Q3 2015 Earnings Call Transcript

Published: 17 Nov 2015

[Operator:]

Good day, ladies and gentlemen and welcome to the Auxilio, Incorporated Third Quarter 2015 Earnings Conference Call. Today's call is being recorded. At this time, I would like to turn the call over to Mr. Mike Cole, MZ Group, North America. Please go ahead, sir.

[Mike Cole:]

Thank you, operator. Good afternoon and welcome everyone to Auxilio's third quarter 2015 earnings call. Joining us today from the Company are Mr. Joe Flynn, President and Chief Executive Officer and Mr. Paul Anthony, 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 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 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. 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. Growth in our MPS and Security Solutions Group offerings remain robust. This was a quarter defined by solid operational execution, as we continue to work through the implementation phase of several large contracts that we commenced earlier in the year. We are currently implementing 18 hospitals within our MPS offerings and are approximately 70% of the way through the implementation process with our two largest contracts. This rapid pace of expansion along with increased traction within our Security Solutions offering should continue to drive top line growth for the foreseeable future, while we expect margins to continue to improve during 2016. As we mentioned on the last call, given the number and sheer size of the recent implementations, margins are still at the lower end of the range as we work through the cycle but up nicely from last quarter. As most of you know, and for the benefit of those new to our story, margins are compressed early on with new implementation and then begin to improve approximately 12 to 18 months from the onset, eventually stabilizing at higher levels in years three through five. While we can make no assurances about the future, that has been historical norm. The current overall margin levels remain somewhat skewed to the downside by those recent large contract wins totaling over $80 million in five year recurrent service revenues. Considering we're at the very beginning of what we expect to be a long maturation cycle, we are pleased with the execution to date and believe everything is tracking to plan. We have also have developed significant asset in the form of three established long standing relationships with many of the largest health systems in the country. We have worked hard to become a trusted resource who delivers a significant value proposition and we are leveraging this to win incremental MPS business with embedded customers, but also to see the first tangible benefits for our Security Solutions Group associated with this effort. Earlier in the year we were focused on integrating the Redspin and Delphiis acquisitions to form our Security Solutions Group. Although this restructuring has had a short-term impact to the Delphiis consulting revenue, we have invested heavily in creating a robust end-to-end security service offering of the highest quality. Last quarter Redspin reported and during the first six months of this year it had provided penetration testing, to more business associates than during all of 2014. That momentum continues and we are pleased to report that October was Redspin's best month ever from a booking standpoint. This couldn’t come at a more critical time for the healthcare security industry. According to a recent survey, 88% of chief information security officers and CIOs report that their security budgets has increased in response to high profile data breaches and many are increasingly using frameworks to define cyber risk and prioritize investment. Our standard best practice security program framework has proven to meet demands of security practices for many leading health systems and was our sweet our assessment security services we have the conduit through our existing MPS customer base that can expedite our ability to gain market share. Customer feedback continues to be favorable and we are well positioned going forward. Our vision of becoming a recognized player in healthcare information security is one which will be realized through organic growth and through opportunistic complementary acquisitions. We anticipate that security based revenues will drive incremental recurring growth while enhancing margins. During the quarter, I believe we did a tremendous job from an operational perspective, given the enormity of the task it have. We expanded our capacity to bring these large scale implementations and we executed well across the board. At this time, I will turn things over to Paul who will go through some of the financial details. Paul?

[Paul Anthony:]

