Auxilio's (AUXO) CEO Joe Flynn on Q4 2015 Results - Earnings Call Transcript

| About: AUXILIO, Inc. (AUXO)

Auxilio, Inc. (OTCQB:AUXO) Q4 2015 Results Earnings Conference Call March 31, 2016 12:00 PM ET

Executives

Ted Haberfield - IR, MZ North America

Joe Flynn - President and CEO

Paul Anthony - CFO

Analysts

Paul Nori - Noble Equity Fund

Jeff Bash - General Pacific Partners

Dallas Salazar - Atlas Consulting

Wyatt Carr - Monarch Bay Securities

Operator

Good day and welcome to this Auxilio Full Year 2015 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Ted Haberfield, MZ North America. Please go ahead, sir.

Ted Haberfield

Thank you, operator. I want to welcome everyone to Auxilio’s full year 2015’s earnings call. Joining us today from the Company are Mr. Joe Flynn, President and Chief Executive Officer and Mr. Paul Anthony, the 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 would now like to turn the call over to Mr. Joe Flynn. Joe, the floor is yours.

Joe Flynn

Thank you, Ted, and thank you everybody for joining today’s call. We finished out 2015 with a great financial performance and our balance sheet continues to strengthen. We delivered 39% top line growth and generated $2.4 million in cash flow from operations. We did this while spending heavily on integration and growth of our IT security business while also implementing the largest group of MPS contract in our history.

Through these new contract wins, Company now truly has a national presence from coast to coast with a significant footprint in the Midwest, a first for our organization. These implementations were substantial, representing 872 locations across the country, including 32 acute care facilities. Right now, we currently classify approximately 40% of our MPS revenue under contract as immature, which is defined as either less than one year old or less than 50% of the MSP [ph] copiers having been converted to lower cost solutions.

As we have discussed in the past, contracts enter the mature or maintenance phase, profitability is expected to improve substantially. Each contract is a little bit different but we believe this provides investors with a good idea of how much our current revenue mix is on the immature side of that spectrum. As you know, one of our key assets is trust and relationships we have developed with some of the largest health systems in the country. The fact that we were able to implement such a large number of locations last year and to do so efficiently and effectively for our clients has translated into invitations to bid on MPS work at new and even larger health systems.

Our MPS integration team did an excellent job last year, and that has definitely opened new doors that we are pursuing. While we continue to pursue those large MPS contracts, we have also expanded our sales staff in order to better pursue middle market opportunities, which we believe will better enable us to bundle MPS and security services. We feel this is a great way to build the security business to a critical mass while also helping diversify our MPS revenue base. Much like we have done with MPS, we feel if we can establish ourselves as a trustworthy partner in security, we can expand our roles in these organizations over time.

The timing for us to build an end to end security offering in healthcare couldn’t be better, given the increasing demand with HIPAA on health systems in general and the consistent recurrence of high profile breaches. Historically, healthcare has been behind the financial and retail sectors in regards to having a mature security program, but that is beginning to change. Data breaches are far more costly and detrimental to a hospital or health system. And the leadership teams inside the hospitals are taking note.

Just this week, MedStar Health reported a Ransomware attack, the fourth health system attack in three months. These attacks are targeting industries such as healthcare with employees are no trained to recognize phishing attacks, systems are antiquated, and budgets are low. However, in a recent PWC report, it states that 88% of healthcare respondents plan to increase or keep their security budgets the same in 2016 and 53% intend to spend more than $1 million on preventive steps in security such as putting in place best practice security strategies including social engineering training, controls and risk management program, an expertise we can deliver to more than just our MPS client base.

Our threat and risk assessment business has a great reputation in the healthcare security industry. We recognize that while dollars for this work may not be overly significant initially, we can use this business to get our foot in the door with the objective and then offering the client preventive strategic consulting services, which traditionally have higher margins. Towards the end of 2015 and early 2016, we invested like spending the sales force and security and our funding enhancements to our recurring 12-month license assessment application and managed services product offering.

