UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

S	QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2013

 

£	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT

 

For the transition period from ____________ to ______________

 

Commission file number: 333-139117

 

EPAZZ, Inc.

(Exact name of registrant as specified in its charter)

 

Illinois	36-4313571
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

 

309 W. Washington St. Suite 1225

Chicago, IL 60606

(Address of principal executive offices)

 

(312) 955-8161

(Registrant's telephone number)

 

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 T   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 T   No £

 

Indicate by check mark whether the registrant is a large accelerated filer, and 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 £	Accelerated filer £
Non-accelerated filer £	Smaller reporting company T

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.

Yes £   No T

 

The number of shares of the issuer’s Class A common stock outstanding as of June 12, 2013, was 2,426,246,028 shares, par value $0.01 per share.

 

 

 

EPAZZ, INC.

 

FORM 10-Q

Quarterly Period Ended March 31, 2013

 

		Page
INDEX
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements	2
	Balance Sheets as of March 31, 2013 (Unaudited) and December 31, 2012	2
	Statements of Operations for the Three Months ended March 31, 2013 and 2012 (Unaudited)	3
	Statements of Cash Flows for the Three Months ended March 31, 2013 and 2012 (Unaudited)	4
	Notes to the Condensed Consolidated Financial Statements (Unaudited)	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	36
Item 4.	Controls and Procedures	36
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	37
Item 1A.	Risk Factors	37
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	37
Item 3.	Defaults Upon Senior Securities	38
Item 4.	Mine Safety Disclosures	38
Item 5.	Other Information	38
Item 6.	Exhibits	39
SIGNATURES		41

 

 

 

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

EPAZZ, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

		March 31,				December 31,
		2013				2012
Assets		(Unaudited)
Current assets:
Cash		$	14,022			$	46,101
Accounts receivable, net			38,465				36,995
Other current assets			42,309				22,027
Total current assets			94,796				105,123
Property and equipment, net			163,927				196,297
Intangible assets, net			777,488				821,150
Goodwill			255,460				255,460
Total assets		$	1,291,671			$	1,378,030
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Dividends payable		$	18,000			$	–
Accounts payable and accrued expenses			118,287				129,651
Accrued expenses, related parties			24,488				19,205
Deferred revenue			231,644				219,590
Lines of credit			76,003				77,047
Current maturities of capital lease obligations payable			28,928				25,699
Notes payable, related parties			20,868				22,085
Convertible debts, net of discounts of $51,092 and $101,192, respectively			83,788				74,708
Current maturities of long term debts			245,106				218,699
Total current liabilities			847,112				786,684
Capital lease obligations payable, net of current maturities			9,309				17,421
Convertible debts, net of discounts of $15,730 and $37,876, respectively			90,139				152,973
Long term debts, net of current maturities			930,901				892,463
Total liabilities			1,877,461				1,849,541
Stockholders' equity (deficit):
Convertible preferred stock, Series A, $0.0001 par value,  1,000 shares authorized, 1,000 shares issued and outstanding			–				–
Convertible preferred stock, Series B, $0.0001 par value,  1,000 shares authorized, 1,000 shares issued and outstanding			–				–
Common stock, Class A, $0.0001 par value, 6,000,000,000 shares authorized, 1,600,828,697 and 1,177,789,125 shares issued and outstanding, respectively			160,082				117,779
Convertible common stock, Class B, $0.0001 par value, 60,000,000 shares authorized, 5,500,000 and 2,500,000 shares issued and outstanding, respectively			550				550
Additional paid in capital			4,584,905				4,324,916
Stockholders' receivable, consisting of 20,000,000 shares			(800,000	)			(800,000	)
Accumulated deficit			(4,531,327	)			(4,114,756	)
Total stockholders' equity (deficit)			(585,790	)			(471,511	)
Total liabilities and stockholders' equity (deficit)		$	1,291,671			$	1,378,030

 

See accompanying notes to financial statements.

 

 

 

EPAZZ, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

		For the Three Months
		Ended March 31,
		2013				2012
Revenue		$	208,010			$	114,477
Expenses:
General and administrative			121,231				130,750
Salaries and wages			216,153				93,515
Depreciation and amortization			76,775				47,474
Bad debts (recoveries)			(8,785	)			7,775
Total operating expenses			405,374				279,514
Net operating loss			(197,364	)			(165,037	)
Other income (expense):
Other income			–				180
Loss on convertible debt modification, related party			(81,792	)			–
Interest income			–				5
Interest expense			(119,415	)			(41,075	)
Total other income (expense)			(201,207	)			(40,890	)
Net loss		$	(398,571	)		$	(205,927	)
Weighted average number of common shares outstanding - basic and fully diluted			1,283,603,738				31,112,972
Net loss per share - basic and fully diluted		$	(0.00	)		$	(0.01	)

 

See accompanying notes to financial statements.

 

 

 

EPAZZ, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

		For the Three Months
		Ended March 31,
		2013				2012
Cash flows from operating activities
Net loss		$	(398,571	)		$	(205,927	)
Adjustments to reconcile net loss to net cash used in operating activities:
Bad debts (recoveries)			(8,785	)			7,775
Depreciation and amortization			33,113				22,547
Amortization of intangible assets			43,662				24,462
Amortization of deferred financing costs			9,903				465
Amortization of discounts on convertible notes payable			72,246				14,978
Loss on convertible debt modification, related party			81,792				–
Stock based compensation issued for services, related parties			91,500				–
Decrease (increase) in assets:
Accounts receivable			7,315				94,198
Other current assets			(14,258	)			(2,295	)
Increase (decrease) in liabilities:
Accounts payable and accrued expenses			(8,364	)			21,153
Accrued expenses, related parties			5,283				–
Deferred revenues			12,054				(9,270	)
Net cash used in operating activities			(73,110	)			(31,914	)
Cash flows from investing activities
Proceeds from the sale of equipment			–				14,175
Purchase of equipment			(743	)			–
Acquisition of subsidiaries			–				(39,200	)
Net cash used in investing activities			(743	)			(25,025	)
Cash flows from financing activities
Payments on capital lease obligations payable			(4,883	)			(18,820	)
Proceeds from notes payable, related parties			41,600				16,580
Repayment of notes payable, related parties			(42,817	)			–
Proceeds from long term debts			108,432				110,603
Repayment of long term debts			(60,558	)			(43,224	)
Net cash provided by financing activities			41,774				65,139
Net increase (decrease) in cash			(32,079	)			8,200
Cash - beginning			46,101				12,668
Cash - ending		$	14,022			$	20,868
Supplemental disclosures:
Interest paid		$	32,991			$	23,934
Income taxes paid		$	–			$	–
Non-cash investing and financing activities:
Acquisition of subsidiary in exchange for debt		$	–			$	460,800
Acquisition of leased assets for debt		$	–			$	17,855
Value of shares issued for conversion of debt		$	83,000			$	10,000
Value of shares issued for conversion of debt, related parties		$	46,000			$	–
Dividends payable declared		$	18,000			$	–
Deferred financing costs		$	15,927			$	–

 

See accompanying notes to financial statements.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1 – Basis of Presentation and Consolidation

 

The interim condensed consolidated financial statements of Epazz, Inc. (“Epazz” or the “Company”), an Illinois corporation, included herein, presented in accordance with United States generally accepted accounting principles and stated in US dollars, have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to not make the information presented misleading.

 

These statements reflect all adjustments, which in the opinion of management, are necessary for fair presentation of the information contained therein. Except as otherwise disclosed, all such adjustments are of a normal recurring nature. It is suggested that these interim condensed financial statements be read in conjunction with the financial statements of the Company for the year ended December 31, 2012 and notes thereto included in the Company's 10-K annual report. The Company follows the same accounting policies in the preparation of interim reports.

 

Principles of Consolidation

The accompanying condensed consolidated financial statements include the accounts of the following entities, all of which are under common control and ownership:

 

		State of				Abbreviated
Name of Entity(2)		Incorporation		Relationship(1)		Reference
Epazz, Inc.		Illinois		Parent		Epazz
IntelliSys, Inc.		Wisconsin		Subsidiary		IntelliSys
Professional Resource Management, Inc.		Illinois		Subsidiary		PRMI
Desk Flex, Inc.		Illinois		Subsidiary		DFI
K9 Bytes, Inc.		Illinois		Subsidiary		K9 Bytes
MS Health, Inc.		Illinois		Subsidiary		MS Health
Cooling Technology Solutions, Inc.		Illinois		Subsidiary		CTS

 

⁽¹⁾All subsidiaries are wholly-owned subsidiaries of Epazz, Inc.

⁽²⁾All entities are in the form of Corporations.

 

The condensed consolidated financial statements herein contain the operations of the wholly-owned subsidiaries listed above. All significant inter-company transactions have been eliminated in the preparation of these financial statements. The parent company, Epazz and subsidiaries, IntelliSys, PRMI, DFI, K9 Bytes, MS Health and CTS will be collectively referred to herein as the “Company”, or “Epazz”. The Company's headquarters are located in Chicago, Illinois and substantially all of its customers are within the United States.

 

These statements reflect all adjustments, consisting of normal recurring adjustments, which in the opinion of management are necessary for fair presentation of the information contained therein.

 

Segment Reporting

FASB ASC 280-10-50 requires annual and interim reporting for an enterprise’s operating segments and related disclosures about its products, services, geographic areas and major customers. An operating segment is defined as a component of an enterprise that engages in business activities from which it may earn revenues and expenses, and about which separate financial information is regularly evaluated by the chief operating decision maker in deciding how to allocate resources. All of the Company’s software products are considered operating segments, and will be aggregated into one reportable segment given the similarities in economic characteristics among the operations represented by the common nature of the products, customers and methods of distribution.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Reclassifications

Certain amounts in the financial statements of the prior year have been reclassified to conform to the presentation of the current year for comparative purposes.

 

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Fair Value of Financial Instruments

Under FASB ASC 820-10-05, the Financial Accounting Standards Board establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. This Statement reaffirms that fair value is the relevant measurement attribute. The adoption of this standard did not have a material effect on the Company’s financial statements as reflected herein. The carrying amounts of cash, accounts payable and accrued expenses reported on the balance sheets are estimated by management to approximate fair value primarily due to the short term nature of the instruments. The Company had debt instruments that required fair value measurement on a recurring basis.

 

Intangible Assets

Intangible assets are amortized using the straight-line method over their estimated period of benefit of five to fifteen years. We evaluate the recoverability of intangible assets periodically and take into account events or circumstances that warrant revised estimates of useful lives or that indicate that impairment exists. All of our intangible assets are subject to amortization. No material impairments of intangible assets have been identified during any of the periods presented. Amortization expense on intangible assets totaled $43,662 and $24,462 for the three months ended March 31, 2013 and 2012, respectively.

 

Goodwill

The Company evaluates the carrying value of goodwill during the fourth quarter of each year and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Such circumstances could include, but are not limited to (1) a significant adverse change in legal factors or in business climate, (2) unanticipated competition, or (3) an adverse action or assessment by a regulator. When evaluating whether goodwill is impaired, the Company compares the fair value of the reporting unit to which the goodwill is assigned to the reporting unit's carrying amount, including goodwill. The fair value of the reporting unit is estimated using a combination of the income, or discounted cash flows, approach and the market approach, which utilizes comparable companies' data. If the carrying amount of a reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill to its carrying amount. In calculating the implied fair value of reporting unit goodwill, the fair value of the reporting unit is allocated to all of the other assets and liabilities of that unit based on their fair values. The excess of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized when the carrying amount of goodwill exceeds its implied fair value. The Company's evaluation of goodwill completed during the year resulted in no impairment losses.

 

Beneficial Conversion Features

From time to time, the Company may issue convertible notes that may contain an imbedded beneficial conversion feature. A beneficial conversion feature exists on the date a convertible note is issued when the fair value of the underlying common stock to which the note is convertible into is in excess of the remaining unallocated proceeds of the note after first considering the allocation of a portion of the note proceeds to the fair value of warrants, if related warrants have been granted. The intrinsic value of the beneficial conversion feature is recorded as a debt discount with a corresponding amount to additional paid in capital. The debt discount is amortized to interest expense over the life of the note using the effective interest method.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Basic and Diluted Net Earnings per Share

Basic net earnings (loss) per common share is computed by dividing net earnings (loss) applicable to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted net earnings (loss) per common share is determined using the weighted-average number of common shares outstanding during the period, adjusted for the dilutive effect of common stock equivalents, consisting of shares that might be issued upon exercise of common stock options. In periods where losses are reported, the weighted-average number of common shares outstanding excludes common stock equivalents, because their inclusion would be anti-dilutive. There were no outstanding potential common stock equivalents for the periods presented. As such, basic and diluted earnings per share resulted in the same figure for the three and three months ending March 31, 2013 and 2012.

 

Stock-Based Compensation

The Company adopted FASB guidance on stock based compensation on January 1, 2006. Under FASB ASC 718-10-30-2, all share-based payments to employees, including grants of employee stock options, are to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. Common stock issued for services and compensation was $91,500 and $-0- for the three months ended March 31, 2013 and 2012, respectively.

 

Revenue Recognition

The Company designs and sells various software programs to business enterprises, hospitals and Government and post-secondary institutions. Prior to shipment, each software product is tested extensively to meet Company specifications. The software is shipped fully functional via electronic delivery, but some installation and setup is required. No other entities sell the same or largely interchangeable software.

