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EPAZZ INC - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) FORWARD LOOKING STATEMENTS: The following discussion of our financial condition and plan of operations should be read in conjunction with our financial statements and the related notes, and the other financial information included in this report. This Management's Discussion and Analysis or Plan of Operations describes the matters Epazz considers to be important to understanding Epazz's history, technology, current position, financial condition and future plans. Our fiscal year begins on January 1 and ends on December 31. The following discussion includes forward looking statements and uncertainties, including plans, objectives, goals, strategies, financial projections as well as known and unknown uncertainties. The actual results of our future performance may differ materially from the results anticipated in these forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievement. PLAN OF OPERATION During the next twelve months, we plan to integrate our recent acquisitions, including Zinergy, Telecorp and Jadian, 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. Results of Operations for the Years Ended December 31, 2013 and December 31, 2012: For the Years Ended December 31, Increase / 2013 2012 (Decrease) Revenues $ 750,139 $ 1,193,217 $ (443,078 ) General and administrative 758,353 698,895 59,458 Salaries and wages 2,201,161 1,665,429 535,732Depreciation and amortization, including impairment 536,705 275,076 261,629 Bad debts (recoveries) (27,129 ) 2,957 (30,086 ) Total Operating Expenses 3,469,090 2,642,357 826,733 Net Operating Income (Loss) (2,718,951 ) (1,449,140 ) 1,269,811 Total other income (expense) (657,287 ) (457,549 ) 199,738 Net Income (Loss) $ (3,376,238 ) $ (1,906,689 ) $ 1,469,549 Revenue: For the year ended December 31, 2013 we had revenue of $750,139, compared to revenue of $1,193,217 for the year ended December 31, 2012, a decrease of $443,078, or 37%, from the comparative year. The decrease in revenues is partially due to a $102,540 increase in deferred revenues over the prior year, and approximately a $195,000, or approximately 50%, decrease in sales within our MS Health subsidiary, which was primarily attributable to transitional deficiencies with the 2012 acquisition. MSHealth software was out dated and the Company is in the process of replacing the software. Our Autohire and K9 Bytes operations accounted for the remaining decline of approximately $145,000. We entered into a few strategic acquisitions in 2014 to rejuvenate our operations and expand our scope of products. 30 General and Administrative: General and administrative expenses increased by $59,458, or 9%, to $758,353 for the year ended December 31, 2013, compared to general and administrative expense of $698,895 for the year ended December 31, 2012. The increase in general and administrative expense is due mainly to increased marketing and public relations expenses over the prior year. Salaries and Wages: Salaries and wages increased by $535,732, or 32%, to $2,201,161 for the year ended December 31, 2013, compared to salaries and wages of $1,665,429 for the year ended December 31, 2012. The increase in salaries and wages is due primarily to the increase in stock based compensation of approximately $435,000 pursuant to stock issuances to our CEO, Shaun Passley, Ph.D., Craig Passley, our Corporate Secretary and two other immediate family members related to Shaun Passley, Ph.D., in addition to increased cash compensation paid to our CEOover the prior year. Depreciation and Amortization: We had depreciation and amortization expense of $260,423 for the year ended December 31, 2013, compared to $275,076 for the year ended December 31, 2012, a decrease of $14,653, or 5%, from the comparative year. This decrease is due primarily to certain intangible assets reaching the end of their useful lives without needing to being replaced by the end of the current year. Impairment on intangible assets: We had impairment on intangible assets of $276,282 for the year ended December 31, 2013, compared to $-0- for the year ended December 31, 2012. This increase is due to $276,282 of impairments on intangible assets that are no longer generating an economic benefit within our PRMI subsidiary. Bad Debts (recoveries): We had bad debts (recoveries) of $(27,129) for the year ended December 31, 2013 as compared to $2,957 of bad debts expense for the year ended December 31, 2012, a decrease of $30,086, or 1,017%, from the comparative year. This decrease is due primarily to improved monitoring and collection efforts over our accounts receivable. We provide an allowance for doubtful accounts of all accounts receivable aging greater than 30 days old. Net Operating Income (Loss): Total operating expenses for the year ended December 31, 2013 were $3,469,090, compared to $2,642,357 for the year ended December 31, 2012, an increase of $1,269,811, or 88%, from the comparative year. We had net operating losses of $2,718,951 for the year ended December 31, 2013 compared to $1,449,140 for the year ended December 31, 2012, an increase in operating loss of $1,269,811, or 88%, from the comparative year. The increase in operating loss was primarily due to revenue