We now have the tools to establish a new relationship with risk assessment services and continue to service that client with high quality recurring maintenance services as well. We can offer that on a standalone basis or bundle MPS and now have the sales force bandwidth to be aggressive in our outbound effort. We’re nearing completion of the integration of our security businesses, we acquired in early 2014 and 2015. Our that process [ph] includes transitioning from legacy contract work which was largely in the form of three to six months contracts in to new business generated by our sales staff. Like I alluded to before, the early part of new security service relationship often generates smaller dollar amount and then has the ability to grow more substantial. We’re excited about the number of new contract wins on the assessment side, which will drive incremental growth over time. Several of these brand new client that diversify and expand our revenue base, not to mention doing so with much higher margin work than MPS.

Overall, I’m very pleased with not only our ability to generate 39% top-line growth in 2015 but also the progress we made in investing our future. We have put ourselves in a great position going forward and we’re certainly excited about 2016, which I will cover in more details in a few minutes.

For now, I’ll turn it over to Paul to go through some of the financial details from last year. Paul?

Paul Anthony

Thank you, Joe. For the 12 months ended December 31, 2015, the Company reported revenues of $61.3 million, an increase of 39% when compared to $44 million reported in 2014. Approximately $8.2 million of the increase is a result of the addition of new recurring service revenue contracts. The Company added approximately $4.4 million in service revenues and software subscriptions from the security offerings, in addition to an increase of $4.2 million in equipment revenue, compared to the same period in 2014.

Cost of revenue for the 12 months ended December 31, 2015 was $50.7 million compared to $35.8 million to the same period in 2014. We incurred approximately $6.6 million additional staffing cost which includes contract labor, approximately $3.4 million in additional service and supply costs, and approximately $0.7 million of additional travel costs primarily as a result of the implementations of our new customers.

Equipment costs increased by approximately $4 million in 2015, primarily as a result of the increase in equipment revenues from some copier fleet refresh activity. Gross profit for fiscal 2015 was $10.6 million or 17.3% of revenues, compared to $8.2 million or 18.7% of revenues for the same period in 2014. As the implementation phase for many of these large contracts complete and transitions into the maintenance phase during the next 12 to 18 months, margins are expected to improve.

Operating expenses for fiscal 2015 were $9.6 million, an increase of $3 million compared to fiscal 2014. Sales and marketing expenses increased by 32% due to the increased headcount to expand our geographical reach and support the sales effort with the newly acquired businesses. General and administrative expenses increased 53% to $6.8 million, due to the acquisition and subsequent integration efforts across the security offering. These integration costs including the related severance were approximately $0.5 million. These costs would decrease as we finalize integration.

Net income for the 12 months ended December 31, 2015 was $1.3 million, or $0.05 per share basic and diluted share, compared to net income of $1.3 million or $0.06 per basic and diluted share in the same period of 2014. Excluding $0.4 million in charges related to stock-based compensation and $0.5 million in amortization of intangibles, the non-GAAP measure of adjusted income from operations was $1.8 million in fiscal 2015, compared to $2.1 million after excluding charges of $0.3 million related to the stock-based comps and $0.1 million in amortization of intangibles for the same period last year.

At December 31, 2015, the Company had $6.4 million of cash and cash equivalents and the working capital of $3.3 million. Cash provided by operating activities for the 12 months ended December 31, 2015 was $2.4 million compared to $1.5 million during the same period in 2014. Company continues to maintain the line of credit with the commercial bank for up to an additional $2 million.

That concludes the financial overview. Joe, hand it back to you.

Joe Flynn

Thank you, Paul. As many of you know, every year, we have engagements which come up for renewal and historically have had a very high retention rate. However, on rare occasions, clients may not renew. Going into 2016, we have one major client who is not going to renew. After six years of engagement, contract came up for bid and the competitor was extremely aggressive in their pricing. To the point, we believe they will likely lose money on the contract. While we hate to walk away from business, we have too many good opportunities right now to allocate company resources for little or no financial gain. This was a unique situation and a complete outlier from typical renewal situations. Given this fact, while we still expect strong double-digit revenue growth this year, we will not see the type of top mark gains we experienced in 2015. Personally, I think the fact we can absorb a client loss of this nature and still deliver solid revenue growth with volumes above the strength of the Company going forward.

