Q3 2014 Earnings Call Transcript

Published: 14 Nov 2014

[Operator:]

Good day and welcome to the Auxilio, Third Quarter Financial Results Conference Call. Today’s conference is being recorded. And at this time, I’d like to turn the conference over to Matthew Selinger with MZ Group. Mr. Selinger.

[Matthew Selinger:]

Hey, thank you operator. Good morning and welcome everyone to Auxilio’s third quarter 2014 earnings call. Joining us todays from the Company are Mr. Joe Flynn, President and Chief Executive Officer and Mr. Paul Anthony, Chief Financial Officer. Before we get into the formal remarks I would like to remind everyone that the presentations and commentary of the officers of Auxilio during the course of this call, as well as any responses by such officers and employees to questions posted during the course of this call contain certain forward-looking statements relating to the business of Auxilio that can be identified by the use of forward-looking terminologies such as beliefs, expect, anticipates, may or similar expressions. Such forward-looking statements involve known and unknown risks and uncertainties including uncertainties relating to product and service development, long and uncertain sales cycles, market acceptance, future capital requirements, competition from other providers, the ability of our vendors to continue supplying the Company with equipment, parts, supplies and services in comparable items and prices and other factors that may cause actual results to differ materially from those described herein as anticipated, believed, estimated, or expected. Certain of these risks and uncertainties are or will be described in greater detail in 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. So at this time, I would now like to turn the call over to Mr. Joe Flynn. Joe, the floor is yours.

[Joseph J. Flynn:]

Thank you, Matthew and thank you everybody for joining today’s call. In previous calls we have addressed to changing landscape of our industry and what that means for Auxilio. With consolidation, our target clients are larger and our lead times have lengthened. I am happy to report that we are in the final stages of negotiation for a couple of new MPS contracts with some of the largest health systems in the United States. The agreements if secured would increase the number of hospitals we serve nationally and possibly open the door to other regions we don’t have a material presence in today. We hope to finalize some of these agreements shortly and expect to start services over the next couple of quarter. This will continue to provide incremental recurring revenue and enhance our growth profile. This is a combination of a lot of hard work and consistent execution over the past several years and while we are excited, I want to give you some clear insight into the opportunities along with the challenges associated with this next phase of growth. Discussing the pros, this means our business model is working. We promise considerable savings between 10% and 30%, we simplify our client’s life in all aspects of print and we deliver on that promise. That has translated into larger and larger opportunities and equally as important and significant penetration across existing customers. As consolidation has progressed this has also created more and more opportunities without the need to convince a brand new customer that we can deliver on our promises. Auxilio’s reference list continues to grow and is no doubt the reason why we are invited to more RSPs or overcoming obstacles with Tier 1 healthcare providers that a few years ago sometime seen insurmountable. As we evaluate these challenges, there are human resources and staffing along with capital commitments from Auxilio to get these projects fully integrated. In addition to concession we may make to secure some of the larger deals to make sure they are mutually beneficial to both parties. The integration of Delphiis has progressed smoothly and growth since our acquisition in July has exceeded expectations. During the past month the team has booked over $1.2 million in new contracts for the existing customers to be provided during 2015 with incremental opportunities to expand the scope of these agreements. This is a testament to our ability to effectively implement comprehensive risk and information security programs that solve a critical problem. HIPAA compliance and large scale security breaches that have cost healthcare providers hundreds of millions of dollars are the reasons why this is a top priority at the executive level. We are at the right place in the right time. Our IT security business will grow through the following means. One by capturing more business with existing customers and we believe the opportunities that exists at these large university healthcare systems are significant in their own regards. Two, by cross selling to MPS customers, we are engaged with performance reviews with a number of our largest customers at this juncture and interest has been high from many – where we have had the initial conversation. We know this will be a process and take time for hiring a full-time sales person to focus and engage other members of the team we expect to see positive results. Three, by launching novel service of products which still a specific void. And perfect example of this is the new Printer Fleet Security Service offering to simplify things printers are favorite target for hackers into hospitals network, our platform measures the maturity level of the hospital printer/copier fleet by benchmarking against four key areas, access, safeguards, data protection fleet availability and attack vulnerability our servers mitigate that risks, while ensuring the fleet is fully managed from a security perspective on an ongoing basis. This is a great cross marketing opportunity for our installed MPS customers and we are pleased that one of our East Coast will pilot this program commencing next month. It is worth noting that a recent security conference, there was a lot of interest surrounding this new service offering. As Chief Information Security Officers are not typically thinking about the management of a printer/copier fleet, when we talk about compliance, I would like to elaborate more on the HIPAA Omnibus Final Rule implemented last fall. This changed something fundamental which is now being fully understood by healthcare facilities and really driving interest and a need for IT security adoption. The rule changed the parameters of a law called the HARM standard and requires the hospitals during a breach to perform a risk assessment to provide assurance that there was a low probability that personal health information was compromised. This is a very big deal in terms of being able to deliver this in a timely manner, the penalties can amount a million of dollars and thus investments being made on an IT security have a very really ROIs starting to be incorporated. At this time I would like to turn it over to Paul, who will walk through our financials.

