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EPAZZ INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) 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. 49 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 ourrevenues. 50 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. 51 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. 52 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. 53 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 theloss 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. 54 LIQUIDITY AND CAPITAL RESOURCES The following table summarizes total assets, accumulated deficit, stockholders' equity (deficit) and working capital at June 30, 2014 compared to December31, 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 CommonStock in lieu of cash. 55 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. 56 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 / Terms Borrowed $0.0001 $0.000075 $0.00005 $0.000025 Origination JMJ Financial Convertible into shares of $ 33,000 330,000,000 440,000,000 660,000,000 1,320,000,000 (Second JMJ common stock at the Note) discretion of the note November 13, holder at a price equal to 2013 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. St. George Convertible into shares of $ 119,275 1,192,750,000 1,590,333,333 2,385,500,000 4,771,000,000 Investments, common stock at the Inc. discretion of the note (First St. holder at a price equal to George Note) sixty percent (60%) of the September 5, average of the two lowest 2013 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. $ 152,275 1,522,750,000 2,030,333,333 3,045,500,000 6,091,000,000 57 |