10-Q 1 epazz_10q-063014.htm FORM 10-Q

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended June 30, 2014

 

[_] 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.)

 

 

205 W. Wacker Drive. Suite 1320

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 [X] No [_]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes [X] No [_]

 

Indicate by check mark 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 [X]

 

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

Yes [_] No [X]

 

The number of shares of the issuer’s Class A common stock outstanding as of September 29, 2014, was 7,213,383,508 shares, par value $0.0001 per share.

 

 

 
 

 

EPAZZ, INC.

FORM 10-Q

Quarterly Period Ended June 30, 2014

 

  Page
   
INDEX  
   
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS  
PART I. FINANCIAL INFORMATION 2
Item 1. Financial Statements 2
  Balance Sheets as of June 30, 2014 (Unaudited) and December 31, 2013 2
  Statements of Operations for the Three and Six Months ended June 30, 2014 and 2013 (Unaudited) 3
  Statements of Cash Flows for the Three and Six Months ended June 30, 2014 and 2013 (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 47
Item 3. Quantitative and Qualitative Disclosures About Market Risk 58
Item 4. Controls and Procedures 58
     
PART II. OTHER INFORMATION 59
Item 1. Legal Proceedings 59
Item 1A. Risk Factors 59
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 59
Item 3. Defaults Upon Senior Securities 60
Item 4. Mine Safety Disclosures 60
Item 5. Other Information 60
Item 6. Exhibits 61
     
SIGNATURES 63

 

 

 

 

 

1
 

 

EPAZZ, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

       

   June 30,   December 31, 
   2014   2013 
Assets  (Unaudited)     
Current assets:          
Cash  $101,871   $208,567 
Accounts receivable, net   71,762    25,248 
Other current assets   65,396    106,114 
Total current assets   239,029    339,929 
           
Property and equipment, net   130,973    113,410 
Intangible assets, net   476,418    374,162 
Goodwill   1,149,041    255,460 
           
Total assets  $1,995,461   $1,082,961 
           
           
Liabilities and Stockholders' Equity (Deficit)          
Current liabilities:          
Dividends payable  $11,000   $11,000 
Accounts payable   312,005    258,163 
Accrued expenses   55,193    45,298 
Accrued expenses, related parties   47,681    28,741 
Deferred revenue   496,510    322,130 
Lines of credit   86,544    73,232 
Current maturities of capital lease obligations payable   4,987    17,421 
Current maturities of notes payable, related parties ($841,618 currently in default)   930,868    397,368 
Convertible debts, net of discounts of $1,112 and $105,300, respectively ($119,275 currently in default)   151,163    115,128 
Current maturities of long term debts   612,898    354,786 
Total current liabilities   2,708,849    1,623,267 
           
Capital lease obligations payable, net of current maturities   3,174     
Notes payable, related parties       85,000 
Convertible debts, net of discounts of $-0- and $4,283, respectively       42,166 
Long term debts, net of current maturities   1,039,472    857,143 
Total liabilities   3,751,495    2,607,576 
           
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            
Convertible preferred stock, Series C, $0.0001 par value, 3,000,000,000 shares authorized, 2,924,722,200 shares issued and outstanding at June 30, 2014     292,472        
Common stock, Class A, $0.0001 par value, 6,000,000,000 shares authorized, 6,796,730,730 and 3,468,358,708 shares issued and outstanding, respectively     679,673       346,836  
Convertible common stock, Class B, $0.0001 par value, 60,000,000 shares authorized, 23,000,000 and 10,500,000 shares issued and outstanding, respectively     2,300       1,050    
Additional paid in capital   9,240,766    6,429,493 
Stockholders' payable, consisting of 19,000,000 shares of Series C Convertible Preferred Stock and 28,875,000 shares of Class A Common Stock at June 30, 2014     26,353        
Stockholders' receivable, consisting of -0- and 20,000,000 shares of Class A Common Stock, respectively           (800,000 )
Accumulated deficit   (11,997,598)   (7,501,994)
Total stockholders' equity (deficit)   (1,756,034)   (1,524,615)
           
Total liabilities and stockholders' equity (deficit)  $1,995,461   $1,082,961 

 

See accompanying notes to financial statements.

 

 

2
 

 

EPAZZ, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

   For the Three Months Ended   For the Six Months Ended 
   June 30,   June 30, 
   2014   2013   2014   2013 
                 
Revenue  $327,525   $279,119   $580,077   $487,129 
                     
Expenses:                    
General and administrative   278,446    166,403    570,139    287,634 
Salaries and wages   108,502    1,555,081    2,444,999    1,771,234 
Depreciation and amortization   51,398    67,385    97,555    144,160 
Bad debts (recoveries)   (5,250)   45    (5,262)   (8,740)
Total operating expenses   433,096    1,788,914    3,107,431    2,194,288 
                     
Net operating loss   (105,571)   (1,509,795)   (2,527,354)   (1,707,159)
                     
Other income (expense):                    
Interest income   1        55     
Interest expense   (501,712)   (143,543)   (1,017,777)   (262,958)
Loss on debt modifications, related parties   (172,864)   (14,240)   (172,864)   (96,032)
Change in derivative liabilities   15,915        (777,664)    
Total other income (expense)   (658,660)   (157,783)   (1,968,250)   (358,990)
                     
Net loss  $(764,231)  $(1,667,578)  $(4,495,604)  $(2,066,149)
                     
Weighted average number of common shares                    
outstanding - basic and fully diluted   5,939,090,272    2,045,979,796    4,783,826,881    1,666,897,778 
                     
Net loss per share - basic and fully diluted  $(0.00)  $(0.00)  $(0.00)  $(0.00)

 

See accompanying notes to financial statements.

 

 

3
 

EPAZZ, INC.

 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   For the Six Months Ended 
   June 30, 
   2014   2013 
 Cash flows from operating activities          
Net loss  $(4,495,604)  $(2,066,149)
Adjustments to reconcile net loss to net cash used in operating activities:                
Bad debts (recoveries)   (5,262)   (8,740)
Depreciation and amortization   25,949    56,837 
Amortization of intangible assets   71,606    87,324 
Amortization of deferred financing costs   233,277    19,905 
Amortization of discounts on convertible debts   495,683    128,612 
Loss on debt modifications, related parties   172,864    96,032 
Loss on default provisions of convertible debt   77,375     
Change in fair market value of derivative liabilities   777,664     
Stock based compensation issued for services   37,500     
Stock based compensation issued for services, related parties   2,243,402    1,522,000 
Decrease (increase) in assets:          
Accounts receivable   1,130    (29,759)
Other current assets   42,835    1,743 
Increase (decrease) in liabilities:          
Accounts payable   44,656    41,662 
Accrued expenses   20,085    (2,914)
Accrued expenses, related parties   54,002    10,536 
Deferred revenues   (74,059)   (30,252)
Net cash used in operating activities   (276,897)   (173,163)
           
Cash flows from investing activities          
Cash acquired in merger   736     
Purchase of equipment   (43,512)   (1,697)
Acquisition of subsidiaries   (482,945)    
Net cash used in investing activities   (525,721)   (1,697)
           
Cash flows from financing activities          
Payments on capital lease obligations payable   (9,260)   (9,713)
Proceeds from notes payable, related parties   675,152    203,950 
Repayment of notes payable, related parties   (82,879)   (119,167)
Proceeds from convertible notes       30,000 
Repayment of convertible notes   (1,500)   (27,500)
Proceeds from long term debts   345,696    271,095 
Repayment of long term debts   (231,287)   (172,719)
Net cash provided by financing activities   695,922    175,946 
           
Net increase (decrease) in cash   (106,696)   1,086 
Cash - beginning   208,567    46,101 
Cash - ending  $101,871   $47,187 
           
Supplemental disclosures:          
Interest paid  $187,563   $106,869 
 Income taxes paid  $   $ 
           
Non-cash investing and financing activities:          
Acquisition of subsidiary in exchange for debt  $312,000  $ 
Value of shares issued for conversion of debt  $533,360   $120,160 
Value of shares issued for conversion of debt, related parties  $112,183   $100,239 
Discount on beneficial conversion feature of convertible debt  $35,028  $33,000 
Discount on derivatives  $422,240   $ 
Deferred financing costs  $235,394   $32,076 
Value of derivative adjustment due to debt conversions  $1,199,904   $ 
Dividends payable declared  $   $18,000 

 

See accompanying notes to financial statements.

 

4
 

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, 2013 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
Terran Power, Inc.(5)   Illinois   Subsidiary   Terran
Telecorp Products, Inc.   Michigan   Subsidiary   Telecorp
Jadian, Inc.   Illinois   Subsidiary   Jadian
FlexFridge, Inc.(3)   Illinois   Subsidiary(4)   FlexFridge

______________

(1)All subsidiaries, with the exception of FlexFridge, are wholly-owned subsidiaries.

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

(3)Formerly Z Fridge, Inc. and Cooling Technology Solutions, Inc.

(4)FlexFridge, Inc. was spun-off on November 21, 2013, and distributed on a 1:10 basis to shareholders of record on September 15, 2013. Epazz has a controlling financial interest in FlexFridge. As such, FlexFridge is consolidated within these financial statements pursuant to Accounting Standards Codification (“ASC”) 810-10. There has been no material activity within FlexFridge to date.

(5)Entity formed for prospective purposes, but has not incurred any income or expenses to date.

 

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, Terran, Telecorp, Jadian and FlexFridge 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.

 

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.

 

5
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 $71,606 and $87,324 for the six months ended June 30, 2014 and 2013, 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 ended December 31, 2013 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.

 

Derivative Liability

The Company evaluates its convertible instruments, options, warrants or other contracts to determine if those contracts or embedded components of those contracts qualify as derivatives to be separately accounted for under ASC Topic 815, “Derivatives and Hedging.” The result of this accounting treatment is that the fair value of the derivative is marked-to-market each balance sheet date and recorded as a liability. In the event that the fair value is recorded as a liability, the change in fair value is recorded in the statement of operations as other income (expense). Upon conversion or exercise of a derivative instrument, the instrument is marked to fair value at the conversion date and then that fair value is reclassified to equity. Equity instruments that are initially classified as equity that become subject to reclassification under ASC Topic 815 are reclassified to liabilities at the fair value of the instrument on the reclassification date. We analyzed the derivative financial instruments (the Convertible Note and tainted Warrant), in accordance with ASC 815. The objective is to provide guidance for determining whether an equity-linked financial instrument is indexed to an entity’s own stock. This determination is needed for a scope exception which would enable a derivative instrument to be accounted for under the accrual method. The classification of a non-derivative instrument that falls within the scope of ASC 815-40-05 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” also hinges on whether the instrument is indexed to an entity’s own stock. A non-derivative instrument that is not indexed to an entity’s own stock cannot be classified as equity and must be accounted for as a liability. There is a two-step approach in determining whether an instrument or embedded feature is indexed to an entity’s own stock. First, the instrument's contingent exercise provisions, if any, must be evaluated, followed by an evaluation of the instrument's settlement provisions. The Company utilized multinomial lattice models that value the derivative liability within the notes based on a probability weighted discounted cash flow model. The Company utilized the fair value standard set forth by the Financial Accounting Standards Board, defined as the amount at which the assets (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties, that is, other than in a forced or liquidation sale.

 

6
 

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 six months ending June 30, 2014 and 2013.

 

Stock-Based Compensation

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 $2,280,902 and $1,522,000 for the six months ended June 30, 2014 and 2013, respectively.

 

Revenue Recognition

The Company designs and sells various software programs to business enterprises including, among others, hospitals, pet stores, 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.

 

7
 

 

Recent Accounting Pronouncements

In June 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-12, Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. The new guidance requires that share-based compensation that require a specific performance target to be achieved in order for employees to become eligible to vest in the awards and that could be achieved after an employee completes the requisite service period be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation costs should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The total amount of compensation cost recognized during and after the requisite service period should reflect the number of awards that are expected to vest and should be adjusted to reflect those awards that ultimately vest. The requisite service period ends when the employee can cease rendering service and still be eligible to vest in the award if the performance target is achieved. This new guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2015. Early adoption is permitted. Entities may apply the amendments in this Update either (a) prospectively to all awards granted or modified after the effective date or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. The adoption of ASU 2014-12 is not expected to have a material impact on our financial position or results of operations.

 

In June 2014, the FASB issued ASU No. 2014-10: Development Stage Entities (Topic 915): Elimination of Certain Financial Reporting Requirements, Including an Amendment to Variable Interest Entities Guidance in Topic 810, Consolidation, to improve financial reporting by reducing the cost and complexity associated with the incremental reporting requirements of development stage entities. The amendments in this update remove all incremental financial reporting requirements from U.S. GAAP for development stage entities, thereby improving financial reporting by eliminating the cost and complexity associated with providing that information. The amendments in this Update also eliminate an exception provided to development stage entities in Topic 810, Consolidation, for determining whether an entity is a variable interest entity on the basis of the amount of investment equity that is at risk. The amendments to eliminate that exception simplify U.S. GAAP by reducing avoidable complexity in existing accounting literature and improve the relevance of information provided to financial statement users by requiring the application of the same consolidation guidance by all reporting entities. The elimination of the exception may change the consolidation analysis, consolidation decision, and disclosure requirements for a reporting entity that has an interest in an entity in the development stage. The amendments related to the elimination of inception-to-date information and the other remaining disclosure requirements of Topic 915 should be applied retrospectively except for the clarification to Topic 275, which shall be applied prospectively. For public companies, those amendments are effective for annual reporting periods beginning after December 15, 2014, and interim periods therein. Early adoption is permitted. The adoption of ASU 2014-10 is not expected to 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 $11,997,598, and as of June 30, 2014, the Company’s current liabilities exceeded its current assets by $2,469,820 and its total liabilities exceeded its total assets by $1,756,034. 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.

 

Note 3 – Subsidiary Formation

 

Formation of Subsidiary – Terran Power, Inc., September 19, 2013

On September 19, 2013, the Board of Directors, consisting solely of Shaun Passley, Ph.D., the Company’s majority shareholder, approved the formation of a new wholly-owned subsidiary of the Company named Terran Power, Inc. The Company plans to file a non-provisional patent application to develop a mobile power device that allows iPhone and other smartphone users to power up their phone on the go without needing an outlet or a second battery, however, as of the date of this filing there has been no activity and, as such, there are no revenues or expenses.

 

8
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Subsidiary Formation – FlexFridge, Inc., March 4, 2013

On March 4, 2013, the Board of Directors of Epazz, Inc. (the “Company”), consisting solely of Shaun Passley, Ph.D., the Company’s majority shareholder, approved the formation of a new wholly-owned subsidiary of the Company named Cooling Technology Solutions, Inc., which was later renamed, Z Fridge, Inc., and ultimately again renamed as, FlexFridge, Inc. (“FlexFridge”) on May 29, 2014. The Company has filed a non-provisional patent application for its Project Flex product, which consists of a patent pending foldable mini-fridge. On November 21, 2013, the Company was spun off to shareholders of record on September 15, 2013, whereby shareholders of Epazz, Inc. received one (1) share of FlexFridge in exchange for each ten (10) shares held of Epazz, Inc. Epazz has a controlling financial interest in FlexFridge. As such, FlexFridge is consolidated within these financial statements pursuant to Accounting Standards Codification (“ASC”) 810-10. There has been no material activity within FlexFridge to date.

 

Note 4 – Mergers and Acquisitions

 

Zinergy (DBA) formerly Cynergy Software, Asset Purchase

On April 4, 2014, we closed on a March 13, 2014 Asset Purchase Agreement with Cynergy Corporation, an Oklahoma corporation (“Cynergy”). Pursuant to the Purchase Agreement, we purchased substantially all of the intangible assets and certain tangible assets used in connection with Cynergy’s help desk software business, including all of its intellectual property, its business trademarks and copyrights, equipment, computers, software, machinery and accounts receivable in consideration for an aggregate of $75,000, of which $25,000 was paid at the closing, $25,000 was paid within fifteen (15) days after the closing and the remaining $25,000 was paid within forty (40) days after the closing. We did not purchase and Cynergy agreed to retain and be responsible for any and all liabilities of Cynergy Corporation. The acquisition was financed in part with a software financing agreement. The financing agreement has a lien against the software assets of Zinergy.

 

Zinergy Service Desk Software is very customizable for business processes. Zinergy integrates with just about every other business tool available. Help Desk Support Software, Help Desk Ticketing Software, Customer Support Software, HRIS Ticketing Solution and much more.

 

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 $65,139 of goodwill. According to the purchase method of accounting, the Company recognized the identifiable assets acquired and liabilities assumed as follows:

 

   April 4, 
   2014 
Consideration:     
Cash paid at, and prior to, closing  $75,000 
      
Fair value of identifiable assets acquired assumed:     
Software  $8,035 
Trade name   1,826 
Total fair value of assets assumed   9,861 
Consideration paid in excess of fair value (Goodwill)(1)  $65,139 

_________

(1) 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 Cynergy, software 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.

 

Jadian Enterprises, Inc., Asset Purchase Agreement

On May 9, 2014, the Company, through a newly-formed wholly-owned Illinois subsidiary, Jadian Enterprises, Inc. (“Jadian Enterprises”), closed on an Asset Purchase Agreement (“APA”) with Jadian, Inc., a Michigan corporation (“Jadian”). Pursuant to the APA, we purchased substantially all of the intangible assets and certain tangible assets used in connection with Jadian’s software business, including all of its intellectual property, its business trademarks and copyrights, equipment, computers, software, machinery and accounts receivable in consideration for an aggregate of $425,000, of which $207,945 was paid at the closing, $7,055 was settled as a result of certain offsets, including an offset for $40,760 for prepaid maintenance contracts received by the seller prior to Closing, as diminished by a credit for Accounts Receivable of $33,705, and $210,000 was financed by way of a Promissory Note (the “Jadian Note”). The terms of the Jadian Note include interest at 6% per annum, a ten (10) year amortization, full right of offset, no payments of either principal or interest for thirty (30) days after Closing and equal payments of principal and interest commencing thereafter, no prepayment penalty, and a balloon payment consisting of full payment of all amounts due after three (3) years. The Jadian Note is secured by a lien on the assets of Jadian. We did not purchase and Jadian agreed to retain and be responsible for any and all liabilities of Jadian. We did not purchase and Jadian agreed to retain and be responsible for any and all liabilities of Jadian.

 

9
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The Company also agreed to provide the seller with additional earn-out rights in connection with the purchase, which provide that the seller will receive up to a maximum of $100,000 per year for the three twelve month periods following the Closing (any delinquent earn-out payment shall bear interest at the rate of 10% per annum until the delinquent amount is paid), based on the gross revenues generated by Jadian during such applicable year based on the following schedule (the “Earn-Out”):

 

Revenue for the Relevant Year Earn-Out
$-0- to $500,000 $
$500,000 to $600,000 $ 25,000
$600,000 to $700,000 $ 50,000
$700,000 to $800,000 $ 75,000
$800,000 or more $ 100,000

 

Provided that in no event shall the total amount payable to Jadian Enterprises in connection with the Earn-Out exceed $100,000 per year, or $300,000 in aggregate. Management has determined the probability of having to pay out any of these Earn-Out provisions as Medium and accordingly, has not recorded a contingent liability.