reductions of approximately $443,000, the increase in stock based compensation of approximately $435,000 pursuant to the issuance of shares of common stock to our CEO, Shaun Passley, Ph.D., and other related parties, an increase in marketing and public relations of approximately $77,000, and $276,282 of impairments on intangible assets no longer in service. Other Income (Expense): Interest income was $57 for the year ended December 31, 2013, compared to $52 for the year ended December 31, 2012, an increase of $5, or 10%, from the comparative year. Interest income increased slightly due to having more cash on hand in interest bearing accounts during 2013. Interest expense was $526,586 for the year ended December 31, 2013, compared to $320,402 for the year ended December 31, 2012, an increase of $242,184, or 76%, from the comparative year. Interest expense increased due to increased borrowings to finance our operations, as well as an increase of approximately $80,000 of finance costs related to the amortized discounts on beneficial conversion features over the $155,759 of amortized discounts recognized during the year ended December 31, 2012. Loss on debt modifications, related parties was $94,758 for the year ended December 31, 2013, compared to $137,199 for the year ended December 31, 2012, a decrease of $42,441, or 31%, from the comparative year. Loss on debt modifications for the year ended December 31, 2013 consisted of the modification of a promissory note with Star Financial that resulted in a loss of $81,792, a loss of $14,240 on a debt conversion with Vivienne Passley and a gain of $1,274 on debt settlements, and for the year ended December 31, 2012, consisted of a loss on debt settlement of $38,671 related to the excess fair value of common stock exchanged in settlement of outstanding debt owed to a related party, and $98,528 of finance costs incurred pursuant to the modification of a convertible note with Star Financial, a related party. 31 Net Income (Loss): We had a net loss of $3,376,238 for the year ended December 31, 2013 compared to $1,906,689 for the year ended December 31, 2012, an increased net loss of $1,469,549, or 77%, from the comparative year. The increased net loss was primarily due to revenue reductions of approximately $443,000, the increase in stock based compensation of approximately $435,000 pursuant to the issuance of shares of common stock to our CEO, Shaun Passley, Ph.D., and other related parties, an increase in marketing and public relations of approximately $77,000, and $276,282 of impairments on intangible assets no longer in service, and increased borrowing costs used to finance our recent acquisitions and sustain operations. LIQUIDITY AND CAPITAL RESOURCES The following table summarizes total assets, accumulated deficit, stockholders' equity and working capital at December 31, 2013, compared to December 31, 2012. December 31, 2013 2012 Total Assets $ 1,082,961 $ 1,378,030 Total Liabilities $ 2,607,576 $ 1,849,541 Accumulated (Deficit) $ (7,501,994 ) $ (4,114,756 ) Stockholders' Equity (Deficit) $ (1,524,615 ) $ (471,511 ) Working Capital (Deficit) $ (1,283,338 ) $ (681,561 ) We had total current assets of $339,929 as of December 31, 2013, consisting of cash of $208,567, net accounts receivable of $25,248, and other current assets of $106,114. We had non-current assets of $743,032 as of December 31, 2013, consisting of $113,410 of property and equipment, net of accumulated depreciation and amortization of $416,668, intangible assets of $374,162, net of accumulated amortization of $796,558, and goodwill of $255,460 related to the purchaseof the Company's subsidiaries. We had total current liabilities of $1,623,267 as of December 31, 2013, consisting of $258,163 of accounts payable, $74,039 of accrued expenses, $322,130 of deferred revenues, current portion of outstanding balances on lines of credit of $73,232, current portion of capitalized leases in the amount of $17,421, notes payable, related parties of $397,368, current maturities on convertible debentures of $115,128, net of discounts of $105,300, and current maturities on long term debts in the amount of $354,786. We had negative working capital of $1,283,338 and a total accumulated deficit of $7,501,994 as of December 31, 2013. We had total liabilities of $2,607,576 as of December 31, 2013, which included total current liabilities of $1,623,267, long-term notes payable, related parties of $85,000, long term convertible debentures of $42,166, net of discounts of $4,283 and the long-term portion of debts of $857,143. We had net cash used in operating activities of $463,980 for the year ended December 31, 2013, which was primarily due to our net loss of $3,376,238 after adjustments for non-cash expenses, a decrease of $38,876 in accounts receivable and an increase of $56,134 of other current assets, an increase of $153,436 in accounts payable, and increase of $38,594 in accrued expenses and $102,540in deferred revenues. We had $6,830 of net cash used in investing activities for the year ended December 31, 2013, which consisted entirely of cash paid for the purchase of equipment. We had $633,276 of net cash provided in financing activities during the year ended December 31, 2013, which represented proceeds from notes payable and convertible debts of $1,287,179, repayments on long term debts of $567,704 and principal payments on capital leases of $25,699. 