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AUXO > SEC Filings for AUXO > Form 10-K on 31-Mar-2014All Recent SEC Filings

Show all filings for AUXILIO INC

Form 10-K for AUXILIO INC


31-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion presents information about our consolidated results of operations, financial condition, liquidity and capital resources and should be read in conjunction with our consolidated financial statements and the notes thereto beginning on page F-1 of this Annual Report.

Overview

We provide integration strategies and outsourced services for print management in healthcare facilities. We help hospitals and health systems reduce expenses and create manageable, dependable document image management programs by managing their back-office processes. The process is initiated through a detailed proprietary managed print services assessment. The assessment is a strategic, operational and financial analysis that is performed at the customer's premises using a combination of proprietary processes and innovative web based technology for data collection and report generation. After the assessment and upon engagement, we charge the customer on a per print basis. This charge covers the entire print management process and includes the placement of a highly trained resident team on-site to manage the entire process. We are focused solely on the healthcare provider industry.

Application of Critical Accounting Policies

The SEC defines critical accounting policies as those that are, in management's view, most important to the portrayal of our financial condition and results of operations and most demanding of our judgment. The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which were prepared in accordance with accounting principles generally accepted in the U.S., which is referred to as "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 related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate these estimates, including those related to stock-based compensation, customer programs and incentives, bad debts, supply inventories, intangible assets, income taxes, contingencies and litigation.


We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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

Revenue Recognition

Revenue consists primarily of fees charged to customers based on the volume of images printed from devices supported under a long-term contract. Revenue also includes the sale of equipment. With respect to revenue recognition for multiple deliverables, we have evaluated and determined that two separate units of accounting exist: recurring service revenue and equipment sale revenue. Revenue is allocated to each unit of accounting using the relative selling price method, which allocates revenue to each unit of accounting based on the relative selling price for both the delivered and undelivered items. We use a combination of third party evidence and historical experiences of our costs to deliver the services in order to determine the estimated amounts to allocate to each unit. If billings for the sale of equipment exceed the amount of contract proceeds allocated to the equipment unit, revenue is deferred.

We recognize recurring service revenue over the period the service is performed and revenue from equipment sales at the time equipment is placed in service. We recognize revenue when the following four basic criteria have been met: (1) persuasive evidence that an arrangement exists, (2) delivery has occurred or services were rendered, (3) the fee is either fixed or determinable and (4) collectability is reasonably assured. Amounts billed which do not meet such criteria are deferred until all four criteria have been met.

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, share-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 share-based compensation expense.

Income Taxes

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amount of tax-related assets and liabilities and income tax expense. These estimates and assumptions are based on the requirements of the Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") relating to accounting for uncertainty in income taxes. Our policy is to classify interest and penalties related to unrecognized income tax benefits as a component of income tax expense.

We assess whether previously unrecognized tax benefits may be recognized when the tax position is (1) more likely than not of being sustained based on its technical merits, (2) effectively settled through examination, negotiation or litigation, or (3) settled through actual expiration of the relevant tax statutes. Implementation of this requirement requires the exercise of significant judgment. Recognizing deferred tax assets will increase tax benefits and increase net income.


Impairment of Intangible Assets

We account for goodwill in accordance with FASB's authoritative guidance which requires that goodwill and certain intangible assets are not amortized, but are subject to an annual impairment test. We complete our goodwill impairment test on an annual basis, during the fourth quarter of our fiscal year, or more frequently if changes in facts and circumstances indicate that impairment in the value of goodwill recorded on our balance sheet may exist. For purposes of testing the impairment of goodwill, we have one reporting unit. To test for impairment, first we perform a qualitative assessment. If we determine, based on qualitative factors, that the fair value of goodwill is more likely than not greater than the carrying amount, a quantitative calculation would not be needed. Our methodology for a quantitative assessment of testing for goodwill impairment consists of one, and possibly two steps. In step one of the goodwill impairment test, we compare our carrying amount (including goodwill) of our entity-wide reporting unit and Auxilio's fair value based on market capitalization. We evaluated how this market capitalization measure compared to the performance-based multiples of revenue and earnings methods and feel it most accurately reflects the Company's valuation given our recent revenue growth accompanied by losses which causes performance-based metrics to portray the Company at an unrealistic value. Our market capitalization is based on the closing price of our Common Stock as quoted on the OTCBB multiplied by our outstanding shares of Common Stock. There was no impairment of goodwill as a result of the annual impairment tests completed during the fourth quarters of 2013 and 2012. Excluding goodwill, we have no intangible assets deemed to have indefinite lives. At December 31, 2013, the fair value of Auxilio, based on our market capitalization, was approximately $30.6 million, exceeding our book value of approximately $2,000,000.

