Q2 2015 Earnings Call Transcript

Published: 18 Aug 2015

[Operator:]

Good day everyone and welcome to the Auxilio, Inc. Second Quarter 2015 Earnings Call. Today's call is being recorded. At this time, I would like to turn the call over to Mike Cole, MZ North America. Please go ahead, sir.

[Mike Cole:]

Thank you, operator. Good afternoon and welcome everybody to Auxilio's second quarter 2015 earnings call. Joining us today from the Company are Mr. Joe Flynn, President and Chief Executive Officer; Mr. Paul Anthony, Chief Financial Officer; and Mr. Dan Berger, President of Redspin. Before we begin the formal presentation, I'd like to remind everybody 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 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. At this time, I'd like to turn the call over to Mr. Joe Flynn. Joe, the floor is yours.

[Joe Flynn:]

Thank you, Mike, and thank you everybody for joining today's call. We continue to be pleased with growth in both MPS and our IT Security Solutions Group offerings, and we expect continued momentum through 2015. As we sit here today, we are in the process of implementing over 80 new hospitals within our MPS segment, which is more than double the pace at which we have expanded at any time in the history of the Company. This has driven substantial revenue growth and we have also incurred the traditional upfront expenses associated with bringing these new facilities online. Those initial expenses include staffing up, optimizing the hardware component and streamlining all the printing processes. These expenditures largely occur during initial year of the contract, then abate with time. Given the number and sheer size of the recent implementations, there will be a more pronounced impact on overall net income over the next 12 months than we would've traditionally seen. This is all very positive for the long-term health of our business. As these contracts mature, margins are expected to improve. On the new business front, we secured two major wins. In July, we signed a five-year estimated $16 million contract for managed print services with Yale-New Haven Health System, one of the nation's leading academic health systems and a major health care contributor in the Northeast. This contract covers more than 7,400 devices including copiers, MFD, printers, fax, thermal and label printers and scanners across more than 300 Yale-New Haven locations. In addition, we also announced an estimated $6 million MPS expansion contract with the fourth region of a Top 10 U.S. health system. In 2005, we first implemented our MPS program in one of the local hospitals of this system and have grown to now serve four of the health system's five regions, representing over 5,000 beds and more than 50,000 employees. The IT Security Solutions Group, consisting of the combined Delphiis and Redspin acquisitions, offers Auxilio a growth opportunity unlike anything I have witnessed to date. Through the acquisition of Redspin, we have significantly bolstered our IT Security Solutions Group and continue to build a best-in-class offering which incorporates an end-to-end solution for valued customers. Redspin's penetration testing creates not only a recurring services element but also brings a large customer base of both healthcare companies and business associates or BAs who need to be HIPAA compliant. This provides an excellent conduit to cross-sell additional security offerings including diagnostic, assessment and compliance services. In fact earlier this month, Redspin reported that during the first six months of this year, it had provided penetration testing for more business associates than during all of 2014. This demand we're seeing is being driven in part by the HIPAA Omnibus Rule requirement for business associates and their subcontractors to fully comply with HIPAA security regulations. A business associate is defined as any organization that has access to the protected health information of a HIPAA covered entity. Business associates are now looking more deeply at their overall security risk exposure, in part in response to the nearly 1,300 major health data breaches affecting more than 143 million individuals since September of 2009, according to the U.S. Department of Health and Human Services. The Department of Health and Human Services estimates that there are 1 million to 2 million business associates creating an excellent target market. Our goal continues to be and always will be to invest in areas of our business where we can garnish the best returns. These will continue to include businesses with short sale cycles and recurring higher-margin revenues. As we have stated in the past, we have created trusted partnerships with some of the largest healthcare systems in the country and feel our on-site positioning provides us with a unique advantage to provide ancillary services to our core competency. Our vision of becoming a recognized player in healthcare information security is one we are fully committed to and will be realized through organic growth and through opportunistic complementary acquisitions. We anticipate that security based revenues will create enhanced margins and also minimize short-term impacts on profitability as we implement large-scale MPS projects in the future. Following Paul's prepared remarks covering the financials, I'm going to ask Dan Berger, the President of our Redspin IT Security Group, to provide some background on the opportunity there. First, I will hand it over to Paul to go through the financials. Paul?

