10-K 2016

10-K
1
aux_10k.htm
FORM 10-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.20549

FORM 10-K

 

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2016.

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____ to _____

Commission File Number: 000-27507

AUXILIO, INC.

(Exact name of registrant as specified in its charter)

Nevada

88-0350448

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer
Identification No.)

 

27271 Las Ramblas, Suite 200, Mission Viejo, California  92691

(Address of principal executive offices) (Zip Code)

(949) 614-0700

(Registrant’s telephone number, including area code)

Securities registered under Section 12(b) of the Act: None

Securities registered under Section 12(g) of the Act:

Common Stock, $.001 par value

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [  ] No [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [  ] No [X]

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [  ]

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.


 

Large accelerated filer  ¨Accelerated filer  ¨

Non-accelerated filer  ¨Smaller reporting company  ý

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes [  ]  No [X]

The aggregate market value of the registrant’s common stock, $0.001 par value per share (“Common Stock”), held by non-affiliates of the registrant on June 30, 2016, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $15.0 million (based on the average bid price of the Common Stock on that date). Shares of Common Stock held by each officer and director and each person known to the registrant to own 10% or more of the outstanding voting securities of the registrant were excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not a determination for other purposes. The registrant has one class of securities, its Common Stock.

As of March 27, 2017, the registrant had 9,379,477 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE.

Part III incorporates by reference certain information from the registrant’s definitive proxy statement (the “Proxy Statement”) for the 2017 Annual Meeting of Stockholders to be filed on or before April 17, 2017.


 

AUXILIO, INC.

ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2016

TABLE OF CONTENTS

Page

Cautionary Note Regarding Forward-Looking Statements

1

PART I

1

ITEM 1.

BUSINESS

1

ITEM 1A.

RISK FACTORS

6

ITEM 1B.

UNRESOLVED STAFF COMMENTS

12

ITEM 2.

PROPERTIES

12

ITEM 3.

LEGAL PROCEEDINGS

12

ITEM 4.

MINE SAFETY DISCLOSURES

12

PART II

13

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

13

ITEM 6.

SELECTED FINANCIAL DATA

14

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

14

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

20

ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

20

ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

20

ITEM 9A.

CONTROLS AND PROCEDURES

20

ITEM 9B.

OTHER INFORMATION

21

PART III

21

ITEM 10.

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

21

ITEM 11.

EXECUTIVE COMPENSATION

21

ITEM 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

22

ITEM 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE

22

ITEM 14.

PRINCIPAL ACCOUNTING FEES AND SERVICES

22

PART IV

23

ITEM 15.

EXHIBITS, FINANCIAL STATEMENT SCHEDULES

23

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Cautionary Note Regarding Forward-Looking Statements

From time to time, we and our representatives may provide information, whether orally or in writing, including certain statements in this Annual Report on Form 10-K (this “Annual Report”), which are deemed to be “forward-looking” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that concern matters that involve risks and uncertainties which could cause actual results to differ materially from those projected in the forward-looking statements. These forward-looking statements are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995 (the “Litigation Reform Act”) and are based on our beliefs as well as assumptions made by us using information currently available. All statements other than statements of historical fact contained in this Annual Report, including statements regarding future events, our future financial performance, our future business strategy and the plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,” “should” and similar expressions, as they relate to us, are intended to identify forward-looking statements. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended or using other similar expressions. In accordance with the provisions of the Litigation Reform Act, we are making investors aware that such forward-looking statements, because they relate to future events, are by their very nature subject to many important factors that could cause actual results to differ materially from those contemplated by the forward-looking statements contained in this Annual Report, any exhibits to this Annual Report and other public statements we make. Such factors are set forth in the “Business” section, the “Risk Factors” section, the “Legal Proceedings” section, the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section and other sections of this Annual Report, as well as in our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. We expressly disclaim any intent or obligation to update any forward-looking statements after the date hereof to conform such statements to actual results or to changes in our opinions or expectations, except as required by applicable law.

PART I

ITEM 1. BUSINESS.

Introduction

Auxilio, Inc. (including our subsidiaries, Auxilio Solutions, Inc. and Delphiis, Inc.) referred to collectively in this Annual Report, as “Auxilio,” the “Company,” “we,” “our” and “us”) is engaged in the business of providing fully outsourced document management solution services and cyber security professional services primarily to the healthcare industry, and also to financial institutions, gaming and other industries. Auxilio was incorporated in Nevada on August 29, 1995, under the name Corporate Development Centers, Inc. As a result of a series of transactions, we changed our name to “Auxilio, Inc.” in April 2004. Our principal executive offices are located at 27271 Las Ramblas, Suite 200, Mission Viejo, California 92691.

For more information on Auxilio and our products and services, please see the section entitled “Principal Products or Services” below or visit our website at www.auxilioinc.com. The inclusion of our Internet address in this Annual Report does not include or incorporate by reference into this Annual Report any information on our website. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, amendments to those reports and other filings with the Securities and Exchange Commission (the “SEC”) are generally available through the EDGAR system maintained by the SEC at www.sec.gov.

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Background

Auxilio, Inc., a Nevada corporation, was incorporated on August 29, 1995. On April 1, 2004, we acquired Alan Mayo and Associates, Inc. dba The Mayo Group (“TMG”), a managed print company. TMG provided outsourced print management services to healthcare facilities throughout California, which services we provide as the successor-in-interest to TMG. After we acquired TMG, we changed our name to “Auxilio, Inc.” and changed the name of TMG’s former subsidiary to “Auxilio Solutions, Inc.” Effective July 1, 2014, we acquired Delphiis, Inc., a California corporation, which provides IT security consulting services.  On April 7, 2015, we acquired certain assets of Redspin, Inc. which provides IT security consulting services. On January 13, 2017, we acquired CynergisTek, Inc., a Texas corporation, which provides IT security consulting services and solutions.  Our Common Stock currently trades on the NYSE MKT under the symbol “AUXO.”

Principal Products and Services

We are engaged in the business of providing fully-outsourced managed document services, workflow solutions and IT security consulting services primarily to the healthcare industry, and provide services to financial institutions, gaming and other industries when the request arises. Our business is operated throughout the United States.

Our document solutions group 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 IT security consulting group serves the most common security needs: technical risk and penetration testing, process and procedure development and risk management utilizing our proprietary 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 software application suite streamlines how covered entities perform annual and on-going risk assessments on their business associates, clinics, projects and hospitals.

 

Competition

We operate in a highly competitive market.  The majority of the competition in the healthcare industry market for document solution services comes from the large photocopy/multi-functional digital device manufacturers such as Xerox, Canon, Konica Minolta, Ricoh and Sharp.  The competitive landscape also contains a number of regional and local equipment dealers and distributors that exist in the communities in which the hospitals serve.  In addition, we compete with in-house departments performing the functions that we are seeking them to outsource to us.