[Paul T. Anthony:]

Thank you, Joe. For the three months ended September 30, 2014, the Company reported revenues of $11.3 million, an increase of 4.2% when compared to $10.8 million in the same period in 2013. That any increase of service revenue was $0.7 million from new contracts implemented since the fourth quarter of 2013. Expansion of services with existing customers in addition of a Delphiis business, this was partially impacted by decreases at some of our existing customers due to normal reductions which I will elaborate on in a minute. And a drop in the sales volumes due to consolidation of some high volume paper producing departments at a couple of accounts, a portion of which this volume expect to recapture with one of the new agreements Joe mentioned. Equipment revenues were approximately 0.7 million in the third quarter of 2014 compared to 1 million for the same period in 2013. I want to spend a minutes to detail a couple of things about our business model and how it impacts growth in volume and revenues. When we sign a client we guarantee them this 10% to 30% of their total premium expenses. We then right size our equipments, ensure they have the correct capacity for their needs and help to eliminate waste and duplication and certain other inefficiencies. Overtime this inherently reduces overall volume as we make good on our promises. So in order to continue to grow, we need to expand the number of facilities we manage with existing customers while adding new customers. The operating leverage we gained comes after the ramp-up period of the agreement as we move into more of an ongoing maintenance. When we resign customers we are pricing our services off to the lower overall volume and more efficient environmental, while we can keep the margin profile similar that typically off of the lower absolute dollars. This simply means our model is working. For the third quarter, cost of revenues was $8.7 million compared to $8.6 million in 2013. Gross margins increased two percentage points to 2.6% and benefited from contract maturing that came on board over the last couple of years, offset by lower revenues from the drop in sales volume from some of our existing customers that I discussed. Operating expenses for the third quarter were $1.7 million, an increase of 25% from $1.4 million in the third quarter of 2013. Sales and marketing expenses increased by 11.1% due to higher staffing costs related to expanding our sales efforts. General and administrative expenses increased 32.2% to $1.2 million which includes professional fees, operating expenses and amortization of the identified intangible assets associated with the Delphiis acquisition. The Company generated $0.8 million of operating income in the third quarter of 2014 compared to $0.9 million in the year ago period. Net income for the three-months ended September 30, 2014 was $0.7 million, or $0.03 per share, compared to net income of $0.8 million or $0.04 per share, in the same period of 2013. Excluding $76,000 in charges related to stock based compensation and $53,000 from the amortization of intangible assets, we achieved positive adjusted income from operations of $1 million in the third quarter of 2014 compared to $0.9 million after excluding charges of $93,000 related to stock-based compensation for the same period last year. At September 30, 2014, the Company had $4.3 million of cash and cash equivalents, cash provided by operating activities for the first nine-months of 2014 was $1 million compared to $1.1 million during the same period in 2013. Working capital improved at $2.1 million at September 30, 2014 compared to $0.3 million at December 31. The company also maintains $2 million accounts receivable base line of credit which can be utilized to help fund some of these growth initiatives. For the nine-months ended September 30, 2014 the company reported revenues of $31.9 million an increase of 3.8% year-over-year, net recurring service revenues increased $2.4 million which included $3.1 million in new contracts and the addition of Delphiis, partially offset by a non renewing contract lower volume of some existing customers due to the consolidation of some operations as well as the impact from the severe storms that hit these coast at the beginning of this year. We have seen dropping equipment sales of approximately $1.2 million compared to the same period 2013, equipment revenues in 2013 were primarily from top year fleet refresh activities at three large customers which we are not repeated in 2014 as we fleet refreshes are typically done every five years in anyone customer facility. This business will fluctuate from year-to-year based on a number of factors and should not be utilized engage our growth performance. Gross margins were 18.8% of sales, 100 basis point increased over 17.8% in the year ago period. Operating expenses for the first nine-months 2014 were $5.1 million, compared to $4.5 million in the prior year period. Net income for the first nine-months of 2014 was $0.7 million, or $0.03 per share in line with the same period a year ago. Excluding $0.3 million in charges related to stock-based compensation and $53,000 from the amortization of intangible assets, we achieved adjusted income from operations of $1.3 million for the first nine-months of 2014, compared to an adjusted income from operations of $1.6 million after excluding charges of $0.4 million related to stock-based comp and $0.2 million in charges related to stock granted for marketing activities in the same period of 2013. We improved our balance sheet further in July when the remaining holders of the 1.55 million of convertible promissory notes are issued in July of 2011 which included several Board members elected to convert all their unpaid principal into the equivalent of 1.55 million shares of common stock, this eliminate a majority of our existing debt. Given our strong balance sheet and credit facility, we feel well-positioned to fund future growth both in our MPS and IT Security businesses will be an investment mode during the coming years were implement these new contracts and higher new sales people to expand both of these business segments. We are excited about 2015 reported to you on our year end conference call in March. I’ll now turn the floor back to Joe.