[Paul Anthony:]

Thank you, Joe. For the three months ended June 30, 2015, the Company reported revenues of $15.6 million, an increase of 50.5% when compared to $10.4 million reported in the second quarter of 2014. Approximately $1.5 million of the increase is a result of the addition of new recurring service revenue contracts. The Company added approximately $1.6 million in service revenues and software subscriptions from the IT Security Solutions Group, in addition to an increase of $2.1 million in equipment revenue, compared to the same period in 2014. For the second quarter, cost of revenue was $13.5 million, compared to $8.7 million in 2014. Gross margins decreased to 14% from 17% of revenues, primarily due to the staffing costs and capital costs associated with the new MPS contract implementations, in addition to some lower-margin equipment revenue. As we move from implementation into the maintenance phase during 2016 and 2017, margins are expected to rebound. Operating expenses for the second quarter were $2.7 million, an increase of $1.6 million compared to the second quarter of 2014. Sales and marketing expenses increased 39% due to increased headcount and marketing expenses as we increased our sales effort, including the support of the IT Security Solutions Group. General and administrative expenses increased 84% to $1.9 million, which includes professional fees, operating expenses and the amortization of identified intangible assets associated with the Delphiis and Redspin acquisitions. The Company reported an operating loss of $0.6 million in the second quarter of 2015 compared to operating income of $0.09 million in the second quarter of 2014. Net loss for the three months ended June 30, 2015 was $0.6 million, or $0.03 per share basic and diluted, compared to a net loss of $0.01 million or $0.00 per basic and diluted share in the same period of 2014. Excluding $0.1 million in charges related to stock based compensation and $0.1 million in amortization of intangibles, we achieved an adjusted loss from operations of $0.3 million in the second quarter of 2015, compared to adjusted income from operations of $0.1 million, after excluding charges of $0.05 million related to the stock-based compensation for the same period last year. The Company absorbed several expenses associated with the expansion of our IT Security Solutions Group. These included $0.3 million of integration and severance related expenses and $0.1 million of expenses related specifically to the acquisition of Redspin which contributed to the loss for this quarter. At June 30th, 2015, the Company had $5.1 million of cash and cash equivalents. Cash provided by operating activities in the first six months of 2015 was $0.5 million compared to $0.5 million during the same period in 2014. Working capital at June 30, 2015 was $1.2 million compared to $2.8 million at December 31, 2014. The Company also maintains a $2 million accounts receivable base line of credit and a term loan with capacity of an additional $2 million which can be utilized to help fund some of our growth initiatives. For the six months ended June 30, 2015, the Company reported revenues of $29.5 million, an increase of 43% when compared to $20.6 million reported in the same period of 2014. Approximately $2.5 million of the increase is a result of the addition of new recurring service revenue contracts. The Company added $2.8 million in service revenues and software subscriptions from the IT Security Solutions Group, in addition to an increase of $3.5 million in equipment revenue, compared to the same period in 2014. Cost of revenue was $25.2 million compared to $17.2 million in 2014. Gross profit for the six months ended June 30, 2015, was $4.2 million, or 14% of revenues, compared to $3.5 million or 17% for the same period in 2014. Operating expenses for the six months ended June 30, 2015, were $4.9 million, an increase of 46% from $3.3 million in the same period of 2014. Sales and marketing expenses increased by 42% due to increased headcount and marketing expenses as we increased our effort including the support of the IT Security Solutions Group. General and administrative expenses increased 47% to $3.3 million due to the integration efforts associated with the two recent acquisitions. The Company reported an operating loss of $0.6 million for the six months ended June 30, 2015, compared to operating income of $0.1 million in the same period of 2014. Net loss for the six months ended June 30, 2015 was $0.7 million, or $0.03 per basic and diluted share, compared to a net loss of $0.08 million or $0.00 per basic and diluted share in the same period of 2014. Excluding $0.2 million in charges related to stock-based compensation and $0.2 million in amortization of intangibles, we achieved an adjusted loss from operations of $0.2 million for the six months ended June 30, 2015, compared to adjusted income from operations of $0.4 million, after excluding charges of $0.3 million related to stock-based compensation, for the same period last year. We're encouraged by the progress of our IT Security Solutions Group. This combined with the recent implementations of our large MPS contract should continue to drive substantial revenue growth and margins are expected to improve. Expected future cash flows combined with our balance sheet and credit facility and term loan capacity leave us well-positioned to fund the growth in our business. I'll now turn the floor over to Dan Berger, President of Redspin.

