10-K 1 aux10k03272013.htm 10-K aux10k03272013.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.20549
FORM 10-K
 
[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2012.
 
[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _____ to _____
 
Commission File Number: 000-27507
 
AUXILIO, INC.
 
(Exact name of registrant as specified in its charter)
 
Nevada
88-0350448
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer
Identification No.)
 
26300 La Alameda, Suite 100, Mission Viejo, California  92691
(Address of principal executive offices) (Zip Code)
 
(949) 614-0700
(Registrant’s telephone number, including area code)
 
Securities registered under Section 12(b) of the Act: None
Securities registered under Section 12(g) of the Act:
 
Common Stock, $.001 par value
(Title of Class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes [  ]    No [X]
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes [  ]    No [X]
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes [X]    No [  ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [X]    No [  ]
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [X]
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.
 

 
 
 

 
 
Large accelerated filer ¨     Accelerated filer ¨
       
Non-accelerated filer ¨     Smaller reporting company ý
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
 
Yes [  ]                 No [X]
 
The aggregate market value of the registrant’s common stock, $0.001 par value per share (“Common Stock”), held by non-affiliates of the registrant on June 30, 2012, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $16.0 million (based on the average bid price of the Common Stock on that date).  Shares of Common Stock held by each officer and director and each person known to the registrant to own 10% or more of the outstanding voting securities of the registrant were excluded in that such persons may be deemed to be affiliates.  This determination of affiliate status is not a determination for other purposes.  The registrant has one class of securities, its Common Stock.
 
As of March 28, 2013, the registrant had 20,154,202 shares of Common Stock outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE.
 
Part III incorporates by reference certain information from the registrant’s definitive proxy statement (the “Proxy Statement”) for the 2013 Annual Meeting of Stockholders to be filed on or before April 5, 2013.
 


 
 
 

ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2012
 
TABLE OF CONTENTS
 
  Page
   
Cautionary Note Regarding Forward-Looking Statements 1
     
PART I    
     
     
     
     
     
     
     
  9
     
     
     
     
     
     
     
     
     
  16
     
     
     
     
     
     
  18
     


 
 
 

 
From time to time, we and our representatives may provide information, whether orally or in writing, including certain statements in this Annual Report on Form 10-K (this “Annual Report”), which are deemed to be “forward-looking” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that concern matters that involve risks and uncertainties which could cause actual results to differ materially from those projected in the forward-looking statements. These forward-looking statements are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995 (the “Litigation Reform Act”) and are based on our beliefs as well as assumptions made by us using information currently available. All statements other than statements of historical fact contained in this Annual Report, including statements regarding future events, our future financial performance, our future business strategy and the plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,” “should” and similar expressions, as they relate to us, are intended to identify forward-looking statements.  Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions.  Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended or using other similar expressions. In accordance with the provisions of the Litigation Reform Act, we are making investors aware that such forward-looking statements, because they relate to future events, are by their very nature subject to many important factors that could cause actual results to differ materially from those contemplated by the forward-looking statements contained in this Annual Report, any exhibits to this Annual Report and other public statements we make.  Such factors are set forth in the “Business” section, the “Risk Factors” section, the “Legal Proceedings” section, the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section and other sections of this Annual Report, as well as in our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. We expressly disclaim any intent or obligation to update any forward-looking statements after the date hereof to conform such statements to actual results or to changes in our opinions or expectations, except as required by applicable law.
 
PART I
 
ITEM 1.
BUSINESS.
 
Introduction
 
Auxilio, Inc. (including our subsidiary, Auxilio Solutions, Inc. are referred to collectively in this Annual Report, as “Auxilio,” “we,” “our” and “us”) is engaged in the business of providing fully outsourced print management services to the healthcare industry.  Auxilio was incorporated in Nevada on August 29, 1995, under the name Corporate Development Centers, Inc.  As a result of a series of transactions, we changed our name to “Auxilio, Inc.” in April 2004.  Our principal executive offices are located at 26300 La Alameda, Suite 100, Mission Viejo, California 92691.
 
For more information on Auxilio and our products and services, please see the section entitled “Principal Products or Services” below or visit our website at www.auxilioinc.com.  The inclusion of our Internet address in this Annual Report does not include or incorporate by reference into this Annual Report any information on our website.  Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and other filings with the Securities and Exchange Commission (the “SEC”) are generally available through the EDGAR system maintained by the SEC at www.sec.gov.
 
Background
 
Auxilio, Inc., a Nevada corporation, was incorporated on August 29, 1995.  We had no significant operations from our incorporation until approximately January 2002.  In January of 2002, our predecessor-in-interest, e-Perception Technologies, Inc. (“e-Perception”), a Human Resources software concern, completed a tender offer with Corporate Development Centers, Inc. (“CDC”), whereby the stockholders of e-Perception received one share of CDC’s common stock for four shares of e-Perception’s common stock.  As a result of the transaction, e-Perception became a wholly owned subsidiary of CDC, and CDC changed its name to “e-Perception, Inc.”
 


 
Approximately eighteen months after the completion of the tender offer, e-Perception changed its name to “PeopleView, Inc.” and traded on the Over-The-Counter Bulletin Board (the “OTCBB”) under the symbol “PPVW,” and subsequently changed its name to Auxilio, Inc. From approximately January 1, 2003 through March 31, 2004, we developed, marketed and supported web based assessment and reporting tools and provided consulting services that enabled companies to manage their human capital management needs in real-time.
 
In March of 2004, we entered into an asset purchase and sale agreement with Workstream, Inc. (“Workstream”) whereby we sold to Workstream substantially all of our assets, including, among other things, our software products and related intellectual property, our accounts receivable, certain computer equipment, customer lists, and the “PeopleView, Inc.” name.  Pursuant to the asset purchase and sale agreement, as modified by an addendum, we received cash consideration in the amount of $250,000, 246,900 shares of Workstream’s common stock, and a warrant to purchase an additional 50,000 shares of Workstream’s common stock at an exercise price of $3.00 per share.
 
On April 1, 2004, we acquired Alan Mayo and Associates, Inc. dba The Mayo Group (“TMG”), a managed print company.  TMG provided outsourced print management services to healthcare facilities throughout California, which services we provide as the successor-in-interest to TMG.  After we acquired TMG, we changed our name to “Auxilio, Inc.” and changed the name of TMG’s former subsidiary to “Auxilio Solutions, Inc.”  Our Common Stock currently trades on the OTCBB under the symbol “AUXO.OB”.
 
Principal Products and Services
 
We are engaged in the business of providing fully-outsourced managed print services to the healthcare industry, working exclusively with hospitals throughout the United States. We are vendor independent and provide intelligent solutions, a risk free program and guaranteed savings. We assume all costs related to print environments through customized streamlined and seamless integration of services at predictable fixed rates.
 
We help hospitals and health systems reduce expenses and create manageable, dependable print image management programs by managing their back-office processes.  The process is initiated through a detailed proprietary 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 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 fixes this price per print for the term of the contract and places a highly trained resident team on-site to manage the entire process.
 
Competition
 
We operate in a highly competitive market.  The majority of the competition in the healthcare industry market for print management services comes from the large photocopy/multi-functional digital device manufacturers such as Xerox, Canon, Konica Minolta, Ricoh and Sharp.  The competitive landscape also contains a number of regional and local equipment dealers and distributors that exist in the communities which the hospitals serve.  In addition, we compete with in-house departments performing the functions that we are seeking to have them outsource to us.
 
Nevertheless, our analysis of the competitive landscape shows a very strong opportunity for fully outsourced managed print services to the healthcare industry, and we believe that we have a strong competitive position in the marketplace due to a number of important factors:
 
 
·
We are entirely focused on the healthcare industry.  No other vendor/service provider has its entire business dedicated to solving issues within the healthcare industry with the expertise and knowledge base that we have.  This is unmatched in the market.
 
 
·
We have a unique approach to providing fully outsourced print management programs.  Our program is completely outsourced and hospitals need only pay a single invoice.  We operate the print management process as a department in the hospital with full-time staff on-site.  In contrast, vendors and dealers in the vast majority of instances have multiple small and large customers in a geographic area to whom they are providing services, which results in major delays in providing service and supplies to the hospitals.
 

 
 
·
By focusing solely on the hospital campus, we enjoy much lower turn-around times for service, greater up-sell opportunities and a much deeper service relationship with the customer.
 
 
·
We are not restricted to any single equipment vendor, which allows us to bring the best hardware and software solutions to our customers.  Our approach is to use the best technology to provide a solution in the best manner possible without any prejudice as to equipment.
 
 
·
We maintain a daily connection with the hospital, which allows us to provide a detailed strategy and plan on equipment acquisitions saving the organization a great deal of time, effort and money in this process.
 
Customers
 
All of our customers are hospitals and their related off-site facilities.  The loss of any key customer could have a material adverse effect upon our financial condition, business, prospects and results of operation.  During the year ended December 31, 2012, our four largest customers represented approximately 59% of our revenues.
 
Intellectual Property
 
We maintain a database that contains information related to our current and prospective customers’ image and document outputs for certain periods of time, image and document outputs for each piece of machinery maintained at the customer’s location and trends for each of the foregoing.  Our database allows us to anticipate our customers’ future needs and to meet those needs.
 
We have not applied for or been granted any patents with respect to our technology, or processes, as such intellectual property related to document and image management or document and image processing.  We have trademarked certain process documents and related marketing documents.  The most valuable of which is the Image Management Maturity Model which allows us to detail processes and offer a service that is duplicable in distributed regions.
 
Employees
 
As of December 31, 2012, we had 173 full-time employees, including 152 employees engaged in providing services, 7 employees engaged in sales and marketing, and 14 employees engaged in general and administrative activities.  Our employees are not represented by any collective bargaining agreement, and we have never experienced a work stoppage.  We believe our employee relations are good.
 
RISK FACTORS
 
Before deciding to purchase, hold or sell our Common Stock, you should carefully consider the risks described below in addition to the other information contained in this Annual Report and in our other filings with the SEC, including subsequent reports on Forms 10-Q and 8-K.  The risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business.  If any of these known or unknown risks or uncertainties actually occurs with material adverse effects on Auxilio, our business, financial condition, results of operations and/or liquidity could be seriously harmed.  In that event, the market price of our Common Stock will likely decline, and you may lose all or part of your investment.
 



Risks Related to Our Industry
 
We face substantial competition from better established companies that may offer similar products and services at a lower cost to our customers, resulting in a reduction in the sale of our products and services.
 
The market for our products and services is competitive and is likely to become even more competitive in the future.  Increased competition could result in pricing pressures, reduced sales, reduced margins or the failure of our products and services to achieve or maintain market acceptance, any of which would have a material adverse effect on our business, results of operations and financial condition.  Many of our current and potential competitors enjoy substantial competitive advantages, such as:
 
 
·
greater name recognition and larger marketing budgets and resources;
 
·
established marketing relationships and access to larger customer bases;
 
·
substantially greater financial, technical and other resources; and
 
·
larger technical and support staffs.
 
As a result, our competitors may be able to respond more quickly than we can to new or changing opportunities, technologies, standards or customer requirements.  For all of the foregoing reasons, we may not be able to compete successfully against our current and future competitors.
 
We are dependent upon our vendors to continue to supply us equipment, parts, supplies, and services at comparable terms and price levels as the business grows.
 
Our access to equipment, parts, supplies, and services depends upon our relationships with, and our ability to purchase these items on competitive terms from our principal vendors.  We rarely enter into long-term supply contracts with these vendors and we have no current plans to change this in the future.  These vendors are not required to use us to distribute their equipment and are free to change the prices and other terms at which they sell to us.  In addition, we compete with the selling efforts of some of these vendors.  Significant deterioration in relationships with, or in the financial condition of, these significant vendors could have an adverse impact on our ability to sell equipment as well as our ability to provide effective service and technical support.  If one of these vendors terminates or significantly curtails its relationship with us, or if one of these vendors ceases operations, we would be forced to expand our relationships with our existing vendors or seek out new relationships with previously unused vendors.
 
Risks Related to Our Business
 
A substantial portion of our business is dependent on our largest customers.
 