 

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 $399,865 of goodwill. According to the purchase method of accounting, the Company recognized the identifiable assets acquired and liabilities assumed as follows:

 

   May 9, 
   2014 
Consideration:     
Cash paid at, and prior to, closing  $215,000 
Seller financed note payable(1)(2)   210,000 
Adjustments to cash paid at closing(3)   (7,055)
    417,945 
Fair value of identifiable liabilities acquired:     
Deferred revenue   86,423 
Fair value of total consideration exchanged  $504,368 
      
Fair value of identifiable assets acquired assumed:     
Accounts receivable  $42,382 
Software   37,180 
Trade name   24,941 
Total fair value of assets assumed   104,503 
Consideration paid in excess of fair value (Goodwill)(4)  $399,865 

 

(1)Consideration included an unsecured $210,000 seller financed note payable (“Jadian Note”), which bears interest at 6% per annum until the maturity date of May 9, 2017, and provides for equal monthly principal and interest payments of $6,389 commencing on June 1, 2014. The Jadian Note includes a balloon payment, consisting of the remaining outstanding balance of principal and interest upon maturity at May 9, 2017. The interest rate shall be 8% per annum with an additional 5% late payment fee upon default.

 

(2)The fair value of the seller financed note in excess of the $210,000 principal balance attributable to the deferred payment terms will be amortized to interest expense over the deferred financing period.

 

(3)The Company agreed to adjust the purchase price in connection with the Closing by paying an additional $33,705 for the accounts receivable acquired, less $40,760 attributable to deferred revenues recognized on previously collected sales for which services are still pending. The net total of $7,055 was credited as payment at the Closing.

 

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

 

10
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Management believes the product line of Jadian, software 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.

 

The unaudited supplemental pro forma results of operations of the combined entities had the dates of the acquisitions been January 1, 2014 or January 1, 2013 are as follows:

 

   Combined Pro Forma: 
   For the six months ended
June 30,
 
   2014   2013 
Revenue:  $748,952   $745,071 
           
Expenses:          
Operating expenses   3,249,648    2,440,624 
           
Net operating income (loss)   (2,500,696)   (1,695,553)
           
Other income (expense)   (1,972,184)   (366,946)
           
Net income (loss)  $(4,472,880)  $(2,062,499)
           
Weighted average number of common shares          
Outstanding – basic and fully diluted   4,783,826,881    1,666,897,778 
           
Net income (loss) per share – basic and fully diluted  $(0.00)  $(0.00)

 

Stock Purchase Acquisition – Telecorp Products, Inc., February 28, 2014

On February 28, 2014, the Company entered into a Stock Purchase Agreement (the “Telecorp Purchase Agreement”) with Troy Holdings International, Inc., an Ontario Canada corporation (“Troy Holdings”), Telecorp Products, Inc. a Michigan corporation and Troy, Inc., a shareholder and the sole stockholder of Telecorp. Pursuant to the Telecorp Purchase Agreement, the Company purchased 100% of the outstanding shares of Telecorp from Troy Holdings, for an aggregate purchase price of $302,000 (the “Purchase Price”). The Purchase Price was payable as follows:

 

  (a) The Company paid Troy Holdings $200,000 at the Closing (the “Cash Consideration”) of the Telecorp Purchase Agreement; and
  (b) The Company provided Troy Holdings with a Promissory Note in the amount of $102,000 (the “Telecorp Note”), as adjusted from an original $120,000 by $18,000 of liabilities acquired in excess of the agreed upon limit of $50,000 of liabilities, which provides for six (6) equal monthly payments of $20,000 commencing thirty (30) days after the Closing. The Telecorp Note is non-interest bearing except upon default, in which case the interest rate shall be 10% per annum.

 

Additionally, the Company agreed to assume aggregate outstanding Telecorp liabilities of up to $50,000 in connection with the Closing. A total of $68,000 of liabilities was actually acquired, and the resulting $18,000 of excess liabilities was credited as payment against the Telecorp Note. As a result of the Closing, Telecorp became a wholly-owned subsidiary of the Company.

 

Telecorp developed and sells software to effectively operate contact centers. Telecorp’s solutions work with equipment from the giants of the computer telephony industry, such as Avaya, Cisco and Nortel Networks. In connection with the Stock Purchase Agreement, the shareholders of Telecorp and the Company entered into a Non-Disclosure/Non-Compete Agreement, pursuant to which the shareholders of Telecorp and the Company, each agreed to not for a period of one (1) year, communicate or divulge to, or use for the benefit of itself or any other person, firm, association or corporation, any information in any way relating to the Proprietary Property, in competition with the business of the Company, and pursuant to the agreement, the shareholders of Telecorp agreed not to compete against the Company for one (1) year from the closing of the acquisition.

 

 

11
 

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 $428,577 of goodwill. According to the purchase method of accounting, the Company recognized the identifiable assets acquired and liabilities assumed as follows:

 

   February 28, 
   2014 
Consideration:     
Cash paid at, and prior to, closing  $200,000 
Seller financed note payable(1)(2)   120,000 
Excess liability adjustment to seller financed note payable(3)   (18,000)
    302,000 
Fair value of identifiable liabilities acquired:     
Accounts payable and accrued expenses   43,500 
Deferred revenue   162,016 
Line of credit   24,500 
Fair value of total consideration exchanged  $532,016 
      
Fair value of identifiable assets acquired assumed:     
Cash  $736 
Other current assets   823 
Technology-based intangible assets   72,490 
Trade name   29,390 
Total fair value of assets assumed   103,439 
Consideration paid in excess of fair value (Goodwill)(4)  $428,577 

 

(1)Consideration included an unsecured $120,000 seller financed note payable (“Telecorp Note”), which provides for six (6) equal monthly payments of $20,000 commencing thirty (30) days after the Closing. The Telecorp Note is non-interest bearing except upon default, in which case the interest rate shall be 10% per annum.

 

(2)The fair value of the seller financed note in excess of the $102,000 principal balance attributable to the deferred payment terms will be amortized to interest expense over the deferred financing period.

 

(3)The Company agreed to assume aggregate outstanding Telecorp liabilities of up to $50,000 in connection with the Closing. A total of $68,000 of liabilities was actually acquired, and the resulting $18,000 of excess liabilities was credited as payment against the Telecorp Note.

 

(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 Telecorp, 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.

 

 

12
 

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, 2014 or January 1, 2013 are as follows:

 

    Combined pro Forma:
    For the six months ended
June 30,
    2014   2013
Revenue: $ 668,780   $ 775,668
             
Expenses:          
  Operating expenses   3,190,846     2,550,029
             
Net operating income (loss)   (2,522,066)     (1,774,361)
             
  Other income (expense)   (1,968,126)     (359,687)
             
Net income (loss) $ (4,490,192)   $ (2,134,048)
             
Weighted average number of common shares          
  Outstanding – basic and fully diluted   4,783,826,881     1,666,897,778
             
Net income (loss) per share – basic and fully diluted $ (0.00)   $ (0.00)

 

Note 5 – Related Parties

 

Debt Financings

From time to time we have received and repaid loans from our CEO and his immediate family members to fund operations. These related party debts are fully disclosed in Note 13 below.

 

In addition to the debts disclosed in Note 13, we had a convertible note with a related party that is disclosed in Note 14 as follows:

 

   June 30,
2014
   December 31,
2013
 
Originated April 2, 2014, an unsecured $51,000 convertible promissory note, carried a 15% interest rate, matured on August 1, 2014, (“First Vivienne Passley Note”) owed to Vivienne Passley, a related party. The convertible promissory note was issued in exchange for a promissory note originally issued on August 12, 2013 to the same debt holder, which did not carry conversion terms. The principal and accrued interest was convertible into shares of common stock at the discretion of the note holder at a fixed conversion price of $0.0001 per share. The debt holder was limited to owning 4.99% of the Company’s issued and outstanding shares. The debt modification resulted in a loss on debt modifications, related party of $172,864. The assigned principal of $51,000, interest of $4,933 and liquidated damages incurred prior to assignment of $2,500 was subsequently converted to a total of 584,333,745 shares of common stock over various dates from April 2, 2014 to June 17, 2014 in complete satisfaction of the debt.  $   $ 

 

 

13
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

           
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, $40,000 into 50,000,000 shares pursuant to debt conversion on April 10, 2013, $26,400 into 80,000,000 shares pursuant to debt conversion on July 9, 2013 and $32,000 into 40,000,000 shares pursuant to debt conversion on August 7, 2013, $18,750 into 125,000,000 shares pursuant to debt conversion on April 7, 2014, $20,000 into 200,000,000 shares pursuant to debt conversion on May 3, 2014, and $15,000, consisting of $7,699 of principal and $7,301 of interest into 150,000,000 shares pursuant to the final debt conversion on May 22, 2014.       46,449 
           
Total convertible debts, related parties       46,449 
Less: unamortized discount on beneficial conversion feature       (5,653)
Convertible debts       40,796 
Less: current maturities of convertible debts, related parties included in convertible debts        
Long term convertible debts, related parties included in convertible debts  $   $40,796 

  

Changes in Stockholders’ Equity, Related Parties

 

Dividends Payable

On January 1, 2013, the Company declared and accrued dividends quarterly 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. Dividends equal to 1.5% of the Company’s revenues per quarter during the year ending December 31, 2013 accrue quarterly, resulting in a dividend payable of $11,000, which was subsequently paid on September 11, 2014, with the issuance of 110,000,000 shares of Class A Common Stock in lieu of cash.

 

Shares of Convertible Series C Preferred Stock Issued for Services to Related Parties

On January 17, 2014, the Company issued 600,000,000 shares of the recently designated Series C Convertible Preferred Stock to the Company’s CEO in exchange for 600,000,000 shares of his previously issued Class A Common Stock. The total fair value of the Series C Convertible Preferred Stock was $568,283 based on an independent valuation on the date of grant; therefore the Company recognized additional compensation expense of $345,427 due to the difference in the fair value of the Class A Common Stock exchanged.

 

On February 7, 2014, the Company issued 2,000,000 shares of Convertible Series C Preferred Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost in consideration for a $26,000 short term promissory note. The total fair value of the common stock was $2,385 based on an independent valuation on the date of grant.

 

On February 21, 2014, the Company issued 10,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $75,000 short term promissory note. The total fair value of the common stock was $9,562 based on an independent valuation on the date of grant.

 

On February 22, 2014, the Company issued 15,000,000 shares of Convertible Series C Preferred Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost in consideration for a $100,000 short term promissory note. The total fair value of the common stock was $14,266 based on an independent valuation on the date of grant.

 

On March 7, 2014, the Company issued 3,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $30,000 short term promissory note. The total fair value of the common stock was $2,912 based on an independent valuation on the date of grant.

 

14
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

On March 22, 2014, the Company issued 200,000,000 shares of Convertible Series C Preferred Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, for providing a personal guaranty on an acquisition loan. The total fair value of the common stock was $127,746 based on an independent valuation on the date of grant.

 

On March 22, 2014, the Company issued 200,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, for providing a personal guaranty on an acquisition loan. The total fair value of the common stock was $127,746 based on an independent valuation on the date of grant.

 

On March 22, 2014, the Company issued 1,821,052,632 shares of the Series C Convertible Preferred Stock to the Company’s CEO in exchange for 1,821,052,632 shares, consisting of 1,730,526,316 previously issued and unvested shares of Class A Common Stock and 90,526,316 shares of his previously issued and vested Class A Common Stock. The vesting terms were accelerated commensurate with the exchange. The total fair value of the Series C Convertible Preferred Stock was $1,163,162 based on an independent valuation on the date of grant; therefore the Company recognized additional compensation expense of $707,025 due to the difference in the fair value of the Class A Common Stock exchanged.

 

On March 22, 2014, the Company issued 13,669,568 shares of the Series C Convertible Preferred Stock to L&F Lawn Services, a company owned by our CEO’s family member, a related party, in exchange for 13,669,568 of their previously issued Class A Common Stock. The total fair value of the Series C Convertible Preferred Stock was $8,731 based on an independent valuation on the date of grant; therefore the Company recognized additional compensation expense of $5,370 due to the difference in the fair value of the Class A Common Stock exchanged.

 

On March 22, 2014, the Company issued 60,000,000 shares of the Series C Convertible Preferred Stock to the Company’s CEO in exchange for 60,000,000 shares, consisting of 54,000,000 previously issued and unvested shares of Class A Common Stock and 6,000,000 shares of his previously issued and vested Class A Common Stock. The vesting terms were accelerated commensurate with the exchange. The total fair value of the Series C Convertible Preferred Stock was $38,324 based on an independent valuation on the date of grant; therefore the Company recognized additional compensation expense of $23,295 due to the difference in the fair value of the Class A Common Stock exchanged.

 

Debt Conversions into Class A Common Stock – Related Parties

On April 2, 2014, the Company issued 250,000,000 shares of Class A Common Stock pursuant to the conversion of $25,000 of convertible debt held by Vivienne Passley, 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 April 7, 2014, the Company issued 125,000,000 shares of Class A Common Stock pursuant to the conversion of $18,750 of convertible debt held by Star Financial Corporation, 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 3, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by Star Financial Corporation, 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 22, 2014, the Company issued 150,000,000 shares of Class A Common Stock pursuant to the conversion of $15,000 of convertible debt held by Star Financial Corporation, 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 June 17, 2014, the Company issued 334,333,745 shares of Class A Common Stock pursuant to the conversion of $33,433 of convertible debt held by Vivienne Passley, a related party, which consisted of $26,000 of principal, $4,933 of interest and $2,500 of liquidated damages. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

Convertible Class B Common Stock Issuance for Services

On March 22, 2014, the Company issued 12,500,000 shares of Convertible Class B Common Stock to the Company’s CEO in consideration for providing services. The total fair value of the common stock was $44,737 based on the closing price of the Company’s common stock on the date of grant.

 

Subscriptions Payable Issued for Shares of Class A Common Stock Granted for Services

On April 23, 2014, the Company granted 3,500,000 shares of Class A Common Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $35,000 short term promissory note. The total fair value of the common stock was $1,050 based on the closing price of the Company’s common stock on the date of grant. The shares were subsequently issued on August 29, 2014.

 

15
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

On April 24, 2014, the Company granted 10,000,000 shares of Class A Common Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost in consideration for a $150,000 short term promissory note. The total fair value of the common stock was $3,000 based on the closing price of the Company’s common stock on the date of grant. The shares were subsequently issued on August 29, 2014.

 

On May 7, 2014, the Company granted 10,000,000 shares of Class A Common Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost in consideration for a $125,000 short term promissory note. The total fair value of the common stock was $2,000 based on the closing price of the Company’s common stock on the date of grant. The shares were subsequently issued on August 29, 2014.

 

On May 28, 2014, the Company granted 3,250,000 shares of Class A Common Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $32,500 short term promissory note. The total fair value of the common stock was $650 based on the closing price of the Company’s common stock on the date of grant. The shares were subsequently issued on August 29, 2014.

 

On June 12, 2014, the Company granted 2,125,000 shares of Class A Common Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $5,000 short term promissory note. The total fair value of the common stock was $213 based on the closing price of the Company’s common stock on the date of grant. The shares were subsequently issued on August 29, 2014.

 

Subscriptions Payable Issued for Shares of Convertible Series C Preferred Stock Granted for Services

On January 15, 2014, the Company granted 5,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $43,000 short term promissory note. The total fair value of the common stock was $6,465 based on an independent valuation on the date of grant. The shares were subsequently issued on July 7, 2014.

 

On February 8, 2014, the Company granted 1,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $13,000 short term promissory note. The total fair value of the common stock was $1,193 based on an independent valuation on the date of grant. The shares were subsequently issued on July 7, 2014.

 

On March 7, 2014, the Company granted 2,000,000 shares of Convertible Series C Preferred Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost in consideration for a $22,000 short term promissory note. The total fair value of the common stock was $1,942 based on an independent valuation on the date of grant. The shares were subsequently issued on July 7, 2014.

 

On March 26, 2014, the Company granted 3,000,000 shares of Convertible Series C Preferred Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost in consideration for a $37,500 short term promissory note. The total fair value of the common stock was $2,928 based on an independent valuation on the date of grant. The shares were subsequently issued on July 7, 2014.

 

On March 26, 2014, the Company granted 3,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $25,000 short term promissory note. The total fair value of the common stock was $2,928 based on an independent valuation on the date of grant. The shares were subsequently issued on July 7, 2014.

 

On March 28, 2014, the Company granted 2,000,000 shares of Convertible Series C Preferred Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost in consideration for a $18,750 short term promissory note. The total fair value of the common stock was $1,594 based on an independent valuation on the date of grant. The shares were subsequently issued on July 7, 2014.

 

On March 28, 2014, the Company granted 3,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $25,000 short term promissory note. The total fair value of the common stock was $2,390 based on an independent valuation on the date of grant. The shares were subsequently issued on July 7, 2014.

 

Equity Based Debt Settlement Financing, Conversions into Class A Common Stock – IBC Funds, LLC

On February 14, 2014, IBC Funds, LLC (“IBC”) filed a Joint Motion for Approval of Settlement Agreement and Stipulation, and Request for Fairness Hearing in the Circuit Court of the Twelfth Judicial Circuit in and for Sarasota County, Florida, Case No. 2014-CA-000899. IBC has contracted with various note holders of the Company to acquire approximately $314,021 of Company debt and subsequently converted the debt to common stock of the Company at 50% of the lowest trading price over the 15 days prior to, and including the conversion request date pursuant to Section 3(a)(10) of the Securities Act of 1933, which allows the exchange of claims, securities, or property for stock when the arrangement is approved for fairness by a court proceeding. In addition, the Company agreed to issue 75,000,000 settlement shares to IBC. The Company has agreed to these terms as the acquisition of these debts and subsequent conversion would alleviate a significant portion of the Company’s liabilities. A fairness hearing was held on February 14, 2014 and the arrangement was approved. A total of 3,040,823,600 shares of Class A Common Stock was issued, in addition to the 75,000,000 settlement shares, in complete satisfaction of the debt, as disclosed in detail below.

