Q1 2017 Earnings Call Transcript

Published: 13 May 2017

[Operator:]

Good day, and welcome to the Auxilio First Quarter 2017 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Mike Cole, MZ North America. Please go ahead, sir.

[Mike Cole:]

Thank you, Operator. I want to welcome everyone to Auxilio's first quarter 2017 earnings call. Joining us today from the Company are Mr. Joe Flynn, Chief Executive Officer; Mr. Mac McMillan, President and Chief Strategy Officer, Mr. Paul Anthony, Chief Financial Officer; and Mr. JD Abouchar, Chairman of the Board. Before we begin the formal presentation, I'd like to remind everyone that some statements made on the call and webcast, including those regarding future financial results and industry prospects, among others, are forward-looking and may be subject to a number of risks and uncertainties that could cause actual results to differ materially from those described in the conference call. Certain of these risks and uncertainties are or will be described in greater detail on the Company's SEC filings. Auxilio is under no obligation and expressly disclaims any such obligation to update or alter its forward-looking statements whether as a result of new information, future events, or otherwise. At this time, I will now turn the call over to Mr. Joe Flynn. Joe, the floor is yours.

[Joe Flynn:]

Thank you, Mike. Thank you, everybody, for joining today's call. When we started the year off with a major acquisition of CynergisTek, we were under no illusions as to how hard the work was ahead of us. I could not be more pleased with the progress we've made during this quarter and the level of conviction in our combined business potential has only grown causing us to further accelerate and expand our integration efforts between two companies. In just the short period of time since the acquisition, we already have examples of success on both the document solutions and security side of the business, largely driven by our ability to offer complete end-to-end document workflow solutions with advanced security capabilities. There is undoubtedly a great opportunity in front of us. Our goal is to solidify our position as a dominant leader in the space and we will continue investing aggressively in support of that objective. One major benefit of the acquisition will undoubtedly be the leadership roles assumed by CynergisTek key Executives going forward. Mac McMillan, Co-Founder of CynergisTek, has been appointed President and Chief Strategy Officer, and will be driving sales, marketing, PR and brand awareness for the combined entities, much like he did with great success at CynergisTek. The CynergisTek team has established a very unique proprietary sales model that will now be employed across both service lines. We worked exhaustively during the quarter to support that build out which required significant investment and that will continue through the balance of the year. We also recently announced that Dr. Mike Mathews, also Co-Founder of CynergisTek, has been appointed Chief Operating Officer and will oversee program development and delivery at the customer level across all service lines. Mike has been the architect behind many of the highly successful CynergisTek service offerings and he will continue to lead the development of next-generation security and managed document solutions capabilities going forward. One of the reasons this acquisition was so advantageous were the synergies between the Executive teams and the common understanding and commitment to what the two companies together can become. Our belief in the future continues to grow and the trend toward a more comprehensive and accelerated integration of the two businesses will continue as a result. As we covered in the recent press release, our security business continues to see strong demand for both remedial and preventative services offering. Health Systems continue to combat the seemingly endless number of security threats, both internal and external, and that will require significant investment for years to come. The healthcare sector is being specifically targeted, given the black market value of patient health information stored with these institutions and the perceived vulnerability of the industry in general. Our customers most pressing concerns have shifted overtime from being device and performance related to security related, and they are increasingly relying on us to stay ahead of the curve in both facets. CynergisTek is viewed as an established thought leader in healthcare security and we continue to invest heavily in new and innovative service offerings to maintain that cutting edge position. Our CAP program, which stands for compliance, assist, partner program, continues to see strong demand with the addition of several new customers during the quarter. Under this program, CynergisTek establishes proactive risk management protocols, then periodically performs audits of key controls to ensure compliance with both regulatory and internal mandates. These contracts tend to have a three-year term and provide recurring monthly revenue streams. The revenue recognition of these new customer additions is spread out over several years and establishes a base of consistent and reliable cash flows going forward. During the quarter we also rolled out our risk sonar SaaS application at two CynergisTek customers, both of which provided great reviews. This is an asset from the Delphiis acquisition that we are now able to offer within the CynergisTek model, providing customers yet another tool to track, assess, and maintain their security assessment. While we continue to see extended sales cycles in the managed document solutions business, there was a noticeable increase in RFP activity during the quarter. This is partially due to our enhanced prospecting initiatives and greater brand awareness in the marketplace, given our expanded geographic footprint with the acquisition of CynergisTek. The Company is now at a size and scope where we are increasingly being invited to participate in the RFP process with customers we simply could not get traction list before. We have established the resources and market presence to compete at all levels and build a significant competitive advantage, being one of the few companies that can bundle security with document workflow solutions. During this quarter, we invested aggressively in expansion and integration of the combined sales and marketing teams and that investment will continue in the future. The potential to cross-sell services within our combined customer base continues to be a major area of emphasis. We have increased our sales personnel to include reps specifically tasked with pursuing these opportunities. As we move through the second quarter and into the third, we expect to see increased activity in the sales pipeline as a result of these additions. The uncertainty around the future of the Affordable Care Act has been causing some delays and lengthening sales cycles within the healthcare sector as a whole but there is undoubtedly strong underlying demand. We are feeling a slight impact in both security and document workflow solution offerings associated with this uncertainty, which we feel can be offset through our internal initiatives to drive growth. We expect when the legislation reaches its final form, this uncertainty with the abate and the market will begin to normalize. We see growing pipelines in both document workflows and security, reflecting that the industry has an urgent need for services and that that will absolutely remain for the foreseeable future. At this time, I will go ahead and hand it over to Paul to go through the financials. Paul?

