Q1 2015 Earnings Call Transcript

Published: 18 May 2015

[Operator:]

Good day and welcome to the Auxilio First Quarter 2015 Results Call. Today’s call is being recorded. At this time, I would like to turn the call over to Matthew Hayden with MZ Group. Please go ahead, sir.

[Matthew Hayden:]

Thank you very much. Good afternoon. I'd like to welcome everyone to who is joining Auxilio’s first quarter 2015 earnings call. The press release that accompany this crossed the wires this past Friday and is on the company's website. Joining us today are Mr. Joe Flynn, President and CEO; in addition Mr. Paul Anthony, the company's Chief Financial Officer. Before we begin the formal presentation, I'd like to remind everyone that some statements made on the call and webcast including those which have future financial results and industry prospects among others are forward-looking and maybe subject to a number of risks and uncertainties that could cause actual results to differ materially than those described in the conference call. Certain of these risks and uncertainties are or will be described in greater detail in the company’s SEC filings and the company 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. With that out of the way, I'd like to turn the call over to Mr. Joe Flynn. Joe, the floor is yours.

[Joe Flynn:]

Thank you, Matt, and thank you everybody for joining today’s call. On our last call, we announced the agreement to acquire Redspin and subsequently closed the transaction on April, the 7th. This time [ph] we have made progress in integrating our Security Solutions Group into Redspin, which includes appointing Daniel Berger, the current President of Redspin to run the new combined organization. Dan has experience in building several technology-related start-ups including Redspin for the past five years, provides us strong leadership in sales, marketing and overall day-to-day management. Mike Gentile, EVP and Former President of Delphiis will continue to be responsible for driving and managing the seamless delivery of our security Program Solutions for our customers. Redspin is known in the industry for the quality and thoroughness of their assessments. This is accomplished through framework technical and regulatory assessments such as HIPAA analysis and penetration testing. What this means is that Redspin mimics the actions of a cyber-attacker and systematically tests all aspects of the IT system for vulnerability. Redspin not only effectively completes this -- the risk assessment testing at the beginning of the process, but also enables ongoing assessment for vulnerabilities. By adding this to our existing capabilities, we now have an end-to-end solution to help clients better safeguard patient health information, or PHI. More specifically our Security Solutions Group provides five pillars

[Paul Anthony:]

Thank you, Joe. For the three months ended March 31, 2015, the company reported revenues of $13.8 million, an increase of 35% compared to $10.2 million in the same period of 2014. The increase came from adding $1 million in recurring MPS services revenue, approximately $1.2 million in consulting revenues, and software subscriptions derived Security Solutions Group not present in the year ago period, while equipment revenues increased by $1.4 million to $1.8 million year-over-year to accommodate copier fleet refresh activities. For the first quarter, cost of revenue was $11.7 million compared to $8.5 million in 2014. Gross margin decreased 15% from 17% primarily due to staffing and capital cost associated with new MPS contract implementations in addition to lower margin equipment revenue. Operating expenses for the first quarter were $2.1 million, an increase of 24% from the first quarter of 2014. Sales and marketing expenses increased by 46% due to higher staffing cost related to expanding our sales effort in both MPS and security. General and administrative expenses increased 15% to $1.4 million which includes professional fees, operating expenses, the amortization of identified intangible assets associated with Delphiis acquisition. The company's income from operations was breakeven for both periods. Net loss for the three months ended March 31, 2015 was $33,000 or $0.00 per basic and diluted share compared to a net loss of $71,000 or $0.00 per basic share and $0.01 per diluted share in the same period of 2014. Excluding $79,000 in charges related to stock-based compensation and $53,000 from the amortization of intangible assets, we achieved positive adjusted income from operations of $0.1 million in the first quarter of 2015 compared to $0.2 million after excluding charges of $200,000 related to stock-based compensation for the same period last year. At March 31, 2015 the company had $5.1 million of cash and cash equivalents. Cash provided by operating activities for fiscal 2015 was $0.4 million compared to $0.1 million during the same period in 2014. Working capital improved to $2.9 million on March 31, 2015 compared to $2.8 million at December 31, 2014. Company also maintains a $2 million accounts receivable base line of credit which can be utilized to help fund some of our growth initiatives. As Joe mentioned, we are in the implementation phase of two very large contracts, some of the largest in our history. There will be resource needs and related expenses along with margin contraction during the coming year. Similar to historic financial results we will see margin expansion as we move from general implementation into ongoing service and maintenance. In addition we are starting to see meaningful growth in our Security Solutions Group and with the integration of Redspin this should expand during the coming year. As we mentioned on last call, we anticipate topline growth of at least 20% for 2015 that when compared to 2015 and this is not including contribution from Redspin. Given our balance sheet and credit facility we are well positioned to fund the growth in both our MPS and IT Security business. I will now turn the floor back to Joe.