 

16
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Employment Agreement

On September 6, 2012, we entered into an employment agreement with Shaun Passley, Ph.D., our Chief Executive Officer, President, and Chairman of the Board of Directors which had a term of ten (10) years. Compensation pursuant to the agreement calls for a base salary of $180,000 per year; of which $30,000 shall be payable annually in cash and $150,000 shall be payable in shares of the Company’s Common Stock at the rate of $0.006 per share, or 25,000,000 shares per year. In addition, the Company issued 1 billion shares of Class A Common Stock to the Company’s CEO as a bonus in consideration for various services performed, and to be performed over a ten year period beginning on September 6, 2012, provided that all of the shares remain subject to forfeiture until such time, if ever, as we generate annual revenues of at least $10 million, subject to the below termination provisions. The total fair value of the common stock was $6,000,000 based on the closing price of the Company’s common stock on the date of grant, which has been 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. The vesting restrictions were subsequently lifted on March 22, 2014 pursuant to the exchange of these shares for Convertible Series C Preferred shares. In the event of the termination of Dr. Passley’s employment agreement for cause by the Company or without good reason by Dr. Passley, any non-vested shares are to be cancelled and he is to be paid any consideration he is owed through the date of termination. In the event of the termination of Dr. Passley’s employment agreement for good reason (as described in the agreement) by Dr. Passley or without cause by the Company, he is due eight additional weeks of compensation and all non-vested shares vest to him immediately. In the event of the termination of Dr. Passley’s employment agreement for any other reason, he is due eight weeks of additional salary and any non-vested shares are to be cancelled.

 

We do not have an employment or consultant agreement with Craig Passley, our Secretary, however on March 20, 2013, we granted 60 million shares to Craig Passley for services rendered between 2012 and 2021. The shares vest annually over the 10 year period with the first 6 million vesting upon the grant date. The vesting restrictions were subsequently lifted on March 22, 2014 pursuant to the exchange of these shares for Convertible Series C Preferred shares.

 

Amendments to Employment Agreement

On August 16, 2013, the Company amended Shaun Passley, Ph.D.’s employment agreement to increase the cash portion of his compensation from $30,000 per year to $100,000 in the initial year of the agreement only. All other terms remain in effect, and the shares of stock awarded as a bonus as previously disclosed were granted in addition to the stock based compensation outlined in the original agreement.

 

Note 6 – 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.

 

17
 

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 June 30, 2014 and December 31, 2013:

 

   Fair Value Measurements at June 30, 2014 
   Level 1   Level 2   Level 3 
Assets               
Cash  $101,871   $   $ 
Intangible assets           476,418 
Goodwill           1,149,041 
Total assets   101,871        1,625,459 
Liabilities               
Lines of credit       86,544     
Capital leases       8,161     
Notes payable, related parties       930,868     
Convertible debts, net of discount of $1,112       151,163     
Long term debts, including current maturities       1,652,370     
Total Liabilities       2,829,106     
   $101,871   $(2,829,106)  $1,625,459 

 

   Fair Value Measurements at December 31, 2013 
   Level 1   Level 2   Level 3 
Assets               
Cash  $208,567   $   $ 
Intangible assets           374,162 
Goodwill           255,460 
Total assets   208,567        629,622 
Liabilities               
Lines of credit       73,232     
Capital leases       17,421     
Long term debts       1,211,929     
Notes payable, related parties       482,368     
Convertible debts, net of discount of $109,583       157,294     
Total Liabilities       1,942,244     
   $208,567   $(1,942,244)  $629,622 

 

There were no transfers of financial assets or liabilities between Level 1 and Level 2 inputs for the six months ended June 30, 2014 and the year ended December 31, 2013.

 

Level 2 liabilities consist of various debt arrangements, and Level 3 assets consist of intangible assets and goodwill. Fair value adjustments related to the measurement of intangible assets of $-0- and $276,282 were necessary during the six months ended June 30, 2014 and December 31, 2013, respectively.

 

Note 7 – Other Current Assets

 

As of June 30, 2014 and December 31, 2013, other current assets included the following:

 

   June 30,   December 31, 
   2014   2013 
Deferred financing costs  $47,980   $44,986 
Other receivable   38    51,250 
Security deposits   17,378    9,878 
   $65,396   $106,114 

 

The Company recognized $233,277 and $19,905 of amortization expense related to the deferred financing costs during the six months ended June 30, 2014 and 2013, respectively.

 

18
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 8 – Property and Equipment

 

Property and Equipment consists of the following at June 30, 2014 and December 31, 2013, respectively:

 

   June 30,   December 31, 
   2014   2013 
Furniture and fixtures  $23,279   $2,187 
Computers and equipment   182,074    325,105 
Software   15,660    67,986 
Assets held under capital leases   17,855    134,800 
    238,868    530,078 
Less accumulated depreciation and amortization   (107,895)   (416,668)
   $130,973   $113,410 

 

Depreciation and amortization expense totaled $25,949 and $56,837 for the six months ended June 30, 2014 and 2013, respectively.

 

A total of $334,722 of fully depreciated assets no longer in service was disposed of on March 31, 2014. No proceeds were received on disposal, resulting in no gain or loss on disposal during the six months ending June 30, 2014.

 

Note 9 – Intangible Assets

 

Intangible assets consisted of the following at June 30, 2014 and December 31, 2013, respectively:

 

   Useful   June 30,   December 31, 
Description  Life   2014   2013 
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 
Technology-based intangible assets – Telecorp   5 Years    72,490     
Technology-based intangible assets – Cynergy   5 Years    8,035     
Technology-based intangible assets – Jadian   5 Years    37,180     
Contracts – MS Health   6 Years    258,000    258,000 
Trade name - K9 Bytes   5 Years    22,000    22,000 
Trade name - Telecorp   5 Years    29,390     
Trade name - Cynergy   5 Years    1,826     
Trade name - Jadian   5 Years    24,941     
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        863,862    690,000 
Less: accumulated amortization        (387,444)   (315,838)
Intangible assets, net       $476,418   $374,162 

 

Amortization expense on intangible assets totaled $71,606 and $87,324 for the six months ended June 30, 2014 and 2013, respectively.

 

Note 10 – Convertible Settlement

 

On February 14, 2014, the Circuit Court of the Twelfth Judicial Circuit in and for Sarasota County, Florida approved the February 12, 2014, Settlement Agreement, entered into between the Company and IBC Funds, LLC (“IBC”) whereby a total of $314,021 of outstanding debts that were acquired by IBC from various creditors, including $288,071 of outstanding debts previously owed to related parties was sold and assigned to IBC. In satisfaction of the outstanding debts acquired by IBC, we agreed to issue IBC shares of our common stock at a 50% discount to the lowest trading price during the fifteen (15) trading days preceding the share request (“Settlement Shares”) in various tranches in an aggregate amount equal to the claim amount of $314,021 until such time as the debts were satisfied. A total of 3,040,823,600 Settlement Shares were subsequently issued pursuant to the Settlement Agreement, in addition to 75,000,000 shares that were issued in consideration pursuant to the settlement agreement. IBC is precluded from owning more than 9.99% of the Company’s common stock in aggregate at any given time. The net proceeds, less the 50% discount retained by IBC, received from the sale of the Settlement Shares in the market were used to satisfy the Company’s outstanding obligations that were acquired by IBC. The convertible settlements liability was fully converted as of June 30, 2014.

 

19
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 11 – Lines of Credit

 

Lines of credit consisted of the following at June 30, 2014 and December 31, 2013, respectively:

 

   June 30,   December 31, 
   2014   2013 
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.  $49,908   $49,508 
           
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.   16,351    18,087 
           
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.       5,637 
           
Line of credit of $25,000 from Bank of America. The outstanding balance on the line of credit bears interest at a rate of 4.25%. Variable payments are due monthly. A total of $24,500 was acquired with the acquisition of Telecorp.   20,285     
           
Total line of credit   86,544    73,232 
Less: current portion   (86,544)   (73,232)
Line of credit, less current portion  $   $ 

 

Note 12 – 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 following 46 months.

 

Lease #2 – 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 $17,855 and $134,800 at June 30, 2014 and December 31, 2013, respectively. Accumulated amortization of the leased equipment was $8,928 and $116,292 at June 30, 2014 and 2013, respectively. Amortization of assets under capital leases is included in depreciation and amortization expense.

 

The future minimum lease payments required under the capital leases and the present value of the net minimum lease payments as of June 30, 2014, are as follows:

 

Twelve Months    
      Ending    
     June 30,  Amount 
       2015  $5,757 
       2016   3,311 
Total minimum payments  $9,068 
Less: amount representing interest   (907)
Present value of net minimum lease payments   8,161 
Less: Current maturities of capital lease obligations   (4,987)
Long-term capital lease obligations  $3,174 

 

20
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 13 – Notes Payable, Related Parties

 

Notes payable, related parties consist of the following at June 30, 2014 and December 31, 2013, respectively:

 

   June 30,   December 31, 
   2014   2013 
On various dates, the Company’s CEO advanced and repaid short term loans to the Company. A total of $77,879 and $209,380 was advanced and repaid during the six months ending June 30, 2014 and the year ending December 31, 2013, respectively.  $   $ 
           
Originated June 30, 2014, an unsecured $20,000 promissory note payable, including a $3,500 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on December 30, 2014. The note also carried a liquidated damages fee of $500 upon default, which was amended and removed on September 19, 2014.   20,000     
           
Originated June 12, 2014, an unsecured $21,250 promissory note payable, including a $4,250 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on October 12, 2014. In addition, a loan origination fee consisting of 2,125,000 shares of Class A Common Stock was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $2,500 upon default, which was amended and removed on September 19, 2014.   21,250     
           
Originated June 3, 2014, an unsecured $5,000 promissory note payable, including a $1,000 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carried a 15% interest rate, matures on December 3, 2014. The note also carried a liquidated damages fee of $500 upon default, which was amended and removed on September 19, 2014.   5,000     
           
Originated June 3, 2014, a $25,000 unsecured promissory note payable, including a $4,000 loan origination fee, owed to GG Mars Capital, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carried a 15% interest rate, matures on December 3, 2014. The note also carries a liquidated damages fee of $1,000 upon default, which was amended and removed on September 19, 2014.   25,000     
           
Originated May 28, 2014, an unsecured $32,500 promissory note payable, including a $7,500 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on September 28, 2014. In addition, a loan origination fee consisting of 3,250,000 shares of Class A Common Stock was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $2,500 upon default, which was amended and removed on September 19, 2014.   32,500     
           
Originated May 7, 2014, a $125,000 unsecured promissory note payable, including a $25,000 loan origination fee, owed to GG Mars Capital, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on August 7, 2014. In addition, a loan origination fee consisting of 10,000,000 shares of Class A Common Stock was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $12,500 upon default, which was amended and removed on September 19, 2014.   125,000     
           
Originated April 24, 2014, a $150,000 unsecured promissory note payable, including a $30,000 loan origination fee, owed to GG Mars Capital, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on June 26, 2014. In addition, a loan origination fee consisting of 10,000,000 shares of Class A Common Stock was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $10,000 upon default, which was amended and removed on September 19, 2014.   150,000     

 

 

21
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

           
Originated April 23, 2014, an unsecured $35,000 promissory note payable, including a $7,000 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on August 23, 2014. In addition, a loan origination fee consisting of 3,500,000 shares of Class A Common Stock was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $2,500 upon default, which was amended and removed on September 19, 2014.   35,000     
           
Originated March 28, 2014, an unsecured $25,000 promissory note payable, including a $5,000 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on May 28, 2014. In addition, a loan origination fee consisting of 3,000,000 shares of Convertible Series C Preferred Stock valued at $2,390 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $2,500 upon default, which was amended and removed on September 19, 2014.   25,000     
           
Originated March 28, 2014, an $18,750 unsecured promissory note payable, including a $3,750 loan origination fee, owed to GG Mars Capital, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on May 28, 2014. In addition, a loan origination fee consisting of 2,000,000 shares of Convertible Series C Preferred Stock valued at $1,594 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $7,000 upon default, which was amended and removed on September 19, 2014.   18,750     
           
Originated March 26, 2014, a $37,500 unsecured promissory note payable, including a $7,500 loan origination fee, owed to GG Mars Capital, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on May 26, 2014. In addition, a loan origination fee consisting of 3,000,000 shares of Convertible Series C Preferred Stock valued at $2,928 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $1,500 upon default, which was amended and removed on September 19, 2014.   37,500     
           
Originated March 26, 2014, an unsecured $25,000 promissory note payable, including a $5,000 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on May 26, 2014. In addition, a loan origination fee consisting of 3,000,000 shares of Convertible Series C Preferred Stock valued at $2,928 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $2,500 upon default, which was amended and removed on September 19, 2014.   25,000     
           
Originated March 7, 2014, an unsecured $30,000 promissory note payable, including a $6,000 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on May 7, 2014. In addition, a loan origination fee consisting of 3,000,000 shares of Convertible Series C Preferred Stock valued at $2,912 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $1,500 upon default, which was amended and removed on September 19, 2014.   30,000     
           
Originated March 7, 2014, a $22,000 unsecured promissory note payable, including a $7,000 loan origination fee, owed to GG Mars Capital, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on May 7, 2014. In addition, a loan origination fee consisting of 2,000,000 shares of Convertible Series C Preferred Stock valued at $1,942 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $7,000 upon default, which was amended and removed on September 19, 2014.   22,000     

 

 

22
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

           
Originated February 22, 2014, a $100,000 unsecured promissory note payable, including a $25,000 loan origination fee, owed to GG Mars Capital, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on April 30, 2014. In addition, a loan origination fee consisting of 15,000,000 shares of Convertible Series C Preferred Stock valued at $14,266 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $35,000 upon default, which was amended and removed on September 19, 2014.   100,000     
           
Originated February 21, 2014, an unsecured $75,000 promissory note payable, including a $15,000 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on April 30, 2014. In addition, a loan origination fee consisting of 10,000,000 shares of Convertible Series C Preferred Stock valued at $9,562 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $25,000 upon default, which was amended and removed on September 19, 2014.   75,000     
           
Originated February 8, 2014, an unsecured $13,000 promissory note payable, including a $3,000 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on March 30, 2014. In addition, a loan origination fee consisting of 1,000,000 shares of Convertible Series C Preferred Stock valued at $1,193 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $500 upon default, which was amended and removed on September 19, 2014.   13,000     
           
Originated February 7, 2014, a $26,000 unsecured promissory note payable, including a $6,000 loan origination fee, owed to GG Mars Capital, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on March 30, 2014. In addition, a loan origination fee consisting of 2,000,000 shares of Convertible Series C Preferred Stock valued at $2,385 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $500 upon default, which was amended and removed on September 19, 2014.   26,000     
           
Originated January 15, 2014, an unsecured $43,000 promissory note payable, including a $10,000 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on March 20, 2014. In addition, a loan origination fee consisting of 5,000,000 shares of Convertible Series C Preferred Stock valued at $6,465 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $500 upon default, which was amended and removed on September 19, 2014.   43,000     
           
Originated November 1, 2013, unsecured promissory note payable owed to GG Mars Capital, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on March 7, 2014. In addition, a loan origination fee of $25,000 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carries a liquidated damages fee of $2,500 upon default. As disclosed in Note 10, pursuant to a settlement agreement, dated February 12, 2014, the $125,000 note, along with $8,264 of accrued interest, was sold and assigned to IBC Funds, LLC and was subsequently converted to stock as part of a court order on February 14, 2014 under Section 3(a)(10) of the Securities Act of 1933.       125,000 
           
Originated October 15, 2013, unsecured promissory note payable owed to Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on June 12, 2015. In addition, a loan origination fee of $3,000 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $500 upon default, which was amended and removed on September 19, 2014.   18,000    18,000 

 

23
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

           
Originated September 7, 2013, unsecured promissory note payable owed to GG Mars Capital, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on February 7, 2014. In addition, a loan origination fee of $10,000 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan, as well as, a loan origination fee, consisting of 6,000,000 shares of Series A Common Stock with a fair market value of $6,600 was granted as consideration for the loan on September 7, 2013 and the shares were subsequently issued on November 13, 2013. As disclosed in Note 10, pursuant to a settlement agreement, dated February 12, 2014, the $65,000 balance of this note, along with $7,528 of accrued interest, was sold and assigned to IBC Funds, LLC and was subsequently converted to stock as part of a court order on February 14, 2014 under Section 3(a)(10) of the Securities Act of 1933.       65,000 
           
Originated August 20, 2013, unsecured promissory note payable owed to GG Mars Capital, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on January 20, 2014. In addition, a loan origination fee of $5,000 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan, as well as, a loan origination fee, consisting of 2,500,000 shares of Series A Common Stock with a fair market value of $3,250 was granted as consideration for the loan on August 20, 2013 and the shares were subsequently issued on November 13, 2013. Currently in default.   25,000    25,000 
           
Originated August 12, 2013, unsecured promissory note payable owed to an immediate family member of the Company’s CEO carries a 15% interest rate, matures on February 15, 2014. In addition, a loan origination fee of $6,000 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan, as well as, a loan origination fee, consisting of 5,000,000 shares of Series A Common Stock with a fair market value of $7,000 was issued as consideration for the loan on August 12, 2013. The note, consisting of $51,000 of principal, $4,933 of accrued interest and $2,500 of liquidated damages, was subsequently sold and assigned to a third party and exchanged for a convertible note on April 2, 2014 and the $58,433 was converted in exchange for 584,333,745 shares of common stock in complete satisfaction of the debt.       51,000 
           
Originated July 19, 2013, unsecured promissory note payable owed to an immediate family member of the Company’s CEO carries a 15% interest rate, matures on January 15, 2014. In addition, a loan origination fee of $3,000 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan, as well as, a loan origination fee, consisting of 2,500,000 shares of Series A Common Stock with a fair market value of $4,250 was issued as consideration for the loan on July 19, 2013. The note, consisting of $23,000 of principal and $1,153 of accrued interest, was subsequently sold and assigned to a third party and exchanged for a convertible note on February 4, 2014.       23,000 
           
Originated August 27, 2013, unsecured promissory note payable owed to Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on January 27, 2014. In addition, a loan origination fee of $2,500 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan, as well as, a loan origination fee, consisting of 1,250,000 shares of Series A Common Stock with a fair market value of $1,500 was granted as consideration for the loan on August 27, 2013 and the shares were subsequently issued on November 13, 2013. As disclosed in Note 10, pursuant to a settlement agreement, dated February 12, 2014, the $12,500 note, along with $3,519 of accrued interest, was sold and assigned to IBC Funds, LLC and was subsequently converted to stock as part of a court order on February 14, 2014 under Section 3(a)(10) of the Securities Act of 1933.       12,500 
           
Originated August 7, 2013, unsecured promissory note payable owed to Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on January 20, 2014. In addition, a loan origination fee of $4,000 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan, as well as, a loan origination fee, consisting of 2,500,000 shares of Series A Common Stock with a fair market value of $4,250 was granted as consideration for the loan on August 7, 2013 and the shares were subsequently issued on November 13, 2013. Currently in default.   24,000    24,000 

 

24
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

           
Originated August 2, 2013, unsecured promissory note payable owed to Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on January 17, 2014. In addition, a loan origination fee of $5,000 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan, as well as, a loan origination fee, consisting of 3,000,000 shares of Series A Common Stock with a fair market value of $5,100 was issued as consideration for the loan on August 2, 2013. Currently in default.   32,000    32,000 
           
Originated July 31, 2013, unsecured promissory note payable owed to Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on January 15, 2014. In addition, a loan origination fee of $5,000 was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan, as well as, a loan origination fee, consisting of 3,000,000 shares of Series A Common Stock with a fair market value of $4,200 was issued as consideration for the loan on July 31, 2013. The note, consisting of $32,000 of principal and $5,000 of accrued interest, was subsequently sold and assigned to a third party and exchanged for a convertible note on February 19, 2014.       32,000 
           
Originated June 12, 2013, unsecured promissory note payable owed to Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 10% interest rate, matures on June 12, 2015. In addition, a loan origination fee of $2,000 was issued as consideration for the loan on June 12, 2013, and is being amortized on a straight line basis over the life of the loan. The note, consisting of $10,000 of principal and $338 of accrued interest, was subsequently sold and assigned to a third party and exchanged for a convertible note on February 4, 2014.       10,000 
           
Originated April 12, 2013, unsecured promissory note payable owed to Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 10% interest rate, matures on April 12, 2015. In addition, a loan origination fee of $7,000 was issued as consideration for the loan on April 12, 2013, and is being amortized on a straight line basis over the life of the loan. As disclosed in Note 10, pursuant to a settlement agreement, dated February 12, 2014, the $57,000 note, along with $9,261 of accrued interest, was sold and assigned to IBC Funds, LLC and was subsequently converted to stock as part of a court order on February 14, 2014 under Section 3(a)(10) of the Securities Act of 1933.       57,000 
           
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. Currently in default.   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. Principal of $5,000 was repaid during the first quarter of 2014. Currently in default.   868    5,868 
           
Total notes payable, related parties   930,868    482,368 
Less: current portion   (930,868)   (397,368)
Notes payable, related parties, less current portion  $   $85,000 

 

The Company recorded interest expense on notes payable to related parties in the amounts of $54,002 and $3,320 during the six months ended June 30, 2014 and 2013, respectively.