Thanks, Joe. For the three months ended September 30, 2015, the Company reported revenues of $15.7 million, an increase of 39.7% when compared to $11.3 million reported in the third quarter of 2014. Approximately $2.7 million of the increase is a result of the addition of new recurring service revenue contracts. The Company added approximately $1.1 million in service revenues and software subscriptions from the company Security Solutions offerings, in addition to an increase of $0.9 million in equipment revenue, compared to the same period in 2014. Cost of revenue was $12.9 million compared to $8.7 million in 2014, increase in the cost of revenue in the third quarter is primarily attributable to the addition of new recurring service revenue contracts recurring approximately $1.9 million additional staffing cost, including contract labor, approximately $1 million in additional service and supply cost and approximately $0.2 million of additional travel costs principally is a result of the implementation work for these new contracts. Equipment cost increased by approximately $0.9 million in 2015 primarily the result of the increased equipment revenues from [indiscernible] refresh activities. Gross profits for the third quarter was $2.9 million or 18.3% of revenue, compared to $2.5 million or 22.6% of revenues for the same period of 2014. The drop in gross profit percentage is directly related to large number of implementations that we currently tackle. Operating expenses for the third quarter were $2.3 million, an increase of $0.6 million compared to the third quarter of 2014. Sales and marketing expenses increased by 36.6% due to increased sales and marketing staff added in the first quarter of 2015 to expand our geographical reach to support the sales effort for newly acquired business. General and administrative expenses increased 33.7% to $1.6 million, due to integration efforts initiated with the two recent acquisition and increased expenses associated with the recently acquired Redspin business. The Company reported an operating income of $0.6 million in the third quarter of 2015 compared to $0.8 million in the third quarter of 2014. Net income for the three months ended September, 2015 was $0.5 million, or $0.02 per share basic and diluted share, compared to a net income of $0.7 million or $0.03 per basic and diluted share in the same period of 2014. Excluding $0.2 million in charges related to stock based compensation and $0.1 million in amortization of intangibles, we achieved an adjusted income from operations of $0.9 million in the third quarter of 2015, compared to adjusted income from operations of $0.1 million, after excluding charges of $7,600 related to the stock-based compensation and $5,300 for amortization of intangibles for the same period last year. At September 30, 2015, the Company had $5.2 million of cash and cash equivalents and working capital of $1.9 million. Cash provided by operating activities in the first nine months ended September 30, 2015 was $0.9 million compared to $1 million during the same period in 2014. The Company maintained line of credit with commercial bank for up to $2 million which can be utilized to help fund some of our growth initiatives. For the nine months ended September 30, 2015, the Company reported revenues of $45.2 million, an increase of 41.8% when compared to $31.9 million reported in the same period of 2014. Approximately $5.2 million of the increase is a result of the addition of new recurring service revenue contracts. The Company added approximately $3.9 million in service revenues and software subscriptions from the Security Solutions offerings, in addition to an increase of $4.4 million in equipment revenue, compared to the same period in 2014. Gross margins were 15.8% compared to 18.8% in the same period of 2014. Operating expenses for the nine months ended September 30, 2015, were $7.2 million, an increase of 41.9% from $5.1 million in the same period of 2014. Sales and marketing expenses increased by 40.4% due to increased sales and marketing staff headcount in 2015 to expand our geographical reach and support the sales effort with the newly acquired businesses. General and administrative expenses increased 42.6% to $4.9 million due to the integration and expansion of our Security Solutions Group. The Company reported marginal operating income for the nine months ended September 30, 2015 compared to operating income of $0.9 million in the same period of 2014. Net loss for the nine months ended September 30, 2015 was $0.2 million, or $0.01 per basic and diluted share, compared to net income of $0.07 million or $0.03 per basic and diluted share in the same period of 2014. Excluding $0.4 million in charges related to stock-based compensation and $0.3 million in amortization of intangibles, we achieved an adjusted income from operations of $0.7 million for the nine months ended September 30, 2015, compared to an adjusted income from operations of $1.3 million, after excluding charges of $0.3 million related to stock-based comp and $5,300 in amortization of intangibles for the same period last year. We're encouraged by the progress of our Security Solutions Group. This combined with the recent implementations of our large MPS contract should continue to drive substantial revenue growth. 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. Joe?

[Joe Flynn:]

Thank you, Paul. In summary like I said earlier, this was a great quarter from an execution standpoint. The first part of the year was one in which we invested heavily in the future of Auxilio both in MPS and Security Solutions offerings, and we anticipate future investments to continue as the market leader in healthcare MPS and security. And that provides a wrap up for today's prepared remarks. Thank you for your continued interest in Auxilio. We appreciate everyone joining us for today's call and we'll open it up now for questions operator.

[Operator:]

Thank you. [Operator Instructions] And we'll take our first question from Dallas Salazar with Atlas Consulting.