 

Installation is a standard process, outlined in the owner's manual, consisting principally of setup, calibrating, and testing the software. A purchaser of the software could complete the process using the information in the owner's manual, although it would probably take significantly longer than it would take the Company’s technicians to perform the tasks. Although other vendors do not install the Company’s software, they do provide largely interchangeable installation services for a fee. Historically, the Company has never sold the software without installation. Most installations are performed by the Company within 7 to 24 days of shipment and are included in the overall sales price of the software. In addition, the customer must pay for support contracts and training packages, depending on their desired level of service. The Company is the only manufacturer of the software and it only sells software on a standalone basis directly to the end user.

 

The sales price of the arrangement consists of the software, installation, and training and support services, which the customer is obligated to pay in full upon delivery of the software. In addition, there are no general rights of return involved in these arrangements. Therefore, the software is accounted for as a separate unit of accounting.

 

The Company does not have vendor-specific objective evidence of selling price for the software because it does not sell the software separately (without installation services and support contracts). In addition, third-party evidence of selling price does not exist as no vendor separately sells the same or largely interchangeable software. Therefore, the Company uses its best estimate of selling price when allocating such arrangement consideration.

 

In estimating its selling price for the software, the Company considers the cost to produce the software, profit margin for similar arrangements, customer demand, effect of competitors on the Company’s software, and other market constraints. When applying the relative selling price method, the Company uses its best estimate of selling price for the software, and third-party evidence of selling price for the installation. Accordingly, without considering whether any portion of the amount allocable to the software is contingent upon delivery of the other items, the Company allocates the selling price to the software, support, and installation.

 

The Company doesn’t currently provide product warranties, but if it does in the future it will provide for specific product lines and accrue for estimated future warranty costs in the period in which the revenue is recognized.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Recent Accounting Pronouncements

In February 2013, Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, to improve the transparency of reporting these reclassifications. Other comprehensive income includes gains and losses that are initially excluded from net income for an accounting period. Those gains and losses are later reclassified out of accumulated other comprehensive income into net income. The amendments in the ASU do not change the current requirements for reporting net income or other comprehensive income in financial statements. All of the information that this ASU requires already is required to be disclosed elsewhere in the financial statements under U.S. GAAP. The new amendments will require an organization to:

 

-

Present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income - but only if the item reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period; and

-

Cross-reference to other disclosures currently required under U.S. GAAP for other reclassification items (that are not required under U.S. GAAP) to be reclassified directly to net income in their entirety in the same reporting period. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is initially transferred to a balance sheet account (e.g., inventory for pension-related amounts) instead of directly to income or expense.

 

The amendments apply to all public and private companies that report items of other comprehensive income. Public companies are required to comply with these amendments for all reporting periods (interim and annual). The amendments are effective for reporting periods beginning after December 15, 2012, for public companies. Early adoption is permitted. The adoption of ASU No. 2013-02 did not have a material impact on our financial position or results of operations.

 

In January 2013, the FASB issued ASU No. 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, which clarifies which instruments and transactions are subject to the offsetting disclosure requirements originally established by ASU 2011-11. The new ASU addresses preparer concerns that the scope of the disclosure requirements under ASU 2011-11 was overly broad and imposed unintended costs that were not commensurate with estimated benefits to financial statement users. In choosing to narrow the scope of the offsetting disclosures, the Board determined that it could make them more operable and cost effective for preparers while still giving financial statement users sufficient information to analyze the most significant presentation differences between financial statements prepared in accordance with U.S. GAAP and those prepared under IFRSs. Like ASU 2011-11, the amendments in this update will be effective for fiscal periods beginning on, or after January 1, 2013. The adoption of ASU 2013-01 did not have a material impact on our financial position or results of operations.

 

 

Note 2 – Going Concern

 

As shown in the accompanying condensed consolidated financial statements, the Company has incurred recurring losses from operations resulting in an accumulated deficit of $(4,531,327), and as of March 31, 2013, the Company’s current liabilities exceeded its current assets by $752,316 and its total liabilities exceeded its total assets by $585,790. These factors raise substantial doubt about the Company’s ability to continue as a going concern.

 

The financial statements do not include any adjustments that might result from the outcome of any uncertainty as to the Company’s ability to continue as a going concern. These financial statements also do not include any adjustments relating to the recoverability and classification of recorded asset amounts, or amounts and classifications of liabilities that might be necessary should the Company be unable to continue as a going concern.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 3 – Subsidiary Formation

 

Subsidiary Formation – Cooling Technology Solutions, Inc., March 4, 2013

On March 4, 2013, the Board of Directors of Epazz, Inc. (the “Company”), consisting solely of Shaun Passley, the Company’s majority shareholder, approved the formation of a new wholly-owned subsidiary of the Company named Cooling Technology Solutions, Inc. The Company plans to file a non-provisional patent application for its Project Flex product in the name of Cooling Technology Solutions, Inc., however, as of the date of this filing there has been no activity and, as such, there are no revenues or expenses.

 

 

Note 4 – Asset Purchase Acquisitions

 

Asset Purchase Acquisition – MS Health, Inc., March 28, 2012

On March 28, 2012, we, through a newly-formed wholly-owned Illinois subsidiary, MS Health, Inc. (“MS Health”), closed on an Asset Purchase Agreement (“APA”) with MS Health Software Corporation, a New Jersey corporation (“MSHSC”). Pursuant to the APA, we purchased all of MSHSC’s assets, including all of its intellectual property, its business trademarks and copyrights, furniture, fixtures, equipment and software in consideration for an aggregate of $500,000, of which $39,200 was paid in cash at the closing, $360,800 was financed using a small business loan and $100,000 was paid by way of a Promissory Note (the “MSHSC Note”). The terms of the MSHSC Note include interest at 6% per annum, a ten (10) year amortization, a right of offset, no payments of either principal or interest for two (2) years and equal payments of principal and interest commencing in year 3, no prepayment penalty, and full payment of all amounts due after five (5) years. The MSHSC Note is secured by a security interest over the assets of MS Health. We did not purchase and MSHSC agreed to retain and be responsible for any and all liabilities of MSHSC. The acquisition was financed in part with a $360,800 Small Business Administration (“SBA”) loan, bearing interest at fixed and variable rates. The initial interest rate is 5.5% per year for three (3) years, consisting of the Prime Rate in effect on the first business day of the month in which the SBA loan application was received, plus 2.25%. The loan terms then transition to a variable interest rate over the remaining seven (7) years of the ten (10) year maturity term, calculated at 2.25% above the Prime Rate, as adjusted quarterly. The Company must pay principal and interest payments of $3,916 monthly. The SBA Loan is guaranteed by PRMI, K9 Bytes, Desk Flex, Inc., MS Health and the Company, and secured by the assets of MS Health and the Company.

 

MSHSC developed and sells CHMCi, an enterprise wide solution that includes tools to effectively provide, manage, bill, and track behavioral healthcare and social services. With CMHCi, an organization will realize the benefits of increased efficiency, accountability, and productivity. CMHCi offers server-based, internet, and secure cloud computing enabling the user to access information as required. By maintaining a complete electronic client record, including data collection and reporting across multiple programs, locations, episodes of care, and service providers, CMHCi helps eliminate redundant record keeping. The scheduler component tracks client, staff, and group appointments. Easy to use, it interfaces seamlessly with service authorization tracking, service history, and billing. The integrated financial reporting component provides the basis for an efficient and comprehensive accounting system, including electronic claims and remittance, third party insurance, and client, municipality, and grantor billing.

 

In connection with the Asset Purchase, the shareholders of MSHSC and the Company (through MS Health) entered into a Covenant Not to Compete; Consulting Agreement, Non-Competition and Consulting Agreement, pursuant to which the shareholders of MSHSC agreed to provide consulting services to the Company for a period of six months following closing. Pursuant to the agreement, the shareholders of MSHSC agreed not to compete against the Company for two years from the closing of the acquisition.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

This acquisition was accounted for as a business combination under the purchase method of accounting, given that substantially all of the Company’s assets and ongoing operations were acquired. The purchase resulted in $114,627 of goodwill. According to the purchase method of accounting, the Company recognized the identifiable assets acquired and liabilities assumed as follows:

 

		March 28,
		2012
Consideration:
Cash paid at closing		$	39,200
Small business loan(1)			360,800
Seller financed note payable(2)(3)			124,697
Fair value of total consideration exchanged		$	524,697
Fair value of identifiable assets acquired assumed:
Other current assets		$	7,367
Equipment			2,703
Contracts			258,000
Technology-based intangible assets			124,000
Non-compete agreement			18,000
Total fair value of assets assumed			410,070
Consideration paid in excess of fair value (Goodwill)(4)		$	114,627

 

(1)Consideration included partial proceeds obtained from a $360,800 Small Business Association (“SBA”) loan, bearing interest at fixed and variable rates. The initial interest rate is 5.5% per year for three (3) years, consisting of the Prime Rate in effect on the first business day of the month in which the SBA loan application was received, plus 2.25%. The loan terms then transition to a variable interest rate over the remaining seven (7) years of the ten (10) year maturity term, calculated at 2.25% above the Prime Rate, as adjusted quarterly. The Company must pay principal and interest payments of $3,916 monthly. The SBA Loan is guaranteed by PRMI, K9 Bytes, Desk Flex, Inc., MS Health and the Company, and secured by the assets of MS Health and the Company.

 

⁽²⁾Consideration included an unsecured $100,000 seller financed note payable (“MSHSC Note”), bearing interest at 6% per annum, a ten (10) year amortization, a right of offset, no payments of either principal or interest for two (2) years and equal payments of principal and interest commencing in year 3, no prepayment penalty, and full payment of all amounts due after five (5) years. The MSHSC Note is secured by a security interest over the assets of MS Health. We did not purchase and MSHSC agreed to retain and be responsible for any and all liabilities of MSHSC.

 

⁽³⁾The fair value of the seller financed note in excess of the $100,000 principal balance attributable to the deferred payment terms will be amortized to interest expense over the deferred financing period.

 

⁽⁴⁾The consideration paid in excess of the net fair value of assets acquired and liabilities assumed has been recognized as goodwill.

 

Management believes the product line of MS Health, customer base and other assets acquired will enable the Company to enhance their business model and strengthen its future cash flows to fund operations and take advantage of additional growth opportunities.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The unaudited supplemental pro forma results of operations of the combined entities had the dates of the acquisitions been January 1, 2013 or January 1, 2012 are as follows:

 

		Combined Pro Forma:
		For the three months ended
		March 31,
		2013				2012
Revenue:		$	208,010			$	177,314
Expenses:
Operating expenses			405,374				347,686
Net operating income (loss)			(197,364	)			(170,372	)
Other income (expense)			(201,207	)			(41,071	)
Net income (loss)		$	(398,571	)		$	(211,443	)
Weighted average number of common shares outstanding – basic and fully diluted			1,283,603,738				31,112,972
Net income (loss) per share – basic and fully diluted		$	(0.00	)		$	(0.01	)

 

 

Note 5 – Fair Value of Financial Instruments

 

Under FASB ASC 820-10-5, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). The standard outlines a valuation framework and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. Under GAAP, certain assets and liabilities must be measured at fair value, and FASB ASC 820-10-50 details the disclosures that are required for items measured at fair value.

 

The Company does not have any financial instruments that must be measured under the new fair value standard. The Company’s financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. The three levels are as follows:

 

Level 1 - Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

 

Level 2 - Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates, yield curves, etc.), and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).

 

Level 3 - Unobservable inputs that reflect our assumptions about the assumptions that market participants would use in pricing the asset or liability.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following schedule summarizes the valuation of financial instruments at fair value on a non-recurring basis in the balance sheets as of March 31, 2013 and December 31, 2012:

 

Fair Value Measurements at March 31, 2013

Level 1

Level 2

Level 3

Assets

Intangible assets

$

–

$

–

$

777,488

Goodwill

–

–

255,460

Total assets

–

–

1,032,948

Liabilities

Lines of credit

–

76,003

–

Capital leases

–

38,237

–

Long term debts

–

1,111,162

–

Notes payable, related parties

–

20,868

–

Convertible debts, net of discount of $66,822

–

173,927

–

Total Liabilities

–

1,485,042

–

$

–

$

(1,485,042

)

$

1,032,948

 

Fair Value Measurements at December 31, 2012

Level 1

Level 2

Level 3

Assets

Intangible assets

$

–

$

–

$

821,150

Goodwill

–

–

255,460

Total assets

–

–

1,076,610

Liabilities

Lines of credit

–

77,047

–

Capital leases

–

43,120

–

Long term debts

–

1,111,162

–

Notes payable, related parties

–

22,085

–

Convertible debts, net of discount of $139,068

–

227,681

–

Total Liabilities

–

1,481,095

–

$

–

$

(1,481,095

)

$

1,076,610

 

There were no transfers of financial assets or liabilities between Level 1 and Level 2 inputs for the three months ended March 31, 2013 and the year ended December 31, 2012.

 

Level 2 liabilities consist of various debt arrangements, and Level 3 assets consist of intangible assets and goodwill. No fair value adjustment was necessary during the three months ended March 31, 2013 and the year ended December 31, 2012.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 6 – Property and Equipment

 

Property and Equipment consists of the following at March 31, 2013 and December 31, 2012, respectively:

 

		March 31,				December 31,
		2013				2012
Furniture and fixtures		$	2,187			$	2,187
Computers and equipment			319,018				318,275
Software			67,986				67,986
Assets held under capital leases			134,800				134,800
			523,991				523,248
Less accumulated depreciation and amortization			(360,064	)			(326,951	)
		$	163,927			$	196,297

 

Depreciation expense totaled $33,113 and $22,547 for the three months ended March 31, 2013 and 2012, respectively.