 

25
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 14 – Convertible Debts

 

Convertible debts consist of the following at June 30, 2014 and December 31, 2013, respectively:

 

   June 30,   December 31, 
   2014   2013 
Originated April 2, 2014, an unsecured $51,000 convertible promissory note, carried a 15% interest rate, matured on August 1, 2014, (“First Vivienne Passley Note”) owed to Vivienne Passley, a related party. The convertible promissory note was issued in exchange for a promissory note originally issued on August 12, 2013 to the same debt holder, which did not carry conversion terms. The principal and accrued interest was convertible into shares of common stock at the discretion of the note holder at a fixed conversion price of $0.0001 per share. The debt holder was limited to owning 4.99% of the Company’s issued and outstanding shares. The debt modification resulted in a loss on debt modifications, related party of $172,864. The assigned principal of $51,000, interest of $4,933 and liquidated damages incurred prior to assignment of $2,500 was subsequently converted to a total of 584,333,745 shares of common stock over various dates from April 2, 2014 to June 17, 2014 in complete satisfaction of the debt.  $   $ 
           
Originated February 19, 2014, an unsecured $37,700 convertible promissory note, carries a 12% interest rate, matures on February 17, 2015, (“Third Magna Group Note”) owed to Magna Group, LLC, consisting of a promissory note acquired and assigned from Star Financial Corporation, a related party, consisting of $32,000 of principal and $5,700 of accrued interest. The acquired promissory note did not carry conversion terms, and were subsequently exchanged for the convertible note. The principal and accrued interest is convertible into shares of common stock at the discretion of the note holder at a price equal to fifty percent (50%) of the lowest trading price of the Company’s common stock for the five (5) days prior to the conversion date, or $0.00004 per share, whichever is greater. The debt holder was limited to owning 4.99% of the Company’s issued and outstanding shares. The assigned principal and interest of $35,491 was subsequently converted to a total of 377,000,000 shares of common stock over various dates from March 10, 2014 to March 19, 2014 in complete satisfaction of the debt.        
           
Originated February 4, 2014, an unsecured $35,491 convertible promissory note, carries a 12% interest rate, matures on February 4, 2015, (“Second Magna Group Note”) owed to Magna Group, LLC, consisting of two notes acquired and assigned from Star Financial Corporation, a related party, consisting of a total of $33,000 of principal and $2,491 of accrued interest. The acquired promissory notes did not carry conversion terms, and were subsequently exchanged for the convertible note. The principal and accrued interest is convertible into shares of common stock at the discretion of the note holder at a price equal to fifty percent (50%) of the lowest trading price of the Company’s common stock for the five (5) days prior to the conversion date, or $0.00004 per share, whichever is greater. The debt holder was limited to owning 4.99% of the Company’s issued and outstanding shares. The assigned principal and interest of $35,491 was subsequently converted to a total of 236,606,400 shares of common stock over various dates from February 13, 2014 to February 27, 2014 in complete satisfaction of the debt.        
           
Unsecured $33,000 convertible promissory note originated on November 13, 2013, including an Original Issue Discount (“OID”) of $3,000, carries a 12% interest rate (“Second JMJ Note”), matures on November 12, 2014. 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 lowest trading price of the Company’s common stock for the twenty five (25) trading days prior to the conversion date, or $0.00009 per share, whichever is greater. The debt holder was limited to owning 4.99% of the Company’s issued and outstanding shares. The unamortized OID is $2,604 at December 31, 2013. On July 11, 2014, the Company and JMJ Financial amended this note. The amendment specifies that due to the previously delinquent SEC filings, any future borrowings shall only be made by mutual agreement of both the borrower and lender.   33,000    33,000 

 

26
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

           
Unsecured $35,028 convertible promissory note originated on December 31, 2013, carries an 12% interest rate (“First Magna Group Note”) owed to Magna Group, LLC. Two notes totaling $33,000 of principal and $1,028 of accrued interest were acquired from and assigned by Star Financial on December 31, 2013 prior to being exchanged for the convertible note, including $1,000 of loan origination costs. The principal and accrued interest is convertible into shares of common stock at the discretion of the note holder at a price equal to fifty percent (50%) of the lowest trading price of the Company’s common stock for the five (5) days prior to the conversion date, or $0.00004 per share, whichever is greater. The debt holder was limited to owning 4.99% of the Company’s issued and outstanding shares. The assigned principal and interest of $35,028 was subsequently converted to a total of 216,806,667 shares of common stock over various dates from January 7, 2014 to February 6, 2014 in complete satisfaction of the debt.       35,028 
           
Unsecured $56,900 convertible promissory note, including an Original Issue Discount (“OID”) of $6,900, carries an 8% interest rate (“First St. George Note”), matures on May 30, 2014. 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 $0.00005 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 note holder converted $15,000 of outstanding principal into 125,000,000 shares pursuant to debt conversion on March 7, 2014.The unamortized OID is $3,791 at December 31, 2013. During the 2nd quarter of 2014, a total of $77,375 of principal and another $7,512 of accrued interest was added to the debt due to default provisions, including $25,000 of principal due to a Late Clearing Adjustment penalty. Currently in default.   119,275    56,900 
           
Unsecured $42,500 convertible promissory note carries an 8% interest rate (“Eighth Asher Note”), matures on June 20, 2014. 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 $0.00005 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 note holder converted $41,000 of outstanding principal into 341,666,667 shares pursuant to debt conversion on March 25, 2014, and $2,750, consisting of $1,500 of principal and $1,250 of interest was repaid in cash during the second quarter of 2014.       42,500 
           
Unsecured $53,000 convertible promissory note carries an 8% interest rate (“Seventh Asher Note”), matures on May 21, 2014. 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 $0.00005 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 note holder converted $27,000 of outstanding principal into 150,000,000 shares pursuant to debt conversion on March 3, 2014, and $28,120, consisting of $26,000 of principal and $2,120 of accrued interest into 200,857,143 shares pursuant to debt conversion on March 5, 2014 in complete satisfaction of the debt.       53,000 

 

27
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

           
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, $40,000 into 50,000,000 shares pursuant to debt conversion on April 10, 2013, $26,400 into 80,000,000 shares pursuant to debt conversion on July 9, 2013 and $32,000 into 40,000,000 shares pursuant to debt conversion on August 7, 2013, $18,750 into 125,000,000 shares pursuant to debt conversion on April 7, 2014, $20,000 into 200,000,000 shares pursuant to debt conversion on May 3, 2014, and $15,000, consisting of $7,699 of principal and $7,301 of interest into 150,000,000 shares pursuant to the final debt conversion on May 22, 2014.       46,449 
Total convertible debts   152,275    266,877 
Less: unamortized discount on beneficial conversion feature       (103,188)
Less: unamortized OID   (1,112)   (6,395)
Convertible debts   151,163    157,294 
Less: current maturities of convertible debts   (151,163)   (115,128)
Long term convertible debts  $   $42,166 

 

The Company recognized interest expense in the amount of $97,918 and $30,867 for the six months ended June 30, 2014 and 2013, 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 $195,652 during the six months ended June 30, 2014 and the year ended December 31, 2013, 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, $95,500 from Asher Enterprises, $33,000 from JMJ Financial, Inc., and $56,900 from St. George Investments 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 of 9.99% of the issued and outstanding shares of Epazz.

 

During the six months ended June 30, 2014 and 2013, the Company recorded debt amortization expense in the amount of $73,443 and $128,612, respectively, attributed to the aforementioned debt discount, including $5,283 and $3,411 of amortization on Original Issue Discounts during the six months ended June 30, 2014 and 2013, respectively.

 

During the six months ended June 30, 2014, the Company issued a total of 4,688,760,477 shares pursuant to debt conversions in settlement of $533,360, consisting of $531,240 of outstanding principal and $2,120 of unpaid interest. In addition, the Company issued a total of 1,059,333,745 shares pursuant to related party debt conversions in settlement of $112,183, consisting of $97,449 of outstanding principal, $12,234 of unpaid interest and $2,500 of liquidated damages during the six months ended June 30, 2014. The principal and interest was converted in accordance with the conversion terms, therefore no gain or loss has been recognized.

 

28
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

During year ended December 31, 2013, the Company issued a total of 462,766,951 shares pursuant to debt conversions in settlement of $343,540, consisting of $336,094 of outstanding principal and $7,446 of unpaid interest, including 220,000,000 shares pursuant to debt conversion in settlement of $144,400 of outstanding principal owed to a related party (“Star Convertible Note”) and 46,856,526 shares pursuant to debt conversion in settlement of $14,838 of outstanding principal owed to a related party (“GG Mars Capital Convertible Note”). The principal and interest was converted in accordance with the conversion terms, therefore no gain or loss has been recognized. In addition, 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.

 

Asher Enterprises, Inc. Convertible Notes

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 had a maturity date of March 29, 2013, and was 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 were 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 $-0- and $11,760 was amortized during the six months ended June 30, 2014 and 2013, 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 had a maturity date of April 26, 2013, and was 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 were 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.

 

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 $-0- and $11,751 was amortized during the six months ended June 30, 2014 and 2013, 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 had a maturity date of July 18, 2013, and was 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 were 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.

 

29
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 $-0- and $19,900 was amortized during the six months ended June 30, 2014 and 2013, 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 had a maturity date of September 14, 2013, and was 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 were 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.

 

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 $-0- and $15,364 was amortized during the six months ended June 30, 2014 and 2013, respectively.

 

On August 19, 2013, 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 $53,000. The Seventh Asher Note had a maturity date of May 21, 2014, and was 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 $0.00005 per share. The shares of common stock issuable upon conversion of the Seventh Asher Note were restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the Seventh 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 Seventh 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 $0.0006 below the market price on August 19, 2013 of $0.0014 provided a value of $39,021, of which $20,007 and $-0- was amortized during the six months ended June 30, 2014 and 2013, respectively.

 

On September 18, 2013, 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 Eighth Asher Note had a maturity date of June 20, 2014, and was 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 $0.00005 per share. The shares of common stock issuable upon conversion of the Eighth Asher Note were restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the Eighth 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 Eighth 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 $0.0004 below the market price on September 18, 2013 of $0.0010 provided a value of $27,210, of which $16,920 and $-0- was amortized during the six months ended June 30, 2014 and 2013, respectively.

 

30
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

GG Mars Capital, Inc. Convertible Note, Related Party

On August 20, 2013, we entered into a Convertible Promissory Note Agreement with GG Mars Capital, Inc. (“GG Mars”), a company owned by our CEO’s family member, pursuant to which we sold to GG Mars an 11% Convertible Promissory Note in the original principal amount of $14,838. The note was acquired from and assigned by another independent lender on August 15, 2013 prior to being exchanged for the convertible note. The First GG Mars Note was convertible into shares of common stock at the discretion of the note holder at a price equal to fifty percent (50%) of the average of the three lowest closing prices of the Company’s common stock for the one hundred and twenty (120) days prior to the conversion date, or $0.0001 per share, whichever is greater. The shares of common stock issuable upon conversion of the First GG Mars Note were restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the First GG Mars Note was exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The debt holder was limited to owning 4.99% of the Company’s issued and outstanding shares. The purchaser was an accredited and sophisticated investor, familiar with our operations, and there was no solicitation.

 

The Company evaluated the First GG Mars 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 $0.001 below the market price on August 20, 2013 of $0.0013 provided a value of $14,838, of which $-0- and $-0- was amortized during the six months ended June 30, 2014 and 2013, respectively.

 

Star Financial, Inc. Convertible Note, Related Party

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 note was again modified on March 5, 2013, resulting in a loss on debt modification of $81,792. 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 50% multiplied by the Market Price (representing a discount rate of 50%). “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 $0.00075 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 $5,653 and $24,176 was amortized during the six months ended June 30, 2014 and 2013, respectively.

 

Tonaquint, Inc. Convertible Note

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 $-0- and $32,669 was amortized during the six months ended June 30, 2014 and 2013, respectively.

 

31
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

JMJ Financial, Inc. Convertible Note

On June 12, 2013, we entered into a Securities Purchase Agreement with JMJ Financial, Inc., (“JMJ”) pursuant to which we sold to JMJ a 12% Convertible Promissory Note in the original principal amount of $33,000. The First JMJ Note had a maturity date of June 11, 2014, and was convertible into our common stock at the greater of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price, not less than $0.00009 per share. The “Variable Conversion Price” shall mean 60% multiplied by the Market Price (representing a discount rate of 40%). “Market Price” means the lowest Trading Price for the Common Stock during the twenty five (25) 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 JMJ Note were restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the First JMJ 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 JMJ 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 June 12, 2013 of $0.0017 provided a value of $33,000, of which $-0- and $9,581 was amortized during the six months ended June 30, 2014 and 2013, respectively.

 

On November 13, 2013, we drew additional funds on the June 12, 2013 Securities Purchase Agreement with JMJ Financial, Inc., (“JMJ”) pursuant to which we sold to JMJ another 12% Convertible Promissory Note in the original principal amount of $33,000. The Second JMJ Note has a maturity date of November 12, 2014, and was convertible into our common stock at the greater of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price, not less than $0.00009 per share. The “Variable Conversion Price” shall mean 60% multiplied by the Market Price (representing a discount rate of 40%). “Market Price” means the lowest Trading Price for the Common Stock during the twenty five (25) 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 JMJ Note were restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the Second JMJ 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 JMJ 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 $0.00024 was above the market price on November 13, 2013 and did not result in a beneficial conversion feature.

 

St. George Investments, Inc. Convertible Note

On September 5, 2013, we entered into a Securities Purchase Agreement with St. George Investments, Inc., (“First St. George Note”) pursuant to which we sold to St. George an 8% Convertible Promissory Note in the original principal amount of $56,900. The First St. George Note has a maturity date of May 30, 2014, 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 two lowest Closing Bid 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 $0.00005 per share. The shares of common stock issuable upon conversion of the First St. George Note are restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the First St. George Note is exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser is an accredited and sophisticated investor, familiar with our operations, and there was no solicitation.

 

On September 24, 2014, St. George Investments, LLC (“note holder”) presented the Company with a notice of default. In accordance with the default provisions, the note began to accrue interest at twenty two percent (22%) per annum effective March 31, 2014. The unsecured convertible promissory note with $41,900 of principal outstanding (“First St. George Note”) matured on June 5, 2014 and was in default effective April 1, 2014 pursuant to Section 3.2 of the Note. In accordance with the default provisions, the outstanding balance prior to the occurrence of default shall increase to 150% of the outstanding balance of principal and interest a maximum of two times. In addition, the note holder was precluded from clearing the conversion of 125,000,000 shares of common stock received pursuant to a March 7, 2014 conversion of $15,000 of outstanding principal until September 10, 2014 (“Late Clearing Adjustment Amount”). Pursuant to Section 1.6(g) of the Note, the note holder was entitled to increase the outstanding balance of the Note by the Late Clearing Adjustment Amount of $25,000. As a result of the Late Clearing Adjustment Amount and Note defaults on April 1, 2014 and June 5, 2014, the principal and interest on the First St. George Note has increased to $136,738 as of September 24, 2014.

 

The Company evaluated the First St. George 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 $0.0005 below the market price on September 5, 2013 of $0.0012 provided a value of $46,555, of which $25,580 and $-0- was amortized during the six months ended June 30, 2014 and 2013, respectively.

 

32
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Derivative Liabilities

In accordance with ASC 815-15, the Company determined that the variable conversion feature and shares to be issued with respect to the Magna Group, LLC convertible notes and the convertible debt with IBC Funds, LLC represented embedded derivative features, and these are shown as derivative liabilities on the balance sheet. The Company calculated the fair value of the compound embedded derivatives associated with the convertible debentures utilizing a lattice model.

 

The aforementioned accounting treatment resulted in a total debt discount equal to $422,240 and $-0- during the six months ended June 30, 2014 and the year ended December 31, 2013, respectively. The discount was amortized using the effective interest method from the dates of issuance until the stated redemption date of the debts, or the accelerated dates of conversion. A total of $422,240 and $-0- was amortized during the six months ended June 30, 2014 and 2013, respectively.

 

Magna Group, LLC Convertible Note

On December 31, 2013, we issued to Magna Group, LLC (“First Magna Group Note”) a 12% Convertible Promissory Note in the original principal amount of $35,028. The note was issued in exchange for two notes totaling $33,000 of principal and $1,028 of accrued interest, along with a $1,000 origination fee, that were acquired from, and assigned by, Star Financial on December 31, 2013. The First Magna Group Note has a maturity date of December 31, 2014, 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 50% multiplied by the Market Price (representing a discount rate of 50%). “Market Price” means the lowest Trading Price for the Common Stock during the five (5) day period prior to delivery of the conversion notice. “Fixed Conversion Price” shall mean $0.00004 per share. The shares of common stock issuable upon conversion of the First Magna Group Note are restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the First Magna Group Note is exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser is an accredited and sophisticated investor, familiar with our operations, and there was no solicitation. The Company evaluated the First Magna Group Note and determined that the shares issuable pursuant to the conversion option were indeterminate and constituted a derivative liability.

