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Executives

Dustin Salem - SVP, MZ North America

Joe Flynn - President and CEO

Paul Anthony - CFO and Corporate Secretary

Analysts

JD Abouchar - Graham Partners

Lisa Thompson - Zacks Investment Research

John Gay - The Quiet Investor

Auxilio, Inc. (OTCQB:AUXO) Q2 2014 Earnings Conference Call August 14, 2014 12:00 PM ET

Operator

Good day everyone and welcome to the Auxilio Second Quarter Financial Results Conference Call. (Operator Instructions) Just as a reminder today’s call is being recorded. And at this time I would like to turn the call over to Dustin Salem, Senior Vice President of MZ North America. Please go ahead sir.

Dustin Salem

Thank you, operator. Good morning and welcome everyone. Joining us from the Company are Mr. Joe Flynn, President and Chief Executive Officer and Mr. Paul Anthony, Chief Financial Officer.

Before we begin the formal remarks I’d like to remind everyone that the presentations and commentary of Auxilio during the course of this call, as well as any responses by such officers and employees to questions posted during the course of this call contain certain forward-looking statements relating to the business of Auxilio that can be identified by the use of forward-looking terminologies such as beliefs, expect, anticipates, or similar expressions. Such forward-looking statements involve known and unknown risks and uncertainties including uncertainties relating to product and service development, long and uncertain sales cycles, market acceptance, future capital requirements, competition from other providers, and the ability of our vendors to continue supplying the company with equipment, parts, supplies and services and comparable items and prices and other factors that cause actual results to differ materially from those described herein as anticipated, believed, estimated, or expected.

Certain of these risks and uncertainties are or will be described in greater detail in the Company’s Form 10-K and Form 10-Q filings with the Securities and Exchange Commission. 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 would now like to turn the call over to Mr. Joe Flynn. Joe, the floor is yours.

Joe Flynn

Thank you Dustin and thank you everybody for being on today’s call. We saw an acceleration in our revenue growth in the second quarter as a result of new contracts brought on board over the past 12 months and expansion of services with existing customers. We are delivering cost savings at or above the 15% to 30% range that we promised our clients and they’re rewarding us with multi-year contracts. These recurring revenues which increased by 8% in the first half of 2014 have been a key driver of the growth in our margins and cash flows.

Although we are happy with this growth it is important to point out Q2 is traditionally a lower volume period for us due to seasonality within the healthcare industry which has a direct impact on service revenue. In addition this year our revenue has been impacted by superior weather on the East Coast as well as the migration of certain high volume departments to their corporate headquarters in one of our largest customers. These types of fluctuations are normal occurrences in our customer base and we expect to offset these volume decreases with normalization of seasonal volume and new business development in the upcoming quarters.

I’m pleased that we signed a five year renewal with the California Pacific Medical Center one of the largest multi-campus hospital groups in San Francisco Bay area and a member of the Sutter Health system. California Pacific Medical Center known as CPMC has been our customer for over 10 years. It is also one of our longest standing customers. As a reminder, this relationship led to our further penetration into the Sutter Health system with the signing of Sutter Health East Bay Region in September of 2013. In this reporting period we also signed a multi-year renewal agreement with Saint Joseph’s Medical Center in Yonkers New York. Signings is our testament to our commitment to the industry and to our clients as a trusted provider.

We took strategic steps in the past three to four months to leverage our reputation and relationship with our nation-wide portfolio of hospitals to extend our offerings with value-added adviser and solution services. We believe this is a natural evaluation given the dramatic pace of change in the industry and sever financial pressures facing healthcare providers.

In March we announced the launch of our Healthcare Consulting and Managed Services IT Group led by Mark Dressel, a 25 year industry veteran with good contacts of CIOs within major healthcare companies. We entered the healthcare consulting business in response to our customers’ needs and seeing an expanding gap between available solutions and the growing need for IT services in the marketplace today.

Further amounting regulatory burdens caused by Healthcare Reform Act and the Health Insurance Portability and Accountability Act known as HIPAA are creating cost pressures and mandated compliance procedures on hospitals large small. Both the cost of compliance and the fines associated with non-compliance are rapidly rising. By example, healthcare IT news recently estimated that data breaches alone cost the industry $5.6 billion annually. These dynamics further escalate information security, the top priority for the healthcare industry.

