CYNERGISTEK, INC - Quarter Report: 2014 March (Form 10-Q)

form10q05092014.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 March 31, 2014

[ ] 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 May 13, 2014 was 20,770,632.

AUXILIO, INC.

FORM 10-Q

TABLE OF CONTENTS


PART I - FINANCIAL INFORMATION
		Page
Item 1	Financial Statements:

	Condensed Consolidated Balance Sheets as of March 31, 2014 (unaudited) and December 31, 2013	3

	Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2014 and 2013 (unaudited)	4

	Condensed Consolidated Statement of Stockholders’ (Deficit) Equity for the Three Months Ended March 31, 2014 (unaudited)	5

	Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2014 and 2013 (unaudited)	6

	Notes to Unaudited Condensed Consolidated Financial Statements	8

Item 2	Management's Discussion and Analysis of Financial Condition and Results of Operations	14

Item 3	Quantitative and Qualitative Disclosures about Market Risk	18

Item 4	Controls and Procedures	18

PART II - OTHER INFORMATION

Item 1A	Risk Factors	19

Item 6	Exhibits	19

Signatures		20

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PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

AUXILIO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS

	MARCH 31, 2014			DECEMBER 31, 2013
	(unaudited)

ASSETS
Current assets:
Cash and cash equivalents	$	4,752,319		$	4,668,624
Accounts receivable, net		3,592,189			3,856,791
Supplies		1,039,388			967,354
Prepaid and other current assets		345,859			332,759
Total current assets		9,729,755			9,825,528

Property and equipment, net		151,222			160,709
Deposits		34,413			34,413
Loan acquisition costs		29,236			51,162
Goodwill		1,517,017			1,517,017
Total assets	$	11,461,643		$	11,588,829

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable and accrued expenses	$	5,231,390		$	5,057,339
Accrued compensation and benefits		1,130,925			1,556,513
Line of credit		400,000			400,000
Deferred revenue		848,397			868,186
Convertible notes payable, net of discount of $47,000 and $82,250 at March 31, 2014 and December 31, 2013, respectively		1,553,000			1,617,750
Current portion of capital lease obligations		64,960			71,933
Total current liabilities		9,228,672			9,571,721

Long-term liabilities:
Capital lease obligations less current portion		32,692			46,558
Total long-term liabilities		32,692			46,558

Commitments and contingencies

Stockholders' equity:
Common stock, par value at $0.001, 33,333,333 shares authorized, 20,743,966 and 20,643,966 shares issued and outstanding at March 31, 2014 and December 31, 2013, respectively		20,745			20,645
Additional paid-in capital		23,791,992			23,491,490
Accumulated deficit		(21,612,458	)		(21,541,585	)
Total stockholders' equity		2,200,279			1,970,550
Total liabilities and stockholders’ equity	$	11,461,643		$	11,588,829

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

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AUXILIO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

	Three Months Ended March 31,
	2014			2013
Revenues	$	10,244,574		$	10,092,152
Cost of revenues		8,504,940			8,515,938
Gross profit		1,739,634			1,576,214
Operating expenses:
Sales and marketing		508,210			682,187
General and administrative expenses		1,201,874			992,479
Total operating expenses		1,710,084			1,674,666
Income (loss) from operations		29,550			(98,452	)
Other income (expense):
Interest expense		(98,823	)		(126,348	)
Total other income (expense)		(98,823	)		(126,348	)
Loss before provision for income taxes		(69,273	)		(224,800	)
Income tax expense		1,600			5,500
Net loss	$	(70,873	)	$	(230,300	)

Net loss per share:
Basic	$	(0.00	)	$	(0.01	)
Diluted	$	(0.01	)	$	(0.01	)

Number of weighted average shares:
Basic		20,658,573			20,115,873
Diluted		22,258,573			20,115,873

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

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AUXILIO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
THREE MONTHS ENDED MARCH 31, 2014
(UNAUDITED)


