10-Q 1 auxo10q09302015.htm 10-Q auxo10q09302015.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
[X]           QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2015
 
[  ]           TRANSITION REPORT UNDER 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
(Issuer’s telephone number)
 
N/A
(Former name, former address and former fiscal year, if changed since last report)
 
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 þ No o
 
Indicated by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date 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 þ No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o                                                                                     Accelerated filer o
Non-accelerated filer o                                                                                     Smaller reporting company þ
 
Indicate by check mark whether the registrant is a shell company (as defined by Section 12b-2 of the Exchange Act).  Yes o No þ
 
The number of shares of the issuer’s common stock, $0.001 par value, outstanding as of November 12, 2015 was 24,323,167.
 

 
 

 

AUXILIO, INC.
FORM 10-Q
 
 
Page
PART I - FINANCIAL INFORMATION
 
   
 
   
 
   
 
   
 
   
 
   
   
   
   
   
PART II - OTHER INFORMATION
 
   
 
 
Item 5. Other Information 27
   
   
 

 
2

 

ITEM 1.                      FINANCIAL STATEMENTS.
 
AUXILIO, INC. AND SUBSIDIARIES
 
   
SEPTEMBER 30, 2015
   
DECEMBER 31, 2014
 
   
(unaudited)
       
             
ASSETS
           
             
Current assets:
           
Cash and cash equivalents
  $ 5,220,919     $ 4,743,395  
Accounts receivable, net
    6,985,391       6,808,183  
Supplies
    1,443,760       1,066,132  
Prepaid and other current assets
    808,566       214,105  
Total current assets
    14,458,636       12,831,815  
                 
Property and equipment, net
    340,589       215,747  
Deposits
    109,011       34,413  
Intangible assets, net
    2,875,000       1,265,000  
Goodwill
    3,665,656       2,473,656  
Total assets
  $ 21,448,892     $ 16,820,631  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
Current liabilities:
               
Accounts payable and accrued expenses
  $ 8,718,691     $ 7,417,361  
Accrued compensation and benefits
    2,336,631       1,447,132  
Line of credit
    -       200,000  
Deferred revenue
    901,272       921,771  
Current portion of long-term liabilities
    598,007       55,546  
Total current liabilities
    12,554,601       10,041,810  
                 
Long-term liabilities:
               
Term loan, less current portion
    1,375,000       -  
Notes payable to related parties, net of discount of $30,189 at December 31, 2014
    -       333,534  
Capital lease obligations, less current portion
    153,172       49,822  
Total long-term liabilities
    1,528,172       383,356  
                 
Commitments and contingencies
               
                 
Stockholders’ (deficit) equity:
               
Common stock, par value at $0.001, 33,333,333 shares authorized, 24,323,167 and 23,623,619 shares issued and outstanding at September 30, 2015 and December 31, 2014, respectively
    24,325       23,625  
Additional paid-in capital
    27,698,925       26,576,506  
Accumulated deficit
    (20,357,131 )     (20,204,666 )
Total stockholders’ (deficit) equity
    7,366,119       6,395,465  
Total liabilities and stockholders’ equity
  $ 21,448,892     $ 16,820,631  
                 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

 
3

 

AUXILIO, INC. AND SUBSIDIARIES
(UNAUDITED)
 
   
Three Months
   
Nine Months
 
   
Ended September 30,
   
Ended September 30,
 
   
2015
   
2014
   
2015
   
2014
 
Revenues
  $ 15,725,616     $ 11,257,870     $ 45,190,062     $ 31,879,715  
Cost of revenues
    12,853,601       8,718,230       38,069,271       25,881,373  
                                 
Gross profit
    2,872,015       2,539,640       7,120,791       5,998,342  
                                 
Operating expenses:
                               
Sales and marketing
    712,522       521,585       2,263,410       1,612,298  
General and administrative expenses
    1,597,793       1,194,959       4,907,162       3,441,587  
                                 
Total operating expenses
    2,310,315       1,716,544       7,170,572       5,053,885  
                                 
Income (loss) from operations
    561,700       823,096       (49,781 )     944,457  
                                 
Other income (expense):
                               
Interest expense
    (31,886 )     (42,453 )     (100,284 )     (246,345 )
                                 
Total other income (expense)
    (31,886 )     (42,453 )     (100,284 )     (246,345 )
                                 
Income (loss) before provision for income taxes
    529,814       780,643       (150,065 )     698,112  
                                 
Income tax expense
    -       (39,000 )     (2,400 )     (40,600 )
                                 
Net income (loss)
  $ 529,814     $ 741,643     $ (152,465 )   $ 657,512  
                                 
Net income (loss) per share:
                               
Basic
  $ .02     $ .03     $ (.01 )   $ .03  
Diluted
  $ .02     $ .03     $ (.01 )   $ .03  
                                 
Number of weighted average shares:
                               
Basic
    24,274,815       23,067,462       24,050,960       21,539,066  
Diluted
    24,983,982       24,736,564       24,050,960       23,199,078  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 
 
4

 
 
AUXILIO, INC. AND SUBSIDIARIES
NINE MONTHS ENDED SEPTEMBER 30, 2015
(UNAUDITED)
 
               
Additional
         
Total
 
   
Common Stock
   
Paid-in
   
Accumulated
   
Stockholders’
 
   
Shares
   
Amount
   
Capital
   
Deficit
   
Equity
 
Balance at December 31, 2014
    23,623,619     $ 23,625     $ 26,576,506     $ (20,204,666 )   $ 6,395,465  
Stock compensation expense for options and warrants granted to employees and directors
    -       -       232,403       -       232,403  
Stock compensation expense for contingent earn-out stock to be issued to employees
    -       -       62,000       -       62,000  
Stock compensation expense for restricted stock granted to key employee
    100,000       100       101,781       -       101,881  
Stock options exercised
    18,347       19       (19 )     -       -  
Conversion of related party note payable to common stock
    128,917       129       257,706       -       257,835  
Common stock issued in connection with the acquisition of Redspin
    452,284       452       468,548       -       469,000  
Net loss
    -       -       -       (152,465 )     (152,465 )
Balance at September 30, 2015
    24,323,167     $ 24,325     $ 27,698,925     $ (20,357,131 )   $ 7,366,119  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

 
5

 

AUXILIO, INC. AND SUBSIDIARIES
(UNAUDITED)
 
   
Nine months ended September 30,
 
   
2015
   
2014
 
Cash flows from operating activities:
           
Net (loss) income
  $ (152,465 )   $ 657,512  
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
               
Depreciation
    110,963       75,650  
Amortization of intangible assets
    340,000       52,500  
Stock compensation expense for warrants and options issued to employees and directors
    232,403       313,864  
Stock compensation expense for contingent earn-out stock to be issued to employees
    62,000       -  
Stock compensation expense for restricted stock issued to key employee
    101,881       15,233  
Interest expense related to accretion of debt discount costs
    30,189       87,017  
Interest expense related to amortization of loan acquisition costs
    -       51,162  
Changes in operating assets and liabilities:
               
Accounts receivable
    3,201       (1,346,948 )
Supplies
    (377,628 )     (52,848 )
Prepaid and other current assets
    (578,630 )     159,704  
Deposits
    (71,420 )     -  
Accounts payable and accrued expenses
    455,133       1,233,479  
Accrued compensation and benefits
    771,490       (155,635 )
Deferred revenue
    (51,745 )     (117,741 )
Net cash provided by operating activities
    875,372       972,949  
Cash flows from investing activities:
               
Purchases of property and equipment
    (12,010 )     (74,674 )
Purchase of Redspin
    (1,876,966 )     -  
Purchase of Delphiis, Inc. net of cash acquired
    -       (995,257 )
Net cash used for investing activities
    (1,888,976 )     (1,069,931 )
Cash flows from financing activities:
               