[Joe Flynn:]

Thank you, Paul. In closing we are as excited as ever about the future of Auxilio. Our MPS business is in the best position since we started the company providing us with visibility into meaningful growth. We have proven that our team can serve any size organization and is able to demonstrate a strong value proposition by delivering on our promises. Over the next 18 months we need to consistently execute as we implement these large contracts in multiple locations all over the country in the aforementioned health systems and we will be updating you on a quarterly basis as to our progress. We have expanded into higher margin value added services through our investments in the IT Security business by integrated the Redspin and Delphiis acquisitions. We now have true end-to-end solution and can effectively become a one-stop-shop for customers. This complete offering is unique and is aimed at ensuring enterprise-wide, mitigating risk and improving efficiencies across the organization, providing a safer environment for patient health information. Given that it’s important for us to layout milestone in which investors can track our success, I want to highlight key goals for our teams during the balance of 2015. One, executing on the unprecedented number of new MPS implementations by turning each of these profitable in a shorter period of time than we have previously experienced. Two, successfully executing on the integration of our Redspin and Delphiis acquisitions and position ourselves in the market as the first and only healthcare focused, end-to-end security solutions providers. Three, aggressively targeting cross sell opportunities between our large MPS client base and our Redspin client base to leverage revenue growth. Four, be disciplined in our acquisition strategy can further strengthen our IT Security offering with complementary technology and/or services. And that concludes today's prepared remarks, thank you for continued interest in Auxilio. I also want to mention that I will be present at the LD Micro Conference in Los Angeles on June 3rd at 1

[Operator:]

[Operator Instructions] We'll take our first question from JD Abouchar from Graham Partners.

[JD Abouchar:]

Hi, Joe. Congrats on a nice results. Maybe you can elaborate a little bit on the synergies and cross selling opportunities between IT Security and MPS?

[Joe Flynn:]

Yeah, great question JD. Thank you. Certainly there are – every single one of our hospitals and even the health system clients are engaged in various levels of security projects. Obviously, they buy lot of hardware and software to protect their networks, but they also do a lot of consulting as to see -- as it relates doing HIPAA assessments as well as remediation and if they had a breach, they will even do forensics work and what they call incident response. So what our goal here is to introduce our offering as a competitive set to what's in the marketplace right now, and one of the things that we are excited about with Redspin is, prior to that the Delphiis team didn’t really have a lot of assessment capabilities, Redspin brings a tremendous amount of that, and that's usually the front end of an engagement. So a customer needs to find out what the issues are in their environment, what the vulnerabilities are they do an assessment and once they know that, they have a diagnosis for what their problems are and then can fix all that. What we do now have is a find capability, our discovery capability and now fixed capability. All of our customers are doing that as well; Redspin has a number of customers that were -- they were only doing assessment work for and when it came to remediation of their problems discovered there wasn’t really much Redspin can do. So one the things we’re going to be doing is going back to all the Redspin customers and -- as they’ve worked within the past that they basically had to turn away because they couldn’t do remediation work and say, now we have those capabilities, let’s talk about how well Redspin can help you. So those are the real immediate opportunities we have.