32 Recent Financing Activities Fourth quarter of 2013: Debt Financing, Related Parties On various dates during the fourth quarter of 2013, the Company's CEO advanced and repaid funds to the Company. A total of $50,900 was advanced and repaid by the CEO during the fourth quarter of 2013. On October 15, 2013, the Company received $15,000 in exchange for an unsecured $18,000 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 added to the principal loan of $18,000, and is being amortized on a straight line basis over the life of the loan. The note also carries a liquidated damages fee of $500 upon default. On November 1, 2013, the Company received $100,000 in exchange for an unsecured $125,000 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. Convertible Debt Financing On November 13, 2013, the Company received $30,000 in exchange for an 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. On July 11, 2014, the Company and JMJ Financial amended the $400,000 convertible promissory note, originally dated November 13, 2013, of which $33,000, including a $3,000 OID, remains outstanding. The amendment specifies that due to the delinquent Form 10-K for the year ended December 31, 2013 and the Form 10-Q for the three months ended March 31, 2014, any future borrowings shall only be made by mutual agreement of both the borrow and lender. On December 31, 2013, the Company issued an unsecured $35,028 convertible promissory note which, 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. Debt Financing 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 costshave been capitalized. 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. 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 #2") 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 MS Health's receivables. The promissory note is also personally guaranteed by Shaun Passley, Ph.D., our Chief Executive Officer. On November 20, 2013, DeskFlex received proceeds of $10,550 in exchange for a demand promissory note bearing interest at 10.25%. The promissory note is payable in monthly installments of $1,223 per month, maturing on August 20,2014 (the "Maturity Date"). 33 First quarter of 2014: Debt Financing, Related Parties, GG Mars Capital, Inc. 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 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 $500 upon default. 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 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 $35,000 upon default. 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 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 damagesfee of $7,000 upon default. 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 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 $1,500 upon default. 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 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 $7,000 upon default. Debt Financing, Related Parties, Star Financial Corporation 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 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 damagesfee of $500 upon default. 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 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 damagesfee of $500 upon default. 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 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 damagesfee of $25,000 upon default. 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 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 damagesfee of $1,500 upon default. 34 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 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 damagesfee of $2,500 upon default. 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 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 damagesfee of $2,500 upon default. Convertible Debt Financing 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. 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. 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. Critical Accounting Policies: The establishment and consistent application of accounting policies is a vital component of accurately and fairly presenting our financial statements in accordance with generally accepted accounting principles in the United States (GAAP), as well as ensuring compliance with applicable laws and regulations governing financial reporting. While there are rarely alternative methods or rules from which to select in establishing accounting and financial reporting policies, proper application often involves significant judgment regarding a given set of facts and circumstances and a complex series of decisions. 35 Principles of Consolidation The accompanying 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 IntelliSysProfessional 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 FlexFridge, Inc.(3) Illinois Subsidiary(4) FlexFridge Terran Power, Inc.(5) Illinois Subsidiary Terran ____________ (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 consolidated financial statements herein contain the operations of the wholly-owned subsidiaries listed above. All significant inter-company transactions have been eliminated in the preparation of these financial statements. The parent company, Epazz and subsidiaries, IntelliSys, PRMI, DFI, K9 Bytes, MS Health and 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. 