[Dallas Salazar:]

Hey guys, good quarter. It sounds like things are going great. Thanks for taking the questions here. I have two, and the first one – actually it's two parts [indiscernible] so hope it's not too much to kick things off, but I wanted to know just in general, how much budget from each of your MPS clients is potentially ready to be cross sold into IT Securities or just sort of how much budget in general could be made available in terms of a broader MPS budget. Is it 3%, 5%, 10%, just general assumption on that figure. And then the second question would be, it's sort of the same but with the different angle, have you seen that things are growing either in composition sort of shifting from MPS to IT Securities or has it been growing in total volume, just anything you comment on from that standpoint? And then I have a follow-up if I can afterwards.

[Joe Flynn:]

Okay, thanks Dallas, that’s a very good question. So I can speak in general terms in the healthcare industry or let's say the healthcare provider industry, that they are traditionally have been 5 to 10 years behind other large industries like the financial services industry. And to give you an idea, the financial services industry typical budget for IT Security is around 10% of their total IT budget. In healthcare that has been in the 2% to 3% range but given what's happening and giving the increased scrutiny and the growth in the number of breaches, according to a group called CHIME which is kind of the council of CIOs in healthcare. They're looking at increasing healthcare IT Security budgets to 5% going into 2016 and climbing to get to that 10% over the next few years. So there is definitely a heightened interest, heightened need to spend more in IT Security and that provides us with a great – I think opportunity and a great opportunity to go after a larger amount of that budget as we could be in the market place. So I hope that answers your first question.

[Dallas Salazar:]

No that does. And that’s, I don’t know if you all sort of the analysis myself here and that’s kind of what I've been hearing and so which is an interesting sort of fact to hear and I guess that’s flows well into my second question which would be, there is that significant lag in the space, in the healthcare space and can you talk about the general dynamic for both MPS and IT Security, like how much time are you guys spending, out of a 100% of your time, on education versus a selling, I mean are we still in more in the education pace for the space, I know you're lining your big deals and they're with singular brand names which is great and I don’t know where it comes from [indiscernible] coming through the door, but it still seems like there is a lot of education to be done and you're just scratching the surface, I mean can you just talk about the general dynamic there sort of like that? And then maybe a few seconds on the end of that, can you talk on like lead generation, so how much of that is outbound versus sort of inbound, people starting to pick up on this MPS and IT Security and going, okay these guys are the comprehensive package, and I'll go into mute, but thank you for your answers and I'll take them in mute.

[Joe Flynn:]

So I'm going to address MPS first in terms of educating the market. One of the challenges in the Managed Print Services business is that there are so many definitions and so many different companies defined – so many different vendors define MPS differently. So there is a level of education and certainly like often times we'll participate in RFPs and the RFP might be skewed much more towards buying equipment or purchasing equipment versus providing a full blown service. And so we find ourselves definitely still educating the market on the type of MPS program that Auxilio provides which is a full service. We take over the entire environment, we take overall the vendors, we provide all the service, it's more comprehensive service. We definitely find ourselves educating the market more on that but certainly since we started the business, the markets much more educated than it was 10 years ago. I just recently came from a conference that I went to at Nashville, in fact myself and one of my colleagues sat in front of 12, 15 executives from healthcare institutions talking about – it was an opportunity for us to kind of pitch what we do and let them pick a part our business model, and it was interesting in there the various different definitions of MPS that came out. So, there is a lot of still education that we're doing in the market as you know, it's very, very large we only have – we're still only operating in about 260, 270 hospitals where there is 6,700 still to go after. So there is still a lot of opportunity, and from a marketing perspective we like doing these one-on-one types of conferences where we get in front of executives at the decision making level, they're a little more expensive but you get to a decision maker versus just going with general trade show, so that’s one big lead gen. We've got two full time sales people, one on the east, one in the west generating opportunities for us as well through their role objectives and through their marketing efforts. And then we typically employ a number of outside consultants, these are former CIOs or former supply-chain executives that work in healthcare that walk us into opportunities. So that’s what I can say from the MPS side. From the Security side, it's very much an IT sale, so you're not really selling to anybody other than the CIO or the CISO which is the Information Security Officer and to a certain extent as well the compliance people. There are a number of specific types of events we go to there, which again we like those one-on-one high level events where we get some of our experts on the team, Dan Berger and others getting up and speaking in front of these groups talking about what's going on in the market place. We specifically like an organization called CHIME which is abbreviated form of the Council of Healthcare Information Management Executives, and it's really the CIOs of all the major health systems. We are members of CHIME and would like to focus on that. There is a lot more education in the IT world around security versus MPS if you were to – because it's much more of a high priority situation. People don’t typically get fired if their MPS program is working very well, but if the security program is not working well then they get fired. So, from a focus I would say at the IT level certainly Security is much higher focus. MPS on the other hand is important because it touches everybody in the hospital, as well there are many different groups involved and say things that can be cornered from a comprehensive MPS program like the ones we're doing with some of our large customers, is quite large, the number of – the dollar savings is quite large. So I hope that answers your question as much detail as possible.