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, with the efforts going to identify, map and record all existing devices and support arrangements for all subject devices. Once this effort is complete, it need not be repeated. This ordinarily takes one to six months to complete, depending on the size of the new customer. These costs are expensed as incurred, and have a negative impact on our statements of operations and cash flows during the implementation phase.

Derivative Liabilities

The Company's 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."

The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP, with no need for management's judgment in its application. There are also areas in which management's judgment in selecting any available alternative would not produce a materially different result. Please see our audited financial statements and notes thereto which begin on page F-1 of this Annual Report on Form 10-K, which contain accounting policies and other disclosures required by GAAP and please refer to the disclosures in Note 1 of our financial statements for a summary of our significant accounting policies.


Results of Operations

Year Ended December 31, 2013 Compared to the Year Ended December 31, 2012

Net Revenue

Revenues consist of equipment sales and ongoing service fees. Net revenue increased by $7,327,957 to $42,974,978 for the year ended December 31, 2013, as compared to the same period in 2012. Service revenue in 2013 totaled approximately $37,100,000 compared to approximately $30,500,000 in 2012. Of this increase, approximately $7,300,000 was a result of the addition of nine new recurring revenue contracts during 2012 and 2013. Another $600,000 of the increase was due to the expansion of services with existing customers. Partially offsetting these increases was a reduction of approximately $900,000 from a nonrenewing contract. We also had a decrease in revenue of approximately $500,000 with existing customers, where there was a reduction in unit price and sales volume. We anticipate this trend to continue as we renew our customers' contracts but anticipate overall revenue growth as a result of the expansion of our customer base. Equipment sales for the year ended December 31, 2013 were approximately $5,800,000 as compared to approximately $5,200,000 for the same period in 2012.

Cost of Revenue

Cost of revenue consists of document imaging equipment, parts, supplies and salaries expense for field services personnel. Cost of revenue was $35,294,204 for the year ended December 31, 2013, as compared to $31,018,117 for the same period in 2012. The increase in the cost of revenue for 2013 is attributed primarily to the addition of nine new recurring revenue contracts during 2012 and 2013 and an increase in our operational support costs to respond to this growth. We incurred approximately $1,300,000 in additional staffing costs. Service and supply costs increased by approximately $3,300,000 as a result of our new customers. Our travel related costs in 2013 were approximately $300,000 lower compared to 2012 because certain staff training initiatives had been mostly completed in the prior year and new customer implementations in 2013 were geographically closer, requiring less travel.

We expect higher cost of revenues at the start of our engagement with most new customers. In addition to the costs associated with implementing our services, we absorb our new customers' legacy contracts with third-party vendors. As we implement our programs, we strive to improve upon these legacy contracts thus reducing costs over the term of the contract. We anticipate this trend to continue but anticipate an overall increase in the cost of revenues as a result of the expansion of our customer base.

Sales and Marketing

Sales and marketing expenses include salaries, commissions and expenses of sales and marketing personnel, travel and entertainment, and other selling and marketing costs. Sales and marketing expenses were $2,112,285 for the year ended December 31, 2013, as compared to $2,604,783 for the same period in 2012. We incurred sales commissions to employees totaling approximately $140,000 in 2013 compared to $490,000 in 2012. The reduction is due to the fact that we initiated more new recurring revenue contracts in 2012 than in 2013. In 2013 we terminated a joint marketing agreement with a channel partner thus reducing marketing expense by approximately $150,000 compared to 2012.

General and Administrative

General and administrative expenses, which include personnel costs for finance, administration, information systems, and general management, as well as facilities expenses, professional fees, and other administrative costs, increased by $131,062 to $3,785,778 for the year ended December 31, 2013. Salary expense increased approximately $230,000 in 2013 and was primarily due to additional office staff needed to handle the increase in transaction volume. Professional fees in 2013 decreased approximately $230,000 due to reduced spending on investor relations services and lower expenses related to legal and accounting services. Stock compensation increased approximately $90,000 in 2013 due to the cost of performance-based warrants granted to some of our executives.


