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AUXO > SEC Filings for AUXO > Form 10-Q on 13-Aug-2013All Recent SEC Filings

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Form 10-Q for AUXILIO INC


13-Aug-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Section 27A of the Securities Act, and is subject to the safe harbors created by those sections. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," "may," "will" and variations of these words or similar expressions are intended to identify forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors. We undertake no obligation to revise or publicly release the results of any revisions to these forward-looking statements.

Due to possible uncertainties and risks, readers are cautioned not to place undue reliance on the forward-looking statements contained in this Quarterly Report, which speak only as of the date of this Quarterly Report, or to make predictions about future performance based solely on historical financial performance. We disclaim any obligation to update forward-looking statements contained in this Quarterly Report.

Readers should carefully review the risk factors described below under the heading "Risk Factors" and in other documents we file from time to time with the SEC, including our Form 10-K for the fiscal year ended December 31, 2012. Our filings with the SEC, including our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those filings, pursuant to Sections 13(a) and 15(d) of the Exchange Act, are available free of charge at www.auxilioinc.com, when such reports are available via the EDGAR system maintained by the SEC at www.sec.gov.

OVERVIEW

We provide total outsourced document and image management services and related financial and business processes for major healthcare facilities. Our proprietary technologies and unique processes assist hospitals, health plans and health systems with strategic direction and services that reduce document image expenses, increase operational efficiencies and improve the productivity of their staff. Our analysts, consultants and resident hospital teams work with senior hospital financial management and department heads to determine the best possible long term strategy for managing the millions of document images produced by their facilities on an annual basis. Our document image management programs help our clients achieve measurable savings and a fully outsourced document image management process. Our target market includes medium to large hospitals, health plans and healthcare systems.

Our common stock currently trades on the OTCQB under the stock symbol "AUXO".

Where appropriate, references to "Auxilio," the "Company," "we," "us" or "our" include Auxilio, Inc. and its wholly-owned subsidiary, Auxilio Solutions, Inc., a California corporation.


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APPLICATION OF CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. We evaluate these estimates on an on-going basis, including those estimates related to customer programs and incentives, product returns, bad debts, inventories, investments, intangible assets, income taxes, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. The results of these estimates form the basis for our judgments about the carrying values of assets and liabilities which are not readily apparent from other sources. As a result, actual results may differ from these estimates under different assumptions or conditions.

We consider the following accounting policies to be most important to the portrayal of our financial condition and those that require the most subjective judgment:

Revenue recognition and deferred revenue

Revenue is recognized pursuant to ASC Topic 605, "Revenue Recognition" ("ASC 605"). Monthly service and supply revenue is earned monthly during the term of the contract, as services and supplies are provided. Revenues from equipment sales transactions are earned when there is persuasive evidence of an arrangement, delivery has occurred, the sales price has been determined and collectability has been reasonably assured. For equipment that is to be placed at a customer's location at a future date, revenue is deferred until the placement of such equipment.

We enter into arrangements that include multiple deliverables, which typically consist of the sale of Multi-Function Device ("MFD") equipment and a support services contract. We account for each element within an arrangement with multiple deliverables as separate units of accounting. Revenue is allocated to each unit of accounting under the guidance of FASB ASC Topic 605-25, Multiple-Deliverable Revenue Arrangements, which provides criteria for separating consideration in multiple-deliverable arrangements by establishing a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable is based on vendor-specific objective evidence ("VSOE") if available, third-party evidence if VSOE is not available, or estimated selling price if neither VSOE nor third-party evidence is available. We are required to determine the best estimate of selling price in a manner that is consistent with that used to determine the price to sell the deliverable on a standalone basis. We generally do not separately sell MFD equipment or service on a standalone basis. Therefore, we do not have VSOE for the selling price of these units. As we purchase the equipment, we have third-party evidence of the cost of this element. We estimate the proceeds from the arrangement to allocate to the service unit based on historical cost experiences. Based on the relative costs of each unit to the overall cost of the arrangement, we utilize the same relative percentage to allocate the total arrangement proceeds.

Accounts receivable valuation and related reserves

We estimate the losses that may result from that portion of our accounts receivable that may not be collectible as a result of the inability of our customers to make required payments. Management specifically analyzes customer concentration, customer credit-worthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. We review past due accounts on a monthly basis and record an allowance for doubtful accounts where we deem appropriate.

New customer implementation costs

We ordinarily incur additional costs to implement our services for new customers. These costs are comprised primarily of additional labor and support. These costs are expensed as incurred, and have a negative impact on our statements of operations and cash flows during the implementation phase.

Impairment of intangible assets

The Company performs an impairment test of goodwill at least annually or on an interim basis if any triggering events occur that would merit another test. The impairment test compares our estimate of our fair value based on its market capitalization to the Company's carrying amount including goodwill. We have not had to perform step 2 of the impairment test because the fair value has exceeded the carrying amount.