 

 

Note 7 – Intangible Assets

 

Intangible assets consisted of the following at March 31, 2013 and December 31, 2012, respectively:

 

		Useful		March 31,				December 31,
Description		Life		2013				2012
Technology-based intangible assets - PRMI		15 Years		$	480,720			$	480,720
Technology-based intangible assets - IntelliSys		5 Years			200,000				200,000
Technology-based intangible assets - K9 Bytes		5 Years			42,000				42,000
Technology-based intangible assets – MS Health		5 Years			124,000				124,000
Contracts – MS Health		6 Years			258,000				258,000
Trade name - K9 Bytes		5 Years			22,000				22,000
Other intangible assets – MS Health		2 Years			18,000				18,000
Other intangible assets - K9 Bytes		2 Years			26,000				26,000
Total intangible assets					1,170,720				1,170,720
Less: accumulated amortization					(393,232	)			(349,570	)
Intangible assets, net				$	777,488			$	821,150

 

Amortization expense on intangible assets totaled $43,662 and $24,462 for the three months ended March 31, 2013 and 2012, respectively.

 

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 8 – Lines of Credit

 

Lines of credit consisted of the following at March 31, 2013 and December 31, 2012, respectively:

 

		March 31,				December 31,
		2013				2012
Line of credit of $50,000 from PNC bank, originating on February 16, 2012. The outstanding balance on the line of credit bears interest at an introductory rate of 4.25% for the first year, subject to renewal thereafter. Payments of $739 are due monthly.		$	49,939			$	49,606
Line of credit of $20,000 from US Bank, originating on June 8, 2012. The outstanding balance on the line of credit bears interest at 9.75%, maturing on June 5, 2019. Payments of $500 are due monthly.			19,658				19,641
Line of credit of $40,000 from Dell Business Credit available for the purchase of Dell products, such as computer and software equipment. The outstanding balance on the line of credit bears interest at a rate of 26.99%. Variable payments are due monthly.			6,406				7,800
Total line of credit			76,003				77,047
Less: current portion			(76,003	)			(77,047	)
Line of credit, less current portion		$	–			$	–

 

 

Note 9 – Capital Lease Obligations Payable

 

The Company leases certain equipment under agreements that are classified as capital leases as follows:

 

Lease #1 - Commenced on March 12, 2010 with monthly lease payments of $2,455 and two months paid in advance, and the remaining payments paid over the next 43 months.

 

Lease #2 – Commenced on March 16, 2010 with monthly lease payments of $2,258 over the following 36 months.

 

Lease #3 – Commenced on January 12, 2012 with monthly lease payments of $480 over the next 48 months, and a bargain purchase price of $1 at the end of the lease.

 

The cost of equipment under capital leases is included in the Balance Sheets as property and equipment and was $134,800 and $134,800 at March 31, 2013 and December 31, 2012, respectively. Accumulated amortization of the leased equipment at March 31, 2013 and December 31, 2012 was $116,292 and $108,090, respectively. Amortization of assets under capital leases is included in depreciation and amortization expense.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The future minimum lease payments required under the capital leases and the present value of the net minimum lease payments as of March 31, 2013, are as follows:

 

Twelve Months
Ending
March 31,		Amount
2014		$	35,783
2015			5,757
2016			4,750
Total minimum payments		$	54,715
Less: amount representing interest			(8,053	)
Present value of net minimum lease payments			38,237
Less: Current maturities of capital lease obligations			(28,928	)
Long-term capital lease obligations		$	9,309

 

 

Note 10 – Notes Payable, Related Parties

 

Notes payable, related parties consist of the following at March 31, 2013 and December 31, 2012, respectively:

 

		March 31,				December 31,
		2013				2012
Originated October 9, 2012, unsecured promissory note payable owed to an immediate family member of the Company’s CEO carries a 15% interest rate, matures on July 15, 2013. In addition, a loan origination fee, consisting of 1,088,957 shares of Series A Common Stock with a fair market value of $6,630 was issued as consideration for the loan on October 9, 2012.		$	13,000			$	13,000
Originated October 9, 2012, unsecured promissory note payable owed to a Company owned by an immediate family member of the Company’s CEO carries a 15% interest rate, matures on July 15, 2013. In addition, a loan origination fee, consisting of 144,928 shares of Series A Common Stock with a fair market value of $884 was issued as consideration for the loan on October 9, 2012.			2,000				2,000
Unsecured promissory note payable owed to a Company owned by an immediate family member of the Company’s CEO carries a 15% interest rate, matured on July 31, 2007. Currently in default.			5,868				7,085
Total notes payable, related parties			20,868				22,085
Less: current portion			(20,868	)			(22,085	)
Notes payable, related parties, less current portion		$	–			$	–

 

The Company recorded interest expense on notes payable to related parties in the amounts of $791 and $13,449 during the three months ended March 31, 2013 and 2012, respectively.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 11 – Convertible Debts

 

Convertible debts consist of the following at March 31, 2013 and December 31, 2012, respectively:

 

		March 31,				December 31,
		2013				2012
Unsecured $440,849 convertible promissory note due to a related party, carries a 10% interest rate (“Star Convertible Note”), matures on July 2, 2017. The principal and unpaid interest is convertible into shares of common stock at the discretion of the note holder at a price equal to 75% of the average closing price of the Company’s common stock over the five (5) consecutive trading days immediately preceding the date of conversion, or the fixed price of $0.005 per share, whichever is greater. The note carries a fourteen percent (14%) interest rate in the event of default, and the debt holder is limited to owning 9.99% of the Company’s issued and outstanding shares. This note was subsequently amended on March 5, 2013 to change the conversion price to, "equal to the greater of, (a) 50% of the Market Price, or (b) the fixed conversion price of $0.00075 per share". The modification resulted in a loss on debt modification of $81,792. The note holder converted $250,000 of outstanding principal into 50,000,000 shares pursuant to debt conversion on September 15, 2012, $46,000 into 50,000,000 shares pursuant to debt conversion on March 14, 2013 and subsequently $40,000 into another 50,000,000 shares pursuant to debt conversion on April 10, 2013.		$	144,849			$	190,849
Unsecured $56,900 convertible promissory note, including an Original Issue Discount (“OID”) of $4,400 and legal fees of $2,500, carries an 8% interest rate (“First Tonaquint Note”), matures on May 31, 2013. The principal is convertible into shares of common stock at the discretion of the note holder at a price equal to sixty percent (60%) of the average of the two lowest trading bid prices of the Company’s common stock for the ten (10) trading days prior to the conversion date, or $0.00009 per share, whichever is greater. The note carries a twenty two percent (22%) interest rate in the event of default, and the debt holder is limited to owning 4.99% of the Company’s issued and outstanding shares. The note holder converted $5,000 of outstanding principal into 4,504,505 shares pursuant to debt conversion on March 12, 2013.			51,900				56,900
Unsecured $16,500 convertible promissory note carries an 8% interest rate (“Sixth Asher Note”), matures on September 14, 2013. The principal is convertible into shares of common stock at the discretion of the note holder at a price equal to forty-one percent (41%) of the average of the three lowest trading bid prices of the Company’s common stock for the ninety (90) trading days prior to the conversion date, or $0.00005 per share, whichever is greater. The note carries a twenty two percent (22%) interest rate in the event of default, and the debt holder is limited to owning 4.99% of the Company’s issued and outstanding shares. The promissory note, consisting of $16,500 of principal and $1,827 of accrued interest, was subsequently repaid in full on April 15, 2013.			16,500				16,500
Unsecured $27,500 convertible promissory note carries an 8% interest rate (“Fifth Asher Note”), matures on July 18, 2013. The principal is convertible into shares of common stock at the discretion of the note holder at a price equal to forty-one percent (41%) of the average of the three lowest trading bid prices of the Company’s common stock for the ninety (90) trading days prior to the conversion date, or $0.00005 per share, whichever is greater. The note carries a twenty two percent (22%) interest rate in the event of default, and the debt holder is limited to owning 4.99% of the Company’s issued and outstanding shares. The promissory note, consisting of $27,500 of principal and $3,389 of accrued interest, was subsequently repaid in full on April 15, 2013.			27,500				27,500

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Unsecured $32,500 convertible promissory note carries an 8% interest rate (“Fourth Asher Note”), matured on April 26, 2013. The principal is convertible into shares of common stock at the discretion of the note holder at a price equal to fifty-nine percent (59%) of the average of the five lowest trading bid prices of the Company’s common stock for the ten (10) trading days prior to the conversion date, or $0.00009 per share, whichever is greater. The note carries a twenty two percent (22%) interest rate in the event of default, and the debt holder is limited to owning 4.99% of the Company’s issued and outstanding shares. The note holder subsequently converted a total of $32,500 of principal and $1,300 of interest into a total of 24,461,538 shares in settlement of the outstanding debt on March 4, 2013 and March 6, 2013.			–				32,500
Unsecured $42,500 convertible promissory note carries an 8% interest rate (“Third Asher Note”), matured on March 29, 2013. The principal is convertible into shares of common stock at the discretion of the note holder at a price equal to fifty-nine percent (59%) of the average of the three lowest trading bid prices of the Company’s common stock for the ten (10) trading days prior to the conversion date, or $0.00009 per share, whichever is greater. The note carries a twenty two percent (22%) interest rate in the event of default, and the debt holder is limited to owning 4.99% of the Company’s issued and outstanding shares. The note holder subsequently converted a total of $42,500 of principal and $1,700 of interest into a total of 23,573,529 shares of common stock in settlement of the outstanding debt between January 3, 2013 and February 26, 2013.			–				42,500
Total convertible debts			240,749				366,749
Less: unamortized discount on beneficial conversion feature			(66,822	)			(139,068	)
Convertible debts			173,927				227,681
Less: current maturities of convertible debts			(83,788	)			(74,708	)
Long term convertible debts		$	90,139			$	152,973

 

The Company recognized interest expense in the amount of $6,484 and $1,542 for the three months ended March 31, 2013 and 2012, respectively, related to convertible debts.

 

In addition, the Company recognized and measured the embedded beneficial conversion feature present in the convertible debts by allocating a portion of the proceeds equal to the intrinsic value of the feature to additional paid-in-capital. The intrinsic value of the feature was calculated on the commitment date using the effective conversion price of the convertible debt. This intrinsic value is limited to the portion of the proceeds allocated to the convertible debt.

 

The aforementioned accounting treatment resulted in a total debt discount equal to $-0- and $277,323 during the three months ended March 31, 2013 and the year ended December 31, 2012, respectively. The discount is amortized on a straight line basis from the dates of issuance until the stated redemption date of the debts, as noted above.

 

The convertible notes, consisting of total original face values of $440,849 from Star Financial, $206,500 from Asher Enterprises and $56,900 from Tonaquint Inc., that created the beneficial conversion feature carry default provisions that place a “maximum share amount” on the note holders that can be owned as a result of the conversions to common stock by the note holders is 9.99% and 4.99%, respectively, of the issued and outstanding shares of Epazz.

 

During the three months ended March 31, 2013 and 2012, the Company recorded debt amortization expense in the amount of $72,246 and $-0-, respectively, attributed to the aforementioned debt discount, including $1,506 of amortization on the $4,400 OID during the three months ended March 31, 2013.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

During the three months ended March 31, 2013, the Company issued a total of 102,539,572 shares pursuant to debt conversions in settlement of $126,000 of outstanding principal and $3,000 of unpaid interest, including 50,000,000 shares pursuant to debt conversion in settlement of $46,000 of outstanding principal owed to a related party (“Star Convertible Note”). The principal and interest was converted in accordance with the conversion terms, therefore no gain or loss has been recognized.

 

During the year ended December 31, 2012, the Company issued a total of 71,292,329 shares pursuant to debt conversions in settlement of $374,228 of outstanding principal and $3,500 of unpaid interest, including 50,000,000 shares pursuant to debt conversion in settlement of $250,000 of outstanding principal owed to a related party (“Star Convertible Note”). The principal and interest was converted in accordance with the conversion terms, therefore no gain or loss has been recognized.

 

On May 27, 2011, we entered into a Securities Purchase Agreement with Asher Enterprises, Inc., pursuant to which we sold to Asher an 8% Convertible Promissory Note in the original principal amount of $50,000. The First Asher Note had a maturity date of February 28, 2012, and is convertible into our common stock at the greater of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price. The “Variable Conversion Price” shall mean 59% multiplied by the Market Price (representing a discount rate of 41%). “Market Price” means the average of the lowest five (5) Trading Prices for the Common Stock during the ten (10) Trading Day period ending on the latest complete Trading Day prior to the Conversion Date. “Fixed Conversion Price” shall mean $0.00009 per share. The shares of common stock issuable upon conversion of the First Asher Note will be restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the First Asher Note was exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser was an accredited and sophisticated investor, familiar with our operations, and there was no solicitation.

 

The Company evaluated the First Asher Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.02603 below the market price on May 27, 2011 of $0.056 provided a value of $43,421 of which $-0- and $7,769 was amortized during the three months ended March 31, 2013 and 2012, respectively.