The loss of any key customer could have a material adverse effect upon our financial condition, business, prospects and results of operation.  Our four largest customers represented approximately 59% of our revenues for the year ended December 31, 2012.  We anticipate that these customers will represent approximately 40% of revenue for 2013; therefore the loss of one or more of these customers may contribute to our inability to operate as a going concern and may require us to obtain equity funding or debt financing to continue our operations.  We cannot be certain that we will be able to obtain such financing on commercially reasonable terms, or at all.
 
Healthcare legislation and regulation.
 
The healthcare industry is highly regulated.  Recent legislation such as the Patient Protection and Affordable Care Act of 2010 will likely change how healthcare services are provided and managed.  In addition, legislation related to electronic medical records may impact our business.  In 2009, the American Recovery and Reinvestment Act of 2009 included incentives and penalties related to electronic medical records.  For example, Medicare/Medicaid reimbursements will be less for providers who fail to use electronic medical records by 2015.
 



The use of electronic medical records does not necessarily mean a hospital’s printing demands will decrease, but we cannot be sure whether this will be the case.  Increased adoption and use of electronic medical records may negatively impact our business.
 
New legislation or regulation.
 
As to prospective legislation and regulation, we cannot determine what effect additional state or federal governmental legislation, regulations, or administrative orders would have on our business in the future.  New legislation or regulation may require the reformulation of our business to meet new standards, require us to cease operations, impose stricter qualification and/or registration standards, impose additional record keeping, or require expanded consumer protection measures.
 
We may be unable to recruit and maintain our senior management and other key personnel on whom we are dependent.
 
We are highly dependent upon senior management and key personnel, and we do not carry any insurance policies on such persons.  The loss of any of our senior management, or our inability to attract, retain and motivate the additional highly-skilled employees and consultants that our business requires, could substantially hurt our business, prospects, financial condition and results of operations.  In addition, we rely on the ability of our management team to work together effectively.  If our management team fails to work together effectively, our business could be harmed.
 
The market may not accept our products and services and we may not be able to continue our business operations; or if the market is receptive to our products but not our services, our revenues and profitability will be harmed.
 
Our products and services are targeted to the healthcare market, a market in which there are many competing service providers.  Accordingly, the demand for our products and services is very uncertain.  The market may not accept our products and services.  Even if our products and services achieve market acceptance, our products and services may fail to adequately address the market’s requirements.
 
In addition, if we are able to sell our products but are unable to provide ongoing services, our revenues and profitability will be harmed.  Our services are integral to the successful deployment of our solutions.  If we do not effectively service and support our customers, our revenues and operating results would be harmed.
 
We may need additional capital in the future and, if such capital is not available on terms acceptable to us or available to us at all, we may be unable to continue our business operations.
 
We may need capital in the future to continue our business operations or to expand.  If we need capital, we cannot be certain that it will be available on terms acceptable to us or available to us at all.  In the event we need to raise capital, we may not be able to:
 
 
·
develop or enhance our service offerings;
 
·
take advantage of future opportunities; or
 
·
respond to customers and competition.
 
Risks Related to the Market for Our Securities
 
Because the public market for shares of our Common Stock is limited, stockholders may be unable to resell their shares of Common Stock.
 
Currently, there is only a limited public market for our Common Stock on the OTCBB and our stockholders may be unable to resell their shares of Common Stock.  Currently, the average daily trading volume of our Common Stock is not significant, and it may be more difficult for you to sell your shares in the future, if at all.



The development of an active trading market depends upon the existence of willing buyers and sellers who are able to sell shares of our Common Stock as well as market makers willing to create a market in such shares.  Under these circumstances, the market bid and ask prices for the shares may be significantly influenced by the decisions of the market makers to buy or sell the shares for their own account.  Such decisions of the market makers may be critical for the establishment and maintenance of a liquid public market in our Common Stock.  Market makers are not required to maintain a continuous two-sided market and are free to withdraw quotations at any time.  We cannot assure our stockholders that an active public trading market for our Common Stock will develop or be sustained.
 
The price of our Common Stock may be volatile and could decline in value, resulting in loss to our stockholders.
 
The market for our Common Stock is volatile, having ranged in the last twelve months from a low of $0.73 to a high of $1.47 on the OTCBB.  The market price for our Common Stock has been, and is likely to continue to be, volatile.  The following factors may cause significant fluctuations in the market price of shares of our Common Stock:
 
 
·
fluctuations in our quarterly revenues and earnings or those of our competitors;
 
 
·
variations in our operating results compared to levels expected by the investment community;
 
 
·
announcements concerning us or our competitors;
 
 
·
announcements of technological innovations;
 
 
·
sale of shares or short-selling efforts by traders or other investors;
 
 
·
market conditions in the industry; and
 
 
·
the conditions of the securities markets.
 
The factors discussed above may depress or cause volatility of our share price, regardless of our actual operating results.  In addition, the highly volatile nature of our stock price may cause investment losses for our stockholders.  In the past, securities class action litigation has often been brought against companies following periods of volatility in the market price of their securities. If securities class action litigation is brought against us, such litigation could result in substantial costs while diverting management’s attention and resources.
 
There are a large number of shares of Common Stock that may be issued or sold, and if such shares are issued or sold, the market price of our Common Stock may decline.
 
As of December 31, 2012, we had approximately 19,818,642 shares of our Common Stock outstanding.
 
If all warrants and options outstanding as of December 31, 2012 are exercised prior to their expiration, up to approximately 8.2 million additional shares of Common Stock could become freely tradable. Additionally, we have granted 265,179 Restricted Stock Units which vest in 2013. Such sales of substantial amounts of Common Stock in the public market could adversely affect the prevailing market price of our Common Stock and could also make it more difficult for us to raise funds through future offerings of Common Stock. Additionally we have $1,800,000 in convertible debt which, if converted to stock, would further dilute the per share value.
 
If our Common Stock is determined to be a “penny stock,” a broker-dealer may find it more difficult to trade our Common Stock and an investor may find it more difficult to acquire or dispose of our Common Stock in the secondary market.
 
Our Common Stock may be subject to the so-called “penny stock” rules.  The SEC has adopted regulations that define a “penny stock” to be any equity security that has a market price per share of less than $5.00, subject to certain exceptions, such as any securities listed on a national securities exchange. For any transaction involving a “penny stock,” unless exempt, the rules impose additional sales practice requirements on broker-dealers, subject to certain exceptions. If our Common Stock is determined to be a “penny stock,” a broker-dealer may find it more difficult to trade our Common Stock and an investor may find it more difficult to acquire or dispose of our Common Stock on the secondary market.
 


 
We do not intend to pay dividends.
 
We have never declared or paid any cash dividends on our Common Stock.  We do not anticipate paying dividends on our Common Stock in the foreseeable future.  We may not have sufficient funds to legally pay dividends.  Even if funds are legally available to pay dividends, we may nevertheless decide in our sole discretion not to pay dividends and to retain any future earnings to fund growth.
 
Other Risks
 
It may be difficult for a third party to acquire us even if doing so would be beneficial to our stockholders.
 
Some provisions of our Articles of Incorporation, as amended, and Bylaws, as well as some provisions of Nevada or California law, may discourage, delay or prevent third parties from acquiring us, even if doing so would be beneficial to our stockholders.
 
As a public company, we are subject to complex legal and accounting requirements that will require us to incur significant expenses.
 
As a public company, we are subject to numerous legal and accounting requirements that do not apply to private companies. The cost of compliance with many of these requirements is material, not only in absolute terms but, more importantly, in relation to the overall scope of the operations of a small company.  The cost of such compliance may prove to be a substantial competitive disadvantage vis-à-vis our privately held and larger public competitors.
 
The impact of any additional deterioration of the global credit markets, financial services industry and U.S. economy may continue to negatively affect our business and our ability to obtain capital, if needed.
 
A deterioration in the global credit markets, the financial services industry and the U.S. economy has resulted in a period of substantial turmoil and uncertainty characterized by unprecedented intervention by the United States federal government and the failure, bankruptcy, or sale of various financial and other institutions.  The impact of these events on our business and the severity of the current economic crisis is uncertain.  It is possible that the current crisis in the global credit markets, the financial services industry and the U.S. economy may adversely affect our business, vendors and prospects as well as our liquidity and financial condition.  As a result, no assurances can be given as to our ability to increase our customer base and generate positive cash flows.  Although we were able to raise additional working capital through convertible note agreements and private placement offerings of our Common Stock, we may not be able to continue this practice in the future or we may not be able to obtain additional working capital through other debt or equity financings.  In the event that sufficient capital cannot be obtained, we may be forced to significantly reduce operating expenses to a point that would be detrimental to our business operations and business development activities.  These courses of action may be detrimental to our business prospects and result in material charges to our operations and financial position.  In the event that any future financing should take the form of the sale of equity securities, the current equity holders may experience dilution of their investments.
 
The forward looking statements contained in this Annual Report may prove incorrect.
 
This Annual Report contains certain forward-looking statements. These forward-looking statements are based largely on our current expectations and are subject to a number of risks and uncertainties. Actual results could differ materially from these forward-looking statements. In addition to the other risks described elsewhere in this “Risk Factors” discussion, important factors to consider in evaluating such forward-looking statements include: (i) changes to external competitive market factors or in our internal budgeting process which might impact trends in our results of operations; (ii) anticipated working capital or other cash requirements; (iii) changes in our business strategy or an inability to execute our strategy due to unanticipated changes in our industry; and (iv) various competitive factors that may prevent us from competing successfully in the marketplace. In light of these risks and uncertainties, many of which are described in greater detail elsewhere in this “Risk Factors” discussion, there can be no assurance that the events predicted in forward-looking statements contained in this Annual Report will, in fact, transpire. Any negative change in the factors listed above could adversely affect the financial condition and operating results of the Company and its products and services.
 

 
 
UNRESOLVED STAFF COMMENTS.
 
As a smaller reporting company, we are not required to include this information in our Annual Report on Form 10K.
 
ITEM 2.
PROPERTIES.
 
We lease approximately 10,000 square feet of office space in one building located  at 26300 La Alameda, Suite 100, Mission Viejo, California  92691. The lease terminates in September of 2015. We expect that the current leased premises will be satisfactory until the future growth of our business operations necessitates an increase in office space.  There is an ample supply of office space in the Orange County, California area and we do not anticipate any problems in securing additional space if, and when, necessary.
 
ITEM 3.
LEGAL PROCEEDINGS.
 
We are not a party to any material legal proceedings, nor has any material proceedings been terminated during the fiscal year ended December 31, 2012.
 
ITEM 4.
MINE SAFETY DISCLOSURES.
 
Not applicable.


 
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
 
Our Common Stock is traded on the OTCBB under the symbol “AUXO.OB.”  As such, the market for our Common Stock may be less liquid, receive less coverage by security analysts and news media, and generate lower prices than might otherwise be obtained if it were listed on a national exchange.
 
The following table presents quarterly information on the high and low sales prices of our Common Stock for the fiscal year ending December 31, 2013 (through March 27, 2013), and the fiscal years ended December 31, 2012 and 2011, furnished by the OTCBB.
 
   
High
    
Low
  
Fiscal Year Ending December 31, 2013
            
First Quarter (through March 27, 2013)
   $ 1.03     $ 0.85  
                 
Fiscal Year Ended December 31, 2012
                
First Quarter
   $ 1.47     $ 0.75  
Second Quarter
   $ 1.40     $ 0.73  
Third Quarter
   $ 1.20     $ 0.74  
Fourth Quarter
   $ 1.15     $ 0.76  
                 
Fiscal Year Ended December 31, 2011
                
First Quarter
   $ 1.01     $ 0.70  
Second Quarter
   $ 0.94     $ 0.52  
Third Quarter
   $ 0.99     $ 0.65  
Fourth Quarter
   $ 0.99     $ 0.70  

The high and low sales prices for our Common Stock on March 27, 2013, as quoted on the OTCBB, were $0.95 and $0.89, respectively.
 
Holders
 
On March 27, 2013, we had approximately 103 stockholders of record.
 
Dividends
 
We have never paid cash dividends on our Common Stock and do not anticipate paying such dividends in the foreseeable future.  The future payment of dividends, if any, will be determined by our Board of Directors (the “Board”) in light of conditions then existing, including our financial condition and requirements, future prospects, restrictions in financing agreements, business conditions and other factors deemed relevant by the Board.
 
Repurchases
 
During the fiscal year ended December 31, 2012, we did not repurchase any of our securities.
 