[Joseph J. Flynn:]

Thank you, Paul. In closing, we’re excited as ever about the future of Auxilio. Our core MPS business is in a best position since we started this business, providing us with a growing base of recurring revenues. We’re proving that our team conserve any size organization and are able to demonstrate a strong value proposition by delivering on our promises. We are expanding into higher margin value-added services through our investments in the IT Security Consulting business. As a reminder, there are over 6,700 hospitals and we are currently operating an approximately 120. The changing dynamics of the healthcare industry through both consolidation and regulation and provided us with a growing set of opportunities to help our client save money, become more efficient and manage their IT Security and risk profile and for Auxilio to gain further market share. Our reputation through solid execution is winning us business and expansion capabilities. We are committed to growing the business in a meaningful way, but will be thoughtful and calculated in terms of the new hires and initiatives taken. To that end we have added two new full-time sales positions, one located in the Midwest, to grow sales in that region and another focus on our security business. In addition Carrie Mulcahy, who joined us with the Delphiis acquisition, is our Director of Corporate Marketing a role in an area that haven’t heavily invested in previous years. Thank you for your continued interest in Auxilio, we appreciate everyone joining us for today’s call and Paul and I will now open the floor to take any questions. Operator?

[Operator:]

(Operator Instructions) And our first question comes from Jeff Bash with General Pacific Partners.

[Jeffrey P. Bash:]

Hi, Joe and Paul.

[Joseph J. Flynn:]

Hey, Jeff.

[Paul T. Anthony:]

Hi, Jeff.

[Jeffrey P. Bash:]

Good quarter. I’ve a few questions. In past years you haven’t commented on drop in paper volume has been anything materially effecting your business and in this year for the first time if I recall correctly you are – do you see this is a – on a long-term trend starting this year or something isolated to this year only or what?