 

On February 4, 2014, we issued to Magna Group, LLC (“Second Magna Group Note”) a 12% Convertible Promissory Note in the original principal amount of $35,491. The note was issued in exchange for two notes totaling $33,000 of principal and $1,491 of accrued interest, along with a $1,000 origination fee, that were acquired from, and assigned by, Star Financial and Vivienne Passley on February 4, 2014. The Second Magna Group Note has a maturity date of February 4, 2015, 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 50% multiplied by the Market Price (representing a discount rate of 50%). “Market Price” means the lowest Trading Price for the Common Stock during the five (5) day period prior to delivery of the conversion notice. “Fixed Conversion Price” shall mean $0.00004 per share. The shares of common stock issuable upon conversion of the Second Magna Group Note are restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the First Magna Group Note is exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser is an accredited and sophisticated investor, familiar with our operations, and there was no solicitation. The Company evaluated the Second Magna Group Note and determined that the shares issuable pursuant to the conversion option were indeterminate and constituted a derivative liability.

 

On February 19, 2014, we issued to Magna Group, LLC (“Third Magna Group Note”) a 12% Convertible Promissory Note in the original principal amount of $37,700. The note was issued in exchange for a note totaling $32,000 of principal and $5,000 of accrued interest, along with a $700 origination fee, that were acquired from, and assigned by, Star Financial on February 19, 2014. The Third Magna Group Note has a maturity date of February 19, 2015, 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 50% multiplied by the Market Price (representing a discount rate of 50%). “Market Price” means the lowest Trading Price for the Common Stock during the five (5) day period prior to delivery of the conversion notice. “Fixed Conversion Price” shall mean $0.00004 per share. The shares of common stock issuable upon conversion of the Third Magna Group Note are restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the Third Magna Group Note is exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser is an accredited and sophisticated investor, familiar with our operations, and there was no solicitation. The Company evaluated the Third Magna Group Note and determined that the shares issuable pursuant to the conversion option were indeterminate and constituted a derivative liability.

 

IBC Funds, LLC Convertible Debt

On February 14, 2014, we issued to IBC Funds, LLC (“First IBC Funds Settlement”) a Settlement Agreement in the original principal amount of $314,021. The Settlement was issued in exchange for five claims totaling $314,021, including $259,500 of principal and $28,571 of accrued interest owed to related parties, along with a $25,950 of additional liabilities. The First IBC Funds Settlement had a maturity date of December 31, 2014, and was convertible into our common stock at the Variable Conversion Price of 50% multiplied by the Market Price (representing a discount rate of 50%). “Market Price” means the lowest Trading Price for the Common Stock during the five (5) day period prior to delivery of the conversion notice. The shares of common stock issuable upon conversion of the First IBC Funds Settlement were restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the First IBC Funds Settlement was exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser is an accredited and sophisticated investor, familiar with our operations, and there was no solicitation. The Company evaluated the First IBC Funds Settlement and determined that the shares issuable pursuant to the conversion option were indeterminate and constituted a derivative liability.

 

33
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 15 – Long Term Debts

 

Long term debts consist of the following at June 30, 2014 and December 31, 2013, respectively:

 

   June 30,   December 31, 
   2014   2013 
On June 6, 2014, the Company received a loan of $42,000 from Global Merchant Cash, Inc. (“GMC Loan”). The loan bears interest at an effective rate of 187%, consisting of 100 daily weekday payments of $599, maturing on November 3, 2014. The loan is collateralized with the accounts receivable of Epazz, Inc. The promissory note is also personally guaranteed by Shaun Passley, Ph.D., our Chief Executive Officer.  $39,021   $ 
           
On May 9, 2014, the Company issued an unsecured $210,000 seller financed note payable as partial payment on an asset purchase (“Jadian Note”), which bears interest at 6% per annum until the maturity date of May 9, 2017, and provides for equal monthly principal and interest payments of $6,389 commencing on June 1, 2014. The Jadian Note includes a balloon payment, consisting of the remaining outstanding balance of principal and interest upon maturity at May 9, 2017. The interest rate shall be 8% per annum with an additional 5% late payment fee upon default.   208,462     
           
On April 30, 2014, the Company purchased furniture and fixtures and computer equipment in the total amount of $41,300 from IKEA, which was partially financed with proceeds of $37,788 pursuant to an equipment financing agreement with Financial Pacific Leasing bearing an effective interest rate of 26.78%, consisting of 36 monthly payments of $1,488; maturing on March 15, 2017. The loan is collateralized with the furniture and fixtures and computer equipment, along with a personal guarantee by Shaun Passley, Ph.D., our Chief Executive Officer.   34,493     
           
On Deck Capital Loan – Telecorp:
On April 4, 2013, the Company received a loan of $65,000 from On Deck Capital, Inc., (“On Deck”), bearing an effective interest rate of 42.74%, consisting of 377 daily weekday payments of $234, maturing on September 11, 2015. The loan is collateralized with Telecorp’s receivables. The promissory note is also personally guaranteed by Shaun Passley, Ph.D., our Chief Executive Officer.
   57,119     
           
On April 2, 2014, the Company received a loan of $25,000 from BSB Leasing, Inc. (“BSB Loan”) as a partial financing to purchase certain assets of Cynergy, Inc. for a total of $75,000. The loan bears interest at an effective rate of 25%, consisting of monthly payments of $944, maturing on February 25, 2017. The loan is collateralized with Cynergy’s assets. The promissory note is also personally guaranteed by Shaun Passley, Ph.D., our Chief Executive Officer.   22,463     
           
On March 20, 2014, the Company received a loan of $25,000 from BMT Leasing, Inc. (“BMT Loan”) as a partial financing to purchase certain assets of Cynergy, Inc. for a total of $75,000. The loan bears interest at an effective rate of 21%, consisting of monthly payments of $910, maturing on March 20, 2017. The loan is collateralized with Cynergy’s assets. The promissory note is also personally guaranteed by Shaun Passley, Ph.D., our Chief Executive Officer.   22,163     
           
On March 25, 2014, the Company received a loan of $25,000 from Navitas Leasing, Inc. (“Navitas Loan”) as a partial financing to purchase certain assets of Cynergy, Inc. for a total of $75,000. The loan bears interest at an effective rate of 21%, consisting of monthly payments of $907, maturing on April 1, 2017. The loan is collateralized with Cynergy’s assets. The promissory note is also personally guaranteed by Shaun Passley, Ph.D., our Chief Executive Officer.   21,639     
           
On February 28, 2014, the Company provided Troy Holdings with a Promissory Note in the amount of $120,000 (the “Telecorp Note”), which was adjusted down to $102,000 for excess liabilities acquired during the acquisition of Telecorp Products, Inc. The Note provides for six (6) equal monthly payments of $20,000 commencing thirty (30) days after the Closing. The Telecorp Note is non-interest bearing except upon default, in which case the interest rate shall be 10% per annum.   67,616     

 

34
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

           
On June 11, 2014, DeskFlex refinanced the Accion #2 promissory note and entered into a $15,207 promissory note, bearing interest at 10.25% (“Accion #3”). The promissory note is payable in monthly principal and interest installments of $1,339 per month, maturing on June 20, 2015 (the “Maturity Date”).   14,153     
           
Can Capital Loan – Epazz:

On November 4, 2013, the Company received net proceeds of $75,381, and a direct payoff of $36,619 on the Rapid Advance Loan listed below, on a loan of $112,000 from CAN Capital Assets Servicing, Inc., (“CAN Capital #4”) bearing an effective interest rate of 53.1%, consisting of 370 daily weekday payments of $552, maturing on November 13, 2014. The loan is collateralized with Epazz’s receivables. The promissory note is also personally guaranteed by Shaun Passley, Ph.D., our Chief Executive Officer.

On April 23, 2014, we amended this loan agreement to increase the loan balance to $150,000, consisting of additional proceeds of $71,685, and a rolled over loan balance of $78,315, to be paid over the restarted term of the loan via 432 daily weekday payments of $648, maturing on July 7, 2015.
   133,425    98,984 
           
On November 20, 2013, DeskFlex entered into a $10,550 demand promissory note bearing interest at 10.25% (“Accion #2”). The promissory note is payable in monthly installments of $1,223 per month, maturing on August 20, 2014 (the “Maturity Date”).       9,417 
           
On October 24, 2013, the Company purchased licenses to develop content management software in the total amount of $51,250 from Igenti, Inc., of which $51,250 was financed pursuant to an equipment financing agreement with Baytree National Bank & Trust Company bearing an effective interest rate of 13.235%, consisting of 36 monthly payments of $1,719; maturing on October 23, 2016. The loan is collateralized with the data management software. Igenti subsequently paid a total of $53,500, including $2,250 of penalties, to the Company for future payment for the development of the content management software. Given the nature and status of the software development, no equipment costs have been capitalized.   38,662    47,321 
           
On October 10, 2013, the Company purchased licenses to develop content management software in the total amount of $34,800 from Igenti, Inc., of which $34,800 was financed pursuant to an equipment financing agreement with Financial Pacific Leasing bearing an effective interest rate of 31.625%, consisting of 36 monthly payments of $1,438; maturing on October 9, 2016. The loan is collateralized with the content management software. Igenti retained a total of $1,300 of financing fees and paid the remaining proceeds of $33,500 to the Company for future payment for the development of the data management software. Given the nature and status of the software development, no equipment costs have been capitalized.   28,220    32,025 
           
Can Capital Loan – MS Health:

On June 24, 2013, the Company received a loan of $15,000 from WebBank, c/o NewLogic Business Loans, Inc., (“NewLogic”), which has been renamed to CAN Capital Assets Servicing, Inc (“CAN Capital”) bearing an effective interest rate of 63.9%, consisting of 176 daily weekday payments of $106, maturing on February 19, 2014. The loan is collateralized with MS Health’s receivables. The promissory note is also personally guaranteed by Shaun Passley, Ph.D., our Chief Executive Officer.

On January 7, 2014, we amended this loan agreement to increase the loan balance to $22,025, consisting of additional proceeds of $18,323, a rolled over loan balance of $3,702 to be paid over the restarted one year term of the loan via daily payments of $113.
   13,261    4,202 
           
Can Capital Loan – K9 Bytes:

On February 20, 2014, the Company received a loan of $22,283 from WebBank, c/o CAN Capital Assets Servicing, Inc (“CAN Capital”) bearing an effective interest rate of 58.7%, consisting of 308 daily weekday payments of $130, maturing on December 25, 2014. The loan is collateralized with K9 Bytes’ receivables. The promissory note is also personally guaranteed by Shaun Passley, Ph.D., our Chief Executive Officer.
   14,181     

 

35
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

           
On May 1, 2013, the Company purchased licenses to develop data management software in the total amount of $51,250 from Igenti, Inc., bearing an effective interest rate of 11%, consisting of 36 monthly payments of $1,674, maturing on April 30, 2016. The loan is collateralized with the data management software. Igenti retained a total of $4,615 of financing fees and paid the remaining proceeds of $46,615 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.   33,210    41,167 
           
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; maturing on March 6, 2016. 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.   28,948    38,361 
           
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, maturing on February 21, 2016. 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.   32,010    40,108 
           
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.   8,200    10,228 
           
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.   57,170    78,603 
           
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, maturing on March 27, 2022. 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.   298,043    312,095 
           
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, maturing March 27, 2022. 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.   103,228    94,000 

 

36
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

           
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, Ph.D., our Chief Executive Officer.   1,544    2,510 
           
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.   8,454    8,186 
           
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.   50,954    60,573 
           
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.   128,699    137,087 
           
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, Ph.D., 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 Dr. 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.   187,032    197,062 
           
Total long term debt   1,652,370    1,211,929 
Less: current portion   (612,898)   (354,786)
Long term debt, less current portion  $1,039,472   $857,143 

 

The Company recorded interest expense on long term debts, credit lines and capital leases in the amount of $370,174 and $100,160 for the six months ended June 30, 2014 and 2013, respectively.

 

Note 16 – Derivative Liabilities

 

As discussed in Note 14 under Convertible Debts, the Company issued convertible debts with variable conversion provisions. The conversion terms of the convertible debts are variable based on certain factors, such as the future price of the Company’s common stock. The number of shares of common stock to be issued is based on the future price of the Company’s common stock. As such, the number of shares of common stock issuable upon conversion of the debts is indeterminate. Pursuant to ASC 815-15 Embedded Derivatives, the fair values of the variable conversion debts and shares to be issued were recorded as derivative liabilities on the issuance date.

 

37
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The fair values of the Company’s derivative liabilities were estimated at the issuance date and are revalued at each subsequent reporting date, using a lattice model. The Company recorded current derivative liabilities of $-0- and $-0- at June 30, 2014 and December 31, 2013, respectively. The change in fair value of the derivative liabilities resulted in a net loss of $777,664 and $-0- for the six months ended June 30, 2014 and 2013, respectively, which has been reported as other income (expense) in the statements of operations. The net loss of $777,664 for the six months ended June 30, 2014 consisted of a loss of $837,010 due to the value in excess of the face value of the convertible notes, as offset by a net gain in market value of $59,346 on the convertible debts.

 

The aforementioned accounting treatment resulted in a total debt discount equal to $422,240 and $-0- during the six months ended June 30, 2014 and the year ended December 31, 2013, respectively. The discount was amortized using the effective interest method from the dates of issuance until the stated redemption date of the debts, or the accelerated dates of conversion. A total of $422,240 and $-0- was amortized during the six months ended June 30, 2014 and 2013, respectively.

 

The following presents the derivative liability value by instrument type at June 30, 2014 and December 31, 2013, respectively:

 

 

   June 30,
2014
   December 31,
2013
 
Convertible notes, Magna Group  $   $ 
Convertible debt, IBC Funds, LLC        
   $   $ 

 

The following is a summary of changes in the fair market value of the derivative liability during the six months ended June 30, 2014 and the years ended December 31, 2013, respectively:

 

   Derivative
Liability
Total
 
Balance, December 31, 2012  $ 
Increase in derivative value due to issuances of convertible promissory notes, Magna Group    
Increase in derivative value due to issuances of debt, IBC Funds, LLC    
Change in fair market value of derivative liabilities due to the mark to market adjustment    
Debt conversions    
Balance, December 31, 2013  $ 
Increase in derivative value due to issuances of convertible promissory notes, Magna Group   124,323 
Increase in derivative value due to issuances of debt, IBC Funds, LLC   1,134,927 
Change in fair market value of derivative liabilities due to the mark to market adjustment   (59,346)
Debt conversions   (1,199,904)
Balance, June 30, 2014  $ 

 

Key inputs and assumptions used to value the convertible debentures and warrants issued during the six months ended June 30, 2014:

 

·Stock prices on all measurement dates were based on the fair market value and would fluctuate with projected volatility.
·The holders of the securities would convert monthly to the ownership limit starting at 4.99% increasing by 10% per month.
·The holders would automatically convert the note at the maximum of 3 times the conversion price if the Company was not in default.
·The monthly trading volume would reflect historical averages and would increase at 1% per month.
·The Company would redeem the notes based on availability of alternative financing, increasing 2% monthly to a maximum of 10%.
·The holder would automatically convert the note at maturity if the registration was effective and the Company was not in default.
·The computed volatility was projected based on historical volatility.
·The expected risk-free interest rate is based on the yield of the 1-year U.S. Treasury note.
·The estimated value represents the average or expected value from the Monte Carlo simulation. The simulation was specified to run until the expected value was within 1.0 percent of the true value using a 95% confidence interval. A total of 8,020,000 trials were necessary to reach the specified level of precision.

 

 

38
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 17 – Changes in Stockholder’s Equity (Deficit)

 

On January 14, 2014 and May 17, 2013, the Board of Directors, consisting solely of Shaun Passley, Ph.D., 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 and authorize a third class of preferred stock, Series C Convertible 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 one thousand (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 1st 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 1st 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 one thousand (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 1st 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 1st 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.

 

Convertible Preferred Stock, Series C

Effective January 14, 2014, the Company has three billion (3,000,000,000) authorized shares of $0.0001 par value Series C Convertible Preferred Stock (“Series C Preferred Stock”). The Series C Preferred Stock accrues dividends equal to 1.5% of the Company’s revenues per quarter, beginning on January 1st 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 1st 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 C Preferred Stock includes a liquidation preference equal to $0.0001 per share, plus any accrued and unpaid dividends. Subject to certain conversion restrictions over the first three months from the original issuance date, each share of Series C Preferred Stock is convertible, at the option of the holder into three (3) shares of the Company’s Class A Common Stock, with five business days’ notice. The following conversion restrictions shall apply; (i) the holder shall be prohibited from converting any Series C Preferred shares for a period of one (1) month from the original issuance date, (ii) the holder shall be prohibited from converting not more than 30% of the Series C Preferred shares originally issued to holder during the second (2nd) month following the original issuance date, (iii) the holder shall be prohibited from converting not more than 30% (60% in total) of the Series C Preferred shares originally issued to holder during the third (3rd) month following the original issuance date, (iv) the holder shall be prohibited from converting not more than an additional 40% (100% in total) of the Series C Preferred shares originally issued to holder following the end of the third month following the original issuance date. The Series C Preferred Stock shall each vote three voting share and shall vote together with the Common Stock of the Company. 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.

 

Shares of Convertible Series C Preferred Stock Issued for Services to Related Parties

On January 17, 2014, the Company issued 600,000,000 shares of the recently designated Series C Convertible Preferred Stock to the Company’s CEO in exchange for 600,000,000 shares of his previously issued Class A Common Stock. The total fair value of the Series C Convertible Preferred Stock was $568,283 based on an independent valuation on the date of grant; therefore the Company recognized additional compensation expense of $345,427 due to the difference in the fair value of the Class A Common Stock exchanged.

 

On February 7, 2014, the Company issued 2,000,000 shares of Convertible Series C Preferred Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost in consideration for a $26,000 short term promissory note. The total fair value of the common stock was $2,385 based on an independent valuation on the date of grant.

 

39
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

On February 21, 2014, the Company issued 10,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $75,000 short term promissory note. The total fair value of the common stock was $9,562 based on an independent valuation on the date of grant.

 

On February 22, 2014, the Company issued 15,000,000 shares of Convertible Series C Preferred Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost in consideration for a $100,000 short term promissory note. The total fair value of the common stock was $14,266 based on an independent valuation on the date of grant.

 

On March 7, 2014, the Company issued 3,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $30,000 short term promissory note. The total fair value of the common stock was $2,912 based on an independent valuation on the date of grant.

 

On March 22, 2014, the Company issued 200,000,000 shares of Convertible Series C Preferred Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, for providing a personal guaranty on an acquisition loan. The total fair value of the common stock was $127,746 based on an independent valuation on the date of grant.

 

On March 22, 2014, the Company issued 200,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, for providing a personal guaranty on an acquisition loan. The total fair value of the common stock was $127,746 based on an independent valuation on the date of grant.