[Paul Anthony:]

Thank you, Joe. For the three months ended March 31, 2017, the Company reported revenues of $18.3 million, an increase of 26% when compared to $14.5 million reported in the prior year’s period. The Company services revenue increased $3.1 million in first quarter of 2017, and increased Cyber security professional services as a result of the CynergisTek acquisition. Equipment sales were $1.2 million for the first quarter compared to $0.6 million for the first quarter of '16. Cost of revenue for the three months ended March 31, 2017 and 2016 were $13.7 million, compared to $12.2 million, an increase of 12%. The increase is primarily attributable to the cost of labor for professional services offered by CynergisTek. Gross profit for the quarter, first quarter 2017, was $4.6 million or 25% of revenues compared to $2.3 million or 16% of revenues for the same period in '16. Increase in gross margins is due to the higher gross margins from the professional services delivered by CynergisTek. In the managed document solutions business, we expect to see a decrease in gross margin over the balance of the year due to some recent increase in turnover. We expect this to be partially offset from increased sales activity. Operating expenses for the first quarter of 2017 were $4.2 million, an increase from $2.4 million in the same period a year ago. Sales and marketing expenses increased by 104% in the first quarter to $1.4 million due to the addition of the CynergisTek sales and marketing teams. G&A expenses increased 58% to $2.8 million. This increase was also attributable to a CynergisTek acquisition and the absorption of this business. Included in this amount was approximately $0.3 million of non-recurring expenses related to the acquisition as well the uplisting to the NYSE market exchange. The Company reported operating income of $0.4 million for three months ended March 31, 2017 compared to an operating loss of $0.1 million in the same period of the prior year. We reported net income of $6,000 for the three months ended March 31, 2017 or zero cents per basic and diluted share compared to a net loss of $0.2 million or $0.02 per basic and diluted share in the same period of 2016. Excluding $25,000 in charges related to stock based comp and $0.5 million in amortization of intangibles, we achieved adjusted income from operations of $1 million in the first quarter of 2017 or $0.10 per diluted share compared to an adjusted income from operations after excluding charges of $46,000 in stock-based comp and $0.1 million in amortization of intangibles for $0.01 per basic and diluted share for the same period last year. At March 31, 2017, deferred revenue was $1.8 million, up from $0.6 million at December 31, 2016. The Company had $3.2 million of cash and cash equivalents at the end of the quarter. Cash used for operating activities for the three months ended March 31, 2017 was $1.7 million compared to $0.8 million during the same period in ‘16 with the decline being attributable to the timing of some AR collections, as well as the crude expenses associated with the CynergisTek acquisition. The Company maintained a line of credit with a commercial bank for up to $5 million; credit line currently has no outstanding balance and the full amount is available. This concludes the financial portion. At this point, I'll hand it back to you Joe.

[Joe Flynn:]

Thanks, Paul. Before we close, I'd like to thank all of our employees from Auxilio, CynergisTek and Redspin teams for their hard work and dedication over the past quarter, as we have worked long, hard hours in our integration efforts. I would also like to thank all of our Shareholders for their continued support and confidence in us as we invest in and grow this Company. We would be glad to answer any questions you have at this point. I'll hand it over to the Operator for Q&A. Operator, please go ahead.

[Operator:]

[Operator Instructions] We'll take our first question from Matt Hewitt with Craig-Hallum.