Securities Authorized for Issuance under Equity Compensation Plans
 
The following table provides certain information as of December 31, 2012 with respect to our existing equity compensation plans under which shares of our Common Stock is authorized for issuance.
 



Plan
  
Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights
    
Weighted Average Exercise Price of Outstanding Options, Warrants and Rights
    
Number of Securities Remaining Available for Future Issuances Under Plans (excluding securities reflected in column (a))
  
   
(a)
    
(b)
    
(c)
  
Equity compensation plans approved by security holders (1):
     5,725,031     $ 1.02       152,253  
Equity compensation plans not approved by security holders (2):
     2,454,606     $ 1.34       -  
Restricted stock units (3)
     265,179       -       -  
Total
     8,444,816               152,253  
                                
(1)
These plans consist of the 2000 Stock Option Plan, 2001 Stock Option Plan, the 2003 Stock Option Plan, the 2004 Stock Option Plan, the 2007 Stock Option Plan and the 2011 Stock Incentive Plan.
(2)
From time to time and at the discretion of the Board, we may issue warrants and stock options to our key individuals or officers as performance based compensation.  We have also issued warrants to Sodexo Operations, LLC, (“Sodexo”) in connection with a joint marketing agreement and to Cambria Capital, LLC in consideration for financing arrangements.
(3)
The Board has authorized the issuance of restricted stock units to Sodexo in connection with a joint marketing agreement, and other restricted stock units in compensation for a sales commission.
 
SELECTED FINANCIAL DATA.
 
Not applicable.
 
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 fixes this price per print for the term of the contract and includes the placement of a highly trained resident team on-site to manage the entire process.  We are focused solely on the healthcare 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.  Our methodology for testing 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 2012 and 2011.  Excluding goodwill, we have no intangible assets deemed to have indefinite lives. At December 31, 2012, the fair value of Auxilio, based on our market capitalization, was approximately $18.8 million, exceeding our book value of negative $378,000.  The second step of the impairment test, which compares the implied fair value of the goodwill with the book value, was not required since we passed step one.
 
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, 2012 Compared to the Year Ended December 31, 2011
 
Net Revenue
 
Revenues consist of equipment sales and ongoing service fees.  Net revenue increased by $13,801,402 to $35,647,021 for the year ended December 31, 2012, as compared to the same period in 2011.  Service revenue in 2012 totaled approximately $30,500,000 compared to approximately $19,800,000 in 2011.  Of this increase, approximately $10,700,000 was a result of the addition of eight new recurring revenue contracts between July 2011 and August 2012. Another $1,000,000 of the increase was due to the expansion of services at existing customers. Partially offsetting these increases was a decrease in revenue of approximately $700,000 at 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, 2012 were approximately $5,200,000 as compared to approximately $2,100,000 for the same period in 2011. Of this increase, approximately $3,000,000 was from large copier equipment conversions at three customers, of which approximately $1,600,000 was from an arrangement whereby we are contractually limited to billing for the equipment at our cost.  We limit our revenue recognition of delivered equipment to the extent of funds received for such equipment, and thus only recognized revenue for equipment to the extent of our direct cost for this contract.
 
Cost of Revenue
 
Cost of revenue consists of document imaging equipment, parts, supplies and salaries expense for field services personnel.  Cost of revenue was $31,018,117 for the year ended December 31, 2012, as compared to $19,131,257 for the same period in 2011. The increase in the cost of revenue for 2012 is attributed primarily to the addition of eight new recurring revenue contracts between July 2011 and August 2012 and an increase in our operational support costs to prepare for the growth. We incurred approximately $3,100,000 in additional staffing and approximately $500,000 in additional one-time travel related costs in connection with new staff training and the implementation of new customers.  Service and supply costs increased by approximately $4,900,000 primarily as a result of our new customers.  Equipment costs, which includes equipment provided under the recurring service contracts and equipment sold, increased by approximately $3,300,000 in 2012, primarily as a result of the increase in copier equipment conversions at our customers’ locations.
 
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 customer’s legacy contracts with third-party vendors.  As we implement our programs, we strive to improve upon these legacy contracts thus reduce 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 $2,604,783 for the year ended December 31, 2012, as compared to $1,830,538 for the same period in 2011. We incurred sales commissions to employees totaling approximately $490,000 in 2012 compared to $130,000 in 2011.  Also included in sales and marketing costs in 2012 is a non-cash charge of approximately $350,000 in connection with restricted stock units granted to channel partners for marketing and placement services.  This compares to approximately $80,000 paid in 2011 for the same services.
 
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 $294,203 to $3,654,716 for the year ended December 31, 2012.  Salary expense increased approximately $300,000 in 2012 and was primarily due to additional office staff needed to handle the increase in transaction volume. Professional fees in 2012 decreased approximately $150,000 whereas in 2011 we incurred additional legal fees in connection with registering the underlying shares of common stock for our options and warrants and drafting of the 2011 Stock Incentive Plan. Other consulting fees in 2011 include approximately $200,000 paid to prepare operational training manuals, with no similar charges incurred in 2012.
 


 
Other Income (Expense)
 
Interest expense for the year ended December 31, 2012 was $465,131, compared to $171,945 for the same period in 2011. In 2012 we incurred approximately $380,000 in interest charges from the convertible debt borrowing, compared to approximately $120,000 in 2011. In 2012 we also incurred approximately $80,000 of interest charges from the commercial line of credit agreement which began in May 2012.  Interest income is primarily derived from short-term interest-bearing securities and money market accounts.
 
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 compared to a credit of $62,000 in 2011. 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. This compared to the decrease in market value from when the convertible debt offering first occurred in July 2011 to the end of 2011.
 
Income Tax Expense
 
Income tax expense for the year ended December 31, 2012 was $7,440 and was $7,495 for the year ended December 31, 2011. The charges in both years are 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, 2012, our cash and cash equivalents were $2,190,972 and our negative working capital was $661,457.  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, commercial line of credit borrowings, the exercise of options and warrants and the sale of Common Stock in compliance with applicable federal and state securities laws.
 
During the year ended December 31, 2012, cash used for operating activities was $29,601 as compared to $2,023,052 for the same period in 2011.  The difference in cash from operating activities in 2011 was primarily due to the costs incurred to implement our new recurring revenue contracts, more aggressive sales and marketing efforts to obtain new clients and legal and consulting fees in connection with the development of operational training tools, statutory filings, the drafting and adoption of the new stock incentive plan and investor relations.
 
We expect to continue to establish recurring revenue contracts to new customers throughout 2013.  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 July of 2011, we closed on a private offering of secured convertible notes and warrants with gross proceeds of $1,850,000.  In addition, 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.
 



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, 2012, 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 currently provides that we will pay Mr. Pace $6,500 per month as compensation for his services. During each of the fiscal years ended December 31, 2011 and 2012, we paid Mr. Pace $78,000 and $78,000, respectively.
 
In July 2011, as part of the offering of convertible promissory notes and warrants, we agreed to pay Cambria Capital, LLC a placement fee of $149,850 in sales commissions, reimburse for costs associated with the placement and to issue a warrant to purchase up to 199,800 shares of Common Stock exercisable at a price of $1.50 per share. Cambria Capital, LLC is an affiliate of Michael Vanderhoof, a member of the Board. The engagement of Cambria Capital, LLC, the payment of the placement fee and the issuance of the warrant to Cambria Capital, LLC were approved by a majority of the disinterested members of the Board after full disclosure of Mr. Vanderhoof’s interest. We additionally granted piggyback registration rights to Cambria Capital, LLC in this offering that are the same as those afforded to the investors in the offering.
 
Contractual Obligations, Contingent Liabilities and Commitments
 
As of December 31, 2012, expected future cash payments, including interest portion, related to contractual obligations, contingent liabilities, and commitments were as follows:
 
   
Payments Due by Period
  
   
Total
    
Within 1 year
    
Year 2-3
    
Year 4-5
    
More than 5 years
  
Convertible notes payable
   $ 2,064,000     $ 144,000     $ 1,920,000     $ -     $ -  
Capital leases
     183,536       100,765       82,771       -       -  
Operating leases
     451,407       160,705       290,702       -       -  
Total
   $ 2,698,943     $ 405,470     $ 2,293,473     $ -     $ -  


QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
Not applicable.
 
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
The financial statements required by this item are included in Part IV, Item 15 of this Annual Report.
 
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
 
None.
 


 
CONTROLS AND PROCEDURES.
 
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
 
We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our “disclosure controls and procedures” as of the end of the period covered by this Annual Report, pursuant to Rules 13a-15(b) and 15d-15(b) under the Exchange Act. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures, as of the end of the period covered by this Annual Report, were effective.
 
Management’s Report on Internal Control over Financial Reporting
 
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Management conducted an assessment of the effectiveness, as of December 31, 2012, of our internal control over financial reporting, based on the framework established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on their assessment under the COSO framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2012.
 
This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to final rules of the Securities and Exchange Commission that permit us to provide only management’s report in this Annual Report on Form 10-K.
 
Changes in Internal Control over Financial Reporting
 
There has been no change in our internal control over financial reporting during the most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
ITEM 9B.
OTHER INFORMATION.
 
None.
 
 
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
 
The information with respect to our executive officers and directors appearing in our Definitive Proxy Statement to be filed with the SEC in connection with the 2013 Annual Meeting of Stockholders (“Proxy Statement”), is hereby incorporated by reference.
 
EXECUTIVE COMPENSATION.
 
The information with respect to compensation of our executive officers appearing in our Proxy Statement is hereby incorporated by reference.
 



SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
 
The information with respect to the security ownership of certain beneficial owners and management appearing in our Proxy Statement is hereby incorporated by reference.
 
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE.
 
The information with respect to certain relationships and related transactions with management appearing in our Proxy Statement is hereby incorporated by reference.
 
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES.
 
The information with respect to the principal accounting fees and services appearing in the Proxy Statement is hereby incorporated by reference.
 


 
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
 
(a)
 
     (1)           Financial Statements
 
The following consolidated financial statements and related notes thereto, and the report of our independent auditor are filed as part of this Annual Report:
 
  Page
   
Report of Independent Registered Public Accounting Firm
F-1
   
Consolidated Balance Sheets as of December 31, 2012 and 2011
F-2
   
Consolidated Statements of Operations for the years ended December 31, 2012 and 2011
F-3
   
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2012 and 2011
F-4
   
Consolidated Statements of Cash Flows for the years ended December 31, 2012 and 2011
F-5
   
Notes to Consolidated Financial Statements
 F-7
 
     (2)           Financial Statement Schedules
 
All other financial statement schedules were omitted because they are not applicable, not required or the information required is shown in the financial statements or the notes thereto.
 
     (3)           Exhibits
 
The exhibits listed on the accompanying index to exhibits immediately following the financial statements are filed as part of, or hereby incorporated by reference into, this Annual Report.
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders
 
Auxilio, Inc.
 
We have audited the accompanying consolidated balance sheets of Auxilio, Inc. (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2012.  These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on the consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Auxilio, Inc. as of December 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.
 
/s/ HASKELL & WHITE LLP
 
Irvine, California
March 28, 2013

 
 
AUXILIO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
   
As of December 31,
  
   
2012
    
2011
  
ASSETS
            
Current assets:
            
Cash and cash equivalents
   $ 2,190,972     $ 1,832,115  
Accounts receivable, net
     4,693,660       2,032,738  
Prepaid and other current assets
     52,113       74,977  
Supplies
     1,059,730       651,874  
Total current assets
     7,996,475       4,591,704  
                 
Property and equipment, net
     227,004       191,810  
Deposits
     36,288       28,013  
Loan acquisition costs
     159,036       226,576  
Goodwill
     1,517,017       1,517,017  
Total assets
   $ 9,935,820     $ 6,555,120  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
                
                 
Current liabilities:
                
Accounts payable and accrued expenses
   $ 5,579,720     $ 2,757,670  
Accrued compensation and benefits
     1,558,539       1,031,748  
Line of credit
     528,486       -  
Deferred revenue
     902,542       381,767  
Current portion of capital lease obligations
     88,645       49,881  
Total current liabilities
     8,657,932       4,221,066  
                 
                 
Long-term liabilities:
                
Convertible notes payable, net of discount of $223,250 and $364,250 at December 31, 2012 and December 31, 2011, respectively
     1,576,750       1,485,750  
Derivative warrant liability
     -       126,000  
Derivative additional investment rights liability
     -       235,000  
Capital lease obligations less current portion
     79,358       80,735  
Total long-term liabilities
     1,656,108       1,927,485  
                 
Commitments and contingencies
     -       -  
                 
Stockholders’ equity (deficit):
                
Common stock, par value at $0.001, 33,333,333 shares authorized, 19,818,642 shares issued and outstanding at December 31, 2012 and 19,449,783 shares issued and outstanding at December 31, 2011
     19,820       19,451  
Additional paid-in capital
     22,491,361       20,894,653  
Accumulated deficit
     (22,889,401 )     (20,507,535 )
Total stockholders’ equity
     (378,220 )     406,569  
Total liabilities and stockholders’ equity
   $ 9,935,820     $ 6,555,120  
 
The accompanying notes are an integral part of these consolidated financial statements.
 