Most of the competition in the healthcare industry market for IT security services comes from large or niche consulting and technology firms such as Accenture, KPMG, Dell Secureworks, and Coal Fire.

Nevertheless, our analysis of the competitive landscape shows a very strong opportunity for fully-outsourced document solution services and data security services to the healthcare industry, and we believe that we have a strong competitive position in the marketplace due to several important factors:

 We are primarily focused on the healthcare industry.  We are not aware of any other vendor/service provider which has a majority of its business dedicated to solving issues of HIPAA compliance, including printed and stored documents and improving efficiency for the healthcare industry. Our expertise and knowledge base is unmatched in the market.

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 By focusing solely on the hospital campus, we enjoy much lower turn-around times for service, greater up-sell opportunities and a much deeper service relationship with the customer.

 We have technology that is revolutionizing the way in which healthcare providers perform their annual HIPAA analysis, regulatory and on-going risk assessments, by making it fast, effective and affordable for both the assessor and responder.

 We believe that we are the only provider offering a unique approach to managed security services.  We can deploy a knowledgeable resource allocated 100% to perform a predefined security role on-site or virtually for a defined amount of time, which results in hospital gaining the staff with expertise they need.

 We have a unique approach to providing fully-outsourced managed document services program.  Our program is completely outsourced and hospitals need only pay a single invoice.  We operate the document management process as a department in the hospital with full-time staff on-site.  In contrast, other print vendors and dealers in the majority of instances do not provide full-time staff on-site, which results in delays in providing service and supplies to the hospitals.

 We are not restricted to any single equipment vendor, which allows us to bring the best printer and copier hardware and software solutions to our customers.  Our approach is to use the most appropriate technology to provide a superior solution without any prejudice as to equipment.

 We maintain a daily connection with the hospital, which allows us to provide a detailed strategy and plan on printer and copier equipment acquisitions saving the organization a great deal of time, effort and money in this process.

 

Customers

The majority of our customers are hospitals and their related off-site facilities. The loss of any key customer could have a material adverse effect upon our financial condition, business, prospects and results of operation. During the year ended December 31, 2016, our two largest customers represented approximately 49% of our revenues.

Intellectual Property

We maintain a database that contains our managed print services customers’ image and document outputs for certain periods of time, for each piece of machinery maintained at the customer’s location and trends for each of the foregoing. Our database allows us to anticipate our customers’ future needs and to meet those needs. In addition, we maintain a database that contains information related to our current security customers and their assigned responders who use our Delphiis™ IT Risk Manager application suite.

We have not applied for or been granted a patent with respect to any managed print service technology, or processes, as related to document and image management.

Employees

As of December 31, 2016, we had 282 full-time employees and one part-time employee, including 246 employees engaged in providing services, 13 employees engaged in sales and marketing, and 22 employees engaged in general and administrative activities. Our employees are not represented by any collective bargaining agreement, and we have never experienced a work stoppage. We believe our employee relations are good.

Recent Developments

Acquisition of CynergisTek, Inc.

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Stock Purchase Agreement – CynergisTek, Inc.

On January 13, 2017, Auxilio, Inc. entered into a Stock Purchase Agreement (the “SPA”) with CynergisTek, Inc., a Texas corporation (“CynergisTek”), Dr. Michael G. Mathews (“Mathews”) and Michael H. McMillan (“McMillan,” and together with Mathews, the “Stockholders”), pursuant to which Auxilio acquired 100% of the issued and outstanding shares of common stock (the “Shares”) of CynergisTek from the Stockholders (the “CynergisTek Transaction”). We reported additional details of the CynergisTek Transaction in a Current Report on Form 8-K filed on January 17, 2017 (the “January Current Report”).

Pursuant to the SPA, the purchase price paid for the Shares consisted of four components: the Cash Consideration, the Securities Consideration, the Debt Consideration, and the Earn-out Consideration.

 Cash Consideration.  We paid the Stockholders a cash payment of $15,000,000, less Closing Net Working Capital Deficit, Funded Indebtedness and Designated Transaction Expenses (defined as certain expenses of the Stockholders and certain expenses of CynergisTek). The net cash amount paid to the Stockholders was $14,202,644.76.

 Securities Consideration.  We issued a total of 1,166,666 shares of Auxilio common stock, par value $0.001 per share (the “Auxilio Stock”) to the Stockholders, with each of the Stockholders receiving 583,333 shares.

 Debt Consideration.  We issued promissory notes totaling $9,000,000 to the Stockholders (the “Seller Notes”), with each of the Seller Notes having an initial principal amount of $4,500,000.  The Seller Notes bear interest at 8% per annum, are quarterly interest-only payments due during the first 12 months, quarterly payments of principal and interest due during the last 24 months, using a 36-month amortization period commencing from that point, with a balloon payment due on the maturity date.  Additional details relating to the Debt Consideration is included in the January Current Report.

 Earn-out Consideration.   The Stockholders may be entitled to an additional $7,500,000 based upon the financial performance of CynergisTek after closing of the CynergisTek Transaction, to be calculated based upon EBITDA generated by the CynergisTek business during the earn-out period, which began as of January 1, 2017, and ends on December 31, 2021 (the “Earn-out Payments”).

Pursuant to the SPA, CynergisTek and the Stockholders agreed to deliver to Auxilio certificates representing the Shares; the corporate record books of CynergisTek; and the employment agreements (described below). Auxilio agreed to deliver the Cash Consideration, the Securities Consideration, the Debt Consideration and the signed employment agreements.

CynergisTek is a top-ranked cybersecurity and privacy consulting firm focused on healthcare, and offers an array of solutions that help organizations measure privacy and security programs against regulatory requirements and assists in developing a best practice approach to risk management. Since 2004, CynergisTek has served as a partner to hundreds of healthcare providers, payers and vendors with a consulting team comprised of subject matter experts that have a passion for helping clients achieve success. CynergisTek is also dedicated to supporting and educating the industry by contributing to relevant associations such as HIMSS, AHIMA, HFMA, HCCA, AHIA, AHLA, IAPP and CHIME.  As disclosed in the January Current Report, Auxilio management believes that the acquisition of CynergisTek will allow Auxilio to improve its ability to help clients and other healthcare industry participants to meet their IT security requirements.  Auxilio management believes that CynergisTek is a strong provider of high quality security and compliance services to the healthcare industry.

In connection with the SPA, the Company and the Stockholders also entered into a registration rights agreement (the “Registration Rights Agreement”) and employment agreements, each of which is discussed in more detail in the January Current Report.

Changes in Management; Appointment of Directors; Resignation of Officer; Appointment of New Officers

Employment Agreements

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In connection with the SPA, Auxilio and each of the Stockholders entered into an employment agreement, pursuant to which McMillan was appointed President and Chief Strategy Officer of Auxilio, and Mathews was appointed Executive Vice President of Auxilio.  Detailed information about the employment agreements and biographical information about Messrs. McMillan and Mathews were included in the January Current Report.