[Matthew Hewitt:]

Good afternoon, gentlemen, and congratulations on the strong quarter. A couple of questions for me. First, you're quartering now with the combined Company; how have the discussions gone with customers as they are looking - maybe originally they were in queue to look at the document services, now you're able to bundle or add-on the cyber-security and vice versa; how are those discussions changing and how is it helping to potentially close deals and potentially bigger deals?

[Joe Flynn:]

Yes, so, I'm going to take that. I’m going to actually have Mac chime in as well. I would say that in the early discussions that we've had on both sides of the aisle, we're definitely seeing a great deal of interest. Specifically as it relates to the document Management side, as we've said before but it's even heightened now, when we're invited to a major RFP and there are several of them in the queue now, I think security is a very big element of what the questions are and our ability to answer in a much broader way with specifics around assessments, specifics around print, fleet security, puts us in a much better position to get to the finish line on those RFPs. So, that's been one experience, certainly, right out of the gate. I know Matt just got off the road with some meetings with some the customers on the CynergisTek side and I'll let him chime in a little bit on that as well. Mac?

[Mac McMillan:]

Sure, absolutely. I echo what Joe has said, that the clients that I have also talked to on that side have all expressed the same thing, which is that they've not had a management service provider talk to them about cyber-security the way we are doing it today. But on the other side where we've approached our traditional cyber-security customers on the CynergisTek side and introduced the managed documents service to them, they have also been extremely receptive to it and in fact, we had two meetings last week with clients that we've had for quite a while. One of those who did not have a managed print service and they were very interested in not only understanding that and understanding what that could mean for them, but the other one was even more interesting in that they had already had a managed print service and the feedback that they gave us was that the Auxilio model, with respect to how it tackles going after cost in the environment, was much more prescriptive and much more detailed than what they had had with whoever their previous provider was. And they liked the fact that we had combined the cyber-security components with that model because that was one of the things that they were always concerned about with that fleet under that other provider. So, they were very, very positive discussions on both sides.

[Matthew Hewitt:]

That's great news. Regarding the security side, as it relates to print services, are your competitors - do they have something that competes with you or are they now scrambling to fill what appears to be a pretty big gap in their portfolio?

[Joe Flynn:]

Matt, I would say that - again, in the - on the managed documents side, we primarily compete against very large equipment manufacturers, and so most of their programs are specific around their proprietary equipment, so they might have security elements to their devices but a comprehensive approach, sort of end-to-end, on securing - the long-term securing of the fleet and all of the programs around that, specifically around the compliance protocol that the health system has in place, is not something that they have capabilities around it, and it really differentiates us. Our compliance - our understanding of what health systems need to go through from a compliance perspective is really, really a differentiator; and that - the equipment manufacturers don't really play in. Mac, I'll let you take any of that if you want on the compliance side.

[Mac McMillan:]

No, you nailed it again. The feedback that we've gotten from the customers so far and from talking to some of the providers of these systems; most of the providers that focused on the systems themselves will have security solutions that relate to their specific solution and they don't address any of the other solutions in the environment. In fact, one of the customers we talked to last week who had a vendor in there who was managing their RICO fleet, as an example, had a security package that they could acquire as part of that deal or that service but it only addressed those RICO printers. So, any of the other print devices that they had in their environment weren't covered and that service provider wouldn't even manage or look at those devices. So, this is one of the issues that these people have or these hospitals have, that they've - they don't - they are not one continuous system across the hospital system, and the larger they are, the even more diverse their environment might be with respect to the types of printers or print devices that they might have, and having a comprehensive solution or set of solutions that addresses their entire fleet is much more attractive to them than the one-off that they've seen so far. We haven't seen anybody that offers that and we haven't talked to any customers so far that has told us that they've had anybody that has offered them that.

[Matthew Hewitt:]

Okay. So, a key differentiator. Two more for me and then I'll hop back in the queue. First, regarding the CAP program in Q1; you said you had several - can you break out how many new sales did you have in the first quarter for that program?

[Joe Flynn:]

I don't have that data. I think it's somewhere between three or four.

[Mac McMillan:]

I don't think we're going to provide that information, at least at this point.

[Joe Flynn:]

Okay. Yes.

[Matthew Hewitt:]

Fair enough. Then, one last one, I just want to understand - this might actually be for Paul. You mentioned that the gross margins for the document print services were going to come down a little bit here for the next couple quarters. I'm trying to calibrate, what does that mean for the total gross margin? Obviously, you've got the offsetting piece from the cyber-security; does it fall back to maybe where you were Q3, Q4 of last year, or somewhere in between? Just help us calibrate that appropriately. Thank you.