 

On June 28, 2011, we entered into a Securities Purchase Agreement with Asher Enterprises, Inc., pursuant to which we sold to Asher an 8% Convertible Promissory Note in the original principal amount of $37,500. The Second Asher Note had a maturity date of March 30, 2012, and is convertible into our common stock at the greater of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price. The “Variable Conversion Price” shall mean 59% multiplied by the Market Price (representing a discount rate of 41%). “Market Price” means the average of the lowest five (5) Trading Prices for the Common Stock during the ten (10) Trading Day period ending on the latest complete Trading Day prior to the Conversion Date. “Fixed Conversion Price” shall mean $0.00009 per share. The shares of common stock issuable upon conversion of the Second Asher Note will be restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the Second Asher Note was exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser was an accredited and sophisticated investor, familiar with our operations, and there was no solicitation.

 

The Company evaluated the Second Asher Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.01298 below the market price on June 28, 2011 of $0.035 provided a value of $22,108 of which $-0- and $7,209 was amortized during the three months ended March 31, 2013 and 2012, respectively.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

On July 2, 2012, we modified a previously outstanding non-convertible debt of $342,321, consisting of $296,103 of principal and $46,218 of accrued interest in exchange for a Convertible Promissory Note with Star Financial Corporation (“Star”), a company owned by our CEO’s family member, pursuant to which we issued to Star a 10% Convertible Promissory Note in the original principal amount of $440,849. The modification resulted in a loss on debt modification of $98,528. The Star Convertible Note has a maturity date of July 2, 2017, and is convertible into our common stock at the greater of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price. The “Variable Conversion Price” shall mean 75% multiplied by the Market Price (representing a discount rate of 25%). “Market Price” means the average of the five (5) Closing Prices for the Common Stock during the five (5) Trading Day period ending on the latest complete Trading Day prior to the Conversion Date. “Fixed Conversion Price” shall mean $0.005 per share. The shares of common stock issuable upon conversion of the Star Convertible Note will be restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the Star Convertible Note was exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser was an accredited and sophisticated investor, familiar with our operations, and there was no solicitation.

 

The Company evaluated the Star Convertible Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.00141 below the market price on July 2, 2012 of $0.012 provided a value of $112,382 of which $13,377 and $-0- was amortized during the three months ended March 31, 2013 and 2012, respectively.

 

On July 2, 2012, we entered into a Securities Purchase Agreement with Asher Enterprises, Inc., pursuant to which we sold to Asher an 8% Convertible Promissory Note in the original principal amount of $42,500. The Third Asher Note has a maturity date of March 29, 2013, and is convertible into our common stock at the greater of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price. The “Variable Conversion Price” shall mean 59% multiplied by the Market Price (representing a discount rate of 41%). “Market Price” means the average of the lowest three (3) Trading Prices for the Common Stock during the ten (10) Trading Day period ending on the latest complete Trading Day prior to the Conversion Date. “Fixed Conversion Price” shall mean $0.00009 per share. The shares of common stock issuable upon conversion of the Third Asher Note will be restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the Third Asher Note was exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser was an accredited and sophisticated investor, familiar with our operations, and there was no solicitation.

 

The Company evaluated the Third Asher Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.00551 below the market price on July 2, 2012 of $0.012 provided a value of $36,082 of which $11,760 and $-0- was amortized during the three months ended March 31, 2013 and 2012, respectively.

 

On July 24, 2012, we entered into a Securities Purchase Agreement with Asher Enterprises, Inc., pursuant to which we sold to Asher an 8% Convertible Promissory Note in the original principal amount of $32,500. The Fourth Asher Note has a maturity date of April 26, 2013, and is convertible into our common stock at the greater of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price. The “Variable Conversion Price” shall mean 59% multiplied by the Market Price (representing a discount rate of 41%). “Market Price” means the average of the lowest five (5) Trading Prices for the Common Stock during the ten (10) Trading Day period ending on the latest complete Trading Day prior to the Conversion Date. “Fixed Conversion Price” shall mean $0.00009 per share. The shares of common stock issuable upon conversion of the Fourth Asher Note will be restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the Fourth Asher Note was exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser was an accredited and sophisticated investor, familiar with our operations, and there was no solicitation.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The Company evaluated the Fourth Asher Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.00583 below the market price on July 24, 2012 of $0.0126 provided a value of $27,959 of which $11,751 and $-0- was amortized during the three months ended March 31, 2013 and 2012, respectively.

 

On September 10, 2012, we entered into a Securities Purchase Agreement with Tonaquint, Inc., pursuant to which we sold to Tonaquint an 8% Convertible Promissory Note in the original principal amount of $56,900. The First Tonaquint Note has a maturity date of May 31, 2013, and is convertible into our common stock at the greater of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price. The “Variable Conversion Price” shall mean 60% multiplied by the Market Price (representing a discount rate of 40%). “Market Price” means the average of the lowest two (2) Trading Prices for the Common Stock during the ten (10) Trading Day period ending on the latest complete Trading Day prior to the Conversion Date. “Fixed Conversion Price” shall mean $0.00009 per share. The shares of common stock issuable upon conversion of the First Tonaquint Note will be restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the First Tonaquint Note was exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser was an accredited and sophisticated investor, familiar with our operations, and there was no solicitation.

 

The Company evaluated the First Tonaquint Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.0047 below the market price on September 10, 2012 of $0.0033 provided a value of $56,900 of which $19,472 and $-0- was amortized during the three months ended March 31, 2013 and 2012, respectively.

 

On October 16, 2012, we entered into a Securities Purchase Agreement with Asher Enterprises, Inc., pursuant to which we sold to Asher an 8% Convertible Promissory Note in the original principal amount of $27,500. The Fifth Asher Note has a maturity date of July 18, 2013, and is convertible into our common stock at the greater of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price. The “Variable Conversion Price” shall mean 41% multiplied by the Market Price (representing a discount rate of 59%). “Market Price” means the average of the lowest three (3) Trading Prices for the Common Stock during the ninety (90) Trading Day period ending on the latest complete Trading Day prior to the Conversion Date. “Fixed Conversion Price” shall mean $0.00005 per share. The shares of common stock issuable upon conversion of the Fifth Asher Note will be restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the Fifth Asher Note was exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser was an accredited and sophisticated investor, familiar with our operations, and there was no solicitation.

 

The Company evaluated the Fifth Asher Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.00603 below the market price on October 16, 2012 of $0.008 provided a value of $27,500 of which $9,000 and $-0- was amortized during the three months ended March 31, 2013 and 2012, respectively.

 

On December 12, 2012, we entered into a Securities Purchase Agreement with Asher Enterprises, Inc., pursuant to which we sold to Asher an 8% Convertible Promissory Note in the original principal amount of $16,500. The Sixth Asher Note has a maturity date of September 14, 2013, and is convertible into our common stock at the greater of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price. The “Variable Conversion Price” shall mean 41% multiplied by the Market Price (representing a discount rate of 59%). “Market Price” means the average of the lowest three (3) Trading Prices for the Common Stock during the ninety (90) Trading Day period ending on the latest complete Trading Day prior to the Conversion Date. “Fixed Conversion Price” shall mean $0.00005 per share. The shares of common stock issuable upon conversion of the Sixth Asher Note will be restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the Sixth Asher Note was exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser was an accredited and sophisticated investor, familiar with our operations, and there was no solicitation.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The Company evaluated the Sixth Asher Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.00518 below the market price on December 12, 2012 of $0.0064 provided a value of $16,500 of which $5,380 and $-0- was amortized during the three months ended March 31, 2013 and 2012, respectively.

 

 

Note 12 – Long Term Debts

 

Long term debts consist of the following at March 31, 2013 and December 31, 2012, respectively:

 

		March 31,				December 31,
		2013				2012
On February 22, 2013, the Company purchased licenses to develop data management software in the total amount of $102,500 from Igenti, Inc., of which $51,250 was financed pursuant to an equipment financing agreement with Baytree National Bank & Trust Company on March 7, 2013 bearing an effective interest rate of 11.48%, consisting of 36 monthly payments of $1,674. The loan is collateralized with the data management software. Igenti retained a total of $3,000 of financing fees and paid the remaining proceeds of $99,500 to the Company for future payment to Sveltoz Solutions for the development of the data management software. Given the nature and status of the software development, no equipment costs have been capitalized.		$	49,577			$	–
On February 22, 2013, the Company purchased licenses to develop data management software in the total amount of $102,500 from Igenti, Inc., of which $51,250 was financed with an equipment finance loan from Summit Funding Group, Inc. equipment with a three year loan term consisting of monthly loan payments of $1,828, with $2,078 paid at signing. The loan is collateralized with the data management software. Igenti retained a total of $3,000 of financing fees and paid the remaining proceeds of $99,500 to the Company for future payment to Sveltoz Solutions for the development of the data management software. Given the nature and status of the software development, no equipment costs have been capitalized.			51,250				–
On August 10, 2012, the Company purchased $13,870 of equipment with a three year equipment finance loan. The loan bears interest at an effective interest rate of 31.55%, along with monthly principal and interest payments of $585. The loan is collateralized with the purchased equipment. Matures on August 9, 2015.			12,734				13,448
On April 1, 2012, the Company purchased $129,747 of equipment with a three year equipment finance loan. The loan bears interest at an effective interest rate of 8.3%, along with monthly principal and interest payments of $4,078. The loan is collateralized with the purchased equipment. Matures on April 1, 2015.			104,772				104,129
Consideration for the MS Health acquisition included partial proceeds obtained from a $360,800 Small Business Association (“SBA”) loan, bearing interest at fixed and variable rates. The initial interest rate is 5.5% per year for three (3) years, consisting of the Prime Rate in effect on the first business day of the month in which the SBA loan application was received, plus 2.25%. The loan terms then transition to a variable interest rate over the remaining seven (7) years of the ten (10) year maturity term, calculated at 2.25% above the Prime Rate, as adjusted quarterly. The Company must pay principal and interest payments of $3,916 monthly. The SBA Loan is guaranteed by PRMI, K9 Bytes, Desk Flex, Inc., MS Health and the Company, and secured by the assets of MS Health and the Company.			335,329				343,060

 

 

 

 

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Consideration for the MS Health acquisition included an unsecured $100,000 seller financed note payable (“MSHSC Note”), bearing interest at 6% per annum, a ten (10) year amortization, a right of offset, no payments of either principal or interest for two (2) years and equal payments of principal and interest commencing in year three (3), no prepayment penalty, and full payment of all amounts due after five (5) years. Pursuant to an amendment to a consulting agreement with the seller on March 23, 2012, the Company agreed to begin to repay principal of $1,000 per month, and had repaid a total of $6,000 during the year ended December 31, 2012. The MSHSC Note is secured by a security interest over the assets of MS Health. We did not purchase and MSHSC agreed to retain and be responsible for any and all liabilities of MSHSC.			94,000				94,000
On Deck Capital Loan – DeskFlex, Inc.:   On November 7, 2011, DeskFlex entered into a four month $20,000 note payable agreement with On Deck Capital. Payments of $183 were originally due daily on the loan. Origination fees of $500 were added to the initial loan, agreed to pay additional fees of $387 per month in servicing fees during the term of the loan and to repay the loan via daily payments of $183. The total payments due on the loan equate to an annual interest rate of 18%.   On February 15, 2012, we amended this loan agreement to increase the loan balance to $35,400, consisting of additional proceeds of $19,200, a rolled over loan balance of $10,050, an origination fee of $750 and interest amount of $5,400 to be paid over the restarted four month term of the loan via daily payments of $274.   On July 23, 2012, we amended this loan agreement again to increase the remaining unpaid loan balance to $35,400 again, consisting of additional proceeds of $23,883, a rolled over loan balance of $5,367, an origination fee of $750 and interest amount of $5,400 to be paid over the restarted four month term of the loan via daily payments of $274.   On October 30, 2012, we amended this loan agreement again to increase the remaining unpaid loan balance to $41,300, consisting of additional proceeds of $18,085, a rolled over loan balance of $16,040, an origination fee of $875 and interest amount of $6,300 to be paid over the restarted four month term of the loan via daily payments of $320.   On February 8, 2013, we again amended this loan agreement again to increase the remaining unpaid loan balance to $41,300, consisting of additional proceeds of $17,541, a rolled over loan balance of $16,584, an origination fee of $875 and interest amount of $6,300 to be paid over the restarted four month term of the loan via daily payments of $320.   The proceeds of all refinancing loans were received with substantially the same terms as the original debt.			33,296				28,173
On Deck Capital Loan – Epazz, Inc.:   On January 3, 2012, Epazz entered into a nine month $55,800 note payable agreement with On Deck Capital. Payments of $289 were originally due daily on the loan. Proceeds of $43,875 were received on the loan, origination fees of $1,125 were added to the initial loan, along with interest of $10,800. The total payments due on the loan equate to an annual interest rate of 18%.   On May 25, 2012, we amended this loan agreement to increase the loan balance to $63,000, consisting of additional proceeds of $25,043, a rolled over loan balance of $24,957 and interest of $13,000 to be paid over the restarted nine month term of the loan via daily payments of $326.   On September 10, 2012, we again amended this loan agreement to increase the loan balance to $76,800, consisting of additional proceeds of $22,613, a rolled over loan balance of $35,887, an origination fee of $1,500 and interest of $16,800 to be paid over the revised twelve month term of the loan via daily payments of $299.   The proceeds of all refinancing loans were received with substantially the same terms as the original debt.			35,859				54,088