AUXILIO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
 
   
Year Ended December 31,
  
   
2012
    
2011
  
Net revenues
   $ 35,647,021     $ 21,845,619  
Cost of revenues
     31,018,117       19,131,257  
Gross profit
     4,628,904       2,714,362  
Operating expenses:
                
Sales and marketing
     2,604,783       1,830,538  
General and administrative expenses
     3,654,716       3,360,513  
Total operating expenses
     6,259,499       5,191,051  
Loss from operations
     (1,630,595 )     (2,476,689 )
Other income (expense):
                
Interest expense
     (465,131 )     (171,945 )
Interest income
     300       2,487  
Change in fair value of derivative liabilities
     (279,000 )     62,000  
Total other income (expense)
     (743,831 )     (107,458 )
                 
Loss before provision for income taxes
     (2,374,426 )     (2,584,147 )
Income tax expense
     7,440       7,495  
Net loss
   $ (2,381,866 )   $ (2,591,642 )
                 
Net loss per share:
                
Basic
   $ (0.12 )   $ (0.13 )
Diluted
   $ (0.12 )   $ (0.13 )
                 
Number of weighted average shares outstanding:
                
Basic
     19,589,978       19,376,214  
Diluted
     19,589,978       19,376,214  

The accompanying notes are an integral part of these consolidated financial statements.
 


AUXILIO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31, 2012AND 2011
 
   
Common Stock
                    
   
Shares
    
Amount
    
Additional Paid-in Capital
    
Accumulated Deficit
    
Total Stockholders’ Equity (Deficit)
  
Balance at January 1, 2011
     19,336,651       19,338       20,417,584       (17,915,893 )     2,521,029  
Common stock issued in a cashless exercise of options
     46,465       46       (46 )     -       -  
Stock compensation expense for options and warrants granted to employees and consultants
     -       -       303,979       -       303,979  
Restricted stock granted for marketing services
     66,667       67       81,636       -       81,703  
Warrants issued as loan acquisition costs related to convertible notes payable
     -       -       91,500       -       91,500  
Net loss
     -       -       -       (2,591,642 )     (2,591,642 )
Balance at December 31, 2011
     19,449,783     $ 19,451     $ 20,894,653     $ (20,507,535 )   $ 406,569  
Stock compensation expense for options and warrants granted to employees and consultants
     -       -       391,605       -       391,605  
Common stock granted for consulting services
     100,000       100       104,900       -       105,000  
Restricted stock granted for marketing services
     218,859       219       348,826       -       349,045  
Conversion of convertible note payable
     50,000       50       49,950       -       50,000  
Warrants issued for marketing services
     -       -       25,787       -       25,787  
Warrants issued as loan acquisition costs
     -       -       35,640       -       35,640  
Reclassification of derivative liabilities to equity
     -       -       640,000       -       640,000  
Net loss
     -       -       -       (2,381,866 )     (2,381,866 )
Balance at December 31, 2012
     19,818,642     $ 19,820     $ 22,491,361     $ (22,889,401 )   $ (378,220 )
 
The accompanying notes are an integral part of these consolidated financial statements.

 

AUXILIO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
Year Ended December 31,
  
   
2012
    
2011
  
Cash flows provided by operating activities:
            
Net loss
   $ (2,381,866 )   $ (2,591,642 )
Adjustments to reconcile net loss to net cash used for operating activities:
                
Depreciation and amortization
     117,357       125,601  
Stock compensation expense for options and warrants granted to employees and consultants
     391,605       303,979  
Fair value of restricted stock granted for marketing services
     349,045       81,703  
Fair value of warrants issued for marketing services
     25,787       -  
Fair value of common stock issued for consulting services
     105,000       -  
Change in fair value of derivative liabilities
     279,000       (62,000 )
Interest expense related to accretion of debt discount costs
     141,000       58,750  
Interest expense related to amortization of loan acquisition costs
     128,044       36,544  
Changes in operating assets and liabilities:
                
Accounts receivable
     (2,660,922 )     (872,487 )
Prepaid and other current assets
     22,864       256,506  
Supplies
     (407,856 )     35,971  
Deposits
     (8,275 )     -  
Accounts payable and accrued expenses
     2,822,050       218,842  
Accrued compensation and benefits
     526,791       259,216  
Deferred revenue
     520,775       125,965  
Net cash used for operating activities
     (29,601 )     (2,023,052 )
Cash flows (used for) investing activities:
                
Purchases of property and equipment
     (29,841 )     (24,669 )
Net cash (used for) investing activities
     (29,841 )     (24,669 )
Cash flows provided by financing activities:
                
Net proceeds from line of credit agreement
     528,486       -  
Proceeds from convertible notes payable
     -       1,850,000  
Loan acquisition fees paid
     (24,864 )     (171,620 )
Payments on capital leases
     (85,323 )     (48,451 )
Net cash provided by financing activities
     418,299       1,629,929  
Net increase (decrease) in cash and cash equivalents
     358,857       (417,792 )
Cash and cash equivalents, beginning of year
     1,832,115       2,249,907  
Cash and cash equivalents, end of year
   $ 2,190,972     $ 1,832,115  
 
The accompanying notes are an integral part of these consolidated financial statements.
 


AUXILIO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
 
   
Year Ended December 31,
  
   
2012
    
2011
  
Supplemental disclosure of cash flow information:
            
Interest paid
   $ 196,892     $ 39,630  
Income tax paid
   $ 3,590     $ 2,517  
                 
Non-cash investing and financing activities:
                
Property and equipment acquired through capital leases
   $ 122,710     $ 57,767  
Warrants issued as loan acquisition costs
   $ 35,640     $ 91,500  
Conversion of convertible note payable
   $ 50,000     $ -  
Reclassification of derivative liabilities to equity
   $ 640,000     $ -  
 
The accompanying notes are an integral part of these consolidated financial statements.
 


AUXILIO, INC. AND SUBSIDIARIES
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2012 AND 2011
 
(1)           Basis of Presentation and Summary of Significant Accounting Policies
 
Business Activity
 
We are engaged in the business of providing fully-outsourced managed print services to the healthcare industry, working exclusively with hospitals throughout the United States.
 
Basis of Presentation
 
The accompanying financial statements were prepared in conformity with GAAP, which contemplate continuation of Auxilio as a going concern. We have reported a net loss of $2,381,866 for the year ended December 31, 2012 and an accumulated deficit of $22,889,401 as of December 31, 2012. We reported a net loss of $2,591,642 for the year ended December 31, 2011. We have negative working capital of $661,457 as of December 31, 2012.
 
The consolidated financial statements include the accounts of Auxilio and our wholly owned subsidiaries.  All intercompany balances and transactions were eliminated.
 
Liquidity
 
During the year ended December 31, 2012, cash used for operating activities was $29,601 as compared to cash used for operating activities of $2,023,052 for the same period in 2011.  During this same period our revenue increased by 64%. We expect another year of revenue growth in 2013.  The implementation costs that accompanied the growth in 2012 along with the related sales expense and operational overhead has substantially contributed to our losses. As these new accounts mature, we anticipate a reduction in costs of goods sold per account and an increase in total costs but at a slower rate than revenue, allowing us to reduce our current net cash used from operating activities. We have already seen this trend in the fourth quarter of 2012.
 
The standard term for our management services contracts are three to five years. We refer to mature accounts as those whom we have fully implemented, and have influenced change in our customer’s configuration of equipment, toner procurement vendors, third-party service vendors and/or leased equipment agreements. Accounts normally take six to twelve months to reach maturity, but could take as long as twenty-four months. There is no specific timeframe that results in maturity because our customers are initially in varying positions with regards to their equipment configuration, toner procurement vendors, third-party service vendors and leased equipment agreements. Often these agreements are non-cancellable until they reach their termination date.
 
During 201,1 in preparation for this growth, we raised $1,850,000 in a convertible debt financing.  Additionally, 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. Management believes that improved cash generated from operations, along with the funds raised in these recent debt financings, will be sufficient to sustain our business operations over the next twelve months.
 



Use of Estimates
 
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.
 
Revenue Recognition
 
Revenue is recognized pursuant to ASC Topic 605, “Revenue Recognition” (“ASC 605”).  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 the placement of equipment that is to be placed at a customer’s location at a future date, revenue is deferred until the placement of such equipment. Monthly service and supply revenue is earned monthly during the term of the contract, as services and supplies are provided.
 
When we enter into arrangements that include multiple deliverables, they typically consist of the sale of MFD equipment and a support services contract which includes a reserve for replacement of printer and fax equipment. Pursuant to ASC Subtopic 605-25-25: “Revenue Recognition – Multiple-Element Arrangements – Recognition”(“ASC 605-25-25”), we account for each element within an arrangement with multiple deliverables as separate units of accounting. 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 fair value of both the delivered and undelivered items.
 
Deferred Revenue
 
We enter into arrangements that include multiple deliverables, which typically consist of the sale of 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 (“VSOE”) evidence 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 do not separately sell MFD equipment 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.
 
Cash and Cash Equivalents
 
For purposes of the statement of cash flows and balance sheet classification, cash equivalents include all highly liquid debt instruments with original maturities of three months or less which are not securing any corporate obligations.
 
Accounts Receivable
 
We provide an allowance for doubtful accounts equal to the estimated uncollectible amounts. Our estimate is based on historical collection experience and a review of the current status of trade accounts receivable.  It is reasonably possible that our estimate of the allowance for doubtful accounts will change.  Management believes that no accounts receivable are uncollectible at December 31, 2012.
 


 
Supplies
 
Supplies consist of parts and supplies for the automated office equipment, including copiers, facsimile machines and printers.  Supplies are valued at the lower of cost or market value on a first-in, first-out basis.
 
Property and Equipment
 
Property and equipment are carried at cost less accumulated depreciation.  Depreciation of the property and equipment is provided using the straight-line method over the assets’ estimated economic lives, which range from 2 to 7 years.  Expenditures for maintenance and repairs are charged to expense as incurred.
 
Intangible Assets
 
Under ASC Topic 350, “Intangibles, Goodwill and Other” (“ASC 350”), goodwill and intangible assets with indefinite lives are reviewed for impairment at least annually (December 31), or more frequently when indicators of impairment are present.  Intangible assets with definite lives are reviewed for impairment when indicators of impairment exist.  For goodwill, management compares the carrying value of the reporting unit to its related estimated fair value and recognizes an impairment charge in the amount by which the carrying value exceeds the estimated fair value.  For indefinite life intangible assets, management compares the estimated fair value of the intangible asset to its carrying value and an impairment charge is recognized in the amount by which the carrying value exceeds estimated fair value.  For definite life intangible assets, if the carrying value cannot be recovered from expected undiscounted future cash flows, then an impairment charge is recognized in the amount by which the carrying value exceeds the estimated fair value of the intangible asset.
 
For purposes of testing the impairment of goodwill, we have one reporting unit. Our methodology for testing goodwill impairment consists of one, and possibly two steps.  In step one of the goodwill impairment test, management compares the carrying amount (including goodwill) of the entity-wide reporting unit and the fair value based on market capitalization. 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 2012 and 2011. Excluding goodwill, we have no intangible assets deemed to have indefinite lives. At December 31, 2012, our fair value, based on market capitalization, was approximately $18.8 million, exceeding our book value by approximately $19.1 million.  The second step of the impairment test compares the implied fair value of the goodwill with the book value. We were not required to perform step two since we passed step one.
 
