provision for doubtful accounts, service credits and other
 
645

 
1,040

Adjustment of non-cash transaction taxes
 
(214
)
 
(530
)
(Gain) Loss on disposals of property and equipment
 
3

 
(794
)
Changes in assets and liabilities:
 
 
 
 
Accounts receivable
 
(1,389
)
 
1,896

Prepaid expenses and other assets
 
27

 
1,878

Accounts payable, accrued liabilities and accrued compensation and benefits
 
(1,402
)
 
(4,621
)
Deferred revenue
 
3,109

 
4,002

Other long-term liabilities
 
(336
)
 
45

Net cash provided by operating activities
 
29,438

 
33,525

Cash flows used in investing activities:
 
 
 
 
Purchase of property and equipment
 
(4,378
)
 
(4,450
)
Proceeds from disposals of property and equipment
 
1

 
807

Net cash used in investing activities
 
(4,377
)
 
(3,643
)
Cash flows used in financing activities:
 
 
 
 
Cash dividends to stockholders
 
(7,718
)
 
(8,739
)
Purchase of common stock (including commissions)
 
(6,214
)
 
(11,804
)
Employee stock based compensation tax withholding
 

 
(3,825
)
Net cash used in financing activities
 
(13,932
)
 
(24,368
)
Net increase in cash and cash equivalents
 
11,129

 
5,514

Cash and cash equivalents, beginning of period
 
111,332

 
107,869

Cash and cash equivalents, end of period
 
$
122,461

 
$
113,383

Supplemental disclosure:
 
 
 
 
Income taxes paid
 
$
681

 
$
1,169




The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

4



SPOK HOLDINGS, INC.
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



(1) Business — Spok Holdings, Inc. and its subsidiaries (collectively, "we," "Spok," or "the Company"), through our indirect wholly-owned subsidiary, Spok, Inc., is a comprehensive provider of critical communication solutions for enterprises. We are a leader in critical communication for healthcare, government, public safety and other industries. We deliver smart, reliable solutions to help protect the health, well-being and safety of people primarily in the United States. Organizations rely on Spok for workflow improvement, secure texting, paging services, contact center optimization and public safety response. Our product offerings are capable of addressing a customer's mission critical communications needs.
(2) Preparation of Interim Financial Statements — Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the rules and regulations of the United States Securities and Exchange Commission (the “SEC”). Amounts shown on the condensed consolidated statements of income within the operating expense categories of cost of revenue; service, rental and maintenance; selling and marketing; and general and administrative are recorded exclusive of severance costs and depreciation, amortization and accretion. These items are shown separately on the condensed consolidated statements of income within operating expenses. Foreign currency translation adjustments were deemed immaterial and consequently, no statements of comprehensive income are presented.
The financial information included herein, other than the condensed consolidated balance sheet as of December 31, 2015, is unaudited. The condensed consolidated balance sheet at December 31, 2015 has been derived from, but does not include, all the disclosures contained in the audited consolidated financial statements as of and for the year ended December 31, 2015. In management’s opinion, our unaudited condensed consolidated statements include all adjustments and accruals that are necessary for a fair presentation of the results of all interim periods reported herein and all such adjustments are of a normal, recurring nature (except for the reduction of deferred tax assets and related valuation allowance described in Note 13).
These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2015 (the “2015 Annual Report”). The condensed consolidated statements of income for the interim periods presented are not necessarily indicative of the results that may be expected for a full year.
The accompanying condensed consolidated financial statements include our accounts and the accounts of our wholly-owned direct and indirect subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
The preparation of these condensed consolidated financial statements requires management to make judgments and estimates that affect the amounts reported in our condensed consolidated financial statements and accompanying notes. Actual results may differ from these estimates under different assumptions or conditions.
(3) Risks and Other Important Factors — See “Item 1A. Risk Factors” of Part II of this Quarterly Report on Form 10-Q (“Quarterly Report”) and "Item 1A. Risk Factors" of Part I of the 2015 Annual Report, which describes key risks associated with our operations and industry. 
(4) Recent and New Accounting Pronouncements — In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers. Since this ASU was issued, the FASB has issued several updates including ASU No. 2015-14 in July 2015 which delayed the effective date, ASU No. 2016-08 in March 2016 which updated guidance related to principal versus agent considerations, ASU No. 2016-10 in April 2016 which updated guidance related to the identification of performance obligations and ASU No. 2016-12 in May 2016 which updated guidance related to scope improvements and practical expedients. The effective date is January 1, 2018, and while early adoption to the original effective date of January 1, 2017 is permitted, we have elected not to early adopt.
ASU No. 2014-09 creates a five-step model that requires companies to exercise judgment when considering all relevant facts and circumstances in the determination of when and how revenue is recognized. The two permitted transition methods under the new standard are the full retrospective method, in which case the standard would be applied to each prior reporting period presented, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of initial application. We have completed our review of the acceptable transition methods and have selected the modified retrospective approach. We believe the modified retrospective approach will likely impact both deferred revenue and retained earnings in our 2018 consolidated financial statements. We continue to evaluate the potential impact from this ASU on our consolidated financial statements to assess whether any related impact will be material.

5



SPOK HOLDINGS, INC.
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


In February 2016, the FASB issued ASU No. 2016-02, Leases. The new standard establishes a right of use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than twelve months. Leases will be classified as either financing or operating with the classification affecting the pattern of expense recognition in the income statement.
ASU No. 2016-02 will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years and early adoption of the standard is permitted. A modified retrospective transition approach is required for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. While we are still evaluating the impact of the potential new standard on our consolidated financial statements, we expect that upon adoption we will recognize ROU assets and lease liabilities and that the amounts could be material.
In March 2016, the FASB issued ASU No. 2016-09, Stock Compensation Expense. The new standard is primarily focused on income taxes and the presentation of taxes related to stock compensation, but also provides a simpler method of accounting for forfeitures. An entity will now be able to make an entity-wide accounting policy election to either estimate the number of awards that are expected to be forfeited, as permissible under existing GAAP, or account for forfeitures as incurred. The purpose of this ASU was to reduce cost and complexity of the accounting related to share-based payment awards issued to employees for public and private companies.
ASU No. 2016-09 will be effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, and early adoption upon issuance of the ASU is permitted. We have adopted this new ASU effective January 1, 2016. As part of the adoption, we have made an accounting policy election to account for forfeitures as incurred rather than estimate the number of awards that are expected to be forfeited. The following summary provides further clarification of the transition approaches and the impact on the Company for each issue in ASU No. 2016-09 that requires a retrospective or modified retrospective approach:
For entities electing to account for forfeitures as they are incurred, a modified retrospective transition approach, with a cumulative-effect adjustment recognized in equity, is required for stock based compensation accounted for prior to the date on which the standard is adopted. We made the policy election to account for forfeitures as incurred and therefore, recorded a cumulative-effect adjustment in equity to account for this change in the first quarter of 2016. The overall impact to our consolidated financial statements is immaterial. Future forfeitures will be accounted for as they are incurred rather than estimating the number of awards that are expected to be forfeited at the time of grant.
A retrospective transition approach is required for classification of employee taxes paid in the Statement of Cash Flows when an employer withholds shares for tax-withholding purposes. In the three months ended March 31, 2015, shares were withheld for tax-withholding purposes related to the payment of vested 2011 Long-Term Incentive Plan ("LTIP") awards. Previously, the withholdings were classified as an operating activity within our Statement of Cash Flows. We have retrospectively reclassified those withholdings as a financing activity and the total reclassification was $3.8 million.
There was no additional impact on our financial statements, resulting from the adoption of ASU No. 2016-09, that required a retrospective or modified retrospective approach. Any additional requirements under this ASU will be accounted for on a prospective basis.
(5) Inventory — Inventory of $2.1 million and $2.3 million at September 30, 2016 and December 31, 2015, respectively, consisted of third-party hardware and software held for resale. We value our inventory based on the lower of cost (determined using the first-in, first-out method) or current market value.