Net repayments on line of credit agreement
    (200,000 )     (200,000 )
Proceeds from term loan
    2,000,000       -  
Payments on term loan
    (125,000 )     -  
Payments on notes payable to related parties
    (105,888 )     (100,000 )
Net proceeds from issuance of common stock through employee stock options
    -       61,775  
Payments on capital leases
    (77,984 )     (58,976 )
Net cash provided by (used for) financing activities
    1,491,128       (297,201 )
Net increase (decrease) in cash and cash equivalents
    477,524       (394,183 )
Cash and cash equivalents, beginning of period
    4,743,395       4,668,624  
Cash and cash equivalents, end of period
  $ 5,220,919     $ 4,274,441  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

 
6

 

AUXILIO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
 
   
Nine months ended September 30,
 
   
2015
   
2014
 
Supplemental disclosure of cash flow information:
           
Interest paid
  $ 70,095     $ 104,178  
Income taxes paid
  $ 141,850     $ 81,454  
 
Non-cash investing and financing activities:
               
Property and equipment acquired through capital leases
  $ 223,795     $ 46,309  
Conversion of convertible notes payable
  $ -     $ 1,700,000  
Conversion of note payable to related party
  $ 257,835     $ -  
Common stock issued in connection with the acquisition of Redspin
  $ 469,000     $ -  
Common stock issued in connection with the acquisition of Delphiis, Inc.
    -     $ 1,012,000  
                 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

 
7

 

NINE MONTHS ENDED SEPTEMBER 30, 2015 AND 2014
(UNAUDITED)
 
1.           BASIS OF PRESENTATION
 
The accompanying unaudited condensed consolidated financial statements of Auxilio, Inc. and its subsidiaries (the “Company”, “we”, “us” or “Auxilio”) have been prepared in accordance with generally accepted accounting principles of the United States of America (“GAAP”) for interim financial statements pursuant to the rules and regulations of the Securities and Exchange Commission.  Accordingly, these financial statements do not include all of the information and notes required by GAAP for complete financial statements.  These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, as filed with the Securities and Exchange Commission (“SEC”) on March 30, 2015.
 
The unaudited condensed consolidated financial statements included herein reflect all adjustments (which include only normal, recurring adjustments) that are, in the opinion of management, necessary to state fairly our financial position and results of operations as of and for the periods presented.  The results for such periods are not necessarily indicative of the results to be expected for the full year.
 
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, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  As a result, actual results could differ from those estimates.
 
The accompanying financial statements include the accounts of Auxilio and its wholly owned subsidiaries.  All intercompany balances and transactions have been eliminated.
 
We have performed an evaluation of subsequent events through the date of filing of our Form 10-Q with the SEC.
 
2.           RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
 
In April 2015, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance that requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability instead of being presented as an asset.  Debt disclosures will include the face amount of the debt liability and the effective interest rate.  The guidance requires retrospective application and represents a change in accounting principle.   This guidance will be effective for us in the first quarter of 2016, and early adoption is permitted for financial statements that have not been previously issued.  We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.
 
In November 2014, the FASB issued new guidance on determining whether a host contract in a hybrid financial instrument issued in the form of a share is more akin to debt or to equity.  This guidance does not change the current criteria in GAAP for determining when separation of certain embedded derivative features in a hybrid financial instrument is required, but instead clarifies how current GAAP should be interpreted in the evaluation of the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share, thereby reducing existing diversity in practice.  The guidance is effective for fiscal years beginning after December 15, 2015 and for interim periods within that fiscal year.  We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.
 
 In August 2014, the FASB issued new guidance requiring management of all entities to evaluate whether there are conditions and events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the financial statements are issued (or available to be issued when applicable).  The guidance is effective for fiscal years beginning after December 15, 2016 and for interim periods within that fiscal year.  We do not expect the adoption of this guidance to have a material effect on our consolidated financial statements.
 
 
 
8

 
 
In May 2014, the FASB issued new accounting guidance regarding revenue recognition from contracts with customers, which when effective will supersede existing revenue recognition requirements and will eliminate most industry-specific guidance from generally accepted accounting principles.  The core principle of the new guidance is to require an entity to recognize as revenue the amount that reflects the consideration to which it expects to be entitled in exchange for goods or services as it transfers control to its customers. The new guidance requires additional qualitative and quantitative disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.  An entity can apply the new guidance retrospectively to each prior reporting period presented (i.e., the full retrospective method) or retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application in retained earnings.  As originally issued, the new revenue recognition standard would be effective for us beginning January 1, 2017.  However, in 2015, the FASB voted to defer the effective date of the new guidance for one year. We are currently evaluating the appropriate transition method and any further impact of this guidance on our consolidated financial statements and related disclosures.
 
Additionally, from time to time, new accounting pronouncements are issued that we adopt as of the specified effective date. Unless otherwise discussed in these financial statements and notes or in our financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2014, we believe the impact of any other 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.
 

 
9

 


3.           OPTIONS AND WARRANTS
 
Below is a summary of stock option and warrant activity during the nine month period ended September 30, 2015:
 
Options
 
Shares
   
Weighted Average Exercise Price
   
Weighted Average Remaining Term in Years
   
Aggregate
Intrinsic Value
 
Outstanding at December 31, 2014
    4,886,829     $ 1.05              
Granted
    227,750       1.17              
Exercised
    (18,347 )     0.47              
Cancelled
    (541,677 )     1.51              
Outstanding at September 30, 2015
    4,554,555     $ 1.01       4.38     $ 534,663  
Exercisable at September 30, 2015
    4,131,496     $ 0.99       4.38     $ 531,986  

During the nine months ended September 30, 2015, we granted a total of 227,750 options to our employees and directors to purchase shares of our common stock at an exercise price range of $1.09 to $1.22 per share. The exercise price equals the fair value of our stock on the grant date.  The options have graded vesting annually over three years starting January 2015.  The fair value of the options was determined using the Black-Scholes option-pricing model.  The assumptions used to calculate the fair market value are as follows: (i) risk-free interest rate range of 0.08% to 0.12%; (ii) estimated volatility range of 53.57% to 54.98%; (iii) dividend yield of 0.0%; and (iv) expected life of the options of three years.

Warrants
 
Shares
   
Weighted Average Exercise Price
   
Weighted Average Remaining Term in Years
   
Aggregate
Intrinsic Value
 
Outstanding at December 31, 2014
    2,208,565     $ 1.11              
Granted
    -       -              
Exercised
    -       -              
Cancelled
    (233,334 )     1.13              
Outstanding at September 30, 2015
    1,975,231     $ 1.13       3.71     $ 70,250  
Exercisable at September 30, 2015
    1,508,565     $ 1.16       2.60     $ 70,250  

For the three and nine months ended September 30, 2015 and 2014, stock-based compensation expense recognized in the consolidated statements of operations are as follows:
 
   
Three Months
Ended September 30,
   
Nine months
Ended September 30,
 
   
2015
   
2014
   
2015
   
2014
 
Cost of revenues
  $ 70,396     $ 20,050     $ 127,953     $ 150,029  
Sales and marketing
    8,319       12,406       25,885       35,818  
General and administrative expense
    30,955       43,329       180,446       143,250  
Total stock based compensation expense
  $ 109,670     $ 75,785     $ 334,284     $ 329,097  

We also recognized stock-based compensation of $62,000 in connection with the acquisition of Redspin (Note 16)
 

 
10

 


4.           RESTRICTED STOCK
 
In July 2014, in connection with our acquisition of the common stock of Delphiis, Inc., we issued 400,000 shares of restricted stock to a key employee as part of his employment agreement. The shares vest as follows:
 
Vesting Date
 
Shares
 
July 1, 2016
    100,000  
July 1, 2017
    100,000  
July 1, 2018
    100,000  
July 1, 2019
    100,000  
 
In August 2015, the key employee’s employment agreement was revised such that the first 100,000 shares became fully vested and the remaining shares will be cancelled in January 2016. The stock-based compensation expense recognized for these shares totaled $101,881 for the nine months ended September 30, 2015 (Note 3).
 