Long-Lived Assets
 
In accordance with FASB ASC Topic 350, long-lived assets to be held and used are analyzed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If there are indications of impairment, we use future undiscounted cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable.  In the event such cash flows are not expected to be sufficient to recover the recorded asset values, the assets are written down to their estimated fair value.  Long-lived assets to be disposed of are reported at the lower of carrying amount or fair value of asset less the cost to sell. As of December 31, 2012, management determined there was no impairment of these assets.
 
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.
 
Fair Value of Financial Instruments
 
We account for our Financial Instruments in accordance with ASC Topic 820, “Fair Value Measurements,” (“ASC 820”). ASC 820 defines fair value, provides a framework for measuring fair value and expands the disclosures required for fair value measurements. The standard applies to other accounting pronouncements, but does not require any new fair value measurements.
 
The fair value hierarchy consists of three broad levels, which are described below:
 
Level 1 - Quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.
 
Level 2 - Observable inputs, other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
 
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
 
Our derivative warrant liability and derivative additional investment rights liability are stated at fair value as further described in note 6 below.
 
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and capital lease obligations approximate fair value due to the short-term nature of these financial instruments. The carrying amount of our host debt contract of our convertible debt approximates its fair value as we believe the credit market has not materially changed since the original borrowing date.
 
Stock-Based Compensation
 
We recognize stock-based compensation as an expense in accordance with ASC Topic 718 “Share-Based Payments” (“ASC 718”) and value the equity securities based on the fair value of the security on the date of grant.  Stock option awards are valued using the Black-Scholes option-pricing model.
 
For the years ended December 31, 2012 and 2011, stock-based compensation expense recognized in the statements of operations is as follows:
 
   
Year Ended December 31,
  
   
2012
    
2011
  
Cost of revenues
   $ 102,065     $ 75,290  
Sales and marketing
     63,599       24,014  
General and administrative expenses
     225,941       204,675  
Total stock based compensation expense
   $ 391,605     $ 303,979  




The weighted average estimated fair value of stock options granted during 2012 and 2011 was $0.55 and $0.44 per share, respectively.  These amounts were determined using the Black-Scholes option-pricing model, which values options based on the stock price at the grant date, the expected life of the option, the estimated volatility of the stock, the expected dividend payments, and the risk-free interest rate over the expected life of the option.  The assumptions used in the Black-Scholes model were as follows for stock options granted in 2012 and 2011:
 
   
2012
    
2011
  
Risk-free interest rate
  
0.07% to 0.17%
    
0.08% to 0.19%
  
Expected volatility of our Common Stock
  
64.83% to 82.48%
    
80.95% to 85.78%
  
Dividend yield
    0%      0%  
Expected life of options
  
3 years
    
3 years
  

The Black-Scholes option valuation model was developed for estimating the fair value of traded options that have no vesting restrictions and are fully transferable.  Because option valuation models require the use of subjective assumptions, changes in these assumptions can materially affect the fair value of the options.
 
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 was 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. As of December 31, 2012, we have not granted any restricted stock units under the 2011 Stock Incentive Plan.
 
Basic and Diluted Loss Per Share
 
In accordance with ASC Topic 260, “Earnings Per Share,” basic net loss per share is calculated using the weighted average number of shares of our Common Stock issued and outstanding during a certain period, and is calculated by dividing net loss by the weighted average number of shares of our Common Stock issued and outstanding during such period. Diluted net loss per share is calculated using the weighted average number of common and potentially dilutive common shares outstanding during the period, using the as-if converted method for secured convertible notes, and the treasury stock method for options and warrants.
 
As of December 31, 2012, potentially dilutive securities consisted of options and warrants to purchase 8,179,637 shares of our Common Stock at prices ranging from $0.30 to $2.15 per share. Of these potentially dilutive securities, none of the shares of Common Stock underlying the options and warrants were included in the computation of diluted earnings per share as their effect would be anti-dilutive.
 
As of December 31, 2011, potentially dilutive securities consisted of options and warrants to purchase 9,349,561 shares of our Common Stock at prices ranging from $0.30 to $6.75 per share. Of these potentially dilutive securities, none of the shares of Common Stock underlying the options and warrants were included in the computation of diluted earnings per share as their effect would be anti-dilutive.
 



The following table sets forth the computation of basic and diluted net loss per share:
 
   
Year Ended December 31,
  
   
2012
    
2011
  
Numerator:
            
Net loss
   $ (2,381,866 )   $ (2,591,642 )
                 
Denominator:
                
Denominator for basic calculation weighted averages
     19,589,978       19,376,214  
                 
Dilutive Common Stock equivalents:
                
Options and warrants
     -       -  
Denominator for diluted calculation weighted average
     19,589,978       19,376,214  
                 
Net loss per share:
                
Basic net loss per share
   $ (.12 )   $ (.13 )
Diluted net loss per share
   $ (.12 )   $ (.13 )

Segment Reporting
 
Based on our integration and management strategies, we operated in a single business segment.  For the years ended December 31, 2012 and 2011, all revenues were derived from domestic operations.
 
Subsequent Events
 
Management has evaluated events subsequent through the date of filing of this annual report and determined there is no effect on the financial statements, nor any items that would require disclosure.
 
New Accounting Pronouncements
 
From time to time, new accounting pronouncements are issued by the FASB that we adopt as of the specified effective date.  Unless otherwise discussed in these financial statements and notes or in our Annual Report on Form 10-K for the year ended December 31, 2012, we believe the impact of any recently issued standards that are not yet effective are either not applicable to us at this time or will not have a material impact on our consolidated financial statements upon adoption.
 
(2)           Accounts Receivable
 
A summary of accounts receivable follows:
 
   
As of December 31,
  
   
2012
    
2011
  
Trade receivables
   $ 6,848,090     $ 1,849,131  
Unapplied advances and unbilled revenue
     (2,154,430 )     183,607  
Allowance for doubtful accounts
     -       -  
    $ 4,693,660     $ 2,032,738  




(3)           Property and Equipment
 
A summary property and equipment follows:
 
   
As of December 31,
  
   
2012
    
2011
  
Furniture and fixtures
   $ 55,695     $ 51,398  
Computers and office equipment
     541,895       553,254  
Fleet equipment
     216,857       367,660  
Leasehold improvements
     3,838       -  
      818,285       972,312  
Less accumulated depreciation and amortization
     (591,281 )     (780,502 )
    $ 227,004     $ 191,810  

Depreciation and amortization expense for property, equipment, and improvements amounted to $117,357 and $125,601 for the years ended December 31, 2012 and 2011, respectively.
 
(4)           Line of Credit
 
On May 4, 2012, we entered into a Loan and Security Agreement (the “Loan and Security Agreement”) with Avidbank Corporate Finance, a Division of Avidbank (“Avidbank”).  The Loan and Security Agreement provides us with a revolving line-of-credit up to $2.0 million at an interest rate of prime plus 3.75%; provided, however, that at no time shall the rate be less than seven percent (7.0%) per annum. As of December 31, 2012 the interest rate was 7.0%. The amount available to us at any given time is the lesser of (a) $2.0 million, or (b) the amount available under our borrowing base (80% of our eligible accounts, minus (1) accrued client lease payables, and minus (2) accrued equipment pool liability).  While there are outstanding credit extensions, we must maintain a minimum balance of unrestricted cash and cash equivalents at Avidbank of at least $400,000, measured on a monthly basis, and our maximum quarterly consolidated adjusted EBITDA loss must not exceed:  (i) $1,000,000 for the quarter ended March 31, 2012, (ii) $250,000 for the quarter ending June 30, 2012, (iii) $500,000 for the quarter ending September 30, 2012, and (iv) we must have adjusted EBITDA income of $100,000 for the quarter ending December 31, 2012.  We covenanted not to, among other things, (a) dispose of assets (other than in the ordinary course), (b) change our business, (c) change our CEO or CFO, (d) merge or consolidate with any other person, (e) acquire all or substantially all of the capital stock or property of another person, or (f) become liable for any indebtedness (other than permitted indebtedness, as set forth in the Loan and Security Agreement).  The foregoing description is qualified in its entirety by reference to the Loan and Security Agreement, which is found in our 8-K filing on May 9, 2012 as Exhibit 10.1.
 
In connection with our entry into the Loan and Security Agreement, we granted Avidbank (a) a general, first-priority security interest in all of our assets, equipment and inventory, and (b) a security interest in all of our intellectual property under an Intellectual Property Security Agreement.  Each holder of convertible promissory notes issued in a private offering in July 2011 agreed to subordinate its right of payment and security interest in and to our assets to Avidbank throughout the term of the Loan and Security Agreement.  In addition, we issued Avidbank a 5-year warrant to purchase up to 72,098 shares of our common stock at an exercise price of $1.387 per share, as additional consideration for the Loan and Security Agreement.  The foregoing descriptions are qualified in their entirety by reference to the respective agreements.  These agreements are found in our 8-K filing on May 9, 2012 as Exhibits 10.2, 10.3 and 10.4, respectively.
 
Interest charges associated with the Avidbank line of credit, including amortization of the discounts and loan acquisition costs totaled $78,722, for the year ended December 31, 2012.
 
(5)           Convertible Notes Payable
 
Effective July 29, 2011, we closed on a private offering of secured convertible promissory notes and warrants (“Units”) for gross proceeds of $1,850,000.  Each of the Units consists of (i) a $5,000 secured
 



convertible promissory note (each a “Note” and collectively “Notes”) and (ii) a warrant (each a “Warrant” and collectively “Warrants”) to purchase 1,000 shares of our Common Stock at and exercise price of $1.50 per share.  The Notes mature July 29, 2014 and are secured by our tangible and intangible assets, subject to the senior security interest of Avidbank, as discussed in the immediately preceeding note.  The Notes accrue interest at a rate of eight percent (8%) per annum, compounded annually, and the interest on the outstanding balance of the Notes is payable no later than thirty (30) days following the close of each calendar quarter.  The Notes are convertible into 1,850,000 shares of Common Stock.  The Warrants expire April 29, 2016 and are exercisable to purchase up to 370,000 shares of our Common Stock. We additionally granted piggyback registration rights to the investors in this offering.  Several members of the Board, including John Pace, Michael Joyce, Mark St. Clare and Michael Vanderhoof, participated in the offering.
 
We may call the Notes for prepayment (“Call Option”) if (a) our Common Stock closes at or above $2.00 per share for 20 consecutive days; and (b) our Common Stock has had daily trading volume at or above 100,000 shares for the same 20 consecutive days.  Investors shall have 60 days from the date on which we call the Notes to convert the Notes (thereafter we may prepay any outstanding Notes).
 
At any time prior to the maturity date, the holders of the Notes may elect to convert all or part of the unpaid principal amount of the Notes and any unpaid interest accrued thereon, into shares of our Common Stock. The conversion price shall be $1.00 per share of Common Stock, subject to adjustment upon the occurrence of certain capital events.  If (a) there is any transaction, or a series of transactions, that results, directly or indirectly, in the transfer of 100% of Auxilio including, without limitation, any sale of stock, sale of assets, sale of membership interests, merger or consolidation, reorganization, recapitalization or restructuring, tender or exchange offer, negotiated purchase or  leveraged buyout, and (b) the per share price of our Common Stock in such transaction equals or exceeds $1.00, then the Notes will be automatically converted into our Common Stock.
 
The Note agreement provides holders of the Notes with certain dilution protections.  If (a) by July 29, 2012, we had completed an additional round of debt financing with new investors (“New Debt”) and (b) the New Debt contained more favorable interest rate, payment frequency, amortization, conversion price, warrant coverage and registration rights terms to the New Debt holders than the Notes, then the holder of Notes would have had the option to exchange the Notes for an equal principal amount of new notes with the same terms as the New Debt (the “Exchange Feature”).  The Exchange Feature did not provide for fixed terms for the associated Warrants nor did it allow for an adjustment to the conversion rate of the Notes. As we did not have any additional financing, the Exchange Feature expired on July 29, 2012.
 
We allocated the proceeds from the sale of the Notes and Warrants in connection with ASC Topic 470-25.  Due to the existence of the Exchange Feature, the Warrants were determined to not be indexed to its own underlying stock and therefore did not qualify for equity classification. Therefore the proceeds allocated to the Warrants were determined to be a derivative liability and were measured at fair value.
 