[JD Abouchar:]

Great. And what are the typical margins on the IT side, what do you envision? And is there a chance that some of that offsets the lower gross margin initially we will have from the MPS roll outs?

[Joe Flynn:]

Definitely that's our hope. The typical margin we are seeing per engagement on a security engagement regardless of the service is around 40% gross margin, so those are quite a bit higher than almost double than the MPS does. So we are definitely – that’s obviously one of the impetuses for making these acquisitions, not only offering our customers more services where we can help them with their pain points , but offering them services that have higher margin which then will hopefully lift up the overall margins of corporation if that makes sense.

[JD Abouchar:]

Yeah. Do you expect margins to dip meaningfully in the next couple of quarters or are we sort of already seeing that with sort of the 15% level?

[Paul Anthony:]

JD, we could see an additional dip though, I think, given the sheer size of the implementations that we've got. But, again, we are still kind of early stages of the large implementation and so the timing and the size of each piece of those implementations is still to be determined and so we are not sure yet if it’s going to depend on when they come on line. We are not sure if we’re going to see necessarily a major hit to a quarter or if we can be able to spread that out. It’s still little too early to tell.

[Joe Flynn:]

Like Paul is saying, it’s one of the reasons why in this big deal we are making the implementation. Number one, because we want to sure we do it right. And number two, in order not to have such a negative financial impact, we wanted to spread out that implementation over a longer period of time and it just benefits both us and the customer.

[JD Abouchar:]

Got you. And the final question is, so the MPS is sort of a subset of the whole document management system. So how do you envision sort of integrating that and ultimately as we do more electronic medical records, it all sort of intertwine the security and the printing and service. Do you have a vision there going out a few years as we go theoretically to less paper, although that is not the case clearly?

[Joe Flynn:]

Yeah, I mean, there is a couple of things that -- that’s a great question, by the way. There is a couple of things that are actually happening in our customer set right now, which are interesting opportunities for us. They are coming to us from more workflow and more let’s say electronic content management or document management. There is lots of words for services. Right now we partner with people to do that. So we have a couple of partners where we are bringing into engagements which provide us some additional revenues, revenue streams as well as position us as a solutions provider for our customers. As it relates to the size of those kinds of revenue opportunities, they are not as large as an MPS deal, but certainly they position us in a much more trusted solutions provider. And so we found a couple of -- one in particular very, very good partner on that and we see that relationship developing more and more as the demand comes from our customers. And in fact, we are seeking those opportunities where can drive some additional margins for ourselves and position ourselves better with the customer.

[JD Abouchar:]

Great. And thank you Joe.

[Paul Anthony:]

JD, just to expand on that too from a net revenue model, we recognize that that we may end up ultimately losing gross revenue. But our as Joe mentioned through these partnerships our intention is still to try to get a utilization based solution that offsets that lost volume or lost utilization. So whether it’s a transaction fee, but on an electronic transaction as opposed to a paper transaction.

[JD Abouchar:]

Interesting. Thank you.

[Paul Anthony:]

Yes. Okay.

[Operator:]

We will go next to Wyatt Carr from Monarch Bay Securities.

[Wyatt Carr:]

Hi, Joe and Paul and congratulations on the quarter. Question I have mainly is around the size -- the total available market of the IT security product. And also does the IT -- does Delphiis -- I mean, Redspin cover the entire segment or are there some modules out there that still that you can take up?