Last month we announced plans to accelerate our consulting business through the acquisition of Delphiis a leading information security and HIPAA compliant services provider for the healthcare industry. Founded in 2010 by Mike Gentile a nationally recognized expert in the information security Delphiis’ professional services, developed security and risk programs along with monitoring security threats and remediation projects. In addition the team conducts assessments through the use of their comprehensive risk assessment solution that includes detail assessment analysis, remediation planning and data analytics from monitoring risk trends. We believe that by adding a software and advisory platform solution to help our hospital clients identify and remediate risks associated with data breaches, we build a deeper relationship with our clients and capture a larger share of their IT spend of continuing to reduce both their risks and costs.

Acquiring Delphiis gives us the ability to fuse our core business in print with information security services into one unique approach that the industry has never seen before. As I’ve mentioned in the past in a recent conversation I had with the CFO of a major health system, she looked me straight in the eye and said, “I view every piece of paper coming out of every print device as a potential HIPAA violation”. These comments demonstrate the need for a too broad approach for developing a strategy incorporated both print and data. The Delphiis acquisition provides Auxilio an excellent business extension into the high priority industry of information security.

Delphiis provides a number of compelling strategic and financial benefits to Auxilio and I like to summarize it for you. First, it allows us to introduce new value-added services that solve a major pain point for CIOs within our current NPS clients today. Second, we expect Delphiis like our other consulting businesses will have higher margins than we currently receive for NPS. Third, we gained valuable intellectual property and software solutions capabilities that could potentially generate higher margins, additional recurring revenues and higher valuations. Fourth and finally, the expertise that we acquire from the Delphiis team provides us with the unique and distinctive competitive advantage. We believe the Delphiis acquisition is a win-win for our shareholders and our clients.

We are currently working through the process of making sure that the Delphiis financials are complied with GAAP and continue to anticipate finalizing the audits and filing an amended 8-K in mid September. In the meantime, we’re actively integrating the Delphiis suite of services with our internal resources engaging our customer base and including our extended surface offerings in our sales opportunity pipeline while I have provided some broad and important strokes about this acquisition. We hosted a specific conference call in late July when this deal was announced and I would welcome you to listen a replay which can be accessed from the links on our Web site.

Before I hand the call over to Paul to discuss our second quarter results, let me provide you with a few thoughts regarding our second half outlook. Through industry consolidation our opportunities have gotten larger and our perspective customers need additional time to reach contractual agreement therefore we anticipate fewer but larger deals to be closed. We remain confident and optimistic about the performance outlook for the balance of 2014 from our continuing operations pipeline of managed print services opportunities and additional information security offerings.

I would like to now turn the call over to Paul Anthony to review our financial results. Paul?

Paul Anthony

Thank you, Joe. For the three months ended June 30, 2014 the Company reported revenues of 10.4 million, an increase of 6% when compared to 9.8 million in the same period in 2013. Recurring service revenues increased 8% from new contracts implemented since the fourth quarter of 2013 and expansion of services partially offset by some of the volume reductions we experienced at our existing customers. Equipment revenues were approximately 0.6 million in the second quarter of 2014 compared to 0.8 million for the same period in 2013.

Cost of revenue was 8.7 million compared to 8.2 million in 2013, due to the increase in revenue. Gross profit for the second quarter of 2014 was 1.7 million, or 17% of revenues compared to 1.6 million or 17% for the same period of 2013. Gross margins are impacted by the timing of contracts moving beyond the initial implementation phase, which requires more upfront investment, as well as by adjusted terms from contract renewals. We saw improvement in our gross margin from newer accounts that came on board over the last couple of years offset by the lower revenue from the drop in sales volume from some of our existing customers.

Operating expenses for Q2 2014 were 1.6 million, an increase of 13% from 1.4 million in the second quarter of 2013. Sales and marketing expenses increased by 16% due to higher staffing costs related to expanding our sales efforts. General and administrative expenses increased 12% to 1 million due primarily to the addition of an Executive Vice President of our newly-created Consulting and Managed IT Services Group in February 2014. The Company generated 92,000 of operating income in the second quarter of 2014 compared to an operating income of 0.2 million in the second quarter of 2013.

Net loss for the three months ended June 30, 2014 was 13,000, or $0.00 per share, compared to net income of 0.1 million or $0.00 per share, in the same period of 2013. Excluding 53,000 in charges related to stock-based compensation, we achieved positive adjusted income from operations of 0.1 million in the second quarter of 2014, compared to 0.3 million, after excluding charges of 0.1 million related to stock-based compensation for the same period last year.