6



SPOK HOLDINGS, INC.
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(6) Depreciation, Amortization and Accretion — The total depreciation, amortization and accretion expenses related primarily to property and equipment, amortizable intangible assets, and asset retirement obligations. For the three months ended September 30, 2016 and 2015 total depreciation, amortization and accretion expenses were $3.2 million and $3.4 million, respectively, and for the nine months ended September 30, 2016 and 2015 were $9.8 million and $10.6 million, respectively. The consolidated expenses consisted of the following for the periods stated:
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
(Dollars in Thousands)
Depreciation Expense
 
$
2,066

 
$
2,127

 
$
6,167

 
$
6,496

Amortization Expense
 
1,007

 
1,120

 
3,153

 
3,615

Accretion Expense
 
156

 
166

 
467

 
497

Total
 
$
3,229

 
$
3,413

 
$
9,787

 
$
10,608


(7) Goodwill and Amortizable Intangible Assets — Goodwill at September 30, 2016 and December 31, 2015 was $133.0 million. Goodwill is evaluated in the fourth quarter of each year and when events or circumstances suggest a potential impairment has occurred. There were no triggering events, as of September 30, 2016, which would indicate impairment.
Amortizable intangible assets at September 30, 2016 primarily include customer related intangibles, technology based intangibles, contract based intangibles and marketing intangibles that resulted from our acquisition of Amcom Software, Inc. in 2011 and IMCO Technologies Corporation in 2012. Such intangibles are being amortized over periods ranging from two to ten years. The net consolidated balance of amortizable intangible assets consisted of the following:
 
 
 
 
September 30, 2016
 
 
Useful Life
(In Years)
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Balance
 
 
 
 
(Dollars in thousands)
Customer relationships
 
10
 
$
25,002

 
$
(13,960
)
 
$
11,042

Acquired technology
 
2 - 4
 
8,454

 
(8,454
)
 

Non-compete agreements
 
3 - 5
 
2,370

 
(2,370
)
 

Trademarks
 
6
 
5,754

 
(4,986
)
 
768

Total amortizable intangible assets
 

 
$
41,580

 
$
(29,770
)
 
$
11,810

Estimated amortization of intangible assets for future periods was as follows:
 
(Dollars  in thousands)
For the three months ending December 31, 2016
$
1,007

For the year ending December 31:
 
2017
2,886

2018
2,500

2019
2,500

2020
2,500

Thereafter
417

Total amortizable intangible assets
$
11,810


7



SPOK HOLDINGS, INC.
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(8) Accounts Payable and Accrued Liabilities — Accounts payable and accrued liabilities were as follows:

 
September 30,
2016
 
December 31,
2015

 
(Dollars in thousands)
Accounts payable
 
$
1,584

 
$
2,121

Accrued network costs
 
797

 
917

Accrued taxes
 
3,140

 
3,465

Accrued outside services
 
645

 
1,171

Accrued other
 
1,072

 
1,573

Total accounts payable and accrued liabilities
 
$
7,238

 
$
9,247

Accrued taxes are based on our estimate of outstanding state and local taxes. This balance includes a combination of income and transactional taxes and may be adjusted in the future as we settle with various taxing jurisdictions.
(9) Asset Retirement Obligations — We recognize liabilities and corresponding assets for future obligations associated with the retirement of assets. We have paging equipment assets, principally transmitters, which are located on leased locations. The underlying leases generally require the removal of equipment at the end of the lease term; therefore, a future obligation exists.
At January 1, 2016, we had recognized cumulative asset retirement costs of $3.6 million. During 2016, we have recorded nominal charges and as a result, the total cumulative asset retirement cost remains $3.6 million at September 30, 2016. The asset retirement cost additions during the nine months ended September 30, 2016 increased paging equipment assets and are being depreciated over the related estimated lives of 51 to 60 months. The asset retirement costs and the corresponding liabilities that have been recorded to date generally relate to either current plans to consolidate networks or to the removal of assets at an estimated future terminal date.
The components of the changes in the asset retirement obligation liabilities were:
 
 
Short-Term
Portion
 
Long-Term
Portion
 
Total
 
 
(Dollars in thousands)
Balance at January 1, 2016
 
$
296

 
$
7,543

 
$
7,839

Accretion
 
27

 
440

 
467

Amounts Paid
 
(192
)
 

 
(192
)
Asset additions recorded, net
 

 
23

 
23

Reclassifications
 
116

 
(116
)
 

Balance at September 30, 2016
 
$
247

 
$
7,890

 
$
8,137

The balances above were included within accounts payable and accrued liabilities and other long-term liabilities, respectively, at September 30, 2016.
(10) Deferred Revenue — Deferred revenue at September 30, 2016 was $30.2 million for the current portion and $0.7 million for the non-current portion. Deferred revenue at December 31, 2015 was $27.0 million for the current portion and $0.7 million for the non-current portion. Our deferred revenue balance represents the contractual obligation for maintenance, software license, professional services and wireless services for which the revenue recognition criteria has not yet been met. We will recognize revenue when the service or software license is provided or the delivery otherwise meets our revenue recognition criteria.
(11) Accrued Compensation and Benefits — Accrued compensation and benefits was $11.5 million at September 30, 2016 and $10.9 million at December 31, 2015. The increase of $0.6 million is primarily due to the timing of payroll payments for the period ending September 30, 2016 as compared to the same period ending December 31, 2015.

8



SPOK HOLDINGS, INC.
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


(12) Stockholders’ Equity and Stock Based Compensation — Our authorized capital stock consists of 75 million shares of common stock, par value $0.0001 per share, and 25 million shares of preferred stock, par value $0.0001 per share.
Changes in Stockholders’ Equity. Changes in stockholders’ equity for the nine months ended September 30, 2016 consisted of:
 
(Dollars in thousands)
Balance at January 1, 2016
$
333,553

Net income for the nine months ended September 30, 2016
10,953

Cash dividends declared
(7,893
)
Amortization of stock based compensation
2,067

Common stock repurchase program
(6,214
)
Other
(12
)
Balance at September 30, 2016
$
332,454

General. At September 30, 2016 and December 31, 2015, there were 20,532,338 and 20,886,261 shares of common stock outstanding, respectively, and no shares of preferred stock outstanding.
2015 LTIP. On December 9, 2014, our Board of Directors adopted an LTIP (which provides for a 36 month vesting period) that included a stock component in the form of restricted stock units ("RSUs"). Under this incentive program, RSUs will be granted to eligible employees annually and each annual grant will generally vest over a three year service period. Each annual grant includes performance metrics required to be met for vesting purposes, as established by the Board of Directors. Our Board of Directors also approved that future cash dividends related to the RSUs will be set aside and paid in cash to each eligible employee when the RSUs are converted into shares of common stock. RSUs would be converted into shares of common stock on the earlier of a change in control of the Company (as defined in the 2015 LTIP) or on or after the third business day following the day that we file the Annual Report on Form 10-K with the SEC for the grant's final vesting year, but in no event later than December 31 of the year following the vesting date if the pre-established performance conditions are achieved. Any unvested RSUs awarded under the 2015 LTIP and the related cash dividends are forfeited if the participant terminates employment with the Company.
On January 2, 2015, our Board of Directors granted 254,777 RSUs with a grant date fair value of $4.4 million. On January 28, 2016 our Board of Directors issued a second grant of 227,082 RSUs with a grant date fair value of $3.8 million. An additional 7,629 RSUs were granted to eligible employees who joined the Company during the nine months ended September 30, 2016. All issuances were made to eligible employees under the 2012 Equity Incentive Award Plan (the "2012 Equity Plan") for the 2015 LTIP pursuant to a Restricted Stock Unit Agreement. Eligible employees have the opportunity to earn RSUs based upon continued employment with the Company and the achievement of performance goals established by our Board of Directors for our consolidated revenue and operating cash flows (as defined by the Company) during the period of January 1, 2015 through December 31, 2017 (“the 2015-2017 performance period”) for the 2015 grant and the period of January 1, 2016 through December 31, 2018 ("the 2016-2018 performance period") for the 2016 grant, respectively. A total of $1.7 million was included in stock based compensation expense for the nine months ended September 30, 2016 relating to grants issued under the 2015 LTIP.
The following table summarizes the activities under the 2012 Equity Plan from January 1, 2016 through September 30, 2016:
 