 

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

On March 20, 2012, DeskFlex entered into a $25,000 three year promissory note bearing interest at 11%. The promissory note is payable in monthly installments of $843 per month, maturing on March 20, 2015 (the “Maturity Date”).			17,449				19,483
Pursuant to an asset purchase agreement entered into on October 26, 2011, the Company granted K9 Bytes, Inc., a Florida corporation, a subordinated secured $30,750 promissory note carrying a 6% interest rate, payable in monthly installments of $333 per month starting in November 2011 and ending on October 26, 2014, at which time the then remaining balance of the promissory note ($23,017, assuming no additional payments other than those scheduled) is due. The promissory note is secured by a secondary lien on all of the assets of Epazz’s subsidiary, K9 Bytes, Inc., an Illinois corporation formed to house the purchased assets. The promissory note is also personally guaranteed by Shaun Passley, our Chief Executive Officer.			5,324				6,234
Unsecured $50,000 promissory note originated on September 15, 2010 between Intellisys and Paul Prahl, payable in monthly installments of $970 carries a 6% interest rate, maturing on September 18, 2015. The Company also agreed to provide Mr. Prahl earn-out rights, which provide that he will receive up to a maximum of $13,350 per year for the three calendar years following the Closing (with the first such calendar year beginning on January 1, 2011), based on the revenues generated by IntelliSys during such applicable year, whereas $6,675 is earned if revenues are between $350,000 and $380,000, $10,012 is earned if revenues are between $380,000 and $395,000, or $13,350 is earned if revenues are greater than $395,000 during each relevant year.			9,700				10,520
Unsecured term loan between Epazz and Bank of America, originating on June 15, 2011 bearing interest at 9.5% matures on June 17, 2016. Payments of $1,559 are due monthly.			65,332				68,436
Unsecured promissory note between Epazz and Newtek Finance for $185,000 originating on September 30, 2010 bearing interest at 6% matures on September 30, 2020. Payments of $2,054 are due monthly.			149,434				153,377
The Company raised funds paid pursuant to an asset purchase agreement with K9 Bytes, Inc., a Florida corporation, on October 26, 2011, through a $235,000 Small Business Association (“SBA”) loan from a third party lender (the “Third Party Lender” and the “SBA Loan”). The SBA Loan has a term of ten (10) years; maturing on October 26, 2021, bearing interest at the prime rate plus 2.75% per annum, adjusted quarterly; is payable in monthly installments (beginning in December 2011) of $2,609 per month; is guaranteed by the Company and personally guaranteed by Shaun Passley, the Company’s Chief Executive Officer; and is secured by all of the assets of K9 Bytes, Inc., the Illinois corporation and wholly-owned subsidiary formed to house the acquired assets and the Company, 100% of the outstanding capital of the K9 subsidiary, and a life insurance policy on Mr. Passley’s life in the amount of $235,000. A total of approximately $10,000 of the amount borrowed under the SBA Loan was used to pay closing fees in connection with the loan, $169,250 was used to pay K9 Bytes the cash amount due pursuant to the terms of the Purchase Contract and the remainder of such loan amount was made available for working capital for the Company and the wholly-owned subsidiary, K9 Bytes, Inc.			211,951				216,214
Total long term debt			1,176,007				1,111,162
Less: current portion			(245,106	)			(218,699	)
Long term debt, less current portion		$	930,901			$	892,463

 

The Company recorded interest expense on long term debts, credit lines and capital leases in the amount of $39,894 and $35,040 for the three months ended March 31, 2013 and 2012, respectively.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 13 – Changes in Stockholder’s Equity (Deficit)

 

On May 17, 2013, the Board of Directors, consisting solely of Shaun Passley, the Company’s majority shareholder, amended the Article of Incorporation to change the par value and number of authorized shares of each class of common and series of preferred stock, in addition to the modification of the attributes and dividends. The disclosures herein reflect these modifications and the changes to the par value have been retroactively reflected throughout.

 

Convertible Preferred Stock, Series A

The Company has 1,000 authorized shares of $0.0001 par value Series A Convertible Preferred Stock (“Series A Preferred Stock”). The Series A Preferred Stock accrues dividends equal to 1.5% of the Company’s revenues per quarter, beginning on January 1^st of any calendar year in which the Company has generated revenue over $2 million, and an additional 24% of the Company’s net income beginning on January 1^st of any calendar year in which the Company has generated net income over $2 million. The dividends are payable at the discretion of the Company, provided that any unpaid dividends accrue until paid. The Series A Preferred Stock includes a liquidation preference equal to $0.0001 per share, plus any accrued and unpaid dividends. The Series A Preferred Stock is convertible, at the option of the holder into shares of the Company’s Class A Common Stock, with five business days’ notice into 60% of the total number of then issued and outstanding shares of Class A Common Stock. The Series A Preferred Stock has limited voting rights, relating solely to matters which adversely affect the rights of the Series A Preferred Stock holders. The Company shall reserve and keep available out of its authorized but unissued shares of Class A Common Stock such number of shares sufficient to effect the conversions.

 

Convertible Preferred Stock, Series B

The Company has 1,000 authorized shares of $0.0001 par value Series B Convertible Preferred Stock (“Series B Preferred Stock”). The Series B Preferred Stock accrues dividends equal to 1.5% of the Company’s revenues per quarter, beginning on January 1^st of any calendar year in which the Company has generated revenue over $1 million, and an additional 6% of the Company’s net income beginning on January 1^st of any calendar year in which the Company has generated net income over $2 million. The dividends are payable at the discretion of the Company, provided that any unpaid dividends accrue until paid. The Series B Preferred Stock includes a liquidation preference equal to $0.0001 per share, plus any accrued and unpaid dividends. The Series B Preferred Stock is convertible, at the option of the holder into shares of the Company’s Class A Common Stock, with five business days’ notice into 10% of the total number of then issued and outstanding shares of Class A Common Stock, provided that no conversion will take place until all holders of the Series B Preferred Stock consent to such conversion. The Series B Preferred Stock has limited voting rights, relating solely to matters which adversely affect the rights of the Series B Preferred Stock holders. The Company shall reserve and keep available out of its authorized but unissued shares of Class A Common Stock such number of shares sufficient to effect the conversions.

 

Declaration of Dividends

On January 1, 2013, the Company declared and accrued estimated dividends of $18,000 on its Convertible Series B Preferred Stock pursuant to the recognition of revenues in excess of $1 million during the year ended December 31, 2012 based on 1.5% of the estimated 2013 annual revenues. Dividends equal to 1.5% of the Company’s revenues per quarter during the year ending December 31, 2013 will accrue quarterly and can be paid in cash or in shares of Class A Common Stock, the exact amounts of which are yet undetermined.

 

Common Stock, Class A

The Company has 6 billion authorized shares of $0.0001 par value Class A Common Stock.

 

Debt Conversions into Class A Common Stock

On January 3, 2013, the Company issued 4,000,000 shares of Class A Common Stock pursuant to the conversion of $12,000 of convertible debt, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

On February 19, 2013, the Company issued 8,823,529 shares of Class A Common Stock pursuant to the conversion of $15,000 of convertible debt, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

On February 26, 2013, the Company issued 10,750,000 shares of Class A Common Stock pursuant to the conversion of $17,200 of convertible debt, consisting of $15,500 of principal and $1,700 of accrued and unpaid interest. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

On March 4, 2013, the Company issued 10,000,000 shares of Class A Common Stock pursuant to the conversion of $15,000 of convertible debt, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

On March 6, 2013, the Company issued 14,461,538 shares of Class A Common Stock pursuant to the conversion of $18,800 of convertible debt, consisting of $17,500 of principal and $1,300 of accrued and unpaid interest. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

On March 12, 2013, the Company issued 4,504,505 shares of Class A Common Stock pursuant to the conversion of $5,000 of convertible debt, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

On March 14, 2013, the Company issued 50,000,000 shares of Class A Common Stock pursuant to the conversion of $46,000 of convertible debt owed to a related party, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

Loss on Convertible Debt Modification to Related Party

On March 5, 2013, we amended a convertible promissory note with Star Financial Corporation, which then carried a balance of $190,849, to revise the conversion terms from a $0.005 floor and 75% discount to market to conversion terms consisting of, "equal to the greater of, (a) 50% of the Market Price, or (b) the fixed conversion price of $0.00075 per share". The Company compared the fair value of the debt immediately preceding the modification to the fair value after the modification to determine the loss on modification of $81,792. This value was determined using the value of the shares assuming the note was converted pursuant to the respective conversion terms on the date of modification. The total value of the shares after modification was $272,641, compared to the $190,849 value preceding the modification, resulting in a loss on modification of $81,792.

 

Shares of Class A Common Stock Issued for Services to Related Parties

On March 5, 2013, the Company issued 12,500,000 shares of Class A Common Stock to Vivienne Passley, a related party, for providing a personal guaranty on an acquisition loan that originated on September 30, 2010. The total fair value of the common stock was $25,000 based on the closing price of the Company’s common stock on the date of grant.

 

On March 5, 2013, the Company issued 12,500,000 shares of Class A Common Stock to Vivienne Passley, a related party, for providing a personal guaranty on two acquisition loans that originated on October 26, 2011. The total fair value of the common stock was $25,000 based on the closing price of the Company’s common stock on the date of grant.

 

On March 5, 2013, the Company issued 200,000,000 shares of Class A Common Stock to the Company’s CEO in consideration for providing product development services. The shares will be vested once the Company reports revenue of $10 million in a calendar year. The total fair value of the common stock was $400,000 based on the closing price of the Company’s common stock on the date of grant, which is presented as a deduction against additional paid in capital in the equity section of the balance sheet until the terms of the vesting periods are satisfied.

 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

On March 20, 2013, the Company issued 35,500,000 shares of Class A Common Stock to Vivienne Passley, a related party, for providing collateral on acquisition loans that originated on September 30, 2010 and October 26, 2011. The total fair value of the common stock was $35,500 based on the closing price of the Company’s common stock on the date of grant.

 

On March 20, 2013, the Company issued 60,000,000 shares of Class A Common Stock to Craig Passley, a related party, for providing corporate secretary services from 2012 to 2021. The total fair value of the common stock was $60,000 based on the closing price of the Company’s common stock on the date of grant, which is presented as a deduction against additional paid in capital in the equity section of the balance sheet until the terms of the vesting periods are satisfied. A total of $6,000 was expensed related to the vested services for the year ended December 31, 2012.

 

Convertible Common Stock, Class B

The Company has 60,000,000 authorized shares of $0.0001 par value Convertible Class B Common Stock, convertible at the option of the holder into shares of the Company’s Class A Common Stock on a 1:1 basis. The Convertible Class B Common Stock carries preferential voting rights of 2,000 votes to each Class A Common Stock vote (2,000:1). The Company shall reserve and keep available out of its authorized but unissued shares of Class A Common Stock such number of shares sufficient to effect the conversions.

 

 

Note 14 - Subsequent Events

 

Debt Conversions into Class A Common Stock

On April 2, 2013, the Company issued 15,151,515 shares of Class A Common Stock pursuant to the conversion of $10,000 of convertible debt, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

On April 10, 2013, the Company issued 50,000,000 shares of Class A Common Stock pursuant to the conversion of $40,000 of convertible debt owed to a related party, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

On May 27, 2013, the Company modified a related party debt and issued 14,239,500 shares of Class A Common Stock in settlement of $14,239 of related party debt owed to Vivienne Passley, which consisted of $13,000 of principal and $1,239 of accrued and unpaid interest. The total fair value of the common stock was $28,479 based on the closing price of the Company’s common stock on the date of grant, resulting in the recognition of a $14,240 loss on debt settlement.

 

Shares of Class A Common Stock Issued for Services to Related Parties

On May 16, 2013, the Company issued 710,526,316 shares of Class A Common Stock to the Company’s CEO in consideration for providing product development services. The total fair value of the common stock was $1,350,000 based on the closing price of the Company’s common stock on the date of grant.

 

On May 24, 2013, the Company issued 35,500,000 shares of Class A Common Stock to Fay Passley, a related party, for providing collateral on acquisition loans that originated on September 30, 2010 and October 26, 2011. The total fair value of the common stock was $71,000 based on the closing price of the Company’s common stock on the date of grant.

 

Debt Financing

On April 5, 2013, the Company received a loan of $70,000 from Small Business Financial Solutions, LLC (“SBFS”), of which $34,664 was paid to OnDeck Financial in settlement of total outstanding loans owed by Epazz, Inc. and Desk Flex, Inc., and origination and processing fees of $1,650 were retained by SBFS, and the remaining $33,686 was used to pay off the Fourth Asher Note and the Fifth Asher Note. The promissory note calls for 240 daily payments of $394, resulting in total repayments of $94,500, secured by any and all amounts owing to Epazz now, or in the future, from any merchant processor(s) for charges made by customers via any payment card devices, and all other assets of the Company.