 

On March 22, 2014, the Company issued 1,821,052,632 shares of the Series C Convertible Preferred Stock to the Company’s CEO in exchange for 1,821,052,632 shares, consisting of 1,730,526,316 previously issued and unvested shares of Class A Common Stock and 90,526,316 shares of his previously issued and vested Class A Common Stock. The vesting terms were accelerated commensurate with the exchange. The total fair value of the Series C Convertible Preferred Stock was $1,163,162 based on an independent valuation on the date of grant; therefore the Company recognized additional compensation expense of $707,025 due to the difference in the fair value of the Class A Common Stock exchanged.

 

On March 22, 2014, the Company issued 13,669,568 shares of the Series C Convertible Preferred Stock to L&F Lawn Services, a company owned by our CEO’s family member, a related party, in exchange for 13,669,568 of their previously issued Class A Common Stock. The total fair value of the Series C Convertible Preferred Stock was $8,731 based on an independent valuation on the date of grant; therefore the Company recognized additional compensation expense of $5,307 due to the difference in the fair value of the Class A Common Stock exchanged.

 

On March 22, 2014, the Company issued 60,000,000 shares of the Series C Convertible Preferred Stock to the Company’s CEO in exchange for 60,000,000 shares, consisting of 54,000,000 previously issued and unvested shares of Class A Common Stock and 6,000,000 shares of his previously issued and vested Class A Common Stock. The vesting terms were accelerated commensurate with the exchange. The total fair value of the Series C Convertible Preferred Stock was $38,324 based on an independent valuation on the date of grant; therefore the Company recognized additional compensation expense of $23,295 due to the difference in the fair value of the Class A Common Stock exchanged.

 

Subscriptions Payable Issued for Shares of Convertible Series C Preferred Stock Granted for Services to Related Parties

On January 15, 2014, the Company granted 5,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $43,000 short term promissory note. The total fair value of the common stock was $6,465 based on an independent valuation on the date of grant. The shares were subsequently issued on July 7, 2014.

 

On February 8, 2014, the Company granted 1,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $13,000 short term promissory note. The total fair value of the common stock was $1,193 based on an independent valuation on the date of grant. The shares were subsequently issued on July 7, 2014.

 

On March 7, 2014, the Company granted 2,000,000 shares of Convertible Series C Preferred Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost in consideration for a $22,000 short term promissory note. The total fair value of the common stock was $1,942 based on an independent valuation on the date of grant. The shares were subsequently issued on July 7, 2014.

 

On March 26, 2014, the Company granted 3,000,000 shares of Convertible Series C Preferred Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost in consideration for a $37,500 short term promissory note. The total fair value of the common stock was $2,928 based on an independent valuation on the date of grant. The shares were subsequently issued on July 7, 2014.

 

On March 26, 2014, the Company granted 3,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $25,000 short term promissory note. The total fair value of the common stock was $2,928 based on an independent valuation on the date of grant. The shares were subsequently issued on July 7, 2014.

 

40
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

On March 28, 2014, the Company granted 2,000,000 shares of Convertible Series C Preferred Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost in consideration for a $18,750 short term promissory note. The total fair value of the common stock was $1,594 based on an independent valuation on the date of grant. The shares were subsequently issued on July 7, 2014.

 

On March 28, 2014, the Company granted 3,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $25,000 short term promissory note. The total fair value of the common stock was $2,390 based on an independent valuation on the date of grant. The shares were subsequently issued on July 7, 2014.

 

Common Stock, Class A

The Company has 9 billion authorized shares of $0.0001 par value Class A Common Stock.

 

Class A Common Stock Issuances:

 

Debt Conversions into Class A Common Stock – Related Parties

On April 2, 2014, the Company issued 250,000,000 shares of Class A Common Stock pursuant to the conversion of $25,000 of convertible debt held by Vivienne Passley, 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 April 7, 2014, the Company issued 125,000,000 shares of Class A Common Stock pursuant to the conversion of $18,750 of convertible debt held by Star Financial Corporation, 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 3, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by Star Financial Corporation, 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 22, 2014, the Company issued 150,000,000 shares of Class A Common Stock pursuant to the conversion of $15,000 of convertible debt held by Star Financial Corporation, 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 June 17, 2014, the Company issued 334,333,745 shares of Class A Common Stock pursuant to the conversion of $33,433 of convertible debt held by Vivienne Passley, a related party, which consisted of $26,000 of principal, $4,933 of interest and $2,500 of liquidated damages. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

Equity Based Debt Settlement Financing, Conversions into Class A Common Stock – IBC Funds, LLC

On February 14, 2014, IBC Funds, LLC (“IBC”) filed a Joint Motion for Approval of Settlement Agreement and Stipulation, and Request for Fairness Hearing in the Circuit Court of the Twelfth Judicial Circuit in and for Sarasota County, Florida, Case No. 2014-CA-000899. IBC has contracted with various note holders of the Company to acquire approximately $314,021 of Company debt and subsequently converted the debt to common stock of the Company at 50% of the lowest trading price over the 15 days prior to, and including the conversion request date pursuant to Section 3(a)(10) of the Securities Act of 1933, which allows the exchange of claims, securities, or property for stock when the arrangement is approved for fairness by a court proceeding. In addition, the Company agreed to issue 75,000,000 settlement shares to IBC. The Company has agreed to these terms as the acquisition of these debts and subsequent conversion would alleviate a significant portion of the Company’s liabilities. A fairness hearing was held on February 14, 2014 and the arrangement was approved. A total of 3,040,823,600 shares of Class A Common Stock was issued, in addition to the 75,000,000 settlement shares, in complete satisfaction of the debt, as disclosed in detail below.

 

On February 14, 2014, the Company issued 75,000,000 settlement shares of Class A Common Stock pursuant to the February 12, 2014 settlement agreement entered into with IBC Funds, LLC. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized. The total fair value of the common stock was $37,500 based on the closing price of the Company’s common stock on the date of grant.

 

On February 14, 2014, the Company issued 25,000,000 shares of Class A Common Stock pursuant to the conversion of $3,750 of convertible debt held by IBC Funds, LLC, 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 24, 2014, the Company issued 100,000,000 shares of Class A Common Stock pursuant to the conversion of $15,000 of convertible debt held by IBC Funds, LLC, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

41
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

On February 25, 2014, the Company issued 100,000,000 shares of Class A Common Stock pursuant to the conversion of $15,000 of convertible debt held by IBC Funds, LLC, 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 25, 2014, the Company issued 150,000,000 shares of Class A Common Stock pursuant to the conversion of $15,000 of convertible debt held by IBC Funds, LLC, 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 28, 2014, the Company issued 142,900,000 shares of Class A Common Stock pursuant to the conversion of $21,435 of convertible debt held by IBC Funds, LLC, 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 7, 2014, the Company issued 150,000,000 shares of Class A Common Stock pursuant to the conversion of $15,000 of convertible debt held by IBC Funds, LLC, 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 11, 2014, the Company issued 150,000,000 shares of Class A Common Stock pursuant to the conversion of $15,000 of convertible debt held by IBC Funds, LLC, 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, 2014, the Company issued 101,900,000 shares of Class A Common Stock pursuant to the conversion of $10,190 of convertible debt held by IBC Funds, LLC, 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 25, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by IBC Funds, LLC, 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 27, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by IBC Funds, LLC, 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 2, 2014, the Company issued 151,900,000 shares of Class A Common Stock pursuant to the conversion of $15,190 of convertible debt held by IBC Funds, LLC, 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 7, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $30,000 of convertible debt held by IBC Funds, LLC, 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, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by IBC Funds, LLC, 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 16, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by IBC Funds, LLC, 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 22, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by IBC Funds, LLC, 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 28, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by IBC Funds, LLC, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

42
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

On May 1, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by IBC Funds, LLC, 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 6, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $10,000 of convertible debt held by IBC Funds, LLC, 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 6, 2014, the Company issued 169,123,600 shares of Class A Common Stock pursuant to the conversion of $8,456 of convertible debt held by IBC Funds, LLC, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

Debt Conversions into Class A Common Stock – Magna Group, LLC

On January 7, 2014, the Company issued 25,140,000 shares of Class A Common Stock pursuant to the conversion of $5,028 of convertible debt held by Magna Group, LLC, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

On January 22, 2014, the Company issued 25,000,000 shares of Class A Common Stock pursuant to the conversion of $5,000 of convertible debt held by Magna Group, LLC, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

On January 31, 2014, the Company issued 66,666,667 shares of Class A Common Stock pursuant to the conversion of $10,000 of convertible debt held by Magna Group, LLC, 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 6, 2014, the Company issued 100,000,000 shares of Class A Common Stock pursuant to the conversion of $15,000 of convertible debt held by Magna Group, LLC, 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 13, 2014, the Company issued 103,273,067 shares of Class A Common Stock pursuant to the conversion of $15,491 of convertible debt held by Magna Group, LLC, 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 27, 2014, the Company issued 133,333,333 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by Magna Group, LLC, 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 10, 2014, the Company issued 180,000,000 shares of Class A Common Stock pursuant to the conversion of $18,000 of convertible debt held by Magna Group, LLC, 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 19, 2014, the Company issued 197,000,000 shares of Class A Common Stock pursuant to the conversion of $19,700 of convertible debt held by Magna Group, LLC, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

43
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Debt Conversions into Class A Common Stock – Asher Enterprises

On March 3, 2014, the Company issued 150,000,000 shares of Class A Common Stock pursuant to the conversion of $27,000 of convertible debt held by Asher Enterprises, 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 5, 2014, the Company issued 200,857,143 shares of Class A Common Stock pursuant to the conversion of $28,120 of convertible debt held by Asher Enterprises, which consisted of $26,000 of principal and $2,120 of interest. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

On March 25, 2014, the Company issued 341,666,667 shares of Class A Common Stock pursuant to the conversion of $41,000 of convertible debt held by Asher Enterprises, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

Debt Conversions into Class A Common Stock – St. George Investments, LLC

On March 7, 2014, the Company issued 125,000,000 shares of Class A Common Stock pursuant to the conversion of $15,000 of convertible debt held by St. George Investments, LLC, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

 

Subscriptions Payable Issued for Shares of Class A Common Stock Granted for Services

On April 23, 2014, the Company granted 3,500,000 shares of Class A Common Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $35,000 short term promissory note. The total fair value of the common stock was $1,050 based on the closing price of the Company’s common stock on the date of grant. The shares were subsequently issued on August 29, 2014.

 

On April 24, 2014, the Company granted 10,000,000 shares of Class A Common Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost in consideration for a $150,000 short term promissory note. The total fair value of the common stock was $3,000 based on the closing price of the Company’s common stock on the date of grant. The shares were subsequently issued on August 29, 2014.

 

On May 7, 2014, the Company granted 10,000,000 shares of Class A Common Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost in consideration for a $125,000 short term promissory note. The total fair value of the common stock was $2,000 based on the closing price of the Company’s common stock on the date of grant. The shares were subsequently issued on August 29, 2014.

 

On May 28, 2014, the Company granted 3,250,000 shares of Class A Common Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $32,500 short term promissory note. The total fair value of the common stock was $650 based on the closing price of the Company’s common stock on the date of grant. The shares were subsequently issued on August 29, 2014.

 

On June 12, 2014, the Company granted 2,125,000 shares of Class A Common Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost in consideration for a $5,000 short term promissory note. The total fair value of the common stock was $213 based on the closing price of the Company’s common stock on the date of grant. The shares were subsequently issued on August 29, 2014.

 

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. Effective January 14, 2014, the preferential voting rights of the Convertible Class B Common Stock were changed from preferential voting rights of 2,000 votes to each Class A Common Stock vote (2,000:1) to 10,000 votes to each Class A Common Stock vote (10,000:1). 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.

 

Convertible Class B Common Stock Issuance for Services

On March 22, 2014, the Company issued 12,500,000 shares of Convertible Class B Common Stock to the Company’s CEO in consideration for providing services. The total fair value of the common stock was $44,737 based on the closing price of the Company’s common stock on the date of grant.

 

Dividends Payable

On January 1, 2013, the Company declared and accrued dividends quarterly 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. Dividends equal to 1.5% of the Company’s revenues per quarter during the year ending December 31, 2013 accrue quarterly, resulting in a dividend payable of $11,000, which was subsequently paid on September 11, 2014, with the issuance of 110,000,000 shares of Class A Common Stock in lieu of cash.

 

44
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 18 - Subsequent Events

 

Strand, Inc., Asset Purchase Agreement

On July 31, 2014, one of the Company’s subsidiaries, Telecorp Products, Inc., through a newly-formed wholly-owned Illinois subsidiary, Stratin, Inc. (“Stratin”), closed on an Asset Purchase Agreement (“APA”) with Strand, Inc., an Illinois corporation (“Strand”). Pursuant to the APA, we purchased substantially all of the seller’s assets, including intangible assets and certain tangible assets used in connection with Strand’s software business, including all of its intellectual property, its business trademarks and copyrights, equipment, computers, software, machinery and accounts receivable in consideration for an aggregate of $185,000, of which $100,000 was paid at the closing, and $85,000 was financed by way of a Convertible Promissory Note (the “Strand Note”). The terms of the Strand Note include interest at 6% per annum, no payments of either principal or interest for thirty (30) days after Closing and monthly principal and interest payments of $2,586 commencing thereafter, no prepayment penalty, and a balloon payment consisting of full payment of all amounts due after one (1) year. In the event we default on the July 31, 2015 balloon payment, the seller, may at his option, convert the then outstanding principal and interest into the Class A Common stock of the parent company of Telecorp Products, Inc. (Epazz, Inc.) based on a twenty-five percent (25%) discount to the average closing bid price of Epazz’ common stock over the five (5) trading days prior to the date of default, or $0.00075 per share, whichever is greater. The Strand Note is secured by a lien on the assets of Strand. We did not purchase and Strand agreed to retain and be responsible for any and all liabilities of Strand. We did not purchase and Strand agreed to retain and be responsible for any and all liabilities of Strand.

 

The unaudited supplemental pro forma results of operations of the combined entities had the dates of the acquisitions been January 1, 2014 or January 1, 2013 are as follows:

 

   Combined Pro Forma: 
   For the six months ended
June 30,
 
   2014   2013 
Revenue:  $744,770   $637,732 
           
Expenses:          
Operating expenses   3,193,363    2,334,314 
           
Net operating loss   (2,448,593)   (1,696,582)
           
Other income (expense)   (1,968,949)   (360,762)
           
Net loss  $(4,417,542)  $(2,057,344)
           
Weighted average number of common shares          
Outstanding – basic and fully diluted   4,783,826,881    1,666,897,778 
           
Net loss per share – basic and fully diluted  $(0.00)  $(0.00)

 

Debt Financing, Related Parties, GG Mars Capital, Inc.

Originated August 1, 2014, a $36,000 unsecured promissory note payable, including a $8,000 loan origination fee, owed to GG Mars Capital, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on December 3, 2014. The note also carried a liquidated damages fee of $1,000 upon default, which was amended and removed on September 19, 2014.

 

Debt Financing, Related Parties, L&F Lawn Service, Inc.

Originated August 21, 2014, an unsecured $12,500 promissory note payable, including a $2,500 loan origination fee, owed to L&F Lawn Service, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on December 21, 2014. The note also carried a liquidated damages fee of $1,000 upon default, which was amended and removed on September 19, 2014.

 

Issuances of Series C Preferred Stock Granted for Services to Related Parties on Subscriptions Payable

On July 7, 2014 the Company issued 5,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost that was previously granted on January 15, 2014 in consideration for a $43,000 short term promissory note. The total fair value of the common stock was $6,465 based on an independent valuation on the date of grant.

 

On July 7, 2014 the Company issued 1,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost that was previously granted on February 8, 2014 in consideration for a $13,000 short term promissory note. The total fair value of the common stock was $1,193 based on an independent valuation on the date of grant.

 

45
 

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

On July 7, 2014 the Company issued 2,000,000 shares of Convertible Series C Preferred Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost that was previously granted on March 7, 2014 in consideration for a $22,000 short term promissory note. The total fair value of the common stock was $1,942 based on an independent valuation on the date of grant.

 

On July 7, 2014 the Company issued 3,000,000 shares of Convertible Series C Preferred Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost that was previously granted on March 26, 2014 in consideration for a $37,500 short term promissory note. The total fair value of the common stock was $2,928 based on an independent valuation on the date of grant.

 

On July 7, 2014 the Company issued 3,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost that was previously granted on March 26, 2014 in consideration for a $25,000 short term promissory note. The total fair value of the common stock was $2,928 based on an independent valuation on the date of grant.

 

On July 7, 2014 the Company issued 2,000,000 shares of Convertible Series C Preferred Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost that was previously granted on March 28, 2014 in consideration for a $18,750 short term promissory note. The total fair value of the common stock was $1,594 based on an independent valuation on the date of grant.

 

On July 7, 2014 the Company issued 3,000,000 shares of Convertible Series C Preferred Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost that was previously granted on March 28, 2014 in consideration for a $25,000 short term promissory note. The total fair value of the common stock was $2,928 based on an independent valuation on the date of grant.

 

Issuances of Class A Common Stock Granted for Services

On July 30, 2014 the Company issued 277,777,778 shares of Class A Common Stock to Wellington Shields Holdings, LLC, as a fee for closing on an acquisition. The total fair value of the common stock was $55,556 based on the closing price of the Company’s common stock on the date of grant.

 

Issuances of Class A Common Stock Granted for Services to Related Parties on Subscriptions Payable

On August 29, 2014 the Company issued 3,500,000 shares of Class A Common Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost that was previously granted on April 23, 2014 in consideration for a $35,000 short term promissory note. The total fair value of the common stock was $1,050 based on the closing price of the Company’s common stock on the date of grant.

 

On August 29, 2014 the Company issued 10,000,000 shares of Class A Common Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost that was previously granted on April 24, 2014 in consideration for a $150,000 short term promissory note. The total fair value of the common stock was $3,000 based on the closing price of the Company’s common stock on the date of grant.

 

On August 29, 2014 the Company issued 10,000,000 shares of Class A Common Stock to GG Mars Capital, a related party entity owned by Vivienne Passley, as a loan origination cost that was previously granted on May 7, 2014 in consideration for a $125,000 short term promissory note. The total fair value of the common stock was $2,000 based on the closing price of the Company’s common stock on the date of grant.

 

On August 29, 2014 the Company issued 3,250,000 shares of Class A Common Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost that was previously granted on May 28, 2014 in consideration for a $32,500 short term promissory note. The total fair value of the common stock was $650 based on the closing price of the Company’s common stock on the date of grant.

 

On August 29, 2014 the Company issued 2,125,000 shares of Class A Common Stock to Star Financial, a company owned by our CEO’s family member, a related party, as a loan origination cost that was previously granted on June 12, 2014 in consideration for a $5,000 short term promissory note. The total fair value of the common stock was $213 based on the closing price of the Company’s common stock on the date of grant.