[Joseph J. Flynn:]

Jeff, just I’ll comment at least on a portion that we have seen volume drops in the past they just having necessarily been material, but what we are seeing is as a result of the consolidation in this industry there is also what probably the corporate world have done years ago there is also consolidation of back office operations that are occurring. And in the case where we have hospitals and we don’t have the entire system, what we are seeing is that we are loosing some of that volume maybe to a corporate shared services center or other areas. And so again, as part of our effort and success it continued to expand within our existing client base, we’re trying to make sure that if we do lose any volume as a result of some of these consolidation efforts that we get it back through expansion of services in the market and within that existing customer. So it’s definitely something that we’re seeing more of that kind of impacts our control over that volume, but we are not seeing it necessarily anything that any trend at least from an electronic or other perspective that that is concerning us at the bulk of our customers.

[Paul T. Anthony:]

And I’ll add to that Jeff, I mean the large health systems in some of the system we have all the hospital and some we have a portion of the hospitals are really starting to act more and more like corporations instead of kind of regional operations. And so that consolidation we are definitely seeing from a management standpoint where they are laying off layers of management and consolidating the overall management of these health systems in one region or in one headquarters versus letting it each group do their own thing. So that’s definitely going to have an impact on high paper areas like billing and human resources and things like that.

[Jeffrey P. Bash:]

Do you think that is and in terms of quantifying is like a couple of percent as a contract value per year 5%, 10%, do you have any feeling here what does might be worth?

[Paul T. Anthony:]

Yes, I mean at this point what we see is on the low end it’s 1%, 2%, when it’s happened on the high end we’ve seen 10% but again we’ve seen similar type moves in the past with even some of our existing clients. And so those trends are pretty consistent with what we’ve seen in the past as well just in the case of this recently we’ve seen it at some of our large customers. So it’s had more of material impact, but not uncommon for us to seeing our customer base.

[Joseph J. Flynn:]

And as Paul mentioned Jeff, this particular instance we mentioned earlier we’re working on some large contract. This particular instance is an example of that. We’ve a very strong relationship with this particular health system and they are expanding us throughout the rest of their health systems through this and so for our benefit we’ll be picking up rest of the best volume that may disappeared in that consolidation.

[Jeffrey P. Bash:]

Now, I understand your point at the end and we’ve been in 120 hospitals out of 6,700 and the impact of losing a few percent a year due to paper volume.

[Joseph J. Flynn:]

Correct.

[Jeffrey P. Bash:]

But I just want to get a better feel for. Next question on equipment sales I understand it’s always been sort of lumpy and who knows what else going to be, but I’m curious would you characterize this years level of equipment sales is more normal relative to the size of your company or last years level equipment sales relatively done?

[Joseph J. Flynn:]

Well, I think when we finish out the year Jeff, would be a lot closer to last year. And so I would say that if you looked at the average of last year and what we’re going to end this year that’s probably a pretty good proxy for our current customer base, but as we grow I would expect that line to continue to grow not necessarily at the same rate because of the potential timing issues. But overall I’d say on average with some increase that’s about a reasonable rate for us for equipment.

[Jeffrey P. Bash:]

So translation I mean that you are expecting – reducing sales in the fourth quarter.

[Joseph J. Flynn:]

That’s right.

[Jeffrey P. Bash:]

Roughly how much were professional fees for the Delphiis acquisition in the third quarter numbers?

[Joseph J. Flynn:]

About a 100,000.

[Jeffrey P. Bash:]

So in effect had that not occurs the results would have been 100,000 better at the operating income line?

[Joseph J. Flynn:]

That’s right and again that 100,000 was purely the acquisition cost, so we obviously absorb some of their G&A expenses as well that they had so.

[Jeffrey P. Bash:]

Okay. In terms of acquisition strategy I appreciate that the Delphiis one look like – being in your immediate fiscal neighborhood and fitting great with your company business, its like sort of how could you resist, but would it be fair to say that your general approach to acquisition is opportunistic and you don’t have any basic acquisition plans in general.