Now let met quickly summarize results for the six months ended June 30, 2014. Company reported revenues of 20.6 million, an increase of 4% when compared to 19.9 million in the same period of 2013. Recurring service revenues increased 9% from new contracts closed between December 2013 and May 2014. Gross profit for the first six months of 2014 was 3.5 million or 17% of sales compared to 3.2 million or 16% of sales for the first six months of 2013.

Operating expenses for the first six months of 2014 was 3.3 million compared to 3.1 million in the prior year period. Net loss for the first six months 2014 was 84,000 or $0.00 per share compared to 0.1 million or $0.01 per share in the first six months of 2013. Excluding 0.3 million in charges related to stock-based compensation we achieved adjusted income from operations of 0.4 million for the first six months of 2014 compared to an adjusted income from operations of 0.6 million after excluding charges of 0.3 million related to stock-based compensation and 0.2 million in charges related stock granted for marketing activities for the same period of 2013.

At June 30, 2014, the Company had 4.9 million of cash and cash equivalents up from 4.7 million at December 31, 2013. Cash provided by operating activities for the first six months of 2014 was 0.5 million compared to cash outflow of 70,000 during the same period of 2013. Working capital improved to 0.7 million at June 30, 2014 compared to 0.3 million at December 31st.

We improved our balance sheet further in July when the remaining holders of the 1.55 million of convertible promissory notes issued in July of 2011 which included several Board members at the time of the initial offering elected to convert all their unpaid principal into the equivalent 1.55 million shares of common stock with the bulk being converted in July of this year. This is only a majority of our existing debt and strengthened our capital position. Given our strong balance sheet and growing base of recurring revenues, we feel good about our ability to fund future growth with existing resources and as a reminder we have 1.8 million of unused capacity on our $2 million line of credit we have with bank as of June 30, 2014.

I’ll now turn the floor back to Joe.

Joe Flynn

Thank you, Paul. In closing we are excited as ever about the future of AUXILIO. Our core MPS business remains strong providing us with a growing base of recurring cash flows. We are expanding into higher margin value-added services through our investments in the controlling practice and Delphiis acquisition. The changing dynamics of the healthcare industry continue to provide us with a growing set of opportunities, help our client save money and become more efficient and complaint. Our growing reputation as a trusted partner and our strong capital position enable us to deliver value to all of our stakeholders. Thank you for your interest in AUXILIO. We appreciate everyone joining us for today’s call. And that we’re now ready to take your question.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) The first question today will come from JD Abouchar with Graham Partners.

JD Abouchar - Graham Partners

Hi, Joe, congrats on the quarter, I had a question for you, maybe you could talk qualitatively a little bit about what you’re seeing in your sales pipeline, you mentioned that, the deals could be lumpier because they are bigger. But maybe if you could provide some color around what you’re seeing out there and the opportunities. And sort of, what an outlook could look like?

Joe Flynn

Yes. So, in my comments, I think I said it what we are definitely seeing particularly as it relates to MPS because the large systems are taking this at the corporate level. So even in the case of like a Sutter, they are looking at this now and we’ve kind of picked up a couple of their regions. I know you would love them in the bay area, but Sutter is looking at this now at a system wide level. How can we roll this out everywhere? And so that’s good from our standpoint in that particular case, because we’re kind of the go to organization for that. The challenge for us as sales people as we, when they get to the big deals they get to be much longer and there’s a lot more people involved in the decision making. So that’s one example and we’re definitely seeing that everywhere. We’re absolutely been invited to the table, to some of the largest health systems in the country in their decision making about what they want to do going forward with MPS as a low hanging fruit, cost cutting and operational efficiency opportunity, but unfortunately because of the nature of healthcare these are very involved decisions, you think that they would take a lot less time but unfortunately they take a long time for impatient like people like myself, it’s difficult the waiting game but if we’re patient enough we’re talking about some very, very large opportunities that we are definitely seeing in our pipeline. So I think what I have definitely seen over the last couple of years is the individual hospitals even the large individual hospitals and health systems where they used to be able to make independent decisions are not allowed to make independent decisions. So the decision making is more involved and, more lengthy I hope that answers your question, JD.

JD Abouchar - Graham Partners

And how does the competitive landscape changes if you go to a more system wide decision, different player at the table, how do you, how is that environment changed?

Joe Flynn

No it’s pretty much the same players, honestly it’s really, it’s clearly the, the large OEM manufactures like a Xerox or Ricoh or Canon. You might see some of, it’s interesting with the large OEM guys you might see Xerox direct meaning their direct salesforce in a large deal. Then also, and you might also see one of their large local distributors who may handle 4 or 5 states and they are competing against each other which is amazing, but it’s pretty much the same cash characters we’re seeing everywhere.