 

Issuance of Dividends Paid via Class A Common Stock in Lieu of Cash

On September 11, 2014 the Company issued a total of 110,000,000 shares of Class A Common Stock amongst three related party Convertible Series B Preferred Stockholders pursuant to a dividend payable of $11,000 that was earned at a rate of 1.5% of the Company’s revenues for the 2013 calendar year. The total fair value of the common stock was $55,556 based on the closing price of the Company’s common stock on the date of grant.

 

46
 

 

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 JUNE 30, 2014. 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. (“PRM”), 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”), TELECORP PRODUCTS, INC., A MICHIGAN CORPORATION (“TELECORP”), JADIAN, INC., AN ILLINOIS CORPORATION (“JADIAN”), STRAND, INC., AN ILLINOIS CORPORATION (“STRAND”) AND FLEXFRIDGE, INC., AN ILLINOIS CORPORATION (“FLEXFRIDGE”), 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.

 

47
 

 

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 fifteen (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.

 

48
 

 

FlexFridge, Inc.

 

On March 4, 2013, the Board of Directors of Epazz, Inc. (the “Company”), consisting solely of Shaun Passley, Ph.D., the Company’s majority shareholder, approved the formation of a new wholly-owned subsidiary of the Company named Cooling Technology Solutions, Inc., which was later renamed, Z Fridge, Inc., and ultimately again renamed as, FlexFridge, Inc. (“FlexFridge”) on May 29, 2014. The Company has filed a non-provisional patent application for its Project Flex product, which consists of a patent pending foldable mini-fridge. On November 21, 2013, the Company was spun off to shareholders of record on September 15, 2013, whereby shareholders of Epazz, Inc. received one (1) share of FlexFridge in exchange for each ten (10) shares held of Epazz, Inc. Epazz has a controlling financial interest in FlexFridge. As such, FlexFridge is consolidated within these financial statements pursuant to Accounting Standards Codification (“ASC”) 810-10. There has been no material activity within FlexFridge to date.

 

Telecorp Products, Inc.

 

On February 28, 2014, the Company entered into a Stock Purchase Agreement (the “Telecorp Purchase Agreement”) with Troy Holdings International, Inc., an Ontario Canada corporation (“Troy Holdings”), Telecorp Products, Inc. a Michigan corporation and Troy, Inc., a shareholder and the sole stockholder of Telecorp. Pursuant to the Telecorp Purchase Agreement, the Company purchased 100% of the outstanding shares of Telecorp from Troy Holdings, for an aggregate purchase price of $302,000 (the “Purchase Price”). The Purchase Price was payable as follows:

 

  (a) The Company paid Troy Holdings $200,000 at the Closing (the “Cash Consideration”) of the Telecorp Purchase Agreement; and
  (b) The Company provided Troy Holdings with a Promissory Note in the amount of $102,000 (the “Telecorp Note”), as adjusted from an original $120,000 by $18,000 of liabilities acquired in excess of the agreed upon limit of $50,000 of liabilities, which provides for six (6) equal monthly payments of $20,000 commencing thirty (30) days after the Closing. The Telecorp Note is non-interest bearing except upon default, in which case the interest rate shall be 10% per annum.

 

Additionally, the Company agreed to assume aggregate outstanding Telecorp liabilities of up to $50,000 in connection with the Closing. A total of $68,000 of liabilities was actually acquired, and the resulting $18,000 of excess liabilities was credited as payment against the Telecorp Note. As a result of the Closing, Telecorp became a wholly-owned subsidiary of the Company.

 

Telecorp developed and sells software to effectively operate contact centers. Telecorp’s solutions work with equipment from the giants of the computer telephony industry, such as Avaya, Cisco and Nortel Networks. In connection with the Stock Purchase Agreement, the shareholders of Telecorp and the Company entered into a Non-Disclosure/Non-Compete Agreement, pursuant to which the shareholders of Telecorp and the Company, each agreed to not for a period of one (1) year, communicate or divulge to, or use for the benefit of itself or any other person, firm, association or corporation, any information in any way relating to the Proprietary Property, in competition with the business of the Company, and pursuant to the agreement, the shareholders of Telecorp agreed not to compete against the Company for one (1) year from the closing of the acquisition.

 

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 $428,577 of goodwill. According to the purchase method of accounting, the Company recognized the identifiable assets acquired and liabilities assumed.

 

Zinergy (DBA) formerly Cynergy Software, Asset Purchase

 

On April 4, 2014, we closed on a March 13, 2014 Asset Purchase Agreement with Cynergy Corporation, an Oklahoma corporation (“Cynergy”). Pursuant to the Purchase Agreement, we purchased substantially all of the intangible assets and certain tangible assets used in connection with Cynergy’s help desk software business, including all of its intellectual property, its business trademarks and copyrights, equipment, computers, software, machinery and accounts receivable in consideration for an aggregate of $75,000, of which $25,000 was paid at the closing, $25,000 was paid within fifteen (15) days after the closing and the remaining $25,000 was paid within forty (40) days after the closing. We did not purchase and Cynergy agreed to retain and be responsible for any and all liabilities of Cynergy Corporation. The acquisition was financed in part with a software financing agreement. The Financing agreement has a lien against the software assets of Zinergy.

 

This acquisition was accounted for as a business combination under the purchase method of accounting. The purchase resulted in $65,139 of goodwill. According to the purchase method of accounting, the Company recognized the identifiable assets acquired and liabilities assumed, consisting of $8,035 of software and $1,826 of an intangible asset for the trade name.

 

Zinergy Service Desk Software is very customizable for business processes. Zinergy integrates with just about every other business tool available. Help Desk Support Software, Help Desk Ticketing Software, Customer Support Software, HRIS Ticketing Solution and much more.

 

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Jadian Enterprises, Inc.

 

On May 9, 2014, the Company, through a newly-formed wholly-owned Illinois subsidiary, Jadian Enterprises, Inc. (“Jadian Enterprises”), closed on an Asset Purchase Agreement (“APA”) with Jadian, Inc., a Michigan corporation (“Jadian”). Pursuant to the APA, we purchased substantially all of the intangible assets and certain tangible assets used in connection with Jadian’s software business, including all of its intellectual property, its business trademarks and copyrights, equipment, computers, software, machinery and accounts receivable in consideration for an aggregate of $425,000, of which $207,945 was paid at the closing, $7,055 was settled as a result of certain offsets, including an offset for $40,760 for prepaid maintenance contracts received by the seller prior to Closing, as diminished by a credit for Accounts Receivable of $33,705, and $210,000 was financed by way of a Promissory Note (the “Jadian Note”). The terms of the Jadian Note include interest at 6% per annum, a ten (10) year amortization, full right of offset, no payments of either principal or interest for thirty (30) days after Closing and equal payments of principal and interest commencing thereafter, no prepayment penalty, and a balloon payment consisting of full payment of all amounts due after three (3) years. The Jadian Note is secured by a lien on the assets of Jadian. We did not purchase and Jadian agreed to retain and be responsible for any and all liabilities of Jadian. We did not purchase and Jadian agreed to retain and be responsible for any and all liabilities of Jadian.

 

The Company also agreed to provide the seller with additional earn-out rights in connection with the purchase, which provide that the seller will receive up to a maximum of $100,000 per year for the three twelve month periods following the Closing (any delinquent earn-out payment shall bear interest at the rate of 10% per annum until the delinquent amount is paid), based on the gross revenues generated by Jadian during such applicable year based on the following schedule (the “Earn-Out”):

 

Revenue for the Relevant Year Earn-Out
$-0- to $500,000 $
$500,000 to $600,000 $ 25,000
$600,000 to $700,000 $ 50,000
$700,000 to $800,000 $ 75,000
$800,000 or more $ 100,000

 

Provided that in no event shall the total amount payable to Jadian Enterprises in connection with the Earn-Out exceed $100,000 per year, or $300,000 in aggregate. Management has determined the probability of having to pay out any of these Earn-Out provisions as Medium and accordingly, has not recorded a contingent liability.

 

Jadian sells Enterprise Quality Manager (EQ/M) software. EQ/M is a web-based solution with remote tools that enables enforcement bodies to electronically manage compliance, audit, inspection, work order, and licensing/certification/permits, and enforcement activities. The first version of the software was written in 1990 to help manage the activities related to auditing and corrective actions. The software is now in its third generation, with the current Microsoft .NET™ version released commercially in 2003.

 

PLAN OF OPERATION

 

During the next twelve months, we plan to integrate our recent acquisitions, including Zinergy, Telecorp, Jadian and Strand, 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 our Project Flex product, which consists of a patent pending foldable mini-fridge that has yet to be developed, and continue to pursue growth through additional 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.

 

 

 

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RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2014, AS COMPARED TO THE THREE MONTHS ENDED JUNE 30, 2013:

 

   For the Three Months Ended     
   June 30,   Increase / 
   2014   2013   (Decrease) 
Revenues  $327,525   $279,119   $48,406 
                
General and Administrative   278,446    166,403    112,043 
Salaries and Wages   108,502    1,555,081    (1,446,579)
Depreciation and Amortization   51,398    67,385    (15,987)
Bad Debts (Recoveries)   (5,250)   45    (5,295)
                
Total Operating Expenses   433,096    1,788,914    (1,355,818)
                
Net Operating Loss   (105,571)   (1,509,795)   (1,404,224)
                
Total Other Income (Expense)   (658,660)   (157,783)   500,877 
                
Net Loss  $(764,231)  $(1,667,578)  $(903,347)

 

Revenues:

 

For the three months ended June 30, 2014 we had revenue of $327,525 compared to revenue of $279,119 for the three months ended June 30, 2013, an increase of $48,406, or 17% from the comparative period. The increase in revenues was due primarily to the acquisition of our new subsidiaries.

 

General and Administrative:

 

General and administrative expenses increased by $112,043, or 67% to $278,446 for the three months ended June 30, 2014 compared to general and administrative expense of $166,403 for the three months ended June 30, 2013. The increase in general and administrative expense is due primarily to increased public relations fees and general increases due to the acquisition of subsidiaries incurred during the three months ending June 30, 2014 that wasn’t incurred during the three months ending June 30, 2013.

 

Salaries and Wages:

 

Salaries and wages decreased by $1,446,579, or 93% to $108,502 for the three months ended June 30, 2014 compared to salaries and wages of $1,555,081 for the three months ended June 30, 2013. The decrease in salaries and wages is due primarily to the stock based compensation of $1,430,500 during the three months ended June 30, 2013, which was comprised of the issuance of a total of 746,026,316 shares of Class A Common Stock and 5,000,000 shares of Convertible Class B Common Stock granted amongst Shaun Passley, CEO and Fay Passley. No shares were issued for services during the three months ending June 30, 2014.

 

Depreciation and Amortization:

 

We had depreciation and amortization expense of $51,398 for the three months ended June 30, 2014 as compared to $67,385 for the three months ended June 30, 2013, a decrease of $15,987, or 24% from the comparative period. This decrease is principally due to certain assets reaching the end of their depreciable life cycle and intangible assets that were impaired on December 31, 2013 that are no longer being amortized. We anticipate the replacement of these assets as resources become available.

 

Bad Debts (Recoveries):

 

We had bad debts (recoveries) of $(5,250) for the three months ended June 30, 2014 as compared to bad debts (recoveries) of $45 for the three months ended June 30, 2013, a decrease in bad debts (recoveries) of $5,295, or 11,767% from the comparative period. This decrease is due to changes in our allowance for doubtful accounts. We provide an allowance for doubtful accounts of all accounts receivable aging greater than 30 days old, and are actively managing our receivables.

 

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Net Operating Loss:

 

Total operating expenses for the three months ended June 30, 2014 were $433,096, compared to $1,788,914 for the three months ended June 30, 2013, a decrease of $1,355,818, or 76% from the comparative period. We had net operating losses of $105,571, compared to $1,509,795 for the three months ended June 30, 2013, a decrease of $1,404,224, or 93% from the comparative period. The decrease in operating loss was primarily due to the decrease in stock based compensation to related parties.

 

Other Income (Expense):

 

Interest expense was $501,712 for the three months ended June 30, 2014 compared to $143,543 for the three months ended June 30, 2013, an increase of $358,169, or 250% from the comparative period. Interest expense increased primarily due to significant increased borrowings since the three months ended June 30, 2013.

 

Loss on debt modifications, related parties was $172,864 for the three months ended June 30, 2014 compared to $14,240 for the three months ended June 30, 2013, an increase of $158,624 from the comparative period. The current period loss on debt modification was due to an amended promissory note with Vivienne Passley, which at the time of modification carried a balance of $57,621, consisting principal of $51,000 and $6,621 of interest. We amended the promissory note to include a fixed conversion price of $0.0001 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 $172,864. The prior period loss on debt modification was due to the settlement of a promissory note with Vivienne Passley, which at the time of modification carried a balance of $14,239, including accrued interest of $1,239. We amended the promissory note to satisfy repayment with 14,239,500 shares of common stock valued at $28,479 based on the closing price of the common stock on the grant date. 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 $14,240

 

Change in derivative liabilities consisted of a gain of $15,915 for the three months ended June 30, 2014 compared to $-0- for the three months ended June 30, 2013, an increase of $15,915 from the comparative period. The current period gain on derivative liabilities consisted of a net gain in market value of $15,915 on the convertible debts.

 

Net Loss:

 

We had a net loss of $764,231 for the three months ended June 30, 2014 compared to a net loss of $1,667,578 for the three months ended June 30, 2013, resulting in a decreased net loss of $903,347, or 54% from the comparative period. The decreased net loss was primarily due the decrease in stock based compensation to related parties and $15,915 gain attributable to the change in derivative liabilities, as offset by increased interest expense incurred with increased borrowings, along with the increased loss on debt modifications incurred during the three months ended June 30, 2014 compared to the three months ended June 30, 2013.

 

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RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2014, AS COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2013:

 

   For the Six Months Ended     
   June 30,   Increase / 
   2014   2013   (Decrease) 
Revenues  $580,077   $487,129   $92,948 
                
General and Administrative   570,139    287,634    282,505 
Salaries and Wages   2,444,999    1,771,234    673,765 
Depreciation and Amortization   97,555    144,160    (46,605)
Bad Debts (Recoveries)   (5,262)   (8,740)   3,478 
                
Total Operating Expenses   3,107,431    2,194,288    913,143 
                
Net Operating Loss   (2,527,354)   (1,707,159)   820,195 
                
Total Other Income (Expense)   (1,968,250)   (358,990)   1,609,260 
                
Net Loss  $(4,495,604)  $(2,066,149)  $2,429,455 

 

Revenues:

 

For the six months ended June 30, 2014 we had revenue of $580,077 compared to revenue of $487,129 for the six months ended June 30, 2013, an increase of $92,948, or 19% from the comparative period. The increase in revenues was due primarily to the acquisition of our new subsidiaries.

 

General and Administrative:

 

General and administrative expenses increased by $282,505, or 98% to $570,139 for the six months ended June 30, 2014 compared to general and administrative expense of $287,634 for the six months ended June 30, 2013. The increase in general and administrative expense is due primarily to increased public relations fees and general increases due to the acquisition of subsidiaries incurred during the six months ending June 30, 2014 that wasn’t incurred during the six months ending June 30, 2013.

 

Salaries and Wages:

 

Salaries and wages increased by $673,765, or 38% to $2,444,999 for the six months ended June 30, 2014 compared to salaries and wages of $1,771,234 for the six months ended June 30, 2013. The increase in salaries and wages is due primarily to the stock based compensation of $2,187,923, which was comprised of $1,897,189 of share based compensation related to the accelerated vesting of Class A Common shares and subsequent exchange and issuance of 2,621,052,632 shares of Series C Convertible Preferred stock granted to Shaun Passley, CEO, as well as, the accelerated vesting of Class A Common shares and subsequent exchange and issuance of 73,669,568 shares of Series C Convertible Preferred stock amongst related parties, L&F Lawn Services and Craig Passley valued at $28,602, the issuance of 400,000,000 shares of Series C Convertible Preferred stock valued at a total of $255,492 amongst related parties, GG Mars Capital and Star Financial, in addition to the fair value of $6,640 pursuant to an amendment to increase the Class B Common voting rights from 2,000:1 to 10,000:1 during the six months ended June 30, 2014, compared to stock based compensation of $1,512,500 pursuant to the issuance of a total of 812,526,316 shares of Class A Common Stock granted amongst Shaun Passley, CEO, Craig Passley, Corporate Secretary and Vivienne Passley, and 5,000,000 shares of Convertible Class B Common Stock valued at $9,500 granted to Shaun Passley, CEO, 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, that was incurred during the six months ended June 30, 2013.

 

Depreciation and Amortization:

 

We had depreciation and amortization expense of $97,555 for the six months ended June 30, 2014 as compared to $144,160 for the six months ended June 30, 2013, a decrease of $46,605, or 32% from the comparative period. This decrease is principally due to certain assets reaching the end of their depreciable life cycle and intangible assets that were impaired on December 31, 2013 that are no longer being amortized. We anticipate the replacement of these assets as resources become available.

 

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Bad Debts (Recoveries):

 

We had bad debts (recoveries) of $5,262 for the six months ended June 30, 2014 as compared to bad debts (recoveries) of $8,740 for the six months ended June 30, 2013, a decrease in bad debts (recoveries) of $3,478, or 40% from the comparative period. This decrease is due to changes in our allowance for doubtful accounts. We provide an allowance for doubtful accounts of all accounts receivable aging greater than 30 days old, and are actively managing our receivables.

 

Net Operating Loss:

 

Total operating expenses for the six months ended June 30, 2014 were $3,107,431, compared to $2,194,288 for the six months ended June 30, 2013, an increase of $913,143, or 42% from the comparative period. We had net operating losses of $2,527,354, compared to $1,707,159 for the six months ended June 30, 2013, an increase of $820,195, or 48% from the comparative period. The increase in operating loss was primarily due the increase in stock based compensation to related parties.

 

Other Income (Expense):

 

Interest expense was $1,017,777 for the six months ended June 30, 2014 compared to $262,958 for the six months ended June 30, 2013, an increase of $754,819, or 287% from the comparative period. Interest expense increased primarily due to significant increased borrowings, along with increased non-cash discounts of $657,818 attributable to the amortization of debt discounts, loan origination costs and a loss on convertible debt default provisions incurred during the six months ended June 30, 2014, compared to the same period in 2013.

 

Loss on debt modifications, related parties was $172,864 for the six months ended June 30, 2014 compared to $96,032 for the six months ended June 30, 2013, an increase of $76,832 from the comparative period. The current period loss on debt modification was due to an amended promissory note with Vivienne Passley, which at the time of modification carried a balance of $57,621, consisting principal of $51,000 and $6,621 of interest. We amended the promissory note to include a fixed conversion price of $0.0001 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 $172,864. The prior 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.