[Daniel W. Berger:]

Thank you, Paul. We have a tremendous opportunity in healthcare IT security right in front of us. Consider our service offerings against the market backdrop. In 2015 alone, over 100 million personal healthcare records have been breached by malicious hacker attacks. There is nothing short of a crisis in the healthcare industry, and the call to action throughout the organizations both large and small is to spend more money on IT security. With the integration of our two security groups into Redspin, we now have a broader offering to provide to our clients. More importantly, these additional services result in longer-term consulting contracts and a closer ongoing relationship with C-level executives at these organizations. Redspin has hundreds of healthcare customers. Combined with Auxilio's 220 MPS hospital clients, the opportunities for cross-selling in both directions are enormous. We are actively engaged in several places and are adding additional sales consulting resources to help us, to enable us to take full advantage of our unique position in the market. Several of these cross-selling opportunities we are pursuing are evolving into the later stages of negotiation and I hope to be able to share the details of those agreements with you in the near future. To summarize, to be able to transport long-term growth in the market, it will take years for the healthcare sector to reach the level of security maturity which is demanded of them. Our ability in the Company to provide top-level security services improves exponentially when we combine forces under the Auxilio umbrella. We are just beginning to reap the benefits of this business combination and I think it's safe to say that security will become a very significant part of the future of Auxilio. And I agree with the comment that Joe made earlier, the current environment in the security space is an opportunity unlike any ever experienced before. We have the right people, the right tools and we have better presence within the largest health systems in the country, we are certainly in the right spot at the right time. With that, Joe, I'll hand it back to you.

[Joe Flynn:]

Thank you, Dan. In closing, it is pretty obvious that we are excited as ever about what lies ahead at Auxilio. We have laid a great foundation for the future and the market trends are in our favor. Our team has proven, we can service any size organization and are able to demonstrate a strong value proposition by delivering on our objectives for the customer. Going forward, we will continue to expand into higher-margin value-added services through our investment in the IT Security Solutions Group. We now have a truly integrated solution and can effectively become a one-stop shop. This complete offering is unique and is aimed at ensuring enterprise-wide security, mitigating risk and improving efficiencies across the organization. That provides a wrap for today's prepared remarks. Thank you for your continued interest in Auxilio. We appreciate everyone joining us for today's call and we'd like to open it up for questions. Operator?

[Operator:]

[Operator Instructions] We'll take our first question from Dallas Salazar from Atlas Consulting.

[Dallas Salazar:]

Good quarter. I just had a few and I'll start up just kind of with some of the contract integrations and implementations, how do you guys plan to sort of guide that out to the market? I mean from a cadence standpoint, would we be getting X amount of facilities, healthcare facilities in an 8-K a few months later? How sort of is that going to be communicated to the market?

[Joe Flynn:]

I think it's a great question and we probably should be a little clearer on that, particularly as it relates to for example the Trinity contract or the $50 million contract that we announced earlier this year. That's an 18 months process. So just to give you an example, the first region, that particular contract is broken into five regions, it's going to take us about 18 months where we'll stand up in all hospitals. That first region was implemented starting in June and will be finished by the end of this month, and then we'll start the second region. And so over the course of time that will take place. So that will be the longest term kind of implementation. Yale-New Haven will probably take us about six months. This last one, we just announced the $6 million contract, will probably take us three months. So really I think between now and this time next year, we'll be implementing all the hospitals that we just announced over the course of last six months, or all those contracts over the last six months. So what we probably will do mainly starting with the next conference call is give you an update as to where we are with those implementations, so that people can kind of track that.

[Paul Anthony:]

Because historically especially for deals this size, the implementation schedules are fluid. So in many cases we'll end up moving regions, either delaying them or moving them in front of other regions. So we don't provide necessarily any guidance on these. We just try to give a general update as to how things are progressing and then when we've finalized those implementations when they are of that size.

[Dallas Salazar:]

Right. Okay and I guess that was the other, I guess Part B to question one was, who is sort of in control of that schedule, and then I guess, could you just answer that? I guess the other question would be, if you guys had say a separate credit facility or some type of line where the lender would consent and say, as long as these go to the implementations, you can run this line up at whatever speed or however you base, can you do that because the capital is going to be tied to something productive, would you guys think about sort of pulling forward some of that growth by borrowing if you could speed it up? I mean I know you're not in total control of that but is that something that the Company is open to?

[Joe Flynn:]

At this point in time, at least we're not, and we have enough funds to implement the accounts that we have. The issue is operationally our ability to implement any faster. We are already stretched. And so this is about the maximum that we would ever want to see at any given point in time and there's probably a little more than what we would be really comfortable with. And so at this point in time we don't think that that's necessary because the amount of accounts or the amount of hospital and locations that we are going live with is already kind of pushing us to a limit.

[Dallas Salazar:]

Right, okay. And then just my final question here, and thanks for taking three from me, but for some Web-sites and publications I cover a lot of private tech markets and seeing a lot of activity for penetration testing, sort of in the security space. I know you guys just picked up that capacity, but should somebody come to you with sort of a frothy offer or something that maybe even you guys look at and say, this is getting to the point where it almost doesn't make sense, is that something that you guys would divest transactionally or is that something you're saying, this really isn't for sale, it's going to be part of our platform going forward?