[Paul Anthony:]

I mean, we're still trying to quantify what the long-term effect is. I mean, we're definitely going to see some impact as we saw a little increase in turnover, so we're losing some - one of our mature accounts who had a higher margin, who have been with us for a longer period of time and we're replacing those, ideally with new accounts that are helping to offset the revenue impact but are coming in at a lower margin profile, and so that's going to have a short-term impact. Our hope is that as we continue to grow the security business, that we'll be able to try to offset that from a gross margin perspective in total. So, I think we'll see some weakening but we don't expect it to be material at this point.

[Matthew Hewitt:]

Great, thank you very much.

[Operator:]

We'll go next to Andrew D'Silva with B. Riley.

[Andrew D'Silva:]

Good afternoon, thanks for taking my call, just a couple of quick questions for everyone. We’ll start off with just some bookkeeping; could you just provide a breakout as far as what document management and security revenue was for the period? Then, also gross margins for the two segments, if possible; was the $3.1 million the actual full revenue for security?

[Paul Anthony:]

Yes, at least from a revenue perspective, we can break it out at this point, but as the intention is that we'll be integrating the organizations and have some services that are going to kind of cross over. So, we do not - on a go-forward basis, we may not be in a position to separate those. In this quarter we were because it was a new business, so at least for Q1, security represented about $3.8 million in revenue. Then, gross margin, we won't be able to break that out necessarily for a gross margin perspective, since we've integrated - already integrated at least a large portion of the support organization. The direct side is still in the process.

[Andrew D'Silva:]

Do you feel like the gross margins that you posted in Q1 are, plus or minus a few basis points, fairly accurate or at least what you would expect going forward through the rest of '17, or do you think that some of the turnover that you mentioned will be more than offset by some of the new additions in security? Just a little bit more color on that would be helpful.

[Paul Anthony:]

Again, I think the plus or minus a few basis points, I think at least in the beginning as we work through Q2, Q3, we're going to see probably a negative hit in the beginning and then hopefully as we see the security business continue to grow and we start to increase and replace a number of these other accounts, we do start to see a little bit of growth as we enter into and start into later next year. So, improvement.

[Andrew D'Silva:]

Great. Perfect, thank you. Then, just two more quick book keeping questions. What was your Adjusted EBITDA for the period? Then, how should we think about taxes going forward on a GAAP basis?

[Joe Flynn:]

I mean, our Adjusted EBITDA number, we've got is, for the quarter, was about $1.1 million. From a tax perspective, we're looking at about 36.5% statutory and then as - if we look at our existing NOLs as well as what we anticipate to add to those through a beneficial tax collection associated with the acquisition, it's our initial forecast that we're looking at about $150,000 to $200,000 in tax expense for about the next three years. So, cash tax expense for the next three years, and then after that we'll start to see it move up towards that statutory rate.

[Andrew D'Silva:]

So, the cash expense for this year should be essentially no more than $200,000?

[Joe Flynn:]

That's our expectation at this point, yes.

[Andrew D'Silva:]

Great, that's great color there. I just want to move over to the narrative now; I guess - you mentioned Affordable Care Act as things that we should be looking out for, for potential delays. One thing that I was thinking was, how are your customers or your prospects viewing the integration now that you're able to offer two separate but combined portfolios of goods, right. So, are they looking at things a lot more closely now which is resulting in them taking a longer time to make a final decision? Obviously, when it was two separate entities, the document side of the business, some decision maker would look at it and be like, that works, and then separately another decision maker maybe looks at security side of the business and says, that works. Now that it’s combined, does it add maybe a little bit more complexity in any way that we should be thinking about that could potentially increase the sales cycle?

[Joe Flynn:]

Let me address the first part of your question about the Affordable Care Act; and again, since - now, remember, I'm not a politician myself, there definitely is a sense in the market, because, again, the administration is only in its first 100, 200 days and they just - Congress has passed that. There is a sense in the market that there will be change. The challenge that most of our customers have is they don't exactly know what that change looks like and how it impacts. When they don't know - when there is uncertainty like that, then often times that makes it a little more complicated around decision-making and it's easy for them to put things off. Our business has traditionally, and the same with CynergisTek's business, has been - traditionally been very seasonal, so this is not uncommon that you see our - both businesses will - revenues will grow substantially quarter-to-quarter. It’s very end-of-the-year heavy. But to answer the second part of your question, we're still operating under two brands now and so the discussion is not a complicated discussion. Most customers know Auxilio is an MDS business, CynergisTek in the security business. CynergisTek has an incredible strong brand in the healthcare IT space and extensive relationships with CIO's throughout the country. So, our customer - the customer base in the Auxilio side is very familiar with CynergisTek because they see them at events, they see them at the CHIME events. Conversely, when CynergisTek brings us in the door to their customer base which is more numerous in the number of hospitals and health systems they work in, it's a much easier discussion. We have automatic access to the CIO, the decision maker, or at least one of the key decision makers in the health system. So, it's quite a bit easier than just going in cold with the name Auxilio which some of them may or may not know, depending on what part of the country they're in. So, we've actually found it to be a benefit to have a Company that has, at the current moment, separate brands but different service offerings that are very attractive to the market right now.