Appointment of New Directors; Resignation of Officer; Appointment of New Officers

In addition to their appointments as officers of Auxilio, in connection with the closing of the CynergisTek Transaction, on January 13, 2017, McMillan and Mathews were appointed to fill newly created seats on the Board of Directors of Auxilio.  As of the date of this Report, Auxilio had not determined what committees to which, if any, McMillan or Mathews may be named.

In connection with Mr. McMillan’s appointment, on January 13, 2017, Joseph J. Flynn resigned from his position as President of Auxilio. He remains its Chief Executive Officer.  Mr. Flynn’s resignation was in connection with the closing of the CynergisTek Transaction, and was not due to any dispute or disagreement with Auxilio.

Sales of Unregistered Equity Securities

Issuance of Auxilio Common Stock as Securities Consideration

As noted above, the Company issued the Auxilio Stock in connection with the CynergisTek Transaction. The Auxilio Stock was issued in reliance upon the exemption from securities registration afforded by the provisions of Section 4(a)(2) of the Securities Act, together with regulations promulgated thereunder by the U.S. Securities and Exchange Commission under the Securities Act, based upon the following: (a) there was no public offering or general solicitation with respect to the offering of such shares, (b) each Stockholder was provided with certain disclosure materials and all other information requested with respect to Auxilio, (c) each Stockholder acknowledged that the Auxilio Stock was being acquired for investment intent and constitute “restricted securities” for purposes of the Securities Act, and agreed to transfer such securities only in a transaction registered under the Securities Act or exempt from registration under the Securities Act, (d) each Stockholder represented and warranted that he is an “accredited investor” as defined in Rule 501(a) under the Securities Act, and (e) a legend has been, or will be, placed on the certificates representing each such security stating that it was restricted and could only be transferred if subsequently registered under the Securities Act or transferred in a transaction exempt from registration under the Securities Act.

Amended and Restated Credit Agreement and Related Agreements

As described in the January Current Report, also on January 13, 2017,  Auxilio, and its subsidiaries Auxilio Solutions, Inc., a California corporation (“Solutions”), Delphiis, Inc., a California corporation (“Delphiis”), and immediately upon the consummation of the CynergisTek Transaction, CynergisTek (with Auxilio, Solutions, Delphiis, CynergisTek and such other subsidiaries collectively referred to as “Borrowers”), entered into an Amended and Restated Credit Agreement (the “A&R Credit Agreement”) with ZB, N.A., dba California Bank and Trust (“CBT”), and Avidbank, a California banking corporation (“Avidbank,” and together with CBT, the “Lenders”), as well as Avidbank in its capacity as contractual representative for itself and the other lender (“Agent”).

In connection with the A&R Credit Agreement, Auxilio and the other Borrowers also entered into loan facilities including Term Loans and Revolving Line of Credit; a Security Agreement; and certain subordination agreements. Additional details relating to the A&R Credit Agreement and the related agreements are provided in the January Current Report.

Reverse Stock Split

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On January 12, 2017, the Company announced that it had received approval from the Financial Industry Regulatory Authority (“FINRA”) of the Company’s Company Related Action Notification Form (the “Notification Form”) relating to the implementation of a reverse split of its common stock, par value $0.001 per share (the “Reverse Stock Split”) at a ratio of one-for-three, that is, one new share for each three old shares of the Company’s common stock.

On December 22, 2016, the Company filed a Certificate of Amendment (the “Amendment”) to its Articles of Incorporation relating to the Reverse Stock Split.  The Amendment provides that no fractional shares of Common Stock will be issued to the holders of record of Common Stock prior to the Reverse Stock Split. Instead, all fractional shares will be rounded up to the next whole number of shares.

The Reverse Stock Split was approved at the 2015 Annual Meeting of the Company’s shareholders.  At that meeting, the Company’s shareholders voted to approve a reverse split at a ratio between 1-for-1.5 shares and 1-for-3 shares, to be determined by the Company’s Board of Directors.  The Board determined to implement the Reverse Stock Split at the ratio of 1-for-3 shares.

The Reverse Stock Split became effective with FINRA and in the marketplace at the open of business on Friday, January 13, 2017 (the “Effective Date”), whereupon the shares of common stock began trading on a reverse-split-adjusted basis.

All information related to common stock, stock options, warrants and share price for prior periods has been retroactively adjusted in this Annual Report to give effect to the Reverse Stock Split.

Listing on NYSE MKT

Since February 14, 2017, our Common Stock has been listed on the NYSE MKT under the symbol “AUXO.” Our common stock had previously traded on the OTCQB market.

 

ITEM 1A. RISK FACTORS

Before deciding to purchase, hold or sell our Common Stock, you should carefully consider the risks described below in addition to the other information contained in this Annual Report and in our other filings with the SEC, including subsequent reports on Forms 10-Q and 8-K. The risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business. If any of these known or unknown risks or uncertainties actually occurs with material adverse effects on Auxilio, our business, financial condition, results of operations and/or liquidity could be seriously harmed. In that event, the market price of our Common Stock will likely decline, and you may lose all or part of your investment.

Risks Related to Our Industry

We face substantial competition from better established companies that may offer similar products and services at a lower cost to our customers, resulting in a reduction in the sale of our products and services.

The market for our products and services is competitive and is likely to become even more competitive in the future. Increased competition could result in pricing pressures, reduced sales, reduced margins or the failure of our products and services to achieve or maintain market acceptance, any of which would have a material adverse effect on our business, results of operations and financial condition. Many of our current and potential competitors enjoy substantial competitive advantages, such as:

 greater name recognition and larger marketing budgets and resources;

 established marketing relationships and access to larger customer bases;

 substantially greater financial, technical and other resources; and

 larger technical and support staffs.

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As a result, our competitors may be able to respond more quickly than we can to new or changing opportunities, technologies, standards or customer requirements. For all of the foregoing reasons, we may not be able to compete successfully against our current and future competitors.

We are dependent upon our vendors to continue to supply us equipment, parts, supplies, and services at comparable terms and price levels as the business grows.

Our access to equipment, parts, supplies, and services depends upon our relationships with, and our ability to purchase these items on competitive terms from our principal vendors. We rarely enter into long-term supply contracts with these vendors and we have no current plans to change this in the future. These vendors are not required to use us to distribute their equipment and are free to change the prices and other terms at which they sell to us. In addition, we compete with the selling efforts of some of these vendors. Significant deterioration in relationships with, or in the financial condition of, these significant vendors could have an adverse impact on our ability to sell equipment as well as our ability to provide effective service and technical support. If one of these vendors terminates or significantly curtails its relationship with us, or if one of these vendors ceases operations, we would be forced to expand our relationships with our existing vendors or seek out new relationships with previously unused vendors.