 

 

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS

 

ALL STATEMENTS IN THIS DISCUSSION THAT ARE NOT HISTORICAL ARE FORWARD-LOOKING STATEMENTS. STATEMENTS PRECEDED BY, FOLLOWED BY OR THAT OTHERWISE INCLUDE THE WORDS "BELIEVES", "EXPECTS", "ANTICIPATES", "INTENDS", "PROJECTS", "ESTIMATES", "PLANS", "MAY INCREASE", "MAY FLUCTUATE" AND SIMILAR EXPRESSIONS OR FUTURE OR CONDITIONAL VERBS SUCH AS "SHOULD", "WOULD", "MAY" AND "COULD" ARE GENERALLY FORWARD-LOOKING IN NATURE AND NOT HISTORICAL FACTS. THESE FORWARD-LOOKING STATEMENTS WERE BASED ON VARIOUS FACTORS AND WERE DERIVED UTILIZING NUMEROUS IMPORTANT ASSUMPTIONS AND OTHER IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS INCLUDE THE INFORMATION CONCERNING OUR FUTURE FINANCIAL PERFORMANCE, BUSINESS STRATEGY, PROJECTED PLANS AND OBJECTIVES. THESE FACTORS INCLUDE, AMONG OTHERS, THE FACTORS SET FORTH BELOW UNDER THE HEADING "RISK FACTORS." ALTHOUGH WE BELIEVE THAT THE EXPECTATIONS REFLECTED IN THE FORWARD-LOOKING STATEMENTS ARE REASONABLE, WE CANNOT GUARANTEE FUTURE RESULTS, LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS. MOST OF THESE FACTORS ARE DIFFICULT TO PREDICT ACCURATELY AND ARE GENERALLY BEYOND OUR CONTROL. WE ARE UNDER NO OBLIGATION TO PUBLICLY UPDATE ANY OF THE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS, EXCEPT AS PROVIDED BY LAW. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS. REFERENCES IN THIS FORM 10-Q, UNLESS ANOTHER DATE IS STATED, ARE TO MARCH 31, 2013. AS USED HEREIN, THE “COMPANY,” “EPAZZ,” “WE,” “US,” “OUR” AND WORDS OF SIMILAR MEANING REFER TO EPAZZ, INC., AND INCLUDE EPAZZ’S WHOLLY OWNED SUBSIDIARIES, DESK FLEX, INC., AN ILLINOIS CORPORATION (“DFI”), PROFESSIONAL RESOURCE MANAGEMENT, INC., AN ILLINOIS CORPORATION, INTELLISYS, INC., A WISCONSIN CORPORATION ("INTELLISYS"), K9 BYTES, INC., AN ILLINOIS CORPORATION (“K9 BYTES”), MS HEALTH, INC., AN ILLINOIS CORPORATION (“MS HEALTH”) AND COOLING TECHNOLOGY SOLUTIONS, INC., AN ILLINOIS CORPORATION (“CST”), UNLESS OTHERWISE STATED, OR THE CONTEXT SUGGESTS OTHERWISE.

 

BUSINESS OVERVIEW

 

The Company was incorporated in the State of Illinois on March 23, 2000 to create software to help college students organize their college information and resources. The idea behind the Company was that if the information and resources provided by colleges and universities was better organized and targeted toward each individual, the students would encounter a personal experience with the college or university that could lead to a lifetime relationship with the institution. This concept is already used by business software designed to retain relationships with clients, employees, vendors and partners.

 

The Company developed a web portal infrastructure operating system product called BoxesOS v3.0. BoxesOS provides a web portal infrastructure operating system designed to increase the satisfaction of key stakeholders (students, faculty, alumni, employees, and clients) by enhancing the organizational experience through the use of enterprise web-based applications to organize their relationships and improve the lines of communication. BoxesOS decreases an organization’s operating expenses by providing development tools to create advanced web applications. The applications can be created by non-technical staff members of each institution. BoxesOS creates sources of revenue for Alumni Associations and Non-Profit organizations through utilizing a web platform to conduct e-commerce and provides e-commerce tools for small businesses to easily create "my accounts" for their customers. It further reduces administrative costs, by combining technology applications into one package, providing an alternative solution to enterprise resource planner (“ERP”) modules and showing a return on investment for institutions by reducing the need for 3rd party applications license fees. BoxesOS can also link a college or university’s resources with the business community by allowing businesses to better train their employees by utilizing courseware development from higher education institutions.

 

On, or about June 18, 2008, the Company acquired Desk Flex, Inc., an Illinois corporation (“DFI”), and Professional Resource Management, Inc., an Illinois corporation (“PRMI”).

 

Professional Resource Management, Inc. and Desk Flex, Inc.

 

Professional Resource Management, Inc. was incorporated under the laws of Illinois in June 1985. On or around December 31, 1997, Professional Resource Management, Inc. established a wholly-owned subsidiary, PRM Transfer Corp. On, or around December 31, 1997, Professional Resource Management, Inc., PRM Transfer Corp. and Arthur Goes entered into a Reorganization Agreement, whereby Professional Resource Management, Inc. transferred all of its assets and liabilities to PRM Transfer Corp., with the exception of those assets pertaining to its proprietary source code or software product, Desk/Flex. Also pursuant to the Reorganization Agreement, Professional Resource Management, Inc. amended its corporate charter to change its name to Desk Flex, Inc. (“DFI”), and PRM Transfer Corp. amended its charter to change its name to Professional Resources Management, Inc. (“PRMI”). The transfer was executed in an effort by Mr. Goes to better promote the Desk/Flex product.

 

PRMI and DFI are separate legal entities, but operate in conjunction. PRMI and DFI share office space and certain employees. DFI’s main source of revenue comes from the “Desk/Flex Software” product, which it owns, and PRMI’s main source of revenue comes from the “Agent Power” product line, which it owns. PRMI also acts as the general agent for DFI; however, there is no formal agency agreement between the two companies.

 

Autohire Software

 

Effective February 1, 2010, the Company entered into a Software Product Asset Purchase Agreement (the “Software Rights Agreement”) with Igenti, Inc., a Florida corporation (“Igenti”) to acquire the rights to Igenti’s AutoHire software, domain names, permits, customers, contracts, know-how, equipment, software programs, receivables and the intellectual property of Igenti associated therewith (the “AutoHire Software”). The AutoHire system provides a tool to power career centers, post job ads to sites and job boards, and to collect resumes online. The online processes supported by the system provide the mechanism to comply with the record keeping requirements of Title VII of the Civil Rights Act of 1964, which apply to organizations employing 15 or more persons.

 

IntelliSys, Inc.

 

On or about September 2, 2010, the Company entered into a Stock Purchase Agreement (the “IntelliSys Purchase Agreement”) with IntelliSys, Inc., a Wisconsin corporation (“IntelliSys”) and Paul Prahl, an individual and the sole stockholder of IntelliSys. Pursuant to the IntelliSys Purchase Agreement, the Company purchased 100% of the outstanding shares of IntelliSys. The IntelliSys Purchase Agreement closed on March 31, 2011 (“Closing”). As a result of the Closing, IntelliSys became a wholly-owned subsidiary of the Company. IntelliSys developed the IPMC Software (“IPMC”)(Integrated Plant Management Control) which is a software system design for water and wastewater facility management. IPMC is the technology-based strategy for optimizing operations by automatically collecting, managing, organizing and disseminating information for the operations, management, laboratory, maintenance, and engineering functions.

 

K9 Bytes, Inc.

 

On October 26, 2011, we, through a newly-formed wholly-owned Illinois subsidiary, K9 Bytes, Inc. (“K9 Sub”), entered into an Asset Purchase Contract and Receipt Agreement with K9 Bytes, Inc., a Florida corporation (“K9 Bytes” and the “Purchase Contract”). Pursuant to the Purchase Contract, we purchased all of K9 Bytes assets, including all of its intellectual property, its business trade name, website (k9bytessoftware.com), furniture, fixtures, equipment and inventory, accounts receivable and goodwill.

 

MS Health, Inc.

 

On March 8, 2012, we, through a newly-formed wholly-owned Illinois subsidiary, MS Health, Inc. (“MS Health”), entered into an Asset Purchase Agreement with MS Health Software Corporation, a New Jersey corporation (“MSHSC”). Pursuant to the Purchase Agreement, we purchased all of MSHSC’s assets, including all of its intellectual property, its business trademarks and copyrights, furniture, fixtures, equipment and software.

 

MSHSC developed and sells CHMCi, an enterprise wide solution that includes tools to effectively provide, manage, bill, and track behavioral healthcare and social services. With CMHCi, an organization will realize the benefits of increased efficiency, accountability, and productivity. CMHCi offers server-based, internet, and secure cloud computing enabling the user to access information as required. By maintaining a complete electronic client record, including data collection and reporting across multiple programs, locations, episodes of care, and service providers, CMHCi helps eliminate redundant record keeping. The scheduler component tracks client, staff, and group appointments. Easy to use, it interfaces seamlessly with service authorization tracking, service history, and billing. The integrated financial reporting component provides the basis for an efficient and comprehensive accounting system, including electronic claims and remittance, third party insurance, and client, municipality, and grantor billing.

 

In connection with the Asset Purchase, the shareholders of MSHSC and the Company (through MS Health) entered into a Covenant Not to Compete; Consulting Agreement, Non-Competition and Consulting Agreement, pursuant to which the shareholders of MSHSC agreed to provide consulting services to the Company for a period of six months following closing. Pursuant to the agreement, the shareholders of MSHSC agreed not to compete against the Company for two years from the closing of the acquisition.

 

Cooling Technology Solutions, Inc.

 

On March 4, 2013, we formed a new wholly-owned subsidiary of the Company named Cooling Technology Solutions, Inc. The Company plans to file a non-provisional patent application for its Project Flex product in the name of Cooling Technology Solutions, Inc. to develop a dorm room sized refrigerator that has yet to be developed, however, as of the date of this filing there has been no activity and, as such, there are no revenues or expenses.

 

PLAN OF OPERATION

 

During the next twelve months, we plan to further develop our BoxesOS software, and hope to expand our customer base for our Desk/Flex, Agent Power, AutoHire, IntelliSys, K9 Bytes and MS Health software packages. In addition, we plan to develop a newly formed wholly-owned subsidiary, named Cooling Technology Solutions, Inc. to develop our Project Flex product, a dorm room sized refrigerator that has yet to be developed, and continue to pursue growth through acquisitions. We believe we can satisfy our cash requirements for the next three months with our current cash on hand and revenues generated from our operations. As such, continuing operations and completion of our plan of operation are contingent on finding additional sources of capital. We cannot assure investors that adequate revenues will be generated. In the absence of our projected revenues, we may be unable to proceed with our plan of operations. Even without significant revenues or additional funding within the next several months, we still anticipate being able to continue with our present activities, but we may require financing to potentially achieve our goals of growing our operations and increasing our revenues.

 

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2013, AS COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2012:

 

		For the Three Months Ended
		March 31,								Increase /
		2013				2012				(Decrease)
Revenues		$	208,010			$	114,477			$	93,533
General and Administrative			121,231				130,750				(9,519	)
Salaries and Wages			216,153				93,515				122,638
Depreciation and Amortization			76,775				47,474				29,301
Bad Debts (Recoveries)			(8,785	)			7,775				(16,560	)
Total Operating Expenses			405,374				279,514				125,860
Net Operating Loss			(197,364	)			(165,037	)			35,327
Total Other Income (Expense)			(201,207	)			(40,890	)			160,317
Net Loss		$	(398,571	)		$	(205,927	)		$	192,644

 

Revenues:

 

For the three months ended March 31, 2013 we had revenue of $208,010 compared to revenue of $114,477 for the three months ended March 31, 2012, an increase of $93,533 or 82% from the comparative period. The increase in revenues is mainly attributable to the sales generated by our K9 Bytes subsidiary that was acquired on March 28, 2012.

 

General and Administrative:

 

General and administrative expenses decreased by $9,519 or 7% to $121,231 for the three months ended March 31, 2013 compared to general and administrative expense of $130,750 for the three months ended March 31, 2012. The decrease in general and administrative expense is due primarily to decreased professional fees as a result of not beginning our year-end accounting and auditing process until the second quarter of 2013.

 

Salaries and Wages:

 

Salaries and wages increased by $122,638 or 131% to $216,153 for the three months ended March 31, 2013 compared to salaries and wages of $93,515 for the three months ended March 31, 2012. The increase in salaries and wages is due primarily to the increase in stock based compensation of $91,500 pursuant to the issuance of a total of 66,500,000 shares of Class A Common Stock granted amongst Shaun Passley, CEO, Craig Passley, Corporate Secretary and Vivienne Passley, in addition to increased cash compensation related to additional personnel on hand pursuant to our K9 Bytes subsidiary that was acquired on March 28, 2012. Another 254,000,000 shares valued at a total of $454,000 were issued that have not vested, and are presented as a deduction against additional paid in capital in the equity section of the balance sheet until the terms of the vesting periods are satisfied. No shares were issued for services during the three months ending March 31, 2012.

 

Depreciation and Amortization:

 

We had depreciation and amortization expense of $76,775 for the three months ended March 31, 2013 as compared to $47,474 for the three months ended March 31, 2012, an increase of $29,301 or 62% from the comparative period. This increase is due to having a greater depreciable asset base as a result of our acquisition of K9 Bytes on March 28, 2012.

 

Bad Debts (Recoveries):

 

We had bad debts (recoveries) of $8,785 for the three months ended March 31, 2013 as compared to bad debts expense of $7,775 for the three months ended March 31, 2012, a decrease in bad debts expense of $16,560 or 213% from the comparative period. This decrease is due to changes in our allowance for doubtful accounts as a result of improved monitoring and collection efforts over our accounts receivable. We provide an allowance for doubtful accounts of all accounts receivable aging greater than 30 days old.