[Joe Flynn:]

Well, let me address a couple of things. I kind of alluded to this on the call about the size of the market as it relates to healthcare and I think it’s an important point, I’m glad you asked the question. If you look at our MPS business it’s very much focused on acute care facilities and their surrounding buildings -- okay, so health systems, hospitals and they have doctor’s practices all over the place and clinics and so forth. And that’s all wrapped up in a health system. As it relates to security, it’s a much broader opportunity in terms of potential customers as it relates to healthcare security, because it includes not only the healthcare institutions or the providers of healthcare hospitals, but the payors as well, meaning, insurance companies who interact with the hospitals as well as the thousands upon thousands of vendors and service providers who provide technology and services and products and commodities for healthcare institutions. Each one of those has to have a level of HIPAA compliance. And so as it relates to security services, specifically around HIPAA compliance, specifically around vulnerability testing and even remediation to a certain extent, are offering our securities solutions offerings. It can really provide benefits to all of those different groups. So a size of the market as it relates to security just from a number -- sheer number of potential customers is very, very large. Our MPS business, obviously, if we were to expand outside of healthcare it’s very, very large. But we've taken the tax to focus our MPS business primarily on large health systems. We've only got 220 now -- 220 hospitals under operation -- under contract and there's 6,700 in the market. I'm not sure all 6,700 would be potential clients, because you're talking about a lot of small ones as well, but we still see from an MPS perspective, we're really scratching the surface at the number of potential opportunities we have in front of us for the next several years. So, I hope that answers your question in terms of both of those markets.

[Wyatt Carr:]

Yes. It does. Thank you very much. The other part of the question was on margins, this is a much higher margin business, but at what point do you see it’s a -- right now it's in its infancy? How fast can it ramp and start to impact your margins overall?

[Joe Flynn:]

I mean that's hard to predict. It's going to come down. You're right when you say infancy, because it is infant. They are very, very small businesses right now. But again, I can tell you -- just give you an idea where our heads are in terms of where we're putting our investment dollars enriched specifically to marketing. About 70% of our marketing budget for the next couple of years is going to be focused on security, because we see the opportunity. Obviously, every dollar that we get from security is $0.40 in our pocket, right versus $0.25 in our pocket. So, you want to go where you can drive that revenue as quickly as you can and so we're going to do that by selling -- trying to cross-sell to our existing MPS hospital clients. We're going to do that by selling additional services to Redspin, both hospital and non-hospital clients. We're going to do that by partnerships with large IT outsourcing companies. So, we're building as much partnership capacity, channel marketing capacity that a company our size can develop, so that we can specifically spend as much time as we can driving revenue towards security because we know that that's going to be higher margin. At the same time, there's a lot still [ph] of nice pipeline of opportunities in MPS. As I said, we'll probably focus our business development efforts internally and marketing efforts on security over the next few years so we can ramp that business as quickly as we can. But I can't predict how fast that will happen.

[Wyatt Carr:]

Understand. Thank you very much. I'll get back in the queue.

[Joe Flynn:]

Thank you.

[Operator:]

[Operator Instructions] We'll go next to Jeff Bash from General Pacific Partners.

[Jeff Bash:]

Hey, Joe, Paul.

[Joe Flynn:]

Hey Jeff.

[Paul Anthony:]

Jeff.

[Jeff Bash:]

Well, it's like the first questioner, he had mentioned partnering with respect to electronic records type services, did that offer a different kind of acquisition efforts possibly?

[Joe Flynn:]

It does. Actually it’s a great question Jeff. There are smaller niche traders [ph] that are out there that may not only be in healthcare. I think the smaller the acquisition you make, more likely it's going to have a large non-healthcare customer base, but there are some out there that we have met and have developed relationships with that we'd be very interesting add-on opportunity for us, no question.

[Jeff Bash:]

Next, in terms of -- I guess a question about further dip in the gross margin. I presume I'm proactive dimensionally, you'll reach a growth over time where utilization cost is exceeded by the revenue from already implemented hospitals in those $50 million contract and then the gross margin will then go up even though you may still have material implementation cost, is that correct?