					Additional					Total
	Common Stock				Paid-in		Accumulated			Stockholders’
	Shares		Amount		Capital		Deficit			Equity
Balance at December 31, 2013		20,643,966	$	20,645	$	23,491,490	$	(21,541,585	)	$	1,970,550
Stock compensation expense for options and warrants granted to employees and directors		-		-		200,602		-			200,602
Conversion of convertible note payable		100,000		100		99,900		-			100,000
Net loss		-		-		-		(70,873	)		(70,873	)
Balance at March 31, 2014		20,743,966	$	20,745	$	23,791,992	$	(21,612,458	)	$	2,200,279

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

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AUXILIO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

	Three Months Ended March 31,
	2014			2013
Cash flows from operating activities:
Net loss	$	(70,873	)	$	(230,300	)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation		24,169			34,487
Stock compensation expense for warrants and options issued to employees and directors		200,602			196,516
Fair value of stock granted for marketing services		-			190,484
Interest expense related to accretion of debt discount costs		35,250			35,250
Interest expense related to amortization of loan acquisition costs		21,926			37,052
Changes in operating assets and liabilities:
Accounts receivable		264,602			697,236
Supplies		(72,034	)		(197,928	)
Prepaid and other current assets		(13,100	)		(54,040	)
Deposits		-			1,250
Accounts payable and accrued expenses		174,051			915,760
Accrued compensation and benefits		(425,588	)		(603,921	)
Deferred revenue		(19,789	)		25,843
Net cash provided by operating activities		119,216			1,047,689
Cash flows from investing activities:
Purchases of property and equipment		(14,682	)		-
Net cash used for investing activities		(14,682	)		-
Cash flows from financing activities:
Net repayments on line of credit agreement		-			(528,486	)
Payments on capital leases		(20,839	)		(26,460	)
Net proceeds from issuance of common stock through employee stock options		-			1,175
Net cash used for financing activities		(20,839	)		(553,771	)
Net increase in cash and cash equivalents		83,695			493,918
Cash and cash equivalents, beginning of period		4,668,624			2,190,972
Cash and cash equivalents, end of period	$	4,752,319		$	2,684,890

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

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AUXILIO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)

	Three Months Ended March 31,
	2014		2013
Supplemental disclosure of cash flow information:

Interest paid	$	42,313	$	54,045

Income taxes paid	$	49,460	$	5,655

Non-cash investing and financing activities:

Property and equipment acquired through capital leases	$	-	$	25,834

Conversion of note payable into common stock	$	100,000	$	-

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

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THREE MONTHS ENDED MARCH 31, 2014 AND 2013

(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, 2013, as filed with the Securities and Exchange Commission (“SEC”) on March 31, 2014.

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 these financial statements with the SEC.

2. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

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, 2013, 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.

3. OPTIONS AND WARRANTS

Below is a summary of Auxilio stock option and warrant activity during the three month period ended March 31, 2014:

Options	Shares			Weighted Average Exercise Price		Weighted Average Remaining Term in Years		Aggregate Intrinsic Value
Outstanding at December 31, 2013		5,256,349		$	1.03
Granted		200,000			1.25
Exercised		-			-
Cancelled		(11,538	)		1.11
Outstanding at March 31, 2014		5,444,811		$	1.04		5.14	$	3,923,964
Exercisable at March 31, 2014		4,646,052		$	1.03		4.53	$	3,096,333

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Warrants	Shares		Weighted Average Exercise Price		Weighted Average Remaining Term in Years		Aggregate Intrinsic Value
Outstanding at December 31, 2013		2,983,565	$	1.15
Granted		-		-
Exercised		-		-
Cancelled		-		-
Outstanding at March 31, 2014		2,983,565	$	1.15		4.19	$	1,695,032
Exercisable at March 31, 2014		2,283,565	$	1.20		4.19	$	1,198,032

During the three months ended March 31, 2014, we granted a total of 200,000 options to an employee to purchase shares of our common stock at an exercise price of $1.25 per share. The exercise price equals the fair value of our stock on the grant date. 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 of 0.07%; (ii) estimated volatility of 64.00%; (iii) dividend yield of 0.0%; and (iv) expected life of the options of three years. Of these options, 100,000 have graded vesting annually over three years starting February 2014.The other 100,000 vest contingent with the achievement of certain financial performance metrics of the Company for the year ended December 31, 2014, which would then begin a graded vesting over three years beginning in February 2015.