JD Abouchar - Graham Partners

My question is, as you start to expand in a more IT services, you talked about better margins there, could you may be put a little more color around that?

Joe Flynn

Paul you want to take that?

Paul Anthony

JD it is still kind of in the development stage at this point so I mean ideally we’re looking at less of a labor component in some of the Delphiis products and then on the consulting side we’re looking at higher value service, which lends itself to a higher margin as well. So there is not a lot of color to add yet because it’s not a material part of the business and we’re still kind of getting our hands around it, but in general that’s what our expectations are.

JD Abouchar - Graham Partners

Thank you guys.

Joe Flynn

JD, thank you.

Operator

(Operator Instructions) Next we’ll hear from Lisa Thompson with Zacks Investment Research.

Lisa Thompson - Zacks Investment Research

Hi everyone, good morning, good afternoon whatever it is. I wanted to talk a little bit about revenues and expenses. So obviously you have eliminated about a 124,000 a year in interest expense by the conversion, correct?

Joe Flynn

That’s correct.

Lisa Thompson - Zacks Investment Research

And you have to still and after the June 30th balance sheet you’re going to payout 1 million for the acquisition?

Joe Flynn

That’s right.

Lisa Thompson - Zacks Investment Research

Okay. So it looks like next quarter you’ll be about 23.4 million shares outstanding, is that right?

Joe Flynn

Yes, the numbers are going to be see…

Lisa Thompson - Zacks Investment Research

Is number close to 155 plus the nine…

Joe Flynn

Yes, that’s right we have it approximately 21 today then you have the 1.5 million of additional convertible debt and we’ll have the shares issued for the acquisition.

Lisa Thompson - Zacks Investment Research

So do you have any idea if there will be any revenues from the acquisition in the third quarter?

Joe Flynn

There will be, absolutely.

Lisa Thompson - Zacks Investment Research

Okay.

Joe Flynn

And you’ll get a much better picture of that in I would say in about six weeks, 30 days or so when we file the 8-K.

Lisa Thompson - Zacks Investment Research

You have some idea of what the GAAP revenues look likes for the company like a range at least?

Joe Flynn

I mean at this point we’re still pretty deep into it, so it’s going to be a pretty wide range 2013 I’m looking at somewhere between 750,000 to 900,000. So that is a broad range but I give you some idea.

Lisa Thompson - Zacks Investment Research

Alright, that helps. Okay. So I guess when we looked at sort of the platform the big picture it looked like after you reported the first quarter which has finally got out of that $10 million to $11 million range per quarter and here we are back there again. So when are things going to kick in to start showing some nice growth again, do you see anything on a horizon that is going to cause that?

Joe Flynn

From a short-term perspective we definitely saw the impact as we mentioned the northeast storms because we build on a three month flag and so the fourth quarter and first quarter activity at our customers which translate to our revenue in Q1 and Q2 are traditionally lower and they always have been historically for us and so we saw some of that we did see some anomalies that couple of kind of customers that are uncommon but we did see a larger customer see some volume migration away from our devices. And so we did see a little bit of an impact from that in Q2 here that was a little larger that we had anticipated. But again going into Q3 and Q4 and as we see historically we’ll see some increases in volume, good increases in volume in that Q3 and Q4 and then again we continue to try to drive additional services and continue to try to grow the business. So we still feel confident that we’re going to continue to see some growth there and then obviously we got as we start to see some new business close, we start to see some additional growth.

Paul Anthony

Yes, I mentioned it earlier we definitely are I think a lot of people in our industry are facing the same thing, the sales cycle is lengthening the deals are larger no question. The sales cycle is lengthening and we’re just working through that I mean we’re as anxious as anyone who tried to close these deals that we’ve got in our pipeline. But we have to go at the pace that our customers are going at with us.

Lisa Thompson - Zacks Investment Research

Okay. And how far you think will be some business wins from the two new business offerings?

Joe Flynn

I am not in the business of predicting especially in healthcare, especially right now. So my hope is between now and the end of the year we will have some announcements but those could also drag into early part of next year. So it’s hard to say.

Lisa Thompson - Zacks Investment Research

Okay. Alright, great thank you.

Joe Flynn

The good news is they’re still calling us the good news is that we’re still after table and we’re doing everything we can to close it more importantly so they can benefit from the savings that we put on the table to them, and in some cases pretty big numbers.

Lisa Thompson - Zacks Investment Research

Okay. It makes sense to me.

Joe Flynn

Thanks Lisa.