[Joe Flynn:]

Yeah, absolutely Jeff. The issue is just -- any time we start exceeding 20% plus growth in a given period, we know we see some of that impact still. So, obviously the larger we get the chances of closing any larger deals that push yourself into that greater than 20% growth, we would expect that those implementation cost will be muted.

[Jeff Bash:]

Okay. Now, I have a couple of questions on the actual numbers. You had said that the equipment sales went up $1.4 million to somewhere else in the 10-Q, I believe you said as a course of good associated equipment sales went up $1.3 million. That would suggest that you only got 100,000 gross margin roughly on those equipment sales. Does that sound about right and is that really what you expect to get on equipment sales.

[Paul Anthony:]

Yeah, we only project between 5% and 10% margin on our equipment sales, because again the way our business model works, the more margin we take in equipment sales and less margin that end up coming to service and really the accounting rules kind of push us into certain buckets from that perspective. So, really part of it is just kind of the way our model works. I'm trying to drive margins into the recurrent service revenue in the future, service revenue business, equipment really just being a service that allows us to control and manage the account better.

[Jeff Bash:]

Okay. Now, here's a couple of questions with respect to this quarter comparing with the fourth quarter rather than a year ago quarter. Sales and marketing went up about $230,000, actually between this quarter and year ago quarter and also the fourth quarter. So, am I correct in assuming that your increased Midwest [inaudible] sales and marketing security sales really went up from both quarters to the first quarter and put out a major expansion in the first quarter?

[Joe Flynn:]

Absolutely right. A couple of factors definitely headcount related. We got the sales individual. We also got some support -- sales support type efforts that supported security business. In addition really partially just timing different issues. We also had the number of conferences that were intended here in the first quarter, couple of that were specifically associated with security that also drove that number higher.

[Jeff Bash:]

And G&A for the fourth quarter to first quarter went up about $400,000. About $130,000 of that was -- that's been professional fees and driving away the acquisition which leaves $0.25 million or so increase in the fourth quarter. Does that associate with the new contracts or is that something else?

[Paul Anthony:]

On the G&A, at least from primary increase, there is the -- primary increase was the professional, you're absolutely right, associated with the Redspin acquisition. And those items we did have some additional labor components as we prepped to get ready for the new growth and the new accounts that are coming on board since the -- all the financial support functions related to our service offering run through G&A as opposed cost of goods sold, so we definitely saw some increase there. So, those were the primary reasons.

[Jeff Bash:]

Gross margin -- circle back to gross margin for a moment, that dropped 100,000 from Q4 to Q1 and we know you made 100,000 more equipment sales, so looks like gross margin dropped by couple hundred thousands of -- is that associated also with the new contract?

[Paul Anthony:]

Absolutely, we definitely saw. And Q1 is always - has a little bit lower margin from the traditional MPS business because of the lower volumes that traditionally run through our hospitals towards the end of the calendar years, we built in arrears on a number of accounts. And so we traditionally see Q1 margins a little bit lower due to seasonality associated with our business.

[Jeff Bash:]

Last question. Do you still feel your capital availability is adequate for the next several years or it would be pretty mature inside that? It seems like it is aligning forward.

[Joe Flynn:]

We definitely feel what we have today is sufficient. I will tell you though that we're looking at options to ensure that we have additional funds available if we determine that we want to take advantage of other acquisition opportunities or other solutions that will help drive margin and drive the business. So, we're looking at different options to enhance the balance sheet to support that -- those initiatives.

[Jeff Bash:]

Okay. Thanks. That's it for me.

[Joe Flynn:]

Thanks Jeff.

[Operator:]

And with no further questions in the queue, I would like to turn the call back over to Mr. Flynn for additional or closing remarks.

[Joe Flynn:]

Yes. Thanks. Just want to thank everyone again for joining our earnings call. As always we appreciate your support. And we look forward to addressing you all again in August. Thank you very much.

[Operator:]

This does conclude today's conference. We thank you for your participation.