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Stock-based compensation

Under the fair value recognition provisions of the authoritative guidance, stock-based compensation cost granted to employees is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service or performance period, which is the vesting period. Stock options and warrants issued to consultants and other non-employees as compensation for services to be provided to us are accounted for based upon the fair value of the services provided or the estimated fair value of the option or warrant, whichever can be more clearly determined. We currently use the Black-Scholes option pricing model to determine the fair value of stock options. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, the expected term of the award, the risk-free interest rate and any expected dividends. Compensation cost associated with grants of restricted stock units are also measured at fair value. We evaluate the assumptions used to value restricted stock units on a quarterly basis. When factors change, including the market price of the stock, stock-based compensation expense may differ significantly from what has been recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense.

Income taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial reporting requirements and those imposed under federal and state tax laws. Deferred taxes are provided for timing differences in the recognition of revenue and expenses for income tax and financial reporting purposes and are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred income tax expense represents the change during the period in the deferred tax assets and liabilities. The components of the deferred tax assets and liabilities are individually classified as current and non-current based on their characteristics. Realization of the deferred tax asset is dependent on generating sufficient taxable income in future years. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

Derivative Liabilities

Our derivative warrants and additional investment rights liabilities are measured at fair value using the Black-Scholes valuation model which takes into account, as of the measurement date, factors including the current exercise price, the term of the instrument, the current price of the underlying stock and its expected volatility, expected dividends on the stock and the risk-free interest rate for the term of the item. These derivative liabilities are revalued at each reporting period and changes in fair value are recognized currently in the consolidated statements of operations under the caption "Change in fair value of derivative liabilities."

Reference is made to our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 filed on March 28, 2013 for a discussion of our critical accounting policies.

RESULTS OF OPERATIONS

For the Three Months Ended June 30, 2013 Compared to the Three Months Ended June 30, 2012

Revenue

Recurring service revenues increased by approximately $1,400,000, however overall revenue decreased by approximately $900,000 to $9,801,029 for the three months ended June 30, 2013, as compared to the same period in 2012 due to a drop in equipment revenue. We added approximately $1,600,000 in recurring service revenues from new contracts that started between May 2012 and April 2013. Equipment sales for the three months ended June 30, 2013 were approximately $800,000 as compared to approximately $3,100,000 for the same period in 2012. Equipment revenues in the second quarter of 2012 were high due to a large copier fleet refresh activities at three customers. These fleet refreshes are typically done every five years at any one customer facility.


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Cost of Revenue

Cost of revenue consists of document imaging equipment, parts, supplies and salaries and expenses of field services personnel. Cost of revenue was $8,157,963 for the three months ended June 30, 2013, as compared to $9,323,015 for the same period in 2012. The decrease in the cost of revenue for the second quarter of 2013 is attributed to a reduction in equipment costs of approximately $2,400,000 primarily as a result of the decrease in equipment sales from the copier fleet refresh activities in 2012. Equipment costs includes equipment sold and equipment provided under the recurring service contracts. Offsetting this decrease, our cost of revenue increased in the second quarter of 2013 with the addition of new recurring service revenue contracts that started between May 2012 and April 2013. We incurred approximately $300,000 in additional staffing and $1,000,000 in additional service and supply costs primarily as a result of our new customers. Gross margin increased to 17% of revenue for the three months ended June 30, 2013 as compared to 13% for the same period of 2012. This increase is a result of the large growth in new facilities that we added in 2012 and the reduction in costs as Auxilio's program matures within these new accounts.

We expect higher cost of revenues at the start of our engagements with most new customers. In addition to the costs associated with implementing our services, we pay our new customers' legacy contracts with third-party vendors. As we implement our programs we strive to improve upon these legacy contracts and thus reduce costs over the term of the contract. Given the varying expiration dates of these vendor contracts and the fact that the amount of savings is specific to each arrangement, we cannot predict our anticipated profit margins as these legacy contracts come up for renewal. We anticipate these trends to continue but anticipate an overall increase in cost revenues sold as a result of the expansion of our customer base.

Sales and Marketing

Sales and marketing expenses include salaries, commissions and expenses for sales and marketing personnel, travel and entertainment, and other selling and marketing costs. Sales and marketing expenses were $504,168 for the three months ended June 30, 2013, as compared to $559,543 for the same period in 2012. Staffing costs, including commissions, decreased approximately $60,000 in the second quarter of 2013 primarily because we reduced sales staff headcount.

General and Administrative

General and administrative expenses include personnel costs for finance, administration, information systems, and general management, as well as facilities expenses, professional fees, legal expenses and other administrative costs. General and administrative expenses decreased by $20,251 to $934,251 for the three months ended June 30, 2013, as compared to $954,502 for the three months ended June 30, 2012. In the second quarter of 2012, we made a one-time payment of approximately $50,000 of our common stock to an investor relations firm. Offsetting this decrease we increased staff headcount to address the increased size of our business.

Other Income (Expense)

Interest expense for the three months ended June 30, 2013 was $107,154, compared to $116,939 for the same period in 2012. The small decrease is a result of lower line of credit borrowings in the second quarter of 2013.