 

Net Operating Loss:

 

Total operating expenses for the three months ended March 31, 2013 were $405,374, compared to $279,514 for the three months ended March 31, 2012, an increase of $125,860 or 45% from the comparative period. We had net operating losses of $197,364 for the three months ended March 31, 2013 compared to $165,037 for the three months ended March 31, 2012, an increase in operating loss of $32,327, or 20%, from the comparative period. The increase in operating loss was primarily due the increase in stock based compensation to related parties, as diminished by our increased revenues.

 

Other Income (Expense):

 

Loss on convertible debt modification, related party was $81,792 for the three months ended March 31, 2013 compared to $-0- for the three months ended March 31, 2012, an increase of $81,792 or 100% from the comparative period. The current period loss on debt modification was due to an amended convertible promissory note with Star Financial Corporation, which at the time of modification carried a balance of $190,849. We amended the convertible promissory note to revise the conversion terms from a $0.005 floor and 75% discount to market to conversion terms consisting of, "equal to the greater of, (a) 50% of the Market Price, or (b) the fixed conversion price of $0.00075 per share". The Company compared the fair value of the debt immediately preceding the modification to the fair value after the modification to determine the loss on modification of $81,792.

 

Interest expense was $119,415 for the three months ended March 31, 2013 compared to $41,075 for the three months ended March 31, 2012, an increase of $78,340 or 191% from the comparative period. Interest expense increased due to increased borrowings to finance our acquisitions, as well as an increase of $57,268 of finance costs related to the amortized discount on beneficial conversion features over the $14,978 of amortized discounts recognized during the three months ended March 31, 2012.

 

Net Loss:

 

We had a net loss of $398,571 for the three months ended March 31, 2013 compared to $205,927 for the three months ended March 31, 2012, an increased net loss of $192,644, or 94%, from the comparative period. The increased net loss was primarily due to increased stock based compensation and a loss on convertible debt modification issued to related parties in the combined amount of $173,292, additional debt servicing costs and the recognition of associated amortization costs on debt discounts related to beneficial conversion features, as diminished by our increased revenues.

 

LIQUIDITY AND CAPITAL RESOURCES

 

The following table summarizes total assets, accumulated deficit, stockholders’ equity (deficit) and working capital at March 31, 2013 compared to March 31, 2012.

 

		March 31,				December 31,
		2012				2012
Total Assets		$	1,291,671			$	1,378,030
Total Liabilities		$	1,877,461			$	1,849,541
Accumulated (Deficit)		$	(4,531,327	)		$	(4,114,756	)
Stockholders’ Equity (Deficit)		$	(585,790	)		$	(471,511	)
Working Capital (Deficit)		$	(752,316	)		$	(681,561	)

 

We had total current assets of $94,796 as of March 31, 2013, consisting of cash of $14,022, net accounts receivable of $38,465, and other current assets of $42,309.

 

We had non-current assets of $1,196,875 as of March 31, 2013, consisting of $163,927 of property and equipment, net, including accumulated depreciation and amortization of $360,064, intangible assets of $777,488, net, including $393,232 of accumulated amortization and goodwill of $255,460 related to the purchase of our subsidiaries.

 

We had total current liabilities of $847,112 as of March 31, 2013, consisting of $18,000 of dividends payable in stock or cash at the election of management, $142,775 of accounts payable and accrued expenses, $231,644 of deferred revenues, current portion of outstanding balances on lines of credit of $76,003, current portion of capitalized leases in the amount of $28,928, notes payable, related parties of $20,868, current maturities on convertible debentures of $83,788, net of discounts of $51,092, and current maturities on long term debts in the amount of $245,106.

 

We had negative working capital of $752,316 and a total accumulated deficit of $4,531,327 as of March 31, 2013.

 

We had total liabilities of $1,877,461 as of March 31, 2013, which included total current liabilities of $847,112, long-term portion of capitalized leases of $9,309, long-term convertible debentures of $90,139, net of discounts of $15,730 and long-term debts of $930,901, net of current portion.

 

We had net cash used in operating activities of $73,110 for the three months ended March 31, 2013, which was primarily due to our net loss of $75,140 after adjustments for non-cash operating expenses, a decrease of $7,315 in accounts receivable, an increase of $14,258 of other current assets, and a decrease of $3,081 in accounts payable and accrued expenses, and an increase of $12,054 in deferred revenues.

 

We had $743 of net cash used in investing activities for the three months ended March 31, 2013, which consisted of $743 of cash paid for the purchase of equipment.

 

We had $41,774 of net cash provided in financing activities during the three months ended March 31, 2013, which represented proceeds from notes payable and convertible debts of $150,032, repayments on long term debts of $103,375 and principal payments on capital leases of $4,883.

 

Declaration of Dividends

 

On January 1, 2013, the Company declared and accrued estimated dividends of $18,000 on its Convertible Series B Preferred Stock pursuant to the recognition of revenues in excess of $1 million during the year ended December 31, 2012 based on 1.5% of the estimated 2013 annual revenues. Dividends equal to 1.5% of the Company’s revenues per quarter during the year ending December 31, 2013 will accrue quarterly and can be paid in cash or in shares of Class A Common Stock, the exact amounts of which are yet undetermined.

 

Recent Financing Activities

 

First quarter of 2013:

 

On February 22, 2013, Desk Flex, Inc. received additional financing of $17,541 as part of a refinancing with OnDeck Financial, in which we increased the remaining outstanding debt of $28,173 as of December 31, 2012, less principal payments of $320 paid prior to the amendment in 2013, by an additional rolled over loan balance of $16,584, an origination fee of $875 and interest amount of $6,300, resulting in total indebtedness of $41,300. The revised loan terms include daily repayments of $320 over a four month term. The total payments due on the loan equate to an annual interest rate of 18%.

 

On February 22, 2013, the Company purchased licenses to develop data management software in the total amount of $102,500 from Igenti, Inc., of which $51,250 was financed with an equipment finance loan from Summit Funding Group, Inc. equipment with a three year loan term consisting of monthly loan payments of $1,828, with $2,078 paid at signing, and the remaining $51,250 was financed pursuant to a capital equipment lease with Baytree National Bank & Trust Company on March 7, 2013 bearing an effective interest rate of 11.48%, consisting of 36 monthly payments of $1,674 and a $1 bargain purchase price upon completion of the lease payments. Both, the loan and the lease are collateralized with the data management software. Igenti retained a total of $3,000 of financing fees and paid the remaining proceeds of $99,500 to the Company for future payment to Sveltoz Solutions for the development of the data management software. Given the nature and status of the software development, no equipment costs have been capitalized.

 

Second quarter of 2013:

 

On April 5, 2013, the Company received a loan of $70,000 from Small Business Financial Solutions, LLC (“SBFS”), of which $34,664 was paid to OnDeck Financial in settlement of total outstanding loans owed by Epazz, Inc. and Desk Flex, Inc., and origination and processing fees of $1,650 were retained by SBFS, and the remaining $33,686 was used to pay off the Fourth Asher Note and the Fifth Asher Note. The promissory note calls for 240 daily payments of $394, resulting in total repayments of $94,500, secured by any and all amounts owing to Epazz now, or in the future, from any merchant processor(s) for charges made by customers via any payment card devices, and all other assets of the Company.

 

We have no current commitment from our officers and directors or any of our shareholders to supplement our operations or provide us with financing in the future. If we are unable to raise additional capital from conventional sources and/or additional sales of stock in the future, we may be forced to curtail or cease our operations. Even if we are able to continue our operations, the failure to obtain financing could have a substantial adverse effect on our business and financial results.

 

In the future, we may be required to seek additional capital by selling debt or equity securities, selling assets, or otherwise be required to bring cash flows in balance when we approach a condition of cash insufficiency. The sale of additional equity or debt securities, if accomplished, may result in dilution to our then shareholders. We provide no assurance that financing will be available in amounts or on terms acceptable to us, or at all.

 

Recent Debt Conversions

 

First quarter of 2013:

 

During the three months ended March 31, 2013, we issued a total of 102,539,572 shares of common stock pursuant to debt conversions of a total of $126,000 of principal and $3,000 of accrued interest during the three months ended March 31, 2013, of which, 50,000,000 shares of common stock were issued in conversion of $46,000 of outstanding principal on a related party note owed to Star Financial Corporation. In addition, during April of 2013, we issued a total of 65,151,515 shares of common stock pursuant to total principal debt conversions of a $50,000, of which, 50,000,000 shares of common stock were issued in conversion of $40,000 of outstanding principal on a related party note owed to Star Financial Corporation. We also issued 14,239,500 shares of common stock to Vivienne Passley in settlement $28,479 of related party debt that hadn’t previously been convertible.

 

A total of $146,749 remains outstanding as of the date of this filing, and is convertible at various hypothetical prices discounted to market as depicted in the table below:

 

								Potential issuable shares at various conversion prices
								below the most recent market price of $0.002 per share
Lender /		Conversion			Principal				100%				75%				50%				25%
Origination		Terms			Borrowed			$	0.002			$	0.0015			$	0.0010			$	0.0005
Star Financial (Related Party) July 2, 2012		As amended on March 5, 2013, convertible into the greater of (a) 50% of the average of the closing market price over the 5 days prior to the conversion request, and (b) the fixed conversion price of $0.00075 per share. Interest rate of 10%.		$	104,849				52,424,500				69,899,333				104,849,000				209,698,000
Tonaquint, Inc. (First Tonaquint Note) September 10, 2012		Convertible into 60% of the average of the two lowest trading prices over the 10 days prior to the conversion request, or $0.00009, whichever is greater. Interest rate of 8% with a 22% default rate.		$	41,900				20,950,000				27,933,333				41,900,000				83,800,000
				$	146,749				73,374,500				97,832,667				146,749,000				293,498,000

 

Recent Shares of Common Stock Issued for Services

 

First quarter of 2013:

 

To conserve on the Company's capital requirements, the Company has issued shares in lieu of cash payments to related parties, and the Company expects to continue this practice. In the three months ended March 31, 2013, the Company granted a total of 320,500,000 shares of common stock valued at a total of $491,500 in lieu of cash payments to employees and related parties, including 200,000,000 shares valued at $400,000 issued to the Company’s CEO in consideration for providing product development services that will vest once the Company reports revenue of $10 million in a calendar year, and 54,000,000 shares valued at $54,000 granted to Craig Passley, a related party, for providing corporate secretary services from 2013 to 2021, which will vest in annual increments of 6,000,000 shares over the next nine years. The unvested shares are presented as a deduction against additional paid in capital in the equity section of the balance sheet until the terms of the vesting periods are satisfied. No shares were issued for services during the three months ending March 31, 2012.

 

Second quarter of 2013:

 

On May 16, 2013, the Company issued 710,526,316 shares of Class A Common Stock to the Company’s CEO in consideration for providing product development services. The total fair value of the common stock was $1,350,000 based on the closing price of the Company’s common stock on the date of grant.

 

On May 24, 2013, the Company issued 35,500,000 shares of Class A Common Stock to Fay Passley, a related party, for providing collateral on acquisition loans that originated on September 30, 2010 and October 26, 2011. The total fair value of the common stock was $71,000 based on the closing price of the Company’s common stock on the date of grant.

 

The Company is not now in a position to determine an approximate number of shares that the Company may issue for the preceding purpose in the remainder of 2013.

 

Critical Accounting Policies

 

Our discussion and analysis of our financial condition and results of operations is based upon our unaudited financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. 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 disclosure of any contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to uncollectible receivable, investment values, income taxes, the recapitalization and contingencies. We base our estimates on various assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about 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.

 

Recent Accounting Pronouncements

 

In February 2013, Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, to improve the transparency of reporting these reclassifications. Other comprehensive income includes gains and losses that are initially excluded from net income for an accounting period. Those gains and losses are later reclassified out of accumulated other comprehensive income into net income. The amendments in the ASU do not change the current requirements for reporting net income or other comprehensive income in financial statements. All of the information that this ASU requires already is required to be disclosed elsewhere in the financial statements under U.S. GAAP. The new amendments will require an organization to:

 

 

-

Present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income - but only if the item reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period; and

-

Cross-reference to other disclosures currently required under U.S. GAAP for other reclassification items (that are not required under U.S. GAAP) to be reclassified directly to net income in their entirety in the same reporting period. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is initially transferred to a balance sheet account (e.g., inventory for pension-related amounts) instead of directly to income or expense.

 

The amendments apply to all public and private companies that report items of other comprehensive income. Public companies are required to comply with these amendments for all reporting periods (interim and annual). The amendments are effective for reporting periods beginning after December 15, 2012, for public companies. Early adoption is permitted. The adoption of ASU No. 2013-02 did not have a material impact on our financial position or results of operations.

 

In January 2013, the FASB issued ASU No. 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, which clarifies which instruments and transactions are subject to the offsetting disclosure requirements originally established by ASU 2011-11. The new ASU addresses preparer concerns that the scope of the disclosure requirements under ASU 2011-11 was overly broad and imposed unintended costs that were not commensurate with estimated benefits to financial statement users. In choosing to narrow the scope of the offsetting disclosures, the Board determined that it could make them more operable and cost effective for preparers while still giving financial statement users sufficient information to analyze the most significant presentation differences between financial statements prepared in accordance with U.S. GAAP and those prepared under IFRSs. Like ASU 2011-11, the amendments in this update will be effective for fiscal periods beginning on, or after January 1, 2013. The adoption of ASU 2013-01 did not have a material impact on our financial position or results of operations.