[Dallas Salazar:]

Yeah, no thank you, I appreciate that guys. I look forward to talking to you guys next quarter. Thanks so much.

[Joe Flynn:]

Thank you.

[Operator:]

Thank you. And we'll go to JD Abouchar with Two Lakes Capital.

[JD Abouchar:]

Hi Joe. Couple of questions for you, and congratulations on phenomenal results and that’s really impressive growth and to do a profitably even more impressive.

[Joe Flynn:]

Thank you.

[JD Abouchar:]

One of things you talked about in the past, and I'd like to get a little bit better clarity on is the visibility you have going into the quarter and into the year, so just [indiscernible] you can talk about recurring revenues under contract backlogs things like that.

[Joe Flynn:]

Paul? JD, we don’t traditionally provide a lot of guidance on that, I mean we're still in the process of – when I talk about MPS we're still in the process of implementing these large accounts. We had a pipeline that’s pretty consistent with where it's been over the last couple of quarters. We have had made changes in the organization from a sales side, we move one of our MPS sales people over to Security and we just hired on a new sales person from the east coast. So we have some activities going that we hope will start to drive additional leads into the pipeline. So from an MPS standpoint, again we're feeling pretty good, from a Security standpoint that team is starting to expand, they've added a couple of resources on that side of the business and are actively started to see some results. They had a very good October, so we're hoping to see that some of that momentum carries over as we head into the new year and we start to get the additional sales resources up and running.

[Paul Anthony:]

Yeah, we made the decision JD, towards the end of September to increase the sales resources for Security and really have a full time dedicated outbound sales person going after some of the bigger deals better in the market place. We're definitely seeing opportunities within our own MPS customer base and everyone has been so busy standing up new account that we thought it was appropriate and I'll put somebody full time going after those large security opportunities. We're seeing in Security space, RFP is coming which is interesting, RFP is for – we got one RFP from an existing customer that was – we want a full security partnership, in other words, using a vendor that is the main advisor to them on all things related to security. So we're seeing a little bit of that in the market place and we want to make sure we're putting the right sales and marketing resources towards that so we can get after more and more of those opportunities.

[JD Abouchar:]

So when you talked about in the quarter $2.7 million in sort of recurring service revenues, any clarity you can give us on sort of the length of that contract, is that a three month engagement, one year engagement, so anything that would help us work on our models?

[Paul Anthony:]

Yeah, it relates to the MPS side all those arrangements were five year agreements, so that will continue and I could say they were about 70% implemented, so we're going to see some additional growth coming in Q4 and Q1 from those contracts as they fully implement. So that’s kind of the core. When it comes to Security though, Security is – we have some recurring or software service type arrangements relatively in material to the overall team and then it relates to new business Redspin, that’s primarily repeat business or new business, it's project based short-term two week type projects. So that’s not necessarily recurring revenue, so we can get continue to sell as we go.

[Joe Flynn:]

We're confident on the Security side, again the bulk of the revenue with Redspin has been transactional assessment type work. So the job we have ahead of us now, is now that we have a full suite of services we can offer through the integrated – two acquisitions been integrated. The job we have now is to create long-term two, three year contracts that are fixed rate contracts that provide a variety of security services, not just assessment but assessment through remediation and vulnerability management, all in one and that’s kind of the model we're working towards. At the same time, we want to be opportunistic and go after every piece of business we can possible go after. But as we evolved, especially in the Security space we wanted to be similar to what we've created with MPS, which are these long-term service contract type of arrangements.