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. Cash and Cash Equivalents Epazz maintains cash balances in non-interest-bearing transaction accounts, which do not currently exceed federally insured limits. For the purpose of the statements of cash flows, all highly liquid investments with an original maturity of three months or less are considered to be cash equivalents. There were no cash equivalents on hand at December 31, 2013 and 2012. Property and Equipment Equipment is recorded at its acquisition cost, which includes the costs to bring the equipment to the condition and location for its intended use, and equipment is depreciated using the straight-line method over the estimated useful life of the related asset as follows: Furniture and fixtures 5 years Computers and equipment 3-5 years Software 3 years Assets held under capital leases 3-4 years 36 Amortization of leasehold improvements is computed using the straight-line method over the shorter of the remaining lease term or the estimated useful lives of the improvements. Assets held under capital leases are recorded at the lower of the net present value of the minimum lease payments or the fair value of the leased asset at the inception of the lease. Amortization expense is computed using the straight-line method over the useful lives of the assets due to transfer of ownership after the lease term has expired. Maintenance and repairs will be charged to expense as incurred. Significant renewals and betterments will be capitalized. At the time of retirement or other disposition of equipment, the cost and accumulated depreciation will be removed from the accounts and the resulting gain or loss, if any, will be reflectedin operations. Property and equipment are evaluated for impairment whenever impairment indicators are prevalent. The Company will assess the recoverability of equipment by determining whether the depreciation and amortization of these assets over their remaining life can be recovered through projected undiscounted future cash flows. The amount of equipment impairment, if any, will be measured based on fair value and is charged to operations in the period in which such impairment is determined by management. 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. 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. Amortization expense on intangible assets totaled $446,988 and $155,448 for the years ended December 31, 2013 and 2012, respectively, including impairments of $276,282 and $-0- for the years ended December 31, 2013 and2012, respectively. Goodwill The Company evaluates the carrying value of goodwill during the fourth quarter of each year and between annual evaluations if events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Such circumstances could include, but are not limited to (1) a significant adverse change in legal factors or in business climate, (2) unanticipated competition, or (3) an adverse action or assessment by a regulator. When evaluating whether goodwill is impaired, the Company compares the fair value of the reporting unit to which the goodwill is assigned to the reporting unit's carrying amount, including goodwill. The fair value of the reporting unit is estimated using a combination of the income, or discounted cash flows, approach and the market approach, which utilizes comparable companies' data. If the carrying amount of a reporting unit exceeds its fair value, then the amount of the impairment loss must be measured. The impairment loss would be calculated by comparing the implied fair value of reporting unit goodwill to its carrying amount. In calculating the implied fair value of reporting unit goodwill, the fair value of the reporting unit is allocated to all of the other assets and liabilities of that unit based on their fair values. The excess of the fair value of a reporting unit over the amount assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized when the carrying amount of goodwill exceeds its implied fair value. The Company's evaluation of goodwill completed during the year resulted in no impairment losses. Website Development Costs The Company accounts for website development costs in accordance with ASC 350-50, "Accounting for Website Development Costs" ("ASC 350-50"), wherein website development costs are segregated into three activities: 1) Initial stage (planning), whereby the related costs are expensed. 2) Development (web application, infrastructure, and graphics), whereby the related costs are capitalized and amortized once the website is ready for use. Costs for development content of the website may be expensed or capitalized depending on the circumstances of the expenditures. 3) Post-implementation (after site is up and running: security, training, and administration), whereby the related costs are expensed as incurred. Upgrades are usually expensed, unless they add additional functionality. The Company didn't have any capitalized website development costs during the years ended December 31, 2013 and 2012. 