In terms of driving future growth in MPS, we’re starting to see a trend where device manufacturers are coming to us. We partnered with them on several large sales opportunities. The main driver is the size of these contracts and the health systems demand for a strong MPS program that has the ability to drive costs out of their operating metric. Even though, we don’t expect to win all of these opportunities, we are in a hunt and believe our expertise experience a reputation puts us in an excellent position going forward.

That concludes our prepared remarks for the call. I want to thank you for your support at this point and will hand it over to the operator for Q&A. Operator?

Question-and-Answer Session

Operator

Yes, sir. Thank you. [Operator Instructions] We’ll go ahead and take our first question from Paul Nori with Noble Equity Fund.

Paul Nori

First question, do you anticipate that your margins will improve next year as you’re maturing through some of these contracts?

Paul Anthony

Yes, that is our expectation, Paul, absolutely. We hope to see that. Now, we will have some offset due to the loss of that one large contract that we had since that was one of the mature accounts, but we do expect to improve.

Paul Nori

And was that client before a particularly high margin client?

Paul Anthony

It was an average margin client; it was just its size that had the impact.

Paul Nori

And you said early on the call that the security business is actually a higher margin than the MPS, is it?

Paul Anthony

That’s correct.

Paul Nori

Have you been in cross-selling in the hospitals with the security and the MPS or is it just two totally different touch points?

Joe Flynn

No, we definitely are making a lot of efforts to cross sell to the MPS clients. And most of our MPS clients are very, very large health systems who typically have a much more -- a much larger IT staff and actually security staff on them. It’s a little harder than what we would hopefully would anticipate it, but we’re finding that. However, there are a couple of opportunities right now which could turn into very large contracts for us, which we’re in the stages of negotiating right now with the couple of our clients.

Paul Nori

And for both sides of the business, do you feel like you have the capacity to grow organically completely, or are you still looking for bolt-on acquisitions?

Joe Flynn

Well, up to this point, for the most part, if you look at our history, we’ve grown the business organically with the acquisition strategy that we’ve embarked on about a year and half ago; it’s new to the Company. And so, we’re going to be looking to continue to grow organically -- aggressively organically. But as acquisition opportunities that make sense to us from an offering to our clients, come to our attention, we’re going to take a look at those as well.

Operator

And we’ll move to our next question from Jeff Bash with General Pacific Partners.

Jeff Bash

Congratulations on a descent quarter. The way I look at it, it was $0.04 a share in operating income before interest, taxes and an extraordinary gain up from $0.02 in Q3. So that’s very nice. The reversal of 623,000 of Redspin earn out was disappointing, but not as much as apparently only 500,000 in revenue in Q4 from security, which I get by taking the 4.4 million Paul quoted for the year and comparing it with the 3.9 million, similar number for the nine months. Are there any issues here that haven’t been fixed? Do you wish you hadn’t made these acquisitions? What’s your view on that?

Joe Flynn

Well, let me address the last part of your question. Couple of things; number one, the healthcare IT security market is a very fast growing market and there is a lot of opportunity there. We acquired two small businesses. When you acquire small businesses, you have to invest in them, you’ve got to make them work and sometimes we take a step forward and take a step backward. But we are still very, very bullish on the acquisitions that we made. We’re still going to continue to invest in this area. We recently hired another very senior person who’s had 25 years experience as a PWC consultant who is going to help us build out our consulting practice.

So, we’re excited and looking at the opportunities in the marketplace. We’re very excited about what we’ve done. The sales cycle in healthcare was really anything to do is longer as MPS and security really aren’t that different in that respect. Security sales cycle is probably short, little bit shorter than MPS but healthcare is not an industry that moves quickly on decisions. But that being said, we’re continuing to look at this; we’re continuing to invest in it. And if other opportunities come our way that make sense, we would continue to bolt on those opportunities that we can afford of course into. So, I hope that answers your question on that respect.

Jeff Bash

Partly, but with respect to the 500, what I thought was 500,000 revenue from security in Q4. Is that accurate and is that a sign of what to expect in the near-term, or was that just a non-recurring follow up in the fourth quarter?