[Paul Anthony:]

I'll take that. I think we're just getting involved in this right now. And yes, you're right, there are a lot of frothy valuations out there for a lot of these companies that are doing essentially the same thing that we're doing. You never want to say – you always want to be open to different ideas but we feel that there is an opportunity, and one of the reasons we got into this, is we feel in healthcare in particular, in the healthcare sector there is an opportunity to carve out a leadership position which is our goal, our stated goal. And so we're in the very, very early stages of that, and Dan was a big inspiration in helping us see this and is actually helping us identify other opportunities in the marketplace where we can accelerate that opportunity. So I would say, we're more in a building mode right now because we still think that there is an enormous amount of upside capacity here.

[Dallas Salazar:]

Okay. Thank you, guys. Great quarter. I'll chat with you guys in three months.

[Operator:]

We'll take our next question from [Roger Marfo] [ph], a private investor.

[Roger Marfo:]

I've been involved with your Company for the past 10 plus years. I come away with one basic question. When will the Company become profitable?

[Joe Flynn:]

Roger, you've been listening for quite a while, we've had times when we've been profitable and then times when the Company experiences tremendous growth, like we are now, which makes profitability harder to get in the short term, given the nature of our business model. But given what we have in front of us, we feel comfortable that the Company will be profitable again, can't tell you exactly when, but if you look at our historical numbers, you'll know that when we have these big growth spurts, there is this period of time where we have to take on all this business and all this expense and then eventually as those accounts get mature then the profitability becomes a reality, which has been the case over the course of the last, specifically over the last seven or eight years.

[Roger Marfo:]

But when I say the word 'profitable', in my mind what I mean is, putting a string of say four quarters, one year together, that yields a profit, four profitable quarters in a row. As far as my following of the Company, I really have only seen that done twice in the 41 quarters that I've been following it. The third quarter that I was hoping for a black or positive number fell flat on its nose and therefore the sustained profitability went away. So my basic question is, when do you foresee – and I realize the growth. Right now you guys are pushing a year-end of $60 million. What is the goal, $100 million, $150 million? But until that goal is met, I don't see you guys putting together four quarters of profitability in one year where you can say, we made in this year X amount of dollars. Your expansion is great but on the bottom line the EPS never turns out to be a profitable number on a sustained basis. So I'd like to know if there is a goal, number one, is it $100 million on the top end, but in the interim period, can we please possibly have one year or four quarters in a row of profitability? I understand the growth that you are seeking, but at the same time there's got to be some EPS to go along with it.

[Joe Flynn:]

Roger, we hear you.

[Roger Marfo:]

That's frustration on my part. I'm sure you can feel it in my voice.

[Joe Flynn:]

Yes, and I think, Roger…

[Roger Marfo:]

Four quarters, give me four quarters of profitability in a row in one year that you say you made a profit, and I might feel like a happy camper.

[Joe Flynn:]

And I think, Roger, that's why we're taking some of the steps we are taking to…

[Roger Marfo:]

No, expansion, expansion, you guys just expand, expand, expand, and never give it time for the EPS to catch up to the expansion. And then once I hear the word 'expansion' or a new contract, to me that's expense, meaning that this quarter we can't assume to see a black number, and that's very frustrating. It's like when do you take the pause to say we made some money.

[Joe Flynn:]

I understand, Roger.

[Roger Marfo:]

You guys haven't been profitable. 10 years of unprofitability. If I was presenting with your Company today and looked back and say, they haven't even turned a profit in 10 years, that wouldn't be a very good sales pitch to me. That's where I'll leave it.

[Joe Flynn:]

I appreciate your comments.

[Roger Marfo:]

Give me an answer. Give me an answer to the top line. What are you going for, $100 million?

[Joe Flynn:]

I'm going for every opportunity we can to increase our numbers.

[Roger Marfo:]

That means the bottom line will never see four quarters in a row of positive numbers. [Indiscernible] come out before you got to implement it and that means for the next one or two quarters you're going to be negative. So I guess your philosophy is, grow, grow, grow, grew the bottom line. See you guys.

[Joe Flynn:]

Okay.

[Operator:]

We'll take our next question from Jeff Bash with General Pacific Partners.