5.           NET INCOME (LOSS) PER SHARE
 
Basic net income (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 income (loss) by the weighted average number of shares of the Company’s common stock issued and outstanding during such period. Diluted net income (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.
 
For the three months ended September 30, 2015, potentially dilutive securities consisted of options and warrants to purchase 6,529,786 shares of common stock at prices ranging from $0.30 to $2.15 per share. Of these potentially dilutive securities, only 709,167 of the shares to purchase common stock from the options and warrants are included in the computation of diluted earnings per share as their effect would be anti-dilutive.
 
For the nine months ended September 30, 2015, potentially dilutive securities consisted of options and warrants to purchase 6,529,786 shares of common stock at prices ranging from $0.30 to $2.15 per share. For the nine months ended September 30, 2015, of these potentially dilutive securities, none of the shares to purchase common stock from the options and warrants are included from the computation of diluted earnings per share as their effect would be anti-dilutive.
 
For the three months ended September 30, 2014, potentially dilutive securities consist of options and warrants to purchase 7,259,454 shares of common stock at prices ranging from $0.47 to $2.15 per share and secured convertible notes that could convert into 1,550,000 shares of common stock. For the three months ended September 30, 2014, of these potentially dilutive securities, only 1,213,058 of the shares to purchase common stock from the options and warrants and 456,044 of the convertible notes are included in the computation of diluted earnings per share because the effect of including the remaining instruments would be anti-dilutive.
 
For the nine months ended September 30, 2014, potentially dilutive securities consist of options and warrants to purchase 7,259,454 shares of common stock at prices ranging from $0.47 to $2.15 per share and secured convertible notes that could convert into 1,700,000 shares of common stock. For the nine months ended September 30, 2014, of these potentially dilutive securities, only 1,660,012 of the shares to purchase common stock from the options and warrants are included in the computation of diluted earnings per share because the effect of including the remaining instruments would be anti-dilutive.
 
The following table sets forth the computation of basic and diluted net loss per share:
 
 
 
11

 
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2015
   
2014
   
2015
   
2014
 
Numerator:
                       
Net income (loss)
  $ 529,814     $ 741,643     $ (152,465 )   $ 657,512  
Effects of dilutive securities:
                               
Convertible notes payable
    -       30,811       -       -  
Net income (loss) after effects of conversion of notes payable
  $ 529,814     $ 772,454     $ (152,465 )   $ 657,512  
Denominator:
                               
Denominator for basic calculation weighted average shares
    24,274,815       23,067,462       24,050,960       21,539,066  
Dilutive common stock equivalents:
                               
Secured convertible notes
    -       456,044       -       -  
Options and warrants
    709,167       1,213,058       -       1,660,012  
Denominator for diluted calculation weighted average shares
    24,983,982       24,736,564       24,050,960       23,199,078  
                                 
Net income (loss) per share:
                               
Basic net income (loss) per share
  $ .02     $ .03     $ (.01 )   $ .03  
Diluted net income (loss) per share
  $ .02     $ .03     $ (.01 )   $ .03  

6.           ACCOUNTS RECEIVABLE
 
A summary of accounts receivable is as follows:
   
September 30, 2015
   
December 31, 2014
 
Trade receivables
  $ 7,592,429     $ 8,105,330  
Unapplied advances and unbilled revenue
    (607,038 )     (1,297,147 )
Allowance for doubtful accounts
    -       -  
Total accounts receivable
  $ 6,985,391     $ 6,808,183  

7.           INTANGIBLE ASSETS
 
Intangible assets consist of the following as of September 30, 2015:

   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Net
Carrying
Amount
   
Useful Life (years)
 
Delphiis, Inc.
                       
Acquired technology
  $ 900,000     $ (112,500 )   $ 787,500       10  
Customer relationships
    400,000       (100,000 )     300,000       5  
Trademarks
    50,000       (41,667 )     8,333       1.5  
Non-compete agreements
    20,000       (8,333 )     11,667       3  
 Total intangible assets, Delphiis, Inc.
  $ 1,370,000     $ (262,500 )   $ 1,107,500          
                                 
Redspin
                               
Acquired technology
  $ 1,050,000     $ (52,500 )   $ 997,500       10  
Customer relationships
    600,000       (100,000 )     500,000       3  
Trademarks
    200,000       (20,000 )     180,000       5  
Non-compete agreements
    100,000       (10,000 )     90,000       5  
 Total intangible assets, Redspin
  $ 1,950,000     $ (182,500 )   $ 1,767,500          
                                 
Total intangible assets
  $ 3,320,000     $ (445,000 )   $ 2,875,000          

Please see Notes 15 and 16 below for further discussion of the origin of these intangible assets.
 
 
 
12

 
 
8.           LINE OF CREDIT AND TERM LOAN
 
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”).  On April 26, 2013, we amended the Loan and Security Agreement with Avidbank. On April 25, 2014, we again amended the Loan and Security Agreement with Avidbank (the “Second Avidbank Amendment”). Under the Second Avidbank Amendment, the term of the revolving line-of-credit of up to $2.0 million extended through April 25, 2015, at an interest rate of prime plus 1.0% per annum. This line of credit was further extended through June 25, 2015 under the third amendment to the Loan and Security Agreement. On June 19, 2015, we again amended the Loan and Security Agreement with Avidbank (the “Fourth Avidbank Amendment”). Under the Fourth Avidbank Amendment, the term of the revolving line-of-credit of up to $2.0 million was extended through June 19, 2017, at an interest rate of prime plus 0.75% per annum.  As of September 30, 2015, the interest rate was 4.00%.  There will be no minimum interest payable with respect to any calendar quarter. 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).
 
The Fourth Avidbank Amendment also provided for a term loan facility which allows for advances up to $4,000,000 through June 19, 2016. Our initial draw was for $2,000,000. Term loan repayments shall be in 48 equal installments of principal, plus accrued interest at an interest rate of prime plus 1.25% per annum.
 
As of September 30, 2015 outstanding borrowings under the term loan was $1,875,000.
 
While there are outstanding credit extensions, we are to maintain a liquidity ratio of cash plus accounts receivable divided by all obligations owing to the bank of at least 1.75 to 1.00, measured monthly, and a debt coverage ratio, whereby adjusted EBITDA for the most recent twelve months shall be no less than 1.50 to 1.00 of the sum of the annual principal payments to come due in respect of the term loan advances plus the annualized interest expense of the quarter ending on the measurement date.
 
The foregoing description is qualified in its entirety by reference to the Fourth Amendment to the Loan and Security Agreement between Avidbank Corporate Finance and Auxilio, Inc., which is found as Exhibit 10.1 of our form 10-Q filed on August 14, 2015. We were in compliance with all of the Avidbank agreement covenants as of September 30, 2015 and December 31, 2014.
 
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.  As additional consideration for the Loan and Security Agreement, we issued Avidbank a 5-year warrant to purchase up to 72,098 shares of our common stock at an exercise price of $1.39 per share.  The foregoing descriptions are qualified in their entirety by reference to the respective agreements.  These agreements are found in our Form 8-K filed on May 9, 2012 as Exhibits 10.1, 10.2, 10.3 and 10.4.
 
Interest charges associated with the Avidbank line of credit, including loan origination costs totaled $0 and $2,196, respectively, for the three months ended September 30, 2015 and 2014, respectively, and $16,347 and $20,628, respectively, for the nine months ended September 30, 2015 and 2014. Interest charges associated with the Avidbank term loan, including loan origination costs totaled $22,620 and $38,120, respectively, for the three and nine months ended September 30, 2015.
 