Paul Anthony

Jeff, the Q4 security number was around 1.3 million.

Jeff Bash

Oh, it was?

Paul Anthony

Yes. Total for the year then was about 5.6 million for security. So, overall, we’re pretty happy with the results. We’ve built the earn-out with the understanding that it was aggressive, in addition with the integration efforts. I think that put us a little behind the [indiscernible] as we work through some of the integration. So, we expect now that that’s complete, or about to be complete that team will start to -- start moving forward.

Jeff Bash

You have mentioned many times in the past that they would have roughly 40% to 45% gross margins in this business. Have you been achieving that on the revenue to date or because of all of those development efforts and integration efforts, you really haven’t achieved that?

Paul Anthony

We’re little low but we still achieved about 39% margin for the year on security. So, given some of the changes that we had, I think we’re pretty happy with those results and continue to -- obviously as that volume increases, some of the cost of goods sold are relatively fixed cost with the labor component on them, especially on the Redspin business, lot of their labor has still has the capacity and so we’d look to see some margin improvement as their volume starts to improve.

Jeff Bash

At the Board level, has there been any let’s say discussion about pursuing the security strategy versus a pure MPS strategy; is the Board completely behind what you’re doing? I do notice, you had two fellows recently resigned.

Joe Flynn

Right, I think at this point, obviously with the Board, you’ll always have -- people have various opinions. Currently, we are focusing on making sure that our core business is healthy, our core business continues to grow. We’re making sure that the integration with Redspin continues to go well. We’re learning a lot about securities business and we’re learning that it’s somewhat cyclical, just kind of like MPS business from a volume standpoint. And we’re looking at opportunities, as they come our way. I would characterize the current Board as open to those possibilities, open to possibilities to continue to grow that, but we’re going to be cautious, we’re going to make sure we make the right decisions.

Jeff Bash

Excellent, that’s my view as well. I’m reading some text which I prepared now. As a data point, every year for the last ten years, the stock has traded through $1. With the stock price again under $1, I privately recommended that the Company has a 500,000 share buyback program only at such attractive prices. That would take little capital from other initiatives, yet make a value statement to shareholders. Also by buying stock back as well, under what you issued it at for the security acquisition, you would implicitly be reducing your cost, if not expressively. Are there any debt covenants preventing this? And if not, is there any chance that this might be considered?

Joe Flynn

I think you want to take the debt covenant part and I’ll take the other part.

Paul Anthony

Yes, there is no debt covenants that would prevent it from happening, as long as we ensure that we meet the -- we do have some balance sheet and P&L type covenants as long as the amount of that stuff, it doesn’t trigger any of those covenants, then it is something we could do.

Joe Flynn

Yes, I think, I’ll answer that we have an important Board meeting coming up in April and that is certainly an issue that will be on the table for discussion.

Jeff Bash

Good. My next, the last question, finally very few companies have real sales and earnings like Auxilio has to issue results on or about the last day. Is there any chance for you get results to have somewhat sooner in order to help enhance the Company’s creditability?

Joe Flynn

One of the main drivers, at least for Auxilio, is we use an auditing firm that our pricing allows for us. If we kind of -- since we’re not an accelerated filer, gives them more time to then address our program. So that’s one of the big drivers for us. So, it’s something we can definitely investigate, if think it’ll have an impact. But at least at this point, we continue to use the timing, based on we feel, this is best process with the audit firm that we use.

Jeff Bash

And my final question is, despite what I consider to be excellent Q4 results; the stock is still down today to $0.75 on 146,000 shares as of now. Are you aware of any one with 90-day restriction that might be up today?

Joe Flynn

Not necessarily today but we are aware that most of the shares from the Delphis acquisition, those shareholders have their shares available for sale, so there could be some overhang from there.

Jeff Bash

Okay. And that would be back into my recommendation of stock buyback because you might be getting an opportunity in with that that you wouldn’t otherwise see, considering what I view as the quarter [ph] you just said and improving margins going forward ?

Joe Flynn

Well said.

Operator

We next move to Dallas Salazar with Atlas Consulting.