[Jeff Bash:]

That's sort of a tough act to follow, ask, ask, ask. I was asked to ask a related question, so I'll save that for the end. You talk as if you had a loss now and you're going to continue for a while, but if you look at what you just reported, it is nearly $500,000 of nonrecurring SG&A due to the acquisition, $330,000 for severance and integration costs, $70,000 in professional fees and $100,000 for travel, which were identified in the 10-Q. So unless I'm missing something there, I would characterize this quarter as breakeven.

[Joe Flynn:]

That's right, Jeff.

[Jeff Bash:]

I'm assuming from the tone of your remarks that you don't think gross margin has bottomed out yet and it may get lower still before you hit a crossover point where you have installed two or three regions or generating normal type profits and that overcomes the drag from installing other ones. So that's my first question, have we yet bottomed out on gross margin or not?

[Joe Flynn:]

Jeff, that's our hope at this point but we don't – as you know, we don't provide guidance. But again, we are in the front end of a number of large implementations and we have absorbed obviously the first piece of the Trinity implementation which is a single largest piece of that. So we feel pretty confident that we have taken at least the largest piece of our hit, but again we're right in the middle of this implementation or the start of it. And so our hope is that this thing would have flattened out and now is on its way out, but again we're still early.

[Jeff Bash:]

Okay. I have a few more financial questions, but let me ask the security one now. Are you pursuing any other acquisitions at this time or are you still mostly integrating the existing ones and pursuing opportunities with others?

[Paul Anthony:]

We are definitely integrating our current stuff. I think we're pretty well integrated at this point between Delphiis and Redspin under Dan's leadership with two different, basically a team here in Mission Viejo and a team up in Santa Barbara and then our engineers out in the field. Definitely in the marketplace, in the healthcare IT security marketplace, there are opportunities for us that are being presented. Our ability to continue to, back in the other person's question, now that we have the opportunity with a platform business in the MPS and cash flow and visibility into profitability in the future, it's much easier for us to look at these acquisition opportunities very seriously because when you leverage what we've built to date to do that. So most certainly we're looking at different things. Whether we're actually going to get them, can afford them and everything falls in line remains to be seen, but most definitely we're in the market and looking at those opportunities.

[Jeff Bash:]

Okay. Now in the past I think you've publicly stated gross margin and operating margin targets for say a normal business situation. You're clearly onto that now with having 50% or larger growth. And you've also, since you've mentioned it in the past, have implemented the security business which is now over 10% of sales. So I'd be interested in knowing, what do you have in your head as standardized gross margin for a business that's growing at a more normal rate, not at a fantastic rate, and what kind of operating margin do you think would be associated with that?

[Paul Anthony:]

We're still working through some of that. I mean we're definitely looking at an MPS margin in that 20% range and we still are looking at the security business' gross margin of in that 45% range, is what we're shooting for at this point, Jeff. And so it's going to take us a little bit of time to get caught up here on the MPS, and we definitely put some investment into the security businesses as we shoot that, but those are some of the gross margins that we are shooting for in those particular offerings. And we're still working on kind of the mix and how quickly we think the security business can grow. And so we'll have a better understanding as to what the business mix and the ultimate margin is for the organization as we start to get a better flavor and understanding of that business.

[Jeff Bash:]

And operating margins are, you have anything there?

[Paul Anthony:]

We are still working through that. Obviously we've always trying to be shooting for around that 7%, and then now with bringing in the new businesses, we probably with the security business, we are going to want to see that increase a little bit, and so we're still hoping once we get the full maturity of the new MPS deals and getting security fully integrated and up and running, I would like to see us get closer to 10% or high.

[Jeff Bash:]

This directly goes to the last gentleman's questions. Alright, next, you raised about $1.7 million net of cash from financing during the quarter and the decrease from $5 million mostly having due to money paid out in connection with acquisitions over the last year. Did you really feel the $3 million plus was not enough to operate the business or is this more for appearances with your huge current and possible future customers?

[Paul Anthony:]

You're exactly right. Basically we like to maintain a strong balance sheet, especially with some of the larger MPS clients, some of the larger healthcare providers to ensure – when you're signing a three or five year agreement, we found that that adds a lot more comfort to the customers when they're looking at this opportunity.

[Jeff Bash:]

My last question is related to the prior gentleman's, and I was asked to ask it, but I'll ask it a little differently. As you know, I've been a holder of this stock for many years and I've been really bullish on the potential. But if you look at the chart, the stock really is traded at $1 plus or minus for most of the last 10 years. What do you think it takes to get off a dime here, and considering that at least I think the stock is, the Company is very undervalued, are there any opportunities to acquire the Company, has anyone ever talked to you about it and what would be your interest in such communication if you got one?