For the three months ended March 31, 2014 and 2013, stock-based compensation expense recognized in the statement of operations was as follows:

	2014		2013
Cost of revenues	$	127,164	$	70,969
Sales and marketing		15,075		54,706
General and administrative expenses		58,363		70,841
Total stock based compensation expense	$	200,602	$	196,516

4. RESTRICTED STOCK

On May 11, 2011, we amended (the “May 2011 Amendment”) the November 2008 joint marketing agreement with Sodexo (the “Sodexo Agreement”). 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 were to vest as follows: 66,667 immediately, 66,667 on May 11, 2013 and 66,666 on May 11, 2014. The cost of the remaining shares was to be 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 were to 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 were to vest as follows: 10,588 on July 1, 2013, 10,588 on July 1, 2014 and 10,588 on July 1, 2015.

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 would 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 had brought to us and had signed an agreement for services by August 3, 2013. These commissions totaled $14,101 and $7,791 for the three months ended March 31, 2014 and 2013, respectively. On January 7, 2013, we granted another 25,253 shares to Sodexo as a result of another new sale. These shares vested immediately.

On January 11, 2013 we terminated the Sodexo Agreement. This resulted in the immediate vesting of the remaining 265,179 shares of restricted stock. The cost recognized for all shares vesting totaled $190,484 for the three months ended March 31, 2013.

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5. NET LOSS 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. Diluted net loss per share does not include potentially dilutive securities because such inclusion in the computation would be anti-dilutive.

The following table sets forth the computation of basic and diluted net loss per share:

	Three Months Ended March 31,
	2014			2013
Numerator:
Net loss	$	(70,873	)	$	(230,300	)
Effects of dilutive securities:
Convertible notes payable		(42,524	)		-
Loss after effects of conversion of note payable	$	(113,397	)	$	(230,300	)

Denominator:
Denominator for basic calculation weighted average shares		20,658,573			20,115,873

Dilutive common stock equivalents:
Convertible notes payable		1,600,000			-
Denominator for diluted calculation weighted average shares		22,258,573			20,115,873

Net loss per share:
Basic net loss per share	$	(0.00	)	$	(0.01	)
Diluted net loss per share	$	(0.01	)	$	(0.01	)

6. ACCOUNTS RECEIVABLE

A summary of accounts receivable is as follows:

	March 31, 2014			December 31, 2013
Trade receivable	$	4,269,403		$	4,572,656
Unapplied advances and unbilled revenue		(677,214	)		(715,865	)
Allowance for doubtful accounts		-			-
Total accounts receivable	$	3,592,189		$	3,856,791

7. 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”). On April 26, 2013, we amended the Loan and Security Agreement with Avidbank (the “Avidbank Amendment”). Under the Avidbank Amendment, the term of the revolving line-of-credit of up to $2.0 million extends through April 26, 2014, at an interest rate of prime plus 2.0% per annum. As of March 31, 2014 the interest rate was 5.25%. Minimum interest payable with respect to any calendar quarter is $5,000. 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, our adjusted EBITDA shall be positive, as measured on a quarterly basis; provided however that our adjusted EBITDA may be an adjusted EBITDA loss of up to $200,000 for any single quarter so long as we achieve a positive adjusted EBITDA for the prior quarter and subsequent quarter. The foregoing description is qualified in its entirety by reference to the Avidbank Amendment, which is found as Exhibit 10.1 to our Form 10-Q filed with the SEC on May 15, 2013. We believe we were in compliance with all of the Avidbank agreement covenants as of March 31, 2014 and December 31, 2013.