The conversion rights and the Call Option held by us, or the “Additional Investment Rights,” are embedded derivatives of the host debt contract. The potential variability of the conversion rate and the terms of the Call Option, due to the existence of the Exchange Feature, also caused the Additional Investment Rights to not qualify for equity classification.  Under the accounting guidance for multiple embedded derivatives, we combined these rights into one embedded derivative and allocated proceeds from the offering to the bundled derivative. Accordingly, the bundled Additional Investment Rights were accounted for as a derivative liability to be measured at fair value. We allocated $1,427,000 to the convertible Notes payable, $166,000 to the derivative Warrant liability and $257,000 to the derivative Additional Investments Rights liability.  The debt discount of $423,000 will be amortized as interest expense over the term of the convertible Notes payable.  The valuation methodologies for the fair values of the Derivative Warrant Liability and the Derivative Additional Investment Rights Liability are described in Note 6 below.
 
Interest charges associated with the convertible notes payable, including amortization of the discounts and loan acquisition costs totaled $375,551 and $156,961 for the years ended December 31, 2012 and 2011, respectively.
 



We also agreed to pay Cambria Capital, LLC a placement fee of $149,850 in sales commissions, reimburse for costs associated with the placement of the Units and to issue a warrant to purchase up to 199,800 shares of Common Stock exercisable at a price of $1.50 per share.  Cambria Capital, LLC is an affiliate of Michael Vanderhoof, a member of the Board. The engagement of Cambria Capital, LLC, the payment of the placement fee and the issuance of the warrant to Cambria Capital, LLC were approved by a majority of the disinterested members of the Board after full disclosure of Mr. Vanderhoof’s interest. We additionally granted piggyback registration rights to Cambria Capital, LLC in this offering that are the same as those afforded to the investors in the offering.
 
(6)           Derivative Liabilities
 
Our derivative liability instruments were measured at fair value using the Black-Scholes model. We evaluated the use of other valuation models and determined that given the fact pattern these methods were not anticipated to be materially different from the amounts calculated using the Black-Scholes model.  This determination was based on management’s belief that the likelihood of another round of financing prior to the expiration of the Exchange Feature was remote, and another round of financing with terms more favorable to new investors is even more remote.  If another round of financing were to have occurred, we believe that our need for an additional round of financing by July 2012 would have been driven by significant growth in our business.  This growth would likely have resulted in more favorable terms to us, thus rendering the instruments subject to the Exchange Feature with nominal value.  As a result, we believe that the Black-Scholes model was an appropriate method for valuing the warrants and additional investment rights subject to the Exchange Feature.
 
Derivative Warrant Liability
 
The Warrants outstanding from the convertible notes payable financing had potentially variable terms that could have allowed for the reduction in the exercise price of the Warrants in the event that, prior to July 29, 2012, we completed an additional round of debt financing with new investors that called for better economic terms. We accounted for these Warrants in accordance with FASB ASC Topic 815.
 
We recognized all of our warrants subject to the Exchange Feature as a derivative liability in our consolidated balance sheet.  The derivative liability was revalued at each reporting period and changes in fair value were recognized currently in the consolidated statements of operations.  The initial recognition and subsequent changes in fair value of the derivative liability had no effect on our cash flows.
 
The revaluation of these Warrants during the reporting period resulted in the recognition of a $40,000 gain for the year ended December 31, 2011 and a $92,000 charge for the year ended December 31, 2012, under the caption “Change in fair value of derivative liabilities.”  The fair value of these warrants at December 31, 2011 was $126,000, which is reported on the consolidated balance sheet under the caption “Derivative Warrant Liability.” The fair value of these Warrants as of the expiration of the Exchange Feature, July 29, 2012 was $218,000. On this date, this amount was reclassified as additional paid-in capital.
 
Fair Value Assumptions Used in Accounting for Derivative Warrant Liability
 
We determined that our derivative Warrant liability was a Level 3 fair value measurement.  The fair value as of July 29, 2012 (the extinguishment date) and December 31, 2011 required the data inputs listed in the table below:
 
   
July 29, 2012
    
December 31, 2011
  
Exercise price
   $ 1.50     $ 1.50  
Term (years)
     3.75       4.33  
Risk-free interest rate
     0.65%       0.833%  
Estimated volatility
     78%       79%  
Dividend rate
     -0-       -0-  
Stock price
   $ 1.18     $ 0.76  
 
Derivative Additional Investment Rights Liability
 
We had Additional Investment Rights outstanding with terms that could have allowed for more beneficial consideration to the holders of the Notes in the event that, prior to July 29, 2012, we completed an additional round of debt financing with new investors that called for better economic terms. We accounted for these Additional Investment Rights in accordance with FASB ASC Topic 815.
 
We recognized all of our Additional Investment Rights subject to the Exchange Feature as derivative liabilities in our consolidated balance sheet.  The derivative liability was revalued at each reporting period and changes in fair value were recognized in the consolidated statements of operations.  The initial recognition and subsequent changes in fair value of the derivative Additional Investment Rights liability had no effect on our cash flows.
 
The revaluation of the Additional Investment Rights at each reporting period resulted in the recognition of a $22,000 gain for the year ended December 31, 2011 and a $187,000 charge for the year ended December 31, 2012,under the caption “Change in fair value of derivative liabilities.”  The fair value of the Additional Investments Rights at December 31, 2011 was $235,000, which is reported on the consolidated balance sheet under the caption “Derivative Additional Investment Rights Liability.” The fair value of the Additional Investment Rights as of the expiration of the Exchange Feature, July 29, 2012, was $422,000. On this date, this amount was reclassified as additional paid-in capital.
 
Fair Value Assumptions Used in Accounting for Derivative Additional Investment Rights Liability
 
We have determined that our derivative additional investment rights liability to be a Level 3 fair value measurement.  The fair value as of July 29, 2012(the extinguishment date) and December 31, 2011 required the data inputs listed in the table below:
 
   
July 29, 2012
    
December 31, 2011
  
Conversion price (range)
   $ 1.00-$2.00     $ 1.00-$2.00  
Term (years)
     2.00       2.58  
Risk-free interest rate
     0.34%       0.36%  
Estimated volatility
     78%       79%  
Dividend rate
     -0-       -0-  
Stock price
   $ 1.18     $ 0.76  
 
 
 
 
(7)           Warrants
 
Below is a summary of warrant activity during the years ended December 31, 2011 and 2012:
 
   
Number of Shares
    
Weighted Average Exercise Price
    
Weighted Average Remaining Term in Years
    
Aggregate Intrinsic Value
  
Outstanding at January 1, 2011
     3,362,708     $ 1.36              
Granted in 2011
     869,800     $ 1.31              
Exercised in 2011
     -     $ -              
Cancelled in 2011
     (250,000 )   $ 0.55              
Outstanding at December 31, 2011
     3,982,508     $ 1.40       2.71     $ 130,667  
Granted in 2012
     72,098     $ 1.39                  
Exercised in 2012
     -     $ -                  
Cancelled in 2012
     (1,600,000 )   $ 1.50                  
Outstanding at December 31, 2012
     2,454,606     $ 1.34       1.85     $ 228,983  
                                 
Warrants exercisable at December 31, 2012
     2,254,606     $ 1.37       1.85     $ 226,983  

The following tables summarize information about warrants outstanding and exercisable at December 31, 2012:
 
Range of
Exercise Prices
    
Number of Shares Outstanding
    
Weighted Average Remaining in Contractual Life
in Years
    
Outstanding Warrants Weighted Average Exercise Price
    
Number of Warrants Exercisable
    
Exercisable Warrants Weighted Average Exercise Price
  
$ 0.30 to $0.75       501,667       1.54     $ 0.50       501,667     $ 0.50  
$ 0.91 to $1.84       1,341,898       2.84     $ 1.37       1,141,898     $ 1.44  
$ 1.85 to $2.00       611,041       0.27     $ 1.96       611,041     $ 1.96  
$ 0.30 to $2.00       2,454,606       1.85     $ 1.34       2,254,606     $ 1.37  

In November 2008, we entered into a five year joint marketing agreement with Sodexo (the “Sodexo Agreement”) to provide Auxilio’s document services to Sodexo’s healthcare customer base in the United States.  Under the terms of the Sodexo Agreement, Sodexo invests in sales and marketing resources and assists us with marketing their document services to Sodexo’s U.S. healthcare customer base of more than 1,600 hospitals.  In return, we provide Sodexo with warrants to purchase up to two million shares of our Common Stock at a price of $1.50 per share.  The first 150,000 warrants vested on June 2, 2009. The fair value of the warrant for the 150,000 shares vesting upon execution on June 2, 2009 was $76,807. This amount was recognized as a sales and marketing expense in June 2009. We account for equity based payments to non-employees in accordance with ASC Topic 505-50. As the warrant issued is more reliably measurable at fair value, we use the fair value of the warrant to account for the transaction. The fair value of the warrant was determined using the Black-Scholes option-pricing model, with the following assumptions: (i) no expected dividends; (ii) a risk free interest rate of 0.20%; (iii) expected volatility of 85.07%; and (iv) a contract life of the warrants of five years. An additional 175,000 vested on July 13, 2010 upon the signing of a new customer contract. The fair value of the warrant for the 175,000 shares vesting with the signing of the new customer contract on July 13, 2010 was $90,161. This amount was recognized as a sales and marketing expense in July 2010. The fair value of the warrant was determined using the Black-Scholes option-pricing model, with the following assumptions: (i) no expected dividends; (ii) a risk free interest rate of 0.17%; (iii) expected volatility of 82.56%; and (iv) a contract life of the warrants of four years.  The Sodexo Agreement was amended in October 2012 (the “October 2012 Amendment”) and the balance of the warrant pool was cancelled.
 
On April 1, 2011, we granted 300,000 warrants to our CEO to purchase shares of our Common Stock at an exercise price of $0.94 per share, which exercise price equals the fair value of our stock on the grant date. The fair value of the warrants was determined using the Black-Scholes option-pricing model.  The warrants have graded vesting annually over three years.  The fair value of the warrants was determined using the Black-Scholes option-pricing model.  The assumptions used to calculate the fair value are as follows:  (i) risk-free interest rate of 0.11%; (ii) estimated volatility of 81.36%; (iii) dividend yield of 0.0%; and (iv) expected life of the warrants of three years.
 
 
 
 
On July 29, 2011, we closed on a private offering of secured convertible notes and warrants, wherein warrants for 370,000 shares of our Common Stock were issued to the note holders and a warrant for 199,800 shares of our Common Stock were issued to the placement broker.  Please see Notes 5 and 6 for further information on these warrants.
 
(8)
Stock Option and Stock Incentive Plans
 
In October 2001, we approved the 2001 Stock Option Plan under which all employees may be granted options to purchase shares of our Common Stock.  The maximum number of shares of the Common Stock available for issuance under the 2001 Plan was 5,400,000 shares. Under the 2001 Stock Option Plan (the “2001 Plan”), the option exercise price was equal to the fair market value of the Common Stock on the date of grant.  Options expired no later than 10 years from the grant date and generally vested within five years.
 
The Board approved the 2003 Stock Option Plan (the “2003 Plan”) and it became effective immediately upon stockholder approval at the Annual Meeting on May 15, 2003.  The maximum number of shares of the Common Stock available for issuance under the 2003 Plan was 4,400,000 shares. On May 15, 2003, 899,500 shares were available to grant under the 2003 Plan, and 567,167 had been granted under our former 2000 Stock Option Plan (the “2000 Plan”) and the 2001 Plan.  Although we no longer granted options under the 2000 Plan or the 2001 Plan, all outstanding stock options continue to be subject to the terms and conditions of the stock option agreement and the underlying plans, except to the extent the Board or the Compensation Committee elected to extend one or more features of the 2003 Plan to the outstanding stock options that were granted pursuant to the 2000 Plan or the 2001 Plan.  Under the 2003 Plan, the option exercise price was equal to the fair market value of the Common Stock at the date of grant.  Stock options expired no later than 10 years from the grant date and generally vested within five years.
 