 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Pursuant to Item 305(e) of Regulation S-K (§ 229.305(e)), the Company is not required to provide the information required by this Item as it is a “smaller reporting company,” as defined by Rule 229.10(f)(1).

 

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

We carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a – 15(c) and 15d – 15(e)). Based upon that evaluation, our principal executive officer concluded that, as of the end of the period covered in this report, our disclosure controls and procedures were not effective to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the required time periods and is accumulated and communicated to our management, including our principal executive officer, as appropriate to allow timely decisions regarding required disclosure.

 

Inherent Limitations of Internal Controls

 

Our Principal Executive Officer does not expect that our disclosure controls or internal controls will prevent all error and all fraud. Although our disclosure controls and procedures were designed to provide reasonable assurance of achieving their objectives, a control system, no matter how well conceived and operated, can provide only reasonable, not absolute assurance that the objectives of the system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented if there exists in an individual a desire to do so. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting, other than those stated above, during our most recent quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

 

PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

From time to time, we may become party to litigation or other legal proceedings that we consider to be a part of the ordinary course of our business. We are not currently involved in legal proceedings that could reasonably be expected to have a material adverse effect on our business, prospects, financial condition or results of operations. We may become involved in material legal proceedings in the future.

 

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

The following sales of equity securities by the Company occurred during the three month period ended March 31, 2013:

 

Debt Conversion Issuances

On January 3, 2013, the Company issued 4,000,000 shares of Class A Common Stock pursuant to the conversion of $12,000 of convertible debt, which consisted entirely of principal.

 

On February 19, 2013, the Company issued 8,823,529 shares of Class A Common Stock pursuant to the conversion of $15,000 of convertible debt, which consisted entirely of principal.

 

On February 26, 2013, the Company issued 10,750,000 shares of Class A Common Stock pursuant to the conversion of $17,200 of convertible debt, consisting of $15,500 of principal and $1,700 of accrued and unpaid interest.

 

On March 4, 2013, the Company issued 10,000,000 shares of Class A Common Stock pursuant to the conversion of $15,000 of convertible debt, which consisted entirely of principal.

 

On March 6, 2013, the Company issued 14,461,538 shares of Class A Common Stock pursuant to the conversion of $18,800 of convertible debt, consisting of $17,500 of principal and $1,300 of accrued and unpaid interest.

 

On March 12, 2013, the Company issued 4,504,505 shares of Class A Common Stock pursuant to the conversion of $5,000 of convertible debt, which consisted entirely of principal.

 

On March 14, 2013, the Company issued 50,000,000 shares of Class A Common Stock pursuant to the conversion of $46,000 of convertible debt owed to a related party, which consisted entirely of principal.

 

The Company claims an exemption from registration afforded by Section 3(a)(9) of the Securities Act of 1933, as amended (the “Act”), for the above conversions, as the securities were exchanged by the Company with its existing security holders exclusively in transactions where no commission or other remuneration was paid or given directly or indirectly for soliciting such exchange and Section 4(2) of the Act for the issuances as the issuances did not involve a public offering, the recipients took the securities for investment and not resale, the Company took appropriate measures to restrict transfer, and the recipients are (a) “accredited investors”; or (b) have access to similar documentation and information as would be required in a Registration Statement under.

 

Shares Issued for Services

On March 5, 2013, the Company issued 12,500,000 shares of Class A Common Stock to Vivienne Passley, a related party, for providing a personal guaranty on an acquisition loan that originated on September 30, 2010.

 

On March 5, 2013, the Company issued 12,500,000 shares of Class A Common Stock to Vivienne Passley, a related party, for providing a personal guaranty on two acquisition loans that originated on October 26, 2011.

 

On March 5, 2013, the Company issued 200,000,000 shares of Class A Common Stock to the Company’s CEO in consideration for providing product development services. The shares will be vested once the Company reports revenue of $10 million in a calendar year.

 

On March 20, 2013, the Company issued 35,500,000 shares of Class A Common Stock to Vivienne Passley, a related party, for providing collateral on acquisition loans that originated on September 30, 2010 and October 26, 2011.

 

On March 20, 2013, the Company issued 60,000,000 shares of Class A Common Stock to Craig Passley, a related party, for providing corporate secretary services from 2012 to 2021. The shares vest annually over ten years at a rate of 6,000,000 shares per year.

 

The foregoing securities issued for services were issued in reliance on Section 4(2) of the Securities Act of 1933, as amended.

 

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

None.

 

 

ITEM 4. MINE SAFETY DISCLOSURES.

 

Not applicable.

 

 

ITEM 5. OTHER INFORMATION

 

On January 1, 2013, the Company declared and accrued estimated dividends of $18,000 on its Convertible Series B Preferred Stock pursuant to the recognition of revenues in excess of $1 million during the year ended December 31, 2012 based on 1.5% of the estimated 2013 annual revenues. Dividends equal to 1.5% of the Company’s revenues per quarter during the year ending December 31, 2013 will accrue quarterly and can be paid in cash or in shares of Class A Common Stock, the exact amounts of which are yet undetermined.

 

 

Item 6. Exhibits

 

			Incorporated by reference
Exhibit	Exhibit Description	Filed herewith	Form	Period ending	Exhibit	Filing date
3.1	Articles of Incorporation		SB-2	12/04/06	X	12/04/06
3.2	Articles of Amendment		SB-2	12/04/06	X	12/04/06
3.3	Articles of Amendment		SB-2	12/04/06	X	12/04/06
3.4	Articles of Amendment		SB-2	12/04/06	X	12/04/06
3.5	Statement of Change of Registered Agent		SB-2	12/04/06	X	12/04/06
3.6	Articles of Amendment		SB-2	12/04/06	X	12/04/06
3.7	Amended and Restated By-Laws		SB-2	12/04/06	X	12/04/06
3.8	Articles of Amendment		10-Q	09/30/12	X	12/18/12
3.9	Articles of Amendment		10-K	12/31/12	X	06/03/13
4.1	Form of Stock Certificate		SB-2	12/04/06	X	12/04/06
10.1	Form of Subscription Agreement of July 2005 Private Placement		SB-2/A	05/11/07	X	05/11/07
10.2	Promissory Note with Fay Passley		SB-2/A	09/24/07	X	09/24/07
10.3	Promissory Note with L&F Lawn Service, Inc.		SB-2/A	09/24/07	X	09/24/07
10.4	Promissory Note with Shaun Passley		SB-2/A	09/24/07	X	09/24/07
10.5	Stock Purchase Agreement with DFI, PRMI and Arthur Goes		8-K	06/18/08	X	06/24/08
10.6	Promissory Note between Epazz, Inc. and Arthur Goes		8-K	06/18/08	X	06/24/08
10.7	Security Agreement with Arthur Goes		8-K	06/18/08	X	06/24/08
10.8	June 2008 Promissory Note with Star Financial Corporation		10-Q	06/30/08	X	08/19/08
10.9	Debt Conversion Agreement		10-Q	03/31/09	X	05/19/09
10.10	Letter Amendment to June 2008 Promissory Note with Star Financial Corporation		10-K	12/31/09	X	04/16/10
10.11	Software Product Asset Purchase Agreement		10-K	12/31/09	X	04/16/10
10.12	Stock Purchase Agreement		10-Q	09/30/10	X	11/22/10
10.13	Promissory Note with Paul Prahl		10-Q	09/30/10	X	11/22/10
10.14	Third Party Lender Note		10-Q	09/30/10	X	11/22/10
10.15	Third Party Lender Note Security Agreement		10-Q	09/30/10	X	11/22/10
10.16	Securities Purchase Agreement (May 2011)		10-Q	06/30/11		08/17/11
10.17	Convertible Promissory Note (May 2011)		10-Q	06/30/11		08/17/11
10.18	Securities Purchase Agreement (June 2011)		10-Q	06/30/11		08/17/11
10.19	Convertible Promissory Note (June 2011)		10-Q	06/30/11		08/17/11
10.20	Purchase Contract and Receipt Agreement  – K9 Bytes Transaction		8-K	10/26/11		11/21/11
10.21	Bill of Sale – K9 Bytes Transaction		8-K	10/26/11		11/21/11
10.22	Balloon Installment Promissory Note – K9 Bytes Transaction		8-K	10/26/11		11/21/11
10.23	Small Business Finance – U.S. Small Business Administration Note – K9 Bytes Transaction		8-K	10/26/11		11/21/11
10.24	Consulting Agreement 0 K9 Bytes Transaction		8-K	10/26/11		11/21/11
10.25	Agreement Not to Compete – K9 Bytes Transaction		8-K	10/26/11		11/21/11
10.26	Asset Purchase Agreement – MS Health Acquisition		10-K	12/31/11	X	05/16/12
10.27	Promissory Note – MS Health Acquisition		10-K	12/31/11	X	05/16/12
10.28	Covenant Not to Compete; Consulting Agreement Non-Competition and Consulting Agreement – MS Health Acquisition		10-K	12/31/11	X	05/16/12
10.29	Security Agreement – MS Health Acquisition		10-K	12/31/11	X	05/16/12
10.30	Small Business Administration Note – MS Health Acquisition		10-K	12/31/11	X	05/16/12
10.31	Executive Employment Agreement – Shaun Passley		10-Q	09/30/12	X	12/18/12
10.32	July 2, 2012 – Convertible Promissory Note with Asher (Third Asher Note)		10-Q	09/30/12	X	12/18/12
10.33	July 2, 2012 – Securities Purchase Agreement with Asher (Third Asher Note)		10-Q	09/30/12	X	12/18/12

  

 

10.34	July 2, 2012 – Amendment #1 to Promissory Note with Asher (Third Asher Note)		10-Q	09/30/12	X	12/18/12
10.35	July 24, 2012 – Convertible Promissory Note with Asher (Fourth Asher Note)		10-Q	09/30/12	X	12/18/12
10.36	July 24, 2012 – Securities Purchase Agreement with Asher (Fourth Asher Note)		10-Q	09/30/12	X	12/18/12
10.37	July 24, 2012 – Amendment #1 to Promissory Note with Asher (Fourth Asher Note)		10-Q	09/30/12	X	12/18/12
10.38	October 16, 2012 – Convertible Promissory Note with Asher (Fifth Asher Note)		10-Q	09/30/12	X	12/18/12
10.39	October 16, 2012 – Securities Purchase Agreement with Asher (Fifth Asher Note)		10-Q	09/30/12	X	12/18/12
10.40	October 16, 2012 – Amendment #1 to Promissory Note with Asher (Fifth Asher Note)		10-Q	09/30/12	X	12/18/12
10.41	July 7, 2012 – Convertible Promissory Note with Star Financial Corporation		10-Q	09/30/12	X	12/18/12
10.42	July 7, 2012 – Amendment #1 to Convertible Promissory Note with Star Financial Corporation		10-Q	09/30/12	X	12/18/12
10.43	October 9, 2012 – Promissory Note with L&F Lawn Service, Inc.		10-Q	09/30/12	X	12/18/12
10.44	September 24, 2012 – Debt Conversion Agreement with L&F Lawn Services, Inc.		10-Q	09/30/12	X	12/18/12
10.45	October 1, 2012 – Debt Conversion Agreement with Fay Passley		10-Q	09/30/12	X	12/18/12
10.49	December 12, 2012 – Convertible Promissory Note with Asher (Sixth Asher Note)		10-K	12/31/12	X	06/03/13
10.50	December 12, 2012 – Securities Purchase Agreement with Asher (Sixth Asher Note)		10-K	12/31/12	X	06/03/13
10.51	December 12, 2012 – Amendment #1 to Promissory Note with Asher (Sixth Asher Note)		10-K	12/31/12	X	06/03/13
10.52	September 10, 2012 – Convertible Promissory Note with Tonaquint, Inc. (First Tonaquint Note)		10-K	12/31/12	X	06/03/13
10.53	September 10, 2012 – Amendment #1 to Promissory Note with Tonaquint, Inc. (First Tonaquint Note)		10-K	12/31/12	X	06/03/13
10.54	August 10, 2012 – Equipment Finance Agreement with Direct Credit Funding, Inc.		10-K	12/31/12	X	06/03/13
10.55	February 22, 2013 – Equipment Finance Agreement with Summit Funding Group, Inc.	X
10.56	March 7, 2013 – Lease Agreement with Baytree National Bank & Trust Company	X
16.1	Letter from Lake & Associates, CPA’s LLC		8-K	4/20/12	X	4/20/12
21.1	Subsidiaries	X
31.1	Certifications pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	X
32.1	Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	X
101.INS*	XBRL Instance Document	X
101.SCH*	XBRL Schema Document	X
101.CAL*	XBRL Calculation Linkbase Document	X
101.DEF*	XBRL Definition Linkbase Document	X
101.LAB*	XBRL Labels Linkbase Document	X
101.PRE*	XBRL Presentation Linkbase Document	X

 

*

XBRL (Extensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

 

 

 

SIGNATURES

 

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	EPAZZ, INC.
DATED: June 14, 2013	By: /s/ Shaun Passley
	Shaun Passley
	Chief Executive Officer (Principal Executive Officer), President, Chief Financial Officer (Principal Accounting Officer), and Director