Risks Related to Our Business

A substantial portion of our business is dependent on our largest customers.

The loss of any key customer could have a material adverse effect upon our financial condition, business, prospects and results of operation. Our two largest customers represented approximately 49% of our revenues for the year ended December 31, 2016. We anticipate that these customers will represent approximately 50% of revenue for 2017; therefore the loss of one or more of these customers may contribute to our inability to operate as a going concern and may require us to obtain equity funding or debt financing to continue our operations. We cannot be certain that we will be able to obtain such financing on commercially reasonable terms, or at all.

Healthcare legislation and regulation.  

The healthcare industry is highly regulated.  Legislation such as the Patient Protection and Affordable Care Act of 2010 (the “Affordable Care Act”) has changed and will likely continue to change how healthcare services are provided and managed.  In addition, legislation related to electronic medical records may impact our business.  In 2009, the American Recovery and Reinvestment Act of 2009 included incentives and penalties related to electronic medical records.  For example, Medicare/Medicaid reimbursements will be less for providers who failed to use electronic medical records by 2015.

The use of electronic medical records does not necessarily mean a hospital’s printing demands will decrease, but we cannot be sure whether this will be the case.  Increased adoption and use of electronic medical records may negatively impact our business.

New legislation or regulation.

As to prospective legislation and regulation, we cannot determine what effect additional state or federal governmental legislation, regulations, or administrative orders would have on our business in the future. New legislation or regulation may require the reformulation of our business to meet new standards, require us to cease operations, impose stricter qualification and/or registration standards, impose additional record keeping, or require expanded consumer protection measures.  Congressional leaders and the current administration have announced plans to repeal or modify the Affordable Care Act.  At this time the Company is not certain as to the impact of federal health care legislation on its business.

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We may be unable to recruit and maintain our senior management and other key personnel on whom we are dependent.

We are highly dependent upon senior management and key personnel, and we do not carry any life insurance policies on such persons. The loss of any of our senior management, or our inability to attract, retain and motivate the additional highly-skilled employees and consultants that our business requires, could substantially hurt our business, prospects, financial condition and results of operations. In addition, we rely on the ability of our management team to work together effectively. If our management team fails to work together effectively, our business could be harmed.

The market may not accept our products and services and we may not be able to continue our business operations; or if the market is receptive to our products but not our services, our revenues and profitability will be harmed.

Our products and services are targeted to the healthcare market, a market in which there are many competing service providers. Accordingly, the demand for our products and services is very uncertain. The market may not accept our products and services. Even if our products and services achieve market acceptance, our products and services may fail to adequately address the market’s requirements.

In addition, if we are able to sell our products but are unable to provide ongoing services, our revenues and profitability will be harmed. Our services are integral to the successful deployment of our solutions. If we do not effectively service and support our customers, our revenues and operating results would be harmed.

Our business depends on generating and maintaining ongoing, profitable customer demand for our services and solutions, including through the adaptation and expansion of our services and solutions in response to ongoing changes in technology and offerings, and a significant reduction in such demand or an inability to respond to the evolving technological environment could materially affect our results of operations.

Our revenue and profitability depend on the demand for our services and solutions with favorable margins, which could be negatively affected by numerous factors, many of which are beyond our control and unrelated to our work product. Volatile, negative or uncertain global economic conditions and lower growth in the markets we serve have adversely affected and could in the future adversely affect customer demand for our services and solutions. Our success depends, in part, on our ability to continue to develop and implement services and solutions that anticipate and respond to rapid and continuing changes in technology and offerings to serve the evolving needs of our customers. Technological developments may materially affect the cost and use of technology by our customers. Some technologies may replace some of our services and solutions in the future. This may cause customers to delay spending under existing contracts and engagements and to delay entering into new contracts while they evaluate new technologies. Such delays can negatively impact our results of operations if the pace and level of spending on new technologies is not sufficient to make up any shortfall.

Developments in the industries we serve, which may be rapid, also could shift demand to new services and solutions. If, as a result of new technologies or changes in the industries we serve, our customers demand new services and solutions, we may be less competitive in these new areas or need to make significant investment to meet that demand. Our growth strategy focuses on responding to these types of developments by driving innovation that will enable us to expand our business into new growth areas. If we do not sufficiently invest in new technology and adapt to industry developments, or evolve and expand our business at sufficient speed and scale, or if we do not make the right strategic investments to respond to these developments and successfully drive innovation, our services and solutions, our results of operations, and our ability to develop and maintain a competitive advantage and to execute on our growth strategy could be negatively affected.

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We operate in a rapidly evolving environment in which there currently are, and we expect will continue to be, new technology entrants. New services or technologies offered by competitors or new entrants may make our offerings less differentiated or less competitive when compared to other alternatives, which may adversely affect our results of operations. In addition, companies in the industries we serve sometimes seek to achieve economies of scale and other synergies by combining with or acquiring other companies. If one of our current customers merges or consolidates with a company that relies on another provider for the services and solutions we offer, we may lose work from that customer or lose the opportunity to gain additional work if we are not successful in generating new opportunities from the merger or consolidation.

Many of our contracts allow customers to terminate, delay, reduce or eliminate spending on the services and solutions we provide. Additionally, a customer could choose not to retain us for additional stages of a project, try to renegotiate the terms of its contract or cancel or delay additional planned work. When contracts are terminated or not renewed, we lose the anticipated revenues, and it may take significant time to replace the level of revenues lost. Consequently, our results of operations in subsequent periods could be materially lower than expected. The specific business or financial condition of a customer, changes in management and changes in a customer’s strategy are also all factors that can result in terminations, cancellations or delays.

Achieving the desired benefits of the acquisition of Delphiis, Inc., certain assets of Redspin, Inc. and CynergisTek, Inc. may be subject to a number of challenges and uncertainties which make it hard to predict the future success of each entity.

We acquired Delphiis, Inc., certain assets of Redspin, Inc. and CynergisTek, Inc. with expected benefits including, among other things, operating efficiencies, procurement savings, innovation, sharing of best practices and increased market share that may allow for future growth.  Achieving the anticipated benefits may be subject to a number of significant challenges and uncertainties, including, without limitation, whether unique corporate cultures will work collaboratively in an efficient and effective manner, the coordination of separate organizations, the possibility of imprecise assumptions underlying expectations regarding potential synergies and the integration process, unforeseen expenses and delays, and competitive factors in the marketplace.  We could also encounter unforeseen transaction and integration-related costs or other circumstances such as unforeseen liabilities or other issues.  Many of these potential circumstances are outside of our control and any of them could result in increased costs, decreased revenue, decreased synergies and the diversion of management time and attention.  If we are unable to achieve our objectives within the anticipated time frame, or at all, the expected benefits may not be realized fully or at all, or may take longer to realize than expected, which could have an adverse effect on our business, financial condition and results of operations.