Dallas Salazar

Hey, guys. Nice quarter, nice full year. A lot of my questions were actually answered. I just had two and you address them as one singular question. But in general, can you briefly discuss some of the seasonality, if there is any kind of in the blended model now? And then secondarily, is this sort of the cadence that we’re going to see from Auxilio going forward, which is you guys typically secure these major agreements and then, it takes a year or so to integrate them and to launch them obviously? And so in that year where you’re doing that growth plateaus and then we go after another big agreement. I mean, that’s what would make sense based on some of the capacity constraints of just your size and funding ability. But if you could talk a little bit about that as well after seasonality and I’ll just listen in offline.

Joe Flynn

That’s a very good question, and I think an accurate statement. And if you’ve been following our history that sort of what has happened, especially since about 2010 when we added a number of very large health systems, we need to be able to scale up properly to be able to swallow basically these large deals. And so, you’ve seen that. And so once we go through that high growth period, there is typically a period where I’m not saying -- not necessarily we take a break but certainly we slow things down a bit in order to make sure we implement properly.

I can’t underemphasize how important it is when you’re doing implementation that you do them very, very well. One massive problem during an implementation can ruin your reputation in the marketplace, especially a Company of our size that doesn’t have the resources that some of our competitors have. So, we take very, very -- we are very, very careful in making sure when we get a contract with a large health system like some of that we have that we do it right, we do it on time, we live up to the promises in terms of savings that we’ve committed to in the pro formas and in the contracts. So, that’s sort of been our mantra; and in doing that sometimes we slow things down a bit.

From a seasonality standpoint, certainly what we see in healthcare and what we’re learning in security after having Redspin under our -- this will be the first time that we’ve had Redspin in the first quarter. What we’re learning is that it is seasonal, just like MPS; we see volumes typically in the early part of the year, volume -- paper volume being lower and then it ramps throughout the rest of the year. And we’re kind of seeing that as well in terms of the amount of money, the dollars that are spent in healthcare assessment.

It’s typically slower in the first quarter and then it ramps throughout the year and we saw that with Redspin last year as well. So, there is seasonality; there is -- I wouldn’t say -- I think we’re still in the position to take on large MPS contracts and certainly we’re in the queue for some of that now with some of the opportunities we have in our pipeline. And we’re going to go after those aggressively. But, we want to be cautious; we want to make sure we make the right moves; we want to make sure we don’t screw up in implementation and hurt our reputation in the marketplace. So, I hope that answers your question.

Operator

We’ll take our next question from John Gay from the Quiet Investor. [Ph]

Unidentified Analyst

My question has to do with the recurrence of your base at the moment and where it can support new contacts with new people and still produce bottom line results? I think part of the problem we see today is that even though we have top line growth of extraordinary amount, the bottom line didn’t buzz [ph] and I think that’s a disappointment to a lot of people. Can you go forward in Q1, 2, 3, 4 of ‘16 with the kind of Q4 performance of ‘15?

Paul Anthony

John, this is Paul. We’re definitely going to see some impact from seasonality in Q1, as we traditionally do. So, we should expect that. We are still implementing one of the larger talents. So, we’re still going to see some impact from that for another through -- probably half way through Q2. So, we’ll see some impact from that as well as the loss of the account. But we feel pretty confident, at least in the short term that we’ll be able to offset some of these seasonal issues and this lost customer with improvements in the new accounts. So, it is our expectation and we’ll start to see a margin improvement, but we do have a number of factors that we’re keeping an eye on.

Unidentified Analyst

Secondarily, the loss of the one contact, through some of them, we take [indiscernible] loss; is that a project company or is that a typically like yourselves simply a service company and [indiscernible]?

Joe Flynn

John, I couldn’t really quite hear your question.

Unidentified Analyst

Basically what I was asking was for the competitor that you lost this contract to, is that a project company or is that a group such as yourselves that is simply a service operator?

Joe Flynn

The printer company, the large -- very large printer company.

Unidentified Analyst

Okay. Now, do they really then give the customer the kind of facility [ph] that you’re able to provide?