[Andrew D'Silva:]

Thank you, that was great color, Joe. Two more quick questions, I will just kind of rattle them off together here. Outside of revenue growth, what are maybe key metrics that Management is viewing internally to monitor success of the acquisition and just integration of the combined entity, and then could you refresh my memory on exactly what risk Sonar is as well?

[Joe Flynn:]

So, as it relates to metrics, I mean, obviously with the integration of the sales and marketing organizations we're going to be looking at how that builds our pipeline for both businesses on both sides. So, it's our expectation and our intention through the integration of the sales organization to try really focus on that cross sell opportunity. If we look at the customer base CynergisTek has, every 10% penetration of their organization could be as much as $10 million in annual revenues. So, we're very focused on that. That’s something we feel is realistic that we can accomplish here over the next few years and so we're focused on that cross sell effort.

[Andrew D'Silva:]

All right. Great job, and oh, wait, could you actually give me the breakdown as far as what the…

[Joe Flynn:]

Yes, sorry, I forgot the second part of your question. So, we acquired a Company called Delphiis about four years ago. Primarily what we've acquired there was a piece of software called - which was a risk management tool and what we acquired there was - this is something that does automation, it automates the whole risk assessment process. Something that, right now, is done a lot with spreadsheets and so forth by customers, so it’s a way in which they can access data and be given data on the risk assessments they do on a quarterly, maybe semi-annual, basis. When we acquired that business, we acquired a great tool without a lot of customers. Now, we have a significant customer base to sell that through. I'll let Mac talk a little bit about how he views the tool and how we see that as a competitive advantage in the marketplace for us. Mac?

[Mac McMillan:]

So, our customers have always told us that they're looking for automation as it relates to tools that allow them to capture all this information that they collect when they conduct their risk analysis or if we conduct their risk analysis for them because typically they're conducting risk analysis not only at the enterprise level, but they're conducting risk analysis against their application environments, they're doing it against their physician practices that are affiliated with them, they're doing it against ancillary facilities that are part of their system, they're doing it during an M&A activity when they're getting ready to acquire somebody. So, there's all of these risk analyses that are going on throughout the year and oftentimes this, for a large system, this could actually number in the dozens or over a hundred of these assessments and trying to pull all that together and put it into an enterprise view, a lot of times the biggest issue that you have is just capturing the information, the data itself. So, what this does, what Sonar does for us is it gives us the ability not only to automate the findings out of our risk assessments that we do for our clients now by putting it in there and helping them be able to track their remediation processes from those annual enterprise level assessments that we do, but we're also providing with - providing them with this tool, the capability to automate all of those other tactical level assessments that they perform, either at the application layer, for instance, et cetera. So far, all of our clients that we've talked to or introduced this to an initially have been very excited about it. They are very excited about the fact that we're going to use this and that we're going to include it as part of our CAP program. We're getting ready to launch the Risk Sonar campaign with CHIME and we're getting ready to launch an internal Risk Sonar campaign with all of our various CAP customers. So, we're very excited about this. We're also excited about the fact that it gives us a way of actually tracking the remediation in a better way that our clients are performing which will open the door for other remediation services for us to offer them as well. So, it’s a huge multiplier in terms of sales opportunity.

[Andrew D'Silva:]

Yes, I didn't realize - so, you just renamed the tool that you acquired from Delphiis essentially?

[Joe Flynn:]

Exactly, under the CynergisTek brand.

[Andrew D'Silva:]

Okay. I didn’t know you renamed it. Thank you very much and a great job this quarter and I look forward to seeing what you do going forward.

[Operator:]

Our next question is from Dallas Salazar with Atlas Consulting.