[Joseph J. Flynn:]

I mean I think yes, but now that we are in the security business, it’s a very interesting market and there are kind of similar when we got involved in MPS, there is a lot of very big players that are in multiple industries, but there is very few that really have positioned themselves as healthcare exclusive. So, while we want to absorb this acquisition and we want to make it work, we got our eyes opened to the opportunity and there is a number of opportunities out there that could come our way and we want to look at them, because we are very bullish on the security business. It’s a huge demand and a huge pain point for our customers.

[Paul T. Anthony:]

And if we did do something the difference would be two, in the Delphiis acquisition we were actually purchasing some IP, the expectation is we probably wouldn’t be taking that approach on a go forward basis, it would be more purchasing resources, so we would be targeting specific groups of individuals that we could bring in that would help us drive revenue growth. And so we wouldn’t necessarily be looking at purchasing or paying that premium for necessarily an intellectual property component, because we are happy with the technology that we bought.

[Joseph J. Flynn:]

Yes, it’s very good, it’s very robust.

[Jeffrey P. Bash:]

And my last question has to do with your historical relationships with large hospital service providers like Sodexo and I think you have one now with our mark, sitting in their chair I would say looking at Auxilio, here is a $40 million company that’s in 120 hospitals out of this market, they have really proven that they can do it and from their perspective, they have the access to see suite with their giant customer relations. Why not they knocking down your door to buy you what’s the strategic reasons that you haven’t have this kind of contact to date that logically seems to make somewhat sense is 40 million just too small for them you’d have to be a 100 plus million company that make a event in their business with – I still think that the advantages are overwhelming for them to be doing something near. What I am missing?

[Joseph J. Flynn:]

Well, I think the latter part of what you talk about I mean company is 40 million, 45 million in revenue is pretty small for them. So that’s definitely something we think is an issue. Second thing more importantly Jeff which is amazing, but if you look at Sodexo an Aramark in North America their ability to grow right now is very challenged they are getting squeezed very, very hard by their exciting customers. And we experienced that with Sodexo. We had a good relationship with Sodexo and they brought us some value, but in the midst of that relationship they lost one of their largest customers in it really put them in a tailspin. In North America they’ve seen enormous amount of layoffs and it really hit them hard. In case of Aramark they’ve got new management there you know we are kind of finding our way, it’s an okay relationship I wouldn’t say its something were relaying on for significant growth. But I think in addition to just increase small for them to acquire it right now they are having their own significant internal challenges that you know frankly we don’t have a lot of time to get involved in because we got enough on our plate and we don’t want to be relaying on any big company. So that’s best I can describe as the reason to why.

[Jeffrey P. Bash:]

Is there another type of company like a [indiscernible] who you might have a strategic interest in Auxilio or some other variety of company like might be missing and I guess the reason why we’re asking this, I always thought and I thought from conversations with management years ago that acquisition of the company would be the long-term excess strategy and sort of perplex something that have by now.

[Joseph J. Flynn:]

Yes I mean I think Jeff this is Paul I mean I think in these from our perspective we definitely or always keeping our eye on who made some of the strategic partners might be that we would want to create that relationship with and start to give them better understanding of who we are some of those natural fits or obviously some of our largest vendors and competitors who would be the Ricoh’s and Canon’s and Xerox isn’t so. Those guys are always something that are always individuals that we stay close to for a number of reasons. Now that were in a security space again that’s another area where again we are going to it opens up from our perspective at least other strategic partners that we might be able to target to support our business development efforts and some other things which where those can lead. [indiscernible] so that’s really our what our focus has been recently is because we haven’t seen the necessarily the results we are hoping with Sodexo or Aramark we still drive that business with Aramark, but now that we kind of diversified a little bit, we get more in our toolbox, it’s going to open up from our perspective and we see opportunity to target some other strategic partners and start to get Auxilio’s name familiar in other areas where maybe then we can get some traction.

[Paul T. Anthony:]

In the absence of that Jeff we are working very hard in expanding our businesses as quickly as we possibly can. The good news here I think with the invitation from some of these very large health systems comes to the table and negotiate contracts with them. I believe that’s going to open up a lot of opportunities for us in a number of different areas. So again we are just focused on what we do best and improving that definitely the security acquisition has positioned us very nicely with our existing customers and in RFPs and other types of conversations we are having with very large health systems.