Joe Flynn

No, from what we understand from what the customer decided to do is it is a program very different than ours. And very on the low end in terms of quality of the equipment and a very different type of program that we’re providing, but again from cost standpoint, I think the cost -- customer went with that sort of lower cost, low service touch that certainly we didn’t recommend and we believe they will have significant problem.

Unidentified Analyst

So, you think that down the road that they come on back to you?

Joe Flynn

We would hope so. We left on great terms. We left as friends. And we’re still there but we’ll be winding out of there in about probably another 30 days or so. So, we’re going to do our best to remain friends and stay in touch, and we’ll see how it goes, but we do not think that what they’ve chosen to do is going to be helpful to their clinical staff in anyway.

Unidentified Analyst

It sounds [indiscernible] that for security aspect of your package, you keep a lot of these guys in place because [indiscernible] down the road and [indiscernible]?

Joe Flynn

Yes, I mean, certainly, what we’re seeing with the security element now part of our pitch is certainly in both our existing customers as well as when we’re doing for example presentations to these large MPS bids we’re involved with, the security part of what we offer puts us in a different category and it’s certainly attractive and gets people’s attention, get the attention of these people for sure.

Operator

[Operator Instructions] We move next to a follow-up from Jeff Bash with General Pacific Partners.

Jeff Bash

Two questions for Paul. Are we approaching the point where you might breakout for separate line of business security or is that to be large than it is now?

Paul Anthony

At this point, we’re still under the required amount but we’re definitely evaluating that. And we’ll be working with the Board to finalize what we want to do in that area over the next quarter or two.

Jeff Bash

Okay. And the last one is the 623,000 earn-out reversal, Redspin trigger and impairment analysis could grow [ph] or not?

Paul Anthony

We did an impairment analysis, we do on every quarter. And so that by itself didn’t trigger in impairment analysis but we definitely took a look at it. But again, we felt although they missed the earn-out and from a short-term perspective, given the integration of the things, we didn’t hit numbers we had hoped from a long-term and what we’re seeing in a marketplace, we’re still very bullish on where that business is going.

Jeff Bash

Okay. Thanks so much.

Operator

And we next move to Wyatt Carr with Monarch Bay Securities. Please go ahead.

Wyatt Carr

Just a quick question; could you give us a color on the changes to the Board and the makeup and what the implication is for these changes, and how that’s going to affect to business going forward, how the board is looking at business now?

Joe Flynn

I’m not going to comment on any particular issues as it relates to people leaving there were couple of 8-Ks that went and I’ll just refer you to those 8-Ks. But I’ll comment…

Wyatt Carr

Primarily looking at the people coming on board?

Joe Flynn

Yes, what we’re looking going forward is -- our goal is to constitute a board that provides skill sets that we believe we need as we position the Company now that we’re at the size that we’re at in the healthcare IT space, so couple of things. One, as you saw, we invited or we elected a Board member by name JD Abouchar who has a background in the microcap investment space, which is very important for us because as you know, it is a difficult world in which to navigate. And so having that expertise is really important to us going forward.

Secondly, we want to make sure that we have on the Board and we search of this particular type of a person and there is plenty of candidates out there who have deep experience in healthcare IT. For all practical purposes, we are a healthcare IT services provider in the MPS and the security space. And if we decide to go into other areas, we want to have some who can help us explore those possibilities and really vest those possibilities as it relates to the opportunities in the marketplace. So, if I was to say, kind of the crystal ball, I’d say that we’re going to be building a board that reflects that sort of composition. Does that make sense?

Wyatt Carr

Yes, it does. I’ve JD on the prior conference calls and I guess we’re not going to hear from him today but look forward to seeing the changes he makes.

Joe Flynn

Thank you.

Wyatt Carr

Thank you.

Operator

And ladies and gentlemen, as it appears there are no further questions in queue. I’d like to turn the conference back over to management for any closing or additional remarks.

Joe Flynn

I just want to thank everybody for joining the call today and thank you for your informative questions. And we’ll look forward to continuing talking to you and to our next conference call. Thank you very much.

Operator

Ladies and gentlemen, that does conclude today’s conference. We do thank you for your participation. You may now disconnect. Have a great rest of your day.

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