9.           NOTES PAYABLE – RELATED PARTIES
 
We assumed debt totaling $463,723 when we acquired Delphiis, Inc. effective July 1, 2014 (see Note 15).  In July 2014, we paid $100,000 to the note holders upon Delphiis’s collection of $100,000 from accounts receivable outstanding as of June 30, 2014. On February 19, 2015, a holder of $257,835 of the notes agreed to convert the principal amount of his note into 257,835 shares of our common stock and the other note holder was paid $52,944. The remaining $52,944 principal was repaid in September 2015 when, pursuant to the terms of the note, we accelerated payment on the outstanding amount due at such time as Delphiis, Inc. achieved $4,000,000 of bookings measured from July 1, 2014.
 
 
 
13

 
 
Pursuant to a Note Conversion Agreement, dated February 19, 2015 (the “Conversion Agreement”), the holder of the $257,835 note agreed to convert the principal amount of his note into 257,835 shares of our common stock. In February 2015 he received 128,917 shares of common stock, and in October 2015 he received the remaining 128,918 shares of restricted stock units with the restriction being removed, and common shares being issued when, under the terms of the Conversion Agreement, we accelerated the issuance at such time as Delphiis, Inc. achieved $4,000,000 of bookings measured from July 1, 2014. The foregoing summary of the note conversion is qualified in its entirety by reference to the full context of the Conversion Agreement which is found as Exhibit 99.1 to our 8-K filing on February 27, 2015.
 
Interest expense on the notes, including amortization of the discount, was $3,377 and $33,276, respectively, for the three and nine months ended September 30, 2015.
 
10.           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 consisted 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 an exercise price of $1.50 per share.  The Notes matured July 29, 2014 and were secured by our tangible and intangible assets, subject to the senior security interest of AvidBank, as discussed in Note 8.  The Notes accrued interest at a rate of eight percent (8%) per annum, compounded annually, and the interest on the outstanding balance of the Notes was payable no later than thirty (30) days following the close of each calendar quarter.  The Notes were 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 our Board at the time, including John Pace, Michael Joyce, Mark St. Clare and Michael Vanderhoof, participated in the offering.
 
We also paid Cambria Capital, LLC a placement fee of $149,850 in sales commissions, reimbursement for costs associated with the placement of the Units and issued 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. We additionally granted piggyback registration rights to Cambria Capital, LLC that are the same as those afforded to the investors in the offering.
 
The holders of the Notes elected to convert all of the principal into 1,850,000 shares of common stock with 150,000 shares converted during 2012 and 2013, 150,000 shares converted from March 2014 to June 2014 and the remaining 1,550,000 shares converted in July 2014. The warrants remain outstanding until their exercise or expiration.
 
Interest charges associated with the convertible notes payable, including amortization of the discounts and loan acquisition costs totaled $208,601 for the nine months ended September 30, 2014.
 
11.           EMPLOYMENT AGREEMENTS
 
Effective January 1, 2014, we entered into an employment agreement with Joseph J. Flynn, our President and Chief Executive Officer (“CEO”) since 2009 (the “Flynn Agreement”). The Flynn Agreement provides that Mr. Flynn will continue his employment as our President and CEO. The Flynn Agreement has a term of two years, provides for an annual base salary of $275,000, and will automatically renew for subsequent twelve 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 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 $150,000 per year, the achievement of which is based on Company performance metrics. Further, the Flynn Agreement revised the vesting schedule of warrants granted to Mr. Flynn in January 2013. The revision spreads the vesting date of the remaining 300,000 unvested shares from 150,000 on January 1, 2015 and 150,000 on January 1, 2016 to 100,000 on January 1, 2015, 100,000 on January 1, 2016 and 100,000 on January 1, 2017. The warrants will vest contingent with the achievement of certain financial performance metrics of the Company for calendar years 2015 and 2016. The calendar year 2014 performance metrics were not met and as such, they did not vest.   We may terminate Mr. Flynn’s employment under the Flynn Agreement without cause at any time on thirty days advance written notice, at which time Mr. Flynn would receive severance pay for twelve months and be fully vested in all options and warrants granted to date. The foregoing summary of the Flynn Agreement is qualified in its entirety by reference to the full context of the employment agreement which is found as Exhibit 10.2 to our 10-Q filing on May 14, 2014.
 
 
 
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Effective January 1, 2014, we entered into an employment agreement with Paul T. Anthony, our Chief Financial Officer (“CFO”) since 2004 (the “Anthony Agreement”). The Anthony Agreement provides that Mr. Anthony will continue to serve as our EVP and CFO. The Anthony Agreement has a term of two years, and provides for an annual base salary of $225,000. The Anthony Agreement will automatically renew for subsequent twelve 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 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 $108,000 per year, the achievement of which is based on Company performance metrics.  Further, the Anthony Agreement revised the vesting schedule of warrants granted to Mr. Anthony in January 2013. The revision spreads the vesting date of the remaining 200,000 unvested shares from 100,000 on January 1, 2015 and 100,000 on January 1, 2016 to 66,667 on January 1, 2015, 66,667 on January 1, 2016 and 66,666 on January 1, 2017. The warrants will vest contingent with the achievement of certain financial performance metrics of the Company for calendar years 2015 and 2016. The calendar year 2014 performance metrics were not met and as such, they did not vest.   We may terminate Mr. Anthony’s employment under the Anthony Agreement without cause at any time on thirty days advance written notice, at which time Mr. Anthony would receive severance pay for twelve months and be fully vested in all options and warrants granted to date. The foregoing summary of the Anthony Agreement is qualified in its entirety by reference to the full context of the employment agreement which is found as Exhibit 10.3 to our 10-Q filing on May 14, 2014.
 
12.           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
 
Our three largest customers accounted for approximately 49% of our revenues for the nine months ended September 30, 2015 and our three largest customers accounted for approximately 40% of our revenues for the nine months ended September 30, 2014. Our largest customers had net accounts receivable totaling approximately $2,400,000 and $2,800,000 as of September 30, 2015 and December 31, 2014 respectively.
 
13.           SEGMENT REPORTING
 
We have adopted ASC 280, “Segment Reporting”.  Because we operate in one business segment based on our integration and management strategies, segment disclosure has not been presented.
 
14.           GOODWILL
 
We performed an impairment test of goodwill as of December 31, 2014, determining that the implied fair value of goodwill based on the Company’s market capitalization was greater than the carrying amount of goodwill. We did not perform step 2 since the fair value was greater than the carrying amount.
 
 
 
15

 
 
Although the Company has experienced a net loss for the nine months ended September 30, 2015, the net cash provided by operating activities totaled $875,372.  No other triggering events were noted during the nine months ended September 30, 2015; therefore management did not feel it was necessary to perform an interim impairment test.
 
15.           STOCK PURCHASE AGREEMENT – DELPHIIS, INC.
 
As previously disclosed in our Current Report on Form 8-K, filed with the SEC on July 8, 2014, on July 7, 2014 we entered into a Stock Purchase Agreement (the “Agreement”) with Delphiis, Inc., a California corporation (“Delphiis”), certain stockholders of Delphiis (the “Stockholders”), and Mike Gentile, as seller representative (“Gentile”).  By agreement of the parties, the effective date of the Agreement was July 1, 2014.
 
Pursuant to the Agreement, we acquired 100% of the issued and outstanding shares of common stock (the “Shares”) of Delphiis from the Stockholders.  The purchase price paid for the Shares consisted of three components: the Securities Consideration, the Cash Consideration, and the Debt Assumption.

-  
The Securities Consideration consisted of 930,406 shares of our common stock, which was the number of shares having an aggregate value of $1,250,000, with the price per share equal to the average of the closing price of our common stock on the OTC Markets for the 20 most recent trading days prior to the closing date, rounded up to the nearest whole number of shares.