 

We may need additional capital in the future and, if such capital is not available on terms acceptable to us or available to us at all, this may impact our ability to continue to grow our business operations.

We may need capital in the future to expand our business operations. If we need capital, we cannot be certain that it will be available on terms acceptable to us or available to us at all. In the event we are unable to raise capital, we may not be able to:

 develop or enhance our service offerings;

 take advantage of future opportunities; or

 respond to customers and competition.

We have a substantial amount of indebtedness, which may adversely affect our financial resources and our ability to operate our business.

9


We are party with ZB, N.A., dba California Bank and Trust and AvidBank (the “Lenders”), to, and jointly and severally liable with our subsidiaries for $14.0 million of outstanding debt under term loans issued under our Amended and Restated Credit Agreement, as amended (the “Credit Agreement”). The maturity date of the outstanding term loans is January 12, 2022.  We also have available a revolving line of credit from the Lenders of up to $5.0 million.  Further, we are indebted to the former shareholders of CynergisTek, Inc. in the aggregate amount of $9.0 million pursuant to promissory notes with maturity dates of January 13, 2020.  Our resulting substantial level of indebtedness and other financial obligations increase the possibility that we may be unable to pay, when due, the principal of, interest on, or other amounts due in respect of, our indebtedness.  Further, under the Credit Agreement, we are subject to certain restrictive covenants that, among other things, may limit our ability to obtain additional financing for working capital requirements, product development activities, debt service requirements, and general corporate or other purposes. These restrictive covenants include, without limitation, restrictions on our ability to: (1) change the nature of our business; (2) incur additional indebtedness; (3) incur liens; (4) make certain investments; (5) make certain dispositions of assets; (6) merge, dissolve, consolidate or sell all or substantially all of our assets; (7) enter into certain transactions with affiliates; and (8) transfer more than designated amounts to our subsidiaries during the term of the Credit Agreement.  If we breach any of these restrictive covenants or are unable to pay our indebtedness under the Credit Agreement when due, this could result in a default under the Credit Agreement. In such event, the Lenders may elect (after the expiration of any applicable notice or grace periods) to declare all outstanding borrowings, together with accrued and unpaid interest and other amounts payable under the Credit Agreement, to be immediately due and payable. Any such occurrence would have an immediate and materially adverse impact on our business and results of operations. The Credit Agreement is secured by a security interest in all assets of the Company and its current and future subsidiaries.

Risks Related to the Market for Our Securities

 

Because the public market for shares of our Common Stock is limited, stockholders may be unable to resell their shares of Common Stock.

Currently, there is only a limited public market for our Common Stock on the NYSE MKT and our stockholders may be unable to resell their shares of Common Stock. Currently, the average daily trading volume of our Common Stock is not significant, and it may be more difficult for you to sell your shares in the future, if at all.

The development of an active trading market depends upon the existence of willing buyers and sellers who are able to sell shares of our Common Stock as well as market makers willing to create a market in such shares. Under these circumstances, the market bid and ask prices for the shares may be significantly influenced by the decisions of the market makers to buy or sell the shares for their own account. Such decisions of the market makers may be critical for the establishment and maintenance of a liquid public market in our Common Stock. Market makers are not required to maintain a continuous two-sided market and are free to withdraw quotations at any time. We cannot assure our stockholders that an active public trading market for our Common Stock will develop or be sustained.

The price of our Common Stock may be volatile and could decline in value, resulting in loss to our stockholders.

The market for our Common Stock is volatile, having ranged since January 1, 2016 through December 31, 2016 from a low of $2.25 to a high of $3.51. The market price for our Common Stock has been, and is likely to continue to be, volatile. The following factors may cause significant fluctuations in the market price of shares of our Common Stock:

 fluctuations in our quarterly revenues and earnings or those of our competitors;

 variations in our operating results compared to levels expected by the investment community;

 announcements concerning us, our competitors or our customers;

 announcements of technological innovations;

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 sale or purchases of shares by traders or other investors;

 market conditions in the industry; and

 the conditions of the securities markets.

The factors discussed above may depress or cause volatility of our share price, regardless of our actual operating results. In addition, the highly volatile nature of our stock price may cause investment losses for our stockholders. In the past, securities class action litigation has often been brought against companies following periods of volatility in the market price of their securities. If securities class action litigation is brought against us, such litigation could result in substantial costs while diverting management’s attention and resources.

There are a large number of shares of Common Stock that may be issued or sold, and if such shares are issued or sold, the market price of our Common Stock may decline.

As of December 31, 2016, we had 8,185,936 shares of our Common Stock outstanding.

If all warrants, options and restricted stock grants outstanding as of December 31, 2016 are exercised prior to their expiration, up to approximately 1.8 million additional shares of Common Stock could become freely tradable. Such sales of substantial amounts of Common Stock in the public market could adversely affect the prevailing market price of our Common Stock and could also make it more difficult for us to raise funds through future offerings of Common Stock.

In addition, we issued 1,166,666 shares of common stock in connection with the January 2017 acquisition of CynergisTek, Inc.

 

We do not intend to pay dividends.

We have never declared or paid any cash dividends on our Common Stock. We do not anticipate paying dividends on our Common Stock in the foreseeable future. We may not have sufficient funds to legally pay dividends. Even if funds are legally available to pay dividends, we may nevertheless decide in our sole discretion not to pay dividends and to retain any future earnings to fund growth.

Other Risks

It may be difficult for a third party to acquire us even if doing so would be beneficial to our stockholders.

Some provisions of our Articles of Incorporation, as amended, and Bylaws, as amended, as well as some provisions of Nevada or California law, may discourage, delay or prevent third parties from acquiring us, even if doing so would be beneficial to our stockholders.

As a public company, we are subject to complex legal and accounting requirements that will require us to incur significant expenses.

As a public company, we are subject to numerous legal and accounting requirements that do not apply to private companies. The cost of compliance with many of these requirements is material, not only in absolute terms but, more importantly, in relation to the overall scope of the operations of a small company. The cost of such compliance may prove to be a substantial competitive disadvantage vis-à-vis our privately held and larger public competitors.

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The impact of any deterioration of the global credit markets, financial services industry and U.S. economy may negatively affect our business and our ability to obtain capital, if needed.