37 Deferred Financing Costs Costs relating to obtaining certain debts are capitalized and amortized over the term of the related debt using the straight-line method. The unamortized capitalized balance of deferred financing costs at December 31, 2013, and 2012, was $44,986 and $17,033, respectively. Amortization of deferred financing costs charged to operations was $79,123 and $25,849 for the years ended December 31, 2013 and 2012, respectively. When a loan is paid in full, any unamortized financing costs are removed from the related accounts and charged to operations. Allowance for Doubtful Accounts We generate the majority of our revenues and corresponding accounts receivable from the sales of software products. We evaluate the collectability of our accounts receivable considering a combination of factors. In circumstances where we are aware of a specific customer's inability to meet its financial obligations to us, we record a specific reserve for bad debts against amounts due in order to reduce the net recognized receivable to the amount we reasonably believe will be collected. For all other customers, we recognize reserves for bad debts based on past write-off experience and the length of time the receivables are past due. Bad debts expense (recoveries) was $(27,129) and $2,957 for the years ended December 31, 2013 and 2012, respectively. The allowance for doubtful accounts was $7,017 and $68,521 for the years ended December 31, 2013 and 2012, respectively. 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. Revenue Recognition The Company designs and sells various software programs to business enterprises, hospitals and Government and post-secondary institutions. Prior to shipment, each software product is tested extensively to meet Company specifications. The software is shipped fully functional via electronic delivery, but some installation and setup is required. No other entities sell the same or largely interchangeable software. Installation is a standard process, outlined in the owner's manual, consisting principally of setup, calibrating, and testing the software. A purchaser of the software could complete the process using the information in the owner's manual, although it would probably take significantly longer than it would take the Company's technicians to perform the tasks. Although other vendors do not install the Company's software, they do provide largely interchangeable installation services for a fee. Historically, the Company has never sold the software without installation. Most installations are performed by the Company within 7 to 24 days of shipment and are included in the overall sales price of the software. In addition, the customer must pay for support contracts and training packages, depending on their desired level of service. The Company is the only manufacturer of the software and it only sells software on a standalone basis directly to the end user. The sales price of the arrangement consists of the software, installation, and training and support services, which the customer is obligated to pay in full upon delivery of the software. In addition, there are no general rights of return involved in these arrangements. Therefore, the software is accounted for as a separate unit of accounting. The Company does not have vendor-specific objective evidence of selling price for the software because it does not sell the software separately (without installation services and support contracts). In addition, third-party evidence of selling price does not exist as no vendor separately sells the same or largely interchangeable software. Therefore, the Company uses its best estimate of selling price when allocating such arrangement consideration. In estimating its selling price for the software, the Company considers the cost to produce the software, profit margin for similar arrangements, customer demand, effect of competitors on the Company's software, and other market constraints. When applying the relative selling price method, the Company uses its best estimate of selling price for the software, and third-party evidence of selling price for the installation. Accordingly, without considering whether any portion of the amount allocable to the software is contingent upon delivery of the other items, the Company allocates the selling price to the software, support, and installation. The Company doesn't currently provide product warranties, but if it does in the future it will provide for specific product lines and accrue for estimated future warranty costs in the period in which the revenue is recognized. Advertising and Promotion All costs associated with advertising and promoting products are expensed as incurred. These expenses approximated $181,497 and $104,431 for the years ended December 31, 2013 and 2012, respectively. 