-  
The Cash Consideration was equal to $1,000,000.

-  
The Debt Assumption was equal to $463,723 which was owed by Delphiis to Gentile and two other parties.  By way of background, of such amount, $363,723 is represented by certain amended and restated promissory notes (the “Notes”) dated of even date with the Agreement, which bear interest at the rate of 4% per annum, and pursuant to which Delphiis was to make quarterly interest-only payments on the total principal amount outstanding at the end of each calendar quarter.  The Notes have a maturity date which is 24 months from the date of the Agreement and contain no prepayment penalty.  Pursuant to the terms of the Notes, Delphiis will accelerate payment on (i) fifty percent (50%) of the outstanding amount due under such Notes at such time as Delphiis achieves $1,500,000 of bookings measured from the date of the Agreement, and (ii) the remaining fifty percent (50%) will be paid at such time as Delphiis achieves $4,000,000 of bookings measured from the date of the Agreement, all as set forth in the Notes.  Delphiis also agreed to pay the remaining $100,000 to Gentile and the other noteholders upon Delphiis’s collection of $100,000 from accounts receivable outstanding as of June 30, 2014.  Pursuant to the Agreement, Auxilio, as the sole owner of Delphiis, agreed to assume the obligations of Delphiis and to make the payments pursuant to the terms of the Notes.
 
The allocation of the purchase price of the assets acquired and liabilities assumed based on their fair values was as follows: 
 
Acquired technology
  $ 900,000  
Customer relationships
    400,000  
Trademarks
    50,000  
Non-compete agreements
    20,000  
Goodwill
    956,639  
Other assets received
    376,775  
Deferred revenue
    (154,089 )
Notes payable
    (424,000 )
Other liabilities assumed
    (113,325 )
Total
  $ 2,012,000  
 
Purchased identifiable intangible assets are amortized on a straight-line basis over the respective useful lives. Our estimated useful life of the identifiable intangible assets acquired ranges from 1.5 to 10 years. We recognized goodwill of $956,639. Goodwill is recognized as we expect to be able to realize synergies between the two companies, primarily our ability to provide market and reach for the Delphiis products and services to Auxilio’s customers.
 
 
 
16

 
 
The Company incurred approximately $98,000 in legal, accounting and other professional fees related to this acquisition, all of which were expensed during the nine months ended September 30, 2014.

Escrow Agreement
 
In connection with the Agreement, we entered into an escrow agreement with the Stockholders and Colonial Stock Transfer (the “Escrow Agent”), pursuant to which we deposited $100,000 of the Cash Consideration into an escrow to be held by the Escrow Agent to cover any indemnification claims made pursuant to the Agreement.  Under this escrow agreement, if no indemnification claims have been made prior to July 7, 2015, the Escrow Agent is to release the escrowed funds to the Stockholders. On July 28, 2015, the remaining $100,000 was distributed to the Stockholders by the Escrow Agent.

Employment Agreement
 
In connection with the Agreement, we entered into an employment agreement with Mr. Gentile (the “Gentile Employment Agreement”), pursuant to which Gentile was employed to serve as our Executive Vice President of Innovation and Security.  The initial term of the Gentile Employment Agreement is for three years (unless sooner terminated), and automatically renews for subsequent twelve-month periods unless either party determines to not renew.  Gentile’s base annual salary will be $200,000, and Gentile will be eligible to receive incentive compensation.  Pursuant to the Gentile Employment Agreement, Gentile also received 400,000 restricted shares of our common stock, vesting as follows: 100,000 shares will vest 2 years from the date of the Gentile Employment Agreement; 100,000 shares will vest 3 years from the date of the Gentile Employment Agreement; 100,000 shares will vest 4 years from the date of the Gentile Employment Agreement; and 100,000 shares will vest 5 years from the date of the Gentile Employment Agreement (see Note 4).

On August 16, 2015, we entered into a revised employment agreement with Mr. Gentile. The initial term of the agreement was changed to terminate as of January 1, 2016. The first 100,000 restricted shares of common stock were deemed to be vested and were issued to him in August 2015 (Note 4). The revised agreement requires a payment of $120,000 on January 1, 2016 unless the parties further agree to extend the employment term.

16.           ASSET PURCHASE AGREEMENT - REDSPIN
 
On April 6, 2015, Auxilio entered into an Asset Purchase Agreement (the “Purchase Agreement”) with Redspin, Inc., a California corporation (“Redspin”) and certain owners of Redspin, to acquire substantially all of the assets and certain liabilities of Redspin (the “Acquired Assets”).  A copy of the Purchase Agreement was filed as an exhibit to the Current Report on Form 8-K filed with the SEC on April 6, 2015.   On April 7, 2015, the Company completed its acquisition of the Acquired Assets in an asset purchase transaction (the “Transaction”) pursuant to the terms and conditions of the Purchase Agreement.

As a result of the consummation of the Purchase Agreement, on April 7, 2015, in consideration for the Acquired Assets, the Company paid Redspin $2,076,966 in cash, less a holdback of $200,000 to cover any indemnification claims made pursuant to the Transaction, and issued 452,284 shares of the Company’s restricted common stock, par value $0.001, which was the number of shares having an aggregate value of $500,000, with the price per share equal to the average of the closing price of Auxilio common stock on the OTC Markets for the 20 most recent trading days prior to the date of the Purchase Agreement, rounded up to the nearest whole number of shares. The Company also agreed to pay a cash Earn-out Payment, as defined in the Purchase Agreement, upon the achievement of certain earnings targets in the first year following the date of the Purchase Agreement. Management estimated the fair value of the contingent consideration to be approximately $623,000. If no indemnification claims have been made prior to June 30, 2016, the Company’s secretary will release the holdback funds to Redspin.
 
The Purchase Agreement also provides for the Company to pay employee bonus shares of common stock upon the achievement of the same certain earnings targets and provided they remain with the Company for one year subsequent to the acquisition date. Management previously had considered the $124,000 of fair value of these employee bonus shares to be a component of the acquisition cost, After completing the analysis of the earn-out provisions, Management has determined that the employee bonus shares are post-combination compensation. Accordingly, the Company has recorded $62,000 as stock-based compensation expense for the nine months ended September 30, 2015 for the employee bonus shares.
 

 
17

 
 
The allocation of the purchase price of the assets acquired and liabilities assumed based on their fair values was as follows: 
 
Acquired technology
  $ 1,050,000  
Customer relationships
    600,000  
Trademarks
    200,000  
Non-compete agreements
    100,000  
Goodwill
    1,192,000  
Accounts receivable
    180,409  
Other assets received
    19,009  
Accounts payable and accrued expenses
    (23,196 )
Accrued compensation
    (118,009 )
Deferred revenue
    (31,247 )
Total
  $ 3,168,966  
 
Purchased identifiable intangible assets are amortized on a straight-line basis over the respective useful lives. Our estimated useful life of the identifiable intangible assets acquired ranges from 3 to 10 years. We recognized goodwill of $1,192,000. Goodwill is recognized as we expect to be able to realize synergies between the two companies, primarily our ability to provide market and reach for the Redspin products and services to Auxilio’s customers.
 
The Company incurred approximately $70,000 in legal, accounting and other professional fees related to this acquisition, all of which were expensed during the nine months ended September 30, 2015.

Employment Agreement
 
In connection with the Purchase Agreement, Auxilio and Daniel Berger (“Berger”), CEO of Redspin, entered into an employment agreement (the “Berger Employment Agreement”), pursuant to which Berger was employed to serve as Executive Vice President of Auxilio.  The initial term of the Berger Employment Agreement is for two years (unless sooner terminated), and automatically renews for subsequent twelve-month periods unless either party determines to not renew.  Berger’s base annual salary will be $250,000, and Berger will be eligible to receive incentive compensation, consistent with that generally offered to executives of the Company.  In addition, Auxilio and John Abraham (“Abraham”), Founder of Redspin, entered into an independent contractor agreement (the “Abraham Agreement”), pursuant to which Abraham was retained to perform the work assigned by the Company.  The term of the Abraham Agreement is for two years (unless sooner terminated).  In consideration for such services, the Company agreed to pay Abraham $11,000 per month.