[Jeffrey P. Bash:]

Okay, thanks. Thanks a lot, congratulations again on a good quarter, keep up the good work.

[Paul T. Anthony:]

Thanks Jeff.

[Joseph J. Flynn:]

Thanks Jeff.

[Operator:]

(Operator Instructions) Next we’ll move to JD Abouchar with Graham Partners.

[JD Abouchar:]

Hi, guys I’ve a couple of couple of questions for you. First, Joe, if you could give us any more detail the chasing you gave us on some of these large contracts here working on just sort of relative size duration, what effect that would have to the overall business model?

[Joseph J. Flynn:]

JD I don’t have, I’m not in a position to be able to give that color, I would just – just not in a position right now to do that.

[JD Abouchar:]

Okay, then a question about you mentioned on the call earlier that 2015 to be in investment mode, is that mean where it’s going to burning cash or what did you mean by that?

[Joseph J. Flynn:]

Again this is we are definitely going to be looking at increasing some of our sales expenses in addition as we look at some of the deals that we’ve got in the pipeline and some of these that we are getting real close on, if those kick start to grow in a way that we hope, we are definitely going to be seeing a year of investment next year, but ideally the bulk of that investments is going to be tied to implementation of the MPS business, and growth in that business. In addition, we are putting forward investments in a security business at least at this point we’ve been very happy with the success we’ve seen in that security business. So from our perspective it’s going to more than fund itself with that growth if it keeps going on this trajectory. So we don’t anticipate necessarily a negative financial impact as a result of that investment, but we are going to be looking at some things as this new accounts go online, very similarly what our bottom model has been in the past. We are going to see some impact as we start to grow and as we start to level off than in subsequent years we’ll start to see a rebound.

[JD Abouchar:]

Okay. Maybe given that a company is now at a higher revenue base as you onboard a new customer obviously the gross margins go down because you have to eat the existing contracts et cetera. But obviously you are layering that on to a larger company that you are with a more fixed SG&A. So should there be even though the gross margins come down, we should see some leverage from the fixed OpEx that in fact you don’t take quite as much yet going forward.

[Paul T. Anthony:]

From the G&A perspective absolutely you are going to see that from the sales perspective initially because of the efforts towards in bringing on a Midwest sales rep and then depending on the success of the growth we could see potentially in East Coast and additional East Coast rep. From the sales side I think we’re going to see some investment on that in the next year assuming that we feel comfortable with where we‘re headed from the results in our growth. So but from a G&A perspective, yes we’ll definitely start to see continued leverage of those expenses as we bring on these new accounts.

[JD Abouchar:]

And then you mentioned that 100,000 in merger expenses in the quarter are there any synergies going forward from consolidating Delphiis into the company that we could realize going forward.

[Paul T. Anthony:]

Not a lot I mean Delphiis was a five men shop and from their G&A network or G&A expense was primarily friends and family. So it wasn’t looked pretty low anyways. So I’m not expecting much synergies to come from that perspectives.

[JD Abouchar:]

Got you. And then final question is the revenues in the quarter since we didn’t have a lot of printer hardware expenses, hardware sales and given the high recurring revenue nature of your business. It’s fair to say that sort of a run rate we can plus or minus look forward into next year and then on top of that layering on hopefully some of these new contracts you are talking about?

[Joseph J. Flynn:]

It is.

[JD Abouchar:]

Great. Thank you, guys.

[Joseph J. Flynn:]

Thank you.

[Paul T. Anthony:]

Thank you.

[Operator:]

And it appears there is no further questions at this time. I’ll turn things back to Mr. Flynn for any additional and closing remarks.

[Joseph J. Flynn:]

I would just like to thank everybody once again for joining us today and we look forward to speaking to you again in March at our year-end conference call.

[Operator:]

Once again ladies and gentlemen that does conclude today's conference. We thank you for joining us. And you may now disconnect.