Activity
Total equity securities available at January 1, 2016
1,483,235

Less: 2015 LTIP RSU's awarded to eligible employees, net of forfeitures
213,955

Less: Restricted shares of common stock ("restricted stock") awarded to non-executive members of the Board of Directors
17,615

Total equity securities available at September 30, 2016
1,251,665


9



SPOK HOLDINGS, INC.
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


The following table details activities with respect to RSUs issued and outstanding under the 2015 LTIP for the nine months ended September 30, 2016:
 
 
Shares
 
Weighted-
Average Grant
Date Fair Value
 
Total Unrecognized Compensation Cost
(Dollars in thousands)
 
Weighted-Average
Period Over Which
Cost is  Expected to
be Recognized
(In months)
Non-vested RSUs at January 1, 2016
 
242,468

 
$
17.35

 
 
 
 
Granted
 
234,711

 
16.83

 
 
 
 
Vested
 

 

 
 
 
 
Forfeited
 
(20,756
)
 
17.05

 
 
 
 
Non-vested RSUs at September 30, 2016
 
456,423

 
$
17.10

 
$
4,843

 
21
2016 ESPP. On July 25, 2016 our stockholders approved the registration with the SEC of 250,000 shares of common stock, to be issued from time to time in connection with purchases under the Spok Holdings, Inc. 2016 Employee Stock Purchase Plan ("2016 ESPP"). Shares were first offered for purchase under the 2016 ESPP during the third quarter of 2016. Under the 2016 ESPP, eligible participants can voluntarily elect to have contributions withheld from their pay for the duration of an offering period, subject to the 2016 ESPP limits. At the end of an offering period, contributions will be used to purchase the Company's common stock at a discount to the market price based on the first or last day of the offering period, whichever is lower. Participants are required to hold common stock for a minimum period of two years from the grant date. Participants will begin earning dividends on shares after the purchase date. Each offering period will generally last for no longer than six months. Once an offering period begins, participants cannot adjust their withholding amount. If a participant chooses to withdraw, any previously withheld funds will be returned to the participant, with no stock purchased, and that participant will be eligible to participate in the 2016 ESPP at the next offering period. If the participant terminates employment with the Company during the offering period, all contributions will be returned to the employee and no stock will be purchased at a discounted rate.
We use the Black-Scholes model to calculate the fair value of the options to purchase common stock, under the 2016 ESPP, at the grant date due to the look back feature included in the 2016 ESPP. The look back feature allows for the purchase of common stock at a discount based on the price at the time of grant or purchase date, whichever is lower. The Black-Scholes model requires the use of estimates for the expected term, the expected volatility of the underlying common stock over the expected term, the risk-free interest rate and the expected dividend payment. The fair value of the discount is the difference between the fair value of the underlying stock price at grant date and the discounted purchase price at grant date. The fair value of the look back feature is estimated to be a call option at the discounted rate combined with a put option on one minus the discounted rate where the discounted rate is equal to the discount being offered to participants under the 2016 ESPP. The fair value of the options to purchase common stock under the 2016 ESPP is the combination of the fair value of the discount and the fair value of the look back feature.
We base the risk-free rate for the expected term on the U.S. Treasury Rate as of the grant date. The expected term is equal to the required holding period of two years. The volatility for our common stock was estimated based on the standard deviation of monthly variances in stock price using a rolling three year history of the Company's stock price. Because the expected term includes a period for which a participant earns (the two year holding period less the offering period) and does not earn dividends (the offering period) our fair value is equal to the sum of the Black-Scholes model amount, run for the non-dividend yielding period, plus the Black Scholes model amount, run for the dividend yielding period (for which the total period is equal to the expected term). We use the discrete dividend yield method due to our consistent and routine history of paying dividends. The following assumptions were used for each respective period for employee stock-based compensation related to the 2016 ESPP:
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Expected term (in years)
 
2.00

 

 
2.00

 

Volatility
 
7.89
%
 

 
7.89
%
 

Risk-free interest rate
 
0.34% - 0.78%

 

 
0.34% - 0.78%

 

Dividend payment
 
$
0.125

 

 
$
0.125

 
$


10



SPOK HOLDINGS, INC.
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


For the nine months ended September 30, 2016 the initial offering period was still open and employees had not yet purchased any common stock. The following table summarizes the activities under the ESPP from January 1, 2016 through September 30, 2016:
 
Activity
Total ESPP equity securities available at January 1, 2016

Plus: Registration of 2016 ESPP
250,000

Less: 2016 ESPP common stock purchased by eligible employees, net

Total 2016 ESPP securities available at September 30, 2016
250,000

Amounts withheld from participants will be classified as a liability on the balance sheet until funds are used to purchase shares. This liability amount is immaterial to the overall financial statements.
Stock Based Compensation. We record all stock-based awards, which consist of RSUs, restricted stock and the option to purchase common stock under the ESPP, at fair value as of the grant date. Stock based compensation expense is recognized based on a straight-line amortization basis over the respective service period. Forfeitures and withdrawals are accounted for on an as incurred basis. The following table reflects the items for stock based compensation expense on the condensed consolidated statements of income for the periods stated:
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
Operating Expense Category
 
2016
 
2015
 
2016
 
2015
 
 
(Dollars in thousands)
Cost of revenue (LTIP)
 
$
57

 
$
33

 
$
164

 
$
101

Service, rental and maintenance (LTIP)
 
61

 
29

 
177

 
86

Selling and marketing (LTIP)
 
75

 
16

 
198

 
118

General and administrative (LTIP)
 
391

 
223

 
1,198

 
914

General and administrative (ESPP)
 
9

 

 
9

 

General and administrative (Board of Directors Restricted Stock)
 
107

 
93

 
321

 
278

Total stock based compensation expense
 
$
700

 
$
394

 
$
2,067

 
$
1,497

The increase in stock based compensation expense during the nine months ended September 30, 2016, compared to the same period in 2015, was due primarily to the January 2016 RSU grant under the 2015 LTIP. Each grant is amortized over the corresponding three year service period beginning in the year of issuance.
Cash Dividends to Stockholders. The following table details our cash dividend payments made in 2016. Cash dividends paid as disclosed in the condensed consolidated statements of cash flows for the nine months ended September 30, 2016 and 2015 include previously declared cash dividends on shares of vested restricted stock issued to our non-executive directors and dividends related to vested RSUs issued to eligible employees. Cash dividends on RSUs and restricted stock have been accrued and are paid when the applicable vesting conditions are met. Accrued cash dividends on forfeited restricted stock and RSUs are also forfeited.
Declaration Date
 
Record Date
 
Payment Date
 
Per Share Amount
 
Total  Payment(1)
 
 
 
 
 
 
 
 
(Dollars in thousands)
February 24
 
March 18
 
March 30
 
$
0.125

 
$
2,580

April 27
 
May 23
 
June 24
 
0.125

 
2,570

July 27
 
August 16
 
September 9
 
0.125

 
2,568

 
 
Total
 
 
 
$
0.375

 
$
7,718

(1) The total payment reflects the cash dividends paid in relation to common stock and vested restricted stock.