Pro Forma Information
 
The following supplemental unaudited pro forma information presents the combined operating results of the Company and the acquired business during the three and nine months ended September 30, 2015 and 2014, as if the acquisition had occurred at the beginning of each of the periods presented. The pro forma information is based on the historical financial statements of the Company and that of the acquired business. Amounts are not necessarily indicative of the results that may have been attained had the combinations been in effect at the beginning of the periods presented or that may be achieved in the future.
 
   
Three Months
Ended September 30,
   
Nine months
Ended September 30,
 
   
2015
   
2014
   
2015
   
2014
 
                         
Pro forma revenue
  $ 15,725,616     $ 12,192,344     $ 45,888,738     $ 33,840,426  
Pro forma net income (loss)
  $ 529,814     $ 898,718     $ (353,344 )   $ 436,308  
Pro forma basic net income (loss) per share
  $ 0.02     $ 0.04     $ (0.01 )   $ 0.02  
Pro forma diluted net income (loss) per share
  $ 0.02     $ 0.04     $ (0.01 )   $ 0.02  
 
 
18

 

 
The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q.  This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 27A of the Securities Act, and is subject to the safe harbors created by those sections.  Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “may,” “will” and variations of these words or similar expressions are intended to identify forward-looking statements.  In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements.  These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict.  Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors.  We undertake no obligation to revise or publicly release the results of any revisions to these forward-looking statements.
 
Due to possible uncertainties and risks, readers are cautioned not to place undue reliance on the forward-looking statements contained in this Quarterly Report, which speak only as of the date of this Quarterly Report, or to make predictions about future performance based solely on historical financial performance.  We disclaim any obligation to update forward-looking statements contained in this Quarterly Report.
 
Readers should carefully review the risk factors described below under the heading “Risk Factors”  and in other documents we file from time to time with the SEC, including our Form 10-K for the fiscal year ended December 31, 2014.  Our filings with the SEC, including our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those filings, pursuant to Sections 13(a) and 15(d) of the Exchange Act, are available free of charge at www.auxilioinc.com, when such reports are available via the EDGAR system maintained by the SEC at www.sec.gov.
 
OVERVIEW
 
We provide fully-outsourced managed print services and data security services to the healthcare industry, working exclusively with hospitals and health systems throughout the United States.
 
Our managed print service group is vendor independent, provides workflow solutions, and is a risk-free program with guaranteed savings. We assume all costs related to print environments through customized streamlined and seamless integration of services at predictable fixed rates. Our on-site staff creates manageable, dependable print management programs by managing the back-office processes of our hospital clients.  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 includes placement of a highly trained on-site resident team.
 
Our data security group is built on four pillars to serve the most common security needs in healthcare: Security Process and Program Development, Regulatory and Penetration Assessments, Incident and Breach Response and Delphiis™ IT Risk Manager SaaS Solution. Through our proven and prescriptive methodology we help build the foundation needed to ensure the confidentiality, integrity and security of patient health information (PHI). And our Delphiis™ application suite streamlines how hospitals and health systems perform annual and on-going risk assessments on their business associates, clinics, projects and hospitals.
 
Our common stock currently trades on the OTCQB under the stock symbol “AUXO”.
 
 
 
19

 
 
Where appropriate, references to “Auxilio,” the “Company,” “we,” “us” or “our” include Auxilio, Inc. and its wholly-owned subsidiaries, Auxilio Solutions, Inc. and Delphiis, Inc..
 
APPLICATION OF CRITICAL ACCOUNTING POLICIES
 
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities.  We evaluate these estimates on an on-going basis, including those estimates related to customer programs and incentives, product returns, bad debts, supplies, investments, intangible assets, goodwill, income taxes, contingencies and litigation.  We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances.  The results of these estimates form the basis for our judgments about the carrying values of assets and liabilities which are not readily apparent from other sources.  As a result, actual results may differ from these estimates under different assumptions or conditions.
 
We consider the following accounting policies to be most important to the portrayal of our financial condition and those that require the most subjective judgment:
 
·
Revenue recognition and deferred revenue
 
The Company derives its revenue from four sources: (1) managed print services revenue; (2) multi-function device (MFD) equipment revenue; (3) software subscription services revenue, which are comprised of subscription fees from customers accessing the Company’s enterprise cloud computing services and customers purchasing additional ongoing managed services beyond the standard support that is included in the basic software subscription fees; and (4) consulting services such as process mapping, project management and implementation services.
 
The Company commences revenue recognition when all of the following conditions are satisfied:
 
•           there is persuasive evidence of an arrangement;
•           the service has been or is being provided to the customer;
•           the collection of the fees is reasonably assured; and
•           the amount of fees to be paid by the customer is fixed or determinable.

Managed Print Services and MFD Equipment Revenue
 
Revenue is recognized pursuant to ASC Topic 605, “Revenue Recognition” (“ASC 605”).  Service and supply revenue is earned monthly during the term of the contract, as services and supplies are provided. Revenues from equipment sales transactions are earned when there is persuasive evidence of an arrangement, delivery has occurred, the sales price has been determined and collectability has been reasonably assured. For equipment that is to be placed at a customer’s location at a future date, revenue is deferred until the placement of such equipment.
 
We enter into arrangements that include multiple deliverables, which typically consist of the sale of equipment and a support services contract.  We account for each element within an arrangement with multiple deliverables as separate units of accounting.  Revenue is allocated to each unit of accounting under the guidance of FASB ASC Topic 605-25, Multiple-Deliverable Revenue Arrangements, which provides criteria for separating consideration in multiple-deliverable arrangements by establishing a selling price hierarchy for determining the selling price of a deliverable.  The selling price used for each deliverable is based on vendor-specific objective evidence (“VSOE”) if available, third-party evidence if VSOE is not available, or estimated selling price if neither VSOE nor third-party evidence is available.  We are required to determine the best estimate of selling price in a manner that is consistent with that used to determine the price to sell the deliverable on a standalone basis.    We generally do not separately sell MFD equipment or service on a standalone basis.  Therefore, we do not have VSOE for the selling price of these units. As we purchase the equipment, we have third-party evidence of the cost of this element.  We estimate the proceeds from the arrangement to allocate to the service unit based on historical cost experiences.  Based on the relative costs of each unit to the overall cost of the arrangement, we utilize the same relative percentage to allocate the total arrangement proceeds.
 

 
20

 
 
Software Subscriptions and Managed Services Revenue
 
Software subscriptions and managed services revenues are recognized ratably over the contract terms beginning on the commencement date of each contract, which is the date the Company’s service is made available to customers.
 
Amounts that have been invoiced are recorded in accounts receivable and in deferred revenue or revenue, depending on whether the revenue recognition criteria have been met.
 
The Company’s software subscription service arrangements are non-cancelable and do not contain refund-type provisions.
 
Consulting Service Revenues
 
The majority of the Company’s consulting services contracts are on a time and material basis. When these services are not combined with subscription revenues as a single unit of accounting, these revenues are recognized as the services are rendered for time and material contracts, and when the milestones are achieved and accepted by the customer for fixed price contracts.
 
·
Accounts receivable valuation and related reserves
 
We estimate the losses that may result from that portion of our accounts receivable that may not be collectible as a result of the inability of our customers to make required payments. Management specifically analyzes customer concentration, customer credit-worthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. We review past due accounts on a monthly basis and record an allowance for doubtful accounts when we deem appropriate.
 