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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. 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 $1.387 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.

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 extends through April 25, 2015, at an interest rate of prime plus 1.0% per annum. There will no longer be a 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). While there are outstanding credit extensions, our adjusted EBITDA may be an adjusted EBITDA loss of up to $200,000 for any single quarter so long as we achieve a positive adjusted EBITDA for the prior quarter and subsequent quarter. The foregoing description is qualified in its entirety by reference to the Second Amendment to the Loan and Security Agreement between Avidbank Corporate Finance and Auxilio, Inc. which is found as Exhibit 10.1 to this filing.

Interest charges associated with the Avidbank line of credit, including amortization of the discounts and loan acquisition costs totaled $5,250 and $29,126, respectively, for the three months ended March 31, 2014 and 2013, respectively.

8. 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 an 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 preceding 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 our Board at the time, 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 will 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 shares of our common stock.

Interest charges associated with the convertible notes payable, including amortization of the discounts and loan acquisition costs totaled $90,888 and $93,177 for the three months ended March 31, 2014 and 2013, respectively.

We also agreed to pay Cambria Capital, LLC a placement fee of $149,850 in sales commissions, reimbursement 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. We additionally granted piggyback registration rights to Cambria Capital, LLC that are the same as those afforded to the investors in the offering.

9. EMPLOYMENT AGREEMENTS

Effective January 1, 2012, 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 provided that Mr. Flynn would continue his employment as our President and CEO. The Flynn Agreement had a term of two years, provided for an annual base salary of $269,087, and contained an auto renewal provision. Mr. Flynn also received the customary employee benefits available to our employees. Mr. Flynn is also received a bonus of $127,324 in 2013, the achievement of which was based on Company performance metrics. The foregoing summary of the 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.

Effective January 1, 2014, we entered into a new employment agreement with Joseph J. Flynn (the “2014 Flynn Agreement”). The 2014 Flynn Agreement provides that Mr. Flynn will continue his employment as our President and CEO. The 2014 Flynn Agreement has a term of two years, provides for an annual base salary of $275,000, 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 $150,000 per year, the achievement of which is based on Company performance metrics. Further, the 2014 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. These warrants will vest contingent with the achievement of certain financial performance metrics of the Company in calendar years 2014, 2015 and 2016. We may terminate Mr. Flynn’s employment under the 2014 Flynn Agreement without cause at any time on thirty (30) days advance written notice, at which time Mr. Flynn would receive severance pay for twelve (12) months and be fully vested in all options and warrants granted to date. The foregoing summary of the 2014 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 this filing.

Effective January 1, 2012, we entered into an employment agreement with Paul T. Anthony, our Chief Financial Officer (“CFO”) since 2004 (the “Anthony Agreement”). The Anthony Agreement provided that Mr. Anthony would continue to serve as our Executive Vice President (“EVP”) and CFO. The Anthony Agreement had a term of two years, and provided for an annual base salary of $219,037and contained an auto renewal provision. Mr. Anthony also received the customary employee benefits available to our employees. Mr. Anthony is also received a bonus of $93,280 in 2013, the achievement of which was based on Company performance metrics. The foregoing summary of the 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.

Effective January 1, 2014, we entered into a new employment agreement with Mr. Anthony, (the “2014 Anthony Agreement”). The 2014 Anthony Agreement provides that Mr. Anthony will continue to serve as our Executive Vice President (“EVP”) and CFO. The 2014 Anthony Agreement has a term of two years, and provides for an annual base salary of $225,000. The 2014 Anthony 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 $108,000 per year, the achievement of which is based on Company performance metrics. Further, the 2014 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. These warrants will vest contingent upon the achievement of certain financial performance metrics of the Company in calendar years 2014, 2015 and 2016. We may terminate Mr. Anthony’s employment under the 2014 Anthony Agreement without cause at any time on thirty (30) 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 2014 Anthony Agreement is qualified in its entirety by to the full context of the employment agreement which is found as Exhibit 10.3 to this filing.