A deterioration in the global credit markets, the financial services industry and the U.S. economy could result in a period of substantial turmoil. The impact of these events on our business and the severity of an economic crisis is uncertain. It is possible that a crisis in the global credit markets, the financial services industry or the U.S. economy could adversely affect our business, vendors and prospects as well as our liquidity and financial condition. This could impact our ability to increase our customer base and generate positive cash flows. Although we have been able to raise additional working capital through convertible note agreements and private placement offerings of our Common Stock in the past, we may not be able to continue this practice in the future or we may not be able to obtain additional working capital through other debt or equity financings. In the event that sufficient capital cannot be obtained, we may be forced to minimize growth to a point that would be detrimental to our business development activities. These courses of action may be detrimental to our business prospects and result in material charges to our operations and financial position. In the event that any future financing should take the form of the sale of equity securities, the current equity holders may experience dilution of their investments.

The forward looking statements contained in this Annual Report may prove incorrect.

This Annual Report contains certain forward-looking statements. These forward-looking statements are based largely on our current expectations and are subject to a number of risks and uncertainties. Actual results could differ materially from these forward-looking statements. In addition to the other risks described elsewhere in this “Risk Factors” discussion, important factors to consider in evaluating such forward-looking statements include: (i) changes to external competitive market factors or in our internal budgeting process which might impact trends in our results of operations; (ii) anticipated working capital or other cash requirements; (iii) changes in our business strategy or an inability to execute our strategy due to unanticipated changes in our industry; and (iv) various competitive factors that may prevent us from competing successfully in the marketplace. In light of these risks and uncertainties, many of which are described in greater detail elsewhere in this “Risk Factors” discussion, there can be no assurance that the events predicted in forward-looking statements contained in this Annual Report will, in fact, transpire.  Any negative change in the factors listed above could adversely affect the financial condition and operating results of the Company and its products and services.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS.

None.

ITEM 2. PROPERTIES.

We lease approximately 17,000 square feet of office space at 27271 Las Ramblas, Suite 200, Mission Viejo, California  92691. This lease terminates in April of 2021. We also lease approximately 3,000 square feet of office space at 4690 Carpinteria Ave, Suite B, Carpinteria, CA 93013. This lease is currently on a month-to-month rental. We expect that the current leased premises will be satisfactory until the future growth of our business operations necessitates an increase in office space.

ITEM 3. LEGAL PROCEEDINGS.

We are not a party to any material legal proceedings, nor has any material proceeding been terminated during the fiscal year ended December 31, 2016.

ITEM 4.  MINE SAFETY DISCLOSURES.

 Not applicable.

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information

Since February 14, 2017, our Common Stock has been listed on the NYSE MKT under the symbol “AUXO.”  Prior to such date, our Common Stock was listed  on the OTCQB under the symbol “AUXO.”

On January 13, 2017, the Company effectuated a reverse stock split of its issued and outstanding shares of common stock at a ratio of 1 for 3 (the “Reverse Stock Split”). As a result of the Reverse Stock Split, the Company’s issued and outstanding stock decreased from 24,557,224 to 8,185,936 shares of common stock, all with a par value of $0.001. All information related to common stock, stock options, warrants and share price for prior periods has been retroactively adjusted in this Annual Report to give effect to the Reverse Stock Split.

 

The following table presents quarterly information on the high and low sales prices of our Common Stock fiscal years ended December 31, 2016 and 2015, furnished by the NYSE MKT.

High

Low

Fiscal Year Ended December 31, 2016

First Quarter

$ 3 .51

$ 2 .28

Second Quarter

$2 .88

$ 2 .28

Third Quarter

$2 .82

$2 .25

Fourth Quarter

$2 .64

$2 .28

Fiscal Year Ended December 31, 2015

First Quarter

$3 .75

$2 .88

Second Quarter

$3 .72

$3 .03

Third Quarter

$3 .45

$2 .85

Fourth Quarter

$3 .51

$2 .73

 

Holders

On March 27, 2017, we had approximately 105 stockholders of record.

Dividends

We have never paid cash dividends on our Common Stock and do not anticipate paying such dividends in the foreseeable future. The future payment of dividends, if any, will be determined by our Board of Directors (the “Board”) in light of conditions then existing, including our financial condition and requirements, future prospects, restrictions in financing agreements, business conditions and other factors deemed relevant by the Board.

Repurchases

During the fiscal year ended December 31, 2016, we did not repurchase any of our securities.

Securities Authorized for Issuance under Equity Compensation Plans

The following table provides certain information as of December 31, 2016 with respect to our existing equity compensation plans under which shares of our Common Stock are authorized for issuance.

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Plan

Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights

Weighted Average Exercise Price of Outstanding Options, Warrants and Rights

Number of Securities Remaining Available for Future Issuances Under Plans (excluding securities reflected in column (a))

(a)

(b)

(c)

Equity compensation plans approved by security holders (1)

1,454,242

$2.87

398,071

Equity compensation plans not approved by security holders (2)

326,249

$3.14

-

Total

1,780,491

398,071

 

 

(1) These plans consist of the 2001 Stock Option Plan, the 2003 Stock Option Plan, the 2004 Stock Option Plan, the 2007 Stock Option Plan and the 2011 Stock Incentive Plan.

(2) From time to time and at the discretion of the Board, we may issue warrants to our key individuals or officers as performance-based compensation. We have also issued warrants to debt holders in connection with a convertible debt agreement and to Cambria Capital, LLC in consideration for financing arrangements.

ITEM 6. SELECTED FINANCIAL DATA.

As a smaller reporting company, we are not required to include this information in our Annual Report on Form 10-K.

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

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

Overview

We are engaged in the business of providing fully-outsourced managed document services, workflow solutions and IT security consulting services primarily to the healthcare industry, and provide services to financial institutions, gaming and other industries when the request arises. Our business is operated throughout the United States.

Our document solutions group 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.

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Our IT security consulting group serves the most common security needs: technical risk and penetration testing, process and procedure development and risk management utilizing our proprietary 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 software application suite streamlines how covered entities perform annual and on-going risk assessments on their business associates, clinics, projects and hospitals.

 

Application of Critical Accounting Policies

The SEC defines critical accounting policies as those that are, in management’s view, most important to the portrayal of our financial condition and results of operations and most demanding of our judgment. The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which were prepared in accordance with accounting principles generally accepted in the U.S., which is referred to as “GAAP.” The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate these estimates, including those related to stock-based compensation, customer programs and incentives, bad debts, supply inventories, intangible assets, income taxes, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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

Revenue Recognition and Deferred Revenue

The Company derives its revenue from four sources: (1) document solution services revenue; (2) equipment revenue; (3) software subscription services revenue, which is 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) cyber security professional services such as penetration testing, cyber security risk assessments and security program strategy development.

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.

 Document Solution Services and Equipment Revenue

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

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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 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.

The Company’s contracts with customers may include provisions that relate to guaranteed savings amounts and shared savings. Such provisions are considered by management during the Company’s initial proprietary client assessment and are charged and accrued when deemed by management to be probable. The Company’s historical settlement of such amounts has been within management’s estimates.

 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.

 Cyber Security Professional Services Revenue

The majority of the Company’s cyber security 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 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 income and cash flows during the implementation phase.