11



SPOK HOLDINGS, INC.
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Future Cash Dividends to Stockholders. On October 26, 2016, our Board of Directors declared a regular quarterly cash dividend of $0.125 per share of common stock with a record date of November 18, 2016, and a payment date of December 9, 2016. This cash dividend of approximately $2.6 million will be paid from available cash on hand.
Common Stock Repurchase Program. In October 2015, the Board of Directors extended the common stock repurchase program through December 31, 2016. In extending the common stock repurchase plan the Board of Directors reset the purchase authority to $10.0 million with the repurchase authority to begin the earlier of January 4, 2016 or the completion of the existing common stock repurchase program. The following table presents information with respect to purchases made by the Company during the nine months ended September 30, 2016:
Period
 
Total Number of Shares Purchased
 
Average Price Paid Per Share
 
Total Number of Shares Purchased as Part of the Publicly Announced Plans or Programs(1)
 
Approximate Dollar Value of Shares That May Yet Be Purchased Under the Publicly Announced Plans or Programs(1)
 
 
 
 
 
 
 
 
(Dollars in thousands)
Beginning Balance
 
 
 
 
 
 
 
$
10,000

January 1 through January 31, 2016
 
152,198

 
$
16.53

 
152,198

 
7,484

February 1 through February 29, 2016
 
101,736

 
17.24

 
101,736

 
5,730

March 1 through March 31, 2016
 
37,927

 
16.44

 
37,927

 
5,107

April 1 through April 30, 2016
 
31,468

 
16.40

 
31,468

 
4,591

May 1 through May 31, 2016
 
34,323

 
16.37
 
34,323

 
4,029

June 1 through June 30, 2016
 

 

 

 
4,029

July 1 through July 31, 2016
 

 

 

 
4,029

August 1 through August 31, 2016
 
3,800

 
16.44

 
3,800

 
3,967

September 1 through September 30, 2016
 
10,084

 
16.46

 
10,084

 
3,801

Total
 
371,536

 
$
16.68

 
371,536

 
 
(1) In October 2015, the Board of Directors extended the common stock repurchase program through December 31, 2016, and reset the repurchase authority to $10.0 million as of January 4, 2016.
Additional Paid-in Capital. For the nine months ended September 30, 2016, additional paid-in capital decreased by $4.1 million to $106.3 million at September 30, 2016 from $110.4 million at December 31, 2015. The decrease in the nine months ended September 30, 2016 was due primarily to the repurchase of shares of common stock under the current stock repurchase program offset by the issuance of additional grants under the 2015 LTIP.

12



SPOK HOLDINGS, INC.
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Net Income per Common Share. Basic net income per common share is computed on the basis of the weighted average common shares outstanding. Diluted net income per common share is computed on the basis of the weighted average common shares outstanding plus the effect of all potentially dilutive common shares including outstanding restricted stock and RSUs, which are treated as contingently issuable shares, using the “treasury stock” method. The Company has determined, based on the provisions of the 2015 LTIP, that unvested RSUs do not currently meet, nor have they met since issuance, the criteria to be considered dilutive. Therefore we have excluded them from the calculation of both diluted net income per common share as well as the diluted weighted average shares of common stock and common stock equivalents for the three and nine months ending September 30, 2016 and removed them from the comparative three and nine months ending September 30, 2015. This correction is immaterial to our financial statements and corresponding disclosures. The components of basic and diluted net income per common share were as follows for the periods stated:
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
(Dollars in thousands, except share and per share amounts)
Net income
 
$
4,058

 
$
4,220


$
10,953

 
$
11,515

Weighted average shares of common stock outstanding
 
20,517,419

 
21,301,311

 
20,581,586

 
21,623,612

Dilutive effect of restricted stock, RSUs and the ESPP
 
14,926

 
14,374

 
14,464

 
15,361

Weighted average shares of common stock and common stock equivalents
 
20,532,345

 
21,315,685

 
20,596,050

 
21,638,973

Net income per common share
 
 
 
 
 
 
 
 
Basic
 
$
0.20

 
$
0.20

 
$
0.53

 
$
0.53

Diluted
 
$
0.20

 
$
0.20

 
$
0.53

 
$
0.53


(13) Income Taxes — Spok files a consolidated U.S. Federal income tax return and income tax returns in various state, local and foreign jurisdictions as required.
At September 30, 2016, we had total deferred income tax assets ("DTAs") of $77.8 million and no valuation allowance. This reflects a change from the December 31, 2015 balance of deferred income tax assets of $129.8 million and a valuation allowance of $45.8 million resulting in an estimated recoverable amount of $84.0 million. The change from December 31, 2015 to September 30, 2016 reflects the expected usage of the deferred income tax assets to offset expected 2016 taxable income, changes in tax rates and a write off of our valuation allowance of $45.8 million against DTAs of the same amount as explained below.
During the three months ended September 30, 2016, the US Court of Appeals for the Second Circuit affirmed a Tax Court Decision, unrelated to Spok, regarding the allocation of cancellation of debt income to tax attributes for a company that filed a Federal consolidated income tax return. This impacted the ultimate realization of certain of our net operating loss ("NOL") carryovers. Therefore, during the three months ended September 30, 2016, we wrote off our valuation allowance of $45.8 million against the impacted NOL DTAs. This had no impact on our income tax provision or net income.
We consider both positive and negative evidence when evaluating the recoverability of our DTAs. The assessment is required to determine whether based on all available evidence, it is more likely than not (i.e., greater than a 50% probability) whether all or some portion of the DTAs will be realized in the future. During the fourth quarter of each year, we prepare a multi-year forecast of taxable income for our operations which assists in analyzing the recoverability of our DTAs.
The anticipated effective income tax rate is expected to continue to differ from the Federal statutory rate of 35% primarily due to the effect of state income taxes, the effect of changes to the DTA valuation allowance, permanent differences between book and taxable income and certain discrete items.
As of September 30, 2016, approximately 85% of our DTAs of $77.8 million relate to NOL carry forwards available to offset future taxable income. We no longer have an annual Section 382 limitation on our remaining NOLs.

(14) Related Party Transactions — A member of our Board of Directors also serves as a Director for an entity that leases transmission tower sites to the Company. For the three months ended September 30, 2016 and 2015, we incurred site rent expenses of $1.0 million, and for the nine months ended September 30, 2016 and 2015, we incurred site rent expenses of $2.9 million and

13



SPOK HOLDINGS, INC.
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


$3.0 million, respectively, from the entity on which the individual serves as a Director. Site rent expenses are included in service, rental and maintenance expenses.
(15) Commitments and Contingencies — There have been no material changes during the nine months ended September 30, 2016 to the commitments and contingencies previously reported in the 2015 Annual Report.