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10. 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 43% of our revenues for the three months ended March 31, 2014 and our three largest customers accounted for approximately 54% of our revenues for the three months ended March 31, 2013. Our largest customers had net accounts receivable totaling approximately $1,352,000 and $1,516,000 as of March 31, 2014 and December 31, 2013 respectively.

11. SEGMENT REPORTING

Based on our integration and management strategies, we operate in a single business segment. For the periods presented, all revenues were derived from domestic operations.

12. GOODWILL

We performed an impairment test of goodwill as of December 31, 2013, determining that its estimated fair value based on its market capitalization was greater than our carrying amount including goodwill. We did not perform step 2 since the fair value was greater than the carrying amount.

Although the Company has experienced a net loss for the three months ended March 31, 2014, the net cash provided by operating activities totaled $119,216. No other triggering events were noted during the three months ended March 31, 2014, therefore management did not feel it was necessary to perform an interim impairment test.

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

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

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

Readers should carefully review the risk factors described below under the heading “Risk Factors” and in other documents we file from time to time with the SEC, including our Form 10-K for the fiscal year ended December 31, 2013. Our filings with the SEC, including our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those filings, pursuant to Sections 13(a) and 15(d) of the Exchange Act, are available free of charge at www.auxilioinc.com, when such reports are available via the EDGAR system maintained by the SEC at www.sec.gov.

OVERVIEW

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

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

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

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, inventories, investments, intangible assets, income taxes, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. The results of these estimates form the basis for our judgments about the carrying values of assets and liabilities which are not readily apparent from other sources. As a result, actual results may differ from these estimates under different assumptions or conditions.

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

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● Revenue recognition and deferred revenue

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.

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

● Accounts receivable valuation and related reserves

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

● New customer implementation costs

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

● Impairment of intangible assets

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

● 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.

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● 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, 2013 filed on March 31, 2014 for a discussion of our critical accounting policies.

RESULTS OF OPERATIONS

For the Three Months Ended March 31, 2014 Compared to the Three Months Ended March 31, 2013

Revenue

Revenue increased by $152,422 to $10,244,574 for the three months ended March 31, 2014, as compared to the same period in 2013. Since the first quarter of 2013 we had a net increase of three recurring revenue contracts bringing us approximately $700,000 in additional revenue. Additionally we have a net expansion of service areas at several existing customers accounting for approximately $200,000 in additional service revenue. Equipment sales for the three months ended March 31, 2014 were approximately $400,000 as compared to approximately $1,200,000 for the same period in 2013. This reduction is due to the variance in equipment reaching the end of their initial lease term at our customers, thus not being ready for replacement.

Cost of Revenue

Cost of revenue consists of document imaging equipment, parts, supplies and salaries and expenses of field services personnel. Cost of revenue was $8,504,940 for the three months ended March 31, 2014, as compared to $8,515,938 for the same period in 2013. While cost of revenue for the first quarter of 2014 is comparable to the same period in 2013, service and supply costs were approximately $400,000 more in 2014 and labor costs were approximately $200,000 more in 2014 due to the increase in recurring service contracts in comparison to the prior year. Offsetting this, equipment costs, which includes equipment provided under the recurring service contracts and equipment sold, was approximately $600,000 lower in 2014 due to the lower amount of equipment revenues during that period.

We have implemented services at three new customers in the last four 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 $508,210 for the three months ended March 31, 2014, as compared to $682,187 for the same period in 2013. The variance is primarily a result of the termination of a channel partner agreement in 2013 which accelerated the vesting of equity instruments used in payment for marketing services.