Lisa Thompson - Zacks Investment Research

Thank you.

Operator

(Operator Instructions) Our next question will come from Gail Fortier with [indiscernible] Capital.

Unidentified Analyst

So quick question regarding the margins, you see on one side you’re seeing progressing of an order contract geometry and on the other side, you see some slight decrease on the renewal, can you give an little indication on where you see the trend going forward there?

Joe Flynn

Again the trend is going to be consistent, yes, I think we always are going to see a trend towards on their renewals towards margins, potentially staying the same as a percentage they are coming down as total dollar, but that is the expectation on, and it always has been on a go-forward basis. We do also expect to continue to see margins improve from our newer accounts, anything that’s been here within the last year to two year, we only we expect those to continue to improve. And then again we’re still evaluating as the landscape is changing here with the healthcare space and moving into some of these larger deals we’re still trying to understand whether or not the margin on those deals are going to remain as high from a percentage perspective as we have seen in the past. So if we might see some margin, lower margins from that but higher margin dollars obviously with the larger deals. So that’s still, we’re still evaluating where that’s going, but as far as historical trends, we continue to see newer accounts start to improve, our legacy accounts are holding. And our renewals we’re seeing, we’re giving up some margin dollars the margin percentages are holding pretty good.

Unidentified Analyst

Okay. And I know it’s a little bit early to tell, because the acquisition is very are refresh but are you seeing some potential there, or interesting needs or anything there?

Joe Flynn

Yes. I mean, we’re, we’ve been in this now unit we’ve been one company here for about three weeks. We’re very aggressively rolling out the new service to our existing customer starting with our larger ones first. And getting some interest obviously, this also came with a pipeline on its own. And personally getting involved in a lot of the roll out and then I guess socialization what we just acquire to our customers, pretty those customers who had personal relationships with. So, yes, I mean there’s definitely interest every single of this hospitals systems and individual hospitals have programs in place have plans in place, our goal is to part and have dollars allocated toward this and our goals is try to get piece of that market share with the tool set and the services that Delphiis can provide.

So we’re excited about it, it’s going to take work, it’s going to take some investment, it’s going to take some pounding the street and pounding down doors to get noticed and so forth, but luckily the business comes with some very good existing customers that are really happy and continue to expand with us. So that’s always very helpful, that business is, I mean inherit is mostly here in the West Coast so there’s a lot of opportunity to expand it. So we’re not, we didn’t buy something that, this is brand new and the sense that they didn’t have customers, and if they had customers they have good case studies, good relationship with their customers and we hope to expand that out from what they have and also. Those customers provide us an opportunity for entre with our MPS business because they are pretty large. And there’s an opportunity in those areas with our MPS business as well.

Operator

Next we’ll hear from John Gay with The Quiet Investor.

John Gay - The Quiet Investor

Hi, Joe, I was little confused about some of the reasons given for the reductions in this past quarter, apart from the data related item and the amount relation a couple of portions of one of your customers, the first reason given what’s confusing to me I didn’t quite understand the reduction in margins, can you let me understand a little better what that is?

Joe Flynn

Specifically, I guess, what’s the question, as far the issue and we did experience from a margin perspective the drop in volume that we experience as a result of those two factors in seasonality with a specific driver steals margin because we didn’t have as much volume to offset our fixed associated with our support group in operations.

John Gay - The Quiet Investor

I guess, like my question relates to renew by as far as I understand went on our renewals has provided the greater insight into the working of the customer and the opportunity to increase your margins, is that net still the case?

Joe Flynn

No, no and we do increase our margins overtime and so when we get to renewal we are at what we considered to be our target or ideal margin to get there right, when we sold the deal the customer recognized and understood that their environment was not ideal and that it had a number of inefficiencies. It had excess equipment at other items and so they recognized that we then go into our second period for renewal that they should also see some benefit associated with the fact that we’ve come in and fix the environment and so they’re looking for some of that did come back to them. And so what happen is, in many we’ll lower our rate per image that charge them which lowers our revenue, but responsively we’ll lower our cost structure and so we’re able to maintain the same margin percentage that we’re going to achieve from a customer. But we’ll have to give up some of the margin dollars because our revenue will come down as part of lowering that rate for the client. And that’s all part of the cycle, I guess with the client.

Operator

And at this time there are no further questions.

Joe Flynn

Okay. Thank you everybody for joining us today on today’s conference call. And we look forward to talking to you next quarter. Thank you. Have a great day.

Operator

That does conclude today’s teleconference. Thank all for joining.

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