·
New customer implementation costs
 
We ordinarily incur additional costs to implement our services for new customers.  These costs are comprised primarily of additional labor and support.  These costs are expensed as incurred, and have a negative impact on our consolidated statements of operations and cash flows during the implementation phase.
 
·
Impairment of goodwill and intangible assets
 
The Company performs an impairment test of goodwill at least annually or on an interim basis if any triggering events occur that would merit another test. The impairment test compares our estimate of the implied fair value of goodwill based on the Company’s market capitalization to the carrying amount of goodwill. We have not had to perform step 2 of the impairment test because the fair value has exceeded the carrying amount. For other intangible assets with definite lives, we compare future undiscounted cash flow forecasts prepared by management to the carrying value of the related intangible asset group to determine if there is impairment.
 
·
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.
 
 
 
21

 
 
·
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.
 
Reference is made to our Annual Report on Form 10-K for the fiscal year ended December 31, 2014 filed on March 30, 2015 for a discussion of our critical accounting policies.
 
RESULTS OF OPERATIONS
 
For the Three Months Ended September 30, 2015 Compared to the Three Months Ended September 30, 2014
 
Revenue
 
Revenue increased by $4,467,746 to $15,725,616 for the three months ended September 30, 2015, as compared to the same period in 2014.  Of this increase, approximately $2,700,000 is a result of the addition of new recurring service revenue contracts. We added approximately $1,100,000 in service revenues and software subscriptions from our newly acquired companies, Delphiis, Inc. and Redspin. We anticipate more overall revenue growth as a result of the expansion of our customer base.  Equipment sales for 2015 were approximately $1,600,000 as compared to approximately $700,000 in 2014. Equipment revenues in 2015 were primarily from copier fleet refresh activities at customers which were not needed in 2014 as these fleet refreshes are typically done every five years at any one customer facility.
 
 
 
22

 
 
Cost of Revenue
 
Cost of revenue consists of document imaging equipment, parts, supplies and salaries and expenses of direct labor and indirect support staff.  Cost of revenue was $12,853,601 for the three months ended September 30, 2015, as compared to $8,718,230 for the same period in 2014. The increase in the cost of revenues in 2015 is attributed primarily to the addition of new recurring service revenue contracts. We incurred approximately $1,900,000 in additional staffing, including contract labor, approximately $200,000 of additional travel costs and approximately $1,000,000 in additional service and supply costs, primarily as a result of our new customers.  Equipment costs increased by approximately $900,000 in 2015, primarily as a result of the increase in equipment revenues from the copier fleet refresh activities.
 
Gross margin decreased to 18% of revenue for the three months ended September 30, 2015 as compared to 23% for the same period in 2014. We implemented services at four new customers in the last nine months; this recent growth will result in additional implementation costs over the next 12 months. We expect higher cost of revenues at the start of our engagement with most new customers. In addition to the costs associated with implementing our services, we absorb our new customers’ legacy contracts with third-party vendors. As we implement our programs, we strive to improve upon these legacy contracts and thus reduce costs over the term of the contract. Given the varying expiration dates of these vendor contracts and the amount of savings being specific to each arrangement, we cannot predict our anticipated profit margins as these legacy contracts approach renewal. We anticipate this trend to continue but anticipate an overall increase in cost revenues sold as a result of the expansion of our customer base.
 
Sales and Marketing
 
Sales and marketing expenses include salaries, commissions and expenses for sales and marketing personnel, travel and entertainment, and other selling and marketing costs. Sales and marketing expenses were $712,522 for the three months ended September 30, 2015, as compared to $521,585 for the same period in 2014. We increased our sales and marketing staff headcount in the first quarter of 2015 to expand our geographical reach and support the sales effort with the newly acquired businesses. This resulted in additional salary and related costs.
 
General and Administrative
 
General and administrative expenses include personnel costs for finance, administration, information systems, and general management, as well as facilities expenses, professional fees, legal expenses and other administrative costs. General and administrative expenses increased by $402,834 to $1,597,793 for the three months ended September 30, 2015, as compared to $1,194,959 for the three months ended September 30, 2014. The increase in general and administrative expenses is attributed to approximately $100,000 in staffing an internal Human Resources department, approximately $100,000 in additional executive staff from the recent acquisition of Redspin and approximately $90,000 in additional amortization of intangible assets and approximately $60,000 in contingent employee bonus shares from this same acquisition, The remainder of the increase is primarily due to the additional overhead expenses we incurred as a result of the acquisition of Redspin.
 
Other Income (Expense)
 
Interest expense for the three months ended September 30, 2015 was $31,886, compared to $42,453 for the same period in 2014. The reduction is primarily due to the lower interest rate for our current bank term loan as compared to the interest rate on our convertible debt in 2014.
 
Income Tax Expense
 
Income tax expense for each of the three months ended September 30, 2015 and September 30, 2014, was zero and $39,000 respectively. The variance is a result of the taxable earnings for each period.
 

 
23

 
 
For the Nine months ended September 30, 2015 Compared to the Nine months ended September 30, 2014
 
Revenue
 
Revenue increased by $13,310,347 to $45,190,062 for the nine months ended September 30, 2015, as compared to the same period in 2014.  Of this increase, approximately $5,200,000 is a result of the addition of new recurring service revenue contracts. We added approximately $3,900,000 in service revenues and software subscriptions from our newly acquired companies. We anticipate more overall revenue growth as a result of the expansion of our customer base.  Equipment sales for 2015 were approximately $6,200,000 as compared to approximately $1,800,000 in 2014. Equipment revenues in 2015 were primarily from copier fleet refresh activities at customers which were not needed in 2014 as these fleet refreshes are typically done every five years at any one customer facility.
 
Cost of Revenue
 
Cost of revenue consists of document imaging equipment, parts, supplies and salaries and expenses of direct labor and indirect support staff.  Cost of revenue was $38,069,271 for the nine months ended September 30, 2015, as compared to $25,881,373 for the same period in 2014. The increase in the cost of revenues in 2015 is attributed primarily to the addition of new recurring service revenue contracts. We incurred approximately $5,000,000 in additional staffing, including contract labor, approximately $500,000 of additional travel costs and approximately $2,600,000 in additional service and supply costs, primarily as a result of our new customers.  Equipment costs increased by approximately $4,100,000 in 2015, primarily as a result of the increase in equipment revenues from the copier fleet refresh activities.
 
Gross margin decreased to 16% of revenue for the nine months ended September 30, 2015 as compared to 19% for the same period in 2014. We implemented services at four new customers in the last nine months and recent growth will result in additional implementation costs over the next 12 months. We expect higher cost of revenues at the start of our engagement with most new customers. In addition to the costs associated with implementing our services, we absorb our new customers’ legacy contracts with third-party vendors. As we implement our programs, we strive to improve upon these legacy contracts and thus reduce costs over the term of the contract. We anticipate this trend to continue but anticipate an overall increase in cost revenues sold as a result of the expansion of our customer base.
 
Sales and Marketing
 
Sales and marketing expenses include salaries, commissions and expenses for sales and marketing personnel, travel and entertainment, and other selling and marketing costs. Sales and marketing expenses were $2,263,410 for the nine months ended September 30, 2015, as compared to $1,612,298 for the same period in 2014. We increased our sales and marketing staff headcount in 2015 to expand our geographical reach and support the sales effort with the newly acquired businesses. This resulted in additional salary and related costs.
 