[Dallas Salazar:]

Just two quick questions here, and it may not be appropriate at this time but if they are I appreciate an answer. The first one is, just given the branding and some of the initiatives it sounds like you're outlining on this call, is that going to, A, alter any of the capital allocation strategies at CynergisTek; so, for instance, are you going to be directing increases of headcount or marketing dollars for the branding of sort of this penetration testing or accountability mechanism? So, that's the first question, does it change the allocation of capital as directed in CynergisTek, and I realize they're going to be integrated. The second question is, with the understanding that we're pretty close to the M&A call that you had recently, where would you guys say you are in that integration effort and then also the complete ramp of some of the new headcount brought on at the CynergisTek level? So, I know you were saying that some of the headcount expansion, if there was any, that, if necessary, would take X amount of time to ramp the full productivity. So, I know those aren’t the two cleanest questions but hopefully you got the gist of what I was trying ask.

[Joe Flynn:]

Let me attack the first one as it relates to additional marketing spend. It's not a material number from the branding standpoint because we have a captive group of customers to whom we are selling new services and new products to. So, that doesn’t require us to spend a great deal of money doing that. We are going to be polishing those things and we are going to be aggressive about getting them out. The expansion efforts have been more along the lines of expanding our sales force and as I mentioned in my opening remarks, expanding our Account Managers which are going to be people who will be actively involved in all of the cross selling efforts. So, those are roles that we're going to be bringing on. We have one, I think, now. We're working on a couple more here towards the end of the year. So, we want to have, by the end of the year, a very aggressive and focused sales team, both on the outside from the standpoint of people going after new business, on the inside with inside sales people helping with our marketing events and helping with appointment setting and RFP generation, and then this Account Manager role which is important for us from a cross selling standpoint, will go into our existing customers and sell them new services. So, that's where we're going with all of that. Second part of question was with the integration. So, as I mentioned again in my opening remarks, we have moved very quickly towards integration. It’s something Mac and I, in particular, felt very strongly about when, even during our due diligence and acquisition discussions, because we felt there was an immediate opportunity to combine these two organizations, bring the best of what each one had and go after the market because essentially we're talking to the same - relatively the same people. We're talking to the IT organizations inside healthcare which is always led by a CIO but we felt that, specifically, the first thing we wanted to do was integrate the sales and marketing organizations so that we could take advantage of the market we have and the cross selling opportunities we have. The integration of the operation side, we're taking a little bit longer with. As you know, just recently announced that Mike Matthews has been announced as our Corporate COO. It's going to take a little longer. That's a longer-term situation and it's going to take a little bit longer for Mike to learn that, the MDS business, for those customers and those activities and that much larger group of people to come under one banner but we expect that to happen, but the first thing we want to do is really merge the sales and marketing organization as quickly as we can to get them moving forward. Mac, I'll let you provide any color you want to that to that as well.

[Mac McMillan:]

Sure. No, Joe you're absolutely correct. I mean, we've brought on additional sales resources on the pen testing side - actually, the Red teaming solutions that we have and the other solutions. The sales teams have all been integrated across the board, the marketing teams have been integrated across the board. The PR firm is working across the board with respect to all of our services. We are running coordinated campaigns across all of our service offerings now, both on the security side as well as on the MDS side. We just had our first cybersecurity regional event this past month. We're having our second one next month, we're having our first regional MDS event next month as well and those regional events generate a tremendous amount of our bookings and revenue each year. So, everything is moving in the right direction. The campaigns are flowing out now with respect to all the new services so we are, literally, on the sales and marketing side, working as one team.

[Joe Flynn:]

Yes, and again, just to reiterate that, we started this literally before we even signed the deal. When we knew the deal was going to happen - Mac has an annual sales event in Austin, we all went down there two or three weeks before the deal happened and started this process very, very early on, again, to be fully ready to take advantage of the market opportunity that we have.

[Dallas Salazar:]

Yes, no, I appreciate the color, guys. I understand that there's going to be some gross margin lumpiness with the revenue composition mix shifting kind of between the two sides of the business. I guess, anything - what I was trying to get some color on - it's my assumption that the security side is going to ramp quicker and given the productivity ramp of the new headcount being brought on that side and just its naturally shorter sales cycle, that would ramp quicker than the MPS side, right. And so thinking gross margin would be a way to track how quickly that side is growing, and I guess we're really just going to pay attention to how you guys break that out on your income statement or how you don't, but I appreciate the color and it's something to watch going forward. Thank you, guys.

[Operator:]

We will go next to Jeff Bash with General Pacific Partners.