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Impairment Review of Goodwill and Intangible Assets

We periodically evaluate our intangible assets and goodwill relating to acquisitions for impairment. Goodwill is not amortized, but is evaluated annually at year end for any impairment in the carrying value. We review our intangible assets for impairment on an annual basis or whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Factors we consider important which could trigger an impairment review include, but are not limited to, the following: significant underperformance relative to expected historical or projected future operating results; significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and a significant negative industry or economic trend for a sustained period. Goodwill and intangible asset impairment assessments are generally determined based on fair value techniques, including determining the estimated future discounted and undiscounted cash flows over the remaining useful life of the asset. Those models require estimates of future revenue, profits, capital expenditures and working capital for each reporting unit. We estimate these amounts by evaluating historical trends, the current state of the Company’s industries and the economy, current budgets, and operating plans. Determining the fair value of reporting units and goodwill includes significant judgment by management and different judgments could yield different results. Any resulting impairment loss could have a material impact on our financial condition and results of operations.

Stock-Based Compensation

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

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial reporting requirements and those imposed under federal and state tax laws.  Deferred taxes are provided for timing differences in the recognition of revenue and expenses for income tax and financial reporting purposes and are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  Deferred income tax expense represents the change during the period in the deferred tax assets and liabilities.  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 the deferred tax assets will not be realized. Use of our net operating loss deferred assets may be limited by changes in our ownership.

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

Results of Operations

Year Ended December 31, 2016 Compared to the Year Ended December 31, 2015

Net Revenue

Revenues consist of document solution services revenue, equipment revenue, revenue software subscription services and cyber security professional services. Net revenue decreased by $1,053,470 to $60,200,383 for the year ended December 31, 2016, as compared to the same period in 2015.  This decrease comes from a net reduction of approximately $5,100,000 from existing customers, where there was a reduction in unit price and sales volume, and non-renewing contracts offset by the expansion of services at certain clients. Equipment sales for 2016 were approximately $4,200,000 less in 2016, totaling $3,600,000 as compared to approximately $7,800,000 in 2015. Equipment sales in 2016 were primarily from copier fleet refresh activities at two customers compared to five in 2015. These fleet refreshes are typically done every five years at any one customer facility and vary widely in total revenue value. Partially offsetting these decreases, we added approximately $8,300,000 as a result of the addition of new service revenue contracts in 2016. We anticipate overall revenue growth as a result of the expansion of our customer base.

Cost of Revenues

Cost of revenues consists of document imaging equipment, parts, supplies and salaries expense for field services personnel. Cost of revenues was $47,888,296 for the year ended December 31, 2016, as compared to $50,664,713 for the same period in 2016. Equipment costs decreased by approximately $3,900,000 in 2016, primarily because of the decrease in equipment revenues from the copier fleet refresh activities. We incurred approximately $1,300,000 more in service and supply costs to accommodate our net increase in service clients, but we spent approximately $200,000 less in staffing costs, primarily as a result of our focus to offer less labor intensive solutions to our document solution services customers.

Gross margin increased to 20% of revenue in 2016 as compared to 17% in 2015. This increase is primarily a result of a maturing of our recurring revenue customer base in 2016. In addition to the costs associated with implementing our services, we absorb our new customers’ legacy contracts with third-party vendors.  As we implement our programs, we strive to improve upon these legacy contracts, thus reducing costs over the term of the contract resulting in improved margins with our mature accounts. We anticipate this trend to continue but anticipate an overall increase in cost of revenues as a result of the expansion of our customer base.

 

Sales and Marketing

Sales and marketing expenses include salaries, commissions and expenses of sales and marketing personnel, travel and entertainment, and other selling and marketing costs. Sales and marketing expenses were $2,723,735 for the year ended December 31, 2016, as compared to $2,809,377 for the same period in 2015. Staffing costs, including commissions, decreased approximately $100,000 in 2016 primarily because of lower commissions paid in 2016.

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General and Administrative

General and administrative expenses, which include personnel costs for finance, administration, information systems, and general management, as well as facilities expenses, professional fees, and other administrative costs, increased by $124,822 to $6,927,404 for the year ended December 31, 2016. Payroll and related costs decreased by approximately $400,000 in 2016, mostly because in 2015 we incurred executive severance costs for our security business of approximately $400,000. Rent increased approximately $200,000 in 2016 due to larger facilities we occupied beginning in December 2015. Depreciation and amortization increased approximately $100,000 in 2016 due to a full year of amortization charges for the identified intangibles associated with the recent Redspin acquisition. Professional fees increased by approximately $300,000 primarily due to due diligence efforts related to an acquisition completed in January 2017. Lastly our travel costs decreased by approximately $100,000 in 2016 due to an effort by management to reduce costs in this area.

Impairment of Goodwill and Intangible Assets

In 2016, we recognized an impairment charge of $2,633,701 related to the identified intangible assets and goodwill we acquired with Delphiis, Inc. and Redspin. There was no impairment charge in 2015.

 

Other Income (Expense)

We recognized a gain of $623,000 in 2015 as part of the Redspin asset acquisition. This amount represents contingent consideration initially recorded as part of the acquisition which was not paid to the seller due to certain earn-out goals that were not achieved.

Interest expense for the year ended December 31, 2016 was $91,885, compared to $127,576 for the same period in 2015. The reduction is primarily due to the lower borrowed balance on the term loan in 2016 as compared to 2015.

Income Tax Benefit (Expense)

The income tax benefit for the year ended December 31, 2016 was $5,074,439 as compared to a tax expense of $152,436 for the year ended December 31, 2015. In 2016, the benefit is primarily a result of the removal of a previously recorded valuation allowance against our deferred tax assets from NOL carryforwards. Management removed the valuation allowance given four consecutive years of earnings and its determination that it is more likely than not that such assets will be realized in future periods.

Liquidity and Capital Resources

At December 31, 2016, our cash and cash equivalents were $6,090,844 and our working capital was $5,830,060. By comparison, our working capital was $3,243,652 as of December 31, 2015. Our principal cash requirements were for operating expenses, including equipment, supplies, employee costs, and capital expenditures and funding of the operations. Our primary sources of cash were from service and equipment sale revenues.

During the year ended December 31, 2016, cash provided by operating activities was $417,626 as compared to cash provided by operating activities of $2,445,586 for the same period in 2015.  Our cash provided from operating activities in 2016 was lower than in 2015 primarily due to a slowing in trade receivable collections.