Other Income (Expense)

Interest expense for the year ended December 31, 2013 was $436,476, compared to $465,131 for the same period in 2012. The reduction is due to the reduction in the average borrowings on the bank line of credit and the conversion of $100,000 of debt to equity in 2013.

We had a convertible debt offering which contained a beneficial exchange feature from July 2011 to July 2012. As a result, there was a change in fair value of derivative liabilities charge of $279,000 in 2012. This 2012 charge was reflective of the increase in the market value of the underlying stock from the beginning of 2012 to the end of the beneficial exchange feature in July 2012.

Other income in 2013 of $80,000 was the proceeds from a contract settlement with a former customer. We had no such activity in 2012.

Income Tax Expense

Income tax expense for the year ended December 31, 2013 was $78,419 and was $7,440 for the year ended December 31, 2012. The increase in 2013 is due to taxes for profitable operations this year. The charge in 2012 is primarily for minimum payments and charges for state income taxes in apportioned states that disallow consolidated tax return filings.

Liquidity and Capital Resources

At December 31, 2013, our cash and cash equivalents were $4,668,624 and our working capital was $253,807. Our principal cash requirements were for operating expenses, including equipment, supplies, employee costs, and capital expenditures and funding of the operations. Our primary sources of cash were from service and equipment sale revenues and commercial line of credit borrowings.

During the year ended December 31, 2013, cash provided by operating activities was $2,578,804 as compared to cash used for operating activities of $29,601 for the same period in 2012. The difference in cash from operating activities in 2012 was primarily due to the costs incurred to implement our new recurring revenue contracts and more aggressive sales and marketing efforts to obtain new clients.

We expect to continue to establish recurring revenue contracts to new customers throughout 2014. Since we expect higher cost of revenues at the start of our engagement with most new customers, we may seek additional financing, which may include debt and/or equity financing or funding through third party agreements. In May 2012 we entered into an asset based line of credit agreement with a financial institution. This facility provides for borrowings up to $2,000,000 not to exceed 80% of eligible receivables. We may seek additional financing, however there can be no assurance that additional financing will be available on acceptable terms, if at all. Any equity financing may result in dilution to existing stockholders and any debt financing may include restrictive covenants. Management believes that cash generated from debt and/or equity financing arrangements along with funds from operations will be sufficient to sustain our business operations over the next twelve months. It is our expectation that near the maturity date in July 2014, some of the $1,700,000 convertible debt will be converted to common stock and the remainder will be paid to the lenders. Management believes that cash flows from operations together with cash reserves and our bank line of credit availability will allow us to complete these transactions without disrupting operations.

Off-Balance Sheet Arrangements

Our off-balance sheet arrangements consist primarily of conventional operating leases and purchase and other commitments arising in the normal course of business, as further discussed below under the section "Contractual Obligations, Contingent Liabilities and Commitments." As of December 31, 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.


Related Party Transactions

On August 10, 2009, we entered into a consulting agreement with John D. Pace, Chairman of the Board, to provide support to us in the capacity of Chief Strategy Officer. The agreement provided for payment to Mr. Pace of $6,500 per month as compensation for his services through December 31, 2012. On November 1, 2012, we entered into another consulting agreement with Mr. Pace which set the monthly compensation in 2013 at $4,000. During each of the fiscal years ended December 31, 2012 and 2013, we paid Mr. Pace $78,000 and $48,000, respectively for these consulting services.

Contractual Obligations, Contingent Liabilities and Commitments

As of December 31, 2013, expected future cash payments, including interest
portion, related to contractual obligations, contingent liabilities, and
commitments were as follows:

                                                              Payments Due by Period
                                                                                                    More than 5
                                     Total         Within 1 year      Year 2-3       Year 4-5          years
Convertible notes payable         $ 1,813,333     $     1,813,333     $       -     $        -     $           -
Capital leases                        128,365              76,370        50,817          1,178                 -
Operating leases                      410,661             232,602       178,059              -                 -
Total                             $ 2,352,359     $     2,122,305     $ 228,876     $    1,178     $           -

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