[Jeff Bash:]

First, I want to thank you for getting the results out maybe a week earlier than you have in the past, it’s nice to see. On the $3.1 million of revenue from CynergisTek, that's a little bit less than pro-rata of the $15 million that you quoted for 2016 when you made the acquisition and I assume that's because of your comment that you made to Mr. D'Silva about the business being somewhat end-of-year heavy, is that correct?

[Joe Flynn:]

That’s correct. It’s a seasonality issue, again, with both business’, but CynergisTek had the same experience that we have had.

[Jeff Bash:]

On the MDS turnover, if I understood you correctly, you are getting some turnover in the accounts?

[Joe Flynn:]

We are, that's correct.

[Jeff Bash:]

Now, for many years you had zero turnover and part of that would be attributable the fact that you signed five-year contracts and the five years hasn’t expired, but I'd be curious to get some more color on why that is happening? Does that mean that this is not really a growth business or what?

[Joe Flynn:]

So, the main driver that we've experienced so far in turnover had a lot to do with the mergers and acquisitions within the healthcare industry. Health systems are merging at a pretty rapid pace right now and lot of that's driven financially. So, what we've experienced is when you're on the right side of a merger and acquisition like we were in the case of Catholic Healthcare East and Trinity which exploded our business, that's great news but when you're on the wrong side of it then - and the health system, the new health system, the acquirer comes in and acquires your customer, gets rid of all of the people that you were working with and brings in vendors that they've been working with for years, it's a much more difficult situation and we found ourselves on that short - I guess the short end of that stick as of late, and so because that activity is happening in the marketplace, we're seeing that more and more, at least in the kind of the broad-based services like MDS. I think the security business has not suffered as much, bearing in mind that the majority of our customers are gigantic health systems. So, it's a little bit more of an acute situation from that perspective but our goal is to - we still believe we have a very big greenfield opportunity in MDS, we've just acquired - in acquiring CynergisTek, we acquired north of 120 or so health systems. That is captive pipeline for us that we're aggressively going after, and so that's just the reality of what we're faced with right now but we are still optimistic.

[Jeff Bash:]

As a follow up, in your Roth presentation a month or so ago, you had a slide which showed a $150 million five-year revenue goal. Is the situation we just described mean you would be likely to want to reduce that goal now or do you still feel comfortable in what you had in that presentation?

[Joe Flynn:]

Jeff, we're less than 90 days into the acquisition, or just about 90 days, today. The 17th will be 90 days. We're still optimistic on that goal. It’s a big hairy goal, but one of the main reasons why we integrated these companies and why we're are integrating them as quickly as we can is to focus on that goal, and I think doing it separately with separate sales organizations, separate delivery organizations would confuse that, confuse the marketplace, and more importantly, confuse our teams as they jointly go after these efforts together. So, we're still optimistic.

[Jeff Bash:]

Great, that’s it for me. Thanks.

[Joe Flynn:]

Jeff, just wanted to clarify the number we provided earlier was $3.8 million for security; $3.1 million was the increase in services revenue in total. So, $3.8 million was the actual security revenue for Q1.

[Jeff Bash:]

Thank you. Sorry to get that wrong.

[Operator:]

[Operator Instructions] We will go next to Bill Sutherland with Benchmark Company.

[Bill Sutherland:]

Thank you. Good afternoon, everybody. Just a couple, at this point. I've been interested in seeing how the CynergisTek managed service offering is going because you've talked about the ability to just put more resources into it and behind it. So, are you seeing the bookings you were hoping, or - and also, I'm curious if you've sold one into you - in the Auxilio customer base yet?

[Joe Flynn:]

To answer that last part of question, we just recently jointly inked a deal with a joint customer. CynergisTek had had discussions with them prior to the acquisition but the fact that they were tied with us because they have been a long-standing customer was part of what got them over the hump in terms of the final decision, so that happened relatively quickly and it's a great example of the two companies coming together and the customer feeling a lot more comfortable with one versus the other because they had a pre-existing relationship. So, we were pleased with that. I think that - the market in itself provides a lot of opportunity with that going forward and I think we will see more of that. Like you said, though, it’s early days.

[Bill Sutherland:]

Yes, it is. Sales and marketing were 7.5% of revenue in the quarter. So, clearly understandable what the step up is. Is that kind of the right range to think about for the year?

[Paul Anthony:]

Yes, it's pretty close. I mean, there may be a small increase in the short term as we start to add some of these Account Managers ahead of some of the revenue that we're looking at. So, we may see a slight increase in that but overall, in the short term at least, too, there are some integration related expenses that also are kind of offsetting some of that. So, in general though, I think we're looking for a small increase for the year.