14



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This Quarterly Report contains forward-looking statements and information relating to Spok Holdings, Inc. and its subsidiaries (collectively, "we,"“Spok,” or the “Company”) that set forth anticipated results based on management’s current plans, known trends and assumptions. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Statements that are predictive in nature, that depend upon or refer to future events or conditions, or that include words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,” “target,” “forecast” and similar expressions, as they relate to Spok are forward-looking statements.
Although these statements are based upon current plans, known trends and assumptions that management considers reasonable, they are subject to certain risks, uncertainties and assumptions, including but not limited to those discussed below and under the captions “Business,” “Management’s Discussion and Analysis of Financial Condition and Statements of Income (“MD&A”),” and “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2015, filed with the United States Securities and Exchange Commission (the “SEC”) on February 25, 2016 (the “2015 Annual Report”). Should known or unknown risks or uncertainties materialize, known trends change, or underlying assumptions prove inaccurate, actual results or outcomes may differ materially from past results and those described herein as anticipated, believed, estimated, expected, intended, targeted or forecasted. Investors are cautioned not to place undue reliance on these forward-looking statements.
The Company undertakes no obligation to update forward-looking statements. Investors are advised to consult all further disclosures the Company makes in its subsequent reports on Form 10-Q and Form 8-K that it will file with the SEC. Also note that, in the risk factors disclosed in the Company’s 2015 Annual Report, the Company provides a cautionary discussion of risks, uncertainties and possibly inaccurate assumptions relevant to its business. These are factors that, individually or in the aggregate, could cause the Company’s actual results to differ materially from past results as well as those results that may be anticipated, believed, estimated, expected, intended, targeted or forecasted. It is not possible to predict or identify all such risk factors. Consequently, investors should not consider the risk factor discussion to be a complete discussion of all of the potential risks or uncertainties that could affect Spok's business, statement of income or financial condition, subsequent to the filing of this Quarterly Report.
Overview
The following MD&A is intended to help the reader understand the statements of income and financial position of Spok. This MD&A is provided as a supplement to, and should be read in conjunction with, our 2015 Annual Report and our unaudited condensed consolidated financial statements and accompanying notes. A reference to a “Note” in this section refers to the accompanying Unaudited Notes to Condensed Consolidated Financial Statements.
Spok, acting through its indirect wholly-owned operating subsidiary, Spok, Inc., delivers smart, reliable solutions to help protect the health, well-being and safety of people primarily in the United States. Organizations rely on Spok for workflow improvement, secure texting, paging services, contact center optimization and public safety response. When critical communications matter, Spok delivers.
Business
See Note 1 to our Unaudited Notes to Condensed Consolidated Financial Statements of Part I of this Quarterly Report on Form 10-Q ("Quarterly Report") and "Item 1. Business" of Part I of the 2015 Annual Report, which describes our business in further detail.
Revenue
We offer a suite of unified critical communication solutions that include call center operations, clinical alerting and notifications, one-way and advanced two-way wireless messaging services, mobile communications and public safety response.
We develop, sell and support enterprise-wide systems for healthcare, government, large enterprise and other organizations needing to automate, centralize and standardize their approach to critical communications. Our solutions can be found in prominent hospitals; large government agencies; leading public safety institutions, colleges and universities; large hotels, resorts and casinos; and well-known manufacturers. Our primary market has been the healthcare industry, particularly hospitals. We have identified hospitals with 200 or more beds as the primary targets for our software and wireless solutions.

15



Revenue generated by wireless messaging services (including voice mail, personalized greeting, message storage and retrieval) and equipment loss and/or maintenance protection to both one-way and two-way messaging subscribers is presented as wireless revenue in our statements of income. Revenue generated by the sale of our software solutions, which includes software license, professional services (installation, consulting and training), equipment (to be used in conjunction with the software) and post-contract support (on-going maintenance), is presented as software revenue in our statements of income. Our software is licensed to end users under an industry standard software license agreement. For the nine months ended September 30, 2016 and 2015, wireless revenue represented approximately 60% and 64%, respectively and software revenue represented approximately 40% and 36%, respectively of our consolidated revenue.
Wireless Revenue
Our core offering includes subscriptions to one-way or two-way messaging services for a periodic (monthly, quarterly, semi-annual, or annual) service fee. This is generally based upon the type of service provided, the geographic area covered, the number of devices provided to the customer and the period of commitment. A subscriber to one-way messaging services may select coverage on a local, regional or nationwide basis to best meet their messaging needs. Two-way messaging is generally offered on a nationwide basis. In addition, subscribers either contract for a messaging device from us for an additional fixed monthly fee or they own a device, having purchased it either from us or from another vendor. We also sell devices to resellers who lease or resell devices to their subscribers and then sell messaging services utilizing our networks. We offer ancillary services, such as voicemail and equipment loss or maintenance protection, which help increase the monthly recurring revenue we receive along with these traditional messaging services.
Software Revenue
Software revenue consists of two primary components: operations revenue and maintenance revenue. Operations revenue consists of license revenue, professional services revenue, and equipment sales. Maintenance revenue is for ongoing support of a software application or equipment (typically for one year). We recognize equipment revenue when it is shipped or delivered to the customer depending on the delivery method of Free on Board ("FOB") shipping or FOB destination, respectively. License, professional services and maintenance revenue is recognized ratably over the longer of the period of professional services delivery to the customer or the contractual term of the maintenance agreement. If the period of delivery to the customer is not known, license and professional services revenue will be recognized when software and professional services are fully delivered to the customer and the maintenance revenue will be recognized ratably over the remaining contractual term of the agreement.
The following tables present the wireless and software revenue by key market segments for the periods stated and illustrate the relative significance of these market segments to our operations.
 
 
For the Three Months Ended September 30, 2016
 
For the Three Months Ended September 30, 2015
Market Segment
 
Wireless
 
Software
 
Total
 
% of Total
 
Wireless
 
Software
 
Total
 
% of Total
 
 
 
 
 
 
 
 
(Dollars in thousands)
 
 
 
 
 
 
Healthcare
 
$
20,247

 
$
11,094

 
$
31,341

 
69.1
%
 
$
21,143

 
$
10,667

 
$
31,810

 
68.9
%
Government
 
1,658

 
1,964

 
3,622

 
8.0
%
 
1,986

 
1,976

 
3,962

 
8.6
%
Large Enterprise
 
2,303

 
726

 
3,029

 
6.7
%
 
2,808

 
947

 
3,755

 
8.1
%
Other(1)
 
2,816

 
4,547

 
7,363

 
16.2
%
 
3,438

 
3,216

 
6,654

 
14.4
%
Total
 
$
27,024

 
$
18,331

 
$
45,355

 
100.0
%
 
$
29,375

 
$
16,806

 
$
46,181

 
100.0
%
(1) Other includes hospitality, resort, indirect and billable travel revenue.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Nine Months Ended September 30, 2016
 
For the Nine Months Ended September 30, 2015
Market Segment
 
Wireless
 
Software
 
Total
 
% of Total
 
Wireless
 
Software
 
Total
 
% of Total
 
 
 
 
 
 
 
 
(Dollars in thousands)
 
 
 
 
 
 
Healthcare
 
$
61,788

 
$
32,550

 
$
94,338

 
69.7
%
 
$
64,259

 
$
32,132

 
$
96,391

 
67.7
%
Government
 
5,245

 
5,837

 
11,082

 
8.2
%
 
6,086

 
7,285

 
13,371

 
9.4
%
Large Enterprise
 
7,272

 
2,468

 
9,740

 
7.2
%
 
8,873

 
2,092

 
10,965

 
7.7
%
Other (1)
 
8,750

 
11,467

 
20,217

 
14.9
%
 
11,069

 
10,493

 
21,562

 
15.2
%
Total
 
83,055

 
52,322

 
135,377

 
100.0
%
 
90,287

 
52,002

 
142,289

 
100.0
%
(1) Other includes hospitality, resort, indirect and billable travel revenue

16




Operations — Consolidated
Our operating expenses are presented in functional categories. Certain of our functional categories are especially important to overall expense control and management; these operating expenses are categorized as follows:
Cost of revenue. These are expenses associated with the delivery of our revenue, which consist primarily of hardware, third-party software, outside service expenses and payroll and related expenses for our professional services, logistics, customer support and maintenance staff.
Service, rental and maintenance. These are expenses associated with the operation of our paging networks and the development of our software. Expenses consist largely of site rent expenses for transmitter locations, telecommunication expenses to deliver messages over our paging networks, and payroll and related expenses for our engineering, pager repair functions and development of our software products.
Selling and marketing. These are expenses associated with our direct sales force and indirect sales channel and the marketing expenses in support of those sales groups. This classification consists primarily of payroll and related expenses and commission expenses.
General and administrative. These are expenses associated with information technology and administrative functions. This classification consists primarily of payroll and related expenses, outside service expenses, taxes, licenses and permit expenses, and facility rent expenses.
We review the percentages of operating expenses to revenue on a regular basis. Even though the operating expenses are classified as previously described, expense control and management are also performed by expense category. Approximately 65% of the operating expenses referred to above were incurred in payroll and related expenses, site and facility rent expenses and telecommunication expenses for both the three and nine months ended September 30, 2016 and 2015.
Our largest expense, payroll and related expenses, includes wages, commissions, incentives, employee benefits and related taxes. On a monthly basis, we review the number of employees in major functional categories and the design and physical locations of functional groups to continuously improve efficiency, to simplify organizational structures, and to minimize the number of physical locations for the Company. We had 598 full-time equivalent employees (“FTEs”) at September 30, 2016, a decrease of 1.2% from 605 FTEs at September 30, 2015.
We operate local, regional, and nationwide one-way and two-way paging networks. These networks each require locations on which to place transmitters, receivers, and antennae. Site rent expenses for transmitter locations are highly dependent on the number of transmitters, which in turn is dependent on the number of networks. In addition, these expenses generally do not vary directly with the number of subscribers or units in service, which is detrimental to our operating margins as wireless revenue declines. In order to reduce these expenses, we have an active program to consolidate the number of paging networks, and thus transmitter locations, which we refer to as network rationalization. We have reduced the number of active transmitters by 2.6% to 4,164 active transmitters at September 30, 2016 from 4,277 active transmitters at September 30, 2015.
Telecommunication expenses are incurred to interconnect our paging networks and to provide telephone numbers for customer use, points of contact for customer service, and connectivity among our offices. These expenses are dependent on the number of units in service, the number of customers we support and the number of office and network locations that we maintain. The number or duration of telephone calls to call centers may vary from period to period based on factors other than the number of units in service or customers, which could cause telecommunication expenses to vary.