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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 $209,395 to $1,201,874 for the three months ended March 31, 2014, as compared to $992,479 for the three months ended March 31, 2013. General and administrative expenses increased as a result of severance compensation paid to a terminated employee and additional travel incurred for the purpose of promoting customer relations and new business development opportunities.

Other Income (Expense)

Interest expense for the three months ended March 31, 2014 was $98,823, compared to $126,348 for the same period in 2013. The decrease is a result of lower average amount borrowed in 2014 on the line of credit when compared to 2013. Also borrowings on the convertible notes payable in 2014 as a portion of the debt was converted to stock. Lastly, our borrowings on capital leases were lower in 2014 when compared to 2013.

Income Tax Expense

Income tax expense for each of the three months ended March 31, 2014 and March 31, 2013, was $1,600 and $5,500 respectively, which represents the respective provisions for state income taxes.

LIQUIDITY AND CAPITAL RESOURCES

At March 31, 2014, our cash and cash equivalents were $4,752,319 and our working capital was $501,083. Our principal cash requirements are for operating expenses, including equipment, supplies, employee costs, and capital expenditures and funding of the operations. Our primary sources of cash are service and equipment sale revenues, the exercise of options and warrants and the sale of common stock.

During the three months ended March 31, 2014, our cash provided by operating activities amounted to $119,216, as compared to $1,047,689 provided by operating activities for the same period in 2013. The decrease in cash provided by operating activities in 2014 is primarily due to the costs incurred to implement new recurring revenue contracts. The cash provided by operating activities in 2013 was primarily a result of improved margins being generated from our recurring revenue contracts at our legacy customers.

We expect to close additional recurring revenue contracts to new customers throughout 2014 but at a slower rate than during 2012 and 2013. Because we expect higher cost of revenues at the start of our engagement with most new customers, we have maintained an accounts receivable line of credit with a commercial bank. Management believes that cash available from the line of credit along with funds from operations will be sufficient to sustain our business operations over the next twelve months.

OFF-BALANCE SHEET ARRANGEMENTS

Our off-balance sheet arrangements consist primarily of conventional operating leases, purchase commitments and other commitments arising in the normal course of business, as further discussed below under “Contractual Obligations and Contingent Liabilities and Commitments.” As of March 31, 2014, 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.

CONTRACTUAL OBLIGATIONS AND CONTINGENT LIABILITIES AND COMMITMENTS

As of March 31, 2014, 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
Convertible notes	$	1,676,378	$	1,676,378	$	-	$	-	$	-
Capital leases		108,245		72,119		36,126		-		-
Operating leases		352,996		234,086		118,910		-		-
Total	$	2,137,619	$	1,982,583	$	155,036	$	-	$	-

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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.

ITEM 4. CONTROLS AND PROCEDURES.

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) 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.

No change in our internal control over financial reporting occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART –II - OTHER INFORMATION

ITEM 1A. RISK FACTORS.

As of the date of this filing, there have been no material changes to the Risk Factors included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed with the SEC on March 31, 2014 (the “2013 Form 10-K”). The Risk Factors set forth in the 2013 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 2013 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.

ITEM 6. EXHIBITS.

No.	Item
10.1	Second Amendment to the Loan and Security Agreement between Avidbank Corporate Finance and Auxilio, Inc., April 25, 2014
10.2	Employment Agreement effective as of January 1, 2014, by and between Auxilio, Inc. and Joseph J. Flynn
10.3	Employment Agreement effective as of January 1, 2014, by and between Auxilio, Inc. and Paul T. Anthony
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**	Interactive Data File

* 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.

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SIGNATURES

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: May 14, 2014	By:	/s/ Joseph J. Flynn
		Joseph J. Flynn
		Chief Executive Officer
		(Principal Executive Officer)


Date: May 14, 2014		/s/ Paul T. Anthony
		Paul T. Anthony Chief Financial Officer
		(Principal Accounting Officer)