[JD Abouchar:]

Great. And just my final question, in the quarter I think you mentioned something like $900,000 in contract labor to help on the implementation side. If there were – what is sort of the arc of that spend, I mean obviously if you have signed more contracts there is more implementation to do but I assume some of that goes away as these – the new contracts get fully rolled out and implemented across the hospital network.

[Paul Anthony:]

Well, majority of the contract labor that was referenced in the press release was related to two things. We have some contract labor that we end up using especially in some of these larger implementations as the initial headcount that we used for our onsite resources, it traditionally carries using third-party agencies. It allows us to quickly build up the onsite staff or having trouble recruiting. And so a lot of that contract labors is going to be from a head counting spend is going to be there for the term of the agreement but when we originally bringing on with contract labor it's got a 20% to 30% premium on it that will ultimately will go away. So, it isn't necessarily just for the implementation, these are people that will be staying onsite but they'll be at a lower cost structure once the full time employs come on board. In addition, number of the contractors that were also related to Security, some of the business if you remember from our original Security purchase at the deltas business, lot of those resources at times can be contractor depending on how quickly we have to ramp for particular project. So, those two in combination had a pretty significant growth rate here in the third quarter. We're hoping to on a go forward basis lessen some of the necessary, as I said, from the MPS side which is trying to minimize that and ultimately get away from that and its entirety once we just count up and running but it'll just be a similar expense just 20%, 30% less than on the Security demand.

[Joe Flynn:]

It depends on demand, and so with that the Security pieces depends entirely on demand and made that a very big spike in demand early part of this year that drove that contract labor, but it's one of those things you have to manage, and it's one of challenges you have to manage if you get peaks and values and demands, especially in the Security resources, which are very expensive in the market place.

[Paul Anthony:]

Now we are carrying some excess resources as well as some additional travel and other things to associate with the implementation of the MPS business. As soon as that MPS business starts to slow down a little bit or the growth that slows down to a more manageable pace and spread out over the year little better than we will look to see or drop in that contract or that labor force component as well as the drop in that travel business.

[JD Abouchar:]

Great. All right, thank you guys.

[Joe Flynn:]

Thanks, JD.

[Operator:]

Thank you. [Operator Instructions] We'll go to Jeff Bash with General Pacific Partners.

[Jeff Bash:]

Hey Joe, Paul.

[Joe Flynn:]

Hi Jeff.

[Paul Anthony:]

Hi Jeff.

[Jeff Bash:]

Few questions. The RFPs on Security which you mentioned earlier were they looking for whole solutions, are you short of being able to provide all solution and make them a channel to respond to or how would you characterize your capabilities?

[Paul Anthony:]

I would say, again this is unchartered territory for us.

[Joe Flynn:]

It's the first kind of experience that we're having, but if you look at the RFP I would say that we can handle 80% of what's being asked. The remaining 20% is very much around product that they require, the firewall protection and other things like that which we certainly can source. It's kind of like MPS, we can source those products for them that they need and be the lead in sourcing and implementing but actual work I would say we can handle about 80%, the balance that we can't handle is all product or software related and we have to source for them.

[Jeff Bash:]

Okay, so you can be responsive?

[Joe Flynn:]

Yes.

[Jeff Bash:]

Because that’s probably where the industry is going they probably want to deal with one guy.

[Joe Flynn:]

[indiscernible] hearing that more and more.

[Jeff Bash:]

In terms of synergies, I think some people one time thought that the Security customers might lead to MPS customers or vise versa. But sort of hearing your conversation before in terms of the types of people were involved and the level of – maybe if you get fired if you screw up on Security, maybe there is less synergy than some people have once might have thought. How would you characterize that?