[Bill Sutherland:]

Since, Paul, I've got you - the integration-related expenses, do they remain significant in Q2 or even in the back-half?

[Paul Anthony:]

Nowhere near the number that we saw in Q1. We're definitely going to see a little bit here in the second and third quarter, small amounts, but it shouldn’t be anywhere near the $300,000 that we saw in the first quarter.

[Bill Sutherland:]

It was $300,000?

[Paul Anthony:]

Total, between acquisition, integration and listing.

[Bill Sutherland:]

Okay. Two other, just, housekeeping questions on the quarter, D&A for the quarter and cap ex, I know that’s not - it’s almost meaningless, but…

[Paul Anthony:]

Yes, we had, what was the first part, D&A?

[Bill Sutherland:]

D&A, because I didn’t see a reconciliation for Adjusted EBITDA in the press release.

[Paul Anthony:]

Depreciation was $91,000 for the quarter, amortization of intangibles was $520,000 for the quarter and then I think your cap ex was small, it was about $152,000.

[Bill Sutherland:]

Okay.

[Paul Anthony:]

So, a little bit higher than our normal, we had some purchases related to some new activity for some new accounts that we won recently.

[Bill Sutherland:]

Then, last one for me, I think the customer churn, that’s going to impact the business a bit here. Is it at a level that you guys - I mean, you have some lead time on some of these in the case of the long term contracts that are ending, (inaudible) less visibility but as you look at the roster of possible churn, is it running about where you thought it would when you entered the year?

[Joe Flynn:]

Yes. It’s hard to tell because when the actual count is coming to term and when you're actually out the door, it's sort of hard actually kind of pinpoint it but it's something we anticipated as far back as two or three years ago, and so, again, we're doing - the acquisition was one move towards that direction but more importantly, building pipelines and attacking the market more aggressively by having a larger sales force and a more robust market presence, which we didn't have prior to the acquisition, is really our focus and building the pipeline on the MDS side. We still, again, have a very low penetration rate into the marketplace, is a primary focus so that we can get ahead of that situation and we are optimistic about it.

[Bill Sutherland:]

I know you are. All right, guys, great quarter. Thank you.

[Operator:]

We have a follow-up question from Andrew D'Silva.

[Andrew D'Silva:]

Just a quick follow-up here related to just adjusted EPS; is there a way we should think about that going forward? Obviously everybody on the Street has kind of their own variation of it. Is there kind of a standard that we should think about now that the combined entity is there and generating - what is kind of like a meaningful GAAP tax, I think, on an annualized basis now?

[Joe Flynn:]

I mean, what we have been working through now that we've got interest playing a larger part, interest expense playing a larger part in the business. What we're looking at is maybe transitioning from what was traditionally are adjusted income from operations to some other form of adjusted earnings or adjusted earnings EPS, earnings per share that includes - takes into consideration the interest as well as our, I guess, initial benefit of taxes and the lower rate there. So, we're going to look to, probably, in Q2, initiate the transition to this adjusted earnings per share that takes into consideration taxes and interest and then ultimately, assuming the market reacts positively to that, we will look to move permanently to just reporting that as our only non-GAAP measure.

[Andrew D'Silva:]

Okay, but you'll give us maybe a heads-up before you report so we can make appropriate adjustments as necessary prior to Q2?

[Joe Flynn:]

Absolutely, we will absolutely give you an idea of what we're thinking as far as what should be included in those calculations. It’s all information that is currently disclosed in the Qs and Ks. It’s just a matter of adding it up into a line item that people can appreciate.

[J.D. Abouchar:]

Andy, this is JD, we will go over that with you and the other analysts that we - and anyone else who want to call us today or the coming weeks, to get everyone on the same page that, more in line with what the Street does as standard, but it used to be our adjusted income from operations was a good proxy because we didn't pay - we didn’t have interest expense and were paying taxes. Now, cash taxes are going to be nominal for the next several years so - but they are there so we should factor that in but more importantly, now that we do have an interest expense, it's important to put that in but we can go over that with you, yes.

[Andrew D'Silva:]

Fantastic. Okay. Thank you, and, again, a great job.

[Joe Flynn:]

Thank you.

[Operator:]

With no questions remaining in the queue, I'll turn the call back to Management for any additional remarks.

[Joe Flynn:]

I just want to thank everybody once again for joining the call today, and keep your eyes on us, and we appreciate all your support. Have a great day.

[Operator:]

This concludes today's call. Thank you for your participation. You may now disconnect.