[Joe Flynn:]

I think I can address I guess the attempts that we want to make towards getting a broader audience for the stock. We really believe long-term that we need up-list to a major exchange and that was the stated purpose really for our request for a possible reverse-split should we decide to up-list and then be able to do that. So we asked the shareholders to do that and they granted us that permission. We definitely feel that one of the things holding us back being on the Bulletin Board, as we all know, is a fairly limited audience of people who could potentially buy our stock, I guess number one. So that's a goal we want to accomplish. But that's all about timing and how you do that and do it the right way, and we're investigating that right now. The second thing I would say is, we've made a pretty bold attempt here to begin to diversify our offering, especially into an area like security that has a lot of [eye garner] [ph] right now in the marketplace, and Dan Berger has taken this meeting on many occasions which is the truth, and it's one of these kinds of market opportunities that has really no end in sight. So it's not like Y2K or something like that, year 2000 comes and then it's over. In this case, security is going to be a continuous problem, a continuous threat and healthcare is woefully underserved in this area. And so we're really in kind of a precipice situation here right now where we have a number of opportunities in front of us in that particular area and we believe strongly if we execute properly, and it's going to be all about execution, it can really drive the valuation of this business along with a very strong platform in MPS. And so that's what we would like to accomplish. I would take a little issue with Roger's comments. When you are trying to build a business – we're still a fairly small company, even with our revenue growth and so forth, we're still under $100 million. And so, yes, we absolutely want to go after that $100 million revenue mark because that's where you get – especially if you're getting it on a major exchange, that's where you get meaningful, I think most people would agree that are on this call, that's when you're going to get meaningful attention from the public markets. And so that's a short-term goal that we want to accomplish as quickly as we possibly can. And as Paul said, we know our experience has been in each one of these accounts, especially these larger accounts, and they're being significantly – drawing off significant amounts of cash once we get them mature. So I don't know if it answers your question but that's really kind of where we're going. We want to invest in high-growth high-visible markets like security and continue to take on the business to drive the revenue towards that $100 million mark and get those margins to those targets, the operating margins to those targets that we talked about, closer to that 10% once kind of the dust settles in and as growth slows a bit.

[Jeff Bash:]

Are there any companies that might consider Auxilio a reasonable target for acquisition? I know you have Mr. Leonard from formerly of Aramark on your Board.

[Joe Flynn:]

I think that we have not – and I've said this before, we've not put out our shingle that says, we are for sale, take a look at us. We're always in the marketplace and people know who we are, we are getting more and more known. We would be an interesting target for any of those types of large IT services or even OEMs and so forth. But we're not focused on that, we are really focused on how do we drive the value given the opportunity that's in front of us right now.

[Jeff Bash:]

Okay. Let me just make two quick observations and I'll get off. I think your business model of recurring revenue is grossly under-appreciated by the market. I think that's really a significant plus for the Company especially as the economy isn't doing so wonderfully. And the second comment is, I think people if they looked at the $1.6 million of security revenue in the first quarter and annualize it and threw on a multiple that security companies seem to be getting these days, my find is that you've got double the total current market value of the Company just in this one little element.

[Joe Flynn:]

Thank you, Jeff.

[Operator:]

We'll go next to JD Abouchar from [Glass Street Capital] [ph].

[JD Abouchar:]

Joe, couple of questions for you. First, I'm assuming the equipment margins were at or near zero gross margin, because it's basically a pass-through.

[Joe Flynn:]

Yes, they were a little bit better than that, they were around 5% to 6%, JD.

[JD Abouchar:]

Okay. And are the equipment revenues, I know they are awfully lumpy, is that something that again is sort of part of the implementation where we'll see more equipment revenues early as you are onboarding the hospitals as you have to sort of swap out stuff and then it tapers off as you sort of start mainstreaming them?

[Joe Flynn:]

Not necessarily in the front-end. They are traditionally spikes during that five-year process and they are usually in the first two to three years, but they aren't necessarily at the beginning. But it is an area that we focus on as we start to drive profitability in new account, is when we start to convert out that equipment.

[JD Abouchar:]

Got you. And then one of the things you used to talk about in the past, maybe you can talk about it differently, is you talked about sort of your, for want of a better word, backlog of annual recurring revenues. With all these new contracts that you've done so well in landing, you really haven't sort of updated that number. Is there a way maybe you guys could talk about sort of what you see, with just the current accounts and onboarding them, sort of what the annual recurring revenue or backlog or run rate is or something to help us understand what the Company looks like a year from now?