38 Income Taxes The Company recognizes deferred tax assets and liabilities based on differences between the financial reporting and tax bases of assets and liabilities using the enacted tax rates and laws that are expected to be in effect when the differences are expected to be recovered. The Company provides a valuation allowance for deferred tax assets for which it does not consider realization of such assets to be more likely than not. Basic and Diluted Loss per Share The basic net loss per common share is computed by dividing the net loss by the weighted average number of common shares outstanding. Diluted net loss per common share is computed by dividing the net loss adjusted on an "as if converted" basis, by the weighted average number of common shares outstanding plus potential dilutive securities. For the periods presented, there were no outstanding potential common stock equivalents and therefore basic and diluted earnings per share result in the same figure. Stock-Based Compensation The Company adopted FASB guidance on stock based compensation on January 1, 2006. Under FASB ASC 718-10-30-2, all share-based payments to employees, including grants of employee stock options, are to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. Common stock issued for services and compensation was $1,713,150 and $1,278,151 for the years ended December 31, 2013 and 2012, respectively. Uncertain Tax Positions Effective January 1, 2009, the Company adopted new standards for accounting for uncertainty in income taxes. These standards prescribe a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. These standards also provide guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Various taxing authorities periodically audit the Company's income tax returns. These audits include questions regarding the Company's tax filing positions, including the timing and amount of deductions and the allocation of income to various tax jurisdictions. In evaluating the exposures connected with these various tax filing positions, including state and local taxes, the Company records allowances for probable exposures. A number of years may elapse before a particular matter, for which an allowance has been established, is audited and fully resolved. The Company has not yet undergone an examination by any taxing authorities. The assessment of the Company's tax position relies on the judgment of management to estimate the exposures associated with the Company's various filing positions. As of December 31, 2013, the Company had no uncertain tax positions. Recent Accounting Pronouncements In July 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2013-11: Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. The new guidance requires that unrecognized tax benefits be presented on a net basis with the deferred tax assets for such carryforwards. This new guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2013. The adoption of ASU 2013-11 is not expected to have a material impact on our financial position or results of operations. In February 2013, FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, to improve the transparency of reporting these reclassifications. Other comprehensive income includes gains and losses that are initially excluded from net income for an accounting period. Those gains and losses are later reclassified out of accumulated other comprehensive income into net income. The amendments in the ASU do not change the current requirements for reporting net income or other comprehensive income in financial statements. All of the information that this ASU requires already is required to be disclosed elsewhere in the financial statements under U.S. GAAP. The new amendments will require an organization to: - Present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income - but only if the item reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period; and - Cross-reference to other disclosures currently required under U.S. GAAP for other reclassification items (that are not required under U.S. GAAP) to be reclassified directly to net income in their entirety in the same reporting period. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is initially transferred to a balance sheet account (e.g., inventory for pension-related amounts) instead of directly to income or expense. The amendments apply to all public and private companies that report items of other comprehensive income. Public companies are required to comply with these amendments for all reporting periods (interim and annual). The amendments are effective for reporting periods beginning after December 15, 2012, for public companies. Early adoption is permitted. The adoption of ASU No. 2013-02 did not have a material impact on our financial position or results of operations. 39 In January 2013, the FASB issued ASU No. 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, which clarifies which instruments and transactions are subject to the offsetting disclosure requirements originally established by ASU 2011-11. The new ASU addresses preparer concerns that the scope of the disclosure requirements under ASU 2011-11 was overly broad and imposed unintended costs that were not commensurate with estimated benefits to financial statement users. In choosing to narrow the scope of the offsetting disclosures, the Board determined that it could make them more operable and cost effective for preparers while still giving financial statement users sufficient information to analyze the most significant presentation differences between financial statements prepared in accordance with U.S. GAAP and those prepared under IFRSs. Like ASU 2011-11, the amendments in this update will be effective for fiscal periods beginning on, or after January 1, 2013. The adoption of ASU 2013-01 did not have a material impact on our financial position or results of operations. |