In May of 2004, the Board and stockholders approved the 2004 Stock Incentive Plan (the “2004 Plan”). The maximum number of shares of the Common Stock available for issuance under the 2004 Plan was 6,400,000 shares. As of the date of stockholder approval, May 12, 2004, options to purchase 714,750 shares had been granted pursuant to the 2000 Plan, 2001 Plan and 2003 Plan. Under the terms and conditions of the 2004 Plan, the option exercise price is equal to the fair market value of the Common Stock at the date of grant.  Options expired no later than 10 years from the grant date and generally vested within five years.
 
The Board approved the 2007 Stock Option Plan, as amended (the “2007 Plan”), and it became effective on May 16, 2007 upon receipt of stockholder approval.  On May 16, 2007, options to purchase 2,890,147 shares of Common Stock had been granted pursuant to the 2000 Plan, 2001 Plan, 2003 Plan and 2004 Plan. Under the 2007 Plan, the administrator could grant options to purchase 4,470,000 shares of Common Stock.  The options granted pursuant to the 2004 Plan continue to be governed by the terms and conditions of the 2004 Plan, except to the extent the administrator elected to extend one or more features of the 2007 Plan to the outstanding stock options granted pursuant to the 2004 Plan.  Under the 2007 Plan, the option exercise price was equal to the fair market value of the Common Stock at the date of grant.  Options expired no later than 10 years from the grant date and generally vested within three years.
 
On March 17, 2011, the Board approved the 2011 Stock Incentive Plan (the “2011 Plan”), and it became effective on May 12, 2011. The 2011 Plan authorizes the issuance of no more than 5,970,000 shares of our Common Stock and it provides for the granting of stock options, stock appreciation rights and restricted stock to our employees, members of the Board and service providers. As of December 31, 2012, there were 152,253 shares available for issuance under the 2011 Plan.
 
 
 
 
Additional information with respect to these Plans’ stock option activity is as follows:
 
   
Number of Shares
    
Weighted Average Exercise Price
    
Weighted Average Remaining Term in Years
    
Aggregate Intrinsic Value
  
Outstanding at January 1, 2011
     5,218,909     $ 1.01              
Granted in 2011
     671,500     $ 0.89              
Exercised in 2011
     (46,465 )   $ 0.53              
Cancelled in 2011
     (476,891 )   $ 0.68              
Outstanding at December 31, 2011
     5,367,053     $ 1.03       6.23     $ 208,835  
Granted in 2012
     620,500     $ 1.11                  
Exercised in 2012
     -     $ -                  
Cancelled in 2012
     (262,522 )   $ 1.40                  
Outstanding at December 31, 2012
     5,725,031     $ 1.02       5.65     $ 623,117  
                                 
Options exercisable at December 31, 2012
     4,449,031     $ 1.02       4.78     $ 540,708  

The following table summarizes information about stock options outstanding and exercisable at December 31, 2012:
 
Range of
Exercise Prices
    
Number of Shares Outstanding
    
Weighted Average Remaining in Contractual Life
in Years
    
Outstanding Warrants Weighted Average Exercise Price
    
Number of Options Exercisable
    
Exercisable Options Weighted Average Exercise Price
  
$ 0.30 to $0.75       1,072,500       4.99     $ 0.57       1,066,500     $ 0.57  
$ 0.75 to $0.90       1,590,831       5.04     $ 0.81       1,235,387     $ 0.82  
$ 0.91 to $1.84       2,795,700       6.52     $ 1.22       1,881,144     $ 1.27  
$ 1.85 to $2.00       236,000       2.34     $ 1.99       236,000     $ 1.99  
$ 2.00 to $2.15       30,000       5.67     $ 2.15       30,000     $ 2.15  
$ 0.30 to $2.15       5,725,031       5.65     $ 1.02       4,449,031     $ 1.02  

Unamortized compensation expense associated with unvested options approximates $442,063 as of December 31, 2012. The weighted average period over which these costs are expected to be recognized is approximately 1.5 years.
 
(9)           Restricted Stock
 
On May 11, 2011, we amended the Sodexo Agreement (the “May 2011 Amendment”).  Pursuant to the Sodexo Agreement, as amended by the May 2011 Amendment, Sodexo provided additional sales and marketing resources and expanded the marketing effort directed towards existing or potential Sodexo hospital clients.  The term of the Sodexo Agreement was extended to December 31, 2014.  Upon signing the May 2011 Amendment, we granted 200,000 shares of restricted stock to Sodexo.  These shares vest as follows:  66,667 immediately, 66,667 on May 11, 2013 and 66,666 on May 11, 2014.  The immediately vested shares resulted in a charge to marketing expense of $54,667 in 2011.  The cost of the remaining shares are recognized over the vesting periods using the current market price of the stock at each periodic reporting date.  On April 18, 2012, we granted 23,437 shares to Sodexo as a result of a new sale.  These shares vest as follows:  7,812 on April 18, 2013, 7,812 on April 18, 2014 and 7,813 on April 18, 2015. On July 1, 2012, we granted another 31,765 shares to Sodexo as a result of another new sale.  These shares vest as follows:  10,588 on July 1, 2013, 10,588 on July 1, 2014 and 10,588 on July 1, 2015.  For the year ended December 31, 2012, the cost recognized for these shares totaled $106,413.  Under the Sodexo Agreement, as amended by the May 2011 Amendment, Sodexo also receives a quarterly commission based on actual revenues derived from these new accounts over the initial term of the contract along with an annual marketing fee based on  total revenues received by us, excluding for certain existing accounts.  For the year ended December 31, 2012, these fees totaled $158,793.  In October 2012 we again amended the Sodexo Agreement and eliminated the additional sales and marketing resources that we added under the May 2011 Amendment (such amendment referred to herein as the “October 2012 Amendment”).  Under the new terms we will no longer pay the annual marketing fee, but continue to pay to Sodexo a quarterly commission based on actual revenues received by us from certain existing customers and any new customers Sodexo brings to us and signs an agreement for services by August 3, 2013. Further, the October 2012 Amendment stipulates that we provide 133,333 shares of our common stock to Sodexo instead of paying cash of $97,087 due to Sodexo for unpaid marketing fees pursuant to the May 2011 Amendment.
 
 
 
In January 2011, we entered into an independent contractor services agreement with a sales channel partner to provide us marketing services.  In March 2012, this sales channel partner became fully vested in a grant of 85,526 shares of restricted stock provided for in the agreement.  The cost recognized for the 85,526 shares of restricted stock was $102,631.
 
(10)           Income Taxes
 
For the years ended December 31, 2012 and 2011, the components of income tax expense are as follows:
 
   
Year Ended December 31
  
   
2012
    
2011
  
Current provision:
            
Federal
   $ -     $ -  
State
     7,440       7,495  
      7,440       7,495  
Deferred benefit:
                
Federal
     -       -  
State
     -       -  
      -       -  
Income tax expense
   $ 7,440     $ 7,495  

Income tax provision amounted to $7,440 and $7,495 for the years ended December 31, 2012 and 2011, respectively (an effective rate of (0.3)% for 2012 and (0.3)% for 2011).  A reconciliation of the provision for income taxes with amounts determined by applying the statutory U.S. federal income tax rate to income before income taxes is as follows:
 
   
Year Ended December 31
  
   
2012
    
2011
  
Computed tax at federal statutory rate of 34%
   $ (807,305 )   $ (878,610 )
State taxes, net of federal benefit
     3,947       3,072  
Non-deductible items
     95,392       87,434  
Other
     1,460       2,840  
Change in valuation allowance
     713,946       792,759  
    $ 7,440     $ 7,495  
 
 

 
Realization of deferred tax assets is dependent on future earnings, if any, the timing and amount of which is uncertain.  Accordingly, a valuation allowance, in an amount equal to the net deferred tax asset as of December 31, 2012 and 2011 has been established to reflect these uncertainties.  As of December 31, 2012 and 2011, the net deferred tax asset before valuation allowances is approximately $6,440,000 and $5,784,000, respectively, for federal income tax purposes, and $1,398,000 and $1,225,000, respectively for state income tax purposes. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.  Significant components of our deferred tax assets and liabilities are as follows:
 
   
Year Ended December 31
  
   
2012
    
2011
  
Deferred tax assets:
            
Accrued salaries/vacation
   $ 232,600     $ 195,100  
Accrued equipment pool
     54,100       57,500  
State taxes
     400       800  
Stock options
     768,900       714,300  
Net operating loss carryforwards
     7,121,300       6,443,100  
Total deferred tax assets
     8,177,300       7,410,800  
                 
Deferred tax liabilities:
                
Depreciation
     21,000       75,800  
Amortization of intangibles
     4,700       4,700  
Other
     313,900       321,600  
Total deferred tax liabilities
     339,600       402,100  
                 
Net deferred assets before valuation allowance
     7,837,700       7,008,700  
Valuation allowance
     (7,837,700 )     (7,008,700 )
Net deferred tax assets
   $ -     $ -  
 
At December 31, 2012, we have available unused net operating loss carryforwards of approximately $17,544,000 for federal and $13,081,000 for state that may be applied against future taxable income and that, if unused, expire beginning in 2013 through 2033.
 
Utilization of the net operating loss carryforwards may be subject to a substantial annual limitation due to ownership change limitations provided by the Internal Revenue Code under section 382.  The annual limitation may result in the expiration of net operating loss carryforwards before utilization Our Federal and state net operating loss carryforwards will begin to expire in 2022 and 2013, respectively.
 
Effective January 1, 2007, we adopted new accounting guidance which altered the framework for recognizing income tax contingencies. Previously, the focus was on the subsequent liability recognition for estimated losses from tax contingencies where such losses were probable and the related amounts could be reasonably estimated. Under this new guidance, a contingent tax asset (i.e., an uncertain tax position) may only be recognized if it is more likely than not that it will ultimately be sustained upon audit. We have evaluated our tax positions for all jurisdictions and all years for which the statute of limitations remains open and determined that no additional liability for unrecognized tax benefits and interest was necessary.
 
 
 
 
(11)           Retirement Plan
 
We sponsor a 401(k) plan (the “Plan”) for the benefit of employees who are at least 21 years of age. Our management determines, at its discretion, the annual and matching contribution. We elected not to contribute to the Plan for the years ended December 31, 2012 and 2011.
 
(12)           Commitments
 
Leases
 
We lease our Mission Viejo, California facility under a non-cancellable operating lease effective March 2010 that expires in September 2015. Rent expense for the years ended December 31, 2012 and 2011 totaled $229,381 and $163,534 respectively.  Future minimum lease payments under non-cancelable operating leases during subsequent years are as follows:
 
December 31,
  
Payments
  
2013
     226,663  
2014
     232,602  
2015
     178,059  
Total
   $ 637,324  

Employment Agreements
 
On August 5, 2009, the Board appointed Mr. Joseph J. Flynn as President and Chief Executive Officer (“CEO”) effective August 31, 2009.  Mr. Flynn has served as a member of the Board since 2003.  He previously held the position of our President and CEO from 2003 to 2006, having resigned to take a position as the Vice President of the Sport Group for the Nielsen Company.  Mr. Flynn’s base salary was $261,250.  In addition to the base salary, in 2011 Mr. Flynn earned a $100,000 performance bonus and was granted an option to purchase 100,000 shares of Common Stock.
 
Effective January 1, 2012, we entered into a new employment agreement with Mr. Flynn (the “New Flynn Agreement”). The New Flynn Agreement provides that Mr. Flynn will continue his employment as our President and CEO. The New Flynn Agreement has a term of two years, provides for an annual base salary of $269,087, and will automatically renew for subsequent twelve (12) month terms unless either party provides advance written notice to the other that such party does not wish to renew the agreement for a subsequent twelve (12) months.  Mr. Flynn also receives the customary employee benefits available to our employees. Mr. Flynn is also entitled to receive a bonus of up to $110,000 per year, the achievement of which is based on Company performance metrics. We may terminate Mr. Flynn’s employment under the New Flynn Agreement without cause at any time on thirty (30) days advance written notice, at which time Mr. Flynn would receive severance pay for six (6) months and be fully vested in all options and warrants granted to date. The foregoing summary of the New Flynn Agreement is qualified in its entirety by reference to the full text of the employment agreement, which was filed as Exhibit 10.2 to our 8-K filing on December 23, 2011.
 