17



Statements of Income
Comparison of the Statements of Income for the Three Months Ended September 30, 2016 and 2015
 
 
For the Three Months Ended September 30,
 
Change Between 2016 and 2015
 
 
2016
 
2015
 
Total
 
%
Revenue:
 
(Dollars in thousands)
Wireless
 
$
27,024

 
$
29,375

 
$
(2,351
)
 
(8.0
)%
Software
 
18,331

 
16,806

 
1,525

 
9.1
 %
Total
 
$
45,355

 
$
46,181

 
$
(826
)
 
(1.8
)%
Selected operating expenses:
 
 
 
 
 
 
 
 
Cost of revenue
 
$
7,639

 
$
7,871

 
$
(232
)
 
(2.9
)%
Service, rental and maintenance
 
11,898

 
11,117

 
781

 
7.0
 %
Selling and marketing
 
5,955

 
6,572

 
(617
)
 
(9.4
)%
General and administrative
 
10,593

 
10,410

 
183

 
1.8
 %
Severance
 
12

 
141

 
(129
)
 
(91.5
)%
Total
 
$
36,097

 
$
36,111

 
$
(14
)
 
 %
FTEs
 
598

 
605

 
(7
)
 
(1.2
)%
Active transmitters
 
4,164

 
4,277

 
(113
)
 
(2.6
)%
Revenue — Wireless
Our wireless revenue was $27.0 million and $29.4 million for the three months ended September 30, 2016 and 2015, respectively. The decrease in wireless revenue reflects the decrease in demand for our wireless services. Paging revenue consists primarily of recurring fees associated with the provision of messaging services and fees for paging devices and is net of a provision for service credits. Product and other revenue reflects system sales, the sale of devices and charges for paging devices that are not returned and are net of anticipated credits. The table below details total wireless revenue for the periods stated:
 
 
For the Three Months Ended September 30,
 
 
2016
 
2015
 
 
(Dollars in thousands)
Paging revenue
 
$
25,944

 
$
28,196

Product and other revenue
 
1,080

 
1,179

Total wireless revenue
 
$
27,024

 
$
29,375

The demand for one-way and two-way messaging declined at each specified date and we believe demand will continue to decline for the foreseeable future. Demand for our services has also been impacted by the shift from narrow band wireless service offerings to broad band technology services.
As demand for one-way and two-way messaging has declined, we have developed or added service offerings such as Spok Mobile with a pager number in order to increase our revenue potential and mitigate the decline in our wireless revenue. We will continue to explore ways to innovate and provide customers the highest value possible. Software revenue is anticipated to increase, while the wireless revenue is expected to continue to decrease reflecting the changing technology expectations of our customer base.
Wireless revenue is generally based upon the number of units in service and the monthly charge per unit. The number of units in service changes based on subscribers added, referred to as gross placements, less subscriber cancellations, or disconnects. The net of gross placements and disconnects is commonly referred to as net gains or losses of units in service or the net disconnect rate. The absolute number of gross placements as well as the number of gross placements relative to average units in service in a period, referred to as the gross placement rate, is monitored on a monthly basis. Disconnects are also monitored on a monthly basis. The ratio of units disconnected in a period to average units in service for the same period, called the disconnect rate, is an indicator of our success at retaining subscribers, which is important in order to maintain recurring revenue and to control operating expenses.

18



The following table sets forth information on our units in service by account size at specified dates:
 
 
As of September 30, 2016
 
As of June 30, 2016
 
As of September 30, 2015
Account Size
 
Units
 
% of Total
 
Units
 
% of Total
 
Units
 
% of Total
 
 
(Units in thousands)
1 to 100 Units(1)
 
110

 
9.8
%
 
114

 
10.0
%
 
128

 
10.7
%
101 to 1000 Units(1)
 
222

 
19.8
%
 
228

 
19.9
%
 
250

 
21.0
%
> 1000 Units(1)
 
792

 
70.4
%
 
802

 
70.1
%
 
814

 
68.3
%
Total units in service(1)
 
1,124

 
100.0
%
 
1,144

 
100.0
%
 
1,192

 
100.0
%
(1) 
All figures presented include both direct and indirect units in service
The following table sets forth information on the net disconnect rate by account size for our customers for the periods stated:
 
 
For the Three Months Ended
Account Size
 
September 30, 2016
 
June 30, 2016
 
September 30, 2015
1 to 100 Units
 
(3.5
)%
 
(4.0
)%
 
(4.4
)%
101 to 1000 Units
 
(2.6
)%
 
(4.0
)%
 
(2.4
)%
> 1000 Units
 
(1.2
)%
 
0.6
 %
 
(0.8
)%
Total net unit loss %
 
(1.7
)%
 
(0.8
)%
 
(1.5
)%
(1) 
All figures presented include both direct and indirect units in service
The other factor that contributes to revenue, in addition to the number of units in service, is the monthly charge per unit. As previously discussed, the monthly charge per unit is dependent on the subscriber’s service, extent of geographic coverage, whether the subscriber contracts or owns the messaging device, and the number of units the customer has in the account. The ratio of revenue for a period to the average units in service, for the same period, commonly referred to as average revenue per unit or ARPU, is a key revenue measurement as it indicates whether charges for similar services and distribution channels are increasing or decreasing. ARPU by distribution channel and messaging service are monitored regularly.
The following table sets forth information on ARPU by account size for the periods stated:
 
 
For the Three Months Ended
Account Size
 
September 30, 2016
 
June 30, 2016
 
September 30, 2015
1 to 100 Units
 
$
12.34

 
$
12.48

 
$
12.49

101 to 1000 Units
 
8.64

 
8.65

 
8.69

> 1000 Units
 
6.68

 
6.75

 
6.80

Total ARPU
 
$
7.63

 
$
7.71

 
$
7.82

(1) 
All figures presented include both direct and indirect units in service
While ARPU for similar services and distribution channels is indicative of changes in monthly charges and the revenue rate applicable to new subscribers, this measurement on a consolidated basis is affected by several factors, including the mix of units in service and the pricing of the various components of our services. We expect future annual revenue to decline in line with recent trends. The decrease in consolidated ARPU for the quarter ended September 30, 2016 from the quarter ended September 30, 2015 was due to the change in composition of our customer base as the percentage of units in service attributable to larger customers continues to increase. These larger customers benefit from lower pricing associated with their larger number of units-in-service. We believe that without further price adjustments, ARPU will trend lower for the remainder of 2016. Price increases could mitigate, but not completely offset, the expected declines in both ARPU and revenue.
The following reflects the impact of subscribers and ARPU on the change in wireless revenue:
 