19


 

We expect to continue to establish recurring revenue contracts to new customers throughout 2017. We expect to have higher cost of revenues at the start of the engagements with most new customers. In June 2015, we borrowed $2,000,000 under a four year, $4,000,000 term loan agreement with a financial institution where we also have in place the availability of a $2,000,000 line of credit. In January 2017, in connection with the acquisition of CynergisTek, Inc., we repaid the balance on the existing term loan and borrowed $14,000,000 under a five year agreement.  Additionally, we replaced the $2,000,000 line of credit with a $5,000,000 line of credit. Any equity financing may result in dilution to existing stockholders and any debt financing may include restrictive covenants. Management believes that cash generated from debt and/or equity financing arrangements along with funds from operations will be sufficient to sustain our business operations over the next twelve months. Management believes that cash flows from operations together with cash reserves and our bank line of credit availability will allow us to operate without disruption.

Off-Balance Sheet Arrangements

Our off-balance sheet arrangements consist primarily of conventional operating leases and purchase and other commitments arising in the normal course of business, as further discussed below under the section “Contractual Obligations, Contingent Liabilities and Commitments.” As of December 31, 2016, 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, Contingent Liabilities and Commitments

As of December 31, 2016, expected future cash payments, including interest portion, related to contractual obligations, contingent liabilities, and commitments were as follows:

Payments Due by Period

Total

Within 1 year

Year 2-3

Year 4-5

More than 5 years

Term loan

$1,402,344

$577,813

$824,531

$-

$-

Capital leases

176,699

116,173

56,032

4,494

-

Operating leases

1,945,605

412,187

928,488

604,930

-

Total

$3,524,648

$1,106,173

$1,809,051

$609,424

$-

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The financial statements required by this item are included in Part IV, Item 15 of this Annual Report.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

ITEM 9A. 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.

20


 

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our “disclosure controls and procedures” as of the end of the period covered by this Annual Report, pursuant to Rules 13a-15(b) and 15d-15(b) under the Exchange Act. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures, as of the end of the period covered by this Annual Report, were effective.

Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act. Management conducted an assessment of the effectiveness, as of December 31, 2016, of our internal control over financial reporting, based on the framework established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on their assessment under the COSO framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2016.

This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our independent registered public accounting firm pursuant to final rules of the Securities and Exchange Commission that permit us to provide only management’s report in this Annual Report on Form 10-K.

Changes in Internal Control over Financial Reporting

There has been no change in our internal control over financial reporting during the most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B. OTHER INFORMATION.

On October 27, 2016, in anticipation of the Company’s application for listing on the NYSE MKT, our Board of Directors adopted a Code of Business Conduct and Ethics for our directors, officers and employees and also adopted certain charters of our board committees. Our Code of Business Conduct and Ethics is attached hereto as Exhibit 14.1 to this Annual Report.  Our Code of Business Conduct and Ethics and the charters of our board committees are available in the Corporate Governance section of our website.

On February 13, 2017, our Common Stock was eligible to be listed on the NYSE MKT and began trading on such exchange on February 14, 2017.

 

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

The information with respect to our executive officers and directors appearing in our Definitive Proxy Statement to be filed with the SEC in connection with the 2017 Annual Meeting of Stockholders (“Proxy Statement”) is hereby incorporated by reference.

ITEM 11. EXECUTIVE COMPENSATION.

The information with respect to compensation of our executive officers appearing in our Proxy Statement is hereby incorporated by reference.

21


 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

The information with respect to the security ownership of certain beneficial owners and management appearing in our Proxy Statement is hereby incorporated by reference.

 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE.

The information with respect to certain relationships and related transactions with management appearing in our Proxy Statement is hereby incorporated by reference.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.

The information with respect to the principal accounting fees and services appearing in the Proxy Statement is hereby incorporated by reference.

22


 

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

(a)

    (1) Financial Statements

The following consolidated financial statements and related notes thereto, and the report of our independent registered public accounting firm are filed as part of this Annual Report:

Page

Report of Independent Registered Public Accounting Firm

F-1

Consolidated Balance Sheets as of December 31, 2016 and 2015

F-2

Consolidated Statements of Income for the years ended December 31, 2016 and 2015

F-3

Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2016 and 2015

F-4

Consolidated Statements of Cash Flows for the years ended December 31, 2016 and 2015

F-5

Notes to Consolidated Financial Statements

F-7

 

    (2) Financial Statement Schedules

All other financial statement schedules were omitted because they are not applicable, not required or the information required is shown in the financial statements or the notes thereto.

    (3) Exhibits

The exhibits listed on the accompanying index to exhibits immediately following the financial statements are filed as part of, or hereby incorporated by reference into, this Annual Report.

23


 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders
Auxilio, Inc.

We have audited the accompanying consolidated balance sheets of Auxilio, Inc. (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Auxilio, Inc. as of December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America.

As described in Note 16, in January 2017, the Company acquired 100% of the outstanding common stock of CynergisTek, Inc. in exchange for cash of $14,202,645, promissory notes of $9,000,000, 1,166,666 shares of its common stock, and a potential earn-out payment of $7,500,000. Our opinion is not modified with respect to this matter.

 

/s/ HASKELL & WHITE LLP

Irvine, California

March 28, 2017

F-1


AUXILIO, INC. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

As of December 31,

2016

2015

ASSETS

Current assets:

 Cash and cash equivalents

$6,090,844 

$6,436,732 

 Accounts receivable, net

9,614,486 

7,397,957 

 Prepaid and other current assets

438,140 

625,806 

 Supplies

1,087,318 

1,458,609 

 Total current assets

17,230,788 

15,919,104 

Property and equipment, net

689,418 

495,324 

Deposits

41,522 

58,118 

Deferred income taxes

5,282,531 

Intangible assets, net

1,112,395 

2,731,250 

Goodwill

2,109,143 

3,665,656 

 Total assets

$26,465,797 

$22,869,452 

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:

 Accounts payable and accrued expenses

$7,736,207 

$8,306,860 

 Accrued compensation and benefits

2,495,156 

2,856,165 

 Deferred revenue

562,679 

913,677 

 Current portion of long-term liabilities

606,686 

598,750 

 Total current liabilities

11,400,728 

12,675,452 

Long-term liabilities:

 Term loan, less current portion

750,000 

1,250,000 

 Capital lease obligations, less current portion

199,644 

125,496 

 Total long-term liabilities

949,644 

1,375,496 

Commitments and contingencies (Notes 12-14 and 16)

Stockholders’ equity:

 Common stock, par value at $0.001, 33,333,333 shares authorized, 8,185,936 shares issued and outstanding at December 31, 2016 and 8,150,695 shares issued and outstanding at December 31, 2015

8,186 

8,151 

 Additional paid-in capital

27,985,448 

27,698,363 

 Accumulated deficit

(13,878,209)

(18,888,010)

 Total stockholders’ equity

14,115,425 

8,818,504 

 Total liabilities and stockholders’ equity

$26,465,797 

$22,869,452 

 

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

F-2


AUXILIO, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF INCOME

Year Ended December 31,

2016

2015

Net revenues

$60,200,383