On April 2, 2010, we entered into an employment agreement with Mr. Paul T. Anthony, our Chief Financial Officer (“CFO”) since 2004, to serve as our Executive Vice President (“EVP”) and CFO.  As EVP and CFO, Mr. Anthony reports to the CEO and has duties and responsibilities assigned by the CEO.  Mr. Anthony’s base salary was $212,658.  In addition to the base salary, in 2011 Mr. Anthony  earned a $60,000 performance bonus and was granted an option to purchase 60,000 shares of Common Stock.
 
Effective January 1, 2012, we entered into a new employment agreement with Mr. Anthony (the “New Anthony Agreement”) to continue to serve as our Executive Vice President (“EVP”) and CFO. The New Anthony Agreement has a term of two years, and provides for an annual base salary of $219,037. The agreement will automatically renew for subsequent twelve (12) month terms unless either party provides advance written notice to the other that such party does not wish to renew the agreement for a subsequent twelve (12) months.  Mr. Anthony also receives the customary employee benefits available to our employees. Mr. Anthony is also entitled to receive a bonus of up to $70,000 per year, the achievement of which is based on Company performance metrics. We may terminate Mr. Anthony’s employment under the New Anthony Agreement without cause at any time on thirty (30) days advance written notice, at which time Mr. Anthony would receive severance pay for six (6) months and be fully vested in all options and warrants granted to date.   The foregoing summary of the New Anthony Agreement is qualified in its entirety by reference to the full text of the employment agreement, which was filed as Exhibit 10.1 to our 8-K filing on December 23, 2011.
 
 
 
 
(13)           Concentrations
 
Cash Concentrations
 
At times, cash balances held in financial institutions are in excess of federally insured limits. Management performs periodic evaluations of the relative credit standing of financial institutions and limits the amount of risk by selecting financial institutions with a strong credit standing.
 
Major Customers
 
For the year ended December 31, 2012, there were four customers that each generated at least 10% of our revenues and these customers represented a total of 59% of revenues.  As of December 31, 2012, net accounts receivable due from these customers totaled approximately $2,300,000.
 
For the year ended December 31, 2011, there were four customers that each generated at least 10% of our revenues and these customers represented a total of 40% of revenues.  As of December 31, 2011, net accounts receivable due from these customers totaled approximately $381,000.
 
(14)           Related Party Transactions
 
In August of 2009, we entered in to 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 currently provides that we will pay Mr. Pace $6,500 per month as compensation for his services.  Total cash compensation to Mr. Pace for each of the years ended December 31, 2012 and 2011 was $78,000 and $78,000, respectively.
 
In July 2011, as part of the offering of convertible promissory notes and warrants, we agreed to pay Cambria Capital, LLC a placement fee of $149,850 in sales commissions, reimburse for costs associated with the placement and to issue a warrant to purchase up to 199,800 shares of Common Stock exercisable at a price of $1.50 per share. Cambria Capital, LLC is an affiliate of Michael Vanderhoof, a member of the Board. The engagement of Cambria Capital, LLC, the payment of the placement fee and the issuance of the warrant to Cambria Capital, LLC were approved by a majority of the disinterested members of the Board after full disclosure of Mr. Vanderhoof’s interest. We additionally granted piggyback registration rights to Cambria Capital, LLC in this offering that are the same as those afforded to the investors in the offering.
 
 
 
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
 
No.
Item
2.1
Agreement and Plan of Reorganization dated as of November 20, 2001, by and between Auxilio and e-Perception, Inc., incorporated by reference to Exhibit 1.1 to our Form 8-K filed on January 24, 2002.
2.2
Agreement and Plan of Merger, dated April 1, 2004, by and between Auxilio, PPVW Acquisition Corporation, and Alan Mayo & Associates, Inc., incorporated by reference to Exhibit 2.1 to our Form 8-K filed on April 16, 2004.
3.1
Articles of Incorporation of Auxilio, as amended, incorporated by reference to Exhibit 3.1 to our Form 10-KSB filed on April 19, 2005.
3.2
Bylaws of Auxilio, incorporated by reference to Exhibit 2 to our Form 10-SB filed on October 1, 1999.
4.1
Subscription Agreement, dated January 9, 2002, by and among Auxilio and each of the stockholders of e-Perception, Inc., incorporated by reference to Exhibit 1.1 to our Form 8-K filed on January 24, 2002.
4.2
Form of Subscription Agreement entered into between April 6, 2009 and April 15, 2009 with Michael Vanderhoof and Edward B. Case, incorporated by reference to Exhibit 4.1 of our Form 8-K filed on May 14, 2009.
10.1
Auxilio’s 2001 Stock Option Plan, incorporated by reference to Exhibit 4.1 to our Form S-8 filed on March 3, 2011.*
10.1.1
Form of Stock Option Agreement under Auxilio’s 2001 Stock Option Plan, incorporated by reference to Exhibit 4.6 to our Form S-8 filed on March 3, 2011.*
10.2
Auxilio’s 2003 Stock Option Plan, incorporated by reference to Exhibit 4.2 to our Form S-8 filed on March 3, 2011.*
10.2.1
Form of Stock Option Agreement under Auxilio’s 2003 Stock Option Plan, incorporated by reference to Exhibit 4.7 to our Form S-8 filed on March 3, 2011.*
10.3
Auxilio’s 2004 Stock Option Plan, incorporated by reference to Exhibit 4.3 to our Form S-8 filed on March 3, 2011.*
10.3.1
Form of Stock Option Agreement under Auxilio’s 2004 Stock Option Plan, incorporated by reference to Exhibit 4.8 to our Form S-8 filed on March 3, 2011.*
10.4
Auxilio’s 2007 Stock Option Plan, incorporated by reference to Exhibit 4.4 to our Form S-8 filed on March 3, 2011.*
10.5
Amendment to Auxilio 2007 Stock Option Plan, incorporated by reference to Exhibit 4.5 to our Form S-8 filed on March 3, 2011.*
10.5.1
Form of 2007 Stock Option Agreement, incorporated by reference to Exhibit 4.9 to our Form S-8 filed on March 3, 2011.*
10.6
Auxilio’s 2011 Stock Incentive Plan, incorporated by reference to Exhibit 4.1 to our Form S-8 filed on August 24, 2011.*
10.6.1
Form of Auxilio’s 2011 Stock Option Agreement under the 2011 Stock Incentive Plan, incorporated by reference to Exhibit 4.3 to our Form S-8 filed on August 24, 2011.*
10.6.2
Form of Restricted Stock Agreement under the Auxilio 2011 Stock Incentive Plan, incorporated by reference to Exhibit 4.4 to our Form S-8 filed on August 24, 2011.*
10.7
Asset Purchase Agreement between Workstream USA, Inc., Workstream, Inc. and PeopleView, Inc. dated March 8,.2004, incorporated by reference to Exhibit 2.1 to our Form 8-K filed on April 2, 2004.
10.8
Addendum dated as of May 27, 2004 to Asset Purchase Agreement dated March 17th, 2004 between Workstream Inc. Workstream USA, Inc. and PeopleView, Inc., incorporated by reference to Exhibit 2.1 to our Form 8-K/A filed on August 3, 2004.
10.9
Standard Office Lease Agreement, dated November 12, 2009, by and between Auxilio and Realty Associates Fund V L.P., incorporated by reference to Exhibit 10.15 to our Form 10-K filed on March 31, 2010.
10.10
Consulting Agreement, dated August 10, 2009, by and between John D. Pace and Auxilio, incorporated by reference to Exhibit 10.1 to our Form 8-K filed on August 13, 2009.
10.11
Executive Employment Agreement, effective  January 1, 2012, by and between Auxilio and Joseph Flynn, incorporated by reference to Exhibit 10.2 to our Form 8-K filed on  December 23, 2011.
10.12
Executive Employment Agreement, effective January 1, 2012, by and between Auxilio and Paul T. Anthony, incorporated by reference to Exhibit 10.1 to our Form 8-K filed on December 23, 2011.
10.13
Form of 8% Convertible Promissory Note, dated July 29, 2011, incorporated by reference to Exhibit 10.1 to our Form 8-K filed on August 3, 2011.
10.14
Form of Warrant to Purchase Common Stock, dated July 29, 2011, incorporated by reference to Exhibit 10.2 to our Form 8-K filed on August 3, 2011.
10.15
Placement Agent Warrant to Purchase Common Stock, dated July 29, 2011, incorporated by reference to Exhibit 10.3 to our Form 8-K filed on August 3, 2011.
10.16
Form of Security Agreement, dated July 29, 2011, incorporated by reference to Exhibit 10.4 to our Form 8-K filed on August 3, 2011.
 
 
10.17
Form of Registration Rights Agreement, dated July 29, 2011, incorporated by reference to Exhibit 10.5 to our Form 8-K filed on August 3, 2011.
10.18
Form of Investment Unit Purchase Agreement, dated July 29, 2011, incorporated by reference to Exhibit 10.6 to our Form 8-K filed on August 3, 2011.
10.19
Common Stock Warrant dated April 1, 2011, issued to Joseph Flynn, incorporated by reference to Exhibit 10.1 to our Form 8-K filed on April 4, 2011.
10.20
Form of Agent Warrant to purchase shares of Common Stock, incorporated by reference to Exhibit 10.1 to our Form 8-K filed on March 22, 2011.
10.21
Form of Subscription Agreement, incorporated by reference to Exhibit 10.1 to our Form 8-K filed on March 22, 2011.
14
Code of Ethics, incorporated by reference to Exhibit 14.1 to our Form 10-KSB filed on April 14, 2004.
16.1
Letter regarding change in certifying accountants, dated February 14, 2002, incorporated by reference to Exhibit 16 to our Form 8-K filed on February 15, 2002.
16.2
Letter regarding change in certifying accountants dated December 22, 2005, incorporated by reference to Exhibit 16.1 to our Form 8-K/A filed on January 24, 2006.
21.1
Subsidiaries.
23.1
Consent of Haskell & White LLP, Independent Registered Public Accounting Firm.
24
Power of Attorney (included on the Signature Page).
31.1
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a).
31.2
Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a).
32.1
Certification of CEO and CFO pursuant to 18 U.S.C. §1350 as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002.
 

*           Each of these Exhibits constitutes a management contract, compensatory plan or arrangement.
 


SIGNATURES
 
Pursuant to the requirements of Section 13 or 15(d) with the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
AUXILIO, INC.
 
By:           /s/ Joseph J. Flynn                                                      
Joseph J. Flynn
Chief Executive Officer and
Principal Executive Officer
 
March 28, 2013
 
By:           /s/ Paul T. Anthony                                                      
Paul T. Anthony
Chief Financial Officer and
Principal Financial Officer
 
March 28, 2013
 
POWER OF ATTORNEY AND SIGNATURES
 
We, the undersigned directors and officers of Auxilio, Inc., do hereby constitute and appoint each of Joseph J. Flynn and Paul T. Anthony as our true and lawful attorneys-in-fact and agents with power of substitution, to do any and all acts and things in our name and behalf in our capacities as directors and officers and to execute any and all instruments for us and in our names in the capacities indicated below, which said attorneys-in-fact and agents, or either of them, may deem necessary or advisable to enable said corporation to comply with the Securities and Exchange Act of 1934, as amended, and any rules, regulations and requirements of the Securities and Exchange Commission, in connection with this Annual Report on Form 10-K, including specifically but without limitation, power and authority to sign for us or any of us in our names in the capacities indicated below, any and all amendments (including post-effective amendments) hereto; and we do hereby ratify and confirm all that said attorney-in-fact and agent, shall do or cause to be done by virtue hereof.
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
 

 
Signature
Title
Date
     
/s/ Joseph J. Flynn
Joseph J. Flynn
 
Chief Executive Officer
(Principal Executive Officer and Director)
March 28, 2013
/s/ Paul T. Anthony
Paul T. Anthony
 
Chief Financial Officer
(Principal Financial Officer and Accounting Officer)
March 28, 2013
/s/ Edward Case
Edward Case
 
 
Director
March 28, 2013
/s/ Michael Joyce
Michael Joyce
 
 
Director
March 28, 2013
 
 
/s/ John D. Pace
John D. Pace
 
 
Director
(Non-executive Chairman of the Board)
March 28, 2013
/s/ Max Poll
Max Poll
 
 
Director
March 28, 2013
/s/ Mark St. Clare
Mark St. Clare
 
 
Director
March 28, 2013
/s/ Michael Vanderhoof
Michael Vanderhoof
 
Director
March 28, 2013

 
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