[Joe Flynn:]

No, I mean I think that there is definitely synergy, certainly as it relates to the assessment work that Redspin does. I think that’s probably the easiest sales, in fact when we're in talking to our existing MPS customers, by the way, the difference really from what we bought and what we have is that, Auxilio has contracts with very, very large health systems, right, that may make decisions with that security at the corporate level and it's a little bit more complex as to getting in there and trying to sell the stuff. That’s why our strategy is to lead in with assessment work which they all have to do and it's a little bit of a lower end spend and go at a major customer – trying to sell them $5 million worth of a full blown five year security program, I mean we got to earn that stripes a little bit in security because they don’t – they're just getting aware that we have these capabilities now. So we're going to do the – letting them test the waters with us kind of strategy, I mean that’s already starting to happen with couple of customers right now but our anticipation is that we lead in with smaller projects that hopes would lead to larger projects. But interestingly not some of the deals that Redspin team has kicked up recently are actually with big health systems outside of our MPS customer base which we think will lead to – I mean there are small projects that which they're already talking to us about doing larger projects with them. So, it really all depends on how the purchasing for Security services is done inside these large health systems which we’re quickly learning how it's been done and some cases it's going to be easy for us to sell, in some cases it's going to be more complicated.

[Jeff Bash:]

Okay. Next, I've often thought that one of the risk that doesn’t get discussed on calls of the MPS acquisitions is might be any assessment process whereby the facility might have made a little bit more progress on cutting down on the cost of MPS services or managing a little bit better and you can't quite deliver as a guaranteed results that you promised and therefore the margins are lower. So although you said earlier on these giant customers you recently added that you’re tracking to plan, I interrupted that to be more of an implementation comment. I'm curious as to whether you consider yourselves tracking to plan in terms of the objective gross margins you have in this business going in.

[Paul Anthony:]

Yes, I would say at this point if I were to – I would say that the two large contracts that we signed are good – to be a good flavor for kind of both sides of it. One of them, we definitely we're right in line with where we had anticipated being and hope to being we enter into most of our contracts. The other one, we knew going in that it was going to be a tighter deal. We knew going in that the pricing – the front end was going to be a little more aggressive, knowing that the back end would be – is going to be real profitable. So, I would say it's very consistent with what we've seen in the past, what we've got some deals that we can price right out of the gate and feel pretty good about in other deals. We know we're going to take a hit and it's not the hit we hope but we know long term in light of fact that most or 99% of our customers that renewed that we could take a longer term view of that count.

[Joe Flynn:]

Yes, and to add to that, on those two examples one had a fairly organized set of data that we were looking at the assessment, because it's more of a top down organization. So the data turned out to be really good, really valid and really helpful, and so therefore we could make our pricing and things like that straight up, the other one wasn’t as organized and actually much more disjointed. And so that’s where we have to kind of work through some of the stuff we can handle, and take a longer term view.

[Jeff Bash:]

Okay. So I guess the conclusion I come to is that you might not quite achieved the margins between the two of them that you have on other business.

[Joe Flynn:]

Well, I mean…

[Jeff Bash:]

Is that fair?

[Joe Flynn:]

I mean I would say…

[Jeff Bash:]

In the short-term.

[Joe Flynn:]

Yes, as you're going short-term, yeah one – because of the sheer size of the accounts, one of them will be but I think the other one will be right there. So —I think probably not too different than what we've seen historically on these accounts.

[Jeff Bash:]

Okay, and on the Security business are you still comfortable with past eight months of achieving roughly double the gross margin on security business as you do on the MPS business?

[Paul Anthony:]

At this point, we do. We have seen at least in the short-term, we've seen some weakness on the consulting side of the house because we've had to use a few more subcontractors than we were hoping. So the margin on the consulting business has been a little lower than we had hoped, but the margins on Redspin and that newer business is right in line with where we were hoping it would be. So, overall I think it's still going to get there and even today a blended it's still affording something. So, overall we're feeling pretty good with gross margins.

[Jeff Bash:]

Okay, thank you. That’s it from me, and thanks for the good quarter.

[Joe Flynn:]

Thank you, Jeff.

[Operator:]

Thank you. And there is no additional questions in the queue, I'd like to turn things back over to our speakers for any additional or closing remarks.

[Joe Flynn:]

I just want to thank everybody once again for joining us for this call. And we wish you all happy Thanksgiving. Thank you very much.

[Operator:]

Thank you. And ladies and gentlemen, one again that does conclude today's conference. Thank you all again for your participation.