[Joe Flynn:]

JD, we will be able to. It's a little early because of where we're at in the account, but we'll take that into consideration for the third quarter and give you more visibility into that. And the reason I'm hesitant is because of the amount of growth that we've got coming in the early stages that it's in, I'd like to get a better feeling for where we see that run rate going before I put an amount there, but I'll make sure that we put out some additional information regarding MPS recurring or recurring revenue run rate that we've got. And if it ends up being a contribution from the security business that's recurring, we'll also look to try to give you some of that as well.

[Paul Anthony:]

We'll have more clarity on that by the time the next call comes because we'll be done with the second region of Trinity at that point, JD.

[JD Abouchar:]

Okay. And with security now getting around 10% of revenues, is there a thought about perhaps breaking that business out on at least a margin standpoint?

[Joe Flynn:]

I have to look into that. We really got to look at kind of how we're going to report this information from an SEC perspective and making sure that we look at the business based on the different offerings and so on. So that's something we are developing now as this business starts to grow. So we'll keep you updated on that.

[JD Abouchar:]

I guess the final question then is, Joe, you talked about sort of getting to $100 million in revenues, sort of a nice critical mass milestone from the investor standpoint, but maybe you could talk about from the model standpoint, I assume that there are some synergies and some leverage in OpEx from putting on a third, fourth, fifth region of the same hospital network, that while gross margins in the MPS may be difficult to get above 20%, you should be able to see some synergies in operating leverage help the bottom line.

[Paul Anthony:]

That's absolutely right and that will kind of play itself out here over the next several quarters as we get these hospitals up and running.

[Joe Flynn:]

And we went through a stage, JD, where we didn't have to add any operating expenses associated with the increase in sales that we've experienced over a couple of years, but now with the large amount of accounts that are coming on and the visibility of when they are coming on, it's almost like a cliff, we kind of move up in stages. We've now gotten to another point where we've had to add some additional operating expenses to prepare for this growth that will support us for a couple of years. So we don't anticipate any material changes after this year in our operating expenses associated with supporting that side of the business, but that is hitting us now because we had to prepare for taking on the 80 plus hospitals.

[Paul Anthony:]

The only thing that would impact that, JD, is if we got another gigantic contract in the next 12 months.

[JD Abouchar:]

Got you.

[Joe Flynn:]

I just want to reiterate, just to answer [indiscernible], we wouldn't want to – no business would want to turn that away no matter what. I want to be real clear. If we have another opportunity with another multi-state health system, we're absolutely going to take it because it really helps the long-term health of the business. We know at some point things are going to slow down but we're still really just at the tip of the iceberg in this marketplace. And so that is what it is.

[JD Abouchar:]

Absolutely. I love the growth. We just don't want to lose too much money bringing that onboard. I guess final question on that is, the prior gentleman sort of pointed out about $500,000 in expenses in the quarter were sort of one-time in nature. I don't want to assume I can just take that out of third quarter expenses, especially in light of the fact that you talked about sort of a step function and some OpEx. I would like you to sort of clarify that those were sort of one-time in nature and shouldn't be recurring going forward.

[Paul Anthony:]

There absolutely is approximately $350,000 or $400,000 that were tied specifically to integration and acquisition activities that we do not anticipate, unless we do another acquisition, we don't anticipate to be part of the business in Q3 or Q4.

[JD Abouchar:]

Perfect. Thank you, gentlemen.

[Operator:]

We'll go next to Paul Nouri from Noble Equity Fund.

[Paul Nouri:]

When the first caller had mentioned kind of front-loading the project activity to bring the revenues on quicker, you had alluded that you didn't really have the capacity to do that, which I understand, but does that imply that you're not going to go as hard after the contracts right now over the next 6 to 12 months until you integrate Trinity and Yale or am I misunderstanding that?

[Joe Flynn:]

No, as you said, we're not going to – I mean we are going to continue to pursue business like we would at any other time. So if we get lucky enough to where that problem does occur, then we will have to evaluate what position we're in with the current accounts and where we're at from a cash flow perspective and funding, but we're not going to go out specifically to raise funds to support trying to grow any quicker, especially in light of what we heard today. But we feel the level of growth is sufficient and as long as we can keep that pipeline going of implementations to where we can consistently see anywhere between 10 and 15 a quarter, it would be great. I would love to see it be a little more less spikes and a little more consistent on a quarterly basis with these implementations and these accounts, and so that would be my preference as opposed to necessarily having to throw 80 on in 12 months.

[Paul Anthony:]

It is a 12 month sales cycle, the MPS contract, big multi-site, multi-year, multimillion dollar contracts and they take a long time to close. So that's actually been official to us right now because it can help us spread these things out. If we do get lucky enough to get another one, it would be nice to close it as far as the second quarter next year versus next week, because then it just adds into the [indiscernible], right. But again, it's a problem we have no problem having.