 

Change in derivative liabilities was a loss of $777,664 for the six months ended June 30, 2014 compared to $-0- for the six months ended June 30, 2013, an increase of $777,664 from the comparative period. The current period loss on derivative liabilities consisted of a loss of $837,010 due to the value in excess of the face value of the convertible notes, as offset by a net gain in market value of $59,346 on the convertible debts.

 

Net Loss:

 

We had a net loss of $4,495,604 for the six months ended June 30, 2014 compared to a net loss of $2,066,149 for the six months ended June 30, 2013, resulting in an increased net loss of $2,429,455, or 118% from the comparative period. The increased net loss was primarily due the increase in stock based compensation to related parties and interest expense incurred with increased borrowings, along with a $777,664 loss attributable to the change in derivative liabilities incurred during the six months ended June 30, 2014 compared to the six months ended June 30, 2013.

 

 

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LIQUIDITY AND CAPITAL RESOURCES

 

The following table summarizes total assets, accumulated deficit, stockholders’ equity (deficit) and working capital at June 30, 2014 compared to December 31, 2013.

 

   June 30,   December 31, 
   2014   2013 
Total Assets  $1,995,461   $1,082,961 
           
Total Liabilities  $3,751,495   $2,607,576 
           
Accumulated (Deficit)  $(11,997,598)  $(7,501,994)
           
Stockholders’ Equity (Deficit)  $(1,756,034)  $(1,524,615)
           
Working Capital (Deficit)  $(2,469,820)  $(1,283,338)

 

We had total current assets of $239,029 as of June 30, 2014, consisting of cash of $101,871, net accounts receivable of $71,762, and other current assets of $65,396.

 

We had non-current assets of $1,756,432 as of June 30, 2014, consisting of $130,973 of property and equipment, net, including accumulated depreciation and amortization of $107,895, intangible assets of $476,418, net, including $387,444 of accumulated amortization and goodwill of $1,149,041 related to the purchase of our subsidiaries.

 

We had total current liabilities of $2,708,849 as of June 30, 2014, consisting of $11,000 of dividends payable in stock or cash at the election of management, $414,879 of accounts payable and accrued expenses, $496,510 of deferred revenues, current portion of outstanding balances on lines of credit of $86,544, current portion of capitalized leases in the amount of $4,987, current maturities of notes payable, related parties of $930,868, current maturities on convertible debts of $152,275, net of discounts of $1,112, and current maturities on long term debts in the amount of $612,898.

We had negative working capital of $2,469,820 and a total accumulated deficit of $11,997,598 as of June 30, 2014.

 

We had total liabilities of $3,751,495 as of June 30, 2014, which included total current liabilities of $2,708,849, long-term portion of capitalized leases of $3,174 and long-term debts of $1,039,472, net of current portion.

 

We had net cash used in operating activities of $276,897 for the six months ended June 30, 2014, which was primarily due to our net loss of $365,546 after adjustments for non-cash operating expenses, a decrease of $1,130 in accounts receivable and a decrease of $42,835 of other current assets, and an increase of $118,743 in accounts payable and accrued expenses, and a decrease of $74,059 in deferred revenues.

 

We had $525,721 of net cash used in investing activities for the six months ended June 30, 2014, which consisted of $43,512 of cash paid for the purchase of equipment, $482,945 paid for the acquisition of subsidiaries, offset by $736 received in cash with the merger.

 

We had $695,922 of net cash provided by financing activities during the six months ended June 30, 2014, which represented proceeds from notes payable, related parties of $675,152, and proceeds from notes payable of $345,696, repayments on notes payable, related parties of $82,879, repayments on notes payable of $231,287, repayments on convertible notes payable of $1,500 and principal payments on capital leases of $9,260.

 

Declaration of Dividends

On January 1, 2013, the Company declared and accrued dividends quarterly 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. Dividends equal to 1.5% of the Company’s revenues per quarter during the year ending December 31, 2013 accrue quarterly, resulting in a dividend payable of $11,000, which was subsequently paid with the issuance of 110,000,000 shares of Class A Common Stock in lieu of cash.

 

 

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Recent Financing Activities

 

Second quarter of 2014:

 

Debt Financing, Related Parties, GG Mars Capital, Inc.

Originated April 24, 2014, a $150,000 unsecured promissory note payable, including a $30,000 loan origination fee, owed to GG Mars Capital, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on June 26, 2014. In addition, a loan origination fee consisting of 10,000,000 shares of Class A Common Stock was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $10,000 upon default, which was amended and removed on September 19, 2014.

 

Originated May 7, 2014, a $150,000 unsecured promissory note payable, including a $25,000 loan origination fee, owed to GG Mars Capital, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on August 7, 2014. In addition, a loan origination fee consisting of 10,000,000 shares of Class A Common Stock was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $12,500 upon default, which was amended and removed on September 19, 2014.

 

Originated June 3, 2014, a $25,000 unsecured promissory note payable, including a $4,000 loan origination fee, owed to GG Mars Capital, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on December 3, 2014. The note also carried a liquidated damages fee of $1,000 upon default, which was amended and removed on September 19, 2014.

 

Debt Financing, Related Parties, Star Financial Corporation

Originated April 23, 2014, an unsecured $35,000 promissory note payable, including a $7,000 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matured on August 23, 2014. In addition, a loan origination fee consisting of 3,500,000 shares of Class A Common Stock was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $2,500 upon default, which was amended and removed on September 19, 2014.

 

Originated May 28, 2014, an unsecured $32,500 promissory note payable, including a $7,500 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on September 28, 2014. In addition, a loan origination fee consisting of 3,250,000 shares of Class A Common Stock was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $2,500 upon default, which was amended and removed on September 19, 2014.

 

Originated June 3, 2014, an unsecured $5,000 promissory note payable, including a $1,000 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on December 3, 2014. The note also carried a liquidated damages fee of $500 upon default, which was amended and removed on September 19, 2014.

 

Originated June 12, 2014, an unsecured $21,250 promissory note payable, including a $4,250 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on October 12, 2014. In addition, a loan origination fee consisting of 2,125,000 shares of Class A Common Stock was issued as consideration for the loan, and is being amortized on a straight line basis over the life of the loan. The note also carried a liquidated damages fee of $2,500 upon default, which was amended and removed on September 19, 2014.

 

Originated June 30, 2014, an unsecured $20,000 promissory note payable, including a $3,500 loan origination fee, owed to Star Financial, a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on December 30, 2014. The note also carried a liquidated damages fee of $500 upon default, which was amended and removed on September 19, 2014.

 

Recent Debt Conversions

 

Second quarter of 2014:

 

On various dates between April 2, 2014 and June 17, 2014, we issued a total of 2,780,357,345 shares of common stock pursuant to debt conversions of a total of $275,830, consisting of $261,095 of principal and $12,235 of accrued interest and $2,500 of liquidated damages.

 

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A total of $152,275 of convertible debentures remain outstanding as of the date of this filing, and are 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 $0.0001 per share
    Conversion   Principal   100%   75%   50%   25%
Lender / Origination   Terms   Borrowed   $0.0001   $0.000075   $0.00005   $0.000025
                           
JMJ Financial
 (Second JMJ Note)
 November 13, 2013
  Convertible into shares of common stock at the discretion of the note holder at a price equal to sixty percent (60%) of the lowest trading price of the Company’s common stock for the twenty five (25) trading days prior to the conversion date, or $0.00009 per share, whichever is greater.   $ 33,000   330,000,000   440,000,000   660,000,000   1,320,000,000
                           
St. George Investments, Inc.
 (First St. George Note)
 September 5, 2013
  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 closing bid prices of the Company’s common stock for the ten (10) trading days prior to the conversion date, or $0.00005 per share, whichever is greater.   $ 119,275   1,192,750,000   1,590,333,333   2,385,500,000   4,771,000,000
                           
        $ 152,275   1,522,750,000   2,030,333,333   3,045,500,000   6,091,000,000

 

 

 

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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.

 

 

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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 1A. Risk Factors

 

As a smaller reporting company, we are not required to provide the information required by this Item.

 

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 June 30, 2014:

 

Equity Issuances to IBC Funds, LLC Pursuant to Section 3(a)(10) of the Securities Act of 1933, as Amended

On April 2, 2014, the Company issued 151,900,000 shares of Class A Common Stock pursuant to the conversion of $15,190 of convertible debt held by IBC Funds, LLC, which consisted entirely of principal.

 

On April 7, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $30,000 of convertible debt held by IBC Funds, LLC, which consisted entirely of principal.

 

On April 10, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by IBC Funds, LLC, which consisted entirely of principal.

 

On April 16, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by IBC Funds, LLC, which consisted entirely of principal.

 

On April 22, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by IBC Funds, LLC, which consisted entirely of principal.

 

On April 28, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by IBC Funds, LLC, which consisted entirely of principal.

 

On May 1, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by IBC Funds, LLC, which consisted entirely of principal.

 

On May 6, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $10,000 of convertible debt held by IBC Funds, LLC, which consisted entirely of principal.

 

On May 6, 2014, the Company issued 169,123,600 shares of Class A Common Stock pursuant to the conversion of $8,456 of convertible debt held by IBC Funds, LLC, which consisted entirely of principal.

 

The Company claims an exemption from registration afforded by Section 3(a)(10) of the Securities Act of 1933, as amended (the “Act”), for the above conversions, as the securities were exchanged by the Company in exchange for securities, claims, or property interests, and not for cash 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.

 

Debt Conversions into Class A Common Stock – Related Parties

On April 2, 2014, the Company issued 250,000,000 shares of Class A Common Stock pursuant to the conversion of $25,000 of convertible debt held by Vivienne Passley, a related party, which consisted entirely of principal.

 

On April 7, 2014, the Company issued 125,000,000 shares of Class A Common Stock pursuant to the conversion of $18,750 of convertible debt held by Star Financial Corporation, a related party, which consisted entirely of principal.

 

59
 

 

On May 3, 2014, the Company issued 200,000,000 shares of Class A Common Stock pursuant to the conversion of $20,000 of convertible debt held by Star Financial Corporation, a related party, which consisted entirely of principal.

 

On May 22, 2014, the Company issued 150,000,000 shares of Class A Common Stock pursuant to the conversion of $15,000 of convertible debt held by Star Financial Corporation, a related party, which consisted entirely of principal.

 

On June 17, 2014, the Company issued 334,333,745 shares of Class A Common Stock pursuant to the conversion of $33,433 of convertible debt held by Vivienne Passley, a related party, which consisted of $26,000 of principal, $4,933 of interest and $2,500 of liquidated damages.

 

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.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

On September 24, 2014, St. George Investments, LLC (“note holder”) presented the Company with a notice of default. In accordance with the default provisions, the note shall accrue interest at twenty two percent (22%) per annum effective April 1, 2014. The unsecured convertible promissory note with $41,900 of principal outstanding (“First St. George Note”) matured on June 5, 2014 and was in default effective April 1, 2014 pursuant to Section 3.2 of the Note. 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 $0.00005 per share, whichever is greater. The debt holder is limited to owning 4.99% of the Company’s issued and outstanding shares. In accordance with the default provisions, the outstanding balance prior to the occurrence of default shall increase to 150% of the outstanding balance of principal and interest a maximum of two times. In addition, the note holder was precluded from clearing the conversion of 125,000,000 shares of common stock received pursuant to a March 7, 2014 conversion of $15,000 of outstanding principal until September 10, 2014 (“Late Clearing Adjustment Amount”). Pursuant to Section 1.6(g) of the Note, the note holder is entitled to increase the outstanding balance of the Note by the Late Clearing Adjustment Amount of $25,000. As a result of the Late Clearing Adjustment Amount and Note defaults on April 1, 2014 and June 5, 2014, the principal and interest on the First St. George Note has increased to $136,738 as of September 24, 2014.

 

ITEM 4. MINE SAFETY DISCLOSURES.

 

Mine safety disclosures are not applicable.

 

ITEM 5. OTHER INFORMATION

 

None.

 

 

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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
3.10 Articles of Amendment, January 14, 2014 X        
4.1 Form of Stock Certificate   SB-2 12/04/06 X 12/04/06
10.1 February 22, 2013 – Equipment Finance Agreement with Summit Funding Group, Inc.   10-Q 03/31/13 X 06/14/13
10.2 March 7, 2013 – Lease Agreement with Baytree National Bank & Trust Company   10-Q 03/31/13 X 06/14/13
10.3 Promissory Note with Star Financial Corporation, April 1, 2013   10-Q 06/30/13 X 08/19/13
10.4 Promissory Note with Star Financial Corporation, April 12, 2013   10-Q 06/30/13 X 08/19/13
10.5 Promissory Note with Star Financial Corporation, May 16, 2013   10-Q 06/30/13 X 08/19/13
10.6 Promissory Note with Star Financial Corporation, June 12, 2013   10-Q 06/30/13 X 08/19/13
10.7 First JMJ Financial Convertible Promissory Note, June 12, 2013   10-Q 06/30/13 X 08/19/13
10.8 Software Finance Agreement with CIT Finance, LLC, May 1, 2013   10-Q 06/30/13 X 08/19/13
10.9 Loan and Security Agreement with Small Business Financial Solutions, LLC, April 5, 2013   10-Q 06/30/13 X 08/19/13
10.10 Merchant Agreement with Horizon Business Funding, LLC, June 11, 2013   10-Q 06/30/13 X 08/19/13
10.11 Business Loan Agreement with WebBank, June 19, 2013   10-Q 06/30/13 X 08/19/13
10.12 First Amendment to Executive Employment Agreement, August 16, 2013   10-Q 06/30/13 X 08/19/13
10.13 Promissory Note with Vivienne Passley, July 19, 2013   10-Q 09/30/13 X 11/19/13
10.14 Promissory Note with Vivienne Passley, August 12, 2013   10-Q 09/30/13 X 11/19/13
10.15 Promissory Note with Star Financial Corporation, July 31, 2013   10-Q 09/30/13 X 11/19/13
10.16 Promissory Note with Star Financial Corporation, August 2, 2013   10-Q 09/30/13 X 11/19/13
10.17 Promissory Note with Star Financial Corporation, August 7, 2013   10-Q 09/30/13 X 11/19/13
10.18 Promissory Note with Star Financial Corporation, August 27, 2013   10-Q 09/30/13 X 11/19/13
10.19 Promissory Note with GG Mars Capital, Inc., August 20, 2013   10-Q 09/30/13 X 11/19/13
10.20 Promissory Note with GG Mars Capital, Inc., September 7, 2013   10-Q 09/30/13 X 11/19/13
10.21 Convertible Promissory Note with GG Mars Capital, Inc., August 20, 2013   10-Q 09/30/13 X 11/19/13
10.22 Assignment Agreement with GG Mars Capital, Inc. and Accion Chicago, August 15, 2013   10-Q 09/30/13 X 11/19/13
10.23 Convertible Promissory Note with St. George Investments, Inc., September 5, 2013   10-Q 09/30/13 X 11/19/13
10.24 Note Purchase Agreement with St. George Investments, Inc., September 5, 2013   10-Q 09/30/13 X 11/19/13
10.25 Convertible Promissory Note with Asher Enterprises (Seventh Asher Note), August 19, 2013   10-Q 09/30/13 X 11/19/13
10.26 Securities Purchase Agreement with Asher Enterprises (Seventh Note), August 19, 2013   10-Q 09/30/13 X 11/19/13
10.27 Amendment #1 to Promissory Note with Asher Enterprises (Seventh Asher Note), November 7, 2013   10-Q 09/30/13 X 11/19/13
10.28 Convertible Promissory Note with Asher Enterprises (Eighth Asher Note), September 18, 2013   10-Q 09/30/13 X 11/19/13
10.29 Securities Purchase Agreement with Asher Enterprises (Eighth Note), September 18, 2013   10-Q 09/30/13 X 11/19/13
10.30 Amendment #1 to Promissory Note with Asher Enterprises (Eighth Asher Note), November 7, 2013   10-Q 09/30/13 X 11/19/13
10.31 Amendment #1 to Promissory Note with JMJ Financial (First JMJ Note), August 13, 2013   10-Q 09/30/13 X 11/19/13

 

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      Incorporated by reference
Exhibit Exhibit Description Filed herewith Form Period ending Exhibit Filing date
10.32 Stock Purchase Agreement (Telecorp Acquisition), February 28, 2014 X        
10.33 Closing Statement (Telecorp Acquisition), February 28, 2014 X        
10.34 Non-Disclosure/Non-Compete Agreement (Telecorp Acquisition), February 28, 2014 X        
10.35 Share Pledge Agreement (Telecorp Acquisition), February 28, 2014 X        
10.36 Seller Financed Promissory Note (Telecorp Acquisition), February 28, 2014 X        
10.37 Asset Purchase Agreement (Cynergy Acquisition), April 4, 2014 X        
10.38 Bill of Sale (Cynergy Acquisition) , April 4, 2014 X        
10.39 Asset Purchase Agreement (Jadian Acquisition), May 9, 2014 X        
10.40 Bill of Sale (Jadian Acquisition), May 9, 2014 X        
10.41 Closing Statement (Jadian Acquisition), May 9, 2014 X        
10.42 Security Agreement (Jadian Acquisition), May 9, 2014 X        
10.43 Consulting Agreement (Jadian Acquisition), May 9, 2014 X        
10.44 Employment Agreement (Jadian Acquisition), May 9, 2014 X        
10.45 Guaranty Agreement (Jadian Acquisition), May 9, 2014 X        
10.46 Seller Financed Promissory Note (Jadian Acquisition), May 9, 2014 X        
10.47 Asset Purchase Agreement (Strand Acquisition), July 31, 2014 *        
10.48 Bill of Sale (Strand Acquisition), July 31, 2014 X        
10.49 Guaranty Agreement (Strand Acquisition), July 31, 2014 X        
10.50 Seller Financed Promissory Note (Strand Acquisition), July 31, 2014 X        
10.51 Stock Exchange Agreement (S. Passley), January 17, 2014 X        
10.52 Stock Exchange Agreement (S. Passley), March 22, 2014 X        
10.53 Stock Exchange Agreement (C. Passley), March 22, 2014 X        
10.54 Stock Exchange Agreement (L&F Lawn Services, Inc.), March 22, 2014 X        
10.55 Convertible Promissory Note (Magna Group, LLC), February 4, 2014 X        
10.56 Convertible Promissory Note (Magna Group, LLC), February 19, 2014 X        
10.57 Convertible Promissory Note (V. Passley), April 2, 2014 X        
10.58 Settlement Agreement and Stipulation Pursuant to Section 3(a)(10) (IBC Funds, LLC), February 12, 2014 X        
10.59 Order Granting Approval of Settlement Agreement and Stipulation (IBC Funds, LLC), February 14, 2014 X        
10.60 Convertible Promissory Note Default Notice (St. George Investments, LLC), September 24, 2014 X        
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        

* To be filed by amendment

 

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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: October 2, 2014 By: /s/ Shaun Passley
  Shaun Passley
  Chief Executive Officer (Principal Executive Officer), President, Chief Financial Officer (Principal Accounting Officer), and Director

 

 

63