 
Units in Service As of September 30,
 
Revenue For the Three Months Ended September 30,
 
Change Due To:
 
 
2016
 
2015
 
Change
 
2016
 
2015
 
Change
 
ARPU
 
Units
 
 
(Units in thousands)
 
(Dollars in thousands)
 
(Dollars in thousands)
Total
 
1,124

 
1,192

 
(68
)
 
$
25,944

 
$
28,196

 
$
(2,252
)
 
$
(601
)
 
$
(1,651
)

19



As previously discussed, demand for messaging services has declined over the past several years and we anticipate that it will continue to decline for the foreseeable future, which would result in reductions in wireless revenue due to the decreased number of subscribers and related units in service.
Revenue — Software
Our software revenue was $18.3 million and $16.8 million for the three months ended September 30, 2016 and 2015, respectively, which consisted of operations revenue (from subscriptions, licenses, professional services and equipment sales) and maintenance revenue. The table below details the components of software revenue for the periods stated:
 
 
For the Three Months Ended September 30,
 
 
2016
 
2015
 
 
(Dollars in thousands)
Subscription
 
$
560

 
$
392

License
 
1,842

 
1,457

Services
 
5,578

 
4,600

Equipment
 
1,091

 
1,434

Operations revenue
 
9,071

 
7,883

Maintenance revenue
 
9,260

 
8,923

Total software revenue
 
$
18,331

 
$
16,806

The increase in operations revenue primarily reflects an increase in the number and size of projects completed in the third quarter of 2016 as compared to the same period in 2015. Starting in late 2015, the Company began a reorganization of the sales staff and related sales territories, which realigned territories and replaced lower performing sales employees with new staff. The Company is unable to predict the impact of these changes on the amount and timing of its software operations revenue for the foreseeable future. While the year-over-year results for the quarter were positive, mainly due to a handful of large projects which were completed during the period, we believe the year to date results are a better indicator of the sales reorganization impact on operational revenues. The increase in maintenance revenue reflects our continuing success in renewals of our maintenance support for existing software solutions and in maintenance support for sales of new solutions. The maintenance renewal rates for the three months ended September 30, 2016 and 2015 were in excess of 99%.
Our software revenue is dependent on the conversion of our software bookings into revenues. On a regular basis, we enter into contractual arrangements with our customers to provide software licenses, professional services, and equipment sales. In addition, we enter into contractual arrangements for maintenance with our customers on new solutions or renewals of existing solutions. These contractual arrangements are reported as bookings and represent future revenue. While overall bookings increased by 11.4% for the three months ended September 30, 2016, compared to the same period in 2015, operations bookings decreased by 8.7%. As noted above, starting in late 2015, the Company undertook a reorganization of the sales staff and related sales territories. As part of that reorganization, the Company is replacing lower performing sales employees with new staff. The Company is unable to predict the impact of this reorganization on the level and timing of future software operations bookings. The Company is also migrating its sales focus from individual software solutions to its integrated solution portfolio. The change in sales focus has impacted bookings as the focus on the integrated solution portfolio requires a longer sales cycle to achieve completion. The maintenance bookings continue to reflect a strong renewal rate in excess of 99%. Maintenance bookings increased by 36.3% for the three months ended September 30, 2016, compared to the same period in 2015.
The following table summarizes total bookings for the periods stated:
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
Bookings
 
2016
 
2015
 
2016
 
2015
 
 
(Dollars in thousands)
Operations and new maintenance orders
 
$
8,469

 
$
9,271

 
$
24,274

 
$
28,621

Maintenance and subscription renewals
 
10,190

 
7,475

 
29,555

 
26,893

Total bookings
 
$
18,659

 
$
16,746

 
$
53,829

 
$
55,514


20



We reported a software backlog of $38.8 million at September 30, 2016, which represented all orders received from customers not yet recognized as revenue. We continually review our backlog and adjust the balance to reflect expected amount and timing of customer implementations.
Backlog
 
(Dollars in thousands)
 
 
 
Beginning balance at July 1, 2016
 
$
39,475

Operations bookings
 
8,469

Maintenance and subscription renewals
 
10,190

Available backlog
 
$
58,134

Operations revenue
 
(9,071
)
Maintenance revenue
 
(9,260
)
Other(1) 
 
(991
)
Total backlog at September 30, 2016
 
$
38,812

(1) 
Other reflects cancellations and other adjustments to backlog.
Operating Expenses — Consolidated
The following is a review of our operating expense categories for the three months ended September 30, 2016 as compared to the three months ended September 30, 2015.
Cost of revenue. Cost of revenue consisted primarily of the following items:
 
 
For the Three Months Ended September 30,
 
Change Between 2016 and 2015
 
 
2016
 
2015
 
Total
 
%
 
 
(Dollars in thousands)
Payroll and related
 
$
4,468

 
$
4,277

 
$
191

 
4.5
 %
Cost of sales
 
2,480

 
2,549

 
(69
)
 
(2.7
)%
Stock based compensation
 
57

 
33

 
24

 
72.7
 %
Other
 
634

 
1,012

 
(378
)
 
(37.4
)%
Total cost of revenue
 
$
7,639

 
$
7,871

 
$
(232
)
 
(2.9
)%
FTEs
 
185

 
189

 
(4
)
 
(2.1
)%
As illustrated in the table above, cost of revenue for the three months ended September 30, 2016 was $7.6 million and decreased $0.2 million from the same period in 2015 primarily due to the following significant components and variances:
Payroll and related — Payroll and related expenses were incurred largely for maintenance, support and service personnel. The increase of $0.2 million in payroll and related expenses was due primarily to an increase in the average cost per employee partially offset by a decrease of 4 FTEs.
Cost of sales — Cost of sales consisted primarily of third party software, use of third party resources for software implementation related work, inventory and maintenance of third party products.
Other Other expenses consisted primarily of repairs and maintenance, shipping, outside services and travel costs. The decrease in other expenses was related primarily to a decrease in repairs and maintenance of $0.1 million, shipping and various supplies of $0.1 million and the remaining $0.2 million attributable to a decrease in travel costs and outside services.

21



Service, Rental and Maintenance. Service, rental and maintenance expenses consisted primarily of the following items:
 
 
For the Three Months Ended September 30,
 
Change Between 2016 and 2015
 
 
2016
 
2015
 
Total
 
%
 
 
(Dollars in thousands)
Payroll and related
 
$
5,582

 
$
4,613

 
$
969

 
21.0
 %
Site rent
 
3,626

 
3,763

 
(137
)
 
(3.6
)%
Telecommunications
 
1,162

 
1,392

 
(230
)
 
(16.5
)%
Stock based compensation
 
61

 
29

 
32

 
110.3
 %
Other
 
1,467

 
1,320

 
147

 
11.1
 %
Total service, rental and maintenance
 
$
11,898

 
$
11,117

 
$
781

 
7.0
 %
FTEs
 
182

 
156

 
26

 
16.7
 %
As illustrated in the table above, service, rental and maintenance expenses for the three months ended September 30, 2016 were $11.9 million and increased $0.8 million from the same period in 2015 primarily due to the following significant components and variances:
Payroll and related — Payroll and related expenses were incurred largely for field technicians, their managers, in-house repair personnel, product development, product strategy and quality assurance personnel. Payroll and related expenses increased by $1.0 million for the quarter ended September 30, 2016 as compared to the quarter ended September 30, 2015 due to an increase of 26 FTEs and an increase in the average salary paid per employee. The change in headcount relates to an increase in the number of product development and strategy personnel. Our research and development is included within service, rental and maintenance expenses. The Company is investing in the development of products in the areas of: 1) mobility, 2) a unified software platform, 3) nursing solutions and 4) alerting. The Company plans to continue to increase its staffing to support its integrated solution portfolio. This increase in staffing will impact margins as the benefits from this development will not be immediately realized. Based on this emphasis we expect the number of FTEs to increase in this area impacting future payroll and related expenses.
Site rent — The decrease of $0.1 million in site rent expenses was primarily due to the rationalization of our networks, which has decreased the number of transmitters required to provide service to our customers. The reduction in transmitters has, in turn, reduced the number of lease locations. The number of active transmitters declined 2.6% from September 30, 2015 to September 30, 2016.
Telecommunications — The decrease of $0.2 million in telecommunication expenses was due to the consolidation of our networks. We believe continued reductions in these expenses will occur as our networks continue to be consolidated as anticipated, through the remainder of 2016, and as we reduce telephone circuit inventory.
Other — Other expenses consisted primarily of repairs and maintenance and outside services and includes management of these expenses to reflect the continued transition to support the growth in software revenue.