[Paul Nouri:]

Okay. And then as it relates to the Redspin acquisition, you've talked about revenue synergies a couple of times. Is the point of sale, the person that you are talking to at the hospital system, is that the same person for both the MPS and the security side?

[Joe Flynn:]

Not exactly the same person. In the case of the MPS, many times we get brought in through their supply-chain organization, but invariably we report then to the CIO. Once the contract is done, then we essentially become a department inside of the IT organization. So the point of sale is not exactly the same unless the health system is being driven by the IT organization and they also manage the print side of the house. So it really depends on the culture of the health system and every one of them is different. Invariably though, the CTO and the CIO play a major part in our MPS business and most definitely manage the whole security aspect. So in our existing customers, without a doubt it's the same customer, it's the same stakeholder, but in new accounts it takes a little bit of time to exactly figure out who the players are because a lot of times we're dealing with supply chain which has nothing to do with security, if that makes sense.

[Paul Nouri:]

Yes. And there weren't much in the way of cost synergies with the combination of the two companies?

[Joe Flynn:]

Very little.

[Paul Anthony:]

There was very little. There were some synergies with the two security companies.

[Joe Flynn:]

Right. With the two security companies, there were synergies which we took advantage of and that should move in that direction very quickly, but Auxilio or Redspin there wasn't an enormous amount of synergies.

[Paul Nouri:]

And I don't know if you've reported this in the past, but can you give us any insight into your contracts retention, maybe the first six months of this year versus last year?

[Paul Anthony:]

We don't traditionally or we haven't in the past ever provided any of that information. So at this point, again that's something we could take into consideration and we can try to provide some information going into Q3.

[Paul Nouri:]

Okay. And then final question, you talked about if you can get up-listed that it would be good for investor visibility. Are you taking any steps to get up-listed or are you kind of waiting for something to happen?

[Joe Flynn:]

We're absolutely investigating and seeking out which exchange to go on. We kind of narrowed it down what we'd like to do, beginning sort of the application process now. The issue is going to be a matter of timing of it, what's the best timing and the mechanics around that. So from our standpoint, it's not a matter of if, it's a matter of when.

[Paul Nouri:]

Okay, thank you.

[Operator:]

We'll go next to John Gay from the Quiet Investor.

[John Gay:]

A good quarter I think. I think you can sense that the people on the call that there was a frustration about happiness of the top line growth and the unhappiness of not getting the bottom line in sync with it, and it's something like jam yesterday and jam tomorrow but not jam today like in Alice in Wonderland, but I was going to say rather than ask questions and tell you that, as you are trying to get up-listed and a reverse split in the mix, I would suggest not doing it until you have black on the bottom line because you're going to have an inevitable drop from people who are frustrated themselves because they will see a higher price and still no higher earnings. If you put substantial numbers on the bottom line, the stock will be $4 or $5 even if you have to buy it in the [indiscernible] and Coney Island. So I would just say, become above the position of the stock, we are all waiting for that to happen, but I would really not like to see a reverse-split until you put some numbers down on the bottom.

[Joe Flynn:]

John, it's a good advice. And we stated this many times before, we are building a company. Some shareholders have been in for a long time, we understand that, but it takes a long time – if you want to build a great company, it takes a long time. You're going to have your ups and downs. We feel like we have nothing but ups right now. We're posting big growth numbers. We're excited about that. We're getting involved in highly valuable, highly profitable segments like security. We feel like we're trying to make all the right moves to increase the valuation of this business. And I agree with you, and again, we're taking all that advice, advice like the one you just made about post some earnings before you do the reverse-split and do all those kinds of things, we understand that, we understand those mechanics make sense, and that's why we're not in any rush. We want to do it the right way, we want to do it to benefit shareholders and to provide a broader audience for our Company in the markets, and it's not like we desperately need to do it tomorrow, we want to do it the right way.

[John Gay:]

Yes, that's good. I agree. I think most people on this call, even though they are frustrated, are willing to stick around because they think there is some magnificent growth ahead of you, and I think this is a $5, $10, $20 stock in time. We just need to see something on the bottom line, and I know it's coming, but bring it soon. Thanks, Joe.

[Operator:]

With no further questions in the queue, I would like to turn the call back over to Joe Flynn for any additional or closing remarks.

[Joe Flynn:]

I just want to thank everybody very much for joining us on this quarter's call and we look forward to hearing from you or talking to you in the next quarter. Thank you very much and have a great rest of the week.

[Operator:]

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