General and Administrative
 
General and administrative expenses include personnel costs for finance, administration, information systems, and general management, as well as facilities expenses, professional fees, legal expenses and other administrative costs. General and administrative expenses increased by $1,465,575 to $4,907,162 for the nine months ended September 30, 2015, as compared to $3,441,587 for the nine months ended September 30, 2014.  The increase in general and administrative expenses is attributed to approximately $330,000 in severance and related costs from the integration efforts initiated with the two recent acquisitions, including immediate vesting of stock options, approximately $250,000 in staffing an internal Human Resources department, approximately $190,000 in additional executive staff from the recent acquisition of Redspin, approximately $230,000 in additional amortization of intangible assets from the acquisitions of Delphiis, Inc. and Redspin, an increase in professional fees of approximately $160,000 mostly related to due diligence efforts and ongoing consulting arrangements related to the acquisition of Redspin, and an increase in travel expenses of approximately $160,000, much of it related to supporting this acquisition. The remainder of the increase is primarily due to the additional overhead expenses we incurred as a result of the acquisition of Redspin.
 
 
 
24

 
 
Other Income (Expense)
 
Interest expense for the nine months ended September 30, 2015 was $100,284 compared to $246,345 for the same period in 2014.  The reduction is primarily due to the lower interest rate for our current bank term loan as compared to the interest rate on our convertible debt in 2014.
 
Income Tax Expense
 
Income tax expense for each of the nine months ended September 30, 2015 and September 30, 2014, was $2,400 and $40,600 respectively. The variance is a result of the taxable earnings for each period.
 
LIQUIDITY AND CAPITAL RESOURCES
 
At September 30, 2015, our cash and cash equivalents were $5,220,919 and our working capital was $1,904,035.  Our principal cash requirements are for operating expenses, including equipment, supplies, employee costs, and capital expenditures, debt repayments and funding of the operations. Our primary sources of cash are service and equipment sale revenues and our bank line of credit and term loan.
 
During the nine months ended September 30, 2015, our cash provided by operating activities amounted to $875,372, as compared to $972,949 provided by operating activities for the same period in 2014.  We have maintained a consistent positive cash flow from operating activities while we grow our customer base.
 
We plan to continue to pursue our recent strategy to diversify our business into the data security industry. As a result, we may seek additional financing, which may include debt and/or equity financing or funding through third party agreements. In May 2012, we entered into an asset-based line of credit agreement with a financial institution. This facility provides for borrowings up to $2,000,000 not to exceed 80% of eligible receivables.  In June 2015, we borrowed $2,000,000 of an available $4,000,000 under a four year term loan agreement. 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 existing cash, 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, purchase commitments and other commitments arising in the normal course of business, as further discussed below under “Contractual Obligations and Contingent Liabilities and Commitments.” As of September 30, 2015, 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.
 
 
 
25

 
 
CONTRACTUAL OBLIGATIONS AND CONTINGENT LIABILITIES AND COMMITMENTS
 
As of September 30, 2015, expected future cash payments related to contractual obligations and commercial commitments were as follows:
 
   
Payments Due by Period
 
   
Total
   
Less than
1 year
   
1-3 years
   
3-5 years
   
More than 5 years
 
Term loan
  $ 2,050,782     $ 577,813     $ 1,088,125     $ 384,844     $ -  
Capital leases
    280,324       124,267       156,057       -       -  
Operating leases
    2,127,340       297,684       795,835       880,444       153,377  
Total
  $ 4,458,446     $ 999,764     $ 2,040,017     $ 1,265,288     $ 153,377  

 
As a “smaller reporting company” as defined by Rule 229.10(f)(1), we are not required to provide the information required by this Item 3.
 
 
We maintain disclosure controls and procedures (as defined in Rules 13a-15(c) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (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 defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this Quarterly Report.  Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including each of such officers as appropriate to allow timely decisions regarding required disclosure.
 
As a result of the Delphiis acquisition in July 2014 and the Redspin acquisition in April 2015, management has implemented key controls designed to ensure that financial data related to these businesses is recorded, processed, summarized and reported accurately and timely.  This effort is ongoing and management expects the implementation of additional key controls to take place through at least the rest of the year.
 
Changes In Internal Control Over Financial Reporting. Other than as discussed in the preceding paragraph, there have been no changes in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.
 
 
 
As of the date of this filing, we have identified the following changes to the Risk Factors included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, filed with the SEC on March 30, 2015. (the “2014 Form 10-K”).  The Risk Factors set forth in the 2014 Form 10-K should be read carefully in connection with evaluating our business and in connection with the forward-looking statements contained in this Quarterly Report on Form 10-Q.  Any of the risks described in the 2014 Form 10-K could materially adversely affect our business, financial condition or future results and the actual outcome of matters as to which forward-looking statements are made.  These are not the only risks we face.  Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
 
 
 
26

 
 
We have acquired other businesses, and we may acquire additional businesses, that could negatively affect our operating results, dilute our stockholders’ ownership, increase our debt or cause us to incur significant expenses.
 
We have completed two business combinations over the past twelve months and we may pursue additional acquisitions of businesses and assets. We have limited experience with acquiring other companies and/or assets. We may not be able to find suitable partners or acquisition candidates, and we may not be able to complete such transactions on favorable terms, if at all. If we make any acquisitions, we may not be able to integrate these acquisitions successfully into our existing business, and we could assume unknown or contingent liabilities. Any future acquisitions also could result in the incurrence of debt, contingent liabilities or future write-offs of intangible assets or goodwill, any of which could have a negative impact on our cash flows, financial condition and results of operations. Integration of an acquired company also may disrupt ongoing operations and require management resources that we would otherwise focus on developing our existing business. We may experience losses related to investments in other companies, which could harm our financial condition and results of operations. We may not realize the anticipated benefits of any acquisition.
 
To finance any acquisitions, we may choose to issue shares of common stock as consideration, which could dilute the ownership of our stockholders. Additional funds may not be available on terms that are favorable to us, or at all. If the price of our common stock is low or volatile, we may not be able to acquire other companies using our stock as consideration.
 

On June 26, 2015, the Company entered into a new lease for office space with MVPlaza, Inc. (the “Lease Agreement”).  Pursuant to the terms of the Lease Agreement, the Company, scheduled to commence on October 1, 2015, will lease approximately 18,230 square feet in one building located at 27271 Las Ramblas, Mission Viejo, CA 92691. Tenant improvements are expected to be completed in December 2015, after which we will gain occupancy and rent charges will commence.  The Lease Agreement expires on January 31, 2021 unless earlier terminated in accordance with the provisions of the Lease Agreement.  The Company’s base rent under the Lease Agreement is $33,076 per month, with annual adjustments thereafter.  The foregoing description is qualified in its entirety by the text of the Lease Agreement, which is filed herewith as Exhibit 10.1.

 
27

 


 
No.
Item
10.1
Office Lease between MVPlaza, Inc. and Auxilio, Inc., dated as of June 24, 2015
31.1
Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended. †
31.2
Certification  of the Chief Financial Officer  pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended. †
32.1
Certification of the CEO and CFO pursuant to Rule 13a-14(b) and Rule 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350. +
101.INS
XBRL Instance Document*
101.SCH
XBRL Taxonomy Extension Schema Document*
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document*
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document*
101.LAB
XBRL Taxonomy Extension Label Linkbase Document*
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document*

†           Filed herewith.
 
+           Furnished herewith.  In accordance with Item 601(b)(32)(ii) of Regulation S-K, this exhibit shall not be deemed “filed” for the purposes of Section 18 of the Securities and Exchange Act of 1934 or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934
 
* Pursuant to Rule 406T of Regulation S-T, this XBRL information will not be deemed “filed” for the purpose of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liability of that section, nor will it be deemed filed or made a part of a registration statement or prospectus for purposes of Sections 11 and 12 of the Securities Act of 1933, or otherwise subject to liability under those sections.
 

 
28

 

 
In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
   
 
AUXILIO, INC.
   
Date:  November 13, 2015
By: /s/ Joseph J. Flynn 
 
Joseph J. Flynn
Chief Executive Officer
(Principal Executive Officer)
   
   
Date:  November 13, 2015
By: /s/ Paul T. Anthony 
 
Paul T. Anthony
Chief Financial Officer
(Principal Accounting Officer)

 
29