22



Selling and Marketing. Selling and marketing expenses consisted of the following items:
 
 
For the Three Months Ended September 30,
 
Change Between 2016 and 2015
 
 
2016
 
2015
 
Total
 
%
 
 
(Dollars in thousands)
Payroll and related
 
$
3,502

 
$
3,664

 
$
(162
)
 
(4.4
)%
Commissions
 
1,317

 
1,858

 
(541
)
 
(29.1
)%
Stock based compensation
 
75

 
16

 
59

 
368.8
 %
Other
 
1,061

 
1,034

 
27

 
2.6
 %
Total selling and marketing
 
$
5,955

 
$
6,572

 
$
(617
)
 
(9.4
)%
FTEs
 
120

 
138

 
(18
)
 
(13.0
)%
As illustrated in the table above, selling and marketing expenses for the three months ended September 30, 2016 were $6.0 million and decreased $0.6 million from the same period in 2015 primarily due to the following significant components and variances:
Payroll and related Payroll and related expenses were incurred largely for sales and marketing personnel. The decrease of $0.2 million in payroll and related is primarily due to a decrease of 18 FTEs compared to the same period last year reflecting the reorganization of the sales staff, which includes the replacement of underperforming sales employees partially offset by higher average payroll and related expenses per FTE.
Commissions Commissions expense relates to the payments made to the sales representatives responsible for executing contracts. Commissions are expensed as projects are implemented and are impacted by the level of software operations revenue. The decrease of $0.5 million in commissions is primarily due to lower operations bookings compared to the same period in the prior year as well as a change to our commissions structure.
Other — Other expenses consisted primarily of advertising, trade show, convention and related travel expenses and reflect our focus on identifying sales opportunities.
The sales and marketing staff are all involved in selling our communication solutions domestically and internationally. These expenses support our efforts to maintain gross placements of units in service, which mitigate the impact of disconnects on our wireless revenue base, and to identify business opportunities for additional or future software sales. We have a centralized marketing function, which is focused on supporting our products and vertical sales efforts by strengthening our brand, generating sales leads and facilitating the sales process. These marketing functions are accomplished through targeted email campaigns, website development, social media, webinars, regional and national user conferences, monthly newsletters and participation at industry trade shows.

23



General and Administrative. General and administrative expenses consisted of the following items:
 
 
For the Three Months Ended September 30,
 
Change Between 2016 and 2015
 
 
2016
 
2015
 
Total
 
%
 
 
(Dollars in thousands)
Payroll and related
 
$
4,142

 
$
4,320

 
$
(178
)
 
(4.1
)%
Stock based compensation
 
507

 
316

 
191

 
60.4
 %
Facility rent
 
848

 
868

 
(20
)
 
(2.3
)%
Outside services
 
1,946

 
1,864

 
82

 
4.4
 %
Taxes, licenses and permits
 
1,164

 
1,068

 
96

 
9.0
 %
Other
 
1,986

 
1,974

 
12

 
0.6
 %
Total general and administrative
 
$
10,593

 
$
10,410

 
$
183

 
1.8
 %
FTEs
 
111

 
122

 
(11
)
 
(9.0
)%
As illustrated in the table above, general and administrative expenses for the three months ended September 30, 2016 were $10.6 million and increased $0.2 million from the same period in 2015 primarily due to the following significant components and variances:
Payroll and related — Payroll and related expenses were incurred for employees in information technology, administrative operations, finance, human resources and executive management. Payroll and related expenses decreased by $0.2 million due to a decrease of 11 FTEs partially offset by a higher average salary per employee.
Stock based compensation Stock based compensation increased primarily due to the issuance of the 2016 grants under the 2015 LTIP (see Note 12 to our Unaudited Notes to Condensed Consolidated Financial Statements of Part I of this Quarterly Report).
Outside services Outside service expenses consisted primarily of costs associated with professional services related to financial reporting, taxes and internal control compliance.
Taxes, licenses and permits Taxes, license and permit expenses consisted primarily of property, franchise, gross receipts and transactional taxes and are primarily impacted by our level of revenue and property and equipment base.
Other Other expenses consisted primarily of bad debt, insurance, shipping costs, financial services, office rent and utilities.
Severance. We incurred an immaterial amount of severance expense for the three months ended September 30, 2016, compared to $0.1 million for the same period in 2015.
Depreciation, Amortization and Accretion. Depreciation, amortization and accretion expenses were $3.2 million for the three months ended September 30, 2016 compared to $3.4 million for the same period in 2015. The decrease is primarily related to the timing of new pager purchases and fully depreciated purchases for the nine months ended September 30, 2016 as compared to the same period in 2015.

24



Income Tax Expense
Income Tax Expense. Income tax expense for the three months ended September 30, 2016 was $2.1 million, a decrease of $1.1 million from the same period in 2015. The change in the effective income tax rate to 34.3% for the three months ended September 30, 2016 from 43.3% for the three months ended September 30, 2015 primarily reflects a decrease in income before income tax expense and a decrease in the effective foreign tax expense.
The following is the effective tax rate reconciliation for the three months ended September 30, 2016 and 2015, respectively:
 
 
For the Three Months Ended September 30,
 
 
2016
 
2015
 
 
(Dollars in thousands)
Income before income tax expense
 
$
6,181

 
 
 
$
7,442

 
 
Income tax expense at the Federal statutory rate
 
$
2,163

 
35.0
 %
 
$
2,605

 
35.0
%
State income taxes, net of Federal benefit
 
229

 
3.7
 %
 
254

 
3.4
%
Foreign tax rate differential
 
(210
)
 
(3.4
)%
 
128

 
1.7
%
Change in deferred income tax rates
 

 
 %
 
218

 
2.9
%
Other, including permanent differences
 
(59
)
 
(1.0
)%
 
17

 
0.2
%
Income tax expense
 
$
2,123

 
34.3
 %
 
$
3,222

 
43.3
%
Statements of Income
Comparison of the Statements of Income for the Nine Months Ended September 30, 2016 and 2015
 
 
For the Nine Months Ended September 30,
 
Change Between 2016 and 2015
 
 
2016
 
2015
 
Total
 
%
Revenue:
 
(Dollars in thousands)
Wireless
 
$
83,055

 
$
90,287

 
$
(7,232
)
 
(8.0
)%
Software
 
52,322

 
52,002

 
320

 
0.6
 %
Total
 
$
135,377

 
$
142,289

 
$
(6,912
)
 
(4.9
)%
Selected operating expenses:
 
 
 
 
 
 
 
 
Cost of revenue
 
$
23,167

 
$
25,816

 
$
(2,649
)
 
(10.3
)%
Service, rental and maintenance
 
34,510

 
33,376

 
1,134

 
3.4
 %
Selling and marketing
 
18,912

 
20,409

 
(1,497
)
 
(7.3
)%
General and administrative
 
31,542

 
31,883

 
(341
)
 
(1.1
)%
Severance
 
9

 
1,645

 
(1,636
)
 
(99.5
)%
Total
 
$
108,140

 
$
113,129

 
$
(4,989
)
 
(4.4
)%
FTEs
 
598

 
605

 
(7
)