The change in the fair value of derivative liabilities resulted in a benefit of $205,000 for the three months ended June 30, 2012. This benefit is primarily a result of the change in our stock price between March 31, 2012 and June 30, 2012. There was no such benefit for the three months ended June 30, 2013 because there was no derivative liability at that time.


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For the Six Months Ended June 30, 2013 Compared to the Six Months Ended June 30, 2012

Revenue

Revenue increased by approximately $2,600,000 to $19,893,182 for the six months ended June 30, 2013, as compared to the same period in 2012. Of this increase, approximately $4,700,000 is a result of the addition of new recurring service revenue contracts between May 2012 and April 2013. Equipment sales for the six months ended June 30, 2013 were approximately $1,900,000 as compared to approximately $3,700,000 for the same period in 2012. Equipment revenues in 2012 from large copier fleet refresh activities at three customers were not repeated in 2013 as these fleet refreshes are typically done every five years at any one customer facility.

Cost of Revenue

Cost of revenue consists of document imaging equipment, parts, supplies and salaries and expenses of field services personnel. Cost of revenue was $16,673,902 for the six months ended June 30, 2013, as compared to $15,511,094 for the same period in 2012. The increase in the cost of revenue for the first six months of 2013 is attributed primarily to the addition of new recurring service revenue contracts between May 2012 and April 2013. We incurred approximately $900,000 in additional staffing. Service and supply costs increased by approximately $2,600,000 primarily as a result of our new customers. Equipment costs, which includes equipment provided under the recurring service contracts and equipment sold, decreased by approximately $2,000,000 in 2013, primarily as a result of the decrease in equipment sales from the copier fleet refresh activities.

Gross margin increased to 16% of revenue for the six months ended June 30, 2013 as compared to 10% for the same period of 2012. This increase is a result of the large growth in new facilities that we added in 2012 and the reduction in costs as Auxilio's program matures within these new accounts.We anticipate this trend to continue but anticipate overall increase in cost revenues sold as a result of the expansion of our customer base.

Sales and Marketing

Sales and marketing expenses include salaries, commissions and expenses for sales and marketing personnel, travel and entertainment, and other selling and marketing costs. Sales and marketing expenses were $1,174,063 for the six months ended June 30, 2013, as compared to $1,251,753 for the same period in 2012. Staffing costs, including commissions, decreased approximately $150,000 in the first six months of 2013 because we reduced sales staff headcount. Offsetting this, we incurred approximately $70,000 more with third party channel partners and marketing firms in the first six months of 2013.

General and Administrative

General and administrative expenses include personnel costs for finance, administration, information systems, and general management, as well as facilities expenses, professional fees, legal expenses and other administrative costs. General and administrative expenses increased by $96,283 to $1,939,021 for the six months ended June 30, 2013, as compared to $1,842,738 for the six months ended June 30, 2012. General and administrative expenses increased primarily as a result of increases in staffing headcount to address the increased size of our business.

Other Income (Expense)

Interest expense for the six months ended June 30, 2013 was $233,503, compared to $214,381 for the same period in 2012. The increase is a result of the cost of the line of credit borrowings consummated in May 2012.

The change in the fair value of derivative liabilities resulted in a charge of $85,000 for the six months ended June 30, 2012. This cost is primarily a result of the change in our stock price between December 31, 2011 and June 30, 2012. There was no such charge for the six months ended June 30, 2013 because there was no derivative liability at that time.


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Income Tax Expense

Income tax expense for each of the six months ended June 30, 2013 and June 30, 2012, was $5,500 and $1,600 respectively, which represents the minimum tax liability due for required state income taxes.

LIQUIDITY AND CAPITAL RESOURCES

At June 30, 2013, our cash and cash equivalents were $2,030,126 and our working capital deficit was $135,406. Our principal cash requirements are for operating expenses, including equipment, supplies, employee costs, and capital expenditures and funding of the operations. Our primary sources of cash are service and equipment sale revenues, the exercise of options and warrants and the sale of common stock.

During the six months ended June 30, 2013, our cash used for operating activities amounted to $69,633, as compared to $1,052,321 used for operating activities for the same period in 2012. The improvement in cash used by operating activities in 2013 is primarily a result of improved margins being generated from our recurring service revenue contracts at our legacy customers. The cash used for operating activities for 2012 was primarily due to the costs incurred to implement new recurring service revenue contracts.

We expect to close additional recurring service revenue contracts to new customers throughout 2013 but at a slower rate than during 2012. Because we expect higher cost of revenues at the start of our engagement with most new customers, we have entered into an accounts receivable line of credit with a commercial bank. Management believes that cash generated from the line of credit along with funds from operations will be sufficient to sustain our business operations over the next twelve months.

OFF-BALANCE SHEET ARRANGEMENTS

Our off-balance sheet arrangements consist primarily of conventional operating leases, purchase commitments and other commitments arising in the normal course of business, as further discussed below under "Contractual Obligations and Contingent Liabilities and Commitments." As of June 30, 2013, we did not have any other relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

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